-- Posted Tuesday, 12 June 2007 | Digg This Article
Gold fundamentals still pointing towards $2000+
Introduction:
In times like these when bearish sentiment towards gold is reaching new extremes again and gold bears feeling comfortable feeding the gold community with ludicrous mis-information it’s good to take a few steps back and take a peek at the big picture and wonder what critical drivers launched the gold prices in the first place from a 22 year low of $250 in 2001 to current prices of $650 in 2007. You might wonder if a tiny little 5 year bull market would be enough to wipe out the excesses created by the 22 year bear market which took the gold price down from $850 towards $250, you might wonder if a few years of increased exploration spending would be sufficient in order to announce enough new world class gold discoveries being brought into production in order to replace the gold ounces being produced these days, you might wonder if the dollar can appreciate from here on the back of an ever increasing US spending attitude, you might wonder if demand for gold will be decreasing despite the ever growing appetite coming out of China/India…
Well, I can go on for a while here but my point is that looking at gold’s critical drivers one could clearly see the way for gold is up, not down. The gold bears will have a difficult time explaining gold exceeding $1000 before the end of this decade since their misleading arguments of increased gold supply, rising rates are bad for gold and reduced demand didn’t work for the last 5 years, it won’t work for the next upcoming years either. They sound like a broken record indeed and yes, one day they might be right, most probably early next decade or so. Listen to some popular bear tunes over the years:
- Gold prices are at an historic high and will likely come down (March 2005, gold trading at $430)
- World gold production levels are going up and will bring down the price of gold should it rise. (March 2005, gold trading at $430)
- Gold has nowhere to go but down due to deflation pressures around the corner (November 2002, gold trading at $320). (The man in question here never admitted he was wrong, he still sees the rise in gold towards the $730 mark as a bear market rally)
Now the latest bear tune is the one of rising rates. One noted gold analyst wrote on Friday June 8:
"As interest rates go higher and higher, it makes the purchase of any commodities, which never pay interest or have yield, a poor judgment"..
Well, I couldn’t disagree more since rising rates as a result of a dropping dollar is one of the strongest drivers for gold one could imagine. History makes no mistake about it, the 10 year yield rose from a mere 5% from early seventies to an astronomic high of 15% in the early eighties! What did gold do during this period? Indeed it rose from $35 all the way up to $850.
Now we are here again, the 10 year yield just breached the 5% mark and is heading higher due to a massive sell-off of US debt. This is gold bullish, not bearish! (see chapter II)
Below you’ll find a brief overview of all critical drivers for gold and a historic overview. This gold bull market still has a long way to go. Please remember that bull markets tend to end in mania and needless to say we’re nowhere near mania these days. The last time we’ve been witnessing a gold mania was in 1980 when people were queuing in lines in front of the banks in Toronto in order to buy gold. It was a time when almost 5% of all invested money was in gold and gold shares vs much less than 0.5% today. The tricky part however is to stay on board on our way towards mania since the gold bull tries to shake off as many investors possible before marching on. Please keep in mind that bearish sentiment heats up every time gold is heading towards its 200 dma, we just have to go through it and stick with what the fundamentals are dictating us..
Again, please review the critical drivers for gold once more and stay the coarse, your patience will be rewarded big time by the end of this decade!
1 – Gold & Historical Norm
2 – Gold & US$
3 – Gold & Inflation
4 – Gold & Supply
5 – Gold & Demand
6 – Gold & Oil
6 – Gold & Monetary role
1 - Gold & Historical Norm
When gold (and most commodities) came crashing down from a high of $730 to $540 in just a few weeks time (2006) many experts declared the end of the precious metals (and commodity) bull run. But based on what? What's the sense of declaring the end of a 5 year bull run which followed a 20+ year bear run. Believe it or not but gold is nowhere near historic highs these days, no matter what the 'experts' want you to believe. In order to trade in record high territories based in 2007 dollars we should see gold trading above $2000,- these days. Mind boggling numbers? Well, take a peek at the charts below and judge yourself:
- DOW/GOLD ratio
- Gold vs its own long term average
Dow Gold Ratio
The DOW/GOLD chart is a powerful tool in order to determine major turnarounds. It's simple, when the DOW/GOLD chart tops you buy gold, when the DOW/GOLD chart bottoms you buy equities. Once you've established your position you can ride the wave up or down for at least a decade. The DOW/GOLD chart flashed a 'buy' for Gold again in the year 2000 and indeed 5 years later Gold is already 66% off its lows since then. The DOW/GOLD chart tells you to hold on to your Gold until a new bottom has arrived in the 1 - 5 area. Well, if it were all that simple why don't we hear that much about it?
