Oct 31

King Dollar in a Bull Market

Gold Price Comments Off on King Dollar in a Bull Market
But change your goggles and hey! Commodities in AUD not too bad…!

BORING as it sounds, I want to talk a bit about the end of US QE today, writes Greg Canavan in The Daily Reckoning Australia.
Because it’s very important to how markets are going to behave over the next few months.
As you probably know, yesterday the US Federal Reserve voted to end its policy of quantitative easing. But it will still be reinvesting the interest payments from its $4 trillion plus portfolio and rolling over any maturing treasury securities, so it’s balance sheet will continue to grow, albeit much more slowly.
On the surface, US markets didn’t seem too fussed about the end of an era. Shares sold off around the time of the Fed’s statement and then rallied towards the close. Probably a case of “algo’s going wild” as automated high frequency traders tried to make sense of the Fed’s statement.
And the Fed did its usual job of promising to hold rates as low as they possibly could, which markets seemed happy enough with.
But the real action took place under the surface. That is, the US Dollar spiked higher again. This is an important point because when the US Dollar rallies, it usually signifies tightening global liquidity.
Think of it as liquidity returning to the source (US capital markets) and drying up…or disappearing. That’s certainly what has been happening these past few months. Since bottoming in May, the US Dollar index (which measures the greenback’s performance against a basket of currencies) has increased by nearly 9%.
That might not sound like a huge spike, but in the world of currency movements, it is. Imagine if you’re an exporter and your product just became 9% more expensive…chances are it will lead to a drop in sales as customers look for a cheaper substitute.
This is the problem with the end of QE. It leads to liquidity evaporation as ‘punt money’ returns home…which leads to a strengthening US Dollar…which hurts sales of US multinationals.
It’s not going to happen right away though. Most companies have hedging strategies in place that protect them from sharp moves in the FX markets. But if Dollar strength persists…and the chart above says that it will, then you’ll see the strong Dollar hitting companies’ revenue line in the coming quarterly reports.
Not only that, but the evaporation of liquidity in general could lead to another bout of selling across global markets. QE is all about providing confidence. Liquidity is synonymous with confidence. Take it away and you’ll see the mood of the market change.
Getting back to the Dollar strength…it’s a headache for Australia too. It’s smashing the iron ore price, and the Aussie Dollar isn’t falling fast enough to keep up. In terms of the other commodities though, things aren’t quite so bad.
All you seem to hear lately is negative news about commodities. That’s because the world prices commodities in US Dollars, and as you’ve seen, the US Dollar is a picture of strength. But if you look at commodity prices in terms of Aussie Dollars, things look a little better.
The chart below shows the CRB commodity index, denominated in Australian Dollars. It’s a weekly chart over the past five years. And y’know what…it doesn’t look that bad! Since bottoming in 2012, it’s made considerable progress in heading back to the 2011 highs.
But you’ll want to see it start to bottom around these levels. If it doesn’t, prices could head much lower.
The thing to note about this chart is that it doesn’t include the bulk commodities – iron ore and coal. These commodities tend to dominate the headlines in Australia. Things like nickel, tin, copper and oil don’t get much of a look in.
Which reminds me, in case you missed it, Diggers and Drillers analyst Jason Stevenson recently released a report on some small Aussie oil ‘wildcatters’. With the oil price low, now could be a good time to sniff around the sector.
You could say that about commodities across the board. In the space of a few years, they’ve gone from hero to zero…or the penthouse to the…
That usually means there could be some good value around. One thing you need to look for in the current environment is a decent demand/supply dynamic. Iron ore in particular is heading towards massive oversupply next year. I reckon that makes it a poor investment choice for the next few years.
You’re better off to wait until the China slowdown and supply surge knocks out the juniors and all the marginal producers….leaving the market to BHP and Rio. You’ll then probably be able to pick these mining giants up at much lower levels.
Once you find a commodity with good supply/demand fundamentals, you need to make sure the producer is low cost. That protects it against further price falls…or a rise in the Australian Dollar.
It also protects it against foreign competition. One of the issues with the Aussie resources sector in recent years is costs. Other countries have much cheaper capital and labour costs and can therefore get stuff out of the ground cheaper than us.
That brings me to a final issue: Australia doesn’t really invest in its own resource sector. Via superannuation, we have a huge pool of capital. But this mostly goes into the banks or the major miners. Superannuation capital is not high risk capital.
That means a lot of the capital that flows into the resource sector is foreign. And when global financial conditions change…like the end of QE and the strengthening of the US Dollar…that capital departs.
This will create problems and opportunities for the sector. But given the bearishness towards commodities in general, it’s probably time to start getting interested again.
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Oct 08

Dollar "Blow Off" Missing. But Stocks?

Gold Price Comments Off on Dollar "Blow Off" Missing. But Stocks?
The Gold/Silver Ratio already signals tight liquidity. A rising Dollar will hurt equities…

USING Tom McCellan’s article discussing a “blow off” move in the US Dollar as a starting point, I would like to talk about the Dollar and gold, writes Gary Tanashian in his Notes from the Rabbit Hole, and how they each fit in to the global macro backdrop.
We could add silver into the mix as well because its failure in relation to gold (see the gold/silver ratio’s breakout last week) is the other horseman (joining Uncle Buck) that would indicate a changing macro.
Starting with the McClellan piece at MCOscillator.com, ‘Commercials Betting on Big Dollar Downturn‘, first I would question the term “blow off” when talking about the USD.
Markets that have come off of long-term basing patterns and broken above resistance with plenty of overhead resistance still to come have not blown off. A blow off is Nasdaq 2000, Uranium 2007, Crude Oil 2008, Silver 2011, etc.
Reviewing the monthly chart below, we see nothing of the sort currently when considering a “blow off” move in USD. What we see is a currency that made its real blow off move in 1985 to climax the Volcker interest rate hiking regime.
There is no blow off in USD. What there is is a savage upward move that we charted all along from its birth to its now mature and hysterical potential pivot point.
USD appears to be rising in response to a narrative taking shape about Fed Funds rate hikes by mid-2015. This is brought about by the strong economic performance that has taken place since we clearly anticipated it in early 2013.
Let’s not over complicate this. The currency’s strength and associated rate hike talk are in play because of economic performance, which has been good in key areas like relatively high-paying manufacturing and generally with the improved employment (and unemployment) data.
The chart below shows a disjointed but mostly positive correlation over 3-plus decades between the Fed Funds rate and USD. The little hook upward at the end of the green dotted line is not a blow off, is it? No, it is a projection by the market that the Fed will be compelled to raise interest rates because of economic strength and their own stated targets for employment (currently 5.9% unemployment).
Since we know full well that it was policy that created this phase of strength, the stock market, with its most recent in a string of corrective mini-blips, seems to be working a narrative that says a withdrawal of that policy (ZIRP) would be a bad thing for stocks. Our oft-shown S&P 500/ZIRP/Money Supply and S&P 500/Corporate Profits charts agree wholeheartedly.
The chart above states that it has been policy and policy alone (in the form of the nearly 6 year old ZIRP, along with QE’s 1, 2 & 3) that has driven the economy and along with it, money supply and asset market speculation. The chart below states that corporate earnings may have begun to stall slightly in conjunction with a firming and now impulsively strong US Dollar.
But our theme has been that the US Dollar and the Gold/Silver Ratio (GSR) are running mates, the two horsemen that would change the macro. The precious metals are declining hard along with the commodity complex and inflation expectations in general. People not willing or able to make macro interpretations are getting lost in a “Where’s the inflation??” hysteria.
But the macro theme is that it is moves like this that bring turning points. These turning points are not always what inflationists – probably champing at the bit to get back on the soap box again – want to see. The ‘inflatables’ have been wiped out by the rise in the GSR and with the USD finally making a move as well, the economy is at risk because policy is no longer serving to do what it set out to do to begin with, which is to compromise the currency in favor of assets.
Certain gold bugs are calling “Crash!” now in gold. The ones who have called so many bottoms they would look ridiculous getting on the “Gold to sub-$1000” train have simply gone quiet.
Imagine that, a quiet gold bug. Well, it’s happening. Most of the loud ones now are the ones trying to be square with the bearish backdrop.
Being a former life-long manufacturing guy (to 2012) that is the area I’ll continue to keep the pulse on. US manufacturing has experienced a re-shoring mini boom as the ‘China outsource’ play had many holes in it from quality and service perspectives even before I left the sector.
The 1990s’ theme that we are a consumer-driven economy (with all our manufacturing outsourced) and our ‘King Dollar’ will allow us to consume our way to prosperity at the expense of the rest of the world no longer holds water. The public (ie, consumers) has disproportionately not participated in this economic rebound.
Further, the strength in the USD takes aim directly at manufacturing, which is a sector with relatively good wages. Combined with the message of the GSR’s global liquidity drainage along with various global markets on the wane, the US economy and its stock markets do not want to see a perpetually strong domestic currency.
Going back to the McCellan article and indeed all of our data presented to date showing an over loved US Dollar, despised Euro, bombed out commodities and precious metals all at extremes, it may be time for a rebound in the ‘inflation trade’, with the USD resuming its role as an anti-asset foil. But the US Dollar is bullish based on its impulsive move up from a basing pattern.
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Jul 23

