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Archive for May, 2010



   Posted by: Mr. Gold    in Uncategorized

Several weeks ago I dwelled on the relative merits of four musketeers – perceived safe havens in the times of market plague. The plague has since spread further, underlying the brittle state of market confidence, easily shaken up by anything from a takeover of a Spanish ‘caja’, to a Korean torpedo, to another regulatory rumor emanating from Berlin or Washington. The Japanese Yen, the German Bund, the US dollar and gold have all benefited from increases in risk aversion. In Yen’s case, this is a story of capital repatriation. The Bund’s triumph is a death toll to the decade of Euro-wide credit enhancement. The dollar and the dollar denominated fixed income market (with the exception of the completely vanished corporate issuance) remain the ‘lato sensu’ greatest pool of liquidity for small and big fish alike.

And gold? Gold’s shine has now adapted to a new reality in the currency market. It is a brand new world of carry trades which increasingly use the Euro – rather than the Yen and the dollar – as the funding currency. To be sure, this was an unlikely scenario until December last year when the Mediterranean ripples reached the shores of financial markets. After all, the Euro’s short term rates remain at 1% – several magnitudes above the Japanese Yen. But with the non-European demand for European bonds slowing to a trickle, the support for the currency has largely evaporated. It did not help that China’s trade surplus dissipated in the first quarter on the massive restocking of soybeans and iron ore. Suddenly, there was no dollar surplus to be redeployed into the Euro. Now, the conservative Japanese investors are beginning to vote down Euro exposure in their fixed income portfolios.

Despite the less attractive yield differential, the Euro’s fall from grace offers more stable returns for carry trades on a volatility-adjusted basis. Sudden spikes in risk aversion are unlikely to force non-European capital into the embrace of the Euro area. The combination of these forces and the continued attractiveness of the dollar and the yen indicate that Euro will remain weak for longer. But it is remarkable how well the gold market has adjusted to this paradigm shift.

When gold scored an all-time high in December 2009, its correlation to Euro – dollar pair was at 0.9. This was a close of a year in which trade-weighted dollar suffered enormously, but budged only marginally against the Euro (around 4%). Fast forward five months and, remarkably, the recent highs in the gold price have been registered at a NEGATIVE correlation to Euro of 0.8. The last time we saw such levels was December 2005, a period of heightened geopolitical risk in the Middle East.

To understand the differences between the December and May highs ($1216/$1239 and EUR808/EUR993, respectively), it is worth digging into the technical analysis. The Bollinger charts show that the bandwidth in USD was below 20 in December, but failed to reach even 11 in May. By contrast, in EUR terms, gold bandwidth was 18 in December and a whopping 23 in May. Such high volatility in Euro-gold means that there is little probability of a sharp breakout from the current levels. There is nothing in the candlestick charts that would undermine this hypothesis.

A 14-day relative strength index (RSI) has sent correct sell signals post the new highs (in both the dollar and the Euro), and the commodity channel index (CMCI) has always registered divergence around the highs. No surprises there and not much difference between the gold investors operating out of these two currencies.

The differences between euro-gold and dollar-gold reappear when we focus on 14-day directional movement (DMI). Here, post the December high, dollar gold was in the negative territory for the whole month and in Euro terms for only 5 days. Remarkably, the pullback last week did not trigger a dominance of negative directional indicator (in either currency).

The most fruitful lessons for the short term are to be gleaned from the stochastics. Such leading indicators perform best in sideways markets. Since December, dollar-gold sent 4 ‘buy signals’ and the first weak ‘buy signal’ appeared already within 12 calendar days of the previous high. In May, this period has been even shorter. However, in Euro terms, stochastics remain in overbought territory. What it could mean is that for all the drama surrounding the Spanish cajas, German short-selling curbs, and the fears that foreign reserve managers begin to scowl at the common currency, Euro could probably offer a strong support above 1.10 level. If this was the case (and keeping in mind Bollinger lessons on the unlikely Euro-gold breakout), it is smarter now for dollar-wealthy investors to start accumulating gold positions through the summer, regardless of what the Euro does. Any sign of inflation or ‘old’ correlation returning would come as a huge surprise from the current levels and gold would offer far more than mere ‘capital preservation’.