Well, as said before the DOW/GOLD chart isn't useful at all in order to predict yearly price movements. It could very well be that next year will show a higher reading than this year instead of an expected lower reading thereby losing confidence as being a reliable indicator. Unfortunately that's the same analogy as denying that higher temperatures will arrive in summer based on a single day temperature drop in spring. The problem is that the DOW/GOLD cycle has a wave length that's so big that we humans have a hard time to figure out where to position ourselves into this cycle. Nevertheless many veteran analysts such as Richard Russell and John Hathaway do refer to this cycle. Indeed history does suggest that the DOW/GOLD ratio bottoms periodically in the 1 - 5 range. The Dow/Gold ratio topped in 2000 far above 40 and is heading down now (current reading at 18.8). If the DOW/GOLD ratio can live up to its expectations than we can expect a new DOW/GOLD bottom later this decade or shortly thereafter.
Gold vs its own long term average
Another favorite bear tune these days concerns ‘record’ high gold prices which would be a characteristic of gold’s exhausted bull run. They argue that gold’s monthly averages have reached all time record highs which should be taken as a warning sign. Well, nothing could be further from the truth since bull markets tend to end by making new ‘REAL’ highs and needless to say gold is trading nowhere near new ‘REAL’ highs these days. In order to do so gold should be trading above $2000 levels. The chart below tells it all!
2 - Gold & US$
Gold, a serious hedge against a depreciating dollar?
Gold is often referred to as the anti-dollar so thereby given the status of a 'currency' . Gold is referred to as the anti-dollar since it is a perfect hedge against a falling dollar. The chart below makes it painfully clear that gold is a perfect hedge against a falling dollar indeed. The chart shows the inversed dollar against gold during phase I of the bull market in gold. (till May 2005)
Now another favorite bear tune these days concerns a broken relation ship between the dollar and gold so they argue (the bears) that a dollar decline is no guarantee for a further gold appreciation. Well, nothing could be further from the truth since gold’s performance compared to the dollar only got better ever since May 2005. What does that mean? It simply means that gold could appreciate even on its own without the support of a declining dollar. Sure enough a further dollar decline still fuels the gold price higher. The numbers do speak for themselves. The dollar is trading around the same levels as in December 2004 while gold appreciated by more than $200 over that period of time.
Conclusion: Gold is a perfect hedge against a depreciating dollar.
Since the US is living far beyond its means (in order to finance the exploding US deficits an inflow of foreign capital to the tune of $3 billion dollar each single working day is required) the only way for the dollar is to go down. You don’t have to be a rocket scientist in order to see that the exploding trade deficit in the chart below is not sustainable:
As said above in order to keep the dollar at current levels an inflow to the tune of $3 billion each day is required, now who is financing all this debt?
Well, it's no secret that (specifically Asian) foreign Central Banks have been massive buyers of US debt which is illustrated well in the chart below:
What we see here is an ever increasing pace of appreciation of Central Bank FX Reserves. This is clearly not sustainable and simple logic tells us that all what is not sustainable simply stops. In other words, without foreign support the US$ is in deep trouble.
Now if the soaring trade deficit wasn't already bad enough, the picture only worsens when looking at total US debt which clocked an alarmingly $44 trillion last year. The chart below speaks for itself:
As you can see here total US debt is growing faster than its national income. Ever tried to run a business which its debt grows faster than its income? Well, needless to say you would be heading straight into bankruptcy.
Is that what worries major dollar holding nations? Is that why they're looking for dollar alternatives? How is the US going to solve its debt problem? Can they solve it? Or is it already too late? Well, serious questions indeed and you may wonder why authorities have chosen the path of denial and continue to present an 'all is well' good news show. Or maybe the authorities are telling the truth and the picture painted above is extremely exaggerated to the down-side. Well, facts are facts and the simple fact is that the US is addicted to an inflow of foreign capital to the tune of $3 billion dollars each single working day and when that foreign support stops the US$ is in deep trouble.
Now shifting away from dollars toward euros isn't really a dollar bullish development, in other words, the dollar seems to be heading lower, a view which is shared by China's deputy central bank chief who said last year:
China Raises Red Flag On Dollar
"The exchange rate of the U.S. dollar, which is the major reserve currency, is going lower, increasing the depreciation risk for East Asian reserve assets," wrote Wu Xiaoling, deputy governor of the People's Bank of China, in an academic paper. Wu is ranked by Forbes as the 35th most powerful woman in the world. END.
