Tuesday, April 23, 2013

Gold Correction: 1970s vs Today - Miners In Trouble?

The current Gold correction is closing in on the length of the rout that we saw in the middle of the 1970s bull market. However, the current correction is mild in comparison if we look at the percentages lost from peak.

Below figures have been calculated using the London AM Fix, intraday prices would show slightly different results. Historical data courtesy of Perth Mint's website. The number on the x-axis is total number of days with a London AM Fix published, so doesn't include weekends and other non-trading days.

Click Chart to Enlarge
After peaking in the final few days of 1974, Gold started dropping from US$197.50 to a final low around 20 months later at $103.05 (48% decline, which is represented by the blue line in the chart above). 

The price in the trough of the correction was below the mining costs for many Gold miners and impacted their profits (Financial Post):

Gold Mining Costs in 1975
There's no way to pinpoint an exact reason for any short term price fluctuations in Gold, but the size of the drop into the 1976 low was most likely influenced by the start of the IMF Gold sales, selling around third of their holdings:
Auctions and "restitution" sales (1976–80). The IMF sold approximately one-third (50 million ounces) of its then-existing gold holdings following an agreement by its member countries to reduce the role of gold in the international monetary system. Half of this amount was sold in restitution to member countries at the then-official price of SDR 35 per ounce; the other half was auctioned to the market to finance the Trust Fund, which supported concessional lending by the IMF to low-income countries.
I'm not sure how prevalent technical chart analysis was by individual investors & traders at the time, but no doubt the almost halving in price back then would have had some pointing to broken levels of support, Fibonacci ratios or their proprietary system which pointed to end of the bull market. Even Milton Friedman said that while unpredictable he anticipated Gold to trade in a range between $90 and $140 (this article when Gold was at $107, a month before the final low):

Milton Friedman on Gold in 1976
Little did those with a bearish outlook know that a rally was just about to take place which would add nearly 50% to the price of Gold in 7 months with a final parabolic climax not long after which took the price from $170 to $850 (5x) in 2 short years.

After peaking more recently in September 2011 at $1896.50 (as earlier, figures are all London AM Fix, intraday peak was $1920), the price dropped fast, followed by drifting sideways for around 15 months and has recently started falling again after piercing support at $1500.

Of course Gold's current correction may not have played it's course yet. To match the length of the midpoint correction in the 1970s bull market Gold would need to continue correcting for another 2-3 weeks. To match the 48% decline Gold would need to drop to around $985 (a highly unlikely scenario in my opinion).

As we saw in the 1970's price rout these lower prices are putting extreme pressure on the profitability of Gold mining companies (ABC News):
Gold miners in Western Australia are calling on the State Government to provide the sector with royalty relief until prices improve.

The managing director of Pilbara miner Northern Star Resources, Bill Beament, says many of the state's gold miners are high cost producers struggling to make money amidst wildly fluctuating values.

He says if prices do not improve, many miners could go out of business.

The slump shocked the industry which had already seen local producers, Navigator Resources and Kentor Minerals go into administration and other smaller miners merge.

Mr Beament says while he operates a high grade, low cost mine, he's one of the few in WA.

"Even before the gold price dropped around Easter, we saw two gold producers in WA go into administration so that started showing that some of the high cost producers, some of the marginal ones out there, are really going to struggle," he said.

"If the gold price hangs around this price, sub $1,400 an ounce, we [the industry] could be in trouble, there's a lot of marginal producers out there, this could send a lot of them to the wall."
While there are Gold miners with lower costs internationally, most Australian miners have costs well above the $1000 level (SMH):
A recent Bell Potter survey of 15 mid-tier Australian producers showed that total production costs averaged $1170 an ounce.

Bell Potter analyst Mark Paterson said five of those 15 would be marginal at the present price.

JPMorgan gold analyst Joseph Kim reckons the gold miners under his coverage have ‘‘all in’’ production costs of between $1050 to $1130 per ounce.

But he stresses that companies have numerous individual mines that are more expensive to run than that, such as Newcrest Mining’s Hidden Valley mine in Papua New Guinea, Oceanagold’s Reefton mine in New Zealand, Evolution Mining’s Edna May mine in Western Australia and Alacer Gold’s assets near Kalgoorlie.

‘‘In our view, persistent weakness in gold could result  in  revisions  to  life  of  mine  production  plans  and  scheduling, or even outright closures, as miners react to revised economics under lower gold price,’’ he wrote.
Worth noting that the cash costs reported by many Gold miners to attract investors often does not show the true picture:

Any sustained lull in Gold around AUD$1300-1400 (or lower) is likely to impact heavily on Australia's Gold mining sector. The squeeze in margins is already reducing the profitability of Gold miners and being reflected in their share prices (as it was in the 1970s, see below Barron's Gold Mining Index):

Click Chart to Enlarge -
As reported by Leith on MacroBusiness Gold exports account for around 7% of our commodity exports (by value). Not only is a lower Gold price bad for the mining companies themselves (and their shareholders), it's also a blow to the Australian economy & Government budget (revenues).

