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David Coffin
from kitco ,why SA gold companies are in trouble
The Other Side of the Coin
By David Coffin
December 02, 2003
In the last issue, we pointed out that the lack of pessimism could prove the undoing of the bulls, at least in the short term. A report showing twice the job gain expected in October doing little but holding the line amply illustrates how much “feel good” is priced into the markets already. Both the major markets and the US Dollar closed down on the day that news came out and things have deteriorated since. Gold, being routed prior to the release of the employment figure, rallied for a gain that lifted it above $380 yet again.
The real surprise for many has been the Dollar. As we expected, the good news on the US economy has not lifted the greenback. On the contrary, its plumbing new lows again, even as Wall street talks up the “economic miracle”
After hitting new lows in October, the Dollar rallied on the strong GDP report and industrial and service sector activity reports. The most recent peak came on the day the October jobs number was released. The Dollar was unable to breach its 50-day moving average on that day and currency traders, being a chart driven lot, hit the sell button. As this is written the Dollar Index has decisively broken through the mid October low. Its back to multi year lows for the Greenback and there is no help in sight for it.
This action probably surprised the bulls, but is makes sense in light of the comments we’ve made recently about what's driving the US economy and how the Current Account reacts to economic stimulus. And it makes sense in terms of simple market psychology too. No one expects a repeat of the Q3 economic growth number. That being the case, what would traders be holding on to their Dollars for? Washington imposing tariffs in an attempt to “fix” the trade deficit just reinforces trader’s beliefs that the Dollar is best avoided.
For the next few months the Dollar is going to be a battlefield. On one side will be the bulls that think foreign investors will again find US investments (and thus the Dollar) irresistible, driving the greenback upwards as they cash in their home currencies to buy tech stocks and US second homes.
Arrayed against them will be those who recognize that the US growth surge has been fuelled by an unprecedented orgy of debt and that this debt is increasingly foreign held. This camp also contains those with macroeconomic concerns; namely that a lot of that debt is being used to fund the purchase of imports.
The relative strength of the US economy is simply driving the Current Account deficit higher and the government is in no mood to decrease the Federal deficit entering an election year. Anyone who doubts the effect of a growth spurt on the Current Account need only look at September’s trade figures. The trade deficit was another new record at $41.3 billion (an annualized deficit of almost $500 billion) even with the lower Dollar helping to increase exports.
Asian central banks have been big buyers of the Dollar (for their own selfish reasons) but even here the interest may start to flag. Japan has spent tens of billions propping up the dollar, but its an open question how much difference it made in the end.
Every month that passes the amount of foreign held debt increases and the total US debt load, now $20 trillion, swells. Make no mistake, the US is a very rich country and Americans are capable of carrying more debt than anyone. That said, a lot of that debt is held by buyers who are increasingly concerned about the effect of economic growth combined continued blizzards of new paper as the US funds ongoing spending. It’s not going to take much to lift US rates above their current 40 year low.
The doomsday scenario is all those foreign holders deciding to do some selling before rising rates and a continued fall in the currency deliver a big loss on their US bond holdings. If that happens, the US Dollar Index could easily drop from the current level of about 90 to below 80, or even 70. This scenario clearly resonates with a lot of traders. That’s the reason they exited the Dollar in droves after the October employment report failed to move it upwards. Its also one reason that many are choosing to hedge their bets with some gold holdings.
Gold made another seven year high as this was being written. Traders clearly don’t think Wall St. can save the Dollar, and they see the greenback losing more value. This thinking flowed through into gold stocks, with many reaching for their 52 week highs again in recent days.
We’ve mentioned in the past that our next target is $411, the high of the last cycle. Exceeding that price convincingly would drive home the point (excuse the use of this old Silicon Valley bromide) that “it’s different this time”.
Our expectation is that gold will soon see the high side of $400. On doing that there will a run to the $411 level, though it may consolidate first. That will likely be followed by a period of consolidation as a new base is built in the $395-400 range, flowed by a more sustained upward lift through the $411 level and beyond.
Our call early this year was for Gold to see $400 by year end, and that still holds. The timing of a sustained move through the $411 level is a bit more uncertain but we think its likely to happen before the end of Q1 2004. As always, especially with producers, days of weakness and consolidation are the best times to be putting bids in.
The Dollar is looking very weak technically and that might speed up a move to a new high. We noted when gold first moved through $380, that it might take some backing and filling for the move to be confirmed and the same holds true of the $400-411 range. That is all to the good. We are much happier seeing continued higher base building than a speculative blow off. Its more solid evidence that the run in the gold price is far from over.
