Gold Market Radar (March 18, 2013)
For the week, spot gold closed at $1,592.05, up $13.25 per ounce, or 0.84 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, rose 0.60 percent. The U.S. Trade-Weighted Dollar Index lost 0.67 percent for the week.
Strengths
- Mexico cut its benchmark interest rate by 50 basis points last week after holding it flat for almost four years. This announcement would normally carry little weight into our gold valuation analysis, however, as ISI reports this week, Mexico’s rate cut is the 351st stimulative policy initiative announced around the world over the past 19 months. Furthermore, Roberto Perli, ISI’s Policy Research Managing Director, reiterates his belief the ECB, Bank of England, and Bank of Japan will ease further on the back of reports stating current job upturn is not near to satisfying the Fed.
- The U.S. Consumer Price Index for the month of February rose 0.7 percent month-over-month, surpassing analysts’ forecast of a 0.5 percent increase. This may be the first indication of rising inflation which should bode well for gold as an inflation hedge.
- The two gold equity rallies from 2012 have an important similarity that can help investors learn how to best position their portfolios for a gold equities bounce, according to Dundee Securities. In both rally periods, May 15 to June 5 and from July 23 to September 21, gold explorers and developers had the strongest performance, followed by the intermediates, seniors, junior producers, and finally, gold. We maintain significant exploration and development exposure in our funds, and we select companies with liquidity and superior management teams we believe capable of delivering on their promises.
Weaknesses
- BCA Research reports this week that its gold advance/decline model has broken below its key support level and is now charting at a 2-year low. It is the research company’s opinion that the negative sentiment towards gold is now widespread and the option-based momentum should lead further outflows out of gold ETFs.
- Deutsche Bank adopted an all-in cost to analyze gold miners. In its Australian gold miners industry update, Deutsche Bank concluded all-in cash costs have ballooned year-over-year. The bank reports average all-in cash costs across its covered stocks were $799 per ounce in 2011 and increased by nearly 40 percent in 2012 to $1,108 per ounce. Despite the fact that we continue to believe the all-in cash costs promoted by the World Gold Council, its members, and most analysts, fall short of capturing the true sustaining and replacement costs of an ounce of gold, we agree with Deutsche Bank in its assertion that ballooning costs together with lower average gold prices will increase the challenges for companies trying to turn their gold into profits.
Opportunities
- According to BCA’s Emerging Market Strategy, credit expansion in China has reached unsustainable levels; over the past four years non-public debt to GDP has expanded from 120 percent to 190 percent. BCA argues that most of these transactions take place behind several layers in order to hide the true levels of credit expansion, with banks being accomplices to these schemes. According to the research, some major Chinese companies are operating under unsustainable leverage levels and will crumble at some point. It will be up to the central government to bail out both local governments and corporations. We believe gold could benefit from this situation as a safe heaven in volatile times.
- Christopher Wood of CLSA noted on his Greed & Fear report this week that gross short positions in Comex gold rose to a high of 13.1 million ounces on February 19, and were last reported on March 5 at 12.6 million ounces. These are the highest levels sine July 1999 and are likely held as speculative investments. A breakdown below $1,550 per ounce cannot be dismissed according to Christopher Wood; yet, he believes the gross short positions are a powerful contrarian indicator and sees a massive buying opportunity for bullion at current levels.
- Firm debit balances in margin accounts at the end of January 2013 rose to $364 billion. Many analysts continue dismiss comments on market speculation, but, margin debt level is at its highest level since October 2007, and dangerously close to its July 2007 peak of $381 billion. The leverage excesses investors have been taking on are an unambiguous reminder of the irrationality and aggressiveness of the market participants at that time. It is clear there is abundant enthusiasm to buy the market and shun gold, which in our view is a grand opportunity to buy beaten down gold stocks.
Threats
- Yi Gang, a deputy Chinese central bank governor, said a 2 percent ratio of gold holdings to China’s total foreign exchange reserves is likely to be the limit. The People’s Bank of China (PBOC) last released data on its gold reserves in 2009, when it announced that it held 1,054 tons. There have been no revisions since then and it is speculated the PBOC has continued to accumulate gold reserves by purchasing domestic production. Yi Gang was quoted stating, “We can only invest about 1-2 percent of the foreign exchange reserves into gold because the market is too small.” His assertion serves to reinforce the theory that it is only a matter of time for the unprecedented monetary expansion and high debt to GDP ratios around the world to drive up prices of hard assets such as gold.
- As the gold price flirts with the $1,600 per ounce level, junior gold explorers that were already cash starved may now be well out of it. Lawrence Williams reports that even in minimum survival mode including layoffs and/or no salaries, there are always ongoing costs to further deplete the treasuries. Stock exchange fees, concession fees, and commitments to ongoing office costs may not be cancelled due to contract terms. It is a pretty dire position for some juniors who will, most likely, not be around by year end. However, the situation also offers the opportunity to invest in sound businesses with cash on hand and good exploration potential, all for a few pennies.
