Bull Riding Ain’t Just for Texans
It never fails to amaze me; the material that passes for
informed financial journalism these days. Most of it is
complete fluff - the worst of it is actually hazardous to your
financial well-being. The gold story continues to be
dumbed-down into bite-sized, easily-digestible morsels by
the mainstream media. This week the bull run is blamed on
“terrorism fears” or “war jitters” in the majority of the
mainstream press - as if the bull run is an ephemeral
phenomenon; a fleet of fancy which will go away if we just
all calm down! What utter and total nonsense! Even in a
bull market such as we have, the defenders of gold have to
man the ramparts against the journalistic Huns coming
over the hill, who would drag us back to the Dark Age of
the tech wreck for one more go around. It is indeed
amazing. The gold market is not rocket science, nor is it
intimidating – it is understandable by anyone. And by not
giving you the full story most commentators are doing
gross disservice to the general investing public.
Stalwart yeoman like Bill Murphy, Reg Howe and Adam
Hamilton, if swallowed into the maw of media mediocrity
would no doubt be muffled and emasculated - probably
scribbling the obit page or writing commentary about the
weather. Thank goodness for the internet - our only
contrarian defence against the ho-hum. Those who have
taken the advice of these gentlemen to heart over the last 18
months have not only preserved their wealth, but have
added to it considerably.
For every three E-mails I get from people who have newly
found gold, I get one from someone whose resolve is
wavering, beguiled by the siren-song of Bubblevision to
buy tech and large cap Dow stocks because “they are
cheap” and worried that gold is topping. In Straight Talk
#4 back in October, 2001, I ridiculed an advertisement
that was running on CNBC with Peter Lynch of Fidelity
Investments exhorting us all to stay the course in the stock
market...and yet the markets are down or sideways after its
January-March post 9/11 rebounds. In Kiplinger’s
Personal Finance, June, 2002 issue, John Tumazos of
Prudential Securities is quoted as saying that worldwide
demand for gold jewellery has been shrinking over the past
five years - “There has been a basic change in taste."
Tumazos is the same chap I mentioned back in Straight
Talk #14 who February 11th moved his rating on
Newmont Mining to “sell” from “hold” and stifled what in
February was still a fragile nascent gold bull as his move
was trumpeted far and wide. Let’s see.....Newmont on
February 8th closed at $US25, and last Friday was
$US30.66, for a percentage gain since Mr. Tumazos’
pronouncement of 22.64%. Good move! I’m sure your
clients are most appreciative. Today arch-nemesis of gold,
Goldman Sachs, downgraded AngloGold and Barrick
citing “weakness in the demand for gold jewellery”.
Sounds like scrambled around for some reason to knock
gold, and in typically unoriginal fashion latched on to
Tumazos’ statement. (How lame. How transparent!) Where
do these guys get off downgrading gold stocks in a rampant
bull market??! Why are they so intent on slaying the bull?
Could it be they have a vested interest in choking off the
rally?!
The media is only saved by the fact that it lives in the
sound-bite era, sans memory - every market close expunges
the sins of that day and all is bright, shiny and new on the
morrow with the opening bell. Jay Hancock of the
Baltimore Sun authored an article on May 5th when gold
was $312 [nota bene] “Gold bugs get sort of squashed in
the long run” - an artfully-written piece which slammed
gold with phrases as colourful as I exalt it, “I agree that
gold looks better than a Treasury bond on a wrist or a
bosom, but as a long-term investment it doesn't seem more
attractive than it did a decade ago”. The Toronto Star,
May 26th edition contained an article, “The strange
correlation between Nortel, Kinross”, which ended with
“Technology could be the empty space investors need to
put their gold profits back to work in another asset class.
It’s called rotation. Do it or perish”.
You get the picture. As I read on a gold forum this
morning, “the big brokerages will talk it down all the way
up”. They exist in a parallel universe where all are
perpetually balanced on the cusp of a broad market
turnaround. Look up the recent performance of gold
mutual funds, or view the 6 month graphs for Goldcorp,
Durban Deep, Kinross, Harmony, Newmont and dozens of
others. Now compare them to any Dow 30 component to cut
through this BS.
