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 23

US Oil & Global Gold

Gold Price Comments Off on US Oil & Global Gold
US oil stocks have soared as shale pushes crude prices down. But gold…?

The UNITED STATES is doing better than it has in years, writes Frank Holmes on his Frank Talk blog at US Global Investors.
Jobs growth is up, unemployment is down, our manufacturing sector carries the rest of the world on its shoulders like a wounded soldier and the World Economic Forum named the US the third-most competitive nation, our highest ranking since before the recession.
As heretical as it sounds, there’s a downside to America’s success, and that’s a stronger Dollar. Although our currency has softened recently, it has put pressure on two commodities that we consider our lifeblood at US Global Investors: gold and oil.
It’s worth noting that we’ve been here before. In October 2011, a similar correction occurred in energy, commodities and resources stocks based on European and Chinese growth fears. 
But international economic stimulus measures helped raise market confidence, and many of the companies we now own within these sectors benefited. Between October 2011 and January 2012, Anadarko Petroleum rose 58%; Canadian Natural Resources, 20%; Devon Energy, 15%; Cimarex Energy, 15%; Peyto Exploration & Development, 15%; and Suncor Energy, 10%.
Granted, we face new challenges this year that have caused market jitters – Ebola and ISIS, just to name a couple. But we’re confident that once the Dollar begins to revert back to the mean, a rally in energy and resources stocks might soon follow. Brian Hicks, portfolio manager of our Global Resources Fund (PSPFX), notes that he’s been nibbling on cheap stocks ahead of a potential rally, one that, he hopes, mimics what we saw in late 2011 and early 2012.
A repeat of last year’s abnormally frigid winter, though unpleasant, might help heat up some of the sectors and companies that have underperformed lately.
On the left side of the chart below, you can see 45 years’ worth of data that show fairly subdued fluctuations in gold prices in relation to the Dollar. On the right side, by contrast, you can see that the strong Dollar pushed bullion prices down 6% in September, historically gold’s strongest month. This move is unusual also because gold has had a monthly standard deviation of ±5.5% based on the last 10 years’ worth of data.
Here’s another way of looking at it. On October 3, bullion fell below $1200 to prices we haven’t seen since 2010, but they quickly rebounded to the $1240 range as the Dollar index receded from its peak the same day.
There’s no need to worry just yet. This isn’t 2013, when the metal gave back 28%. And despite the correction, would it surprise you to learn that gold has actually outperformed several of the major stock indices this year?
As for gold stocks, there’s no denying the facts: With few exceptions, they’ve been taken to the woodshed. September was demonstrably cruel. Based on the last five years’ worth of data, the NYSE Arca Gold BUGS Index has had a monthly standard deviation of ±9.4, but last month it plunged 20%. We haven’t seen such a one-month dip since April 2013. This volatility exemplifies why we always advocate for no more than a 10% combined allocation to gold and gold stocks in investor portfolios.
Oil’s slump is a little more complicated to explain.
Since the end of World War II, black gold has been priced in US greenbacks. This means that when our currency fluctuates as dramatically as it has recently, it affects every other nation’s consumption of crude. Oil, then, has become much more expensive lately for the slowing European and Asian markets. Weaker purchasing power equals less overseas oil demand equals even lower prices.
What some people are calling the American energy renaissance has also led to lower oil prices. Spurred by more efficient extraction techniques such as fracking, the US has been producing over 8.5 million barrels a day, the highest domestic production level since 1986. 
We’re awash in the stuff, with supply outpacing demand. Whereas the rest of the world has flat-lined in terms of oil production, the US has zoomed to 30-year highs.
In a way, American shale oil has become a victim of its own success.
At the end of next month, members of the Organization of the Petroleum Exporting Countries (OPEC) are scheduled to meet in Vienna. As Brian speculated during our most recent webcast, it would be surprising if we didn’t see another production cut. With Brent oil for November delivery at $83 a barrel – a four-year low – many oil-rich countries, including Iran, Iraq and Venezuela and Saudi Arabia, will have a hard time balancing their books. Venezuela, in fact, has been clamoring for an emergency meeting ahead of November to make a plea for production cuts. 
Although not an OPEC member, Russia, once the world’s largest producer of crude, is being squeezed by plunging oil prices on the left, international sanctions on the right. This might prompt President Vladimir Putin to scale back the country’s presence in Ukraine and delay a multibillion-Dollar revamp of its armed forces. When the upgrade was approved in 2011, GDP growth was expected to hold at 6%. But now as a result of the sanctions and dropping oil prices, Russia faces a dismally flat 0.5%.
The current all-in sustaining cost to produce one ounce of gold is hovering between $1000 and $1200. With the price of bullion where it is, many miners can barely break even. Production has been down 10% because it’s become costlier to excavate. As I recently told Kitco News’ Daniela Cambone, we will probably start seeing supply shrinkage in North and South America and Africa.
The same could happen to oil production. Extraction of shale oil here in the US costs companies between $50 and $100 a barrel, with producers able to break even at around $80 to $85. If prices slide even further, drillers might be forced to trim their capital budgets or even shelve new projects.
Michael Levi of the Council on Foreign Relations told NPR’s Audie Cornish that a decrease in drilling could hurt certain commodities:
“[I]f prices fall far enough for long enough, you’ll see a pullback in drilling. And shale drilling uses a lot of manufactured goods – 20% of what people spend on a well is steel, 10% is cement, so less drilling means less manufacturing in those sectors.”
At the same time, Levi places oil prices in a long-term context, reminding listeners that we’ve become accustomed to unusually high prices for the last three years.
“People were starting to believe that this was permanent, and they were wrong,” he said. “So the big news is that volatility is back.”
On this note, be sure to visit our interactive and perennially popular Periodic Table of Commodities, which you can modify to view gold and oil’s performance going back ten years.
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Sep 22

Gold Mining "Hurt Long-Term", Output "Peaking in 2014"

Gold Price Comments Off on Gold Mining "Hurt Long-Term", Output "Peaking in 2014"
Gold mining producers cutting exploration, M&A spending as profit margins shrink…

GOLD MINING output worldwide is set to peak and then “plateau” in 2014, according to the leading data analysts, as today’s lower prices force producers to cut exploration spending in a bid to boost profit margins.
“It seems inevitable,” says the new Gold Survey 2014 Update from Thomson Reuters GFMS, that the mining industry’s response to 2013’s gold price crash “will be detrimental to mine supply levels in future years.”
Forecasting a 10% drop in the average market price to $1270 per ounce for full-year 2014 (currently at $1290), “The mining sector is increasing production this year,” says the consultancy, “with a number of important projects coming into production and/or ramping up to full capacity, having benefited from investment flows in earlier years when prices were much higher.”
But new investment is now being cut back, meaning that “longer term, the production profile is likely to come under pressure” with 2014 marking what Thomson Reuters GFMS calls “a cyclical top for mine production.”
Over the first half of the year, global gold mining output rose 4% worldwide from January-June 2013, led by increases from China, Australia and Russia – the top 3 producer nations.
Gold mining output fell however in the next 3 major producers – the United States, South Africa and, most sharply, Peru. There, the giant Yanacocha project, the world’s biggest operational gold mine at its peak a decade ago, saw the quality of gold ore drop 65% from a year before.
Better “husbandry” and falling energy prices mean the average cash cost of mining 1 ounce of gold fell 6% by mid-2014 from a year before, Thomson Reuters GFMS explains. But thanks to the slump in world market prices, the industry’s basic profit margin has fallen 25% year-on-year, it says.
Attempting to cut costs further, the gold mining industry’s “closures or suspensions have so far been limited to small or ageing operations,” the report says. But there have also been “deferrals of major development-stage projects”, because the last “turbulent year” in precious metals at one point saw gold’s market price dip below the mining industry’s average cost of production when exploration and new development expenses are included.
In the stock market this has also led to “a market sell-off that has severely depressed mining valuations.” Mergers and takeovers remain “anemic”, with no “blockbuster consolidation plays” despite continued approaches from Newmont – the world’s No.2 gold mining company – to the world No.1 Barrick aimed at saving $1 billion per year across their operations in Nevada, USA.
Today’s lack of corporate activity in the gold mining  sector, says Bernard Dahdah at French investment and bullion bank Natixis’s London office, contrasts with the “mine acquisition frenzy” of the decade-long bull market in gold prices. Then major companies were “typically purchasing mines at the higher end of the cost curve.” Miners also failed to protect themselves against any drop in prices, remaining “unhedged” after finally closing in 2009-2011 the huge forward sales made at prices 80% lower at the turn of the century.
Gold producers, says Dahdah, “are now resorting to consolidation at the lower end of the cost curve. Exploration budgets are also being cut back.”
Cost-cutting across the base metals sector is being driven further by slowing global demand, reports specialist news and data provider Platts.
“Companies are not only becoming leaner and meaner because the old regimes…became too profligate when commodity prices were high,” writes Paul Bartholomew, Platts’ managing editor for steel in Australia. “Rather, they are responding to a slowing China and subdued global economy.”
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Sep 19

