Gold Market Radar (May 14, 2012)
For the week, spot gold closed at $1,579.48 down $62.74 per ounce, or 3.82 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, fell 3.81 percent. The U.S. Trade-Weighted Dollar Index gained 1.0 percent for the week.
Strengths
- The Indian government caved to pressure from local gold retailers which had been on a 21-day strike and decided to withdraw the levy of 1 percent excise duty that it had imposed. With this move gold is set to become cheaper for consumers in India and traders expect a revival in demand in the coming crucial months. Particularly, June and July are the important months for weddings and also for rural India as the monsoon rolls in across the country and cash crops are harvested. Importantly, the government has also decided to raise the threshold limit for cash purchases of jewelry whereby purchases below this level do not require the buyer to cite their income tax related PAN number.
- Another very positive news story was that mainland China’s gold imports from Hong Kong surged more than six-fold in the first quarter. Imports were 135.53 tons between January and March. Demand has climbed in the world’s second-largest economy as rising incomes and curbs on property speculation boosted purchases. The country is already the world’s top consumer of copper and biggest producer of steel. The purchases through Hong Kong may signal that the mainland is accumulating reserves.
- China’s rapid economic development has completely changed the market for gold over the years. Consumption was 203.1 tons in 2001 and, by 2011 the figure had more than tripled to 769.8 tons according to the World Gold Council. Rising incomes in China have boosted purchasing power and citizens are turning to the precious metal as an investment and a store of value, especially given the weakness of the country’s real estate sector. There is also a strong sentiment for China to increase its official holdings in gold: A senior official was recently quoted by local newspapers as saying that China should further diversify its foreign exchange portfolio and make more gold purchases when the price slips.
Weaknesses
- On Osisko Mining, Mike Curran, gold mining analyst at RBC, noted in his summary of quarterly results that investors were waiting for the Malartic Mine to ramp up, not heat up. It was a tough day for Osisko as the overnight fire at their mill will likely curtail the processing of ore for the next three weeks and the company’s operating results were weak. Osisko missed its guidance on both gold production and anticipated ore grades to be put through the mill.
- Calculating the all in costs to produce an ounce of gold by taking net income minus the revenue and dividing by the number of ounces produced showed Osisko’s all in cost to produce an ounce of gold was $1,399 and this number was even higher than the average costs in 2011 of $1,366. The company ended the quarter with $144 million of cash and equivalents but one analyst, Daniel Earle of TD Securities, noted the balance sheets looks tight. Given the obvious risks the analyst expects the company’s cash balance to decline to $47 million in the third quarter with $245 million in long-term debt.
- Gold Resource Corporation released earnings and held its conference call on Friday. Unfortunately, investors were only allowed to email in their questions to the company and management was able to pick and choose what questions they were willing to address.
Opportunities
- A couple weeks back we mentioned that Bob Hoye of Institutional Advisors published a report noting that gold’s consolidation was approaching an end and that the price performance of gold mining shares relative to the price of gold was at extremes only seen five times in the past 100 years. On Wednesday, May 9, we had a strong divergence in the price of gold, down 1 percent, while the mining shares were up close to 2 percent on good volume setting up a bullish divergence. This rally may have been the first wave of short covering by some faster money players. As TD Securities noted at the start of the week, May is historically the second strongest month of the year for gold equities with an average return of 4.6 percent and the probability of a positive return is 75 percent. Institutional Advisor reported on Friday that the last three bullish divergences occurred in July 2010, January 2011, and June 2011 and that within the next four months gold had rallied greater than 20 percent with silver putting in even stronger gains.
- The Shanghai Futures Exchange started trading silver futures this week. Liberalization of precious metal trading in China has been a big driver of gold over the last decade and China has been a net importer of silver for investment and fabrication demand. Given that silver is a much smaller market than gold any pick up in demand could prove to have quite a substantial price impact. China is a country which has a long association with the metal, having had a silver-related currency standard up until the 1930s.
- With the contraction of gold equities valuations back down to 2009 levels, they are essentially reflecting gold price closer to $950, yet the price of gold is close to 70 percent higher. Central bank buying in March was very strong and China’s demand for gold is showing signs of continued strength in its import numbers. However, U.S. investors are fearful that if financial markets swoon such as in 2008 they will see a sell off in commodities. Don Coxe, a well known financial historian, reminded investors on Friday that unlike today, in 2008 when Lehman went bankrupt it had a portfolio of $65 billion in commodities that J.P. Morgan aggressively liquidated.
Threats
- In the broader markets, companies that are hitting earnings expectations are getting pummeled if there is any hint of a weaker outlook. Investors are obviously concerned with the pending increase in tax rates and scripted cuts in spending that are set to take place in 2013. Some estimate the changes could trim 4 percent off GDP.
- Europe is still a mess, socially, politically, economically, and fiscally. Its long-term refinancing operations (LTRO) program bought banks some time but also locked the banks’ balance sheets to the performance of the government bonds they were encouraged to buy. The public is not happy with austerity and in less than two years, eight or so European leaders or ruling parties have been forced out of office. Youth unemployment is big problem in Europe and even college graduates in the U.S. are having difficulty getting full time jobs a year after graduation.
- Globally, since the start of the recession which took hold in 2008, the total value of government debt backed with AAA-ratings has declined from over a 50 percent share of total outstanding sovereign credit to less than 10 percent.
