Monday, November 16, 2009

Animal Spirits in the Gold Market

16 November 2009, updated 17 November 2009

Up until now, gold's price advance has been orderly. The upward moves, the levelling off, and the pullbacks, were all as expected.

Gold (and gold stocks) were supposed to pull back again this week, after topping out last week.


Things have changed.

The animal spirits are back in the gold market.

This is what bull markets do.

Add ImageHere is a chart of today's unexpectedly lively gold action:

I'm busy today. More later.

16 November 2009 (evening):
I added the following comments on Seeking Alpha today....

The observation that gold may remain a superior investment to the gold stocks has certainly held true since March 2008, in fact, from as long ago as November 2003 and May 2006. Bill Fleckenstein recently stated that gold stocks have been trading as if they are radioactive.

However, current developments are likely to boost the margins of the gold miners considerably. Thus, the fact that they have risen dramatically from depressed levels in October 2008 (at that time, they revisited levels last seen as long ago as June 2002) hardly means that they have climbed too far or too fast. We are just now surpassing strata in the HUI (the unhedged gold miners index) that were observed 2 years ago, when gold first challenged the $800 level.

Yes mining costs have gone up - but not all costs, such as energy, which at $100 oil was pricier 2 years ago than now. The HUI:Gold ratio in late 2007 was ranging from .50 to .55. That ratio fell to .205 in October 2008. We have just now surpassed the .41 level in the ratio.

It is true that gold mining companies have reported more than their share of bad news, even recently. But it's hard to argue that good news is not on the way with gold surpassing the $1100 level.

Here's a rule of thumb. Gold has not surpassed its February 2009 levels in most currencies (at which time the US dollar was considerably stronger).

Gold is certainly going to move to new highs in currencies other than the US dollar before the current run is through - and not just because the US dollar may bounce.

So is gold done yet? I don't think so. Here is Clive Maund's view:

Are the miners done their run? No, we have some ways to go in revaluing the gold miners as well. Here is P. Radomski's visual analysis of the HUI gold miners' index:

With animal spirits in charge, gold is simply going to do what it wants to do... and gold mining stocks will be tugged along for the ride.

Enjoy the ride. It might get a little bit wild!

17 November 2009:

With animal spirits breaking out in the gold market, I don't think anyone can say where it is going (apart from $1200 pretty soon). Captain Hook has an idea, based on some of his proprietary charting tools. He thinks we might be headed to $1386 as a "next stop."

Who knows? But Captain Hook might be onto something here.

P. Radomski confirms that we remain a long, long way from a top in the gold price, based on his analysis of the silver to gold ratio. The silver price tends to move parabolically at gold peaks.

Guess what?

We're not even close.

So someplace, such as $1200, or even today's $1140, could be a resting place for the gold price for a while - even constituting a short-term resistance zone. But gold - and silver with it - are going much higher than today's prices.

Over two years ago, I gathered together some arguments that gold is probably headed to $5000 per ounce or higher.

Click here to read more about gold's longer-term targets.

Monday, November 09, 2009

Where the Fed's Bailout Money Is Now Going

9 November 2009

Just in case you wondered where the Federal Reserve's $1.5 trillion in (new) bailout funds are now going, here is the chart to sum it all up for you, courtesy of The Business Insider:

Note that we started 2007 with about $800 billion in traditional security holdings. That figure is now down to about $500 billion. Lending to financial institutions was big in late 2008 and early 2009 (up to $1.5 trillion), but that is now winding down. Providing liquidity (easy money) to credit markets is now also declining.

So what is up? Long term treasury purchases are the well-known "helicopter money." This is the money printed out of thin air to buy US bonds when nobody else in the global market wants them, also referred to euphemistically as "quantitative easing." The Fed has promised to keep a lid on this area of expenditure, as it makes the US look a little more like Zimbabwe, Weimar Germany or Rome in decline, and a little less like the proprietor of the global reserve currency.

But look at the full trillion dollars that is now in mortgage-backed securities. This is the taxpayer-funded bailout of the Wall Street speculators who thought they could keep slicing, dicing and repackaging worthless mortgage portfolios and charging commissions (and awarding themselves bonuses) with each slicing and dicing in a never-ending shell game (which of course ended when the music stopped playing).

American taxpayer dollars are now making those bonuses good while people with long-term disabilities and those reliant on company-funded employee and retiree pension and health plans find that their coverage has disappeared due to bankruptcies.