Roxgold: Headed for a Transformational Fourth Quarter

Gold Price Comments Off on Roxgold: Headed for a Transformational Fourth Quarter

CEO John Dorward believes the building blocks are in place for the company to move from being an explorer to a developer to a producer.

Continue reading…

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Sep 17

Time to Buy Gold Stocks Cheap?

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Mining equities just keep getting cheaper as gold prices struggle…

WITH a career spanning three decades in the investment markets, Brien Lundin serves as president and CEO of Jefferson Financial, a highly regarded publisher of market analyses and producer of investment-oriented events.
Under the Jefferson Financial umbrella, Lundin publishes and edits Gold Newsletter, a cornerstone of precious metals advisories since 1971. He also hosts the New Orleans Investment Conference, the oldest and most respected investment event of its kind.
As Lundin here tells The Gold Report, he now believes at least a small amount of the massive liquidity produced by loose monetary policy in Western economies will find its way into mining equities following the summer pullback – but don’t wait long…
The Gold Report: On July 30, you sent out a Gold Newsletter alert that forecast a pullback in the midsummer bull market. The next day the Dow dropped 317 points, while the Nasdaq fell about 93 points. Since then the Dow has climbed back above 17,000, the Nasdaq above 4,600. Should investors dismiss that drop or do you believe it was akin to a tremor preceding an earthquake?
Brien Lundin: That particular call made me look like a genius at the time, but right after that drop the stock market took off and reached new highs. The stock sell-off in late July was a sign that investors were nervous because we haven’t had a meaningful correction during this bull market. However, there are potential pitfalls ahead for the economy – we still have to navigate the US Federal Reserve’s ending of quantitative easing and its first interest rate hikes. There’s nothing directly ahead that indicates a major correction will occur, yet these things happen when you’re least expecting them.
TGR: You’ve been warning investors in Gold Newsletter about the erosion of the foundation of the US equity market. Please give our readers a few points to underpin your thesis.
Brien Lundin: When I put forth that thesis, Q1 ’14 gross domestic product (GDP) had missed consensus estimates by 3.3%. The consensus going into that report was for 1.2% growth but it turned out to be just 0.1% – only to be subsequently revised further down to -2.1%. The miss for the consensus estimate was remarkable.
I posited that these reports had possibly captured some underlying weakness in the economy. I expected a rebound in Q2 ’14 because a lot of economic activity was put off due to the unusually cold winter weather. But Q2 ’14 GDP was over 4%. I certainly wasn’t expecting anything like that, and neither was anyone else.
So, the idea of a major stock market decline stemming from a weakening US economy has become more remote, at least for the time being.
TGR: What are you seeing now?
Brien Lundin: The massive amount of money created in developed economies since the 2008 credit crisis really has not resulted in significant retail price inflation. If anything, there has been disinflation in major economies, such as in Europe where the European Central Bank is now turning to quantitative easing. The real result of quantitative easing in the US and loose money policy throughout the Western economies is a virtual flood of liquidity looking for places to land. It’s why we have US Treasuries being bid down to their lowest rates ever, while the US stock market is hitting record highs. Those two asset classes should be at opposite sides of the seesaw, but there’s so much money looking for a home that both are soaring simultaneously.
TGR: The Market Vectors Junior Gold Miners ETF (NYSEArca:GDXJ) has been trading lower since mid-July. In fact, the Dow Jones Industrial Average has outperformed that ETF over the last month or so. Is that a buying opportunity?
Brien Lundin: I think so. The timing is critical, though. While I don’t see a near-term, fundamental driver to push the market higher in the very near future, there are some factors that I think will push the junior resource stocks and the metals higher this fall. So your real buying opportunity is probably over the next couple of weeks.
All of the liquidity that I referred to earlier has to go somewhere. There’s a broad consensus that gold is going lower and a lot of money is shorting gold. At some point over the next month or so – at the first sign that gold is not going lower – we’re going to see some short positions get covered, and that ocean of money is going to start sloshing into gold and silver. At that point we should also see stronger seasonal demand for gold and that also will help power the gold equities market forward.
TGR: Every year your company, Jefferson Financial, puts on the New Orleans Investment Conference. This year the show celebrates its 40th anniversary from October 22-25. The headline event is a panel discussion with former Fed Chairman Alan Greenspan, legendary investor Porter Stansberry and Marc Faber, publisher of the Gloom, Boom & Doom newsletter. What can investors learn from this?
Brien Lundin: On the Greenspan panel we’re going to pointedly ask him about the Fed and the Treasury’s role in manipulating the gold price and how that occurs, if it occurs. He no longer has any reason to obscure the truth. There will also be a moderated Q&A with Greenspan where he’ll take questions from the audience. Those two panels with Greenspan are going to make headlines, if not history. He has a fascinating story. Greenspan was one of the most ardent and eloquent goldbugs in the 1960s. He was a close follower of Ayn Rand and some of his writings on gold still stand today as among the best ever produced on the role of gold in protecting citizens from currency depreciation.
The rest of our lineup includes Dr. Charles Krauthammer, Peter Schiff, Rick Rule and Doug Casey. People come back year after year because they get to meet these experts and talk with them. They get stock recommendations and strategies that they’ll never get anywhere else. It’s always a dynamic event.
TGR: Thank you for talking with us, Brien.
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Sep 13

Cash First, Then a Catalyst

Gold Price Comments Off on Cash First, Then a Catalyst
Better yields from better mining will lead investment cash back into gold stocks…

