Gold Against Paper, The Crash In Mining Shares And Economic Decline

by: Emmet Kodesh

This article will identify salient features of the PM (precious metals) and miner sector in the context of deepening economic decline. For the latter I again will focus on Europe. In earlier articles I have examined structural problems in our own economy. The datum with which I begin is the crushing of the PM prices by the singularly low guidance on gold ($1450/oz) by Goldman Sachs April 10 and its advice to short sell the metal. The flood of paper shorts triggered a cascade of stops, covering and panic selling. It also initiated a worldwide surge in purchases of physical metal I will note and link to below. This barrage of buying has made hash of Goldman analysts' contention that "conviction in holding gold is quickly waning." Six days later they reiterated their guidance but Tuesday reversed themselves, perhaps seeing the demand their smack down elicited. The recovery of mining share April 24 may indicate that support has been reached and that values are being recognized.

I pose three questions: first, how does surging purchase of physical gold v selling of paper contracts like the SPDR ETF (NYSEARCA:GLD) relate to the deepening decline in Europe documented in the April 22 PMI figures? Second, will increasing liquidity and end-game escalation of fiat fiscal policies that destroy economies with debt suppress the mining sector long term or will the move toward a reserve system that includes gold support recovery of commodities and of PM miners in particular? By some blend of planning and default a new world reserve system is approaching, the question is how soon and under what terms. The flip side of this concern is how long those managing the fiat system can continue to play the game of inflating asset prices before systemic collapse? Even then they might not adopt a gold-anchored monetary system. However, the proliferation of ex-USD bilateral trade agreements would make such isolationism difficult to maintain. Buying patterns help us make sense of these concerns.

If there is another smack-down via short selling or paper liquidation recent patterns indicate that buying of physical assets will again surge. During a discussion of this buying in Resource Investor April 22, Frank Holmes, CEO of Global Investors quotes The Wall Street Journal, "Gold shops from Tokyo to Dubai have witnessed frantic buying of the coins, alongside other items such as gold wedding bracelets. The surge has been triggered by cheaper prices." Stories like this increase awareness of positive views on gold in Asia and support prices.

China Daily reported a similar buying enthusiasm occurring in jewelry stores in Beijing, Shanghai and Guangzhou. Shanghai's newspaper reported that "while gold markets in the United States and Europe saw panic selling, sales of gold bars and jewelry jumped in China as buyers viewed the lower prices as an opportune moment to invest" and purchase gifts. They "continue to view gold as a savings proxy," that is, as a store of value and hedge against inflation, market volatility and paper instruments. Resource Investor headlined, "Strong gold demand in Asia could offset selling in NY and London." Even before the GS hit, observers of the PM space expected Asian buying alone to counteract paper selling in the West. This buying makes a floor and indicates that any drop in bullion prices will be vigorously bought. This adds to very oversold miners and contributes to today's rally. Expect it to extend.

Note that other major banks have issued guidance very different from that of GS. For instance, UBS has a 2013 Au price target of $1740/oz, that already has been revised down on the unlikely assumption of an end to QE. Peter Krauth in the previous link hints at the confluence of Fed "hints" and the first of GS's two estimate drops as strategic moves. As I do, he doubts the chance that QE will cease: the markets would drop. He writes, "the vast majority of analysts consistently estimate [gold prices] too low." In any case, Deutsche Bank has a 2013 Au target of $1637/oz. So the GS guidance that ravaged PMs and miners and caused $billions of losses (nominal for those who watched, real for those who panic sold) seems more like socio-political governance, a fiat-defense agenda than truly valued production, exchange or demand. Volatility may continue buy buying will continue to push up support levels.

On the Shanghai Gold Exchange a staggering 43 tons of gold were purchased April 22. Bloomberg reports that Indian gold buying is expected to rise 36% by June while since the April 10-15 plunge sales from the Perth mint in Western Australia have doubled. "Psychological damage has been done" in the West" commented an analyst but added, "the drop seemed very overdone." This is my view and confirms the urgency of avoiding panic-selling.