Now what do you think foreign countries holding large chunks of US dollars will do or planning to do once realizing the US$ is losing confidence fast? Sure enough they will start diversifying out of the dollar into eg euros and/or gold. Already by end of last year we saw statements from several countries just doing that:
UAE considers cut in dollar reserves
By Peter Garnham
The United Arab Emirates, the second-largest Arab economy, signalled on Monday that it might cut its holdings of dollars by almost half, highlighting a recent trend of reserve diversification away from the US currency. END.
Costello seeks orderly $US withdrawal
John Garnaut Economics Correspondent
TREASURER Peter Costello has called on East Asia's central bankers to "telegraph" their intentions to diversify out of American investments and ensure an orderly adjustment. Central banks in China, Japan, Taiwan, South Korea and Hong Kong have channelled immense foreign reserves into American government bonds, helping to prop up the US dollar and hold down American interest rates.
Mr Costello said "the strategy had changed" and Chinese central bankers were now looking for alternative investments. END.
Chinese plans to diversify reserves into gold provides further support
Marketwatch.com Nov 09
There was further support in comments from Peoples Bank of China Governor Zhou Xiaochuan who said at a Frankfurt conference that China has very clear plans to diversify its currency reserves, which now stand at more than $1 trillion. A wide range of instruments are under consideration, including gold and oil. END.
So a depreciating dollar seems to be inevitable coming years but what if the dollar depreciates in a disorderly way, could it morph into a dollar (financial) crisis then? Well, sure enough no-one knows but serious warnings have been surfacing lately which shouldn't be taken lightly:
WASHINGTON -- Democratic lawmakers warned on Thursday that U.S. reliance on foreign countries to purchase U.S. debt could lead to a financial crisis as they faulted the Bush administration's economic stewardship.
"If the United States does not begin to take steps to reduce its unsustainable dependence on foreign borrowing in an orderly way, there could be a run on the dollar that could precipitate an international finance crisis and a sharp increase in interest rates," a report issued by Democrats on the congressional Joint Economic Committee and House of Representatives Financial Services Committee said. END.
Investment advisor Bridgewater isn't too optimistic about the dollar either:
Bridgewater's Hennecke Comments on Dollar, Yuan, Yen, Gold
Martin Hennecke, a senior manager at independent investment adviser Bridgewater Ltd. in Hong Kong, comments on the outlook for the dollar, euro, yuan, yen, Swiss franc and commodities. Hennecke spoke in German in a televised interview.
“What concerns us most right now is the U.S. dollar and the decline of the housing market, the crash of the real estate market. Many of the companies that build houses have started to reel. That will have a global effect and could lead to a dollar crash.'' END.
Well, pretty hard words right? But former FED chief Paul Volcker seems to agree since he raised one of his strongest warnings by end of last year concerning a potential dollar crisis, he was very specific and mentioned a time frame of within two and a half years:
Reviewing the systemic case for gold investment
AME Info Nov 19
So far the US has organized an orderly devaluation of the US dollar which has fallen by almost a third in value this century. However, in all market mechanisms there comes a tipping point where a trend becomes a rout - and it has to be said that expecting global creditors to continue to accept falling real debts is not sustainable.
This is why an authority as eminent as Paul Volcker forecasts a dollar crisis within the next two-and-a-half years, and why he is unwilling to extend that timeframe according to recent statements. END.
Now it seems that almost all financial heavyweights see a shift from dollars into euros. Alan Greenspan recently told a conference sponsored by the Commercial Finance Association to see a shift from dollars to euros among central banks indeed:
WASHINGTON (Reuters) - Former Federal Reserve Chairman Alan Greenspan said on Thursday that both private investors and central banks were shifting away from the U.S. dollar and toward the euro. "We're beginning to see some move from the dollar to the euro, both from the private sector ... but also from monetary authorities and central banks,"
END.
Well, seems Greenspan is right:
U.A.E. Central Bank Is Selling Dollars, Buying Euros
Dec. 27 (Bloomberg) –
The United Arab Emirates will convert 8 percent of its foreign-exchange reserves to euros from dollars before September after the U.S. currency slumped this year, the country's central bank governor said.