A DOUBLE EDGED SWORD
The Dollar has been the biggest factor in the rising gold price, though the change in market psychology that made hedging a dirty word shouldn’t be forgotten. This currency shift has not been a boon for all, however, and the effects are very uneven. If you are trading gold producers its critical to understand the effect of local currency on costs.
The four charts above show the gold price since the start of 2000 in US Dollar, Euro, Rand and Australian Dollar terms
The top left chart is familiar to you all, showing the price of gold in its’ “home” currency, the Dollar. We haven’t included a chart showing the Gold price in Canadian Dollars, but the $AUS chart is a pretty good proxy for it.
If one weren’t familiar with the effect of home currencies on gold prices it would be easy to believe the four charts referred to different commodities. The charts give you some good insight to the activities of gold producers in these different areas, as well as the waxing and waning of investment flows in to the sector.
The Euro chart shows a remarkably flat performance, though there have been a couple of periods of strong upwards moves, usually curtailed when the Euro started moving against the Dollar, reducing the effect of earlier gold price increases.
The chart shows positive movement overall, with an 18% gain in the gold price in Euro terms. The big gains came in the 2001—mid 2002 period when the gold price was starting to move and the Euro was still basing in the $0.85-90 range. Not coincidentally, this was also the period when many European funds rediscovered the gold market.
The Australian Dollar and SA Rand charts are a different story. Both of these “producer” currencies have seen huge gains against the Dollar in the past couple of years. Neither currency has a large float and both are perceived as proxies for resource prices. The Rand in particular is considered the premier “gold” currency because of the large output of the South African industry.
Sadly for the South African Gold sector, this has been more curse than blessing. In the past year the Rand has surged over 40%. Normally, this sort of strength in a currency would have the benefit of reducing inflation, but South African producers haven’t even had that advantage. Internal, particularly wage, inflation has remained relatively high, adding to the burden of Rand based costs increasing relative to $US gold sales. In Rand terms the price of gold has declined 25% in the past year, and producer margins are getting squeezed.
If the trend continues, some of the world’s larger producers could see production cutbacks, particularly in the deep high grade deposits that had high cash costs even before the Rand started moving. One example is Durban Deeps, which has seen its cash cost spiral upwards with the Rand, and its share price come off almost two thirds from its 52 week high. The story is better for larger, more diversified Gold Fields but even it has seen cash costs per ounce rise from $180 to $280 in the past year.
This trend has two effects; South African producers continue to invest heavily in exploration in order to bring along deposits or buy production outside of South Africa (Durban recently bought 20% of the Porgera mine in Papua New Guinea). Secondly, the deep narrow mining operations that have been the mainstay of South Africa’s production will be increasingly imperilled.
Australians have been focusing on a different sort of deposit, gravitating to low grade oxide heap leach situations. There has been a tendency to push production in Australia, with many small operations of marginal grade opening up. These narrow margins explain the market activities of many small producers. There was a lot of hedging activity by Australian producers at the start of 2003 and the $AUS gold chart shows why. Gold peaked at $650AUS in January and has since dropped 15%, thinks to a surging currency. It was fear of their currency shooting up that drove the hedging, not lack of faith in the gold market. What hedging there was to do is likely over for a while since it was poorly received by shareholders, whatever the reason.
The main point here is that if you are looking at producers, find out where the production is based and check the trend in cash costs. If the Dollar does implode things may get worse before they get better for many South African and Australian miners. All other things being equal production from weak currency areas, or the US itself are the safest bet.
Most Central and South American currencies have either been weak or are pegged to the $US. Unlike other major trading partner currencies, the Mexican Peso has been virtually unchanged against the US in the past couple of years. That won’t change as Mexico has no desire to revalue the Peso and most US imports from Mexico (aside from oil) are partially fabricated parts going back to US home plants. Its unlikely there will be a backlash against Mexico like the one shaping up against China. That’s one reason we have a lot of exploration situations in those areas on our list. The Chinese backlash we feared is beginning. Gold’s latest story has many chapters yet to unfold.
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The above editorial was excerpted from the HRA Journal, November 2003, which was sent to subscribers on November 23, 2003. To learn more about the HRA family of publications and how they can help you profit from the commodity bull market, visit our website at www.hardrockanalyst.com or email us at trial@h-r-a.com for more information. Subscription line 1-800-381-2493
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