Click Chart to Enlarge
Australia is the worlds second largest Gold producer, behind only China who are net importers of Gold. Given Australia's national interest in having a high level of Gold exports & miner profitability, it defies sensible reason that economists such as Stephen Koukoulas would try and knock the metal, in fact he should have reason to cheer it higher.

Where the Gold price goes from here will be decided by the market rather than charts or history repeating exactly. While the costs to mine Gold are unlikely to provide any support in way of a "price floor" in the short term (new mine supply only adds a small percentage to overall supply each year), the immense scramble for physical (and resultant retail shortages) suggests that there are buyers prepared to step in front of the falling knife and buy at current levels. That may not indicate we've seen the low if the futures market takes spot lower, but given that this buying has been occurring from India, to Japan, to China, to the US and in Australia I would say there is good reason to expect the price won't fall much further, certainly not to the sub $1000 level that would be required to match the 48% correction seen in 1976 (and for Koukoulas to win our bet).

As these charts from Tiho at The Short Side of Long show, we could still have a long way to go if the gains of this bull market are to match that we saw 30 years ago.

Gold vs Stocks in the 1970's:

Click Chart to Enlarge

Gold vs Stocks in the 2000's:

Click Chart to Enlarge
While there is no guarantee we get another blow-off top, as has been the theme of this blog since it's inception, it's my opinion that Gold will head higher into a similar bubble peak. The metal won't race into a parabolic move without taking the miners with it (eventually) and by the end of the bull market it is my opinion their after total costs profits will be measured in thousands of dollar per ounce rather than hundreds. No doubt there will be more casualties between now and then though, make sure you pick any Gold miners carefully.

You can follow me on Twitter. I'm usually sharing links and opinions daily (@BullionBaron). You can also CLICK HERE to signup for free email updates.

 Buy bullion online - quickly, safely and at low prices

Tuesday, April 16, 2013

The Kouk: Gold is a Novelty, Useless & Bubble to Burst

Back in December I wrote a post about some views that Stephen Koukoulas (aka The Kouk) had shared via Twitter:

His comments included claims that Gold was a dud investment, expensive to hold, no different to every other commodity and that it was in a bubble, soon to deflate to less than $1000. I countered these claims in my post and sought further clarification on his bubble and sub $1000 call via Twitter to which he replied an article would be on the way.

Yesterday in Business Spectator he wrote an article on Gold which outlines his views on the metal (would recommend a read through in original form before I cherry pick pieces below):

While I agree with some of his comments, I disagree with most. From the way he writes about Gold, referring to it as useless and a novelty in the first few lines, this talks to the shallow level of analysis the metal is going to get from his article. It reminds me of a quote from Bob Dylan "Don't criticize what you can't understand".

After calling Gold useless in the opening paragraph and openly admitting that he finds it difficult to comprehend why people consider it a viable asset class he writes:
To be sure, gold was first seen as a valuable metal a few thousand years ago when it was used to make coins and thus it became a medium of exchange. This trend has continued to this day where some coins are made from gold although very few of them are in circulation anywhere in the world. In other words, its value is as a novelty, not a medium of exchange.
I agree that Gold is no longer a medium of exchange (for the majority). However, the functions of money are as a medium of exchange, a unit of account and a store of value. While Gold has lost it's place as a medium of exchange, once depegged from Gold (it's link to something of intrinsic value) and after a substantial increase in monetary base, the US Dollar (and other fiat currencies) have lost their place as a store of value (over the long term). 

Gold may fluctuate in price wildly at times, but when measured over the long term we can see that Gold tends to retain a similar amount of purchasing power. Of course there is the overused "fine suit" example:

"With an ounce of gold a man could buy a fine suit of clothes in the time of Shakespeare, in that of Beethoven and Jefferson, in the Depression of the 1930s." Forbes

But one of the better examples I have encountered was the Australian weekly wage measured in Gold (see my post here) which shows it oscillating from overvalued to undervalued, but staying within a reasonably tight range (over 100 years and perhaps longer).

This divide we've seen in money where fiat currencies are no longer a store of value and where the ultimate store of value (Gold) no longer plays a role as a medium of exchange lends quite nicely to the theory that we might one day have a more officially recognised dual monetary system such as Freegold where the two functions are split (fiat currencies are used transactionally and Gold used as a store of value by the people and it's flow between nations to settle balance of trade).

If Koukoulas thinks Gold only has value as a novelty, I would love to hear some more serious thoughts on why he thinks that some of the most powerful nations on earth keep a majority of their foreign reserves in the metal (for example United States and Germany who both hold greater than 70% in Gold)? Perhaps he can explain why China, world's largest Gold producer, is not only hoarding their mined Gold, but are also a net importer? Perhaps he can explain why Russia has been aggressively adding Gold reserves over the past 5 years?

