What's Driving Gold and Gold Stocks: Part 1

Gold and gold stocks have been hit hard in recent days. In part one we examine the reasons as to why, and in part two cover why gold stocks could be one of the biggest trades of 2009.

Gold and gold stocks have been hammered as of late. The yellow metal took a header on Monday, with the futures closing right on the 200-day exponential moving average. If that support doesn’t hold today (Tuesday), gold may even be trading lower by the time you read this.

So what’s going on exactly?

There are a few factors at work at here. To skip ahead a bit, there is still strong reason to believe gold stocks could be one of the best trades of the year – but in the short run, the environment for gold looks challenging.

The IMF Bogey

One old bogey that has come out of the woodwork is the prospect of IMF gold sales. At the recent meeting of the G-20 in London, there was general agreement that the IMF (International Monetary Fund) should sell just over 403 tons of gold to free up cash for loans to poor countries.

Yawn.... the “IMF to Sell Gold” headline makes for much better press than the actual details.

For one thing, 403 tons of gold is just not that much. We’re talking roughly $11 billion worth at today’s prices. That’s a drop in the bucket, especially compared to China’s roughly $2 trillion pile of reserves... less than one percent of which are held in gold.

(For more detail on the relatively tiny gold holdings of many of the world’s central banks, see the Feb. 24 Taipan Daily piece “Why the IMF and Fort Knox Won’t Put the Hurt on Gold.”)

For another thing, the prospect of IMF sales is not new. The IMF has actually been trying to sell gold for more than two years. Part of why it hasn’t been able to do so is because authorizing the sales requires an 85% majority vote from the IMF’s 185 member countries.

On top of that 85% hurdle, the United States basically holds veto power over any IMF gold sales measure (because America’s proportional voting rights are so large). In that regard, the U.S. government has informed the IMF that, by order of law, authorization from Congress is required for any gold sale to go ahead. (Can you imagine Turbo Timmy making that request, to this Congress, in this climate? Ron Paul would have a field day.)

So any approved IMF gold sale would be small, in quantities easily absorbed by countries like Russia or China (who have openly stated a distaste for their overlarge dollar holdings). Any sale would further require 85% approval, plus approval from the United States Congress... and last but not least such sales, if they happened, would probably be disbursed over many years. The remaining 3,200 tons of gold the IMF holds represent quota requirements from member countries and cannot legally be sold.

But, still, gold has been sinking like a stone. What else could be the problem?

Ready to Scrap

Another factor hurting gold in the short term is “gold scrap,” or scrap sales. Private holders of jewelry and trinkets, particularly in Turkey, the Middle East and Asia, have been stepping up and selling their scrap gold.

India, the “world’s largest gold buyer by a wide margin,” has even stopped importing “for the first time in 10 years,” the Financial Times reports. In February and March India saw zero gold imports, while January imports came in light. Vietnam and Thailand, normally reliable buyers of gold, have also been selling. Stepped-up scrap sales have even put Asia scrap sales at a discount to the standard London quote.

It’s important to point out that many of these scrap sales are driven by distress more than any sense of market timing. Unemployment woes and rising food costs have forced hard-up Asian families to dip into their emergency stashes. Traders have further noted that these scrap sales seem sensitive to price. As the gold price per ounce fell towards $900 and below, scrap sales volume saw a clear decline.

Mark-to-Whatever

Yet another factor weighing on gold has been the suspension of “mark-to-market” accounting rules.

Last week America’s FASB (Financial Accounting Standards Board) bowed to pressure from Wall Street and loosened up mark-to-market accounting rules, causing a huge sigh of relief from the banks. Here is how I explained it to Macro Trader members on Friday:

Part of the reason stocks rallied big on Thursday was a suspension of “mark-to-market” accounting rules.

In plain English, this means the banks will no longer have to use real-time pricing for the stinky stuff on their balance sheets. They’ll be able to “estimate” what the toxic assets should be worth instead.