Andrew Maguire formerly a watchdog on the LBMA (London Bullion Market Association) says, "I'm not seeing any let-up in physical demand for gold … I have checked the numbers and we are now close to 1000 tons delivery YTD into Shanghai, adding, "I would think it's going to be difficult to get your physical [gold] out" from London warehouses. "I had a large client recently get refused [for delivery] and they paid him off with cash." There are reports that banks in Switzerland also are only giving cash for gold held in allocated accounts on the grounds that the gold could "be used for [funding] terrorism." Clearly the gold has been leased out and sold and likely made its way East. The narrative of bullion banks is fraying and new insights on the leasing of gold from Western vaults will appear.

On April 17, Americans bought 63.5k oz/Au, two tons worth from the U.S. Mint. Amid heavy purchases, the Mint had to suspend selling its .10 oz/ gold coin when the inventory was depleted. Gold coin sales have doubled yoy. Buying of U.S. silver eagles also set records in Q1 with 17.45 million sold YTD. Translation: many people know that PM prices are artificially depressed and that the USD has been hollowed out by electronic issuance of Treasury debt or digital dollars. Therefore they are buying value recognized everywhere but Western media and CB talking points. If they drive the price down a few more dollars more Americans and Europeans will line up to buy in volume.

So the paper-trade, short-sell smack down of PMs led to a massive increase in buying of physical assets. It would seem that paper-contracts by their own manipulability are exiting the larger market and the interface of PMs with economies and commerce. The global economic picture suggests that demand for physical assets will not abate making contract ETFs like GLD almost irrelevant. But the context for these developments and the arena in which they are playing out is a world economy that continues to sag toward recession.

Heavy Chinese buying of gold bars, coins and jewelry is getting a tailwind from unsteady economic conditions. Bloomberg headlines "China's Recovery Falters" as the PMI (Purchasing Managers' Index) fell to 50.5 from 51.6 in March. Fifty is the dividing line between growth and contraction. China and emerging markets are unlikely to stem the slide into full recession and one wonders how long American and European markets can continue their bull run away from underlying distress. This demand will support miners but their prospects interface with global economic contraction.

Business Insider: "Flash: the Economic Crisis has Infected Europe's Core." German manufacturing output at 49% and manufacturing output at 47.9%. It appears that the Germans no longer can be Europe's draft horse. The eurozone PMI remains weak at 46.5 and France, the world's fifth largest economy is mired at 44.2. The ECB & IMF efforts to finesse this situation will lead to more printing, riots against austerity and possible redefinition of depositor accounts. Germany's PMI chart from 4Q 2010 to today closely resembles its descending slope from 1Q 2001 - 1Q 2003. Days when the indices falter are likely to increase. Underlying fundamentals suggest this may be more than a typical 2Q malaise.

The week of April 15 the Fed grew its balance (debt) by $58 Billion but the market sagged and continued breaking down. I have expected that the high from POMO injections will lose its efficacy: dosing an addict with heroin does not promote improved and sustainable health. Floods of digital artifice cannot create or support a genuine economy. Look at workforce participation, net real income and worth and you see a society-economy that is suffering and being given toxic nostrums by quack doctors. Lawrence Fuller on SA proposed this as a hypothesis: to me it is plain. Fuller suggests that "we are on the cusp of a consumer-led recession." I agree and the data in this article and my previous, "Gold's Crash, Europe's Woes Signal Decline" indicate that consumers in both Europe and America are breaking under the strain of supporting markets based on financial quackery and insider manipulation that concentrates wealth while starving the economy.

Thus, the LEI ("Leading Economic Indicators") index has gone negative and the loan/deposit ratio continues shrinking ("a rally without investors"). Fuller mentioned the decline in the earnings of McDonald's (NYSE:MCD) and like him I find this an indicator of distress. Asians are buying lots of PMs and fewer hamburgers. That suggests expectations of crisis or perhaps it is just savvy business: in coming months and years their metal may buy their families not just a week of burgers but perhaps a franchise or a home in Vancouver.