B.Comm. and MBA students are force-fed the mantra,
“diversify, diversify, diversify”. It is all they know
(knowledge however mysteriously abandoned during the
tech Bubble). Most of the analysts and business journalists
of the mainstream media know diddly about the gold
sector, and so you will see whatever goes out on the wire
services parroted by every hack from Fairbanks to Key
West. Gold scares the hell out of ‘em, especially as it
becomes “the only game in town”. Many of these folks are
twentysomethings who were in diapers when gold took its
last great run. Recent low volume on the DOW and
NASDAQ is explained away on Bubblevision as “early
summer doldrums”, “market malaise” or blamed on
“uncertainty”. But it can equally be explained by people
exiting the markets altogether. Think about it. When
someone sells Cisco and puts money in the bond market or
physical gold they aren’t moving that money into another
stock market sector. Anecdotal evidence says much of the
market exiting is being done by foreigners.
Enough of this purple prose! Below are THE TOP TEN
REASONS to invest in gold. These cannot be easily
rendered down to journalistic sound-bites, but I have done
my best. They draw on many earlier posts. I haven’t
included reasons that could be construed as philosophical
or moral (sound money arguments). These arguments are
compelling in the face of currency meltdowns like we have
witnessed in Argentina, but they won’t move markets until
America suffers a similar fate. I don’t have an economics
degree myself, but I’ve been following the gold market for
over 20 years, and I remember the bull of ‘79 -‘80. Today
we have an incredible and unprecedented conjunction of
macroeconomic and market forces moving gold.
In the background - the fundamentals underpinning
higher gold prices:
1. Supply and demand
The supply of new gold from mining operations has not
been able to satisfy the worldwide demand by fabricators
for at least 16 years
gold-eagle.com
The only thing that has prevented a squeeze in supply has
been the drawing on gold reserves cached away by Central
Banks. The vast majority of western governments have
considered gold a “non-producing asset” and so have
off-loaded it into the market over the last decade, and not
added to their reserves at all. Obviously, once the stockpile
is gone, or governments decide it is imprudent to sell gold,
the situation for supply gets desperate. Mine production is
scheduled to decline over the next three years, even if the
gold price skyrockets, because it takes time to find new
underground reserves and develop them. During the last 5
lean years in the mining business there has been little
investment in gold exploration. To replace draw downs on
gold reserves from current mining, the industry must find
at least fifteen, 5 million ounce gold deposits ANNUALLY.
Do you know how many new mines of this size were found
last year? None! The year before? None! None of this
magnitude for 5 years! Mine supply is declining and
there’s nothing anybody can do about it.
2. Inflation fears
Pundits talk about the strong housing market and
consumer confidence, but it comes against a backdrop of
substantially increased business risk, low or no interest
loans, and massive expansion of personal debt. It is phony
growth without creation of profit. Some months ago we had
a lot of public hand-wringing about whether or not we
were in a recession. This has since evaporated as the
consumer has ridden to the rescue, encouraged first by tax
rebates and later by the lowest interest rates in 40 years.
The housing bubble (which Greenspan explains away as
“immigrant purchases”) when it pops could catapult
America into depression.
How is America to get out of this mess? The only solution is
continued and enhanced massive injections of liquidity and
consequent inflation. Possibly the “war on terror” has
ulterior motives - to put America on a quasi-continuous
war footing in order to justify massive deficit spending.
Governments can only get away with running
debt-economies of the order we are approaching in times of
war.
3. A fallacy: “All the gold ever mined is still out there
waiting to be sold”
This is a line trotted out again and again by gold-knockers.
I have heard it 3 times in the last three days. It is the
short-syllable, unthinking, refuge behind which many
gold-knockers hide. Because gold is near chemically inert
and indestructible we hear time and again that it will go
back into the equivalent of the recycling bin at the end of
the driveway, should gold prices spike upwards. This is
nonsense. During the Asian Crisis only a small fraction of
private holdings were actually dishoarded, and in 1979-80
when gold and silver spiked up, yes, there were people
selling their silverware and jewellery for scrap, but there
were just as many buying gold and silver. Can anyone ever
envision a scenario when all the peoples of the world
dishoard all their gold at precisely the same moment? Of
course not, and especially not in a rampant bull market.
With a tanking US dollar, it is increasingly unlikely that
Germany will liquidate its large holdings, as was mooted
back a few months ago. One clearly uninformed writer
suggested that Russia would dishoard their gold in the
near future. They have been recently adding to reserves
and in any case are way down the list of gold holders.
