The Start of a Run for Gold

The price of rice doubled in the last 2 months raising fears of fresh outbreaks of social unrest across Asia, where the grain is a staple food for more than 2.5 billion people (See article in FT.com here).

This should come as no surprise since grains, energy, and just about every other commodity prices have risen a minimum of 50% in the last 6 months. And a strong physical demand and lax monetary policy will continue to fuel high commodity prices.

You might have also read that Carlyle Fund and Bear Stearns (BSC) blew up in the past month. Two companies going down is not a cause of concern as companies rise and fall all the time. However, when considering they have about $300 billion worth of mortgage positions with their counterparty sweating, you begin to understand why the New York Fed agreed to advance $30 billion to help JPMorgan (JPM) assume Bear Stearns positions. Last year, I wrote that the mortgage mess was minimum a $2-3 trillion problem. We are about half way through, so expect to still see massive write downs from pension funds, endowments in 2008, together with perhaps another major blow up besides Bear Stearns.

All those bailouts are creating moral hazards and the Fed has no room to raise rates to combat inflation. Monetary instability and fears of inflation are gold's best friends. This is why my focus right now is on precious metals. I expect the mortgage mess climax to take place in 2008, which will more or less correspond to a spectacular rise for gold this year.

Asia barely sneezed at subprime but they sure are catching cold feet on inflation and fever on gold. Technically, at $920/oz Gold is comfortably above previous all times of $850/oz set in 1980. I am very confident the downside is $850-$890/oz. While the upside is anyone's guess, studies suggests a gold price between $1,500 to $2,000/oz based on today's oil and copper price of $100/barrel and $3.7/pound respectively.

Interestingly though, gold juniors as a whole were trading yesterday at their lowest level this decade relative to the price of gold as illustrated in the chart of this article.

It makes no sense that the American mortgage crisis is impacting Canadian gold and resource juniors. One can now margin at 5% to buy oil trusts paying 15% dividend and gold juniors for less than $10/oz in the ground. I am confident the situation will reverse, offset not by higher interest rates but by higher junior stock prices.

Within two months and as soon as we hit the bottom of interest rates, I expect all the hoarded money to spill out looking for a new home as it simply does not pay to park money earning 2% with real inflation running at double digits.

I monitor hundreds of companies every day and pick entry points. In the last 6 months, juniors have decisively bottomed after their prices have been slashed up to 90% in some extreme cases. I am now seeing nice pops here and there like mushrooms on a sunny spring day after the storm. There are many quality junior companies with good cash positions, a low market cap and good prospects. Some of them are featured at GoldMau.

I hope you have enjoyed this update. I invite you to join the gold ride.

Comments

[phdinsuntanning]

is the oil price that keep gold juniors down

[NI123]

Yeah - My question is: If gold is at $900/oz, why can't gold miners make any money? Their cost inputs are too high.... The best bets are juniors who have a good chance of being bought, holding the metal directly, and the GLD and SLV ETFs.

[Malkiel]

Over the last year gold hasn't behaved as the refuge from fire, famine, inflation, etc., that the gold bugs believe because too much of it is owned in leveraged form. Whenever speculators get that margin call at each market crisis point they end up liquidating their gold ETF shares to make margin, driving the price down. For gold not to appreciate in a crisis the way Joe Main Street hopes is not a good selling point for cable tv infomercials...

[L-bow]

