attention all gold bulls..... read below:
GOLD MINING OUTLOOK: 20 REASONS TO BUY/NOT BUY GOLD
Presented at the
Astrology and Stock Market Forecasting Seminar
May 16, 1999
Hotel Inter-Continental 111 East 48th Street New York City
Sam Hewitt, Ph.D., CFA
Chief Technical Analyst, Van Eck Global
Good morning, ladies and gentlemen. With gold currently trading below $300 per ounce and an upcoming favorable summer period astrologically according to the Astrologer's Fund, Henry Weingarten thought it would be useful for me to comment on gold's fundamental outlook for the balance of 1999.
I will open by commenting just how rapidly gold's fundamentals have changed in recent years. For who could have forecast even two years ago that the Swiss would decide to abandon the link of their currency to gold, mining company production costs would plummet over 25%, and that gold would rise only $30 during one of the world's worst financial crises since the Great Depression in the fall of 1998? These events underscore the importance of understanding gold's new fundamentals and their impact on future investment performance.
As a setting for today's presentation, I will take you back to last fall, during the height of financial turmoil and present “24 Reasons to Buy Gold Now,” written by the late Jim Blanchard, one of this country's most devoted advocates of precious metals as alternative investments. Taking 20 of Mr. Blanchard's examples, I will briefly explain both pros and cons of each point without taking an official stance on each topic. To make this more interesting, the audience is asked to vote pro or con for each of the 20 reasons on a voting form that has just been distributed. I will give you advance warning that due to time constraints I will address the pros and cons of the 20 points in a rapid fire manner leaving little time for decision making. I encourage each of you not to think to hard and let your first gut reaction guide your voting. Remember you will not be graded on your results.
--------------------------------------------------------------------------------
Download Conference Voting results (Excel xls.format) AFUND VOTING
--------------------------------------------------------------------------------
1) World Gold Demand Leaps 50% in the Midst of a Global Deflationary Crisis.
“For the second quarter of 1998, total world gold demand surged 50% above the first quarter 1998 levels, and stands at only 9% below the historical demand record set in the second quarter of 1997.” [World Gold Council data.]
Pro. The fact that gold demand quickly recovered after the serious debacle of Southeastern Asian dishoarding is somewhat amazing. Less than 7 months after a television image showed Korean women taking off their gold rings and throwing them into a bucket to help the government, the Koreans were back on the buy side in the latter half of 1998. The resurgence in demand bodes well for gold's long term-outlook.
Con. Even though gold functioned well as a currency hedge for Asian consumers, dollars would have performed even better. This is a lesson not unlearned by the Japanese who in recent months have created long lines in Tokyo, wrapping around the block of Citibank's branch office waiting to open a US dollar bank account. As we move forward in history, the availability of multi-currency accounts in many parts of Asia will present serious competition from gold, especially after Asian consumers learn that dollar accounts pay interest and gold doesn't.
Please cast your votes.
2) Investment Demand Beginning to Take Off.
“Latest reports from both the World Gold Council and the CPM Group show that more and more investors are fleeing the tremendous volatility in equities and currencies and are seeking the safe haven of gold. In fact, projections show that investors are expected to purchase a net 15.7 million ounces of gold, marking a stunning 45.9% increase from last year's levels.”
Pro. Following Southeast Asia's dishoarding during 1998-Q1, investment demand has returned to the region, averaging 52 tonnes per quarter albeit at about half the quarterly levels observed since 1993. As Asian economies have rebounded more quickly so far in 1999 than most pundits forecast even three months ago, gold demand may continue rising as Asian consumers reflect on the value of gold as a capital preservation asset which served them so well in the 1997 financial panic. Another pro for gold is that its demand is a global one, and that for every country whose gold demand falters, there is seemingly another one to take up its slack. For example, during 1998-Q1 when Asian demand slumped, a surge in Indian demand provided a partial offset.
Con. What the World Gold Council fails to emphasize is that much of the increase in 1998's investment demand originated from large investment funds that simply covered short positions. In their most recent Gold 1998 - Update 2, Gold Fields Minerals Services estimates an increase in world investment from 166 tonnes in 1997 to 511 tonnes for 1998. However, 235 of that increase is attributable to investors which merely covered shorts. In fact the current skew in over-the-counter put volatility indicates that large investment funds are gearing up for another attack on gold after letting it rest for the last 15 months.
Please cast your votes.
3) A “Safe Haven” Once Again
“Gold has suddenly regained the safe haven status that it had relinquished to the dollar, and the forces that had been holding gold down have seemingly been lifted over the past few weeks. As you will see later in this article, I feel that those forces included a strong dollar, a large undisclosed flow of central bank gold, and massive short sales by hedge funds and other large speculators. And as you will also see, each of these forces has now abated, and in fact turned in gold's favor.
Pro: Those who view gold as a currency alternative join the ranks of the world's central banks which – even in spite of recent sales – still maintain a sizeable proportion of their reserves in gold bullion. With the dollar as the world's primary reserve currency, gold has historically performed well when the dollar has not. Once foreign money leaves the speculative hotbed of the U.S. share market and U.S. Treasury bonds after inflation begins to rise, all one will hear is the sound of a crashing dollar as the balance of payments turns sharply lower. Gold will then skyrocket.
