Guidance On Precious Metals, Inflation, And Seasonality

by: Emmet Kodesh

This article first presents a snapshot of inflation in basics Americans must buy, then it will consider some mainstream comments about inflation, jobs and gold, then it will offer advice on playing the surging PM (precious metals & mining) sector. The sector would be less volatile if governments were not intensely interested in its behavior but that is a story for another time. At the close, I note four of the best silver miners as a preview to discussing them further in my next piece.

On August 11, as equities wobbled and PMs surged, three Regional Fed Presidents repeated familiar government claims about an improving job situation, subdued inflation and that tapering was okay. Richard Fisher, of the Dallas Fed, Charles Evans of Chicago and Sandra Pianalto of Cleveland were cited in this piece. The lead sentence was about a supposed decline in bullish sentiment on gold even as PMs soared. This kind of article and comments are beginning to seem like efforts to talk down PM prices and distract attention from alarming economic basics.

Robert Fitzwilson of the Portola Group and Michael Pento of Pento Portfolio Strategies are among many that remain disturbed by the disjunction between economic fundamentals and the indices.

Here by way of a salubrious antidote to Fed-nuanced narratives is a link to John Williams of American Business Analytics noting actual CPI-U inflation at 5.6% and U-6 inflation at 15%. Let me provide some Main Street data to clarify inflation realities and what they portend for our bond markets, the tenuous housing recovery and for equities generally.

Three months ago, Comcast (NASDAQ:CMCSA), the provider of my "bundled" internet, TV and phone service raised their monthly charge 22%. A year prior they raised it 27%. The electricity bill has risen about 9% Y/o/Y. My heating oil costs about 26% more than it did five years ago. The same food that four years ago cost me $45/week now costs $75/week, an increase of 66%. This month my "health insurance" will rise 7% Y/o/Y. The previous year it also rose 7%. While real median incomes (using government measures of inflation which this paragraph debunks) have remained flat during the past decade, the costs of College have spiked 66% while the quality of education disintegrates.

This comment is based on my experience teaching and developing and directing BA programs at the College-University level 1978-2010. I was in an NEA working group 2002-03 that formulated sound curricula and teacher competency tests in an effort at HS remediation: the DC bureaucracy chewed up this work. That also is costing America.

It is plain that real inflation rates for essential goods and services are at least as high as the data provided by John Williams. This means that the 2.71% yield on the Ten-Year T-Bill, although it has spiked 61% in ten weeks remains far too low to attract rational investors. That leaves the Fed to buy our "return-free risk" with the likelihood that yields will continue to rise even if taper-talk subsides. It is likely that the next 4+ months will see something like the 6-20% correction in the indices foreseen by analysts as diverse as Jeffrey Saut of Raymond James, Tobias Levkovich of Citi and Dr. Marc Faber as quoted in the last paragraph of my previous piece. As noted above, Michael Pento sees a 20% correction based on the bond/inflation crisis and the fight over the budget ceiling that will burgeon as the October 1 deadline (to raise the debt ceiling) approaches. When this occurred in 3Q 2011, US debt was downgraded and the DJIA shed 2k points. Pento believes that the Fed will begin to taper and then back off when the economy and indices sag. In my view, uncertainty about the degree of Federal intervention in the markets remains the primary black swan.

The remarks by Fed Presidents Fisher and Evans are filled with unmerited assumptions: e.g. "Gold fell into a bear market as fears about inflation did not materialize," etc. We already have seen that inflation is serious. Additionally, the fact is that gold and silver were in an extended plateau at frequently tested support ($1555/oz. gold, $26.50/oz. silver) until the short sell guidance by Goldman Sachs and ensuing computerized and panic selling knocked the price to $1385 in four days in mid-April. After the PMs recovered, from June 17-27 a similar event occurred, dropping gold to $1180 in the face of record demand by CBs and retail investors I often have cited. The depletion of Western inventories and surge of PMs and miners indicates that these two drops were not organic. The previous support levels will now serve as resistance that industrial-tech plus retail demand for silver, and retail, CB and monetary reserve issues for gold will determine. I share the view of Dr. Stephen Leeb and many others that these fundamentals will support and raise PM prices.

A few days after Fed Presidents Evans and Fisher had talked up the economy and talked down inflation and gold, on August 14, St. Louis Fed President James Bullard showed the futility of speculation about Fed intentions by stating that "in recent years FOMC predictions have tended to be too optimistic" about the economy. Thus, contra Evans and Fisher, and speaking against Wednesday's red tide (DJIA down 113), Bullard hinted that the Fed would not taper next month. Perhaps the next step if for Las Vegas bookies to begin setting odds and taking bets on the result of indices-by-spin. In the mean time, the bond, mortgage and housing markets are showing signs of strain.

