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Posts Tagged ‘gold and currencies’

21
Oct

IT’S THE DOLLAR, STUPID

   Posted by: Mr. Gold    in Uncategorized

The effervescence in commodity markets has been barely checked by China’s 25bp interest rate hike this week. Gold bugs, silver bugs, LME complex bugs – have all espoused a worldview buttressed by the stories of a ‘supercycle’, ‘the collapse of the global monetary system’, ‘currency wars’, and now even rare earth wars. This year’s price charts – in gold as in other metals – seem to bear out this enthusiasm, although one wonders how positive for the rest of the developed nations such trends are.

What these commodity punters and casual observers seem to share is pervasive currency myopia. Until mid-October, most metals, including gold, notched multi-year nominal highs. Silver, gold, copper and tin were particularly hot and seemed hotter by the day in an incessant drive redolent of the heady days of Spring 2008. But peek under the cover of the US dollar’s weakness, and the story is much less compelling.

The Fed first alluded to what has now commonly been dubbed “QE2” in late August. In a classic ‘triple waterfall’ effect, further confirmation of impending purchase was delivered on September 21, and then again sealed with FOMC’s minutes, released last week. At every turn, the dollar responded by abseiling ever deeper against traded emerging market currencies, against the Yen, and most importantly against the Euro. FX markets simply assume that increased liquidity will impact long term interest rates in the US, eventually driving the greenback further down.

When the trend reverses, as it did briefly last Tuesday, comments abound about “commodity selling”. But how relevant are Chinese interest rates for the global liquidity binge, other than potentially sucking even more illegal capital flows into the country? China remains the marginal buyer of the last pound of copper and the last ton of iron ore, but it is not (yet?) a similarly dominant source of physical demand for gold. And yet, gold responded to this short-term reversal with southbound conviction.

There is no mystery to it. Most of gold’s “gains” since last June are a matter of nominal adjustment to the denominator’s value. The denominator (i.e. the dollar) has fallen nearly 13% on a trade-weighted basis, a measure still flattered by the untradeable nature of the renminbi. During the same period, gold has gained only slightly over 8%. Looking at gold in other currencies, we may have a hunch that the stories of “buying” (most of time) and “selling” (as on Tuesday) are, most of time, suspect. On any given day, one has to look for gold to rise in a cyclically weak (currently the dollar) and a cyclically strong (right now the euro) currency to draw a solid conclusion about gold’s popularity or lack thereof. And to understand the underlying trend, it is advisable to adjust gold prices for the trade-weighted dollar, however imperfect even this measure is.

Viewed from this perspective, we notice that gold has not made any gains since the heyday of European panic buying in May-June. Most of the nominal gains that the metal has registered since then simply reflect the dollar’s losses.

gold adjusted for trade-weighted dollar

Interestingly, similar story appears when we analyze copper prices, adjusted for the dollar weakness/strength. The red metal has not made any significant gains since as far back as March. The copper bullishness, which marked the LME week in London, should, in short term, translate into dollar bearishness and little else. While no one denies the well-documented problems of the slow replacement of the current mining production and supply challenges going forward, the spot premiums on Asia’s physical markets are falling and near-term copper demand appears to be slackening.

copper adjusted for trade-weighted dollar

In theory, low value of the dollar should be good for commodity purchase, as it makes them more affordable for Yen, Pound, Euro and other currency holders. China, the marginal consumer, has a structurally driven demand. The bill it foots for, say, iron ore, is bound to generate much hand-wringing among steelmakers, but the client must eventually relent, despite the artificially low value of its currency. Likewise, large trade imbalances driven by oil imports lead to increase in the supply of dollars against other currencies whenever oil prices rise. Yet none of these commodity/currency mechanisms are present in gold, which is economically inert. Weak dollar is not, per se, “good” for gold because the metal is predominantly an investment good today and its demand relies on the perception of its future value. A much stronger Rupee, or a much stronger Renminbi, against the dollar, could yet drive copper, molybdenum and metallurgical coal into a bubble territory, but in the local markets they might trigger negative price expectations and actually depress future demand for gold.

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1
Jul

STRONG QUARTER ENDS WITH DOUBTS

   Posted by: Mr. Gold    in Uncategorized

Amid the return of global uncertainty and market volatility, the end of the second quarter of this year has seen off the 7th straight 3-month gain in gold prices. Indeed, no other asset class can compete with gold’s current “for all seasons” performance.