A different view:
Gold is typically a scarce metal versus jewelry demand and has relatively limited industrial uses. At the height of the internet boom when we were creating a millionaire a minute (think jewelry purchasers) and what small uses gold has industrially (think conductants), gold was selling from $250-$450 an ounce. Somewhere therein is where gold's combined value as jewelry and industrial uses were perceived then.
Occasionally, as now, gold is viewed as a hedge against inflation or a hedge against uncertainty: On inflation, Gold is up about 42% per year since 2001 with US inflation somewhere between 5 and 9%, making gold light years ahead itself as an inflation hedge. If one is buying gold as a hedge against inflation, then one is buying an asset that has appreciated 300% since 2001 to hedge against 5-9% inflation annually. Strictly odds wise, it would appear better to buy the dollar as a hedge against gold price deflation.
Per gold as a hedge against uncertainty, if things get really bad, gold is virtually useless. Both Hyper-inflation and Hyper-deflation suggest major economic turmoil. In both events, jewelry just does not spring to the forefront. Hard assets in hyper inflation, yes, gold no! Hard assets in times of deflation spells broke.
Additionally, what if, at the moment, real estate, stocks, commodities and soon bond prices (as rates must rise) are falling. Oh, wait a minute, they are! Assume for a moment that food prices are rising at a micro level, but that is simply a lag effect of past increases in the money supply. What if at the macro level they are falling, which will filter down as all commodoties continue to drop, as world economies slow dramatically. What if we have already had inflation and assets are now deflating. Perhaps wealth is and will will be destroyed faster than money is created. Relatively speaking, who is left to borrow following years of free money turbo charged by derivatives?
What if Gold mania like tulip mania is all imaginary and fueled by collective energies. After all, gold has no real use! It is simply ornamental because we have collectively agreed that it either looks cool or implies status. Gold mania, plain and simply, feeds upon itself. Folks jump on the gold train as it begins to move and more more folks pile in until it can no longer budge. The problem is that nobody really knows how much steam the engine has because the steam is all in our heads. The steam is pure illusion making gold's movements even more transparent than with most other investments. However, the known entity at the moment is that the track got real steep and/or the train got real heavy at around the 1000 foot mark, in the face of massive incertainty (Bear Stearns potentially taking down the entire global financial system), and is now around the 900 foot mark, metaphorically speaking. It looks to me at least that something around $1000 an ounce is the max folks were willing to pay as a risk premium for virtually unlimited uncertainty. Knowing that, folks are now jumping off the train, with a few of you trying to persuade them to stay aboard. Curiously, the IMF is evidently npw considering selling vast quantities of gold.
In this sense, trying to convince folks to remain on board a train heading down the mountain in hopes of eventually getting them to the top, when the very real threat of an implosion of the entire world financial system could not get it above the $1000 mark would not seem logical.
Furthermore, assume someone rings your doorbell today and offers to sell you a one ounce gold nugget the size of a gumball for a thousand dollars, would write the check?
Just points to ponder, I could be wrong!

[L-bow]

A different view:
Gold is typically a scarce metal versus jewelry demand and has relatively limited industrial uses. At the height of the internet boom when we were creating a millionaire a minute (think jewelry purchasers) and what small uses gold has industrially (think conductants), gold was selling from $250-$450 an ounce. Somewhere therein is where gold's combined value as jewelry and industrial uses were perceived then.
Occasionally, as now, gold is viewed as a hedge against inflation or a hedge against uncertainty: On inflation, Gold is up about 42% per year since 2001 with US inflation somewhere between 5 and 9%, making gold light years ahead itself as an inflation hedge. If one is buying gold as a hedge against inflation, then one is buying an asset that has appreciated 300% since 2001 to hedge against 5-9% inflation annually. Strictly odds wise, it would appear better to buy the dollar as a hedge against gold price deflation.
Per gold as a hedge against uncertainty, if things get really bad, gold is virtually useless. Both Hyper-inflation and Hyper-deflation suggest major economic turmoil. In both events, jewelry just does not spring to the forefront. Hard assets in hyper inflation, yes, gold no! Hard assets in times of deflation spells broke.
Additionally, what if, at the moment, real estate, stocks, commodities and soon bond prices (as rates must rise) are falling. Oh, wait a minute, they are! Assume for a moment that food prices are rising at a micro level, but that is simply a lag effect of past increases in the money supply. What if at the macro level they are falling, which will filter down as all commodoties continue to drop, as world economies slow dramatically. What if we have already had inflation and things are now deflating. Perhaps wealth is and will will be destroyed faster than money is created. Relatively speaking, who is left to borrow following years of free money turbo charged by derivatives?
What if Gold mania like tulip mania is all imaginary and fueled by collective energies. After all, gold has no real use! It is simply ornamental because we have collectively agreed that it either looks cool or implies status. Gold mania, plain and simply, feeds upon itself. Folks jump on the gold train as it begins to move and more more folks pile in until it can no longer budge. The problem is that nobody really knows how much steam the engine has because the steam is all in out heads. The steam is pure illusion making gold's movements even more transparent than with most other investments. However, the known entity at the moment is that the track got real steep and/or the train got real heavy at around the 1000 foot mark, in the face of massive incertainty (Bear Stearns potentially taking down the entire global financial system), and is now around the 900 foot mark, metaphorically speaking. It looks to me at least that something around $1000 an ounce is the max folks were willing to pay as a risk premium for virtually unlimited uncertainty. Knowing that, folks are now jumping off the train, with a few of you trying to persuade them to stay aboard. Curiously, the IMF is evidently npw considering selling vast quantities of gold.
In this sense, trying to convince folks to remain on board a train heading down the mountain in hopes of eventually getting them to the top, when the very real threat of an implosion of the entire world financial system could not get it above the $1000 mark would not seem logical.
Furthermore, assume someone rings your doorbell today and offers to sell you a one ounce gold nugget the size of a gumball for a thousand dollars, would write the check?
Just points to ponder, I could be wrong!