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   Posted by: Mr. Gold    in Uncategorized

Yet another amazing week in the gold market and yet another all-time high record in Euro terms last Monday. Since then, the market has stabilized and pulled back. To determine how far this pullback goes requires some conjectures about who was at the forefront of buying – and selling – at the height of the currency panic that gripped the markets after ECB’s implicit capitulation to the requirements of Europe’s increasingly dysfunctional sovereign debt market.

We know some things with relative certainty. Comex speculative positions by non-reportable and non-commercial investors jumped last week to the near record of 32.4moz. Then, of course, we saw the gold ETFs jump to a new record of 62moz worldwide, with over half of the inflows registered in the SPDR Trust. For all the signs of panic in Europe, the London and Zurich ETFs trailed the inflows into the NYSE-listed competitor. Reports from Switzerland and Germany pointed instead to a sustained demand for coins and bars. Yet such a dispersed physical offtake is unlikely to be the driver for the new prices. Rather, it points to how solid the floor is under the current prices.

Other markets have sent a mixed signal. Akshaya Tritya festival in India has been a disappointment for gold bulls. Anecdotal evidence points to barely a third of purchase registered a year before. It did not help that the jump in the gold price coincided with the depreciation of the Indian currency, which has lost 4.3% to the dollar in barely two weeks. The combination of these two moves has conspired against gold sales as bullion in Rupee terms rocketed 430% in annualized terms during the period immediately preceding the festival. On Monday, front-dated gold hit an all-time high on India Commodity Exchange MCX. Such volatility is bound to destroy demand ahead of the weaker season in what remains the world’s largest gold market.

However, other Asian markets have reported different stories. Even though Singapore and Hong Kong premiums began to soften last Friday (and Tokyo discount deepened further, with electronics industry turning their backs en masse), there are signs that scrap availability may be less than in the record year of 2009. Locally, it leads to tight markets – as in Thailand, plagued by dramatic events these days, or in Vietnam, where headline inflation is again in double digits.

Traders in Asia tend to classify gold scrap as falling into three – albeit not perfectly distinct – categories. At the top of the secondary supply chain, one finds opportunistic investors. These large volume players buy and sell gold, turning profit from even small price movements in the local currencies. As investors, speculators and physical gold holders, their main objective is to realize specific price points. They provide high quality product, and are largely responsible for dampening the volatility of the gold prices globally.

The 2nd tier scrap market participants hold significant stock of jewelry products. The price they receive for their sizable volumes is better than in the retail market and the spreads are very tight – especially if compared to the vocal, yet still fledgling gold currency market in the United States (Sears, K-Mart, etc).

These 1st and 2nd tier players dominated the huge secondary market throughout most of 2009. However, in many markets it now seems that the supply from these sources is drying up. It is not entirely clear if the reversion of gold price correlation to the US dollar has thwarted any of the time-tested strategies.

To be sure, the secondary market is still lively, though increasingly dominated by the hitherto vaguely present “3rd tier” suppliers. These are small savers and retail consumers who punt their lifetime savings in buy-back centers around Asia’s periphery. Although the quality of their product is poor, it is welcomed by the wholesale market because it can sidestep the restrictions on cross-border trade, which still prevail in authoritarian regimes jealously guarding whatever source of hard currency (e.g. Vietnam, Burma, China).

If these trends prevail, in longer term we may experience even more volatility in the gold market. However, in the short term, inventory holders are now facing a risk unknown since last summer. In the last several days, Libor has responded to Europe’s interbank woes. Since May 7th, 3-month Libor jumped 11%. Should this move reveal some deeper malaise about international banking, gold lease rate could be pulled up in the wake. And this is (almost) never positive for spot prices.