Oil Unrest to Drive Gold Price Higher

Gold Price Comments Off on Oil Unrest to Drive Gold Price Higher
Summer correction ahead amid geopolitical uptrend…

BYRON KING writes for Agora Financial, editing their flagship Outstanding Investments plus two other newsletters, Real Wealth Trader and Military Technology Alert.
Studying geology and graduating with honors from Harvard University, King also holds advanced degrees from the University of Pittsburgh School of Law and the US Naval War College. He has since advised the US Department of Defense on national energy policy.
Now he says global unrest and inflation will play a role in improving fundamentals for gold and silver, as he tells The Gold Report here. But miners have to control costs and clean up their internal cash flow, too…
The Gold Report: Byron, gold is above $1300 per ounce – although not by much – and silver topped $20 per ounce. What was holding their prices down, and what are the fundamentals that will move the prices going forward?
Byron King: The short answer is that, for all its faults, the Dollar has strengthened, which holds down gold and silver prices. The longer answer is that gold and silver are manipulated metals. That is, the world’s central banks have an aversion to things they can’t control, and one of the things that they can’t control is elemental metals like gold and silver.
Let’s ask why the Dollar has strengthened. The US is probably in its weakest geopolitical situation in decades. The Wall Street Journal on July 17 had a front-page story about the confluence of crises across the world – Ukraine, Middle East, Southeast Asia – all of which are profound challenges to American power militarily, diplomatically and economically. But the Dollar is still holding up. Why?
I believe the dramatic recent increase in US energy production is what’s behind the stronger Dollar. With more oil and natural gas from fracking, the US is the world’s largest energy producer. In addition, we’re importing far less oil and exporting a lot more refined product. It helps the Dollar.
Still, when I look at the big picture for gold, I see a resource whose production is challenged on the best of days. Gold mining output is declining in the major traditional sources: South Africa is in decline; Australia is challenged; some of the big plays in Nevada are getting long in the tooth.
TGR: Is there a cycle that builds on itself? As the gold price goes down, companies – especially the majors – spend less on exploration and development, which depletes their reserves, production declines and their costs increase. Are we in that part of the cycle where lower prices are setting the stage for less supply and the need for a higher gold price later?
Byron King: Yes, exactly. Falling supply and static price makes a classic economic case. We are setting the stage for less supply and higher prices. The market is dancing around the reality, but it’s still the reality. Consider that, in the last year or so, gold has been as cheap as $1200 per ounce. In late March or early April, the price almost touched $1400 per ounce. That’s a 16-17% price swing in two months. Is this the sign of a well-balanced market?
Now consider how macro-events drive things. In the first half of 2014, geopolitical events – Ukraine, Syria, Iraq – drove the gold price. And to me, these locales bring it back to that Dollar-energy relationship.
Iraq produces 2.5 million barrels per day of exportable oil. In June, when it looked as if Iraq might not survive, the idea of those 2.5 million barrels being taken out of the market helped drive the price of gold from $1240 per ounce to over $1300 per ounce.
Or look at Ukraine. It straddles key gas export lines to Europe, and the situation involves Russia, which is one of the world’s largest energy producers. Problems with Russia, let alone sanctions and such, affect perceptions of future energy supply, which tends to benefit the Dollar.
All in all, where is the gold price headed? Long-term, I think the answer is up. Inflation is not going away. I think that the central banks of the world, and the people who run university economic departments and train the leaders of the future, really do believe that we ought to have long-term inflation. If that is indeed where they’re coming from, you need to own gold and silver.
I think the long-term prospects for demand – the long-term prospects for gold as money and as backing for money – are much better than they used to be.
TGR: Given the volatility that you discussed and the challenges of the US Dollar, is there significant retail and institutional cash on the sidelines waiting to find the confidence to jump back into precious metals, as commodities and mining equities?
Byron King: There is an immense amount of money waiting for the next step. In the last few years, the big indexes have done incredibly well; everything has gone up, from airlines to consumer electronics, Silicon Valley, aerospace. A lot of people have made a lot of money in the big markets and in traditional investments.
Now, where does it all go? All that recently minted money needs a new home. If you have balance sheet appreciation from the large caps and the big blue chips, you’re looking for something else. My sense is that a lot of people are looking at the basic resource sector.
We have already seen some of that money step back into the market in the first half of this year. Some of the highest-quality small and midsized mining plays have seen large moves.
TGR: The last time we talked, you explained that, in the context of history, we’ve just entered the early stages of the materials revolution, using advanced forms of graphite and rare elements. Can you give us an update on that revolution?
Byron King: When you get into the graphite space, you quickly realize that graphite is more of a technology play than a basic resource play. There is a materials revolution going on with carbon, certainly with graphite. It’s extremely investable, but you have to have patience, and be willing to learn some complex new science. If an investor doesn’t want to become educated on the high-end carbon chemistry that’s happening out there, this could become an uncomfortable space in a hurry.
Look at it this way. If I mine gold, silver or copper, I can sell it to pretty much anybody, from dentists to jewelers to wire makers to electronic makers. The end users will buy it as long as there is a basic spec or quality to it.
Graphite is different. Once you mine it, what you do with the graphite depends on who your user is. The end user has a specific use in mind – battery anodes, fire suppression, heat dissipation, high-strength materials – that requires an entire industrial chain that has to happen between the mouth of the mine and the end user.
TGR: Do you have any words of wisdom for investors who are trying to decide when to enter the market?
Byron King: We’ve seen several strong investment points for gold and silver in the last six months. Right now, I think we might be due for a summer correction, although geopolitical events seem to be exploding all over the place. Sorry, but I just don’t have a subscription to next week’s Wall Street Journal. My issue only comes every morning.
Still, we’ve got tremendous volatility. Just in the time we’ve been talking, the price of gold dropped $33 per ounce [Mon 14 July] which is a bit of an eye-opener. It makes you want to look at the rest of the world and see what’s going on, what might have prompted that drop.
The question for the investor is, what are you going to do? Well, if there’s a downdraft to gold and silver prices, then you want to be involved in companies that can get their costs down faster than the market can beat down the price. But whatever happens day to day, I think metal prices will go up over the long term, because of inflation.
When it comes to picking companies in which to invest, you need to be willing to diversify across many ideas. While it’s great to put a lot of money into a couple of plays and see one or two do really well, that’s usually not the way life works. In the small-cap resource space in particular, you need to find 6 to 10 quality plays – or more – and spread your investments around.
Then you need to watch carefully, and be willing to cut your losses. You also need to be ready for surprises on the upside. When a company gets a takeout offer or has a good piece of news from the drill rig, you can see fabulous gains flowing to patient investors. Just remember that, when good things happen, you need to sell some shares and take some of that gain off the table.
TGR: Byron, it’s always a pleasure. Thanks for your time and your insights.
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Jul 02