Yet lurking behind the gloss, there is a disturbing sign of global asset underperformance, increasingly shrouded in murky tales of impending deflation. It is a global picture of cash being hoarded by the private sector – companies and households alike. Most of these funds find their way back into the Treasury market of the perceived “safe” (read: sufficiently liquid) countries. Whenever the shift of capital into sovereign debt crosses a currency divide, the returns on gold holdings by local investors are heavily affected. And while gold notched up in the last quarter an impressive 22% in Euro, 16% in Canadian dollars (hitting an all-time high on the last day of June), and nearly 12% in USD, it only yielded pale 4% for Japanese investors.

European investors were the supposed winners in this global rush to capital preservation. Their 22% gain in gold largely reflected the loss of Euro’s purchasing power. A trade-weighted Euro lost 9% this quarter. And while it ceded 22% of its value to gold, it also fell against the Yen (11%), US dollar (9%), Swiss Franc (7%), and the pound – inexplicably buoyed by the market’s infatuation with UK’s new budget. Only the commodity currencies, spooked by the unexpectedly softer Chinese data have lost more ground than the common currency. In particular, the Aussie dollar has been penalized by the capital flight back to Japan.

In response to China’s sobering PMI numbers, the commodity rout has been widespread. Over the quarter, zinc has lost 25% of its value, iron ore 24%, lead 19%, copper 16%. Many of these metals are important buy-products of gold producing companies and can seriously affect the mines’ cost structure. As for oil, the correlation to gold has turned negative and the oft-watched gold/oil ratio hit record spreads twice during the quarter.

But while bullion and gold ETFs offer some solace to those who see debt monetization as an inevitable outcome of the current strains in developed world’s public finances, the mainstream investor is suffering from poor equity returns and scrams headlong into the Treasury market. Increasingly signaling serious deflation risks, the 10-year US Treasury yield dipped below 3%, bringing the returns to 4% over the quarter.

Not surprisingly, a crater has opened underneath the global equity market. In the flight from risk, global equities (MSCI world) returned negative 13.5% this quarter, while S&P500 has lost 10.9%. By comparison, the gold stocks’ performance has been stellar, yet in absolute terms it has been all but.

In fact, as the gold price continues to advance across all currencies and the commodity currencies are now suffering from China jitters, the returns on gold mining stocks have been trailing, yet again, the bullion’s gains. In a mean-reverting industrial commodity, such a yawning discount to NAV would presage a sudden collapse of the value of the underlying commodity (as was the case with many commodities two years ago). Are gold stocks now sending a warning shot?

In fact, the performance of global gold stocks varied widely. Asian equity markets are a depressing spectacle these days. Hong Kongers in particular are happy to swap their wealth into a bet on an IPO of one Chinese bank. Hong Kong market has lost 6.5% over the quarter and its gold stocks returned “only” 11.25%. Australian gold companies enjoyed somewhat of a late rally in June, leading to a 12.6% return. In North America, gold mining companies compare favorably to the broader market: GDX index returned 17%, HUI index 16%. The biggest winners were South African miners, with 17.9% return (most of which occurred in April – May) and London-listed gold stocks with an impressive 20.69% vs only 13% gains for bullion denominated in the British Pounds. London is one market which continues to favor gold equities over ETFs – a fact certainly not lost on the executives of the nascent Kazakhgold/Polyus giant.

All this means that the global equity sell-off has affected the performance of gold stocks even though the companies’ top line, cost of capital, inflation pressures and currency movements have all conspired towards higher margins. Indeed, since gold stabilized after hitting the most recent all-time high in USD terms (June 18), North American gold stocks have slipped around 3%. At the same time, exploration stocks, as measured by GDXJ index, have tumbled 9.2% and returned a relatively paltry 8% over the quarter. Not surprisingly, most exploration-focused gold funds registered a loss.

It is hard to imagine that the monetary and fiscal authorities would stand idle if the global economy began to slide into deep deflation, a scenario which may not bode well for the gold market. Yet many of the gold stocks are now attracting multiples more akin to industrial sectors dependent on the robustness of global demand. The outcome is binary. Either they are becoming a dangerous value trap, or should be treated as a tremendous opportunity should the current deflationary scare ease.

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