Kristjan Velbri's  Instablog

Back in August, China started publicly endorsing gold and silver as an investment on state sponsored television. Western financial media, but in particular a lot usually made fun of, the gold bugs, were quick to pick up the story and flood every precious metals section on every financial news website with the news from China. Even I wrote a piece on it. I don't consider myself a gold bug, but having taken a look at the fundamentals of gold and silver, I am as convinced as any gold bug that there is huge upside potential for gold and silver. Factor in the frantic money printing all over the world and global economic and social instability, a combination which has historically been positive for the price of gold, and you've got yourself a front page news story. But this is not the end of the story.

When I first wrote about the Chinese disclosing their gold purchases back in April, I was pretty sure that any upside potential these purchases might have were long gone. But then, stories about Chinese government officials openly decrying the US dollar started to surface. Officials from other countries followed suit and German Head of State Angel Merkel dismissed Obama's cries to print more money. But the US didn't care, it kept on monetizing debt and buying up toxic assets from insolvent companies. All of this was followed by the TV commercial story.

The TV commercial story, on its surface, is groundbreaking enough to put a smile on every gold bug's face. But beneath the obvious is something much more powerful. From Lawrence Williams at Mineweb.com:

Chinese state endorsement of gold and silver as good investments means the country can no longer afford to let precious metals prices drop by any significant amount.

If this doesn't make you want to run to gold, consider the fact that the Chinese government has to manage it's way around 1,338,000,000 people, according to the latest estimates for 2009. Civil unrest has been a problem for years with tens of thousands of protests each year occurring all over China, but it is only going to get worse as factories are being closed for various reasons and environmental degradation takes a toll on the health of citizens; unless the government acts in ways to mitigate those problems. One has to realize that the only objective of the Communist Party is to stay in power and the only way to do that is to keep the probability of a revolution, peaceful or not, as close to zero as possible. That government cannot afford to lose the trust of its citizens and it has to, and will, do everything in its power to keep that from happening. Keeping its promises and standing by its words (endorsing gold and silver as an investment) is a part of that.

One also has to consider cultural implications:

‘Losing face' is an important aspect of Chinese psychology and if millions of investors lose out because state-promoted investment in precious metals is not borne out this would be a massive government loss of face and one which is certainly not beyond its capabilities of not allowing to happen.

The Chinese have no problems with keeping a floor under the price of gold and silver, especially considering the huge currency reserves that they have accumulated over the years and their diversification plans which involve the central bank of China and an undisclosed number of Chinese sovereign wealth funds buying up domestic as well as international gold. In effect, the Chinese have issued a massive insurance policy on the price of gold and silver. So there you have it. Considering that China started promoting gold and silver as an investment back in August, one can assume that the current floor is around the price seen in August: 950 in US dollars, 650 in euros, 1130 in Australian dollars, 1030 in Canadian dollars, 570 in pound sterling, 890,000 in Japanese yen. The price of silver was around $14 in August, which means that one ounce of gold bought you 67.85 ounces of silver (use this ratio in case you want to calculate the price of silver in other currencies for the month of August). Over time, I would expect to see the floor price rise as more and more Chinese accumulate gold and silver at higher price levels.

Disclosure: long gold and silver bullion.

At the end of April, the financial media was screaming "sell in May and go away". Just before June they were warning us of the "summer doldrums". In both cases the financial media has emphasized "seasonal weakness" based on historical data. And they are doing it again. September is supposed to be a weak month, again, based on historical performance. Before making any financial decisions based on those warnings, it would be wise to look at what exactly constitutes historical performance.  Historical performance, as influential at it might sound to some who listen to the warnings of the financial media and some bloggers, is nothing but a historical average of all the data that is available. If media tells us that September is a historically weak month for the stock markets then this means nothing more that based on the data that we have to date, the average September has been weak. It doesn't mean that every September has been weak. Based on historical data, the average return in September over the last 100 years has been a negative 0.96%. Of all the 100 Septembers from 1908 to 2008, 68 have brought a negative return. But what about the 42 that haven't? Are you willing to disregard the 42 cases in which September has been a gaining month just because the "odds" are against you?

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“Gold is a commodity that combines the attributes of a currency, financial commodity and general commodity. Despite the declining function of gold as currency in the world, the activeness and development of investment activities with gold as the target indicates that gold still has a strong financial nature and remains an indispensable investment tool. In major financial centers in the world, the gold market, together with the money market, securities market and FX market, constitutes the main part of the financial market.”
- Dr. Zhou Xiaochuan, Governor of the People’s Bank of China, writing in The Alchemist (issue 36, 2004)

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Whether or not the price of gold, as many have been arguing here and elsewhere, is being manipulated or not, interestingly enough, doesn't matter.Gold is told to be an excellent preserver of wealth, especially in rough times like these and I agree with that but I don't think the manipulation hypothesis should be given as much focus as it's been given so far, simply because there is nothing wrong with central and commercial banks occasionally pushing the price lower.

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It is well established that gold and the US dollar are inversely correlated. This rule of thumb is not often broken and traders who hold their free funds in foreign currencies can benefit from that. The dollar has been trending down for months now and last week we saw some gains in the dollar index. Gold, consequently, was down. What if you could benefit from the fall in gold and from the rise in the dollar (compared to other major currencies) at the same time? Well, for non-US traders it's actually quite simple.

I am not a resident of the US, therefore, I don't keep a large amount of my portfolio in dollars to limit my losses from a possible fall in the dollar compared to the euro (which the Estonian kroon is pegged to). When I see a possible trade, I first buy dollars and then buy the stocks. For me and other traders who use the same strategy, the combination of a rising dollar and falling gold prices is very lucrative, because it allows us to benefit from a rise in one asset and a fall in a currency at the same time.

They way to benefit from this is to buy dollar denominated stocks that are inversely correlated to gold. For people with less risk appetite, PowerShares DB Gold Short ETN (DGZ) should be enough. For traders with more risk appetite and knowledge there is the PowerShares DB Gold Double Short ETN (DZZ). Before trading the latter, make sure you know what a 'double short' means. There are plenty of articles on Seeking Alpha about leveraged ETFs.

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In the previous article, I gave an overview of the current situation in the uranium market and why I think it's headed for a new, long term, bull run. Now is the time to take a look at some specific stocks. Uranium, like any other energy source, is in a long term bull market and the investment opportunities presented below are for investors, not traders. That is also the reason why I am not going to give any technicals on the stocks.

As my broker has limited my stock transaction to a relatively few countries, of which Australia and Canada are not a part of, I have limited my field of research to companies listed on the US markets.

Cameco

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