JEFF KILLEEN has been with the CIBC Mining Research team since early 2011, covering and providing technical assessment of junior and intermediate exploration and mining companies worldwide.
Prior to joining CIBC, Killeen worked as an exploration and mine geologist in several major mining camps, including the Sudbury basin and the Kirkland Lake region. Now he has spent much of 2014 on the road vetting junior mining projects, and says – speaking here to The Gold Report – that the cash-and-catalyst mindset should remain prevalent for investors looking at explorer and developer equities…
The Gold Report: Two years ago CIBC World Markets recommended taking a short position on a selection of gold stocks. What’s CIBC’s view on gold stocks today?
Jeff Killeen: We had put out a basket of names recommending some short positions, but at that time gold was trading at about $1600/ounce ($1600 per ounce) and there was little support for the price at that level. That dynamic doesn’t seem to be at play in today’s environment. We are maintaining our current recommendation: Investors should be at market weight with respect to their gold equity allocations.
Many mining stocks have performed well in 2014 and the move has largely been motivated by several factors. First, gold bullion itself has found a footing. The gold price has traded in a range of $1250-1,350 per ounce, which is fairly narrow compared to how gold prices have moved in the past three to five years. Investors are becoming comfortable with the idea that gold will remain range bound for the coming 12 months or more, and concerns that gold could drop significantly over a short period seems to be waning with gold seeing support around $1250 per ounce.
While some profit taking on strong first half share performance is certainly justifiable, I continue to recommend buying gold stocks with a focus on companies that are currently generating healthy margins and could enjoy higher trading multiples as they gravitate up toward longer-term averages. I also like gold stocks that have underperformed relative to their peers in 2014 that are projecting improving operations or have meaningful catalysts in the near term.
TGR: What do you expect the trading range for gold to be through the end of 2015?
Jeff Killeen: Our gold price estimate for 2015 is $1300 per ounce. Next year is likely to look a lot like 2014 with typical seasonal moves and maintaining that price range of roughly $1250-1,350 per ounce for the year.
TGR: Do you think the Market Vectors Junior Gold Miners ETF (GDXJ:NYSEArca) will be up another 30% through the first eight months of 2015?
Jeff Killeen: That would be difficult. There could be stocks that realize some strong performance in the back half of this year and into next year, but I don’t think it will be as broad based as we saw early in 2014.
TGR: In the near term do you expect gold buying to gain steam or have seasonal gold buying trends become something of the past?
Jeff Killeen: We’ve spent a lot of time tracking gold’s seasonal price patterns over 5-, 10- and 15-year trends. Plotting the relative performance of gold prices over those periods shows a fairly consistent seasonal pattern. A move in the gold price in early June on the back of geopolitical tensions was unexpected and may have taken some of the steam out of a fall rally, but we need to realize that the typical fall rally is largely spurred by physical demand from the East. I don’t see a reason why typical physical demand wouldn’t materialize in 2014 and we expect the gold price to do well over the next few months.
TGR: One division of CIBC World Markets uses quantitative models to identify predictive relationships and broad market trends. What are these models telling investors about small-cap gold stocks and the gold space?
Jeff Killeen: Our quantitative analyst, Jeff Evans, has been promoting the idea that gold stocks, especially the more volatile small- to mid-cap gold stocks, have high beta outperformance relative to the S&P 500 and the Toronto Stock Exchange given the current environment for stable or marginally upward moving interest rates over the long term. That’s from a technical standpoint.
With that in mind, we have to be cognizant of the fact that we’ve seen better downside support and some strong moves in the gold price in 2014 that weren’t necessarily expected and I’m sure that has helped move some gold stocks upward. But interest rates are having an effect on how people look at gold and gold equities, and using that as a trigger to buy or sell gold stocks makes sense to me.
TGR: In June 2013 positive news had largely stopped moving equity prices. You told us then that it would be temporary. What news is moving producer and developer equities in this market?
Jeff Killeen: On the producer side, improving operations has been the biggest motivator for share prices. Although I expect a lot of the cost improvements in the gold mining space have already been incorporated into operations, the market is thinking about how sustainable those cost improvements might be. Companies that maintain lower costs through 2014, relative to where they may have been in previous years, are likely to get attention as investors think about 2015 performance and if they should consider increasing their estimates for company earnings and cash flow. Such a scenario could generate further share support for good operators. Of course, companies that realize further cost improvements in the second half of 2014 are also likely to get investors’ attention.
TGR: What about developers?
Jeff Killeen: On the developer side, we’re starting to see share prices get rewarded for good drill results, resource growth and even new discoveries. When we spoke back in mid-2013 I recommended that investors stick to the cash-and-catalyst mentality, because an exploration stock needs to have a strong balance sheet and material near-term catalysts [ie, news likely to send the stock higher]. That approach was the right one and I’d stick with that concept today.
TGR: Would you make any modifications to the cash-and-catalyst thesis given what has transpired between then and now?
Jeff Killeen: Cash and catalysts are not the only components that a company must have. The main project has to have gold grades that are amenable to the type of process it is proposing, and the economics have to work at current gold prices to have a realistic chance of seeing a takeover offer. A company definitely has to have a solid management team to navigate today’s tricky financing waters or wisely allocate capital.
TGR: Which types of companies are seeing interest from institutional investors?
Jeff Killeen: My producer coverage is in the small to intermediate market cap in the gold space. The intermediate producers tend to have a higher beta to the bullion price so that segment of my coverage seems to have sustained greater institutional interest in 2014. Despite some merger and acquisition (M&A) activity in 2014, the general feeling among investors is that although M&A is likely to continue, it’s expected to come in the form of smaller consolidations or the sale of noncore assets by majors. In that context, exploration companies are struggling to attract attention from the institutional market.
TGR: One recent drill result at TV Tower was 130.9 meters grading 1.5 g/t Au and 0.48% Cu starting at surface. You model results like these all the time. What does that look like to you?
Jeff Killeen: No project is a single drill hole, but to have a single hole with those kinds of numbers is an excellent start. If you put several intercepts like that together you can quickly build pounds and ounces. Being able to validate a surface geological interpretation is big and a great starting point for any drill program.
TGR: What’s your sense of where we are in the recovery of precious metals equities?
Jeff Killeen: I get the feeling that we have hit the bottom and taken the first leg up – but the next leg up could take some time to materialize. There are individual stocks that should have good performance through the back half of 2014 and over the next 12 to 18 months.
From a broader perspective, a lot of the cost improvements have already materialized and I think there is little producers can do to significantly improve margins or cash flow. To accomplish those things we need to see a few things happen: more fundamental support from the gold price and an increase in physical demand in India and the rest of Asia. Better yields will catalyze the generalist investor back to investing in gold stocks.
TGR: Thank you, Jeff, for your insight.
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Aug 28

Gold Buying Well Behind 2013

Gold Price Comments Off on Gold Buying Well Behind 2013
Scale of last year’s surge shown by latest 2014 gold buying data…

