Gold: Been There, Done That And Bought The T-Shirt

By: John Ing | Mon, Apr 22, 2013
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Gold collapsed over 14 percent in the sharpest tumble since 1983 raising fears that its twelve year bullion is over. Some blame the collapse on the fear that Cyprus and other weakened European countries would have to dump their gold reserves. Wrong. Under an earlier agreement, all European countries must seek permission and the sale of gold is limited to 400 tonnes. Others blame the fear of a slowdown in China. China's growth remains in excess of 7.5 percent and its state-owned companies are leading the way. The People's Daily recently noted today 54 state-owned companies now rank on the Fortune 500 list of the biggest companies in the world. Only two decades ago, the total revenues of the top Chinese companies were less than that of General Motors. Still others blame the lack of inflation though none seem plausible to explain the magnitude and breadth of the decline.

In our view that leaves the main reason which was an estimated 400 tonnes of gold futures dumped in two tranches on the NYMEX Comex. The sales were worth about $20 billion equivalent to about 15 percent of the entire world's mine supply. In fact two years ago, the European central banks took one year to sell that amount of gold. Comex is a futures market where the buying and selling of gold is backed by physical gold in warehouses. Comex sets the initial margin at 10 percent so the purchases or sales were leveraged. Comex releases statistics daily on all trades, and the Commitment of Traders Report (COT) lists trades weekly. As time moves on, the contracts are reduced and on expiration, the majority of trades are rolled over. In the last week alone more than a million contracts traded on Comex, which is the equivalent of about 3,000 tonnes, easily surpassing the mine production of 2,600 tonnes per year. And the volume was unprecedented exceeding 700,000 lots or 4 times the 30 day average. Comex subsequently raised the margin requirements to 19 percent, making the trades more expensive for both buyers and sellers.

To be sure, 400 tonnes of physical gold did not hit the market but the future contracts (paper gold) were too big for the market to absorb and likely a big short sale bet by speculators. The identities of those speculators, of course, are unknown but are likely a combination of the big bullion banks and hedge funds which have been feasting on gold's volatility. To be sure, gold's long term uptrend chart has been broken sparking a classic panic investor capitulation, particularly liquidation from the gold ETFs. Indeed, in over four decades of following the barbaric metal, we have never seen gold more technically oversold. Similarly gold miners which were already beaten up by their non-performance have become even cheaper. However, given our belief that gold's collapse was an orchestrated raid by speculators and not spec longs, the expiry this week must see the "shorts" cover and the calling of their bluff. We thus expect the next big move will be up, sparked by the inevitable short covering rally.

We also believe that the dramatic drop was an effort by these same players to accumulate more physical gold. Yet, ironically while there was a rush to sell paper gold, there was a rush to buy physical gold, which remains in a bull market, trading at whopping premiums. While much attention has been paid to the plunge in gold, trading premiums in gold coins had risen more than 5 percent above the spot price which compares to 3 percent at the beginning of the year. It is no coincidence that only three weeks earlier there was a dramatic two million ounce drawdown from Comex warehouses after the Cyprus "bail-in" which saw the confiscation of depositors' asset to save Cyprus' banks. We believe this premium for spot gold is getting higher and higher and the price correction only makes it more appealing. In India more than 15 tonnes was bought in three days and gold imports are expected to rise to almost 900 tonnes. China, the largest gold producer in the world, has also seen big demand in Hong Kong and its overall demand is expected to be about 800 tonnes, while producing 400 tonnes. The volume for Shanghai Gold Exchange exceeded 43 metric tonnes today for the first time ever. Both India and China are expected to purchase 70 percent of world supply. Gold is simply moving from the West to the East. Gold is held by central banks as a reserve and have been big buyers not sellers particularly emerging market banks. Then the largest Dutch bank, ABN Amro ran out of gold, defaulted and was forced to give out paper to those holders of gold. The shortage too has been part of trend whereby requests to from central banks to repatriate their gold have increased from Germany's request to the Bank of England or to the State of Texas asking that their gold be moved from New York depository to Texas. We believe that the huge short position and orchestration was done to not only make money but also to allow those players to build-up their physical holdings. Simply, possession is nine tenths of the law and physical holdings can't be confiscated nor replaced by specie as in ABN customers' case.

The other question most often asked of us, "is this the end of the bull market?". Having the good fortune of being around when gold was $35 an ounce and watching it go to $200 an ounce when the Americans were allowed to buy and then watch gold fall to $100 an ounce, we were told that we would never see $200 an ounce again. Gold went to $850 an ounce and then in 2008, gold collapsed, subsequently reaching new highs at $1,920 an ounce. Gold always comes back to post new highs. Gold is an asset which unlike collateralized debt obligations or mortgage backed securities or Bank of Herstatt shares or even Fannie Mae debt, always comes back. Gold is a store of value and indeed the fact that gold repeatedly has made new highs in the last twelve years is a reflection of its haven-type characteristics. It is not that gold has done so well, but that the purchasing power of currencies has done poorly. Everybody has it wrong; it is not different this time.

Central bank Balance Sheets

Gold is also a barometer of investor anxiety. Sometimes it moves as a commodity but most times it moves as a safe haven. Gold's twelve year bull run was due in part to the financial crisis in 2008 and the subsequent rounds and rounds of quantitative easing by the central banks to revive their economies that eventually will lead to more bubbles and inflation. Real interest rates remain negative. Governments have been printing money at an unprecedented rate, creating demand for gold as an alternative currency. Indeed, gold has become the defacto currency. It is this currency debasement that provides gold's underpinning as an attractive long term investment, now and in the future.

So while the selloff in our opinion was technically driven, what is to happen next? It is our opinion that the fundamentals have not changed. The "band-aid" solution de jour remains piling on more debt. For the fundamentals to change, the US dollar would have to be the best investment in the world, and for that the Americans would have to reduce the record amount of debt and stop having a string of trillion dollar deficits every year and pass perhaps a budget in both houses to grow their economy. Unlikely to be sure. Consequently while gold had broken down from its long term trend with a correction of more than 20 percent, as in 2008, we believe the correction is a false breakdown and temporary. Indeed, the shares are particularly attractive down here and correction is overdue. Multi-miners and low cost Agnico Eagle and Eldorado are favoured around here. Near term, we anticipate a rally to $1,525 an ounce and maintain our expectation that gold will reach $2,000 an ounce this year. Gold's obituary is premature. We still have the T-shirt.


Analyst Disclosure
Company Name Trading Symbol *Exchange Disclosure code
Eldorado Gold Corp ELD T 1
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John Ing

Author: John Ing

John R. Ing
Maison Placements Canada
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