Gold Market Radar (December 2, 2013)
For the week, spot gold closed at $1,251.39, up $7.76 per ounce, or 0.62 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, were off 0.31 percent. The U.S. Trade-Weighted Dollar Index lost 0.06 percent for the week.
Strengths
- Chinaās net imports of gold from Hong Kong climbed to the second-highest level on record in October as jewelers and retailers bought the metal to build up inventories ahead of a peak-demand season at the end of the year. A total net purchase of 131 tonnes in the month, nearly 20 percent above the 111 tonnes in September, is only slightly lower than the record of 136 tonnes of net imports registered in March 2013. Back in the second quarter, the market dismissed the surge in Chinese purchases of physical gold as purely speculative and one-time, mainly attributable to the sharp decline in the gold price. However, as seen in recent macro data, the appetite for gold from China has proved to be both remarkable and persistent. The much touted ETF liquidations that helped bring gold prices down to the $1,200 level have been absorbed entirely by China. Gold refineries in Switzerland have been busy converting the 400-ounce bullion bars, typically owned by ETFs, into one kilogram bars preferred by Chinese jewelry makers and gold investors.
- Chow Tai Fook Jewellery Group Ltd., the worldās largest listed jewelry chain, forecasted steady growth for the rest of the fiscal year after first-half profits almost doubled on a surge in Chinese demand for gold. Net income rose to HK$3.5 billion and was above the average estimate of HK$2.98 billion from five analysts compiled by Bloomberg. The company said it opened 118 new points of sale, which includes standalone stores and concessionaire counters, taking the total to 1,954 as of the end of September. Not surprisingly, Tiffany & Co., the worldās second-largest jewelry retailer, delivered blowout earnings this week, mostly due to international growth, where the Asia Pacific region had sales growth of 27 percent. Investors should remember that roughly 50 percent of the global demand for gold is fueled by the āLove Trade,ā and evidenced by the success of these two retailers.
- Enthusiasm with the broader equity markets in the United States is getting fairly toppy. The spread between the bull and the bear camps in the Investor Intelligence poll recently widened to 41.4 percentage points. The last time it was this high was in April 2011 and returns seen three to six months later were close to 15 percent lower. In addition, margin debt is now at an all time record of $412 billion, up 30 percent from a year ago. From a contrarian standpoint, when returns have come too easy relative to fundamentals, courtesy of the Federal Reserve, one should read the present tape as ātime to take some money off the table and buy what has been written off,ā such as gold in the current environment. Plain and simple asset allocation, sell high and buy low, is a prudent plan to grow your wealth.
Weaknesses
- Gross speculative short positions on the COMEX have doubled in the past three weeks to 82,842 contracts. According to David Rosenberg of Gluskin Sheff, this is only the fifth time that this has happened in the past decade, which as a strong contrarian indicator sets up the gold market for a nice countertrend rally. The biggest factor weighing on the market is a resumption of selling by ETFs. ETF holdings stabilized during the summer, but have since resumed, with investors having liquidated 1 million ounces over the past month, with 600,000 ounces of that coming over the past week. The renewed decline in ETF holdings suggests that weak hands havenāt completely exited the market.
- Waterton Global Mining laid off 182 employees at its Nevada operations, as the companyās Hollister Mine and Esmeralda Mill commence the next phase of its āvalue creation plan.ā Waterton is going to concentrate on drilling and resource definition in the near term as the company believes it provides the best long-term value and sustainability. Similarly to Hollister, Ryan Gold Corp. announced the shutdown of its Yukon operations given the generally poor market conditions for exploration companies. The company will conserve its cash and cease exploration activities. Despite having funds to proceed, it appears both these companies are not going to attempt to āswim against a fast moving riverā any longer. This news marks the proverbial ātap-outā sign or surrender flag for two juniors, which continue to piece together signs of a market bottom.
- Detour Gold, the worst performing stock in the Toronto Stock Exchange this year, sank to the lowest close since December 2008 on news that Chief Executive Officer Gerald Panneton resigned without providing a reason. He will be replaced by Paul Martin, the chief financial officer, on an interim basis. Detour Gold has plunged 86 percent this year with the market dismissing Mr. Pannetonās assurances that Detour did not need to raise more capital. It is very likely Detour will come back for additional funding through the ramp-up period, with the downside risks to equity holders remaining very high and not necessarily fully priced in.
