Category: precious metals

Gold fund exodus at record levels

As reported by Bloomberg, investors withdrew $1.27 billion from gold and precious-metals funds in the week ended May 8, according to Cameron Brandt, the director of research for Cambridge, Massachusetts-based EPFR Global, which tracks money flows. This year’s outflows of $20.8 billion are the largest withdrawals since the firm began tracking the data in 2000.

Is gold the canary in the carry trade coal mine?

According to a recent article in Bloomberg, various asset classes have been 90% correlated to the upside over the past 8 month rally, the highest such correlation of the past 50 years. In other words, the global carry trade is back with a vengeance. Only this time the primary funding currency is the U.S. dollar (i.e., the speculators are short the buck).

These tight correlations blew apart on Friday as the dollar and stocks rallied on a better-than-expected employment report while gold tanked $60/oz. and bonds sold off. Will “good” economic news unwittingly prick the carry trade bubble and provide the gravitation pull that pancakes these assets in concert? We suspect so. We also suspect that gold will at least hold up better than equities.

Three months ago the Gold/S&P 500 ratio bottomed at 0.93. By last Thursday this ratio had rallied to 1.10. Today it stands at 1.03 (1143.50 per oz. gold/1108 on the S&P). This ratio peaked at nearly 6x during the gold bubble of early 1980 and troughed at 0.20 in 2000-2001. With the monetary authorities hell bent on destroying the economy and ultimately the currency, a ratio of 2, 3, or 4x is not outside of the realm of possibilities.

Paired trade of the decade?

Long gold ($869.00/oz.), short the S&P 500 (1255.08). The gold/S&P ratio is currently 0.69 and going much, much higher (see above).

The catalyst? The federal government is planning to cut a check for $900 billion to bail out Fannie/Freddie and now purchase mortgage-backed securities at above-market prices. The final tab is going significantly higher, the lion’s share of which will be paid for with printed dollars. From these delusional levels, a 1930s-style collapse in real terms is all but guaranteed.

Addendum: As the graph shows, U.S. equities have been in a relentless bear market versus gold since their tech bubble highs of 1999-2000. In fact, a unit of the S&P 500 that purchased 5.23 ounces of gold 9 years ago buys just 1.45 ounces today. The S&P has lost 72% of its gold value during that time.

The difference between gold and commodities

We are having a hard time understanding the recent hand-wringing over gold. Since July 11 its price is down just 14.8% in dollar terms (currently $818.60/oz. on the Dec. futures contract), this after a 3.7-fold rise over a 7 ½ year bull market. During the past 2 months gold has also lost 9.3% of its purchasing power vs. the S&P 500 and 4.6% against the euro. However, gold now buys 3.8% more copper, 9.0% more corn, 32.3% more crude oil, 44.0% more silver, and 58.6% more platinum.

We were actually expecting a correction in gold and were underweight 2 months ago. Since that time the case for gold has clearly improved with the lower price and better fundamentals (i.e., massive bailouts moving us closer to the day of running the printing presses flat out). We now have our gold/gold stock weighting back up to about 19%, and expect to take this higher.

Commodities are a different animal, its inflation-hedge credentials questionable heading into a global recession/depression. That said, we actually did some nibbling in the food/fuel area yesterday on the weak open (in part because there has been a bit of capitulation by some commodity bulls like Ken Heebner). Over the long haul, we’d prefer to own the businesses instead of the actual commodities. Michael Aronstein stated the rationale against owning physical commodities very well a few weeks ago:

“The whole cycle that began around the turn of this century ended. Human ingenuity creates productivity, and the real price of almost everything that’s extracted or manufactured goes down over time. That’s the nature of human progress.”

This is not to say commodity-related businesses can not do well in a declining price environment; witness Dell Computer in the 1990s. They just don’t prosper in a weak economy. As for industrial commodities, we’ll relegate these to the penalty box at least until the global malaise is constant front page news.