Independence Day: Now Government, Not Liberty

Gold Price Comments Off on Independence Day: Now Government, Not Liberty
The United States now celebrate the very opposite of what Independence Day means…

THIS WEEK Americans will enjoy Independence Day, writes former US Congreeman Ron Paul, with family cookouts and fireworks.
Flags will be displayed in abundance. Sadly, however, what should be a celebration of the courage of those who risked so much to oppose tyranny will instead be turned into a celebration of government, not liberty.
The mainstream media and opportunistic politicians have turned Independence Day into the opposite of what was intended. The idea of opposing – by force if necessary – a tyrannical government has been turned into a celebration of tyrannical government itself! 
The evidence is all around us.
How would the signers of the Declaration of Independence have viewed, for example, the Obama Administration’s “drone memo”, finally released last week, which claims to justify the president’s killing American citizens without charge, judge, jury, or oversight? Is this not a tyranny similar to that which our Founders opposed? And was such power concentrated in one branch of government not what inspired the rebellion against the English king in the first place?
The “drone memo”, released after an ACLU freedom of information request, purports to establish the president alone as the arbiter of who is or is not a terrorist subject to execution by the US government. There is no due process involved, just the determination of the president. Thus far the only American citizens killed by the president are Anwar al-Awlaki and his teenaged son, but the precedent has been established, according to the memo, that the president has the authority to kill Americans he believes are terrorists.
Even the New York Times, which generally backs whatever US administration is in power, is troubled by the White House’s legal justification to claim the authority to kill Americans. A Times editorial last week concluded that:
“…the memo turns out to be a slapdash pastiche of legal theories – some based on obscure interpretations of British and Israeli law – that was clearly tailored to the desired result.”
I agree with the New York Times’ conclusion that, “[t]his memo should never have taken so long to be released, and more documents must be made public. The public is still in the dark on too many vital questions.”
Coincidentally, in addition to the “drone memo” released last week, a broader study of the US use of drones was also released by the Stimson Center. The study, co-chaired by Gen. John Abizaid, former US Central Command (CENTCOM) commander, concluded that contrary to claims that drones help prevent wider conflicts by targeting specific individuals, the use of drones “may create a slippery slope leading to continual or wider wars.”
In fact, the study concluded, the use of drones overseas is likely counterproductive. “Civilian casualties, even if relatively few, can anger whole communities, increase anti-US sentiment and become a potent recruiting tool for terrorist organizations,” the study found. 
Seven years ago I wrote in an Independence Day column:
“Only the safe-guards and limitations that are enshrined in a constitutionally-limited republic can prohibit a nation from lurching toward empire…I hope every person who reads or hears this will take the time to go back and read the Declaration of Independence. Only by recapturing the spirit of independence can we ensure our government never resembles the one from which the American States declared their separation.”
On Independence Day we should remember the spirit of rebellion against tyranny that inspired our Founding Fathers to set out our experiment in liberty. We should ourselves celebrate and continue that struggle if we are to keep our republic.
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Jun 11

"Least Loved" Bull Hits Euphoria

Gold Price Comments Off on "Least Loved" Bull Hits Euphoria
Nothing has tracked the S&P500’s post-2009 bull run like US Fed money creation…