The U.A.E. has started ``in a limited way'' to sell part of its dollar reserves, Sultan Bin Nasser al-Suwaidi said in an interview in Abu Dhabi on Dec. 24. ``We will accumulate euros each time the market appears to dip,'' as part of a plan to expand the country's holding of euros to 10 percent of the total from 2 percent today, he said.
The Gulf state is among oil producers including Iran, Venezuela and Indonesia, looking to shift their currency reserves into euros or sell their oil, which is currently priced in dollars, in the 12-nation currency. END.
The simple truth is that gold protects against a declining dollar, the central bank of QATAR figured it out already:
Qatar Triples Gold Reserves to Protect Against Dollar
2007-03-15 04:19 (New York)
March 15 (Bloomberg) -- Qatar tripled its gold reserves in January from the previous month to protect against a weakening dollar. Qatar joins oil producers including Iran, Venezuela, Indonesia and the United Arab Emirates, looking to shift their currency reserves out of dollars or sell their oil, currently priced in dollars, in euros…END.
One month later Qatar’s gold reserves were expanded even further:
Qatar gold reserves up more than fivefold in Jan-Feb
Qatar central bank gold holdings rose more than fivefold during January and February, central bank data showed, even though gold prices only climbed 4.5 percent during the same period. Gulf Arab oil and gas producer Qatar, which said last year it wanted to diversify its foreign exchange reserves away from the dollar.
Qatar pegs its currency to the dollar, which declined about 10 percent against the euro last year. That helped spur Qatari inflation to 11.83 percent last year, the highest rate on record.
END.
So there it is, a peg to the dollar spurs unwanted inflation so how to deal with it? Well, what about de-linking de dollar? It seems that this is the way to proceed indeed for many:
KUWAIT DOLLAR KUWAIT GIVES UP DOLLAR PEG
date: 20 05, 2007
KUWAIT, MAY 20 (BNA) – The Kuwaiti dinars Exchange rate against the US$ will be based on a basket of major currencies as of today, the government has decided. The decline in the exchange rate of the dollar against most major currencies, which coincided with the move to link the dinar to it on January 5, 2003 had a negative impact on the countrys economy, he said. The central bank has not managed to reduce the effects of the decline which has brought down the value of the Kuwaiti Dinar against major currencies, except the dollar, he added. He said this had contributed to a rise in inflation. END.
Syria dumps dollar peg
Tuesday, June 05 - 2007
Syria has become the second Middle East nation to de-peg from the ailing US dollar, Bloomberg reports. Syria's currency will instead be linked to a broad range of currencies starting mid-July, according to Syria's Central Bank. The dollar slid 10% in 2007 and central banks worldwide are increasingly looking to diversify their forex reserves to other currencies. END.
U.A.E. May Be Next to End Dollar Peg
June 5 (Bloomberg) -- The United Arab Emirates may be the next Middle Eastern country to stop pegging its exchange rate to the U.S. dollar, according to trading in currency forwards.
The second-largest Arab economy may follow Syria and Kuwait, which both said in the past two weeks that they would dump the dollar peg to curb rising import costs and inflation
END.
Last week the FED reported that foreign central banks were net sellers of US debt indeed what resulted in the 10 year Treasury note yield to jump to its highest level since mid July:
Foreign central banks net sellers of U.S. debt-Fed
Thu Jun 7, 2007 4:30pm
NEW YORK, June 7 (Reuters) - Foreign central banks were net sellers of U.S. Treasuries last week, Federal Reserve data showed on Thursday. END.
Now what kind of implication you think a US treasuries sell off would have? Sure enough rates will go up and inflation fears will kick in:
Wall Street plunges on inflationary pressures
NEW YORK, June 7 (Xinhua) -- Wall Street plunged Thursday on inflationary pressures as bond yields rose.
Worries on inflation was stirred as the U.S. Labor Department said Wednesday unit labor costs rose at higher-than-expected 1.8 percent in the first quarter while the European Central Bank lifted its key interest rate 4 percent.
The yield on the benchmark 10-year Treasury note jumped to 5.13 percent, hitting its highest points since mid-July. END.
As said above the fact that rates are rising now is being touted by the bears as the death knell for gold. The argument goes that rising rates makes the dollar more attractive for investors thereby supporting the dollar’s strength. A stronger dollar translates itself into lower gold prices they say. Although this might sound logical it is totally wrong. Just think about it for a moment. What is the primary reason for selling US bonds? The answer is simple, investors dump bonds because they are concerned that the yield being offered does not compensate for the expected loss in buying power of the dollar (inflation). This lowers the price and drives up the yield. The chart below tells it all:
So if this is all so bearish for the dollar then why is the dollar heading higher lately you wonder?