[foobah]

I'm writing this to clarify my own thinking. Inflation of discretionary items is yesterday's news, but it still has a few months to run. When the drying up of credit takes hold the prices of things -- read housing, electronics, cars -- will drop in the US. The demand for oil and base metals from the developing world will diminish a bit easing the prices, but not enough to cause the prices to collapse. The price of agricultural commodities will continue to increase as may the prices of materials and equipment needed for agriculture. While all this is going on what will the dollar be doing? If it continues to fall relative to important currencies (Swiss franc, Yuan, Yen) gold priced in dollars will go up. If the bottom should fall out of the dollar -- heaven forbid -- gold priced in dollars will go up. Whether gold mining stocks increase in price when all this is going on will depend as much on the level of the DJIA as it does on the price of gold.

[bearfund]

No, I wouldn't, Dan P. Because that gumball doesn't have a respectable hallmark or mint mark and the spot price of gold is not $1000. I'd consider writing him a check for $500 if I were reasonably satisfied by my own inspection that the gumball actually contains one troy ounce of gold, to reflect the risk I am taking. Then I'd have it assayed and if it turns out to be junk I'd stop payment. So your question is silly and hyperbolic.

There are various grades of economic turmoil. At low grades, there may be double-digit inflation as we see now in the US and has happened in Latin America numerous times in recent memory, bank failures, or long periods of recession and stagnation with flat to falling prices, as we've seen recently in Japan. At medium grades, we have hyperinflation (Weimar Germany, Zimbabwe) or long, deep depression (the 1930s, Russia in the Soviet era). At the extremes, we would expect output to collapse almost entirely, with only a minimum of commerce occurring in the production of foodstuffs, timber, metals, and coal, along with transport of same - a return to the pre- or early industrial economy.

Now, ask yourself how gold will work in each scenario. At low grades of turmoil, gold actually tends to outpace its intrinsic value as credit is still available and traders make leveraged bets on future fear. Moreover, the amount of money in the system and its perceived value remain exceedingly high and rising even as the perceived value of assets other than metals declines precipitously. The result is a big run-up in hard asset prices owing more to relative effects than to an increase in absolute value (remember, the market is discounting future turmoil and the price of gold in paper reflects that). We've seen exactly that thus far. In more severe turmoil, gold will continue to outperform in nominal terms but begin to underperform in purchasing power as output collapses. Indeed, that's exactly what happened in the 1930s when the dollar was devalued in a gold-standard monetary system but output declined even in nominal terms. However, the downside risk to holding currency rises greatly as any further deterioration in the underlying economy places the existence of the issuing nation at risk (and with modern communication and alliances, wars and chain reaction collapses are all but certain). With hyperinflation especially, holding currency instead of gold is insane. In extreme collapse scenarios, currency will be worthless. The purchasing power of gold will surely be dramatically less than it is today, because output will be so greatly reduced and the amount of gold unchanged. But given the alternatives, it's the best option: food is perishable, demand for coal and oil will be greatly reduced, currency and other paper will be worth only the value of the heat it produces when burned. Better to have to pay an ounce of gold for a bushel of wheat than to offer a wheelbarrow full of dollars and be shown the door at the point of a rifle. The closest thing we've seen to this was the collapse of the Roman Empire, which had devalued its coinage by over 99%. The empire itself fell apart but the gold and silver that was once in its coins was still there. Most of it remained with the Church and the nobility, which together used the strength of that metal to acquire land and armies and rebuild Europe into what it is today. Today's Church, ECB, and other European treasuries and central banks still own most of that metal.