Eddie George in Britain is taking renewed flak for selling
part of the Bank of England’s stock. Who is going to sell?
Secondly, all the gold consumed in electronics and dental
work is mostly out of play for good and is not recoverable.
It’s a known fact that the majority of diamonds in the
jewellery market never ever see a pawn broker. Most are
lost or handed down to relatives. In a similar way gold
jewellery which is meant to be worn is mostly lost, worn
away by use or tightly held as family keepsakes and
heirlooms.
For the majority of this planet’s population, who are rather
cynical about banks and paper money, gold is the ultimate
wealth refuge, to be liquidated only in times of extreme
financial distress. As Pinank Mehta recently pointed out in
a study of the Indian gold market,
gold-eagle.com
“the mentality is so possessive for gold that it will be sold as
a last resort only, and before that most of the other assets
will be liquidated”. The peoples of the Subcontinent are the
largest consumers of gold on the planet. Mr. Mehta tells me
that the increased trouble in Kashmir will cause Indians to
desert the domestic stock market for the protection of the
yellow metal.
4. Safe haven buying:
After 9/11, gold spiked up in price and then came back
down. The Financial Times and the Wall St. Journal
then ran articles along the lines of “gold’s safe haven status
tarnished” etc. But with the ensuing Afghan war weeks
later and trouble in Kashmir certainly the red line on the
world thermometer of political tension didn’t drop.
President G.W. Bush’s pronouncements about the “Axis of
Evil” and renewed calls for military intervention didn’t
help reduce the global temperature either. Yet the gold
price went down. But now the media has chosen to blame
gold’s riotous run on “safe haven buying”, blaming Al
Qaeda, Kashmir - heck some even throw in that tired old
chestnut the Middle East - suggesting that in a similar way
to September 2001, gold will spike up and quickly move
back down again. You can’t have it both ways boys!
I don’t wish to get on a political soapbox, but the constant
barrage of warnings of impending terrorist attacks are
starting to ring hollow in light of a conspicuous lack of
arrests of conspirators and fifth-columnists, or discovery of
caches of explosives and weapons, or actual terrorist
attacks themselves. All that has happened lately has been a
crazed American college student putting pipe bombs in
rural mailboxes. America’s allies against terror have given
Bush’s idea to pre-emptively attack Iraq a cool reception.
There is probably no gold anywhere that is being bought
for the safe haven reasons of a “terrorist threat” - none in
the US, none in Europe, none in the Orient. There is much
more being bought as a safe haven against the dollar. It is
possible that foreigners are beginning to worry about the
mounting costs of Bush’s adventures in Asia and its effects
on the dollar when it is eventually all tallied up.
Forces moving the market today:
5. The End of Central Bank Sales and the Gold Carry
Trade:
When Alan Greenspan lowered interest rates in the US he
made the Gold Carry Trade unprofitable. The Gold Carry
Trade has weighed down gold prices all through the late
1990's. It worked like this: Central Banks would lease out
their gold to bullion banks who would sell the gold into the
market and invest the proceeds in vehicles that offered a
greater return, like treasuries. It only worked well when
there was considerable spread between the gold lease rate
and the rate on bonds, which mitigated against any minor
increases in the price of gold when the gold had to be
eventually purchased on the spot market and repaid. Of
course the situation could be disastrous to the borrower if
gold started to move substantially upwards. This is what
happened. Now Central Banks are increasingly reluctant to
lend their gold and risk not getting it back. As well, the
spreads have shrunk so much that the Gold Carry Trade is
no longer profitable and is being abandoned en masse.
Governments are coming under increasing attack from
their citizens for selling gold over the last two years at what
are in hindsight, bargain-basement prices. Chancellor of
the Exchequer, Eddie George in the UK used the cash from
gold sales to buy Yen and Euros, both of which were also
bad investments.