MARCUS GRUBB is the managing director of investment strategy for market-development organization the World Gold Council.
Based in London, he leads both investment research and product innovation, as well as marketing efforts surrounding gold’s role as an asset class. Grubb has more than 20 years’ experience in global banking, including expertise in stocks, swaps and derivatives.
Here, and after the release of the World Gold Council’s latest quarterly Gold Demand Trends survey, Marcus Grubb speaks to HardAssetsInvestor‘s managing editor Sumit Roy about some of the report’s more surprising conclusions…
HardAssetsInvestor: Physical investments demand fell 56% in the second quarter from Q2 2013, but it’s still at a pretty high level historically. Do you think it’s going to rebound, stabilize or fall further from here?
Marcus Grubb: Gold bar and coin demand is substantial in the United States, but even bigger in Asia. The big falls were in a lot of those Asian countries. But we should put this in context. Last year in Q2 there was that big decline in the gold price to the tune of more than 20%. That triggered a big consumer-buying binge in Asia. We had great figures last year and so this year’s drop of 56% is from those high levels.
Looking forward, things are likely to get better – first of all, that comparisons get easier year in Q3 and Q4. That’s because Q2 was really where all the big events happened – the price drop, the huge redemptions in the ETFs, the big consumer demand response with the big jump in jewelry and bar and coin demand. So Q3 and Q4 are just mathematically going to look better.
The other thing is that you could say some of the softness in this latest quarter was due to the fact that the price trend has been ambiguous this year. Gold’s done better than many expected, and has returned quite well, better than some stock markets around the world. But it’s too early to really say there’s a strongly rising price trend for gold. And I think a lot of the bar and coin consumers in Asia are looking for that. There’s evidence they have held back on buying until there’s a clearer direction for the gold price. 
The final thing I’d say is that the figure for total investment for Q2 is actually up 4% compared with last year. And that’s really because the performance of the ETFs are so much better than they were in Q2 2013. They still saw redemption of about 40 tonnes, but there were redemptions of 402 tonnes in the same quarter last year. ETF investors are definitely more comfortable owning gold this year than they were last year.
HardAssetsInvestor: And those ETF investors, would you say they’re predominantly Western investors?
Marcus Grubb: Yes. The majority of the holdings in the ETFs are really in six to eight different instruments, either in the United States or UK or Europe.
The other thing is that the investors who were in gold ETFs for the price appreciation and for the financial system hedge after the Lehman failure in ’08 are the people who have left gold. They’ve reallocated into other asset classes. A lot of those investors will say, “We bought gold; we had it because we were worried about the Dollar and about the financial system. When things started to improve last year, we moved out of our gold position and we sold at a profit.” They often will say “gold did the job we wanted it to do.”
The people who are still left now – and remember there’s 1,850 tonnes globally still in gold ETFs – those investors are using gold as a hedge asset, as an insurance policy, as a hedge against inflation if it comes, a hedge against tail risks, and as a diversifier. So we see them as pretty strong holders of gold in small allocations in their portfolios.
HardAssetsInvestor: Are the remaining ETF investors basically going to be keying off Federal Reserve monetary policy and things like that?
Marcus Grubb: That’s certainly one key element. But also, central bank policy globally and interest rate policy globally. And that’s part of the reason things are actually better on the ETF front this year than they were last year.
If you look at the rest of the world, we’ve just seen pretty awful GDP number in Japan. A lot of that was due to the consumer tax increase in that country, but it’s still a big negative number. And then you see the most recent numbers in Europe, Germany and Italy showing that the Eurozone is also swerving down. It looks like the ECB is almost definitely going to ease policy further. Whichever tool they choose – whether it’s interest rates or even quantitative easing – most strategists and economists are betting on further monetary easing in Europe between now and the end of the year.
HardAssetsInvestor: And we did see the German 10-year bond yield fall below 1% recently. Is that bullish for gold, at least from an European perspective?
Marcus Grubb: Yes. And I think that’s why if you look at the latest ETF numbers globally in July and August, we’ve had net new creates. I think those two things are related.
HardAssetsInvestor: Looking at individual countries you mentioned earlier, how is demand from China and India faring so far this year after last year’s record year?
Marcus Grubb: If you look at the half-year, total demand in China is about 471 tonnes. That’s still a fall compared with the first half of 2013 to the tune of about 35%. And India is at 394 tonnes for the half-year, down about 33%.
Having said that, we have been in the weaker seasonal period for gold demand. We should now see stronger numbers in both Q3 and Q4. You’ve got the ending of the monsoon in India and then Diwali. And then you’ve got the same phenomenon in China. There are some festivals in China in the autumn, and then the run-up to the Chinese new year where you see increase in gold imports in that country.
We actually think by year-end you’re going to see China come in around 900 to 1000 tonnes for the full year. And we think India will come in around 850 to 950 tonnes. If that happens, that’ll still be the second-best year for China ever, and not a bad year for India either.
HardAssetsInvestor: It looks like central banks continued to accumulate gold steadily in Q2. But is Russia pretty much the predominant buyer when it comes to central banks?
Marcus Grubb: I would certainly say this year they have been. It’s also true to say that over the last decade, Russia is the largest central bank buyer of gold that we know about. The Russian central bank now has over 1,000 tonnes of gold. They’re holding just under 10% of reserve assets in physical gold.
But overall, central banks were strong, and in fact, we just revised our target for these figures for the year. We now expect central bank purchases around 500 tonnes for this year. If we get that, it will be the second-best year since the 1960s.
These central banks continue to buy gold as a currency diversifier because they’re very overweight US Dollars. Gold acts as a diversifier against sovereign debt and partly against equities too, because a number of central banks are now buying equities, which is a recent phenomenon. As you know, gold is a good hedge against equities.
HardAssetsInvestor: Any word on China’s central bank purchases?
Marcus Grubb: No, and they are not contained in these figures. We have no new information on that. Officially, Chinese gold holdings are around 1,054 tonnes. The last disclosure they gave was in 2009.
HardAssetsInvestor: Presumably those could be pretty big purchases going on behind the scenes, could they not?
Marcus Grubb: It’s hard to comment without any official releases or disclosure. But it is interesting to note that if you look at the Chinese gold market for the last seven years or so, there is a surplus in the demand and supply figures. In other words, more gold has gone into China through imports than you can account for through local demand from jewelry, bars and coins, technology, and other measured sources of demand from the private sector. Over the last several years, the total is that somewhere between 800 and 1,000 tonnes of supply has gone in and can’t be accounted for.
Now, some of that may have gone into inventories as the gold industry’s gotten a lot bigger in China over the last seven years because of the boom in the market. There are a lot more jewelry outlets, a lot more fabrication factories for jewelry, etc. In any case, some of that gold is sitting in holdings somewhere in China, and it’s not measured in the consumer demand. So people can draw their own conclusions.
HardAssetsInvestor: Turning to the supply side, we saw mine production up 4% from a year ago in the latest quarter. Is that significant?
Marcus Grubb: It’s likely we will see a slowdown in the rate of growth of mine production later this year. This latest increase is effectively a hangover from the expansion we saw before last year’s price decline. This may be the year for peak mine production in the medium term. 
It’s quite likely that sometime between now and the early part of 2015, gold mine production will peak, and after that, it will decline as a result of all the measures that have been taken in the last 12-18 months in response to low gold prices.
You’re seeing large amounts of cost cutting, delays and postponements to projects, some closures and some very large projects in the hundreds of millions or even billions being put on ice until the market improves and more funding is available. That takes time to kick in and affect supply, but we think it will start to do that later this year, and definitely into 2015.
Although the price isn’t affected directly by that in the short term, it reaffirms that, in the long run, gold is in limited supply against strong demand. The other key factor, which is much more price sensitive, is recycling. Year-to-date, recycled gold supply is actually down for the half-year by around 8%. The only way you can increase the supply from recycling is by having a significant increase in the gold price.
All of this says gold is returning to its longer-term position of being in a shortage or a deficit, where the demand from central banks, technology, jewelry and the consumer will push this market back in a deficit soon. If investors come back into the market, the deficit will be just that much larger.
HardAssetsInvestor: I want to get your take on the producer hedging that we saw last quarter. How does producer hedging impact supply?
Marcus Grubb: We did have the first hedge for some, which has tipped this quarter into net hedging of 50 tonnes, versus Q1 where we had a de-hedge. But it’s fair to say that this latest hedge is very mining project-specific. We don’t see this as marking a return to hedging generally. 
Moreover, the hedge book is still near an all-time low, with about 125 tonnes in total. Also, this hedging is not necessarily the same as the hedging we had in the bear market in gold either. That entailed borrowing gold from central banks, selling it at spot with the banks in the middle providing the financing, and then the mining company producing into the hedge to deliver gold back to the commercial bank. And then from them, back to the central bank.
My sense of these hedges is that they are more collateralized financings, where effectively the mining company is selling forward production at a fixed price to raise capital for developing the mine. In that sense, I would say it doesn’t have necessarily the same impact on supply that the old style of hedging did, where the gold was borrowed and sold in the spot market.
HardAssetsInvestor: That’s an interesting point. So it’s not really adding to physical supply, unlike in the past.
Marcus Grubb: I would say that it potentially isn’t, no. Without knowing more details about that particular transaction, I would say it won’t have as much effect on physical supply as the hedging did in the past.
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Aug 05

Tough Investing in Stagflation Ahead

Gold Price Comments Off on Tough Investing in Stagflation Ahead
Blame the Keynesians. It’s always and everywhere their phenomenon…

