Precious Metals: Emotions Still Stronger Than Fundamentals 17 comments
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Co-written by Daniel Gschwend.
There we have it again: During the last few weeks, the commodity sector had a very tough time and hence, the psychology in the metals market especially shifted from super bullish to super bearish. In the middle of the storm, some well-known “gurus” and analysts called it the end of the commodity bull market, as they did several times before when the market went through similarly difficult times. Since the beginning of the bull market in 2001, it was always the wrong call. At least until today.
Internally, we discussed whether to publish another update or whether to inform our investors on an individual basis. As it seems, the markets just went through another heavy correction as the general markets worldwide are still in a very difficult period. Nothing has changed: As mentioned in earlier updates, we never believed that we have seen the end of the credit crisis yet and as everybody realizes now this was the right assumption.
In fact, we believe that this problem will accelerate in the weeks ahead: The twins Fannie Mae (FNM) and Freddie Mac (FRE), the two mortgage giants, have to refinance bonds over USD 223 billion until October 2008, and as we could observe, Freddie Mac already had to pay record interests for a “small” financing of USD 3 billion, which was fixed over the last weeks.
We are convinced that this upcoming event will create some headache for several markets. It is therefore no surprise that GSE Agency spreads are extending to the Treasuries. ALT-A Mortgage paper continues to decline sharply (www.markit.com) and CDS Rate spreads are also widening dangerously.
As the following chart shows, the spread between Treasuries and Corporate Bonds will soon reach the top again, as seen in March when gold reached its all time high above USD 1000. A widening spread is nothing else than a confirmation that investors are becoming risk averse again.
click to enlarge images
This time, however, the price of precious metals decided to go the opposite way and went through a real hurricane. Since the top in March, gold finds itself 21% lower and still shows signs of “strength”, as opposed to the other three precious metals: silver saw its low last week at around USD 12.21, a heavy minus of 43% since March. Even worse is the platinum group: We missed the big uptrend in platinum early this year, and we are now glad to not have participated in the uptrend at this time. Platinum crashed in a matter of weeks from USD 2200 down to below USD 1300. Palladium having lost more than 50% of its value is just completing the story. Certainly, these moves do not represent the real value of these metals.
It is no big news that such a heavy correction had to with a psychological shift of the US dollar, which in the meantime has seen a kind of a revival. We also blame the oil market, which finally decided to take a break (or more?) in its own strong uptrend. It is also not surprising that the correction happened in a month when physical demand and market activity are dull (check seasonal chart later). It is not the first time the sell-off days happen when half of Europe or other important market participants are on holiday.
Still, we decided to publish another special update, as we would like to point out some rather strange developments, which we have not yet observed since the beginning of this bull market:
While almost all articles and analyses point out that the metal markets will see even lower prices due to the recession most western countries are facing, we hear and get the facts that physical demand for gold is just exploding.
What must be encouraging for the gold investor though, particularly for those coming in at the current price level, is that a surge of buying from India, the world's largest gold consumer, seemed to be underpinning prices when they were below $800 an ounce. We saw reports over the past few days/weeks that there had already been a strong turn around in buying interest as the festival and wedding season in India just started. As gold plunged through the $800 mark, the buying accelerated and, according to the Times of India, the sales volume has almost doubled in the past week alone. Interesting enough that the Economic Times of India reported that the recent drop in gold price has led to a flurry of demand, which bullion banks were unprepared for. This has caused a shortage in supply and the market suddenly created an astonishing fact: The demand for paper gold has risen again and ETFs are trading at a premium of between 35% and 5% to the spot price of gold during the last weeks.
We could argue that this market has its own rules and does not reflect the events in the worldwide markets. Before we strengthen such an opinion, we should look at the following press releases, which so far did not get the appropriate attention by the financial newspapers or most analysts:
- The US Mint, the official US coin factory, suspended sales of the 1 oz Gold American Eagle and Gold Buffalo Coins temporally and is refusing orders from authorized Coin dealers. Due to the unprecedented demand for American Eagle Gold 1 oz bullion coins, the inventories have been depleted. (Reuters).