AFTER nearly six years of unprecedented intervention by the world’s top central banks, the world’s financial markets are hopelessly broken, writes Gary Dorsch, editor of the Global Money Trends newsletter.
What used to be accepted as market gospel that guided investors’ decisions in the marketplace, before the 2008 financial crisis, no longer seems to apply in today’s marketplace. Wall Street is no longer the bastion of free and open markets, where the prices of bonds and stocks are determined by the collective judgment of millions of investors. Instead, market prices are determined by political appointees, called central bankers, who pull the monetary levers behind the scenes.
Playing by the older and more traditional set of rules of investing has caused many astute investors to miss out on some of the biggest gains in Wall Street’s history. The “Least Loved” bull market is 63-months old, and it’s the fourth longest money minting rally in history. It’s still running on steroids to new all-time highs, with the S&P500 index now zeroing in on the psychological 2,000-level, (less than 3% away). The Dow Jones Industrials are within spitting distance of the psychological 17,000-level, with most long-term buy-and-hold investors sitting back, snacking on popcorn, and enjoying the show.
Even as the stock market bulls stampede to new stratospheric heights, the trading volume in the most actively traded exchange traded fund – based on the S&P500 index, (ticker symbol; SPY) – has plunged by 60% compared with a year ago. Amid such thin market conditions, a few big blocks of buybacks from Corporate America can jettison the market sharply higher. And for those traders with a fear of heights, there’s always the safety net of the secretive “Plunge Protection Team” (PPT) that intervenes clandestinely in stock index futures.
The aging bull market on Wall Street is dubbed the “Least Loved” bull, because it’s been accompanied by the weakest economic recovery from a recession since the 1930s. After a recession, the US economy has usually grown by 4-5% per year. However, since the recovery officially began in June 2009, the US economy has been growing at an anemic 2%. The rapidly expanding wealth on Wall Street, accruing to the richest 10% of US households, hasn’t trickled down to the average household – whose take home pay of $839 a week in April ’14 – was only $20 higher than in January 2008, when discounted for inflation.
Tragically, what the Perma Bears and market skeptics failed to realize over the past 5 years is that when operating in the “Twilight Zone” – in a centrally-planned market – negative news on the US economy is construed as bullish for the stock market. As the Bank of International Settlements (BIS) warned a year ago, on 6 June 2013, “the equity markets are under the spell of monetary easing policies that enabled market participants to tune out signs of a global growth slowdown.”
The “Least Loved” bull was able to shrug off weak economic data and instead, continued to extend its relentless gains “fueled by the prospect of further central bank stimulus. Abundant liquidity and low volatility fostered an environment favoring risk-taking and carry trade activity,” the BIS observed.
As recently as 20 May 2014, Philly Fed chief Charles Plosser lamented, “It’s the Fed’s fault that the markets are ignoring the fundamentals.”
Since the onset of the financial crisis, central banks have become highly interventionist in their efforts to manipulate asset prices and financial markets in general, as they attempt to fine-tune economic outcomes. This approach has continued well past the end of the financial crisis. While the motivations may be noble, we have created an environment in which “it is all about the Fed. Market participants focus on how the central bank may tweak its policy, and central bankers have become too desirous of managing prices in the financial world,” he said. 
“I do not see this as a healthy symbiotic relationship for the long term. If financial market participants believe that their success depends primarily on the next decisions of monetary policymakers rather than on economic fundamentals, our capital markets will not deliver the economic benefits they are capable of providing (ie; accurate price discovery). And if central banks do not limit their interventionist strategies and focus on returning to more normal policymaking aimed at promoting price stability and long-term growth, then they will simply encourage the financial markets to ignore fundamentals and to focus instead on the next actions of the central bank.”
The trading desk that controls the formerly free market is situated on the ninth floor of 33 Liberty Street, also known as the home New York Fed.
From a glass-enclosed conference room situated next to a small cluster of trading desks, the uber-secretive “Plunge Protection Team” (PPT) controls the money flows that determine the daily fate of credit, equity and virtually all other markets, that have now been hijacked by the central planners at the White House and the US Treasury.
As the number of shares traded each day in stock market dwindles to a six year low, the PPT has become an even more influential price setter in the stock market, while other market participants are content to let their bets ride on the Fed. One big block in the Dow Jones Industrials futures market can move the S&P500 index several points, with market volumes as pathetically low as they are today.
The biggest winners in the financial markets last year were traders that respected the old axiom, “Don’t Fight the Fed.” They rode the QE gravy train, and kept their bets focused on the increasing size of the Fed’s portfolio of bonds. Under the cloak of “Infinity” QE, the Fed injected $1.5 trillion into the coffers of its agents on Wall Street, which in turn, was used to inflate the market value of NYSE and Nasdaq listed stocks by $6.5 trillion to a record $25 trillion today. In other words, for every $1 of QE, the Fed increased the wealth of shareholders by $4.20.
Propaganda artists at the Fed say the QE injections were bottled up at the Fed itself, in special reserves accounts. However, the chart above shows a 87% degree of correlation between the direction of the Fed’s bond portfolio and the value of the S&P500 index.
Even after racking up a stellar 28% gain for all of 2013, the biggest annual gain in 16 years, the “Least Loved” bull market was easily able to shrug-off news of a 1% contraction in the US economy in Q1 of 2014. The S&P500 index ended the first quarter 1.2% higher, despite the lousy economy. The old adage, “Sell in May and Go Away,” was also tossed aside into the dustbin and the aging bull showed its agility amid its inexorable climb to new stratospheric highs.
Everyone can stop pretending that the Fed is anything but a machine that funnels out free money to bankers and shareholders with little regard for Price to Earnings ratios.
The “Least Loved” bull is flying on two cylinders. Corporate America – flush with $2 trillion of cash stashed in their US banking accounts – has decided there’s nothing more attractive than itself. So the S&P500 companies are spending big bucks to buy back their own shares.
Last year, the Oligarchs plowed about 80% of their profits into the hands of shareholders, while refusing to give wage increases to their struggling workers. As a result, the number of outstanding shares of stock available to be bought or sold on the US stock exchanges has shrunk by nearly 10% since the end of 2010, Investors like buybacks because they automatically increases earnings per share (EPS). And most often, though not always, a higher EPS leads to rising stock prices.
Some notable examples are Northrup Grumman (ticker NOC), the military contractor expects to reduce its shares outstanding by 25% by the end of 2015, with buybacks.  Home Depot (ticker HD) announced a $17 billion buyback program that will remove 18% of the shares outstanding at current prices. Shareholders in FedEx (FDX), operator of the world’s largest cargo airline, authorized a buyback plan equivalent to 10% of its shares outstanding.
The powerful impact of Corporate QE can be seen with the outsized performance of the Power-Shares Buyback Achievers fund (ticker; PKW) compared with the benchmark S&P500 index. PKW buys shares of companies that have already purchased at least 5% of their shares outstanding over the past 12 months. The goal is to avoid companies whose buybacks go solely toward offsetting stock option grants and don’t shrink the share count. Since 1 January 2009, PKW has increased in market value by 176%, compared to a gain of 113% for the S&P500 index fund SPY. In other words, the incredibly shrinking stock market fueled about one third of the “Least Loved” bull market. In fact, analysts estimate that 40% of the increase in the earnings per share of S&P500 companies in the past 12 months was due to the “financial engineering” of corporate treasurers.
Buybacks are also being financed with the issuance of debt. For example, on 29 April Apple Inc (AAPL) issued $12 billion of bonds as the iPhone maker locked in a cheaper alternative to reward its shareholders (and its CEO, whose wealth is tied to stock options) rather than repatriate some of its $151 billion in overseas cash. Luca Maestri, who will soon take over as Apple’s chief financial officer, said on the earnings call:
“To repatriate our foreign cash under current US  tax law, we would incur significant tax consequences and we don’t believe this would be in the best interest of our shareholders.”
Apple will spend an additional $30 billion to buy back shares of the company’s stock, taking to $130 billion how much it plans to spend on repurchases and dividends by the end of next year.
As a special additive, AAPL’s board endorsed a 7-for-1 stock split. “We are taking this action to make Apple stock more accessible to a larger number of investors,” CEO Tim Cook added. However, prior to the stock split, AAPL’s share price has already soared 23% higher, closing near $647 today. That made the “King of Wall Street” – Carl Icahn – a happy man, with his hedge fund holding 7.5 million shares of AAPL.  Part of the proceeds from the AAPL bond sale will be used to increase its quarterly dividend by 8%.
Even as stock prices continue to spiral higher, the S&P500 companies are expected to keep the dividend yields steady at around 2% on average, by raising their dividend payouts by 10% this year. The number of companies boosting their dividend is at a 16-year high, with 421 of the S&P blue-chips expected to pay to a combined $348 billion this year.
There hasn’t been a correction of 10% in the benchmark S&P500 index for 34 months. Historically, such a 10% correction occurs about 18 months apart, on average. Yet there was a stealth correction within the US stock market from the beginning of March through the middle of May. It went undetected by the unsuspecting US public.
For instance, the small-cap Russell 2000 index fell exactly 10% from its all-time highs to the 1,100-level, and other segments of the high flying Nasdaq index, such as the social media, bio-tech, and internet retailers stocks fell 20% or more. Some Nasdaq kingpins such as Amazon (AMZN) lost more than a quarter of their market value from peak levels, and even heavyweight Google (GOOGL) stumbled 15% from its highs.
As of 17 May, roughly one-third of all US listed stocks were 20% or more below their 52-week highs (a bear market), with the average Russell 2000 member down 24%.
At its peak levels in early March, the Russell 2000 index was priced at a whopping 103 times its 12-month trailing earnings. Historically, its price/earnings ratio has averaged 35 times. If there is a bubble to be found anywhere in the marketplace, the most obvious place to look is the Russell 2000 index, which is home to two thirds of all listed US companies. It’s a homegrown collection of companies that earn about 85% of their revenue within the United States’ borders, and is often seen as a proxy for the US economy. The sudden 10% correction through the middle of May shaved the Russell 2000 index’s trailing P/E ratio to 73 times.
Typically, when small-caps get in trouble, a sell-off in the big names is next.  However, on 7 May, the new Fed chief Janet Yellen sought to prevent the large cap S&P500 Oligarchs from suffering the same fate, by assuring Wall Street traders in a speech before Congress that “valuations for the broad stock market remain within historical norms. Overall, broad metrics don’t suggest we are in obviously bubble territory.”
And with those magical words, Yellen put a floor under the Dow Jones Industrials at the 16,350-level. As the Dow Industrials and Transports quickly regained their footing and climbed to new heights, the small-caps breathed a sigh of relief. The Russell 2000 index built a base of support at the 1,100-level, and recovered most of its recent losses to close at the 1,165-level today. When the PPT does intervene in the stock index futures market, it concentrates its firepower in the Dow Industrials contract, where it can get the biggest bang for its buck.
Nowadays, the higher the S&P500 Oligarchs climb, the less investors seem to worry. About 353 million shares traded in S&P500 index fund (ticker; SPY) in the week ended 6 June, or 62% less than a year ago. In the previous week, only 279m shares traded.
When the S&P500 index hit an all-time high on 23 May, only about 24 of its 500 companies reached 52-week highs. That’s the lowest number in a year. When volume and breadth are weak, even as stocks surge, it’s often seen as a warning sign that has preceded losses in the past. However, such warnings signs have been routinely ignored by traders operating in the hallucinogenic world of QE, and the Zero Interest Rate Policy (ZIRP).
The S&P500 index’s parabolic surge towards the 2,000-level has been accompanied by a sharp drop in the number of shares changing hands. That’s not necessarily a sign of danger, because a certain amount of money will buy fewer shares the higher the stock price goes. Corporate buybacks would lose some of their potency as share prices get more expensive.
Since 1990, there have been four other times when the SPX set a 52-week high with fewer than 10% of its members peaking and the overall volume trailing the average. In 3-out-of-4 occasions, the SPX fell at least 5% in the next two or three months. But for now, most traders are reluctant to jump off the Fed’s QE-gravy train, and the safety net of buybacks.
Warren Buffett told CNBC on 4 March 2014 that US stock indexes will go a lot higher and advises investors not to pay so much attention to short-term moves.
“Games are won by players who focus on the playing field, not by those whose eyes are glued to the scoreboard,” Buffet said. And there is no need for investing expertise. Buffett recommends a low-cost S&P500 index fund for nonprofessionals. “Forming macro opinions or listening to the macro or market predictions of others is a waste of time,” he adds.
His bottom line fundamental advice:
“Ignore the chatter, keep your costs minimal, and invest in stocks as you would in a farm.” 
In other words, just buy-and-hold, and never sell.
Apparently, traders don’t see the need to buy ultra-cheap insurance either, against the possibility of a nasty market correction. The CBOE Volatility Index (VIX), also known as fear gauge, can be bought as a hedge against falling markets.Yet the VIX plunged to its lowest level in 7-years this week, reflecting the lack of fear of even a slight pullback. Instead, a serene sense of calm and tranquility reigns over the stock market.Investors on Wall Street are living in a calm and predictable universe, where there is no demand for protection against turbulence, while sitting upon $25 trillion of equity wealth. What’s sedated this market is all the money printed by central banks, and the safety net of corporate buybacks.
Outlook? The “Least Loved” bull market is still running on steroids, even though it’s now 63-months old. The median lifetime of the Top-12 bull markets is 55-months. So it’s lasted 8-months beyond its mid-life. A 10% correction hasn’t happened for the past 34 months, far beyond the average of 18 months between corrections. Yet it looks as though the S&P500 index has entered the Euphoria stage, or the fourth a final phase of the bull market.
It wouldn’t be surprising to see frustrated investors jump off the sidelines to buy equities, along with indiscriminate buyers such as corporate treasurers. The Euphoria stage could see the S&P500 index reach for the 2,200-level, or just over +10% higher from today’s close of 1,950. The ultimate market top would be reached when valuations get too stretched and prices would begin to fall under their own weight. The longer the Fed waits to lift interest rates, the bigger the ensuing bubble and the harder the eventual crash over the distant horizon.
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May 01