ALTHOUGH it might seem odd for a school of economics to largely ignore the role of money in the economy, writes John Butler – investing author, previously head of the Index Strategies Group at Deutsche Bank, and now commodities CIO at Amphora – at the Cobden Centre, this is indeed the case with traditional Keynesian economics.
Declaring in 1963 that, “Inflation is, always and everywhere, a monetary phenomenon,” Milton Friedman sought to place money at the centre of economics where he and his fellow Monetarists believed it belonged. Keynesian policies continued to dominate into the 1970s, however, and were blamed by the Monetarists and others for the ‘stagflation’ of that decade – weak growth with rising inflation.
Today, stagflation is re-appearing, the inevitable result of the aggressive, neo-Keynesian policy responses to the 2008 global financial crisis. In this report, I discuss the causes, symptoms and financial market consequences of the new stagflation, which could well be worse than the 1970s.
During the ‘Roaring 20s’, US economists mostly belonged to various ‘laissez faire’ or ‘liquidationist’ schools of thought, holding that economic downturns were best left to sort themselves out, with a minimal role for official intervention. President Hoover’s Treasury Secretary Andrew Mellon (in)famously represented this view following the 1929 stock market crash when he admonished the government to stay out of private affairs and allow businesses and investors to “Liquidate! Liquidate! Liquidate!”
The severity of the Depression caught much of the laissez faire crowd off guard and thus by 1936, the year John Maynard Keynes published his General Theory, there was a certain open-mindedness around what he had to say, in particular that there was a critical role for the government to play in supporting demand during economic downturns through deficit spending. (There were a handful of prominent economists who did warn that the 1920s boom was likely to turn into a big bust, including Ludwig von Mises.)
While campaigning for president in 1932, Franklin Delano Roosevelt famously painted Herbert Hoover as a lasseiz faire president, when in fact Hoover disagreed with Mellon. As Murray Rothbard and others have demonstrated, Hoover was a highly interventionist president, setting several major precedents on which FDR would subsequently expand. But all is fair in politics and FDR won that election and subsequent elections in landslides.
With the onset of war and the command war economy it engendered, in the early 1940s the economics debate went silent. With the conclusion of war, it promptly restarted. Friedrich von Hayek fired an early, eloquent shot at the Keynesians in 1946 with The Road to Serfdom, his warning of the longer-term consequences of central economic planning.
The Keynesians, however, fired back, and with much new ammunition. Beginning in the early 20th century, several US government agencies, including the Federal Reserve, began to compile vast amounts of economic statistics and to create indices to aggregate macroeconomic data. This was a treasure-trove to Keynesians, who sought quantitative confirmation that their theories were correct. Sure enough, in 1947, a new, definitive Keynesian work appeared, Foundations of Economic Analysis, by Paul Samuelson, that presented statistical ‘proof’ that Keynes was right.
One of Samuelson’s core contentions was that economic officials could and should maintain full employment (ie low unemployment) through the prompt application of targeted stimulus in recessions. As recessions ended, the stimulus should be withdrawn, lest price inflation rise to a harmful level. Thus well-trained economists keeping an eye on the data and remaining promptly reactive in response to changes in key macroeconomic variables could minimise the business cycle and prevent Depression.
For government officials, Samuelson’s work was the Holy Grail. Not only was this a theoretical justification for an active government role in managing the economy, as Keynes had provided; now there was hard data to prove it and a handbook for just how to provide it. A rapid, historic expansion of public sector macroeconomics soon followed, swelling the ranks of Treasury, Commerce, Labor Department and Federal Reserve employees.
Notwithstanding the establishment of this new economic mainstream and a public sector that wholeheartedly embraced it, there was some dissent, in particular at the so-called ‘freshwater’ universities of the American Midwest: Chicago, Wisconsin, Minnesota and St Louis, among others.
Disagreeing with key Keynesian assumptions and also with Samuelson’s interpretation of historical data, Monetarists mounted an aggressive counterattack in the 1960s, led by Milton Friedman of the Chicago School. Thomas Sargent, co-founder of Rational Expectations Theory, also took part.
The Chicago School disagreed that there was a stable relationship between inflation and employment that could be effectively managed through fiscal policy. Rather, Friedman and his colleagues argued that Keynesians had made a grave error in largely ignoring the role of money in the economy. Together with his colleague Anna Schwarz, Friedman set out to correct this in the monumental Monetary History of the United States, which re-interpreted the Great Depression, among other major events in US economic history, as primarily a monetary- rather than demand-driven phenomenon. Thus inflation, according to Friedman and Schwarz, was “always and everywhere a monetary phenomenon,” rather than a function of fiscal policy or other demand-side developments.
By the late 1960s the dissent played a central role in escalating policy disputes, due primarily to a prolonged expansion of US fiscal policy. Following Keynesian policy guidance, the government responded to the gentle recession of the early 1960s with fiscal stimulus. However, even after the recession was over, there was a reluctance to tighten policy, for reasons both foreign and domestic. At home, President Johnson promised a ‘Great Society’: a huge expansion of various programmes supposedly intended to help the poor and otherwise disadvantaged groups. Abroad, the Vietnam War had escalated into a major conflict and, combined with other Cold War military commitments, led to a huge expansion of the defence budget.
In the early 1960s a handful of prescient domestic observers had already begun to warn of the increasingly inflationary course of US fiscal and monetary policy (Henry Hazlitt wrote a book about it, What Inflation Is, in 1961.) In the mid-1960s this also became an important international topic. Under the Bretton-Woods system, the US was obliged to back Dollars in circulation with gold reserves and to maintain an international gold price of $35 per ounce. In early 1965, as scepticism mounted that the US was serious about sustaining this arrangement, French President Charles De Gaulle announced to the world that he desired a restructuring of Bretton-Woods to place gold itself, rather than the Dollar, at the centre of the international monetary system.
This prominent public dissent against Bretton-Woods unleashed a series of international monetary crises, roughly one each year, culminating in President Nixon’s decision to suspend ‘temporarily’ the Dollar’s convertibility into gold in August 1971. (Temporarily? That was 43 years ago this month!)
The breakdown of Bretton-Woods would not be complete until 1973, when the world moved formally to a floating-rate regime unbacked by gold. However, while currencies subsequently ‘floated’ relative to one another, they collectively sank in purchasing power. The price of gold soared, as did the price of crude oil and many other commodities.
Rather than maintain stable prices by slowing the growth rate of the money supply and raising interest rates, the US Federal Reserve fatefully facilitated the Dollar’s general devaluation with negative real interest rates. While it took several years to build, in part because Nixon placed outright price controls on various goods, eventually the associated inflationary pressure leaked into consumer prices more generally, with the CPI rising steadily from the mid-1970s. Growth remained weak, however, as the economy struggled to restructure and rebalance. Thus before the decade was over, a new word had entered the economic lexicon: Stagflation.
Keynesians were initially mystified by this dramatic breakdown in the supposedly stable and manageable relationship between growth (or employment) and inflation. Their models said it couldn’t happen, so they looked for an explanation to deflect mounting criticism and soon found one: The economy had been hit by a ‘shock’, namely sharply higher oil prices! Never mind that the sharp rise in oil prices followed the breakdown of Bretton-Woods and devaluation of the Dollar: This brazen reversal of cause and effect was too politically convenient to ignore. Politicians could blame OPEC for the stagflation, rather than their own policies. But an objective look at history tells a far different story, that the great stagflation was in fact the culmination of years of Keynesian economic policies. To generalise and to paraphrase Friedman, stagflation is, always and everywhere, a Keynesian phenomenon.
Why should this be so? Consider the relationship between real economic activity and the price level. If the supply of money is perfectly stable, then any negative ‘shock’ to the economy may reduce demand, but that will result in a decline rather than a rise in the general price level. The ‘shock’ might also increase certain prices in relative terms, but amidst stable money it simply cannot increase prices across the board, as is the case in stagflation.
