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Archive for November, 2010



   Posted by: Mr. Gold    in Uncategorized

Stupor, bewilderment, anxiety, shock and anger meet yet another provocation dished out by Pyongyang on its southern neighbor. These are the feelings expressed by those directly and indirectly affected, those still married to the post-war, UN-regulated order, the naïve bunch that has not quite grasped to what extent the rules of the game have shifted. Despite years of international sanctions, North Korea, an entity born out of sweat and blood of Mao Tse Tung’s troops, has now happily turned into a China’s bad boy testing ground. Assessing the patience of neighbors, fraying at the global resolve to cap the mercurial ambitions of the ruling family, helping Pyongyang to run its businesses and obtain more uranium for enrichment… The “global community”, if there was ever one, can’t stop it because Kim’s backers are today full of liquidity-oiled hubris and see no interest in hemming in the wayward behavior. Behavior that may well be channeled through the tensions with the immediate neighbor to the South, but ultimately is aimed at Beijing’s traditional enemies and rivals in the region – Japan and the US. After all, China invited Kim Jong-il when his navy killed 45 South Koreans in Cheonan incident last March. From Burma to North Korea, the neo-imperial Middle Kingdom revels in this sort of archaic clientelism. One just gets tired of the press mantra about Beijing’s concern about “refugees flooding into PRC”. China is managing the ‘refugee’ problem all right, stuffing stacks of banknotes into the pockets of every Manchurian who spots and denounces a non-fluent Chinese speaker in the backyard of the chilly Jilin Province. A police state does not need a private militia to protect its flank. Amnok River is no Rio Grande.

But there is a group of excited investors who, while may not exactly cheer Kim Jong Il’s (and now possibly Kim Jong-eun’s) aggressive antics, are anxious to see instability as a litmus test for further gains in the safe haven asset par excellence: gold, geum, huangjin – or whatever else it the 79th element on Mendeleev’s table could be called in that troubled region.

And the oxymoronically sobering news is – there is actually something to get excited about. In a simplistic, single-variable overview, gold’s usual response to Pyongyang’s ultimately unpredictable actions is positive and not necessarily short-lived.

We looked at 9 incidents caused by the North over the last 5 years, ranging from missile launches, to nuclear tests to warship clashes and bombing campaigns. We added to this any reports concerning dramatic changes at the top of the state’s structure (Kim family issues). We then compared the performance of the gold market in the ensuing period. It appears that gold in dollar terms is lifted by an average 0.09% in the day after an incident. In only two cases (reports on Kim Jong Il’s stroke in September 2008 and the second nuclear test in May 2009) did the gold price actually fall on the news. More surprising yet is the fact that in the week following the events, gold gains an average 2.31%, and a month later it is still higher by 5.36%, in dollar terms.

Of course, this is a single variable extracted from a wealth of other macro- and gold-specific influences. What is stunning is the regularity of the metal’s behavior, possibly coincidental and certainly orthogonal but regular nonetheless. Importantly however, in only one case (May 09) did the subsequent trading reverse the pre-existing trend. In all other instances, gold’s trajectory simply amplified or extended the trend. Remarkably, Korean incidents have a peculiar feature of not occurring during occasional gold market pullbacks.

One hypothesis could be that any posturing or outright aggression induces Asians to actually purchase more gold. This would require further research into historical demand data, but it is an intriguing thought. Just as most Westerners seem resigned to the swell of Asian juggernauts, locals may be a little more aware of the precarious state of liquidity-driven property boom, unresolved territorial disputes, ultra-nationalistic educational systems and the premature demographic peak. Contrary to Norman Angell’s hopeful students, there are reasons to believe a war in a region run by unreformed dictatorships is not becoming any less likely just because many of its inhabitants have now become wealthier.

Nor should the conclusion be any different if you are a South Korean resident and most your wealth is Won-denominated. Not only have you suffered from your central bank’s ongoing intervention to keep the currency competitive against the undervalued Renminbi, but now the Kims up north are doing this job just as efficiently. You may have little choice but to hold gold as an insurance against sudden falls in the value of your currency. On the basis of the 9 peninsular incidents, it turns out that your wallet’s one-day gold price sensitivity is seven (!) times higher than for dollar-denominated gold investors.