This is sort of like a homeowner saying “well, my house might not be saleable in this tough real estate market, but in a better market I’m sure it would be worth, oh, $300,000... so that’s what I’ll say it’s worth for now...”

Some people think the suspension of mark-to-market rules for bank assets is a smart idea. Others think it’s a terrible idea. Either way, it’s pretty bullish for the financials, at least in the short term.

Stocks also rallied [recently] on news of a potential trillion dollar injection into the IMF (International Monetary Fund), and the general perception that the G-20 meeting in London was a success.

The mark-to-market change is basically a cheap magic trick. The banks may benefit from the opportunity to abandon real-world accounting in favor of fantasy-world accounting, but toxic assets are still toxic assets. Smoke and mirrors won’t change that.

Hot Money Rotation

In sum, the current weakness in gold and gold stocks is all about short-term perceptions (with the exception of increased pressure from scrap sales, which remain sensitive to distress and price). The IMF news is more hype than substance, and the abandoning of mark-to-market accounting rules is more a tacit admission of how ugly the picture still looks for banks, rather than a concrete step towards fixing the problem.

Meanwhile, rally-happy traders saw the chance to buy up risky assets on the back of mark-to-market suspension and good G-20 news. As a result of the major move we just saw – the biggest 4-week rally in the S&P 500 since 1933 – areas of the market that had previously suffered from lack of liquidity, like high-yield debt, commercial real estate assets and so forth, caught a huge bid. There was a fast-and-furious hot money rotation out of “crisis insurance” type assets (like gold and gold stocks) and into “woohoo let’s party!” type assets (like bank stocks and high-yield debt).

That wraps up the near-term end of things as to why gold (and thus gold stocks) are out of favor right now.

Tomorrow I’ll share my reasoning as to why gold and gold stocks could still be setting up for one of the biggest trades of the year.

Comments

[RUSSIANFM:]

Yawn Yawn....another person touting to buy gold...you can argue and justify why it SHOULD be a buy all you like - but that will not move it back up. There are far cheaper ways to play the reflation angle than buying gold. I argue that you should be buying base metals to play that theme - these metals actually have a use, and will play a real-life part in government spending plans on infrastructure in particular. They are also trading 70% off their highs, rather than gold which is only 10% off the highs.

"That wraps up the near-term end of things as to why gold (and thus gold stocks) are out of favor right now."

10% off the highs is not 'Out-of-favour'...

Apr 08 09:54 AM

[gotnochips:]

EXCELLENT article focusing on gold. I notice the focus is gold, not "base metals" or cars or wheat; a very bottom-line, timely explanation,

Apr 08 11:01 AM

[Conan the B...:]

gotnochips: so far all he has said was wait til tommorow.

Gold is going nowhere but down unless all of the other things you mention go Up. That's the Inflationary aspect you are talking about above. Additionally if Risk Aversion continues to go down, both the Dollar and Gold will go Down as well.

So far that's 2 reason's for a sustained down move in Gold. On the flip side of the coin is the USD drop, if all of the other commodities that you don't like surge, especially Oil. Then Gold will decouple from the dollar, stabilize and Move up.

Last year's proposed IMF sales were based on the Funding available. The G20 fixed that, Sales could be triple that amount.

Apr 08 12:43 PM

[ibejack:]

One thing gold proved throughout this crisis: It is still the world's number 1 safehaven. That doesn't tell us where the price is going from here but looking back, gold behaved exactly as it should. That's why most people should continue to hold 10-15% in gold and not sale it.

Apr 08 02:34 PM

[yellowhoard:]

Go to a coin shop and look around yourself. 4:1 sellers of scrap to buyers of coins. It is a perverse barometer, but it explains much.

It breaks my heart to see people doing this right now. The inevitable parabolic rise in gold will see a reversal of this ratio.