Opportunities
- According to Dr. Martin Murenbeeld, Dundeeās Chief Economist, if we were to summarize gold market developments for 2013 to date the first concept that would come to mind would be that of a great rotation out of debt and into equity. What has actually happened is a great rotation out of gold and into equity instead. The chart above compares the gold price and the S&P500, showing that the correlation between the two is about as negative as it has ever been. The most curious part is that gold has declined in the face of exponential growth of global liquidity. The negative correlation of gold is much higher with the S&P 500, than with the U.S. dollar for example, which suggests the S&P 500 is driving the gold complex. The chart shows that gold is now -2.4 standard deviations below the S&P 500, an oversold level that on purely statistical terms, has to trigger a correction in the near to medium term.
- Gold producersā price-to-cash-flow multiples remain near the lowest in at least a decade, according to a recent Bloomberg study. Even after a mild bounce during the third quarter, the multiples are well below one standard deviation from the historical average. Not only have the multiples tumbled, but so have the consensus cash flow projections made by analysts, which have declined more than 50 percent from the first quarter of 2012. The resulting cratering of stock prices has many investors completely abandon the sector. However, the fact that cash flow multiples, which tend to be fairly consistent, are sitting at oversold levels bodes well for a bottom in gold stocks.
- Throughout this year, the Indian government increased import duties on gold and silver three times in a bid to protect the currency from a widening current account deficit. The All India Gems and Jewellery Federation has finally stepped up and appealed to the government to roll back the import duty from 15 percent to 5 percent. The abrupt and arbitrary rulings are threatening jewelers by making it very difficult to access the much needed gold and silver. The import curbs force jewelers to pay a record $200 per ounce premium over the London price from next month to obtain supplies, according to the All India Gems & Jewellery Trade Federation. The premium is currently at near record $120-$130 an ounce. As a result, Mumbai-based Tara Jewels said that it will close some of its less profitable gold-led stores to adapt to the current regulatory environment.
Threats
- Goldman Sachs is set to swap $1.68 billion in cash with the Venezuelan central bank, to be backed by $1.85 billion of the nationās gold reserves. The terms of the loan dictate the South American government will pay 7.5 percent plus three month LIBOR over seven years, with Goldman Sachs holding the gold in a margin account. Speculation has been rampant after some details of the story were leaked to the press, with some analysts calling the transaction a classic, non-transparent emerging market transaction where deduction is necessary to guesstimate where the story is going. In our view, the gold provided by Venezuela to Goldman Sachs will create another source upon which the bank can write and sell massive paper gold bets on, increasing the already speculative paper gold market, and continuing to disturb the well-earned reputation of physical gold.
- The daily gold fix in London, the benchmark used by miners, jewelers and central banks to trade the yellow metal, is being scrutinized amid speculation there could be superior knowledge by those involved in the fixing. Tradition calls for five banks to meet, from a few minutes to an hour, to set the price of gold twice a day. However, unnamed traders who have been involved in the process, as well as other dealers and economists argue that knowledge gleaned from the calls could potentially give traders an unfair advantage in the market. Although there is no concrete evidence of wrongdoing, both academics and economists concur in that the system is outdated and vulnerable to abuse, especially considering gold trading is a $20 trillion market.
- Turquoise Hill Resources has filed its final prospectus for the $2.4 billion rights issue. Rights have been priced at $2.40 per share, a 42 percent discount to the November 25 close price of $4.16 per share. The rights issue is a one-for-one, resulting in 1,006 million new shares being issued. The analysts at BMO Research calculate that the issuance will cause existing shareholders who forgo their rights, a theoretical 21 percent dilutionary effect. Despite the numerous dilutions, the highly attractive underground development would be well capitalized, thereby reducing financial risk. Political risk remains a concern and is reflected in the relatively attractive post rights price to net present value (P/NPV) multiple of 0.6x; Turquoise Hill provided no further update regarding its ongoing discussions with the Mongolian Government.