Con: Interactions between the current account, capital account, and balance of payment accounts are only partially influenced by financial market returns. In the Y2K environment, what appears bleak for the US is nothing compared to indescribable conditions for emerging market countries and Europe which have recently devoted their financial resources to mere survival (in the case of the emerging markets) and the Euro currency conversion (for European countries). The U.S. financial system is the most Y2K compliant internationally and the dollar will attract a flight to quality bid from global investors in an uncertain Y2K environment. When people realize they can't spend their American Eagle gold coins at Safeway, gold's myth as a safe haven will quickly be exposed as a farce.
Please cast your votes.
4) Gold Demand to Grow Strongly in 1999, While Supplies Decrease
“The deep Asian currency devaluations are causing ballooning trade surpluses, as exports to U.S. and European markets of now-cheaper Asian products boom. This fact, along with high savings rates and strong work ethics, will lead to a sharp rebound in the Asian economies in 1999. In turn this will create a similar recovery in gold demand . . . [On the supply side citing a CPM Group study] ‘The flow of newly refined gold into the international market could decline 3.4% to 98.3 million ounces in 1999. This would be the first decline in total gold supply since it fell 2.2% in 1987.”
Pro: As stated earlier, gold fabrication demand has showed a sizeable rebound following Asian dishoarding in early 1998. On the supply side, exploration expenditures for gold mining shares have all but dried up as costs have been cut to the bone in a poor gold price environment. This will lead to a reduced inventory of gold deposits available for development in the future and bodes well for keeping the lid on annual mine supply. What's more, the so-called “declining production cost phenomenon” which in a world of falling production costs keeps mine supply high, is a temporary phenomenon as most North American gold mining companies are now mining the high-grade portions of their deposits. One high-grade ore is depleted, a surge in production costs will occur as low-grade ore replaces high-grade ore. Higher production costs will lead to a suspension of mining operations, reduced mine supply, and higher gold prices.
Con: In fact the declining production cost story is only partly attributable to high-grading. Weakness of primary gold producer's currencies, including the Australian dollar, the Canadian dollar, and the South African rand, has widening local operating margins. As long as these currencies remain weak in a deflationary global economic climate, there is no motivation for a curtailment of supply from producers operating in these countries. Despite contrary warnings earlier in 1998, annual mine supply showed a year over year increase of 2.3% for 1998.
Please cast your votes.
5) Cracks in the Foundation of the U.S. Stock Market are Spreading
“On September 21, Lipper Analytical Services announced that net new investment in stock mutual funds swung into negative territory in August, to the tune of an amazing $9 billion.”
Pro: No matter what the fundamentals, technicals, or astrology says, money flows will always win in the end. For a bull market to continue charging, it needs fuel. According to Trimtabs Investment Research, since July 1998, stock market mutual fund inflows have failed to match their torrid pace established during 1996 and 1997. The bull appears to be on a diet and is losing weight fast. This bodes well for gold investment demand. As a capital preservation tool and alternative asset, gold requires that returns from competing markets to fall before gold becomes interesting. Reduced money flows are an important indicator that cracks are indeed spreading.
Con: No matter what the money flows do, as long as the narrow indexes retain their health investors are unlikely to jump into capital preservation tools like gold. What's particular healthy about the market at this phase is the broadening of the rally since April 7, 1999 which marked lows in the US broad market. As investors finally see most of their mutual funds go up which have lagged index funds since the broad market top in April 1998, money flows are likely to return to the stock market and drive the indexes to sharply new highs.
Please cast your votes.
6) A Global Currency Crisis
No one should be surprised that the world is in the middle of a currency crisis, because fiat currency systems guarantee that: 1) Even so-called “hard currencies' will depreciate at a slow-but-sure rate, and 2) Other fiat currencies will crash in value . . . As it stands today, the bottom line is that almost all nations are devaluing against the dollar, but the dollar is the currency of the world's largest debtor nation, and eventually the ‘new era' economy and stock market will fall apart. Then we will enter a major new bear market in the dollar, and gold will be the remaining bulwark of value.
Pro: The period of imminent stock market weakness is resoundingly bearish for the dollar. While one could invest in overseas investments, if the US economy goes into recession, so likely will the rest of the word. Gold becomes the only rational alternative investment to US financial assets and global currencies.
Con: As a percent of total Gross Domestic Product, the total federal budget debt has shrunk to miniscule proportions as the Clinton administration as done a superb job in creating annual budget surpluses recently. The resiliency of the US economy that has confounded doomsayers ever since 1987 is a testament to the creative power of Americans and the capitalistic system. In this environment, it does not pay to buy gold as a portfolio insurance asset in a continued era of capital growth.
Please cast your votes.
7) Huge Japanese Banking Troubles are a Sign of Things to Come
Jim quotes my colleague Harry Bingham, gold strategist for Van Eck Global who says: “The multitude of bad debts, not just in Japan, may make coordinated expansionary policy the only option, which, if history is any guide, means a coordinated devaluation against gold. Whenever bad debts have proliferated, newly created credit has been acceptable only when denominated in a higher gold content achieved either by acquiring more gold or raising its price. In other words, when all nations want to devalue at once, the only monetary unit against which they can devalue is gold.”