Commodity boom meets demand destruction

Apparently, even the 7-year commodity boom is not immune to the laws of supply and demand…

According to the World Gold Council, total demand for gold dropped 19% in the second quarter from a year ago to 735.6 tonnes. Jewelry demand was particularly sensitive to higher gold prices, with the greatest declines coming from India (down 47% to 118 tonnes) and the U.S. (down 30% to 33 tonnes).

Crude Oil
According to the Department of Transportation, Americans drove 12.2 billion fewer miles in June 2008 than in June 2007, a decline of 4.7%. “Since last November, Americans have driven 53.2 billion miles less than they did over the same period a year earlier – topping the 1970s’ total decline of 49.3 billion miles.”

Finally, in a bearish article on gold, silver and commodities on, Gary North states the obvious: commodity demand does not fare well in consumer-led recessions.

If we are talking economic fundamentals, gold and silver have had their big run. From now on and for months ahead, the pressure will be downward. Why is this the case? Because the recession is real. If the rest of the world moves into recession, as I think is likely, the demand for commodities will fall. The value of commodities has nothing to do with value in themselves. They are valuable only because the consumer goods that commodities are used to produce are expected to rise in price.

The Bearing Fund has traditionally held a significant long position in gold and gold mining equities, as well as a small long position in commodities. As of July 31, the fund held its smallest position ever in gold (6.15%) and gold stocks (11.35%), and its largest short position ever in commodities (15.31%) which is comprised of crude oil, grains, and copper. We have, however, been slowly adding to our holdings in physical gold and gold shares on recent weakness.

The case for the U.S. dollar

A good friend and astute observer of the financial scene posted “The Case for the U.S. Dollar” on Prudent Bear’s message board last Friday:

The case against the US dollar is well documented and explains why gold has been so strong. Gold may also do well in a period of sustained dollar strength and credit deflation as the “currency of last resort”, but this latter thesis is untested and vulnerable and thus the first investor reaction to a strong dollar is likely to be to sell gold.

The case FOR a strong dollar against other fiat is simply that the alternatives suck worse:

Japan: The BOJ is screwing its culturally-predisposed saving-society with close to 0% interest rates; Japanese housewives are speculating in the difficult currency markets in a desperate attempt to offset dwindling investment income. China: Interest rates below US rates for an emerging market with high and rising inflation, an opaque banking system, corruption, and corporate earnings juiced by corporate treasury stock speculation.

United Kingdom: The UK is the US Financial System on Speed. Real estate bubble, sub-prime mortgage debacle, current account deficit and interest rates too high to support it all. Oh, and a central banker who warns about moral hazard a day before deploying it. What a joke.

Euro: This is an untested currency. Let’s see how the Greeks and Italians (with budget deficits much bigger than the US, by the way) handle “cohesion” when their economies go down the drain. They’ll want a much weaker currency or they’ll want out. But more relevant to the present, the US may have created all the “exotic” mortgage crap, but the naïve German banks bought the stuff. Germany is pissed at what they perceive as US rating agency fraud; they will unlikely be willing to accept a strong currency and weak exports for a fraud perpetrated against them. Oh, I almost forgot. Spain is about to financially implode.

Central Europe: Let’s see, Hungary and Poland are funding their mortgages in Euros. Smart move until it blows up. Latvia has a bigger real estate bubble than US. Czech Republic has lower interest rates than US.

Russia: Check out the money supply. Don’t ever complain about US M3 growth unless you are willing to complain doubly about monetary growth in Russia. The Ruble is obviously very dependent on high oil.

Well, you can always buy the Thai Baht but it’s now a negative carry trade!!

The difference between US dollar bad news, and non-US dollar bad news, is that the latter is NOT priced in.

Predictably, our friend’s contrarian take was not well received. In fact, the dollar is routinely despised, particularly among the bear community.

We must profess a small, but growing, place in our hearts for the lowly dollar. In five of the past six years, it has lost ground versus the currencies of its trading partners. Last Friday, the Bullish Consensus on 5 major currencies (yen, euro, pound, Canadian dollar and Swiss franc) averaged 80%, one of the most exuberant readings ever. The U.S. Dollar Index weighed in with just 20% bulls. The loonie is so strong, Canadian students are reportedly throwing parity parties and shoppers are crossing the border in droves in search of bargains.