African Politics Change, But Not Its Geology

Gold Price Comments Off on African Politics Change, But Not Its Geology
No, things might not be so secure. But short-life gold mining may be profitable…

DUNCAN HUGHES has been head of research for RFC Ambrian Ltd. in Perth, Australia, since 2010. A geologist, he has more than 15 years of experience in the resources industry and managed the discovery and development of the Prospero, Tapinos and Alec Mairs ore bodies for Jubilee Mines/Xstrata.
Now, with gold prices hovering around $1300 an ounce, there’s not much room for error, says Duncan Hughe. In this interview with The Gold Report, Hughes counsels that investors should seek high-grade, low-cost projects with exploration upside in stable jurisdictions…
The Gold Report: After hitting $1380 an ounce in March, gold fell below $1300 and has hovered around there since then. Do you expect the price to change much either way in the next few months?
Duncan Hughes: That’s not easy to predict. I think $1300 per ounce seems a sensible assumption for 2014. If it were to fall much below that, most of the sector would be operating at a loss.
TGR: Assuming a gold price of $1300 per ounce, what are the qualities that will distinguish the junior gold companies that become successful?
DH: In the recent past, companies paid too much attention to the size of resources and potential scales of production. The focus now is profitable production scenarios. Low-cost producers and undervalued developers that look likely to become low-cost producers are the key for investors.
One way to achieve stronger profit margins is through higher-grade ore bodies. Grade has always been king but is now even more so. Low-cost producers are not only most likely to survive this difficult market; those making profits may also pay dividends. Given that share-price appreciation is more challenging than previously, dividends have become more attractive.
TGR: To what extent should investors restrict themselves to companies with management teams with winning track records?
DH: If I were an investor, I’d look for management with a track record. If management doesn’t have that track record – not only finding mines but bringing them to production – then the asset is the overriding factor. If the asset is strong enough, I’d want board members with a nice mix of technical skills – a geologist, an engineer, perhaps even a metallurgist – complemented by members with financial skills and access to equity and debt finance.
TGR: Which type of company is most likely to be taken out?
DH: Because funding is much harder to secure than it once was, the main focus will be developers with strong projects that require significant initial capital expenditures.
TGR: How should investors balance potential reward and risk in West Africa, specifically with regard to the various gold-producing jurisdictions?
DH: Several years ago, gold companies in West Africa traded at a premium because of the excellent exploration opportunities engendered by the geology. Since then markets have changed, and investors have become risk averse. In Africa, we have seen the Arab Spring, a push for nationalization and the coup in Mali. These events remind investors that the African political landscape is not as secure as some other parts of the world.
But the geology of the Birimian Greenstone Belt hasn’t changed. A number of countries, such as Côte d’Ivoire, Liberia and Burkina Faso, have vast fortunes in land that is still relatively underexplored. Ghana has a track record of political stability and stable gold production. Next door, in Côte d’Ivoire, which lacks this stability, there is the same geology but many fewer mines. Guinea is working through a new mining code, and I would say that it is still a risky place to consider.
Burkina Faso, on the other hand, is a great place. It has got seven gold mines coming into production there.
TGR: Liberia was considered a failed state for decades. How great has its recovery been?
DH: I see real opportunity there. It’s like Burkina Faso, at an earlier stage of development, obviously. I visited after the 2011 election, which was peaceful. Ellen Johnson Sirleaf, who won the Nobel Peace Prize that year, was re-elected.
I met the minister of mining and came away with the feeling that the Liberian government is very supportive of mining. Before the political strife began in 1980, Liberia was a significant iron ore producer and retains that infrastructure.
TGR: What’s the size of the resource at New Liberty?
DH: It is 924,000 ounces (Koz) at 3.4 grams per ton (g/t) and a quite high strip ratio. According to the definitive feasibility study, the mine is expected to produce 119 Koz annually for the first six years of production at $900 per ounce. This should be a profitable operation.
TGR: That’s a short mine life. How much exploration potential do you see?
DH: A lot. Not necessarily at New Liberty itself. In that part of the world, that’s probably a bit too far to truck to New Liberty, but what’s exciting about Ndablama is that it is shaping up to be another standalone gold operation. New Liberty is the present, but Ndablama is probably the future.
TGR: We recently did an interview with analyst Richard Karn and he pointed out that 200 of the 700 ASX-listed mining and resource companies are effectively moribund.
DH: You could make a similar judgment about the TSX Venture Exchange.
TGR: Certainly. Karn argued that the culling of these “zombie” companies would be a positive step. Do you agree?
DH: Yes. Many companies on the Australian Stock Exchange, the TSX Venture Exchange and London’s AIM exchange are not going to make it, and that consolidation will be a good thing. As I mentioned earlier, investors in the recent past just looked at the size of a resource and said, “Wow. There’s 2 Moz there, and this stock looks cheap.” But they weren’t looking at the quality of those ounces. I think investors have since wised up. Too late, however, for many companies.
TGR: Some 12 months ago, when it seemed that gold might fall to $1000 per ounce, financing pretty much dried up. Now that gold seems to have stabilized around $1300 per ounce, has the funding picture improved?
DH: I don’t think it has improved that much yet. You said that the gold price seems to have settled, but let’s face it, this stability has only existed for a very short time. I think major financiers and the equity markets need to be persuaded that there is a floor of perhaps $1200-1,300 per ounce. When this occurs, funding will improve.
TGR: Duncan, thank you for your time and your insights.
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Jan 20

