-- Posted Monday, 8 November 2004 | Digg This Article
Introduction
When I started working on an update of the Gold drivers 2004 report I quickly realized that the volume of the new report would make it unusable for an easy read. Therefore I’ve decided to publish each chapter one by one over an 6 week time-span which makes it easier to digest. So what to expect from the Gold drivers 2005 report ? Key drivers for Gold such as the US dollar, demand/supply, negative real rates etc.. will be discussed in each chapter separately. This preview will shine a light on each chapter and gives a good impression of things to come.In the end (mid December) the entire report will be available in pdf format. Readers can drop a mail in order to obtain the entire report.
Chapter I Gold & US$
Projections about a declining dollar due to an ever increasing twin deficit supported by many investment veterans (Buffet, Soros, Rogers,Templeton etc..) are met by much denial from as well politicians as well as from investors. Dick Cheney for example publicly said that deficits don’t matter and that the world is happy to continue investing (and thereby financing these deficits) in the US. Sure, as long as foreigners are willing to pour in the amount of $2 billion dollars every working day the dollar won’t crash. But if foreign confidence were to wane, the US dollar will be heading south. Already rumors are surfacing (source Financial Times) that China is selling US dollars and buying Asian currencies in readiness to switch the renminbi's dollar peg to a basket arrangement, something Chinese officials have increasingly hinted at. However some analysts argue that the mountain of US debt should work as a ‘synthetic short position’ in the dollar which would result in a sharp appreciation of the dollar. This chapter deals with these issues in detail and will show that no matter how you look at the US twin deficits and America’s future fiscal liabilities, this problem is huge and some painful adjustments not only seem to be necessary but unavoidable as well. It should be obvious that one of these major painful adjustments will be a massive devaluation of the US dollar. It seems that the idea of a dollar devaluation is gaining support from the FED when the president of the Dallas Fed, Robert McTeer recently said:
“over time, there is only one direction for the dollar to go – lower."
Former ECB president Wim Duisenberg quoted by Spanish Newspaper El Pais recently said :”A dollar devaluation seems inevitable due to the tremendous US Current Account deficit.” Furthermore he recently said on Dutch television that we can only hope and pray for a smooth economic transition in the US. END. Well, I can’t help but to think that he’s afraid of a dollar crash. Why is this so important ? Simple, the US dollar is the primary key driver for Gold, as the dollar goes, so will gold but in opposite direction, gold is the anti-dollar with a high inversed correlation to the dollar ! In the end, gold is still a monetary asset and trades like a currency.
Chapter II Gold & Inflation, Interest rates, negative real rates
Although official inflation statistics do suggest that inflation is well under control, the opposite seems to be true. Just ask people if they are happy with sky-rocketing food, energy and health care prices and you’ll get an idea. Hedonic adjusted Pentium IV processors won’t cure the pain felt in consumer pockets. Needless to say that over 90% of the American public don’t believe the official inflation statistics and neither does PIMCO’s managing director Bill Gross.
A dollar devaluation and future inflation seems to be inevitable coming years due to the astronomical fiscal liabilities of the US government. Peter Peterson, secretary of commerce during the Nixon administration and Prof. Laurence Kotlikof, senior economist at the President’s Council of Economic Advisors (CEA) during the first Reagan administration, published excellent books lately ( “Running on Empty” , “the coming Generational Storm” ) in which they explain in greatest detail why the US is heading towards bankruptcy. They project a fiscal liability of more than 50$ trillion which requires a budgetary resource that only inflation can provide. Sure, these topics weren’t discussed during last presidential debates and the brave ones dealing with this issue and willing to tell the truth are simply fired (O’Neill). O’Neill after his resignation:
"It’s all about sound bites, deluding the people, pandering to the lowest common denominator," he said. "I didn’t adjust (in Washington) and I’m not going to start now."
So a fiscal gap of $50 trillion+ is looming on the horizon but the sad truth is that this amount of money isn’t simply there. As Prof. Laurence Kotlikoff says, it requires a budgetary resource that only inflation can provide. Inflation leads to higher Gold prices. Will the FED follow the inflation curve by hiking short term rates as well ?
The FED started raising interest rates from a 40 year low of 1.0% but still has a long way to go to catch up with more realistic inflation figures. As Long as the FED stays behind the inflation curve real rates will stay negative which have been according to its own history one of the strongest drivers for Gold. Furthermore this chapter will shine a light on rising rates and Gold. The mainstream argument that rising rates are the death for Gold (a rate-hike should strengthen the dollar and therefore be bearish for Gold) is simply a lie. Rising rates as a result of a dropping dollar is very Gold friendly. What does history say about rising rates and Gold ? Well, the chart below doesn’t need any further explanation :
Chapter III Gold & demand
Demand for Gold is growing these days. It comes from several sectors such as , producer dehedging, increase of investment demand, shift from CB selling into CB buying etc. Just China itself will contribute considerably to the expected increase in demand for Gold.