All that remains is to decide how likely any particular scenario is. If you are a true believer in modern financial wizardry, you shouldn't waste your time trolling gold articles; there are BANK STOCKS for sale out there BELOW BOOK VALUE! GET BUYING!!! If you're merely looking to take advantage of other people's hopes and fears, you're probably like most readers here, looking for places to enter and exit the market profitably (or maybe you're looking to stir up fear so you can cover an ill-advised short position?). Your comment doesn't contain anything investable for such people, nor does it convey your own strategy. You suggest buying dollars to hedge against gold deflation, but why not EUR or CHF or NOK or even RMB? Have you given any thought to the fundamentals underlying the dollar? Clearly not, which makes your comment useless. Finally, if one's a true goldbug, he doesn't care what people like you write; he assumes you're the guy on the other side of his trades, and someday he'll be turning away you and your wheelbarrow full of dollars in your last desperate attempt to buy some food after the American debt bubble explodes and takes the global economy with it. So your comment is neither educational nor investable and will surely be ignored by just about everyone, which I suppose is why you posted it twice?

[User 150045]

Gold "virtually useless" in hyperinflation scenario ? Can't agree Dan P. Hyperinflation implies confetti money and gold moves inversely to paper currency (not just USD) devaluation. The use gold will have in hyperinflationary times will be as the only currency having any value at all. Which is why ownership of it will be outlawed, as it was in the 1930s.

Bill Occam

[L-bow]

"BEARFUND"- No agenda (or emotion) here whatsoever. I am just your regular John Q Citizen considering hedge options and throwing some ideas out in cyberspace to see what comes back. Lots of folks peddling gold these days and I see no harm in a good cyber debate to bring the truth to the surface.
One glaring flaw in your truth though is that gold would might become a medium of exchange: Doubtful, with the minimal amount of "circulating"... gold. Anything might, and has historically become that medium. If at the end of the day, as the pendulum begins to swing and food becomes the critical element, why not fill a room of the house with dry goods, canned goods and peanut butter etc, then once the new currency becomes known, trade for it, with the added benefit of having plenty to eat, and thereby eliminating all uncertainty?
Sounds ridiculous doesn't it? Well, that is exactly what is happening with rice in Asia at the moment. My point is that if the trend continues exponentially and people are starving, the guy with the most rice would be best positioned to buy gold and not the other way around, particularly as gold would be relatively worthless!

[eric hart]

I have a collection of German coins. They're gold and were minted during the hyper-inflationary period of the 20's and 30's, before the currency became confetti.

The German government tried to convince its citizens NOT to trade its paper currency for gold; the government said that to hold the DeutchMark bills was patriotic.

Then the bills became worthless. The people that held the gold DM were able to eat, and not live in dire poverty. Those that only held paper suffered much more.

Many people know this little bit of history, but its quaint and far removed, and felt that it cant happen here. The people I talk to consider this an anomaly, an outlier, and highly improbable.

A historical reading of paper currencies shows the contrary truth: that almost all currencies ever introduced reverted to their intrinsic value. Confetti.

The exceptions are the ones extant.

But the current dollar meltdown has been predicted for decades. It is likely to continue for many years. Soros, Buffett, Rogers, and many people far smarter than I have been explaining the dangers of our bloated nations debt problems for years, and expect this to continue.

My coin collection, by the way, has appreciated in value. A German DM in 1920 was worth about .25 dollar, if I remember correctly. My 20 DM coins would have been worth $5 dollars then.

Today they are worth $225 for the 20 DM gold coin. Thats a 45 fold increase, not incredibly impressive, compared to stocks, but nothing to sneeze at.

More importantly, the paper 20 DM I can buy on e-bay for about $5, before shipping.


Now, which would you rather own? Gold has never been relatively worthless, it is the one currency that has been used throughout 10,000 years of the history of money (in almost every culture).

Food is important as is water, and you need them, no doubt. But its a false dichotomy--you don't need to pick one or the other. Food spoils, and is cumbersome to transport. Diamonds might make a good currency too, as would silver. But gold is one form of a store of value. Why not own food, water, silver, gold and diamonds? (Diamonds are the easiest way to smuggle large amounts of wealth with no electronic trace, but they need to be graded and authenticated) .

[L-bow]

Ok, all of us who posted above are on a desert island, I own all the food and you guy's collectively own all the gold. I have no gold. Who wins? The way I see it, I own you and your gold!

[mark mchugh]

Dan P,

No question - we all need food and water, but we also need currency as a way to balance trading hogs, corn, water or whatever (otherwise stores would really be messy). Gold is scarce, durable and impractical, in other words, the perfect natural currency. Human beings have been forgetting and re-learning this for four thousand years. You can't trust paper money. Think about it.

[DMon707]

It takes oil to mine gold. One South African mining CEO recently said that if gold fell below $800 per troy ounce, at the current oil price it would not be economical for his company to mine it. This may help explain the spread between the price of gold and gold mining equities.