To wrap it up. The Fed is demonstrating that it is (1) willing to print money out of thin air, though only up to a point (about $200 billion so far, but we're not out of the woods yet), and (2) willing to rescue the reckless by bankrolling Wall Street bonuses while retired, sick and disabled people get left holding the (empty) bag.

Hmmm. Something to think about.

By the way, don't blame this primarily on Wall Street greed (of which there is certainly no shortage). Look first to the policies of the US government and the Federal Reserve, who, according to Ted Forstmann, are actively promoting the risk taking strategies which have culminated in financial disaster. Mr. Forstmann (quoted in the Wall Street Journal) states, "They just throw money at the problem every time Wall Street gets in trouble. It starts out when they have a cold and it builds until the risk-taking leads to cancer."

If you want to know why mortgage-backed securities created so much trouble, Chris Gasparino explains it well (again in the Wall Street Journal):

"Easy money wasn't the only way government induced the bubble. The mortgage-bond market was the mechanism by which policy makers transformed home ownership into something that must be earned into something close to a civil right. The Community Reinvestment Act and projects by the Department of Housing and Urban Development, beginning in the Clinton years, couldn't have been accomplished without the mortgage bond—which allowed banks to offload the increasingly risky mortgages to Wall Street, which in turn securitized them into triple-A rated bonds thanks to compliant ratings agencies.

"The perversity of these efforts wasn't merely that bonds packed with subprime loans received such high ratings. It was also that by inducing home ownership, the government was itself making home ownership less affordable. Because families without the real economic means to repay traditional 30-year mortgages were getting them, housing prices grew to artificially high levels.

"This is where the real sin of Fannie Mae and Freddie Mac comes into play. Both were created by Congress to make housing affordable to the middle class. But when they began guaranteeing subprime loans, they actually began pricing out the working class from the market until the banking business responded with ways to make repayment of mortgages allegedly easier through adjustable rates loans that start off with low payments. But these loans, fully sanctioned by the government, were a ticking time bomb, as we're all now so painfully aware....

"With so much easy money, with the government always ready to ease their pain, Wall Street developed new and even more innovative ways to make money through risk-taking. The old mortgage bonds created by Messrs. Fink and Ranieri as simple securitized pools had morphed into the so-called collateralized debt obligations (CDOs), complex structures that allowed Wall Street banks as well as quasi-governmental agencies Fannie Mae and Freddie Mac to securitize ever riskier mortgages.

"Mr. (Stan) O'Neal (former CEO of Merrill Lynch), the man considered most responsible for Merrill's disastrous foray into risk-taking, told me in an interview last year that in the fall of 2007, when he saw that the firm's problems were insurmountable, he had a deal to sell Merrill to Bank of America for around $90 a share. But Merrill's board rejected it, believing he would be selling out cheaply. The CDOs would eventually recover, they argued, as the Fed pumped life into the markets.

"Likewise, nearly to the minute he was forced to file for bankruptcy, former Lehman CEO Dick Fuld believed the government wouldn't let Lehman die. After all, government largess had always been there in the past.

"All of which brings me back to Mr. Fortsmann's comment about policy makers helping turn a cold into cancer. What if the Fed hadn't eased Wall Street's pain in the late 1980s, and again after the 1994 bond-market collapse? What if policy makers in 1998 had allowed the markets to feel the consequences of risk—allowing LTCM to fail, and letting Lehman Brothers and possibly Merrill Lynch die as well?

"There would have been pain—lots of it—for Wall Street and even for Main Street, but a lot less than what we're experiencing today. Wall Street would have learned a valuable lesson: There are consequences to risk."

My insurance advice? Buy gold, and sleep well at night... for decades to come!

P.S. Here's an important story. 10 states face looming budget disasters: Regarding problems in the US economy, everyone has been talking about the overbuilding and weakness in commercial real estate (definitely a problem). But there's now a bigger problem sneaking up on us from behind.

California is not the only state in trouble. It is, or soon may be, just as bad in nine other states - and they are important states.

Why are state financial problems a concern? Well, the US government can print money to its heart's content, and the crazy people around the world keep buying US dollars in the form of (a) payments in trade, and (b) government bonds. Guess what? States don't print money - or if they did, nobody would want it. So when California cuts spending by $20 billion per year and still sees 17% tax revenue shortfalls, that's a big problem.

Now we have 9 additional states in the same boat: "Arizona, Florida, Illinois, Michigan, Nevada, New Jersey, Oregon, Rhode Island and Wisconsin join California as those most at risk of fiscal calamity, according to the report by the Pew Center on the States."