Regarding the basic materials company index outlined in my previous piece, on April 23 DuPont (NYSE:DD), Dow Chemical (NYSE:DOW), Caterpillar (NYSE:CAT), Vale (NYSE:VALE) and Royal Dutch Shell (NYSE:RDS.B) were robust, significantly topping the 1% rise in the indices. ArcelorMittal (NYSE:MT) and the Timber ETF (NYSEARCA:CUT) were fine though Copper (NYSEARCA:JJC) flashed trouble for world growth. But the indices ignored the troubling numbers from Europe and the woes of Americans. The major losers in the basket on Tuesday were Gold Corp. (NYSE:GG) -2.80 and Newmont (NYSE:NEM) -2.90, declines that were reversed April 24 with GG and Halliburton (NYSE:HAL) leading intraday. Like PM miners, my producers and suppliers index shows recovery. The question is whether it can be sustained amid shrinking world economic activity.

PMs and the indices are in an inverse relation: PMs have been suppressed to artificial lows while markets have been artificially stimulated and totter like junkies on tight wire highs whose economic struts are cracking.

The mid to long term outlook from here for PMs is strong. Central Bank purchasing indicates that the world is moving to a currency-basket reserve system including gold. Retail investors will participate in the fruits of this change if society can withstand systemic breakdowns. It is not clear that failing businesses would accept bullion. Moreover, banks already are prepared legally to re-classify depositors as share holders to "protect systemically important financial institutions." So even with recovering prices I would be temperate in further bullion purchases even at today's oversold levels. It is best to hope the economy and socio-political institutions can at least limp along though given the character of the "pathocracy" they may prefer to stomp around the wreckage like giant killing-machines in an apocalypse film.

PM miners are a fascinating sector in that they mediate between the growing demand for hedges against the fiat system and economic decline but also are enmeshed in the matrix of political-economics: credit, debt service, demands from government and conflict with unions. Growing purchases of physical assets and the transition, at least by many nations toward gold-backed reserves should support the miners even as economic turbulence and continued suppression of PMs by the fiat bloc damages sentiment, momentum and their prices. Those with investable cash and the ability to sustain near-term losses have many attractive choices in the mining space: GG, Yamana Gold (NYSE:AUY), Eldorado (NYSE:EGO), Silver Wheaton (NYSE:SLW) and Sandstorm (NYSEMKT:SAND) are very undervalued. Only the vagaries of the mining sector keep them from being bought the way oversold bullion are being purchased. April 24 the Gold Miners (NYSEARCA:GDX) and junior miners (NYSEARCA:GDXJ) recovered +4.17% and +4.41% with GG leading at +5.32% intraday.

Given current realities and trends most people should favor defensive equities and allocations. Despite valuations, limit adding to miners unless you have a high degree of certainty on their prospects and cash that can wait to show positive returns. The whip saw between markets and economies, paper trading and securitized debt vs. bullion is like a strange bar in a foreign city: one must keep an eye on the room and the path to the door. Fundamentals for bullion and for many miners are good but reason does not always rule the day.

The April 24 rebound of commodities and PMs heartens but these are cruel times. Systemic economic problems, institutional chicanery and even malice are plain. Perhaps the directors of our major institutions will not run wild as Huxley foretold they would: perhaps. We should do what we can to preserve the bases of society and courtesy. In this era of formless wars and the Caesarism of multi-national groups that use governments to control humans, the best weightings rise from gold, silver and equities to a farm. Let the equities be defensive and complemented by an S&P index (NYSEARCA:SPY) and short-term investment grade bonds for cash. If and when economies improve, the producers and suppliers of basic goods presented in my previous piece will reflect signs of resurgent life and invite investment. For now be temperate in buying recovering bullion and miners.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in SLW, EGO over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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