Koukoulas continues:
The price of gold is underpinned because it is reasonably scarce or rather, it is currently difficult and therefore expensive to mine. The price is also supported by the demand from people who want to buy it and lock it up in a vault or an exchange traded fund, hide it in their undies drawer or bury it in a biscuit tin in the back yard. It serves no purpose in this form.
To suggest hoarded Gold doesn't serve purpose (because it sits unused) is like saying building and contents insurance for your home serves no purpose. It serves purpose, you just hope you never have to use it in a practical fashion. The person burying their tin in the backyard probably holds it as last resort insurance. It's probably a stretch to consider needing something like this in Australia, but in less stable countries, hidden & portable wealth which could be dug out of the ground or drawer and relocated easily obviously could have purpose.

Gold serves purpose in different ways depending on who owns it and in what form:

"If we could get everyone in the West to vote in this poll, I think "gold is an investment" would win in a landslide. If we could get everyone in the precious metals blogosphere to vote, then "gold is money" would probably win. So, to most Westerners, gold is an investment. To the gold bugs and HMS crowd, gold is money. And to the bullion banks, gold is a currency (ISO code XAU) upon which credit is issued and traded. So what did A/FOA mean by the statement that gold is wealth, not any of these other things? I mean, surely gold is whatever its users think it is, subjective use value and all, right?

Actually, that's exactly right! Gold is whatever its users think it is. And the point A/FOA was driving at was that the vast majority of the above-ground gold, today somewhere around 165,000 tonnes, is held by people who understand it as wealth." FOFOA

Koukoulas continues:
The massively inflated price for gold is a reflection of it being fashionable on the one hand, which seems legitimate, but in recent years there has been the ongoing perception that it is a store of wealth and while enough suckers believe this, its price is likely to stay high.
Koukoulas talks about Gold's role as a store of wealth and says it's a recent development, but in his earlier paragraphs has already talked about the many thousands of years that Gold has played a role as money... so which is it?

Dropping labels such as "suckers" to those who hold some Gold in their portfolio is just childish. I guess all the Central Banks and prominent billionaires who've bought Gold are all suckers.

Koukoulas continues:
As with any item, the price of gold is determined by demand and supply. It is just another commodity and to that extent, it is little different from soya beans, tin or other commodities.
Already covered in the last post... there are many ways that Gold is different to other commodities, here is just one:

Gold acts more like a currency than a commodity (and it's attributes such as high stock to flow support this likeness, even if it's not used regularly as a medium of exchange).

Koukoulas continues:
One issue the gold bugs rarely if ever deal with is what happens to its underpinning, hedge against inflation or store of wealth if there is a massive discovery of cheap and easy to mine gold?
Even if such a discovery were made it would take years before the resource was properly defined through extensive sampling and drilling programs, following which it would take years and many resources (energy, labour, money) to build the infrastructure required to dig it out of the ground. Let's fantasize a massive discovery which once developed manages to double annual Gold production within 5 years. New Gold mine production is but only a small addition to the Gold market each year so even a doubling to around 5000 tonnes mined per year is only adding around an additional 3% to the existing 170,000 tonne stockpile which already exists. Compare that to Japan who has recently announced they will be doubling their currency supply within the next couple of years... should our investment actions be swayed by the highly unlikely or from the events that are taking place now?

Koukoulas gets downright silly when he writes:
It is hard to say how much the price would fall if the US Fed sold even half of its 8,133 tonnes of gold, or if the Bundesbank in Germany sold half of its 3,391 tonnes of gold holdings. It would be a bursting a bubble that would make the Nasdaq tech-bubble crash look like a picnic.
Sure, if the Fed or Bundesbank dumped half of their Gold onto the market (or even threatened to) it would likely result massive downward pressure on price, but equally if China decided to dump half a trillion worth of US Treasuries onto the market it would probably be the end of the USD unless the Fed was able to step in and buy the lot and many more being sold in the resulting panic... such fantasy scenarios are best left to ones imagination than written in an article we are supposed to take seriously. 

Koukoulas would do himself a favour by trying to understand why those Central Banks still hold their Gold and why Central Banks have turned into net buyers from sellers over the past couple of years:

Click Chart To Enlarge - Central Banks Buying Gold, Just For The Novelty?
Late in the article Koukoulas does make a case for holding physical (although probably without realising he's done so):
Making the gold price issue all the more complex, is that much of the turnover in gold is on paper – its traded in a futures market where the turnover is many multiples of all the gold ever mined. Its price can be influenced and distorted by derivative traders and punters and has nothing to do with its true value.