Last year the Honk Kong edition of Friday’s China Daily quoted the Bank of China’s bullion guru saying : “local consumers could pour $36 billion into the metal, equivalent to around 2,950 tonnes, or more than one year of supply, at current prices.” Xi Jianhua, the Bank of China's gold business expert, is also quoted saying that it would be "safe and feasible" for China swap to some foreign exchange reserves for gold. Furthermore the World Gold Council reported that Chinese demand for Gold is expected to triple in next few years. Besides China, also the CB’s of Russia and Argentina are accumulating Gold. Regarding Producer dehedging expect this program to continue at the rate of at least 300 ton/year coming years. Hedging is dead and won’t be reinvented this decade. This should be obvious when the king of hedgers Barrick Gold announced earlier this year that they won’t do any hedging anymore for the next 10 years ! Furthermore issues such introduction of Gold ETF’s and industrial Gold demand will be covered.
Chapter IV Gold & Supply
The Gold industry is facing a decline in Gold production coming years. This is a direct consequence of a lack of Exploration during the 1997 – 2002 period. Exploration budgets have been cut by 67% during this period due to uneconomical prices of Gold. From 2002 onwards many Alarm Bells were being raised regarding future Gold production. Alex Davidson (Vice President Exploration Barrick Gold) said last year : "Big mining companies need to spend more on exploration, or else, at current annual production rates, reserves will be depleted in 10 years, he said. It can take six to eight years between making a discovery and starting mine production, and "we're not currently funding exploration at a level required to replace reserves," Davidson said." Well fortunately the Exploration sector attracted more investment capital again since 2003 but the sad truth is that it doesn’t matter how much money you’ll throw at Exploration, no matter what the Gold price is, it still takes 3 – 5 years from scratch before a big discovery will be made and after that it still takes 4 – 7 years before a mine can be opened in order to mine the new discovery. This year (2004) showed painfully clear that the miners do face a decline of Gold production indeed. Even a blind man can see the supply/demand gap widening sharply coming years which will fuel the primary uptrend in Gold.
Projected decline in Gold production see chart below :
Chapter V Gold & Manipulation
Although this topic won’t be discussed by most main-stream Gold analysts (because they don’t want to be associated with groups like GATA) it’s getting harder and harder for them to ignore the ever increasing amount of circumstantial evidence which they provide. This chapter will show the rapid increase of support for GATA’s manipulation claims and discusses the Blanchard case. (GATA predicted years ago that sooner or later JPMorgan and Barrick Gold would be sued due to their Gold manipulation scheme, how right they proved to be) Furthermore it will address key questions which GATA opponents always fail to answer, questions such as :
- Why do enormous derivatives build ups in Gold among the big bullion dealers (commercials) always coincide with drastic declines in the price of Gold ?
- How come that 4 standard deviation preemptive selling events pop up EXACTLY 6 months prior to 2,600 tonne gold deliveries in the UK according to Her Majesty's Customs records ?
- How come that these repeated events would happen only once by chance in 1,538 years of COMEX trading.
- How come that leading statistics professors have concluded intervention is real ?
- Straight MA lines simply don’t exist in free traded markets. How come that they are clearly visible in the charts of the dollar index adjusted value of Gold ?
- Why the commercial dealers NEVER run for cover when the speculators are piling in big time, they (the commercials) just keep selling and selling until the long specs are getting tired of failing breaking key-resistance levels and start bailing out en masse thereby giving the commercial dealers exactly what they want which is a possibility to cover their shorts at much more convenient (cheaper) levels. So the commercials NEVER lose, is this same pattern visible in other free-traded markets ?
- How come that furious attacks on Gold always happen during COMEX sessions and without any downside limit ?
- How come that during COMEX sessions the price of Gold NEVER appreciates more than $6 ? And when it does (less than 3 times a year) , why is it smashed down right away the very next day ?
The statements mentioned above are going against all common TA logic. The technical analysts do fail again and again because they consider two parties only in the game, those who are seeking profits and those who are fearing losses, but the truth is that there is a third player in the market as well and that’s the US government. Whatever their main reason is (protection of the dollar, keeping inflation expectations in check, avoiding a flee from equities into precious metals, etc..) , they don’t seem to be pleased with a sharp rise in the price of Gold.
Chapter VI Gold & Monetary use
Since 1971 no currency with any kind of Gold backing does exist so many analysts do argue that Gold hasn’t any monetary status anymore. Well, nothing could be further from the truth. In 1971 president Nixon closed the Gold window. Critics of Gold back then argued that Gold had lost its monetary use and therefore would collapse below 35 US$ / ounce. They assumed that the paper dollar gave value to Gold, not the other way around, they did not know that Gold was money. So what happened ? Instead of falling below $35 it took off skyrocketing all the way up to its all time high of $850 US$ / ounce. Why ? Because investors lost their confidence in the US$. So where to go with your money when you lose your confidence in the world’s reserve currency ? Well, there is only one reliable alternative to the world’s reserve currency and that is Gold. It’s that simple, Alan Greenspan says : “Gold still represents the ultimate form of payment in the world.” When confidence in the world’s reserve currency is high there is no need to hold Gold and vice versa. Therefore Gold holds a tight inverse correlation to the dollar and is called the anti-dollar (see chapter I). The financial authorities these days admit that Gold still remains an important monetary asset.