Pro: The biggest pool of bad debt in the world remains hidden in the Japanese banking system. The only way to out of the Japanese deflationary spiral is either (1) let the entire house of cards fall to the ground and wait for a genuine resumption of demand and growth or (2) act preemptively and inject large monetary reserves to offset the effects of a deflationary monetary contraction. Japan's low interest rate policy and aggressive approaches to banking reform are in fact a desperate signal from a central bank which has lost control of the economy. Printing money has always been the easiest political route and Japan is playing out a textbook example of procedure. Reckless monetary expansion has always been bullish for gold.
Con: While aggressive monetary expansion of the yen may be bullish for gold in yen terms, what is means for gold in dollar terms is anything but clear. Especially when US banks continue to generate record profits and do not show the same symptoms of bad loans as in Japan. To paint the global banking system with the same brush as Japan is a misguided generalization.
Please cast your votes.
8) European Gold Selling to End Soon
“There have been some very credible indications that these sales have begun to wind down over the last few weeks. Regardless, European central bank gold sales must end by the end of the year [1998]. At that point, control of gold reserves will shift to the new European Central Bank, which will be dominated by the pro-gold nations of France, Germany and Italy.”
Pro: Begining in 1992, European Central Banks were large sellers of gold reserves prior to entry into the European Monetary Union. Sales were not encouraged but nevertheless tolerated until the launch of the Euro in 1999. The key question is what happens to excess gold held by EMU member central banks held above and beyond what was transferred to the European Central Bank. The market's understanding is the ECB now has effective veto power of any gold sales, even from reserves held outside the ECB by member countries. With a desire of the ECB to conduct its policies very conservatively in order to uphold the value of a brand new world currency, it is unlikely that they will allow any gold sales which may unintentionally call into question their motives.
Con: Europe includes more countries than just EMU members, as the U.K's recent surprise gold auction announcement reminded us. And don't forget all the non-ECB gold held by EMU member nations. While this gold may be under lock and key for another year or so, don't be surprised in the year 2000 or 2001 that 5 to 10 years of equivalent annual mine supply will suddenly be added to the auction block still warm from the blows of the U.K.
Please cast your votes.
9) Commodity Prices Have Bottomed
“The world is in the middle of a massive monetary reflation. This will lead to a rebound in commodity prices, including gold. In late August, the CRB commodity index closed below 200, a level that has repeatedly indicated a major bottom and proceeded a rapid rebound.”
Pro: It was under Wayne Angel's leadership at the Fed when commodity prices took a more prominent role as an indicator of the stance of monetary policy. Certainly the 1997 collapse in commodity prices, a symptom of slackening global growth, was one factor behind coordinated central bank rates cuts last fall. And look what's happened since: though the CRB took out the 200 support level, the index has stabilized after reaching the low 180s this past February. More importantly, the energy dominated Goldman Sachs Commodity Spot Index rallied 27.2% from its December 21, 1998 low on the heels of a strong crude oil rally. With economic growth recovering this year, monetary stimulus appears to be working and inflationary pressures have started to rise again. Gold has historically done well during periods of high inflation.
Con: The commodity rally has been dominated by crude oil and a careful look at its supply and demand factors reveals an important point. Crude rallied not because monetary policy stimulated large incremental demands for crude oil; crude oil rallied because OPEC decided to make a supply side response by cutting production. This destroys the link between last fall's ease in monetary policy and commodity demand. Furthermore, if inflation were to rear its ugly head, surely Alan Greenspan would raise rates in a pre-emptive strike. One of the benefits of his tenure is avoiding monetary policy mistakes of the 1970s that included negative real interest rates. Why buy gold when Greenspan is at the helm?
Please cast your votes.
10) Real Value
“In 1980, the price of gold peaked at $850. Today the real gold price in 1967 dollars is about $60. In 1980 the gold-to-Dow Jones ratio was one-to-one. The current ratio is about 27 to one. In other words, in terms of U.S. stocks, gold is an extraordinary undervalued investment.”
Pro: One of the classic approaches to asset allocation practiced by Morgan Stanley's strategist Barton Biggs and others is the application of reversion to the mean. In other words, long periods of over or underperformance of financial assets are usually reversed. This concept is easily expressed by the Dow to gold ratio and shows how askew the relationship has become.
Con: The reason why stocks have outperformed gold is arguably the success of capitalistic progress, corporate profits, and the power of capital appreciation over gold as a capital preservation tool. As Wall Street often says: “Cash is Trash.” Further, microeconomic theory predicts that prices under competition will converge to average cash production costs in the short run and average total production costs in the long run. With cash costs of gold production falling to $191/ounce in the third quarter of 1998 [Gold Fields Mineral Services], microeconomics theory predicts that gold can fall to $191 in the short run. Total costs, which include overhead and other expenses that must be covered in the long run for mining companies to stay in business, were tallied at $289 during the same period. Last quoted at $278.80, gold's decline has simply followed the laws of microeconomics.
Please cast your votes. |