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The events of the last several days were nothing short of extraordinary. As the political viability of aggressive austerity plans became even more untenable, the markets cascaded into risk aversion territory unseen since the nadir weeks of 4Q 2008. In the days leading to the massive dislocations of May 6 and May 7, flight to “quality credit” was accompanied by a growing short position in Euro, peaking at some $17bn. All along, gold kept inching up, losing only two days over 13 sessions. The ETF positions grew to a record, the speculative Comex long shot up, coins and bar sales picked up strongly in Germany and in the US. Imports to India remained strong ahead of the upcoming Akshaya Tritya festival, to be held on May 16.

But then an equally extraordinary realization kicks in. Gold has resumed its risk aversion function, but from a perspective of a different currency. Euro woes and Euro depreciation lead to stronger flows in gold, undermining a decade-long dogma about the relationship between the dollar and gold. In fact, in the dramatic hours and minutes of the May 6th market “glitch”, gold benefited in synch with the other areas of refuge: the liquidity of the US Treasury market, the credibility of the German Bund and the risk aversion of capital repatriated by the Japanese investors back into the Yen space. For several trading days it seemed like the UK gilts could join this rarified company, but the inconclusive election and the prospects of a new man on Downing Street discovering something “Greek” about the British books have stalled any further interest in the UK debt.

The Magnificent Four were all aligned to accept inflows from various sources of capital, with only the German Bund investors “trapped” in the Euro area – with losses offset by the unprecedented compression in yields – from 3.4% to 2.8% within several weeks. Against the backdrop of street clashes in Greece and the Shanghai market entering a bear territory, an academic could ponder on the relative merits of the four safe heavens.

The arguments in favor of Yen assets are well known – the gross debt to GDP is double the size of Japan’s net debt to GDP and the government’s financial assets equal roughly the outstanding bond value of JPY 551 trillion. Importantly for the holders of Japanese debt (only 7% of which is held overseas), the BOJ has a rule not to hold more JGB than total banknotes in circulation and thus it cannot monetize government debt. There is, therefore, some merit in parking capital in a developed economy with what is nominally the largest debt burden on the public balance sheet.

The Bund’s attractiveness even increased with the political censure meted out to Berlin’s politicians for their perceived largesse towards those “verschwenderisch” Greeks. And although federal accounts do not quite meet the Maastricht treaty, Germany remains an oasis of fiscal conservatism even after the 2008 tax cuts and 2009 stimulus package. However, the situation in the Länder and municipalities is much less rosy. Large sections of the German public are tired of financing re-unifications, EU enlargements and now bail-outs. Their quest for gold coins is understandable, but hedged for currency effects, the Bund remains a defensive investment par excellence.

The US Treasury market has stabilized without major hitches, following the successful phase-out of QE. Interestingly, the increased tax receipts in the recovering economy will now lead to a reduced supply of new Treasuries, with concomitant pressure on the yields. The attractiveness of these products lies invariably in the size and the depth of its pool. Unfortunately, the wall of money running into the dollar space will push down the lending costs in the US, recreating some of the conditions which led to the financial crisis in the first place. At the same time, by bidding up the dollar, the inflows will make it harder for the US industry to compete in the global markets.

This leaves us with gold. The most interesting day came for gold after EU leaders announced the $1 trillion package to soothe the markets. In the early Asian hours on Monday, gold retraced considerably. However, it was the ECB’s unprecedented announcement of the future expansion of its balance sheet to “purchase malfunctioning securities” that switched gold traders’ focus from Mediterranean austerity woes to potential inflationary effects of the joint EU/ECB intervention. Should ECB fail to successfully sterilize the purchase of the less palatable products, the liquidity conditions in the global market could be affected as in 2009. In the late trading on Monday, Euro stabilized and gold resumed its climb.

The optimism has not lasted for long, the Euro has now weakened again, Chinese inflation chill continued to spread and gold has notched its 20th all time high in Euro in some 60 trading days and shortly after that an all time high in US dollars as well. We are now entering a serious currency crisis and the risks that a sequel could unfold any day – in Euro or in the British Pound. For now, the Magnificent Four are on the march again… Which of them will fail first?

