Gold Market Radar (August 6, 2012)

Gold Market Radar (August 6, 2012)

For the week, spot gold closed at $1,603.48 down $19.42 per ounce, or 1.20 percent.  Gold stocks, as measured by the NYSE Arca Gold Miners Index, fell 1.04 percent. The U.S. Trade-Weighted Dollar Index slid 0.48 percent for the week.

Strengths

• Central bank buying of gold continues to be a strong theme.  This week the Bank of Korea, which has the world’s seventh biggest foreign exchange reserves, announced it had purchased 16 metric tons of gold last month, increasing reserves to 70.4 tons. Central banks and the International Monetary Fund (IMF) are the largest bullion owners with 29,500 tons at the end of last year, or 17 percent of all mined metal, World Gold Council data shows.  Central banks have been net buyers for two straight years, the Council said.  Purchases this year will probably exceed the 456 tons added in 2011, the Council estimates.
• Although gold was down for the week we think the price action was positive.  Gold was down somewhat when the strong ADP jobs number came out on Wednesday morning, and then gold initially declined further after Federal Reserve Chairman Ben Bernanke held off on announcing new stimulus measures.  The selloff did not last long before buyers came back in and scooped up the metal.  The simplistic trade of shorting gold on no new Bernanke announcement for another round of quantitative easing has become quite crowded.
• Although global gold mine production has fallen -2.9 percent year-to-date and has registered year-over-year declines for eight months running may sound like bad news, and it has been for certain gold producers, this is certainly a positive for those companies that have maintained or grown their production.  Despite the 11 years of consecutively higher gold prices, gold production has been flat and this should bode well for higher prices in the future.

Weaknesses

• Kinross Gold replaced CEO Tye Burt this week.  This is the second senior gold company CEO to have been removed by their boards in the past month.  The replacement CEO is J. Paul Rollinson, a long-time associate of Mr. Burt. Mr. Rollinson is also a former investment banker, with a geology and engineering background.  In general, analysts lamented that they would have preferred a high profile manager with a proven track record of operating and/or building mines and/or turning companies around.
• Standard & Poor’s has downgraded Barrick Gold from “A-” to “BBB+” with a negative outlook.  The rating agency’s negative outlook on Barrick “reflects our view that the execution risks surrounding Pascua-Lama could potentially stretch the company’s credit measures and free operation cash flow generation beyond the levels we have assumed within our base case scenario.”
• The Indian market is still seeing no relief as the rupee remains weak, the arrival of the monsoon season has been disappointing and the multi-state electric grid collapse last week caused widespread blackouts across the region, obviously curtailing near-term economic activity.

Opportunities

• Nick Holland, CEO of Goldfields Ltd., recently addressed the Melbourne Mining Club and covered a 35-page presentation surveying all the things that gold miners have been getting wrong over the last decade and offering a few ways to solve some of them.   Nick Holland pointed out that one theme has run through the presentations of large gold producers at investor conferences over the last 15 years is that production is going to increase and this will result in the company increasing its earnings.  Nick notes that if the gold industry had actually met all its production promises over the last five years, then it would not have dropped output on a compound annual basis by 2 percent between 2006 and 2011.  Unfortunately gold miners have not met their production promises and investors have become skeptical.
• Nick also highlighted that gold miners need to think differently about costs.  “Who are we trying to kid?  We don’t kid the investors because they know how much cash we really generate after everything is accounted for.  The sell-side also understands this.  The only people we’re kidding are governments and communities, who, not surprisingly, say, okay, you’re making super profits, please pay up.  And before we know it we have windfall taxes, higher royalties and so on.  We’ve got to change the lens through which we and the world view this industry, and start talking about what it really costs to produce an ounce of gold.  I don’t care if we call it NCE or something else, but to talk about cash costs only is not telling the full story.”  We view this type of examination of the industry as a strong positive for management to take full notice of and start delivering on what the investor is expecting from gold mining companies.
• Bank of America Merrill Lynch noted that while the Federal Open Market Committee (FOMC) did not take any easing action at its current meeting, under its forecast, the economic data should weaken enough by the September 13 FOMC meeting to convince most Fed officials to support more QE and extend the forward guidance then.  But the call on further Fed easing remains very dependent on the path of incoming data.  We think only a small portion of recent gold buyers entered with the expectation of a Fed move this week but it is more likely a greater number are looking toward the Jackson Hole meeting at the end of August, and then the September FOMC meeting as key entry points into the gold market.

Threats

• While most governments are outright buyers of gold, Vietnam’s government has a different view on gold.  The problem is nobody wants to use their local currency, the dong but instead more and more rely on gold to settle transactions.  The Vietnamese people have a huge affinity with gold, but the country’s government is taking major steps to restrict the gold market and the practice of replacing the dong with gold in transactions.  These restrictions included banning gold as a medium of exchange and issuing seven directives which are designed to reduce “goldization” the practice of replacing the dong with gold in transactions.
• David Rosenberg, of Gluskin Shelf, pointed out that U.S. investors withdrew a net $11.5 billion out of equity funds in the prior week according to the Lipper data that includes ETFs, the sharpest outflow in two years.  Taxable bond funds attracted over $3 billion and that brings the year-to-date tally to $151 billion as the secular shift in investor behavior towards income-generation continues apace.
• Baby boomer investors looking forward to retirement have been burned by the tech bubble, the housing boom and ensuing credit crisis. Much of the shift in money flows has been to extreme risk aversion and government bonds have been the choice for the safety.  Unfortunately, the market has the uncanny ability to move in a direction that will disappoint the most investors.  It is unlikely, given the rising debt burden of governments, that the masses will be rewarded for seeking safety in bonds for the next five years. Under owned assets which are out of favor, such as gold, deserve some consideration for portfolio diversification.