Click here for Judy Lin's (AP) coverage of this very important story - still too far in the background for my taste. I think this is a very big problem.

Sunday, November 01, 2009

Gold Tsunami VII: This Is It

1 November 2009

The gold tsunami is now rolling in.

This is the big wave.

Let me clarify. I am not a short-term market timer, nor a prognosticator. However, I watch a number of indicators. While gold and gold stocks are presently in a period of weakness, here's what I'm noticing....

On Friday, October 30, 2009, there was a solid recovery in the gold price - while much else was falling.

There was also a recovery in the Toronto Gold Stock Index, despite weakness in general equities.

Notice that the S&P 500 didn't recover on Friday, October 30.

I also follow proprietary indicators published by investment advisories. I recommend that you subscribe to the Aden Forecast. Their leading indicator for gold shows that gold's almost $400 climb from its October 2008 low takes us only a little more than "halfway" to where gold is going on its current bull run (be advised that the positive 8-year trend produces both higher highs and higher lows - that is, the leading indicator produces bigger numbers on the up side than on the down side).

I also advise that you subscribe to Adam Hamilton's Zeal Intelligence Service. Mr. Hamilton's relativity analysis (based on comparing current prices to 50 and 200-day moving averages) shows that the current prices of gold and gold mining stocks remain moderate. Note that relative gold can run much higher from here. Why? Gold is outperforming just about every other class of investment in the current market - thus it is not particularly high relative to its 50 and 200-day moving averages.

There is also room for the HUI (Gold Bugs Index of unhedged gold mining stocks) to run another 50% or so from here. That is, the HUI has no technical impediments to moving to the 600 level, and with a stretch, it could move somewhat higher. Interestingly, the recent sharp pullback has bought the HUI much more "relative" upside room. That is the positive function of "corrections of sentiment." Lower levels now give us more room to run in future without taking us to overbought levels. Consider that a tsunami works on the same principle. That is, the advancing wave draws energy from the receding sea before it.

The long-term HUI-to-gold ratio (which recently bottomed at .361 on Friday, October 30, 2009) can also run up another 50% from here without stretching beyond levels attained in 2003-04 and 2006-07. And as you'll read below, there are good fundamental reasons to expect a return to such levels to occur.

Returning to gold, here is an indicator I haven't watched previously, but it is very interesting. This chart indicates that gold's more recent 50-day moving average can run much higher against gold's longer-term 200-day moving average.

I also highly recommend P. Radomski's Sunshine Profits to my readers. This fellow is producing some of the most insightful technical analysis out there. What are Mr. Radomski's charts telling us? In brief, that this is the best gold stock buying opportunity since October 2008....

The Gold Miners Bullish Percent Index reinforces this message.

In sum, what is the picture? Every indicator I follow is presently bullish both for the price of gold and for gold stocks. This is a combination of circumstances that occurs only rarely. Why are we seeing every technical indicator lining up in favour of gold and gold stocks right now?

The gold tsunami is here.

Gold is now exploring new highs with no ceiling in sight.

Gold mining stocks are increasing (and restoring) their leverage to gold. With higher gold prices and lower production costs than in 2006-2008, increments in the gold price strongly boost the profit margins of the gold miners. This equips them with hoards of cash that can be used to develop and expand existing operations, to acquire other miners, and, longer term, to pay increasing dividends to their shareholders.

Have you ever wanted to own a gold mine? If so, now may be just the right time to purchase your share in more than one of them!

My gold tsunami posts are as follows:

There Is a Tsunami Coming in Gold

Gold Tsunami II: Anthropomorphizing Gold

Gold: Safe Haven in the Approaching Perfect Storm

Gold Tsunami III: James Kunstler's Use of the Analogy

Bond Prices: The Seismic Shift That Triggers the Gold Tsunami (IV)

Gold Tsunami V: The $23 Trillion Bailout... and Counting

Gold Tsunami VI: Looking for Patterns in Gold Price Advances

Gold Tsunami VII: This Is It

Gold Tsunami VIII: Gold Mining Stocks Now Participating

Sunday, October 25, 2009

Is Gold Disappearing from the Streets and Going Back to the Vaults?

25 October 2009

As I have recently posted, I have been visiting the Seeking Alpha site in order to find up-to-date investment market news and more intelligent than average reader commentary.

A couple of interesting ideas came up while I was reading Andrew Butter's article, "Roubini Hates Gold: Is He Wrong Again?"

