Bank of Eng­land vault

Gold Mar­ket Cheat Sheet (Octo­ber 17, 2011)

For the week, spot gold closed at $1,680.73, up $42.88 per ounce, or 2.62 per­cent.  Gold stocks, as mea­sured by the NYSE Arca Golds BUGS Index, jumped 5.47 per­cent lower. The U.S. Trade-Weighted Dol­lar Index slumped 2.69 per­cent for the week.

Strengths

• Gold and the whole suite of pre­cious met­als had a mean­ing­ful rebound this week with the sig­nif­i­cant drop in the U.S. dol­lar. Not only was gold up strongly but sil­ver rose 3.88 per­cent and cop­per, which is a byprod­uct of for a num­ber of the gold min­ers, rose 4.65 percent.
• More sig­nif­i­cantly, the gold and sil­ver min­ing stocks rose even more than the bul­lion prices as investors took advan­tage of the over­sold con­di­tions in equities.
• Con­sid­er­ing some of the forced liq­ui­da­tions in the prior week or two, due to some hedge funds los­ing a third to half their value in Sep­tem­ber alone, the sell­ing pres­sure has cer­tainly waned as we saw a hand­ful of com­pa­nies’ share prices rise as much as 50 per­cent over the past five days.

Weak­nesses

• The only draw­back to the sharp rebound in some of the gold stock prices was the return of the invest­ment bankers with a num­ber of bought deal financ­ings this week.
• While it is pos­i­tive that some of the invest­ment firms have the courage to risk their cap­i­tal on an equity raise, per­haps sig­nal­ing they don’t see any dis­tressed clients on the side­lines; it is a bit wor­ri­some that sev­eral com­pa­nies were will­ing to issue equity with only a minor rebound in their share price.
• Per­haps their man­age­ment was as shell shocked as some investors were with the pre­cip­i­tous decline in val­u­a­tions and the haunt­ingly painful mem­ory of 2008 still lingering.

Oppor­tu­ni­ties

• The oppor­tu­nity before us is the poten­tial for a sig­nif­i­cant rebound in gold and gold equi­ties.  For our gold-oriented funds we have now marked three quar­ters in a row of neg­a­tive per­for­mance.  This has only hap­pened one other time in the last ten years and that was dur­ing the 2008 credit crises.  In the ensu­ing two years after that era, there was only one quar­ter out of the fol­low­ing eight quar­ters which had a neg­a­tive return.
• What is also sig­nif­i­cant over the two year win­dow post the 2008 col­lapse was that gold stocks were one of the few assets to appre­ci­ate beyond the high marks which were estab­lished prior to the credit crisis.
• As we are all aware, the prob­lems of 2008 have not gone away, how­ever, much of the coun­ter­party risks now reside within the gov­ern­ments that sug­gested lend­ing stan­dards should be relaxed so every­body could buy a house or bor­row money in per­pe­tu­ity.  Per­haps you don’t want to own a com­pany that sells a prod­uct or ser­vice to gov­ern­ment, unless they sell inks and dyes, but pre­cious met­als and min­ing stocks were one of the strongest per­form­ers com­ing out of this period.

Threats

• Earn­ings sea­son is upon us and gold min­ing com­pa­nies are begin­ning to report pro­duc­tion met­rics for the quar­ter.  For the ten or so com­pa­nies that have reported so far, only one com­pany actu­ally exceeded guid­ance for the quarter.
• In addi­tion, most gold min­ing com­pa­nies con­tinue the prac­tice of report­ing “cash cost” met­rics for gold pro­duc­tion which arti­fi­cially makes the com­pany look very prof­itable.  For instance a company’s press release may show gold pro­duc­tion costs at $450 but in actu­al­ity, the total cost of pro­duc­tion is closer to range of $1,000 to $1,500 per ounce of pro­duc­tion.  It’s no won­der that resource rents and wind­fall profit taxes have sky­rock­eted over the last five years of this ten year run in gold.
• Zam­bia is only the lat­est coun­try to sug­gest that it now wants to increase state own­er­ship in min­ing com­pa­nies oper­at­ing within its bor­ders to 35 percent.

Frank Holmes is CEO and chief investment officer of U.S. Global Investors, Inc., and a Toronto, Canada native, which manages a diversified family of mutual funds and hedge funds specializing in natural resources, emerging markets and infrastructure. The company’s funds have earned more than two dozen Lipper Fund Awards and certificates since 2000. The Global Resources Fund (PSPFX) was Lipper’s top-performing global natural resources fund in 2010. In 2009, the World Precious Minerals Fund (UNWPX) was Lipper’s top-performing gold fund, the second time in four years for that achievement. In addition, both funds received 2007 and 2008 Lipper Fund Awards as the best overall funds in their respective categories. Mr. Holmes was 2006 mining fund manager of the year for Mining Journal, a leading publication for the global resources industry, and he is co-author of “The Goldwatcher: Demystifying Gold Investing.” He is also an advisor to the International Crisis Group, which works to resolve global conflict, and the William J. Clinton Foundation on sustainable development in nations with resource-based economies. Mr. Holmes is a much-sought-after conference speaker and a regular commentator on financial television. He has been profiled by Fortune, Barron’s, The Financial Times and other publications. Read more from the author/contributor here.

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