Does that sound familiar with other derivatives blowing up from time to time?
Mentioned is the futures market, which not only turns over huge volume, but operates in a similar way to the fractional reserve banking system. The COMEX doesn't have enough physical in the warehouse to cover a situation where all open longs sought delivery. The below are comments from Kyle Bass in 2011:

"And then we went and looked at the COMEX. The COMEX at the time they had about $80 billion in open interest between futures and futures options. In the warehouse they had $2.7 billion of deliverables. So $80 billion in open interest — $2.7 billion in deliverables. We're gonna own it a long time. You're on the board, as a fiduciary, what do you do? That's an easy one. You go get it. So you go take a billion of $2.7 billion and you let them worry about the rest."

"When I talked to the head of deliveries at COMEX NYMEX, I was like, 'What if 4% of the people want deliveries?' He said, 'Oh Kyle, that never happens. We rarely ever get a 1% delivery.' And I asked, 'Well what if it does happen?' And he said, 'Price will solve everything' and I said, 'Thanks, give me the gold.'"

If we were ever to see the paper or derivatives Gold market "blow up" as Koukoulas speculates, it would be beneficial for the physical price of Gold as everyone scrambled out of their "paper Gold" and into the real stuff. Perhaps unbeknown to Koukoulas, such an event is the wet dream of many Goldbugs.

Koukoulas finishes on this note:
If you want to buy gold and hold it – go for it!

I would say the same for those wanting to buy soya beans, pork bellies, iron ore, wine or fine art. Good luck to you – I hope you make lots of money. But for me, I’ll be sticking to something that has a stronger underpinning and is an important part of the real economy.
While I concentrate on Gold and Silver mostly in a speculative fashion on this blog, the investor with a diversified portfolio should perhaps only hold a maximum of 5-10% in the metals. The more adventurous might consider a 25% position in Gold as part of a Permanent Portfolio or similar. It's not necessarily about making lots of money, but ensuring that you have exposure to an asset class which plays an important role in various types of portfolios.

The other night on Twitter we agreed to a little wager, with Gold at roughly $1500 (now more than $100 lower!), if the price drops to US$999.99 (before reaching $2000.01) then I will send him a bottle of Mount Mary Cabernet or alternatively if it reaches $2000.01 before US$999.99, then he will owe me 3 ounces of Silver. No need for headline grabbing $100m bets or dropping of pants, just a gentleman's agreement which will be kept (as all my bets are).

While there is the possibility that Gold could drop to US$1000 (briefly) and remain in a secular bull market (the price of Gold halved in the middle of the 1970s decade) it would certainly challenge my belief that it remains so. Perhaps Gold above $2000 will challenge Mr Koukoulas' view that Gold is just a useless lump of metal with only novelty purposes (but probably not).

You can follow me on Twitter. I'm usually sharing links and opinions daily (@BullionBaron). You can also CLICK HERE to signup for free email updates.

 Buy bullion online - quickly, safely and at low prices

Wednesday, April 3, 2013

Michael Pascoe Refers to Pascometer / Pascoe Indicator

Unfortunately the Pascometer (contrarian Gold price indicator) has remained broken for the last 18 months as several articles from Michael Pascoe on Gold have failed to generate a sustained rally to take the price to new highs. Is it possible that, by discovering this self monitoring tool, Michael Pascoe has actually thrown off its accuracy? He writes today:
There are unkind gold bugs about who believe every time I write something negative about their favourite metal, its price subsequently rallies, so time to throw them a bone: a decade after the launch of the first gold exchange traded fund, the yellow metal is going nowhere, it’s Australian price of $1,507 an ounce is where it was 20 months ago without a dividend or interest payment to soften the under performance.

And it could be worse – anyone buying gold at the peak in August, 2011, is carrying a capital loss of $291 an ounce at the time of writing, never mind the opportunity cost of not being in, say, appreciating and high-yielding bank shares over that period.

Of course the five-and-a-half years before that were very fine indeed for gold, running up from about $600 to $1800 when stock markets were not happy places – an expensive time to be wrong about gold’s appeal, as I was. Yahoo Finance
Well, thanks for the bone, here's hoping that it kicks along the price as it has been a very boring correction then sideways consolidation over the last year and a half. Although not as deep as some other corrections, the tedious nature of the sideways grind has been enough to generate bull market lows in sentiment and oversold levels as discussed recently on the blog.

To Pascoe's credit the last article he penned titled "Sell gold, buy base metals at the End of Fear" has worked out well (at least so far) with Gold priced in AUD falling around 5% since published and base metals (measured by the GFMS Base Metals Index) having traded higher:

Click Chart To Enlarge: GFMS Base Metals 6 Month Chart

You can follow me on Twitter. I'm usually sharing links and opinions daily (@BullionBaron). You can also CLICK HERE to signup for free email updates.


 Buy bullion online - quickly, safely and at low prices