Briefly, Mr. Butter reprises Nouriel Roubini's recent arguments against gold's currently rising price. Mr Roubini stated (wrongly in my view):

"I don’t believe in gold. Gold can go up for only two reasons. [One is] inflation, and we are in a world where there are massive amounts of deflation because of a glut of capacity, and demand is weak, and there’s slack in the labor markets with unemployment peeking above 10 percent in all the advanced economies. So there’s no inflation, and there’s not going to be for the time being.

"The only other case in which gold can go higher with deflation is if you have Armageddon, if you have another depression. But we’ve avoided that tail risk as well. So all the gold bugs who say gold is going to go to $1,500, $2,000, they’re just speaking nonsense. Without inflation, or without a depression, there’s nowhere for gold to go. Yeah, it can go above $1,000, but it can’t move up 20-30 percent unless we end up in a world of inflation or another depression. I don’t see either of those being likely for the time being. Maybe three or four years from now, yes. But not anytime soon."

Mr. Butter was also, in my opinion, off-base in his critique, stating the following:

"I don’t exactly agree with Roubini, although I agree with him on deflation, just I don’t buy the idea that it’s inflation (in particular) that drives gold prices; but I agree with his conclusion, and it’s good to know that there is at least one other person in the world who doesn’t buy the idea of gold breaking out and heading towards heaven (I was getting pretty lonely actually).

"I think that gold is a bubble fuelled by excess liquidity and wonky valuations that you tend to get at the top of every bubble (remember the weird explanations of how to value a stock at the top of that bubble).

"The latest I heard is that it’s all about lack of confidence in government. Well, the peak of that 'lack of confidence' was February/March 2009; and what happened to gold then? It dropped.

"The best predictor of the gold price since 1971 was the price of oil (74% R-Squared on an annual basis), and by that measure at $75 a barrel the price of gold should be $750, which means now it’s a bubble, which means if it comes down and oil doesn’t go up, then it could drop to $600."

While I disagree with both Mr. Roubini's and Mr. Butter's primary theses, I was struck by the number of insightful comments by readers in response to Mr. Butter's article. Many commenters were not taken in by the above (spurious) arguments. And one post in particular set my thoughts meandering down a new path.

In this comment, "manya05" (I'm not sure why people don't use their actual names in making internet posts, but what do I know of young folks' behaviour these days?) stated:

"Roubini gives two scenarios in which gold can move up and discounts them both, and maybe he is right. But he forgot a third possible reason giving force to a move up in gold. Most central banks around the world (big and small) are trying to figure out how to 'de-dollarize' their reserves. They are diversifying as best they can, I am sure they are converting dollars to other currencies, but ultimately they realize that holding reserves in the currency of another government is not a wise idea...whatever the currency. So, what are they going to keep as reserves? Amphorae of olive oil and bags of grain like in the old days? I don't think so, if gold worked as a good store of value for 1000s of years, for the short term, it is the obvious route for central banks to take. So I think Roubini is wrong, gold is disappearing from the streets and going back to the vaults, and that will keep the price supported, and possibly even drive it higher. Until central banks regain confidence in a currency, any currency, gold is not going down."

It was the vision of gold's "disappearing from the streets" that captured my imagination - though I mean this neither positively nor negatively. It is an implication of the current gold bull market that I had not so far contemplated.

For example, we often speak of gold as "an alternative currency." Well, what kind of currency would "disappear from the streets?" It is a mental puzzle... a conundrum... a koan if you will.

But I think manya05 may be onto something? If he or she is right, then gold will continue to function more as a store of value (something for the vaults) rather than as a currency (a publicly-accessible and widely distributed medium of exchange). My instincts tell me that manya05 is likely to be proven correct.

Think about it... if gold moves over the coming years into the thousands of dollars per ounce, as I think it inevitably will, are you going to feel comfortable stuffing a gold coin or bullion bar into your pocket and walking down the street? I don't think so. Gold will be storing too much value per ounce to function as a public unit of exchange.

Far more likely, gold will be consigned to the vault, as well as be subject to rising security concerns. It will remain a store of value, but it will not function as a currency on any broad basis. I certainly don't rule out gold certificates (exchangeable for gold), though even here, I suspect that most gold certificates will be electronic, and subject to electronic security measures, rather than physical.

Hmmm? And what will become of jewellery stores? There will be changes here too, at a minimum, increased security measures in jewellery stores.