- Gold dealer Blanchard & Co notes that South African Krugerrands are also very hard to come by in the US.
- During the last days, the Royal Canadian Mint asked several brokers/banks if they could lend them some of the gold that the brokers/banks hold in inventory on behalf of a bigger asset management company. As our reliable source mentioned, they asked one bank for 400’000 ounces of gold.
- The holdings in Barclays Silver ETF (SLV) increased over the last week by over USD 1 billion.
It seems to be a worldwide fact that physical supply is extremely tight. And the strong annual gold demand season has only started.
We think this is very bullish for the gold, but the market so far has failed to recognize that strong physical demand. With the upcoming hiccups due to the credit crisis, financial turmoil and all other bullish reasons for gold, we can expect the market to realize that sooner or later – even though we might continue to see a bumpy road for the price of gold and other metals for a few more weeks.
So far we discussed the physical demand. The demand side is still what matters in the general market. It seems that some market participants forgot that a price for goods can also rise on a higher level when demand remains the same: When supply is decreasing.
This is actually a fact since 2001. It is still not a topic in the overall market that we not only have “Peak Oil”, we also have “Peak Metals”. We could blame the press as they prefer to write about Peak Oil as this seems to be a hotter topic.
Companies struggle to keep up with their production. Pan American Silver (PAAS), Harmony (HMY) and Cameco (CCJ), to name a few, are companies which published only during the last week that they will miss their production targets. Companies are still fighting higher costs. Overall production costs for an ounce of gold rose to way over USD 600.
On the other hand, as Peter Munk (Chairman of Barrick Gold (ABX)), mentioned:
This also creates a certain floor in the price of gold at around USD 650/700. If some of the gold bears confirm their assumption that the price of gold will fall to such a level, many mining companies could shut their mines down immediately. This certainly would strain the supply side even further.
This week, according to the Financial Times, the world’s most aggressive company buyer, Xstrata, announced that it had shut down a ferronickel mining and processing operation in the Dominican Republic for at least four months due to soaring energy costs and lower nickel prices. The Swiss-based mining group said that its Falconbridge Dominicana (Falcondo) operation, which each year produced 29,000 tons or 2 per cent of the world's primary nickel, would be suspended until market conditions improved.
With the ongoing credit crisis, young companies especially have big difficulties in get financed. This fact will accelerate the troubles on the supply side even more in the coming years. This could happen sooner than we believe. The mining business seems to be one of the least understood sectors among the general market participants.
Most investors prefer, with valuable arguments, investments in physical gold or in ETFs. We would be a bit prudent with investments in US gold ETFs, as there are open short positions. As Ted Butler remarked:
If you buy a gold ETF from a seller which is opening a short position, is it guaranteed that these certificates are covered with physical gold?
It has been an ongoing debate since Mr. Butler opened that question. The gold stocks have less support by the investors. Most investors are disappointed with their performance as they struggle with rising costs. We do not fully support this opinion as nowadays these stocks are traded on ridiculous levels. The Net Present Values of assets from some North American companies are traded with a 30% discount. And yes, the margins are still small for these companies, but the bigger the leverage if the price of gold rises again. The reserves and resources of a company, a real asset still sitting in the safe called “Earth”, get little recognition by investors. Sooner or later, this represents even more leverage if the stock market realizes these facts in the mining business.
With the ratio between the price of gold and the XAU Mining Index, we realize how cheap the mining stocks are related to the price of gold: It is the second highest ratio level since 1984, just shy of the absolute top from the year 2000, exactly when the gold bull market started.
What We Expect Short- and Midterm
As mentioned, the bumpy ride is not over yet. Gold could be in favor again as we expect the financial crisis to intensify again. The technical indicators show an incredibly oversold valuation, which in itself lets us expect a bigger recovery.
Gold as a product which creates emotions and therefore it is not surprising that it belongs to the sectors with the highest volatility. For months, the volatility of the XAU Mining Index has been above 40 points.