Oresme on Money, AD 1375

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Weights, measures and gold with 14th century economics…

The CLASSICAL VIEW of money is that it should be as stable, neutral, unchanging and reliable as possible, writes Nathan Lewis at New World Economics in an article first published at Forbes.
Money should act like other weights and measures, such as the meter or kilogram.
This view was held by those British economists known as the Classical economists, dating from roughly 1750 to 1925. The practical expression of these ideals, in the real world, was the world gold standard system, particularly as it evolved after 1850.
The Mercantilist view, in contrast, was that money should be a tool used to achieve various short-term policy goals, such as funding government deficits or reducing unemployment. Money was to be managed by government bureaucrats, the “statesmen” described by James Denham Steuart in his 1767 book An Inquiry into the Principles of Political Economy.
This culminated a long tradition of thinking on the topic by those British thinkers known as the Mercantilists, between roughly 1600 and 1750. The practical expression of Mercantilist ideas is a government-managed floating fiat currency.
Obviously, people have talked about these things for hundreds of years. But, this debate has been around far longer than that. Plato was an infamous soft-money man, or what I am calling a Mercantilist; his student Aristotle was a hard-money guy, or a Classicalist.
The first written work focused on money, in the Western world, was apparently the De Moneta of Nicholas Oresme (1320-1382). The book was written in roughly 1375. (The first written work focused on money is the Chuan Chih or Treatise on Coinage, written by Hung Tsun in 1149. I hope someone undertakes a translation of it at some point. The Chinese invented paper money in the early 11th century, and soon had many wild adventures with it.)
The De Moneta is not nearly so daunting as its title suggests, but is a rather short and practical essay. Oresme begins his essay – the Introduction – with these words, which perfectly describe the tension between the Classical and Mercantilist strategies.
“Some men hold that any king or prince may, of his own authority, by right or prerogative, freely alter the money current in his realm, regulate it as he will, and take whatever gain or profit may result: but other men are of the contrary opinion. I have therefore determined to write down in this treatise what seems to me from a philosophical and Aristotelian point of view, essentially proper to be said, beginning with the origin of money.
“I make no rash assertions, but submit everything to the judgment of my seniors. Perhaps my words will rouse them finally to settle the truth of this matter, so that the experts may all be of one mind, and come to a conclusion which shall be profitable both to princes and subjects, and indeed to the state as a whole.”
Oresme makes many arguments in a charmingly fourteenth-century sort of way, concluding that:
“[Altering the value of the currency] does not avoid scandal, but begets it…and it has many awkward consequences,…Nor is there any necessity or convenience in doing it, nor can it advantage the commonwealth. A clear sign of this is that such alterations are a modern invention, as was mentioned in the last chapter. For such a thing was never done in cities or kingdoms formerly or now well governed….If the Italians or Romans did in the end make such alterations, as appears from ancient bad money sometimes to be found in the country, this was probably the reason why their noble empire came to nothing. It appears therefore that these changes are so bad that they are essentially impermissible.”
Oresme later observes:
“As time goes on and changes [in the value of money] proceed, it often happens that nobody knows what a particular coin is worth, and money has to be dealt in, bought and sold, or changed from its value, a thing which is against its nature. And so there is no certainty in a thing in which certainty is of the highest importance, but rather uncertain and disordered confusion, to the prince’s reproach. Also it is absurd and repugnant to the royal dignity to prohibit the currency of the true and good money of the realm, and from motives of greed to command, or rather compel, subjects to use less good money; which amounts to saying that good is evil and vice versa.”
Oresme had some interesting views on who tends to benefit from floating fiat currencies:
“Some sections of the community are occupied in affairs honourable or profitable to the whole state, as in the growing of natural wealth or negotiating on behalf of the community. Such are churchmen, judges, soldiers, husbandmen, merchants, craftsmen and the like. But another section augments its own wealth by unworthy business, as do money-changers, bankers or dealers in bullion: a disgraceful trade as was said in Chapter XVIII. These men, then, who are as it were unwanted by the state, and some others such as receivers and financial agents, etc., take a great part of the profit or gain arising from changes in coinage and by guile or by good luck, draw wealth from them, against God and Justice, since they are undeserving of such riches and unworthy of such wealth. But others, who are the best sections of the community, are impoverished by it; so that the prince in this way damages and overburdens the larger and better part of his subjects and yet does not receive the whole of the profit; but the persons abovementioned, whose business is contemptible and largely fraudulent, get a large part of it.”
Does that perhaps describe our own situation?
Today we are in a deeply Mercantilist mindset. All of academia insists that government-managed fiat money is the only sensible approach. They do not want to give up their goals of supposedly managing the economy by way of money-jiggering.
But the historical record is clear. It was clear in Oresme’s day; it was clear in Copernicus’ time. It is clear from all that has happened since then, up to our present forty-two-year-old funny money experiment. The Classical approach produces certain predictable results; the Mercantilist approach produces other results, equally certain and predictable.
For 182 years, from its inception in 1789 to 1971, the United States followed the Classical principle of Stable Money – in practice, a gold standard system. The US became a continent-spanning economic and military superpower, with the most prosperous and broadest middle class ever known.
Since 1971, there have been better times and worse times, but the overall trend is clear. The median working male is paid less today than in 1970. For a time, this problem was rectified by putting Mom to work; but even with two incomes, the US median household income is no better than in 1988 today. The middle class has eroded from all sides, while the working poor, and non-working poor, have multiplied.
The US is in decline. It will remain so until it abandons its Mercantilist money-jiggering fantasies. Eventually another country – China most likely – will discover the economic advantage that sound money brings, and use that strategy to surpass the United States and similar countries, just as the US did in past times. The Classical approach to money will rise again, simply because it produces better outcomes.
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Jan 10

Gold Price Pain Point

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At a gold price of $1050 some 50% of gold mining is losing money. Tough for analysts too…