I shall leave further speculation on this subject to the fertile minds of my readers. In the interim, here is my own reply (slightly edited) to Mr. Butter's article:

While I find much with which to agree and disagree, I appreciate the general level of intelligence of the commentary at this site. I have read every comment on this article, for example, because I was able to learn by doing so. Few other sites offer much more than rude, emotive or reflexive commentary, so it is refreshing to visit Seeking Alpha (I would appreciate less rudeness, even here, however).

I entered the market in precious metal mining shares when gold was at $330 in 2003 - and wish now that I had been there at $250, whether in 1999 or 2001. I have made a mix of good and bad short-term calls, but my long-term perspective on the gold market has never proven wrong.

The gold price is driven by increases in the money supply, a phenomenon which is pervading every major global currency - including the good ones, such as the Yuan.

I wish it were more complicated than that, but it's not. Monetary inflation (increases in the money supply) is what causes the rising gold price.

That trend has much longer to run, particularly when one considers John Williams' consistently calculated inflation numbers, which place briefly peaking 1980 gold at the $6000 US level. By no indicator of which I am aware is gold anywhere near a bubble, though of course as a contrarian I shouldn't be letting that cat out of the bag!

In fact, every metric and leading indicator that I follow telegraphs that the current gold price breakout is in its infancy.

Does Roubini understand inflation and deflation? I don't think so.
At this time, the big banks (who by the way are the primary shorts in COMEX gold - and thus again wasting taxpayer dollars to bet against the barbaric relic) are playing Fed loans against the treasury market for modest gains on their federally-donated, taxpayer-funded, dollar handouts, rather than taking on additional risk in consumer or commercial loans.

Thus our newly-minted electronic Federal Reserve Notes are not being leveraged into the broader economy - at this point.

It is exactly true that necessities are escalating in price, while discretionary items (let's include the overbuilt real estate market in the latter category) are languishing on the shelves. But that phenomenon is only for here and now.

Our present economy is inflationary, plain and simple. The money supply dam is bursting, and the new dollars will inevitably wend their way through the cracks in the dams of our economic institutions, creating inflation in places that we do and do not expect.

Now, could the entire house of cards collapse in the face of such unprecedented international money printing? I suppose this is still possible. That is, printed Greenspan-Bernanke dollars can be neutralized by being mismanaged, as has already been proven. It's just that the Fed would rather create a new Zimbabwe than see that happen.

As to the correlation of the nominal prices of gold and oil, as I was taught in statistics 101, correlations do not demonstrate cause and effect relationships.

That is, both the gold and oil price are derivative phenomena, of which the primary drivers are (1) the unprecedented increase in the global money supply (pick a currency - any currency), (2) the finite nature of gold and oil supplies, and (3) the utility of both gold and oil.

I have intentionally referred to the utility of gold, as this obvious fact is so often misunderstood in various articles and commentaries.

What is gold good for? It holds one heck of a lot of value in irreproducible form in a very small space. It is a combination of protons, neutrons and electrons that is rare in nature, appealing to the eye, physically dense and compact, industrially useful (just expensive for its most obvious applications), and, above all, historically validated over millennia in diverse human cultures spanning the globe.

That is, currencies have always served as media of exchange, and gold has the most desirable combination of characteristics of any currency on the planet, as has been the case from the dawn of human civilization.

As manya05 stated, "gold is disappearing from the streets and going back to the vaults, and that will keep the price supported, and possibly even drive it higher."

I had not previously meditated on the notion that gold is likely to "disappear" from the streets. Manya05 may have a point here. I'm not sure what will happen to the jewellery stores, but of this I am certain - it is gold in the vaults that is driving the current gold bull market.

I guess perhaps gold could disappear from the streets - and perhaps it will soon enough grow dangerous to carry it visibly on the streets as well (let's not forget what happened to copper pipes in 2007-08!). The demand for gold will be stronger than that for copper, this is certain.

To conclude, is Mr. Roubini wrong to despise gold, at least at this time?

I'd say that at a minimum, he has not yet captured the timing of the gold market. Gold's day is not 3-4 years away. It is today.

Is Mr. Butter correct that gold is "a bubble fuelled by excess valuations?"

At some future point this statement will inevitably prove accurate - yes, the gold bull market will end in a bubble.
But there is not a single indicator that gold is in a bubble today. No, not one.

So as to Mr. Butter's and Mr. Roubini's primary points, both may at some future point be proven correct, but neither has accurately characterized today's gold market (which will continue in a strong rise here and now).

For my other comments on Seeking Alpha, click here.