Hedging by gold producers is no longer de rigueur. The
hedge was an invention by Barrick years ago to guarantee
a stable revenue stream in an oscillating gold market,
which would take the risk out of gold mining. It was
embraced widely throughout the industry. Bankers loved
it. Mining companies would sell their production forward
at a negotiated price. In falling markets hedgers became
big winners. However hedging acted as a mechanism which
also capped the price. Investors had little expectation of
higher gold prices when most of the industry’s gold - even
for years in the future - was already sold at a
predetermined price. Hedgers are now almost all with a
unified voice denouncing the practice and are busy
attempting to unwind their positions, now that the gold
price is trending upwards. If it were to rise above the price
in their hedge agreements the hedge would be
“underwater”. A few years ago Ashanti and Cambior both
nearly went bankrupt when their hedge books went
underwater. They had provisions in their agreements to
pay penalties in the unlikely event that the gold price
spiked upwards. Both were caught off guard. It is hard to
say how many miners are at similar risk. At some magical
point miners will scramble to unwind their hedges by
buying spot gold. Caught in a feedback loop, the spot
market will spike up with renewed vigour, causing even
more short covering in a cascade effect. The results could
be disastrous. The keys to preventing a crisis are to choke
off the gold rally, or at least draw it out over time. Time in
this case is in short supply.
I won’t say too much about gold derivatives, but we know
the market is HUGE! A sharp, unforseen and
unanticipated run-up of the gold price could cause massive
losses and short covering by those engaged in this tricky
business.
6. Tanking dollar
For a couple of years now the balance of trade has been
tipped towards foreign importers. In essence it has been
cheaper for Americans to buy imported goods rather than
domestically produced goods. Just look at all the “Made in
China” goods in your local Wal-Mart. Sounds fine I
suppose....until it starts to impact American workers and
jobs are lost. The government has accused foreign
governments of unfair dumping and attempted to redress
the balance by imposing trade barriers and tariffs against
foreign imported steel and softwood lumber, and has raised
American farm subsidies. European trade partners and
Canada have cried foul. Many of these same folks are allies
in the war against terrorism. Running a trade deficit year
after year is not a sustainable thing.
Foreigners have taken those dollars earned from exports
and put them in American equity markets. As American
companies report falling earnings and forecast poorer
outlooks those foreigners are getting nervous and selling
dollar denominated investments. What Greenspan can
NOT do is protect the dollar by hiking up interest rates,
because he would instantly plunge the US economy into
depression, and so with poor and risky (more and more
downgrades of bonds to junk status) returns on American
investments the dollar will continue to be jettisoned for
other options.
The dollar and gold price have been inextricably linked
since gold was allowed to float in the Nixon era.
Abandonment of the dollar - the economic lingua franca
of the world - without a viable alternative safe haven
currency in the Euro or the Yen, is precipitating a
stampede into gold.
With a tanking US dollar it may be worthwhile to purchase
your gold shares on foreign exchanges in non-US currency
to get a double bonus.
7. Scandalous times
Who could have forecasted all the scandals, all the
investigations and the sudden “retirement for personal
reasons” of so many CEOs to tropical islands? We’ve had
Enron, Andersen, Merrill, Worldcom, Adelphia.... all in a
row. There is a general and widespread distrust of Wall
Street and its pundits/bandits. How can a spin campaign
against gold get anywhere?
The current gold bull run started out as conservative
“wealth protection”, as investors saw an opportunity to
rotate their money into a sector free from scandal and with
considerably less downside risk than the broad market.
Gold mining wasn’t susceptible to the knock-on effects of
downsizing or bankruptcy by major purchasers of product
- for instance, the arm-in-arm relationship between
computer manufacturers and chip makers, or fibre optic
cable manufacturers and telecom companies. The health of
a given business is often inextricably intertwined and
reliant on the health of suppliers and customers. At about
the same time as the first scandals broke, the stories of
Japanese lining up to buy gold were making the American
evening news. Japanese investors piled into gold ahead of
the curtailing of bank deposit insurance on large accounts.
The scandals keep coming. It is Bre-X writ large. However
in the years since Bre-X numerous efforts have been made
by regulatory agencies to clean up the mining industry and
restore confidence. These regulations are already now in
place. The mining business has taken its lumps. Vigilance
is high, and the chances we will see another Bre-X to tank
this market are nil.
Factors that will continue to move this market:
8. The gold market is small.
Barrick, the largest gold company by market capitalization
is still smaller than Alcoa, the aluminium producer.