Grant Williams underscored a point I have made a number of times the past six months. On August 13 he wrote: "everywhere you look markets are dependent on central banks, and that's a very dangerous thing." He also discussed "the disconnect between [overbought] stock markets and the global economy," a thesis I have developed for your consideration in trading decisions since April.

Barclays said August 5 it was a good time to short sell copper as the rise of the last two weeks in the miners ETF (NYSEARCA:COPX) and DJ-UBS ETF (NYSEARCA:JJC) began. This bet to date has been wrong as JJC continues the rise it began before the ongoing 6-day surge in PMs. JJC is now 15% above its recent 52-week bottom and copper prices touched $3.32/lb. "Robust copper demand may catch short-sellers by surprise" Reuters noted as China draws down copper inventories in Shanghai. Net short positions in Corn (NYSEARCA:CORN) are at their lowest in 35 months and prices of ETFs reflecting grains (NYSEARCA:JJG), agribusiness (NYSEARCA:MOO) and (NYSEARCA:WEAT) are at secular lows. WEAT made another low August 14.

Though gold and silver's decline get intense mainstream scrutiny, far less noticed are the similarly stark declines in the prices of Corn, Wheat and grains. Not long ago we were schooled that population must decline because there is inadequate food. Now basic foodstuffs are so plentiful that prices are depressed, at least on American indices. The issue of trust on this matter may be more basic than price action. I suggest buying WEAT, JJG and consider a small position in JJC in case China's growth is real as the Reuters article suggests.

It is well known (and used to be studied in middle schools) that the government has been regulating commodity prices for eighty years. QE is a difference in degree, albeit large degree, but not in kind from intervention in products and markets that is long-established part of American governance and socio-economics. This point pertains to the use of taper talk to massage the indices, to put a happy face on a challenged economy and, as with Dr. Evans' comments cited above, to destroy sentiment on PMs. Like the effects of QE, this is wearing off.

On August 11, Robert Fitzwilson (linked above) wrote that "central planners may conclude that there is no viable, traditional solution to our financial and woes. That leaves only power as an option," that means drastic, fiat intervention in the social loci of wealth, e.g. IRA accounts, heaven forbid. I repeatedly have shown, quoting authors and scholars like Adorno, Melville, Molnar and Lobaczewski that wanton and punitive abuse of power, interventionism von Mises termed it, has become a definitive trait of our "pathocracy." Understanding the ugly potential outcomes of current economic disorder and danger in governance will help one buffer the impact of harsh reversals in policies.

Strategy on PMs: take some gains if you are unwilling to ride out the next dip, trim other equities more. Be patient: familiarize yourself with the price history and profitability/debt metrics of PM stocks in which you are interested. Folks whose total assets including home equity are between $.5 - 2.5$ million should remain 10-20% in PMs if they can stomach the intra-day and weekly volatility. Those with ample income stream and the inclination can raise the % of PMs in their allocation because of the macro situation described above. Paper claims on gold are 42.5x physical supply: this and demand is driving prices higher.

In closing I note that silver has begun outperforming gold. Premier streaming company Silver Wheaton (SLW) expects 34 million oz. silver this year which it acquires for c. $4.10/oz and will sell into the market as prices rise. Its new guidance expects its stream at 49 million silver equivalent oz/year by 2017. SLW expects Barrick Gold's (NYSE:ABX) Pascua Lama project currently undergoing remediation of tailings and water diversion to be producing in 2016. The best four silver miners in my view are First Majestic (NYSE:AG) on which I wrote here; Endeavor Silver (NYSE:EXK), Silver Standard Resources (NASDAQ:SSRI) and Tahoe Silver (NYSE:TAHO), see my focus article here. I hope soon to offer focus studies on SSRI and EXK. The latter has three good producing mines in Mexico and seven development properties. Overall costs have risen slightly and are higher than AG's but revenue growth is outstanding, its cash flow is double its total debt and there is a steady rise in production. As noted in my recent pieces on PMs (and in the concluding paragraphs of my study of key sectors in the Global Power Matrix), I look for number of producing sites, revenue growth, cash flow/debt, quick ratio, total revenues and, lastly, dividend if any in evaluating companies. If TAHO gets Escobal into production in 1Q 2014 as expected, its share price will increase substantially: it is a very rich site: 367 million oz. silver.

Be prepared for a general pullback in equities which are range-bound 1684 (May 22 high) and 1709 and mind the taper talk and bond yields. Stay light on bonds and continue to buy into PMs. Analysts as diverse as Goodhaven and Dr. Faber have cited Barrick gold for its ability to weather difficult times given its immense revenue and reserves.

Disclosure: I am long SLW, WEAT. 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.

Additional disclosure: I own precious metal companies in several diversified funds and separately.