Well, the thing is that no market goes up or down in a straight line and neither does the dollar. Since the dollar is subject to heavy short selling it can recover every now and then upon short cover rallies which takes the dollar back to its 200 dma again. The overall trend remains down, see chart below:
So we should be a bit patient here in order to see the dollar’s current bear market rally running into exhaustion before it will resume its downward path. An inevitable dollar panic sell-off seems not to be far away once the dollar breaches its long-term support at 80 to the downside.
A dollar losing another 20-30% of its current value would launch the price of gold into new all time highs ($850+)..
A lower dollar supporting higher gold prices is a view supported by ABNAMRO Bank, they reported lately:
ABNAMRO sees strong gold prices in 2007 and 2008
LONDON - Prices of key precious metals will surge this year and next because of contracting mine supply, an expected decline in the dollar and lower sales by Europe's central banks, ABN-AMRO said on Thursday.
Average gold prices were likely to jump to $695 an ounce in the current year and to $740 in 2008 from $604 last year, it said in its latest Global Mining report.
Supporting themes were a dollar weakness, positive supply-demand fundamentals underpinned by constrained mine supply, demand growth, geopolitical tensions and the fact that signatories to the European gold agreement were unlikely to meet their full 500 tonnes a year allocated gold sales, it said. END.
John Embry of Sprott Asset management is a bit more optimistic, he said in his May submission for Investor’s Digest:
John Embry: Expect a try for a new gold record by year end.
The fundamentals for gold are strengthening on an almost daily basis and are inexorably underwriting a sharp upward move in the price in the very near future. The fact that the price explosion has not occurred as rapidly as logic would dictate is a testament to the power of the central banks and their accomplices, the large bullion banks. However, the price is moving higher despite their best efforts, and a multi year high, exceeding the peek in May 2006 could be expect shortly, to be followed by an assault on the all time highs (US$ 850) before year end. END.
JP Morgan seems to share the view of new all time highs in the medium term:
Gold may touch $1000: JP Morgan
Bloomberg / Mumbai June 08, 2007
Gold may rise to more than $1,000 an ounce as demand from India, China and exchange traded funds increases and production of precious metal falls, according to JP Morgan Chase & Co., the third-largest US bank.
Gold, which has risen 5.2 per cent this year, may reach $850 an ounce in the “medium term,’’ on the way to $1,000, analysts from JP Morgan led by John Bridges said in the report dated June 6. They didn't specify what the medium term was. END.
Now please don’t think that the investment case for gold is built upon a crashing dollar only since many other critical drivers for gold are pointing towards much higher gold prices as well indeed. Yes, inflation, supply and demand are all contributing to higher gold prices as well and last but not least when investors figure out that central banks only own half the amount of gold they say they own then gold could explode to the upside towards levels hard to imagine today. In the end this might be the strongest driver for gold since there is no way to return the central bank’s leased gold to its vaults without launching the gold price into a 4 digit number. We will shine a light on this subject in a separate essay in which we will deal with GATA’s view that says the central banks only own half of the gold they say they have. If GATA will be proven right then gold prices could soar to a few thousand dollar per ounce indeed.
You get the picture? Gold’s fundamentals are strong and are pointing towards gold prices exceeding the $1000 mark with ease before the end of this decade. Now what do you think your junior gold shares will be worth by then? Please remember that the biggest moves in gold mining shares in the seventies occurred in the 78/79 period. It’s my strong believe we will be witnessing a strong run in gold mining shares once investors realize that gold is on its way towards new all time highs indeed so we might need to be a bit patient here. Nevertheless times like these do provide excellent ‘BUY’ opportunities since one could load up on many high quality junior gold mining shares almost for free. At the Gold Discovery Letter we do track promising junior companies which we believe could be huge winners before this decade is out. If you would like to participate you could opt for a free trial subscription (one month) HERE
Next chapters will deal with inflation, supply, demand and monetary role. (for subscribers only)
Please feel free to send comments to:
ehommelberg@golddrivers.com
Stay tuned,
Best Regards,
Eric Hommelberg
The Gold Discovery Letter/
The Gold Drivers Report
www.golddrivers.com
-- Posted Tuesday, 12 June 2007 | Digg This Article