According to fund-tracker Lipper Inc., gold represents just
1% of total industry assets. With all the money parked on
the sidelines we could see tremendous moves in the gold
sector. Old time miners used to use a method called
“hydrauliking” to wash gold from hillsides with high
pressure water. They didn’t have any pumps, so they used
to take a small creek and funnel the water down into a
large diameter pipe. Down the length of the pipe they
would progressively neck the diameter down by using
narrower pipes, finally to end in a brass nozzle on a fire
hose. The pressure would be enough to cut a man in half,
should he be unlucky enough to be in the way, and the
hoses were typically mounted on a metal swivel support to
harness them. In a similar way we could see a rather small
shift of investment into the gold sector translating into
huge gains, as large numbers of investors pile into a small
market. In the past few weeks we have seen some junior
stocks doubling and trebling.
Also, the sector is shrinking all the time, as miners
consolidate to attain the magical mystical large cap status
that gets them on the radar of the larger funds. We’ll
continue to see the number of listed companies shrink until
the junior and IPO markets really roar to life.
9. Is the gold market a “bubble”?
The gold-knockers are already making noises about the
gold share market being a bubble, because of high and
increasing P/E ratios. Many companies have made
conscious decisions to forgo earnings and get leveraged to
the price of gold by taking on currently uneconomic or
inactive mine projects. It works like this: if an orebody
costs $300/oz to mine, every dollar increase in price means
a substantial increase in operating profit. Leveraged
miners are betting on a higher gold price. It’s hard to say if
the share market will continue to run ahead of the price of
physical gold at so great a pace. As stocks become more
expensive we may see the momentum slowing and a catch
up of the gold price to the share activity. This would lower
the P/E ratios for many miners. Tremendous efforts have
been made over the past 15 years to improve recovery
techniques and lower the costs of mining gold, but few
mines are making money at $330/oz gold. The majority of
mining companies fail to factor in exploration,
administration and other costs into their cost-per-ounce
numbers. Most companies are in fact being carried by one
or two super-profitable orebodies. We won’t see a return to
real profitability of the industry until we are upside of
$400/oz. In other words, we are still way below the point at
which return on investment is meaningful, and at which
ounces from depleted reserves can be replaced. So don’t
expect any sudden flood of newly-mined gold on to the
markets. This bull market has a long way to run.
Talking about a gold “bubble” brings back uncomfortable
memories of the tech wreck. The gold phenomenon is a
different beast entirely. After all, we are not talking about a
product for which we will have to artificially create
demand! Gold mining has been around for 4,000 years. We
don’t have to dream up a new paradigm or declare a New
Era. The fundamentals underpinning a higher gold price
are there. They are reality! Some of the bizarre products
the techies dreamt up were obsolete when they hit the
drawing board - others were things no one really wanted.
and, perhaps most importantly:
10. Jumpin’ on the bandwagon
Market psychology (some would say “mass hysteria”) was
what fuelled the recently deceased Tech Bubble. What a
windfall for the gold market! We have a greater percentage
of people participating in stock market casino than ever
before, the majority of which couldn’t care less what sector
it is in, “as long as it is going up”. The gold market offers
them what they least expected....a potential chance to win
back their tech losses! This could be the single most
powerful and potent force for the gold bull market. Could
we truly see the gold sector become the “only game in
town”? Up until recently the gold bull has been cloaked in
stealth mode. Bubblevision and the mainstream media
wouldn’t talk about it. Now the gold story is undeniable. I
heard the gold price quoted today on the radio, along with
the closing numbers for the Dow and Nasdaq. That’s the
first time I’ve heard it for years!
With a lack of viable investment alternatives we have the
potential for “feeding frenzy” type activity. My own simple
gauge of market behaviour is the ever-increasing number
of E-mails I get from investors leaping into gold for the
first time. Few seem to be getting any meaningful guidance
from their brokers. A common phrase is, “Is it too late to
get in?” For a summary of what we could be in for, look at
my Straight Talk 11 - Predictions for 2002. If
feeding-frenzy behaviour should become reality, throw out
the forecasts, throw out the historical comparisons, throw
away the crystal balls, for we will be in uncharted territory.
******
We’ll have Geology 101 back next issue. Our website at
straighttalkonmining.com is coming along. We
have all the old commentaries back to creation (S.T.O.M
creation that is) now there for your viewing pleasure.
Watch for new developments! Send us your E-mail address
and we’l let you know when we’re fully operational.
May 29, 2002.
Keith M. Barron Ph.D. |