They only way in which the toxic stagflationary mix of both reduced growth and rising prices can occur is if the money supply is flexible. Now this does not imply that a flexible money supply is in of itself a Keynesian policy, but deficit spending is far easier with a flexible money supply that can be increased as desired to finance the associated deficits. Yes, this then crowds out real private capital, with negative long-term consequences for economic health, but as we know, politicians are generally more concerned with the short-term and the next election.
Contemporary examples provide support for the reasoning above. It is instructive that two large economies, Japan and France, have been chronically underperforming in recent years, slipping in and out of recession. Both run chronic budget deficits in blatant Keynesian efforts to stimulate demand. In Japan, where the money supply is growing rapidly, inflation has been picking up despite weak growth: stagflation. In France, where the money supply has been quite stable, there is price stability: That is merely stagnation, not stagflation.
The UK, US and Germany have all been growing somewhat faster. Following the large devaluation of sterling in 2008, the UK experienced a multi-year surge in prices amidst weak growth, clearly a stagflationary mix. The US also now appears to be entering stagflation. Growth has been weak on average in recent quarters – outright negative in Q1 this year – yet inflation has now risen to 4% (3m annualised rate). Notwithstanding a surge in labour costs this year, the US Fed has, up to this point, dismissed this rise in CPI as ‘noise’. But then the Fed repeatedly made similar claims as CPI began to rise sharply in the mid-1970s.
In Japan, the UK and US, the stagflation is highly likely to continue as long as the current policy mix remains in place. (For all the fanfare surrounding the US Fed’s ‘tapering’, I don’t consider this terribly meaningful. Rates are still zero.) In France, absent aggressive structural reforms that may be politically impossible, the stagnation is likely to remain in place.
Germany is altogether a different story than the rest of these mature economies. While sharing the same, relatively stable Euro money supply as France, the price level in Germany is also stable. However, Germany has been growing at a faster rate than most other developed economies, notwithstanding a smaller deficit. This is compelling evidence that Germany is simply a more competitive, productive economy than either the US or UK. But this is nothing new. The German economy has outperformed both the US and UK in nearly every decade since WWII. (Postwar rebuilding provided huge support in the 1950s and 1960s but those days are long past.)
The persistence of German economic outperformance through the decades clearly demonstrates the fundamental economic superiority of what is arguably the least Keynesian set of policies in the developed world. Indeed, Germans are both famed and blamed for their embrace of sound money and fiscal sustainability. ‘Famed’ because of their astonishing success; ‘blamed’ because of, well, because of their astonishing success relative to economic basket cases elsewhere in Europe and around the world. As I sometimes say in jest to those who ‘blame’ the Germans for the economic malaise elsewhere: “If only the Germans weren’t so dammed productive, we would all be better off!”
Stagflation is a hostile environment for investors. As discussed above, Keynesian policies require that the public sector siphon off resources from the private sector, thereby reducing the ability of private agents to generate economic profits. So-called ‘financial repression’, a more overt seizure of private resources by the public sector, is by design and intent hostile for investors. Regardless of how you choose to think about it, stagflation reveals previously unseen resource misallocations. As these become apparent, investors adjust financial asset prices accordingly. (Perhaps this is now getting under way. The Dow fell almost 500 points last week.)
The most recent historical period of prolonged stagflation was the 1970s, although there have been briefer episodes since in various countries. Focusing here on the US, although there was a large stock market decline in 1973-4, the market subsequently recovered these losses and then roughly doubled in value. The bond market, by contrast, held up during the first half of the decade but, as stagnation gradually turned into stagflation, bonds sold off and were sharply outperformed by stocks.
That should be no surprise, as inflation erodes the nominally fixed value of bonds. Stock prices, however, can rise along with the general price level along as corporate revenues and profits also rise. It would seem safe to conclude, therefore, that in the event stagflationary conditions intensify from here, stocks will outperform bonds.
While that might be a safe conclusion, it is not a terribly helpful one. Sure, stocks might be able to outperform bonds in stagflation but, when adjusted for the inflation, in real terms they can still lose value. Indeed, in the 1970s, stock market valuations failed to keep pace with the accelerating inflation. Cash, in other words, was the better ‘investment’ option and, naturally, a far less volatile one.
Best of all, however, would have been to avoid financial assets and cash altogether and instead to accumulate real assets, such as gold and oil. (Legendary investors John Exter and John van Eck did precisely this.) The chart below shows the total returns of all of the above and the relative performance of stocks, bonds and cash appears irrelevant when compared to the soaring prices of gold and oil, both of which rose roughly tenfold.
Real vs nominal asset prices in stagflation (Jan 1971 = 100). Source: Bloomberg; Amphora
Some readers might be sceptical that, from their current starting point, gold, oil or other commodity prices could rise tenfold in price from here. Oil at $100 per barrel sounds expensive to those (such as I) who remember the many years when oil fluctuated around $20. 
Gold priced at $1300 also seems expensive compared to the sub-$300 price fetched by UK Chancellor Brown in the early 2000s. In both cases, prices have risen by a factor of 4-5x. Note that this is the rough order of magnitude that gold and oil rose into the mid-1970s. But it was not until the late 1970s that both really took off, leaving financial assets far behind.
If anything, a persuasive case can be made that the potential for gold, oil and other commodity prices to outperform stocks and bonds is higher today than it was in the mid-1970s. Monetary policies around the world are generally more expansionary. Government debt burdens and deficits are far larger. If Keynesian policies caused the 1970s stagflation, then the steroid injection of aggressive Keynesian policies post-2008 should eventually result in something even more spectacular.
While overweighting commodities can be an effective, defensive investment strategy for a stagflationary future, it is important to consider how best to implement this. Here at Amphora, we provide investors with an advisory service for constructing commodity portfolios. Most benchmark commodity indices and the ETFs tracking them are not well designed as investment vehicles for a variety of reasons. In particular, they do not provide for efficient diversification and their weightings are not well-specified to a stagflationary environment. With a few tweaks, however, these disadvantages can be remedied, enabling a commodity portfolio to produce the desired results.
For those inclined to trade commodities actively, and relative to each other, there are an unusual number of opportunities at present. First, grains are now unusually cheap, especially corn. This is understandable given current global weather patterns supportive of high yields, but beyond a certain point producers are fully hedged and/or are considering withholding some production to sell once prices recover. That point is likely now close.
Second, taking a look at tropical products, cotton has resumed the sharp slide that began earlier this year. As is the case with grains, we are likely nearing the point where producer hedging and/or holding out for higher prices will support the price. By contrast, cocoa prices continue their rise and I note that several major chocolate manufacturers have recently increased prices sharply to maintain margins. That is a classic indication that prices are near a peak.
Third, livestock remains expensive. Hog prices have finally begun to correct lower but cattle prices are at record highs. There are major herd supply issues that are not easily resolved in the near-term but consumers are highly price sensitive in the current environment and substitution into pork or poultry products is almost certainly now taking place around the margins. Left to run for awhile, this is likely to place a lid on cattle prices, although I do expect them to remain elevated for a sustained period until herds have had a chance to re-build.
Fourth, following a brief correction lower several weeks ago, palladium prices have risen back near to their previous highs of just under $900 per ounce. Palladium now appears expensive relative to near-substitute platinum; to precious and base metals generally; and relative to industrial commodities. The primary source of demand, autocatalysts, has remained strong due to auto production, but recent reports of rising unsold dealer inventory in a handful of major countries, including the US, may soon weaken demand. In the event that the fastest growing major auto markets – the BRICS – begin to slow, then a sharp decline in palladium to under $700 is likely.
Finally, a quick word on silver and gold. While both have tremendous potential to rise in a stagflationary environment, it is worth noting that, following a three-year correction, they appear to have found long-term support. Thus I believe there is both near-term and well as longer-term potential and I would once again recommend overweighting both vs industrial commodities.
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Jul 23