DEFLATION, inflation and re-inflation all play into scenarios for the gold price and precious metals equity markets, according to Paolo Lostritto, director of mining equity research at National Bank Financial when he gave this recent interview to The Gold Report
The Gold Report: Paolo, what three words would you choose to give our readers a sense of what to expect in the gold mining and precious metals equity space in 2014?
Paolo Lostritto: Defense, defense and more defense.
TGR: The Vince Lombardi approach.
Paolo Lostritto: Even though deflation risk is priced into most of the equities, it’s difficult to predict when inflation expectations will start to gain traction. While quantitative easing tapering efforts are being introduced with some signs of economic improvement in the US, we believe tapering could reignite deflation fears.
The market was reassured after Janet Yellen’s nomination as Federal Reserve chair, but the bond yield-to-maturity suggests that deflation risk is still alive and well. There is more work to be done before inflation becomes a bigger concern, and as such, we believe the gold market will remain challenging. The challenge is centered on balance sheet risk in a market where margins are negative, thus resulting in many value traps that are out there right now.
TGR: Earlier this week, I spoke with a US-based analyst who believes that rising wage pressure, higher rent and food prices in the US will lead to a slow climb in inflation in 2014 and beyond. Yet, you are talking about the risk of deflation. Other than bond yield rates, what else tells you that deflation is the bigger risk?
Paolo Lostritto: Across the board, commodity prices have been under pressure, suggesting that the risk of deflation is still real. Another data point is the inflation expectations data set compiled by the Cleveland Federal Reserve. Right now, it shows that inflation expectations are muted at best.
We believe we are in a similar environment to the 1974-1976 midcycle correction in gold before the onset of inflation. During that period, gold fell from $200 per ounce to $100 before higher money velocity generated inflation in the Western world that drove gold prices to more than $700. While gold has nearly decreased by a similar percentage since the highs set in 2011, we have yet to see definitive evidence of higher money velocity. This, combined with positive real rates, results in our cautious stance.
It is worth noting that if higher inflation were to materialize, it is likely to be driven by emerging markets, which would then begin to export said inflation. I believe gold could go much higher in the long term, but in the meantime, we’ve got to take a position that a lower price is quite possible and that balance sheet risk remains high.
TGR: An October 2013 research report from National Bank Financial (NBF) suggests that there is inflation risk when the money multiplier increases beyond a 1:1 ratio. What will keep that ratio below 1:1?
Paolo Lostritto: The money multiplier is a crude measure of money velocity. While it demonstrates that both the monetary base and M1 are growing, there has been enough to translate into higher inflation expectations. The government is giving mixed signals. The Fed’s policies are reinflationary. Government policies, in contrast, have been emphasizing austerity.
We need to see that the liquidity being provided is actually getting traction and is producing real economic growth. While there are early signs that this is starting to happen, I would like to see how the bond market reprices inflation expectations. We still believe the deflation risk remains high – you need to be defensive.
There are signs that the US economy is turning around. But, many economists don’t see inflation in the system, and that’s bad for gold. That will change only when the velocity of money starts to improve, leading to better capacity utilization, which translates to higher inflation expectations. It will take time for those signals to align.
TGR: In the event of another collapse, what weapons does the Fed have left?
Paolo Lostritto: More money is all we’ve got left. The Fed can purchase more bonds, which effectively introduces more liquidity, but we would probably see monetary policies that would coincide with fiscal policy to allow for some infrastructure projects. We would want the new liquidity to show up in the real economy, as opposed to the coffers of Tier 1 banks.
TGR: Physical holdings in exchange-traded funds (ETFs) have fallen in lockstep with the gold price. Are Chinese and Indian gold imports enough to sustain the gold price, or push it higher?
Paolo Lostritto: About 800 tonnes have sold out of the ETFs, and there have been a similar amount of purchases through Hong Kong into mainland China. Demand in India remains robust, despite elevated import taxes. There also are signs of more smuggling into India. However, we’re still dealing with a potential 1,800 tonnes of ETF supply.
The weak gold price is less a function of supply-and-demand and more a function of deflation risk. We see gold as another type of currency. If all the gold mines in the world shut down tomorrow, it would only equate to removing 0.1% of aboveground stocks.
TGR: What’s your projected trading range for gold in 2014?
Paolo Lostritto: We’re using $1300 per ounce to value our stocks. If our worries are confirmed and the bond market starts to signal an increased risk of deflation, we could be dealing with a lower gold price deck.
The average all-in sustaining cost number may be the better number to use. That could drop to $1000-1200 per ounce.
On the flip side, if we see velocity and inflation expectations start to go up and the real rates go negative again, that fair-value number is probably closer to $1600-1800 per ounce. This is a very difficult time to predict the gold price.
TGR: When NBF calculates all-in cash costs for gold miners it uses a different definition than the World Gold Council. You omit non-cash remuneration and stockpiles/product inventory write-downs. On all-in sustaining costs, you also omit reclamation and remediation at operating and non-operating sites. Would investors be better served if these definitions were the same across the board?
Paolo Lostritto: We, and the World Gold Council, are trying to define the true average cost of the industry. We are roughly in the same ballpark. You mentioned what we exclude, but we also include cash taxes. The World Gold Council excludes cash taxes and interest payments.
Remember, we’re tabulating this based on public data. Not every company breaks out its true sustaining capital in a given quarter versus growth capital. We approximate the sustaining capital number by using depreciation, depletion and amortization as a proxy. Of course, it won’t be accurate because it uses depreciated data dollars as a proxy, but it’s a good start.
TGR: Roughly what percentage of the producers you follow make money at today’s level of all-in cash costs or all-in sustaining costs?
Paolo Lostritto: From an all-in sustaining cost perspective, the Q3/13 50th percentile is around $1050 per ounce. That means 50% of the industry is losing money, not from a growth perspective, but from a sustaining basis at $1050 per ounce and above. It was $1200 per ounce in Q2/13.
TGR: That’s shocking. Does that make you want to look for a different line of work?
Paolo Lostritto: We’re in the midst of a once-in-a-century event. I believe there are two ways out of it. Scenario one: We have a deflationary recession, also called a depression. Scenario two: We repeat what happened in the 1970s and we inflate our way out. But this time it’s on a global scale.
Based on the behavior of the central banks of Japan, the UK and the US, they seem to be trying to inflate their way out. The question then becomes, when will inflation gain traction?
TGR: A recent NBF research report compared takeover transactions among senior producers, midtier producers, developers and explorers. Where are investors getting the best bang for their buck?
Paolo Lostritto: Historic transactions have to be considered in the context of the market at the time. Today’s market resembles 2008. One could argue that this is a great time for free cash flow entities to acquire assets. In a market where cash is king, it’s all about doing bite-size, tuck-in type acquisitions that allow companies to take advantage of a challenging market.
Structurally, some large companies are set up to mine gold at a rate that Mother Nature cannot support. Deposit discoveries are not the size or frequency that can support them. There’s an opportunity for the smaller companies to acquire good assets that can be developed to create tremendous value when the market turns.
TGR: On net asset value (NAV) and enterprise value per ounce, which of those four spaces provides the best return to investors?
Paolo Lostritto: There’s a lot of value out there, but investors want to avoid being caught in a value trap. For example, a company may be cheap on a price-to-NAV and price-to-cash flow basis, but it also could have lots of balance sheet risk. If it goes bankrupt before the market turns, investors are caught on the wrong side of the trade, despite the fact that it’s great value.
I would rather buy something that generates free cash flow. “Be defensive” has been our thesis since early 2013. Free cash flow companies will yield, even if this market lasts four more years; the NAV continues to grow. When the market rerates, investors are actually up.
TGR: Do you have a parting thought for investors as we usher in 2014?
Paolo Lostritto: It’s been a challenging market on multiple fronts. There are a lot of moving parts and it has been frustrating for everybody in the mining space. A lot of exuberance has been flushed out of the system.
Nonetheless, there are good people doing some good things. There are value propositions out there. Solid management teams will be able to take advantage of this market to drive value in the longer term.
TGR: But you’re still preaching defense?
Paolo Lostritto: Correct.
TGR: Paolo, thanks for your time and insights.
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Nov 28

Junior Gold Miners’ Mistake

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Analyst Eric Coffin says the junior gold strategy of the last decade was a big error…