For all other gold investors the solution lies elsewhere. For as long as the North Korean forays remain low frequency events (on average every 7 months over the last 5 years, but with significant variance), the option market may not adequately price in the probability of such idiosyncratic shocks. When things quiet down a bit, the lingering uncertainty left by the 60-year long positioning in the region may in fact give the advantage to investors paying for long vol on a regular basis. To all those who retort that this could sound like a bet against traditional Korean concept of kibun (interpersonal harmony), here’s a quick refresher. Although peace and security are the objectives of kibun, flare-ups and hostility occur if it is not observed. The frustrated, exaggerated reactions to the perceived lack of harmony can be observed anywhere in this cultural context – from violent students’ demonstrations to fistfights by upset clients on Korean Air flights. Betting against kibun with option volatility assumptions slightly above the ‘implied’ number on the screen could yet be one way to derive value from the fat boy’s ascendancy into a Beijing-backed loose cannon.

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   Posted by: Mr. Gold    in Uncategorized

Looking for tigers in India is today almost as futile as looking for dragons in China. Other than in the outlying areas of Assam, tourists tend to turn away from their Indian safaris without much success in spotting the archetypal stripes of the world’s largest feline. Still less common is the sighting of a tiger pouncing on its prey – be it a spotted deer or a sambar.

And what about India’s gold market pouncing forward? WGC’s third quarter statistics shed again some useful light on this issue. India’s performance as the world’s largest gold market is critical to the support under the gold prices. Yet with ubiquitous commentary about China’s “rise”, many casual observers may be excused to expect that the dragon is breathing hard on the heels of a tired (and elusive) tiger. Or does s(he)?

The third quarter statistics are important as they span a period preceding the festival-heavy fourth quarter. In this context, retail inventory numbers are less demonstrative than the actual sales. And the numbers are stunning. India’s jewelry demand rocketed 36.5% year on year in the third quarter. Instead, it is the dragon that seems to be tiring, by comparison – with barely 8% growth in jewelry sales over the same period. Throwing in identifiable sales of gold for investment purposes makes the spread somewhat less glaring, but India’s continued growth still outpaces China’s, 28% to 14%. For the twelve months ending September 2010, India’s demand was up 64% yoy, compared to 21% growth in China, yet this discrepancy is probably more illustrative of subcontinent’s demand sensitivity during the depth of the financial crisis 2008-09.

Some of the difference between the performance of the two markets could be explained away by the fact that a strengthening rupee made purchase in India more affordable, at current dollar prices, than in China – where the monetary authorities spend $1bn a day to keep its currency undervalued. Yet longer term time series show that Chinese consumers are momentum buyers and usually purchase more gold in times of stronger prices. Thorsten Veblen’s conspicuous consumption theory goes a long way among Chinese ‘xinfu’ (new rich).

Equally important are the differences in real disposable income, inflation expectations and availability of alternative investments. India has registered a very good monsoon this year, which bodes well for gold volumes in the third and fourth quarter. The country’s equity market has outperformed all other BRIC markets this year (not difficult when compared with the hapless Shanghai Composite, down 12% year to date).

India’s core inflation has been entrenched and earlier this year spread from food and energy to manufacturing goods. This led Reserve Bank of India to intervene several times throughout the year. But a stronger Rupee has somewhat protected the economy from imported inflation. From the domestic perspective there is a downside of a current account deficit as some of India’s investment has to be financed from abroad.

The contrast could not be bigger with China’s model. Disposable incomes are growing more slowly than the GDP, which continues to be overdependent on urban fixed asset investment. Although consumption in value grows, its share of national income is being eroded. In other words, the country grows fast because private consumption continues to be suppressed, with massive transfer of wealth towards the (state-owned) corporate sector. Add to it the manipulated level of currency and you end up with a scenario where relative prices have to adjust through domestic costs and prices. As we know, the inflation numbers have rocketed in China recently, raising expectations of higher interest rates and leading to a bloodbath in commodity markets this week.

