Gold Market Radar (July 15, 2013)
For the week, spot gold closed at $1,285.70, up $62.50 per ounce, or 5.11 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, rose 4.27 percent. The U.S. Trade-Weighted Dollar Index lost 1.79 percent for the week.
Strengths
- In keeping up with the physical demand trend, we have reports that U.S. Mint gold coin sales have risen 20,000 ounces in the first week of July, compared to 34,500 ounces for the full month of July 2012. So far in 2013, U.S. gold coin sales have reached 810,500 ounces, just shy of the entire 2012 level. Similarly, Chow Tai Fook Jewellery, the world’s biggest jewellery chain, said its first-quarter same-store sales rose 48 percent as Chinese shoppers rushed to buy gold products after the price of the precious metal dropped.
- Chinese inflation accelerated 2.7 percent over a year ago in June, boding well for gold as it remains the most widely held hedge against risky assets and inflation in many parts of Asia. Coincidentally, trading volumes surged during the inauguration of an after-hours trading session on the Shanghai Futures Exchange. Volumes reached 224,320 in the five-and-a-half hour session from 9 pm local time on July 7, compared with an average of 87,129 in June during the regular four-hour trading day.
- Klondex Mines announced further results of its ongoing 2013 exploration and development program on the Joyce structure of its Fire Creek project in Nevada. The weighted average grade of samples from the Joyce structure is 132.8 grams per ton along a 473 ft strike. Previous drilling demonstrates that the mineralization extends beyond the current boundaries, both along strike and at depth. On the same note, Pretium Resources’ CEO Robert Quartermain gave an interview this week in which he highlighted the conditions necessary to be successful in the current cycle. His opinion is that two essential elements have to be present: a high grade gold deposit and keen focus on cost and cash deployment. Based on these metrics, both Pretium and Klondex have great potential to become the next niche North American producers.
Weaknesses
- Allied Nevada Gold announced that Randy Buffington has been appointed President and CEO, while Bob Buchan will remain active as Executive Chairman. The appointment of Mr. Buffington is by no means negative, as he has been steering Allied Nevada through the mill expansion since he was hired as COO last year, according to BMO. However, his appointment highlights a trend that has yet to prove beneficial for the gold sector. BMO restates that out of 71 gold companies in its research coverage universe, this is the nineteenth CEO change in 18 months; all 19 have been replaced by executives internal to the company at the time of promotion.
- Detour Gold released preliminary second-quarter production results, missing its production target as well as under-delivering in terms of grade. Most sell-side analyst coverage appeared too forgiving. Thankfully, George Topping at Stifel Nicolaus provided some color. According to Topping, CEO Panneton said guidance is maintained but can always be changed, leaving room for speculation on a downward revision for guidance in the future. Furthermore, operating costs at $90 million yield cash costs of $2,000 per ounce of gold poured. The company is certainly ramping up, but you can expect more hiccups along the way, concludes Topping.
- Commodities guru Jim Rogers, who successfully predicted gold’s decline to $1,200, gave an interview earlier in the week in which he updated his gold forecast. In his opinion, gold could certainly have a longer correction for the same reason it corrected to $1,200; it had gone up for 12 years in a row. Given this background, gold is likely in the process of making a correction, one which could continue to bring it lower. One thing is certain, according to Rogers; the bull market is not over. Gold is going to eventually make new highs. But first, gold may decline to $960, a point where it will shake even some of the faithful, some of the mystics, as he describes them.
Opportunities
- Bloomberg reports that gold traders have turned the most bullish in five weeks following Fed Reserve Chairman Ben Bernanke’s speech on Wednesday. Nineteen analysts surveyed by Bloomberg expect prices to rise next week, while nine were bearish and three were neutral. Ross Norman, chief executive officer of Sharps Pixley highlighted, “With the Fed comments, with the increased cost of funding a short position and some recalibration in peoples’ thinking about the end of quantitative easing, the onus is really on the bears now.”
- Alamos Gold announced the acquisition of two projects from Esperanza Resources, in a transaction that was well received by the markets. Scotia Research shows Alamos paid approximately $21.50 per ounce of gold compared to a list of recent acquisitions which average $123 per ounce. An 84 percent discount! Not only did Alamos get a bargain price, it also purchased very high quality assets. Alamos is the first company to take advantage of the cheap valuations to acquire valuable assets.
- Despite expectations for the Chinese economy to grow in excess of 7 percent in 2013 and 2014, the Li Keqiang-led government is focusing on three key pillars: no stimulus, deleveraging and structural reform. This policy, which its economists have dubbed “Likonomics,” appears to be the best policy for the long term. However, it comes with further downside risks for both Chinese economic growth and asset prices. According to Barclays, “a steep fall in China’s growth could be the trigger for acceleration in structural changes in the country’s gold demand. A hard landing could shake faith in the government and lead to a big fall in CNY-denominated assets which could mean gold becomes important for domestic investors to hedge what we think they will view as a greater set of risks than previously.”
Threats
- Macquarie’s U.S. Economic research this week highlighted the common error of focusing solely on the unemployment rate to gauge the current status of the labor market, which is in essence what the market anticipates the Fed is doing based on its releases to the press. However, it appears both the Fed and the market are missing the likelihood of a rebound in labor force participation, which is at record lows. According to Macquarie’s research, a conservative timeline for the first Fed rate hike looks more like fourth quarter 2016, a full 24 months later than market consensus of fourth quarter 2014. In fact, Macquarie cites a paper written by the Boston Fed which comes to the same conclusion: the labor participation rate is depressed. In our opinion, the participation rate will pick up faster as we approach the 6.5 percent unemployment rate, ensuring a postponement of any planned rate hikes.
- Scotiabank precious metals analyst Tanya Jakusconek provided an interesting review of financial covenants among senior gold producers. Tanya recommends companies with strong balance sheets and low risks of covenant stress at lower gold prices. According to Tanya, the majority of the debt facilities in place are revolving credit facilities and senior secured/unsecured loans. Financial covenants associated with these facilities are calculated on a four-quarter trailing basis and therefore most are not likely to be triggered in the near future. However, companies expected to have write-downs or those with elevated debt levels, such as Barrick Gold and Goldfield, do not have a lot of room for gold prices to decline before triggering a covenant.
- Upon revisiting its gold supply assumptions, the analysts at Stifel concluded that unlike the copper market, gold miners have historically been reluctant to shut down supply. It can be incredibly expensive to shut mines in terms of severance, crystallizing environmental liabilities and costs of decommissioning. Gold companies prefer shuttering mines as they retain an option on their gold reserves. Miners also resort to high-grading, slashing sustaining capital expenditures, and downsizing before forcing a final closure. With 5 percent of production amongst the senior producers already at uneconomic levels, there is a significant risk of owning loss-making gold producers for prolonged periods of time. This is the main reason why we emphasize the importance of active management and careful stock selection, rather than reliance on indexed exchange traded funds.