"Gold still represents the ultimate form of payment in the world." - Alan Greenspan, Testimony before US House Banking Committee, May 1999.
"Gold will remain an important element of global monetary reserves." - Statement by the European Central Bank, September 1999.
Some CB’s who want to diversify from their dollars are accumulating Gold. Recent examples are the CB’s of China, Russia and Argentina.
Furthermore some countries are investigating the possibility of launching the Gold Dinar which if they succeed in doing so will strengthen Gold’s monetary role only further.
Chapter VII Gold & Oil
This chapter will shine a light on previous oil shocks and their consequences. As we will see, previous oil shocks were a perfect call for higher inflation figures and recession. Will this time be any different ? According to Alan Greenspan yes, he says that higher oil prices won’t be much of a problem for the economy these days and inflation won’t pop up as during the seventies.
Well, energy experts such as Mathew Simmons and Colin Campbell do think otherwise.
They make a powerful case for the end of cheap energy. The nasty consequence of a lack of cheap energy is the end of economic growth. Will we ever come out of a recession again for a sustained period of time ? Well, Richard Heinberg author of “The Party is over – Oil, War and the Fate of Industrial Societies” doesn’t think so. Matthew Simmons (energy advisor for Dick Cheney) just uses different words, he says : “ there is not one serious economist in this world who would say that you can have significant economic growth without the availability of cheap energy.” Simmons rules out the possibility of cheap energy coming decades. When asked if there is a solution to the impending energy crisis he said : “I don’t think there is one. The solution is to pray. Under the best of circumstances, if all prayers are answered there will be no crisis for maybe two years. After that it’s a certainty.” END. We’ll have to get used to oil prices far exceeding the $100/barrel mark. This leads us to the Gold/Oil ratio which is at an historic low these days. Such imbalances won’t stay there for a long period of time so what gives ? Oil going down or Gold catching up ?
This chapter provides some background material explaining what Peak-Oil is all about and what its impact could be on the world economy.
Chapter VIII Gold & Investment opportunities in junior gold mining/exploration companies
Since the start of the current bull market in Gold in 2001 the Gold share index HUI appreciated by more than 600%. Still lot of denial does exist among fund managers regarding the strength of this current bull. It seems that the first phase of this bull market in Gold (which was characterized by denial) is in its latest stage and phase two (which will be characterized by acceptance) will be launched by slashing Gold’s 16 year high of $430. Expect some serious inflow of investment capital during this second phase of the bull market in Gold and watch out what will happen with the high quality junior mining firms. They can go ballistic but it requires a stomach of steel in order to keep them during severe corrections. They tend to rise faster as their senior brothers but also the opposite is true, they fall much harder during corrections, so investors should get used to increasing volatility among the junior shares. Is an investment in a junior mining firm extremely risky as some people want you to believe ? Well, Ian Gordon (vice president of Canacord Capital and editor of the long Wave Analyst) gave some presentations in Europe lately (sept 04) in order to promote the investment opportunities in junior mining firms.
His presentation was titled:
“Investing in Junior Gold Mining Shares. What risk? What reward?”
He clearly pointed out that an investment made today in a high quality junior mining firm should not be categorized as being a high risk investment. Why not ? Because you’ll buy them at historic low levels today thereby reducing the downside risk towards a minimum.
So what makes the juniors so special then ? Well, the reason is twofold. First of all the senior producers will go after them so why won’t you as an investor do the same ? Second is that Juniors tend to rise much faster in a Gold bull market as their senior brothers but as said before also the opposite is true, they’ll drop much faster during severe corrections. So why are the senior producers hunting for the better juniors ? Well, the Gold industry is facing a decline in Gold production coming years and the senior gold producers will be struggling in order to replace their dwindling gold reserves. How do you think major producers are going to replace their dwindling Gold reserves in short term ? The only way out for them is to go after the better junior companies with promising assets or on the verge of discovery. Remember that the juniors are responsible for 75% of all discoveries, so that makes it quite obvious why the senior producers are heading this way. Barrick already opened an office earlier this year in Vancouver in order to monitor Junior companies, AngloGold speaks pubicly about take overs of high quality junior mining companies, Goldfields invests in Juniors etc… The trend is obvious.
This chapter will show that junior mining companies should benefit more from a rise in the price of Gold as their senior brothers and should benefit tremendously from major discoveries because their senior brothers are watching them like a hawk !
END.
See you back next week with Chapter VIII “Gold & Investment opportunities in junior gold mining/exploration companies”
I won’t publish the chapters in chronicle sequence. I’m still working on all chapters right now and will publish whatever comes first. As said before readers who are interested in the entire report can drop a mail. I’ll send the report in pdf format somewhere around mid December.
November 8, 2004
Eric Hommelberg
ehommelberg@planet.nl
-- Posted Monday, 8 November 2004 | Digg This Article