In other words, in absence of a major currency reform, China will continue to form a sizable and growing market for gold, provided the growth in disposable incomes catches up with inflation expectations. Yet, in a country with $100bn speed rail budget this will be a rather slow process, lagging the overall increase in wealth. In the meantime, we can still get excited by an odd communist official calling for PBOC to purchase 10kt gold (this is a number that surfaced recently). Since the country produces 324t pa, it may need much higher gold prices to attain this level of reserves from its domestic production. What better way to achieve this than to talk up the gold price and see Xinjiang and Shandong resources convert into reserves? Gold investors, beware.

Thanks to bladder-like swelling on top of their heads, dragons in China could become airborne without wings and imperial houses used to build high thresholds in the doorway to make them fly into their abodes. Today, thresholds for gold market’s explosive growth in China remain high and manifold. And flying is probably done differently.

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   Posted by: Mr. Gold    in Uncategorized

The last week has marked several records for the gold market – record highs in US dollar, record volatility, record press coverage in response to the proposals formulated by the World Bank’s president to re-anchor the global monetary system to gold. It is understandable that among this intense newsflow, many investors have lost from sight the details provided by the earnings season and the reporting by the principal actors of the gold market – the mining companies.

The volatile swings in the gold market make an interesting background to differentiate the performance of the main players – both as operating companies and as investment vehicles. After all, the reversal of the correlation between gold’s behavior and the euro/dollar correlation has helped, this time again, to propel the yellow metal with a momentum unseen since last May. But CME’s announcement to increase margin requirements in the silver market subsequently depressed the heady levels experienced by the precious metals for four straight sessions. How did the gold stocks performed through this rollercoaster, and what does it tell us about the relevance of earnings, earnings expectations and the companies’ viability as gold proxies?

There were several common characteristics in the results published by North American producing companies. Those with significant by-products (base metals and silver) benefited handsomely from lower cash costs. As expected, many companies have boosted their dividends. Those with larger portfolios of operating mines also used the quarter to execute sequencing in a way least damaging to the overall performance of the company. Yet, as usual, there were some surprises and most relate to grade variability in some of the mines.

Using the date of the earnings results, we have compared share price performance of the top 16 North American producers with the earnings surprises presented for the third quarter. By the close of market Nov 10, the correlation has been high – over 64%. The market has been sensitive to past results despite the wave of new interest from the generalist crowd. It punished the laggards (Jaguar, Centerra, Iamgold, Silver Wheaton) and rewarded the winners (Barrick, Freeport, Yamana, Goldcorp). There are, however, some incongruous discrepancies. Despite lower-than-expected EPS at Agnico-Eagle, investors seem to be swayed by negative cash costs at La Ronde. Coeur d’Alene’s miss has also been rewarded, not least due to silver’s epic run but also due to 99% drop in costs at Palmarejo. Kinross’s disappointment has been shrugged away as all eyes are on Tasiast drilling and most operations performed in line.

It would seem that careful, stock-by-stock analysis has rewarded the investor. But what does it mean for a momentum trader? Here the results are much less convincing.

The precious metals market entered a new phase in reaction to QE2 on November 4. By rebasing the share performance of the producing companies back to this date, we find some surprising results, showing little, if any relevance to the recently reported earnings and cash flows. This is less of a case among silver companies, which have enjoyed a stronger run. Hecla – whose outperformace of consensus earnings was nothing short of extraordinary – has squarely beaten the competition, and its share price has risen by 25 % over the week. But here the ‘logical’ correlations end. Overall, the share performance of the main tickers has a weak relationship with the positive earnings surprises – a mere 22% correlation based on 17 stocks which have reported recently. This is still better than the insignificant correlation between cash flow per share surprises and the stock performance. The difference between the two correlations could imply that generalist investor base is now a more important force as it probably focuses on the EPS numbers despite its limited utility in the context of the mining industry.