We do not expect the market to finally discover the big supply problem within the next few weeks. These arguments will be used by analysts and others later, once the price of gold has jumped 20% or more. In the meantime, the correlation with oil and the USD will continue.
Our internal short term indicators, which has helped us to find outperformance compared with other funds with similar investment strategies, just indicated a new short term buy signal.
The short term sell signal of the US dollar confirms the buy signal in gold.
Overall, we remain very upbeat that mining stocks are offering great entry points, but we can’t say if the worst is already over. Selective buying in big cap stocks should work out fine. As for the juniors, and particularly the exploration companies, many will not survive, and this can be a positive for the long term. There have been too many companies that never achieved anything in years and only absorbed good money. This also contributed to the mistrust of investors towards this business sector. Once the washout is over, most of the remaining companies will have a very bright future.
We also re-structured our fund’s asset allocation in the last months and significantly added big cap stocks (since this was the market’s first choice) and sold some of our junior and exploration holdings. We are still upbeat about junior and exploration stocks, but we are very selective and only hold on to investments which can survive the current (overdone) washout. We are confident that our fund is very well positioned to fully participate in a market rebound. The change of our fund’s strategy has already proven to be fruitful since we have been able for some time now to outperform some of our main peer group competitors.
We know that the last 12 months have been very confusing and required nerves of steel because of the illogical impacts of the subprime crisis and its after shock, particularly in mining stocks. Nevertheless, it is very important to keep the long term picture in mind, and not to get distracted by short term noise. Long term, we are still in a bull market which should lead to excellent returns in the coming years.
Disclosure: The fund has a position in PAAS and ABX.
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This article has 17 comments:
Where is all the GC Central Banks sold at 1000$,wasn't it bought by dealers who expected to resell it to average Joe for 1500$ in coins,bars,jewelry.
What happened in reality is,the hedgies that bought then futures for 1000$ average took physical delivery as price was lower in a matter of days,they expected to get rid of it sooner and get their money back,but as it didn't happened those same investors today are bleeding and spread various rumors that there is no Gold on earth,that all gold is already sold to Indians,Chinesse,Russi... then in fact each ounce of gold mined since 2000 years ago and before is still here with us in jewelry,coins,watches etc., that was lost is maybe 50% of all mined Gold,but not every second person on earth losses his/hers all Gold.I have my Rolex Daytona 18K n my wrist and expect to have it tomorrow at the same wrist,only if somebody will come at night and cut my hand or still it,then this Rolex will still be somwhere else.
Bottom line,those like me that bought Gold investments in 1998 and sold them in few years time not being greedy made good profit and moved else,those that bought GC at 1000$ probably will never see their money.Greed knows no limits but pressure of the metals will make all those who bought higher sell at a loss,maybe then it will be a right time to buy GC again,but not before,excesses must be liquidated first.
Does anyone here believe Shark has a Rolex?
Perhaps 'some advisers' have determined that your 'change' - in dollar fortunes - does not appear to have any basis whatsoever in fundamentals, and therefore does not, in fact, represent a lasting change at all, but a transient rally to be followed by a crash.
Or did the US government suddenly do a 180 and become the very model of fiscal responsibility when I wasn't looking?? Fat chance.
I love that everyone of your posts (click on his name for proof) begins with, "I have read 2-7, 10-12, 1-15, words......blah , blah blah,". Great to see you doing your part to actually read a post before commenting...
Interesting...
Wise up. Until Obama is elected gold is just another metal in a failing economy. But Obama can spend it into demand. Watch. Z
1. Gold mining supply is still lower than global demand, has been for over a decade
2. The credit crisis isn't getting better, on the contrary its getting worse
3. The US has no choice but to continue to debase the currency, all other nations will, and already are, following suit
4. The average mom and pop citizen hasn't caught on yet, don't believe me? Go ask 100 random people if they invest in gold, the response will shock you.
5. Gold has always been, and will always be the foundation of the global financial system. Bundesbank just admitted it, something you don't see a bank do very often.
www.rapidtrends.com/bl.../