6 Stupid Claims About China’s Gold Demand

Gold Price Comments Off on 6 Stupid Claims About China’s Gold Demand
Don’t worry about the gold price, says this Western analyst. China’s got your back…

I DON’T want to say that mainstream analysts are stupid when it comes to China’s gold habits, writes Jeff Clark, senior precious metals analyst and editor of Big Gold at Casey Research.
But I did look up how to say that word in Chinese…
One report claims, for example, that gold demand in China is down because the Yuan has fallen and made the metal more expensive in the country. Sounds reasonable, and it has a grain of truth to it.
But as you’ll see below, it completely misses the bigger picture, because it overlooks a major development with how the country now imports precious metals.
I’ve seen so many misleading headlines over the last couple months that I thought it time to correct some of the misconceptions. I’ll let you decide if mainstream North American analysts are stupid or not.
The basis for the misunderstanding starts with the fact that the Chinese think differently about gold. They view gold in the context of its role throughout history and dismiss the Western economist who arrogantly declares it an outdated relic. They buy in preparation for a new monetary order – not as a trade they hope earns them a profit.
Combine gold’s historical role with current events, and we would all do well to view our holdings in a slightly more “Chinese” light, one that will give us a more accurate indication of whether we have enough, of what purpose it will actually serve in our portfolio, and maybe even when we should sell (or not).
The horizon is full of flashing indicators that signal the Chinese view of gold is more prudent for what lies ahead. Gold will be less about “making money” and more about preparing for a new international monetary system that will come with historic consequences to our way of life.
With that context in mind, let’s contrast some recent Western headlines with what’s really happening on the ground in China. Consider the big picture message behind these developments and see how well your portfolio is geared for a “Chinese” future…
#1. “Gold Demand in China Is Falling”
This headline comes from mainstream claims that China is buying less gold this year than last. The International Business Times cites a 30% drop in demand during the “Golden Week” holiday period in May. Many articles point to lower net imports through Hong Kong in the second quarter of the year. “The buying frenzy, triggered by a price slump last April, has not been repeated this year,” reports Kitco.
However, these articles overlook the fact that the Chinese government now accepts gold imports directly into Beijing.
In other words, some of the gold that normally went through Hong Kong is instead shipped to the capital. Bypassing the normal trade routes means these shipments are essentially done in secret. This makes the Western headline misleading at best, and at worst could lead investors to make incorrect decisions about gold’s future.
China may have made this move specifically so its import figures can’t be tracked. It allows Beijing to continue accumulating physical gold without the rest of us knowing the amounts. This move doesn’t imply demand is falling – just the opposite.
And don’t forget that China is already the largest gold producer in the world. It is now reported to have the second largest in-ground gold resource in the world. China does not export gold in any meaningful amount. So even if it were true that recorded imports are falling, it would not necessarily mean that Chinese demand has fallen, nor that China has stopped accumulating gold.
#2. “China Didn’t Announce an Increase in Reserves as Expected”
A number of analysts (and gold bugs) expected China to announce an update on their gold reserves in April. That’s because it’s widely believed China reports every five years, and the last report was in April 2009. This is not only inaccurate, it misses a crucial point.
First, Beijing publicly reported their gold reserve amounts in the following years:
  • 500 tonnes at the end of 2001;
  • 600 tonnes at the end of 2002;
  • 1,054 tonnes in April 2009.
Prior to this, China didn’t report any change for over 20 years; it reported 395 tonnes from 1980 to 2001. There is no five-year schedule. There is no schedule at all. They’ll report whenever they want, and – this is the crucial point – probably not until it is politically expedient to do so.
Depending on the amount, the news could be a major catalyst for the gold market. Why would the Chinese want to say anything that might drive gold prices upwards, if they are still buying?
#3. “Even with All Their Buying, China’s Gold Reserve Ratio Is Still Low”
Almost every report you’ll read about gold reserves measures them in relation to their total reserves. The US, for example, has 73% of its reserves in gold, while China officially has just 1.3%. Even the World Gold Council reports it this way.
But this calculation is misleading. The US has minimal foreign currency reserves – and China has over $4 trillion. The denominators are vastly different.
A more practical measure is to compare gold reserves to GDP. This would tell us how much gold would be available to support the economy in the event of a global currency crisis, a major reason for having foreign reserves in the first place and something Chinese leaders are clearly preparing for.
The following table shows the top six holders of gold in GDP terms. (Eurozone countries are combined into one.) Notice what happens to China’s gold-to-GDP ratio when their holdings move from the last-reported 1,054-tonne figure to an estimated 4,500 tonnes (a reasonable figure based on import data).
At 4,500 tonnes, the ratio shows China would be on par with the top gold holders in the world. In fact, they would hold more gold than every country except the US (assuming the US and EU have all the gold they say they have). This is probably a more realistic gauge of how they determine if they’re closing in on their goals.
This line of thinking assumes China’s leaders have a set goal for how much gold they want to accumulate, which may or may not be the case. My estimate of 4,500 tonnes of current gold reserves might be high, but it may also be much less than whatever may ultimately satisfy China’s ambitions. Sooner or later, though, they’ll tell us what they have, but as above, that will be when it works to China’s benefit.
#4. “The Gold Price Is Weak Because Chinese GDP Growth Is Slowing”
Most mainstream analysts point to the slowing pace of China’s economic growth as one big reason the gold price hasn’t broken out of its trading range. China is the world’s largest gold consumer, so on the surface this would seem to make sense. But is there a direct connection between China’s GDP and the gold price?
Over the last six years, there has been a very slight inverse correlation (-0.07) between Chinese GDP and the gold price, meaning they act differently slightly more often than they act the same. Thus, the Western belief characterized above is inaccurate. The data signal that, if China’s economy were to slow, gold demand won’t necessarily decline.
The fact is that demand is projected to grow for reasons largely unrelated to whether their GDP ticks up or down. The World Gold Council estimates that China’s middle class is expected to grow by 200 million people, to 500 million, within six years. (The entire population of the US is only 316 million.) They thus project that private sector demand for gold will increase 25% by 2017, due to rising incomes, bigger savings accounts, and continued rapid urbanization. (170 cities now have over one million inhabitants.) Throw in China’s deep-seated cultural affinity for gold and a supportive government, and the overall trend for gold demand in China is up.
#5. “The Gold Price Is Determined at the Comex, Not in China”
One lament from gold bugs is that the price of gold – regardless of how much people pay for physical metal around the world – is largely a function of what happens at the Comex in New York.
One reason this is true is that the West trades in gold derivatives, while the Shanghai Gold Exchange (SGE) primarily trades in physical metal. The Comex can thus have an outsized impact on the price, compared to the amount of metal physically changing hands. Further, volume at the SGE is thin, compared to the Comex.
But a shift is underway. In May, China approached foreign bullion banks and gold producers to participate in a global gold exchange in Shanghai, because as one analyst put it, “The world’s top producer and importer of the metal seeks greater influence over pricing.” The invited bullion banks include HSBC, Standard Bank, Standard Chartered, Bank of Nova Scotia, and the Australia and New Zealand Banking Group (ANZ). They’ve also asked producing companies, foreign institutions, and private investors to participate.
The global trading platform was launched in the city’s “pilot free-trade zone,” which could eventually challenge the dominance of New York and London.
This is not a proposal; it is already underway. Further, the enormous amount of bullion China continues to buy reduces trading volume in North America. The Chinese don’t sell, so that metal won’t come back into the market anytime soon, if ever. This concern has already been publicly voiced by some on Wall Street, which gives you an idea of how real this trend is.
There are other related events, but the point is that going forward, China will have increasing sway over the gold price (as will other countries: the Dubai Gold and Commodities Exchange is to begin a spot gold contract within three months).
And that’s a good thing, in our view.
#6. “Don’t Be Ridiculous; the US Dollar Isn’t Going to Collapse”
In spite of all the warning signs, the US Dollar is still the backbone of global trading. “It’s the go-to currency everywhere in the world,” say government economists. When a gold bug (or anyone else) claims the Dollar is doomed, they laugh.
But who will get the last laugh?
You may have read about the historic energy deal recently made between Chinese President Xi Jinping and Russian President Vladimir Putin. Over the next 30 years, about $400 billion of natural gas from Siberia will be exported to China. Roughly 25% of China’s energy needs will be met by 2018 from this one deal. The construction project will be one of the largest in the world. The contract allows for further increases, and it opens Russian access to other Asian countries as well. This is big.
The twist is that transactions will not be in US Dollars, but in Yuan and rubles. This is a serious blow to the petroDollar.
While this is a major geopolitical shift, it is part of a larger trend already in motion:
President Jinping proposed a brand-new security system at the recent Asian Cooperation Conference that is to include all of Asia, along with Russia and Iran, and exclude the US and EU.
Gazprom has signed agreements with consumers to switch from Dollars to Euros for payments. The head of the company said that nine of ten consumers have agreed to switch to Euros.
Putin told foreign journalists at the St. Petersburg International Economic Forum that “China and Russia will consider further steps to shift to the use of national currencies in bilateral transactions.” In fact, a Yuan-ruble swap facility that excludes the greenback has already been set up.
Beijing and Moscow have created a joint ratings agency and are now “ready for transactions…in Rubles and Yuan,” said the Russian Finance Minister Anton Siluanov. Many Russian companies have already switched contracts to Yuan, partly to escape Western sanctions.
Beijing already has in place numerous agreements with major trading partners, such as Brazil and the Eurozone, that bypass the Dollar.
Brazil, Russia, India, China, and South Africa (the BRICS countries) announced last week that they are “seeking alternatives to the existing world order.” The five countries unveiled a $100 billion fund to fight financial crises, their version of the IMF. They will also launch a World Bank alternative, a new bank that will make loans for infrastructure projects across the developing world.
You don’t need a crystal ball to see the future for the US Dollar; the trend is clearly moving against it. An increasing amount of global trade will be done in other currencies, including the Yuan, which will steadily weaken the demand for Dollars.
The shift will be chaotic at times. Transitions this big come with complications, and not one of them will be good for the Dollar. And there will be consequences for every Dollar-based investment. US-Dollar holders can only hope this process will be gradual. If it happens suddenly, all US-Dollar based assets will suffer catastrophic consequences.
In his new book, The Death of Money, Jim Rickards says he believes this is exactly what will happen. The clearest result for all US citizens will be high inflation, perhaps at runaway levels – and much higher gold prices.
Only a deflationary bust could keep the gold price from going higher at some point. That is still entirely possible, yet even in that scenario, gold could “win” as most other assets crash. Otherwise, I’m convinced a mid-four-figure price of gold is in the cards.
But remember: It’s not about the price. It’s about the role gold will serve protecting wealth during a major currency upheaval that will severely impact everyone’s finances, investments, and standard of living.
Most advisors who look out to the horizon and see the same future China sees believe you should hold 20% of your investable assets in physical gold bullion. I agree. Anything less will probably not provide the kind of asset and lifestyle protection you’ll need. In the meantime, don’t worry about the gold price. China’s got your back.
We think you don’t have to worry about silver either, because we think it holds even greater potential for investors. In the July Big Gold, we show why we’re so bullish on gold’s little cousin, provide two silver bullion discounts exclusively for subscribers, and name our top silver pick of the year. Get it all with a risk-free trial to our inexpensive Big Gold newsletter.
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Jul 16