In other words, the quarterly operating and financial performance of gold (and silver) miners proves to be a poor guide for the stock’s response to rapid price swings of the underlying asset. The recent spell of momentum trading (with some big liquidations last Tuesday) bears even less relation to longer term beta between the North American gold producers and gold prices in US dollars. It shows that short term gyrations in the market have to be taken in the context of much more long-term relationship between the gold prices and the way they affect both the revenue line of the operating companies and their cost of capital.

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   Posted by: Mr. Gold    in Uncategorized

This is clearly a week that calls for a historical perspective. In the United States, presidential historians are scrambling to find historical parallels to the tsunami of discontent that swept through the House of Representatives, undermining the policies of the current Chief Executive. Monetarist historians are trying to find any precedent similar to the Fed’s decision to expand its balance sheet in the order of $75bn per month (plus reinvested maturing mortgages). And dollar historians are now eyeing the greenbacks slide, seeking anchors beyond what looks on charts like a one-year long contour of a perfectly symmetric Swiss mountain. Henceforth, Mariana Trench anyone?

The combination of the feared legislative gridlock, monetary hyper-activism and the relentless dollar slide is making gold bugs licking their lips. This is the case in particular in countries whose currencies are pegged to the lameduck dollar and possibly among investors in countries whose authorities have decided to step up intervention into their capital account. Brazilians, Koreans, Indians, Canadians and Chinese are certainly a lot more excited about gold’s renewed attempt to break nominal records. And you may excuse Australians, Europeans, the Swiss, the Japanese, Scandinavians and South Africans for not sharing much of this effervescence.

We are touching here, in fact, a two-fold issue. First is the way in which gold’s local gains depend largely on the relative value expectations formulated by the fx market. Secondly, it raises the perennial question of the universality of the product.

For as long as the developed economies represented 75% of the global GDP, this did not quite matter. But as the first decade of the new century has seen their contribution shrunk by a third (in PPP terms), what ‘others’ can gain from a particularly fungible form of investment is a highly relevant question. Cultural and regulatory differences abound – from the ultra-sensitivity of Vietnamese savers, who use gold shops as a proxy for black market hard currency hedges to countries where private ownership of gold is still not permitted.

Gold bugs would like you to believe that there is something uniquely ‘universal’ about gold’s attractiveness. As any absolutist claim, this betrays poor knowledge of history. There is nothing deterministic about the appearance of gold coinage in the first place. The country which popularized gold coinage was Lydia in western Asia Minor. The reason was the relative availability of electrum (a natural alloy of gold and silver) found in local river Pactolus. Lydia happened to be located near the juncture of important trade routes and the combination of scarcity with low annual fluctuation of output made (gold) coinage a more attractive form of value exchange than grain or barter. But at the same time that Lydians were putting their ‘staters’ into circulation, Mesopotamia used copper ingots and China used proto-coinage made of bronze. These developments occurred between 9th c and 6th c B.C. and go some way to deny the validity of universalist claims of gold’s “eternal” value.

The myth of gold’s universal value is widespread. Every Latin American populist, from Guatemala to the Andes, runs on a platform of historical victimhood, branding the educated (white) elite as the direct descendants of Spaniards who “took our gold and gave us pieces of glass”. The fact that such trade did take place at the beginning of the 16th c proves the point that the attractiveness of gold pales in comparison to products or assets whose availability, at a given time, is even less constrained. Just ask any rare earth trader.

When Placer Pacific’s explorers penetrated Papua in the 1930s, they were stunned to see how little interest the Highlanders had in alluvial gold. Prospectors’ camps did not even have to guard the inventory of naturally occurring gold. This and other stories should remind us that there is nothing deterministic about the gold’s value.

This is a tough statement to make on a day when the yellow metal is, again, hitting a (US dollar) nominal high. But the travails of the global monetary system and the attempts of the Federal Reserve to reflate the world’s economy will bring solace to gold investors only in some parts of the world. The relative size of the winners’ capital and its propensity to leak into alternative assets will determine how high gold can go against the basket of currencies, not just in the dollar and the Renminbi.

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