Apr 08 03:53 PM

[Roger Knights:]

"Last year's proposed IMF sales were based on the Funding available. The G20 fixed that, Sales could be triple that amount."

Huh? Isn't the IMF proposing to sell the same 403 tons they talked about previously? And why would they need funding to sell gold?

Apr 08 10:22 PM

[Conan the B...:]

RK: The IMF's funding courtesy of the G20 went up dramatically. Much larger than anyone anticipated plus another 50% and they were told if more was needed, it would be provided.

$1.1 Trillion and counting, the funding has usually been in the form of Gold, when they need cash they sell Gold. This money will be to help the emerging markets whether Asian or Eastern Bloc who are not getting help elsewhere. Latvia, Ukraine, etc.

That tonnage is last years news, I believe all the IMF had to work with Was $250 Billion. IF the Czechs need $40 Billion, $40 billion in Gold goes up for sale. $50 Billion for Ukraine...ditto and they have $1.1 Trillion to work with, 1 Billion oz of Gold entering the Market as Needed. If the IMF runs out, a New round of financing will be provided.

The IMF is now the Lender to those in need who owe Western Europe, the USA etc, can not repay but need more help.

I guess the G20 was such a nonevent, that this was ignored by many gold investors at SA, it sure as hell hasn't been ignored by the Gold markets.

Its going to be an Unknown Gold overhang, you won't know when it will come, but it will.

One more thing about the 3 amigos: Soros, Faber and Mobius. Soros=currency trader, Faber =Commodity Trader, Mobius/Templeton Funds= Stock market investor.

Which of the above would be a better expert in assessing stock markets?

Apr 09 02:46 AM

[sorgmot:]

Let us look at history for a few moments.

Gold is the strongest currency on planet Earth.

It is stronger than the Swiss Franc.

The Swiss Franc traded at $0,20 in in 1950 and at about $1.00 in 2008. That represents a 5 times increase against the US Dollar.
The Swiss Franc fell over the years in terms of real assets lick copper, steel, aluminum, and yes gold, Let us say that gold went up 10 times against the US dollar over 60 years to 2008.

Unfortunately, gold prices in US $'s were manipulated by the USA Federal Government. One could say that the US $ price of gold should have gone up 10 times since 1960 and 100 times since 1900. The end game is that the 2009 price of gold at 1000 per ounce in US$ is a reasonable number and not too high based on the inflation in US$ price inflation of other assets.

Set aside the discussion of the causes of the big waves and long pauses in the pattern of gold prices in US$ for another day.

Where does the US $ to gold price ratio go now and in the years 2009 to 2020.? Answer, it doubles. Why?

Nations in Europe and Asia will find it advantageous to run their currencies up against the US$ to get lower cost food products and more for products they sell to the US market.. The USA is an industrial wreck with IOU's beyond count. The USA put out worthless paper IOU's in the years 2002 to 2009.which were bought by really stupid governments and their banks all over the world including the USA. Once burned, long term frightened.

Good luck.


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Apr 09 10:54 AM

[HBWOW:]

A year ago, the word "manipulation" as referred to insane volatility of the market was scoffed at, can't happen, you're crazy BUT now this word is being used in a majority of market editorials and the TV news channels reportings. Scheduled sell offs by market categories is prevalent daily regardless of individual firm financial stats or specific breaking news WHICH normally are the causes for a stock's movement in price and/or volume. It has not been that many years ago that an investor could fall asleep looking at his stock portfolio's inaction for weeks or even months. The big money boyz are controlling the market at the loss of the general public investors. Add to the out drain of corporate cash by insiders,
a recent look at a large company, reflected treasury stock at over $17 billion, the public investors lose again.

Apr 09 12:32 PM

[RUSSIANFM:]

Anyone made any money being long gold in the last month?

Perhaps I may get some acknowledgement for my recommendation to be long base metals and short gold, instead of the usual thumbs for mentioning the word short and gold in the same sentence.

Apr 16 09:51 AM