Commodities Win First-Half 2014

Gold Price Comments Off on Commodities Win First-Half 2014
Six months into 2014, here’s how the commodity markets look today…

WHAT a difference six months can make, writes Frank Holmes at US Global Investors.
After a disappointing 2013, the commodities market came roaring back full throttle, outperforming the S&P 500 Index by more than 4 percentage points and 10-year Treasury bonds by more than 6.
Leading the rally was nickel, delivering a 37.14% return, followed by palladium (17.70%) and gold (10.90%). Nickel also saw the largest gain from last year, climbing more than 55 points to settle close to $19,000 per metric tonne. Gold jumped 38 percentage points to $1,327 an ounce, and palladium rose 16 points to $843 an ounce.
At the back of the herd lagged lead, copper and wheat, which was the best performer only two short years ago.
Below you can see the 2014 halftime edition of our periodic table of commodity returns, which has proven to be a perennial favorite among our investors.
That commodity prices often fluctuate so wildly supports the need to have your investments in the resources space diversified and actively managed by an experienced team of professional investors. Simply put, there are far too many worldly factors – some of them political, others acts of God, all tugging and pulling at the market in tandem – for any one person to reasonably keep track of. It’s important to have a limber group of managers and analysts with the expertise and diligence to monitor and anticipate the most pressing global trends. 
What we know is that now many investors have become bullish on resources. At a conference in New York at the end of last month, Credit Suisse polled 350 investors and found that 42% of them were planning to be overweight in commodities in the coming months. For some perspective, when the same question was asked of them the previous year, only 19% had a rosy attitude toward commodities.
As I said, what a difference six months – or, in this case, a year – can make. With money flowing back into commodities, the market is finally trying to reverse the downtrend that we’ve been up against since 2011.
As usual, government policy is often a precursor to change. Nowhere did we see this adage in action more transparently this year than in Indonesia, whose government shocked the market in January by enacting an outright ban on nickel ore exports. Because the Southeast Asian country is the world’s second-largest producer of nickel ore, accounting for about a fifth of global supply, any alteration to its export policy was bound to send far-reaching ripples throughout the market.
China, one of the leading importers of not just Indonesian nickel but other global raw materials as well, reacted by stockpiling the silvery-white metal, 75% of which is used worldwide in stainless steel production. This in turn encouraged investors to drive prices even higher out of fear of a supply shortage.
A repeal of the export ban is unlikely to happen in the near-term, as both Indonesian presidential contenders, Joko Widodo and Prabowo Subianto, who are both claiming victory in the recent election, favor its continuation. We will keep our eyes on nickel, as a correction might very well come when and if the ban is ever rescinded.
Prices of the platinum group metals (PGMs) hit three-year highs following the double whammy of a five-month-long miner strike in South Africa and trade sanctions against Russia, the world’s leading producer of palladium. Fear of a shortage in PGMs, which are essential to the production of catalytic converters in automobiles, drove prices skyrocketing.
This comes at a time when US auto sales have surged to 16.9 million in June alone, an increase of 9.2% over the same time last year. Auto manufacturing is expected to grow 10.3% in the third quarter, according to International Strategy & Investment (ISS).
Although the labor strike ended last month, PGM production cannot reasonably resume within the next three to five months. And with a separate strike underway, this one led by the National Metalworkers of South Africa, country leaders fear yet another economic setback that has already threatened a third of South Africa’s manufacturing output.
Regarding gold, we believe we intimately understand the dynamics of both the Love and Fear Trade in the global goldmarket. We also know how to read and act on China’s positive purchasing managers index (PMI), which has recently hit a six-month high of 51. Any number over 50, of course, indicates strong growth in the manufacturing sector. China is already the world’s largest producer and consumer of gold, and because its middle class is swelling in rank – the country is expected to have over 670 million middle class citizens early next decade – gold sales should remain robust.
Besides China, other global drivers of gold consumption at this time include India and the Middle East. Diwali – otherwise known as the Indian Festival of Lights – Christmas and other international celebrations encourage generous giving of gifts, of which gold jewelry is one of the most traditional and popular. Ramadan, scheduled to end on July 28, involves a type of alms-giving called zakat, which is one of the Five Pillars of Islam. Zakat is obligatory for all observant Muslims, who handsomely give precious metals such as gold to those in economic hardship.
“So we’re coming to that trough on a seasonal pattern, and that seasonal pattern is predominated by what I call the Love Trade, where you have jewelry demand, et cetera, coming out of Asia, Middle East and India…And this is the first time that we had what they call the Flash HSBC PMI. And this is very important for job creation and GDP per capita rising, and that’s highly correlated with consumption of gold for the jewelry trade. So the second half [of 2014] looks great, and I think it’s also very important for all exports of any resources.”
Although not one of the top leaders in the first half, crude oil deserves a shout-out. Its 7.06% annual return is closing in on the 7.19% return in 2013, when oil was the second-best performer. Because of unrest in Iraq, North Sea Brent crude has set a record for trading between $107 and $112 a barrel for 12 consecutive months, handily beating the 170 consecutive days in 2008 when it traded over $100 a barrel.
In its monthly energy report, the US Energy Information Administration (EIA) forecasts that 2015 will represent the highest level of West Texas Intermediate (WTI) crude production since 1972. Global consumption of oil, driven largely by China once again, is expected to reach 94 million barrels a day (bbl/d) by the end of next year.
Global Resources Fund (MUTF:PSPFX) portfolio manager Brian Hicks reiterates these points on why we are bullish in light of the current domestic oil production boom:
“Within our portfolio, we are investing heavily in the shales through upstream oil and gas companies, oil services companies and equipment companies. Shale is transformational; it is really changing the energy landscape. Almost overnight, companies are developing resources that are long-lived and repeatable. Remember, only five years ago we were talking about peak oil. Now, we’re producing roughly 8.4 million bbl/d. That’s the highest we’ve seen since the mid-’80s. It is a trend that is going to continue.”
Even though the commodities market has so far exceeded everyone’s expectations this year, especially following a lackluster 2013, a correction could occur with little warning. That’s why the portfolio managers of PSPFX, Gold and Precious Metals Fund (MUTF:USERX) and our World Precious Minerals Fund (MUTF:UNWPX) are constantly looking out for opportunities and threats as well as ensuring that the fund is optimally diversified to protect against changes in the market.
For now, however, it appears as if resources could continue their strong performance for at least the near-term and hopefully much longer.
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