ERIC COFFIN is editor of the Hard Rock Analyst family of publications. Coffin has a degree in corporate and investment finance and has extensive experience in merger and acquisitions and small-company financing and promotion.
For many years, Coffin tracked the financial performance and funding of all exchange-listed Canadian mining companies and has helped with the formation of several successful exploration ventures. Coffin was one of the first analysts to point out the disastrous effects of gold hedging and gold loan-capital financing in 1997. He also predicted the start of the current secular bull market in commodities based on the movement of the US Dollar in 2001 and the acceleration of growth in Asia and India.
Now he says that, as the gold price rose upward over the last decade, junior miners chased ounces at all costs. This was a huge mistake, says Coffin, because it resulted in unexciting projects, low margins and a depressed market. Whereas, he explains here to The Gold Report, the essence of the junior gold miner should be new discoveries with high margins…
The Gold Report: Federal Reserve of Dallas President Richard Fisher gave a speech in Australia declaring that quantitative easing (QE) must end or it would “fuel the kind of reckless market behavior that started the global financial crisis.” If the Fed isn’t going to end QE until employment improves, how will this end?
Eric Coffin: Fisher gets to voice his opinion at Federal Open Market Committee (FOMC) meetings, but he won’t be a voting member until January. He hasn’t been comfortable with QE from the start and has said so repeatedly. There isn’t any news in that quote.
I don’t think you’ll see much change when the FOMC gets four different members next year. Janet Yellen, who will become chairman, is more dovish than Ben Bernanke. I think she was the right choice, not because she loves creating money from nothing but because she’s probably been the most accurate forecaster of the bunch.
TGR: What about the bubble that Fisher fears?
Eric Coffin: If you want to be cynical, you can make the argument that a bubble is exactly what the Fed has been trying to create. It wanted to get equity markets to go up because that increases wealth and raises consumer confidence. About half of the Fed’s QE program is buying mortgage bonds. It is trying to keep mortgage rates down and resuscitate the housing sector.
Fisher is right in a sense, but I don’t think we’re at the point where I’d be terribly concerned about things running out of control. I have to admit, though, that based on the growth of the economy, the US equity markets are probably getting a little bit ahead of themselves. Most consumer inflation measures have been trending down, not up. Personally, I’m more worried about deflation, which is far harder for a central bank to fight than inflation.
TGR: The Q3/13 gross domestic product (GDP) report shows 2.8% growth.
Eric Coffin: Right now, I’m kind of neutral on the economy. The data quality is going to be crappy for a month or two because of the government shutdown. The economy grew 2.8% because there was big growth in inventories, which is not the reason you want. Without that it came in at 2%, which was the expected number. You’re probably going to see production cut a little bit this quarter because more stuff was made than could be sold.
TGR: Karl Denninger pointed out that the gross change in GDP from Q2/13 to Q3/13 was $196.6 billion, but the Fed’s QE program injected $255bn. So the economy actually shrank during Q3/13.
Eric Coffin: I think he’s oversimplifying a little bit. QE is really swapping paper, creating money out of thin air and using that to buy bonds that inject money into the economy. But the velocity of money has been very low since the crash. It’s not as if the banks are taking that $85bn per month and lending it all. That’s where the real multiplier effect is. Right now a lot of the money created through QE has ended up in bank’s excess reserves, not in the wider economy. Karl is a bit of a permabear, but I would agree with him that it wasn’t that great a report.
TGR: Let’s assume that QE continues at its present rate until June 2014. How will that affect gold and silver?
Eric Coffin: When the Fed starts tapering, we have to assume gold and silver prices will get hit. Of course, if it doesn’t actually start tapering until well into next year, we could see gold and silver go up for two or three months before that. That doesn’t preclude later increases in the gold price based on physical demand, but the short term traders are completely fixated on QE (or lack thereof) and will be sellers once the taper starts, and the market will have to get past that before recovering.
TGR: What if it becomes clear we are going to get QE forever?
Eric Coffin: Then I think gold goes to $2000 per ounce.
TGR: At the Subscriber Investment Summit in Vancouver last month, you compared the 10-year chart for gold prices, rising to 2011 and holding above 2010 levels today, to the 10-year chart for junior resources. The first chart looks good, but this second chart of junior gold miner stock prices looks terrible. Why?
Eric Coffin: For all the money thrown at exploration – and, of course, that number has been tumbling dramatically for the past two years – not many good discoveries resulted, especially in the last couple years. That’s one reason. The chart below shows the amount of gold discovered each year since 1990, counting only new gold discoveries above 2 million ounces. You can see how few discoveries there have been in the past couple years. Compared to the 1990s the numbers are tiny.
The other reason is that when the gold price was rising continuously many companies were looking for what I referred to in Vancouver as “crappy ounces”. Their intentions were good. They weren’t trying to hoodwink anybody. They made the reasonable assumption that with gold going up and up, economic cutoff grades would keep dropping. But you can’t produce gold at ever-lower grades with difficult metallurgy and infrastructure and make more money. 
As it turned out, costs rose almost in lockstep with the gold price. A lot of the ounces that were marginal at $500 or $700 or $900 per ounce haven’t been salvaged by the gold price going to $1300 per ounce. Many of those resources are still uneconomic and would require more capital expenditures with longer payback periods than larger producers are willing to accept.
TGR: You said that junior gold miners have a major credibility issue, specifically, that preliminary economic assessments (PEAs) and feasibility studies do not match production realities.
Eric Coffin: There are a couple reasons for that. I’ve already mentioned costs. And when the gold mining sector recovered after 2000, there was a real capacity issue. There weren’t enough geologists or engineers. There weren’t even enough people who make truck tires.
Many NI 43-101s, PEAs and feasibility studies have been written by people who lacked experience. To be fair to the engineering companies, miners can have cost overruns of 20% and still be within the stated margin of error, but people never read the fine print. They just look at the production cost, so when it comes in $100-200 per ounce higher, everybody freaks out.
TGR: Juniors chased lousy projects because gold was soaring, and money flooded into the market. Now that gold has fallen 30%, will this engender the return of old-fashioned values?
Eric Coffin: I think it already has. The large mining companies, having spent huge amounts of money on capital expenses (capexes) that didn’t add to their bottom line, are now saying, “Show me margin.” Large and medium companies will now pick up deposits smaller than what they would have touched 10 years ago because they have the grades, the geometry and the metallurgy to enable low-cost production.
TGR: So is margin now more important than grade?
Eric Coffin: Grade is king, but margin is the key. Majors are focused on margin per ounce produced. You can get high margins with a lower-grade deposit if everything goes right but, by and large, the higher grade the better the margin should be. It comes down to net present value (NPV) and internal rate of return (IRR).
Companies now want gold projects that can be built for $100-150 million, with NPVs of $300m or $400m and all-in cash costs of $600-800 per ounce – assuming they’re big enough. They don’t want to go too small because they can spread themselves only so thin. I don’t see majors picking up 50,000-ounce-per-year deposits, but we might see them picking up 100-150,000 per year projects, when a few years ago few majors would look at a deposit unless it was capable of generating 250,000 ounces per year or more.
In Sonora, Mexico, half a dozen mines that began production in the last five years don’t have grade. They’re 0.8, 0.7 or 0.6 grams per ton, but they have fantastic combinations of logistics, costs, workforces, metallurgy and geometry, and they produce at $500-700 per ounce cash costs.
TGR: Why are new discoveries so important to the junior sector?
Eric Coffin: That’s what the juniors exist for. The market wants something new, with blue-sky potential. The companies with really big runs in the last year or two are, almost without exception, companies that made discoveries. They don’t always work out, but that’s the risk you take.
If you go back to the pretty spectacular bull market in the mid-1990s, it was driven by companies going international for the first time in a long time, juniors going to South America and Africa and finding 3, 5 and 10 million-ounce deposits. Gold prices rose in the mid-1990s, but discoveries drove the bull market.
TGR: Eric, thank you for your time and your insights.
Eric Coffin: You’re welcome. I have a new report available for your readers that is free to download – it is actually an interview with one of the companies I’m tracking, which I think is a very worthwhile read. We also have a special subscription offer included in this report.
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