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   Posted by: Mr. Gold    in Uncategorized

Like an ominous thunder at the onset of Northern Territory’s wet season, the Resource Super Profit Tax (RSPT) fell from the hitherto welcoming Australian skies, hitting the mining shares in Sydney and spreading the fear to other equity markets. The so-called Henry Tax Review contains the seeds of further trouble for miners, including gold miners. For all the dismissive tone since the weekend announcement, the challenge is much more than a 2012 super profit bomb.

The vague definition included in the RSPT proposal, defines “super profit” as any earnings over the risk-free rate, currently around 4.5% in Australia. This lunacy reflects bureaucrats’ utter ignorance of mining finance where required hurdle rates are rarely below 15%. No wonder the global markets shuddered. In three days, Australian equities lost A$6bn, world mining index plunged 7.35% and London’s mining index by 7.19%. Only global gold equity indexes continued to hover near all-time highs, uncomfortably buoyed by the bloodiest sequel yet to the Greek drama.

For almost a decade, Australia’s economy has been buttressed by China’s unquenchable appetite for commodities. The country’s gold miners have so far hardly benefited from the iron ore and coal boom. If anything, gold companies have suffered the consequences of a strong Aussie dollar, recurrently bid up by the Japanese and Western carry trades. The bulk mining boom has also pushed up broader mining inflation and by early 2008 led to obvious signs of overheating, with upstream capacity, contracting fees and equipment running short and forcing projects behind schedule.

But Australia’s mining has been an oasis of stability and predictability in a mining world plagued by intermittent tax reforms (Tanzania), legal wrangles (Mongolia), legacy issues (South Africa) and community challenges (from South America to India to Philippines). After the initial hiccups, the Native Title framework turned the lucky country into a viable destination for mining investment and foreign miners spend the late 1990s and early 2000s consolidating the Australian gold industry. Not surprisingly, of the four top gold miners, three (Newmont, Barrick and AngloGold Ashanti) boast operations in Australia. Only the relative late bloomer Goldcorp has been adamant about its commitment to opportunities in the Western Hemisphere.

The new, 40% tax on profits from “non-renewable resources” is slated to generate A$9bn in revenues (a number that pales in NPV terms when compared to this week’s market damage). The levy, to be imposed by July 2012, does not affect Australian-listed operators overseas (such as the Zambia-focused copper miner Equinox), but it will bite a chunk off the foreign listed operators in Australia. Projects most affected are cash cows with most capital written off – which includes both Newmont and Barrick’s Super Pit and AngloGold Ashanti’s Sunrise Dam. Exploration will be deductible, but the economics of early stage projects will be affected (e.g. Independence and AngloGold Ashanti’s Tropicana). A web of other offsets has been put forward for a debate, but BHP has already calculated that its overall tax burden would grow by 13%.

It is unclear at this moment whether Australia is planning to reinvest the proceeds for the long term, as Norway has. What is certain is that two years after the collapse in commodity and mining values, other governments will now revisit surplus taxes, new royalty schemes and other levies. In the wake of the February earthquake, Chile has already made clear that large mining groups should not treat the highly advantageous tax scheme as their birthright. But Chile – a copper paradise – accounts for only a small fraction of global gold production. Australia, on the other hand, produces 10% of globally mined gold (some 230mtpa).

The equity market reaction was predictable. Most Sydney-listed gold miners were decimated, including Kingsgate (so far essentially a Thailand risk proxy), Avoca, Dominion, Lihir and Newcrest – whose sweetened offer for Lihir actually re-balances the asset base away from Australia. The chill has now spread to other mining equity centers as if in recognition what the “Henry Tax” proposal might mean for the global mining industry elsewhere.

Despite gold’s relentless climb towards its dollar all-time high (while it notches fresh highs in Euro and Swissie), it could be premature to punt any of the depressed gold stocks as near term “value” opportunities. The global commodity sell-off will continue to spread in cancerogenous fashion, easily swayed by ripples from yet another hike in China’s reserve requirement ratio. Mining equities and gold mining equities may be caught in the downdrift as we are inching towards the seasonally weaker summer. For value hunters, stock-picking will this year be an exciting exercise, but not before August lull sets in.

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