Our dollar-warming friend makes an intriguing point: the dollar may be trash, but is it really any worse than other fiat currencies the world over? After all, the European Central Bank grew its balance sheet 9.7% over the past year versus just 3.5% for Bennie and the Fed. The official government-doctored inflation rate in the U.S. clocked in at 2.0% in August, while China’s statisticians admitted to a 6.5% annual CPI rate. And let’s not forget, the U.S. was not the only country fomenting a mortgage finance bubble – just look at the housing-related messes in the UK and Spain.

So the dollar does have some redeeming qualities – it is undervalued (on a purchasing power parity basis) and enjoys plenty of competition in the monetary mismanagement department. But perhaps its strongest appeal right now is that it is nearly friendless.

Bernanke’s printing press drives gold stocks to all-time highs

U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

Since Ben Bernanke gave his fateful deflation prevention speech on November 21, 2002, the Greenspan/Bernanke Fed has succeeded beyond its wildest dreams. The value of the dollar has dropped 26%, commodities – as measured by the CRB Index – have risen 44%, and gold has vaulted 130%. Corn is +52%, silver +200%, and crude oil +205%. Meanwhile, the official measure of inflation, the CPI, is only up 14.9% (+3.0% per annum).

Let’s review their combined track record:
  1. Preventing deflation: Commodity prices for American consumers have risen 8.1% per year, for foreigners just 1.4%/year.
  2. Keeping inflation expectations contained: Official inflation is only up 3.0%/year, even less after subtracting volatile food and energy prices. The 10-year TIPS spread shows fixed income investors expect CPI reported inflation over the next 10 years of just 2.31%, up from 1.64% in November, 2002.
  3. Keeping asset inflation stoked: The investor class is happy, with the S&P 500 up 64%, or 11.2% per year.
  4. Lining the pockets of their banking constituents: The total return for bank stocks is roughly 10% per year, while the total return of brokerage stocks is about +23%/year. The Bernanke Fed in particularly has done everything in its power to rescue Wall Street and the commercial banks from their ill-conceived investments.
Great job, guys. But before you accept your Central Banker of the Century awards, you might want to pay closer attention to 27-year highs in gold prices and inflation creeping into every nook and cranny except where you most need it – in real estate prices. Right now, inflation expectations are contained. (For example, the Rydex Precious Metals Fund has experienced a steady stream of outflows the past 4 years, despite the recent breakout in gold stocks. See graph below.) But what happens as investors begin to wake up, as they inevitably will? You are in a box. Lower short-term rates and you unleash inflation expectations, driving up long-term rates and ultimately short-term rates. Do nothing – your best course of action – and you let your banking cronies suffer the consequences of their recklessness, ineptitude, and fraudulent behavior of the past 7 years.

We wish you well.

Newcrest Mining to buy out gold hedges

Reports the WSJ:

The announcement yesterday that Australia’s biggest gold miner is closing its gold hedgebook helped push up prices. In the late morning trade in New York, the December gold contract was up US$1.90 at US$711.60.

The company will sell A$2 billion (US$1.65 billion) of shares through a rights offering to finance the move. It said the restructuring would give it “full upside exposure” to strong gold prices and strengthen its capital structure, allowing it to fund capital expenditures at existing sites and to pursue growth opportunities.

Newcrest has total forward gold commitments of 700,000 ounces a year for six years, totaling 4.2 million ounces, which Managing Director Ian Smith in the past has said could cost the company up to A$1.4 billion.

This on the back of a similar capital raise of US$800 million by Lihir Gold:

The move follows that of Papua New Guinea-based gold producer Lihir Gold Ltd., which recently raised A$972 million to fund the closing of its own gold hedgebook.

My comment: From here, gold will largely have to advance on its own merits, not on mining companies unwinding hedges.

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