Category Archives: Gold

where’s the bottom for the gold price?

July 8, 2013 By in cash flow/share vs. earnings/share, Current Market Thoughts, Gold, Industry Analysis, Mining, Stock ideas Tags: , , , , , , 4 Comments

falling gold

The gold price has fallen steadily from a high of just under $1800 an ounce last October to the current spot price of $1231 this morning.

How low can the gold price go from here?

supply/demand…

In the simplest terms, prices fall when producers supply more to the market than buyers want at a given price.  The price drops to the point where buyers are willing to absorb the excess supply.  Typically, producers read the market signal and begin to cut back on the amount they put on the market.  When cutbacks are large enough, the price stabilizes.

For most things, adjustment happens quickly.  For gold   …not so much.

…for gold

Gold is mined in remote, inhospitable places by hardy workers who operate expensive and highly specialized machinery that needs considerable maintenance.  Once a mine shuts down, chances are it won’t reopen.  It’s hard to reassemble the needed mining crews…and it’s expensive to bring the plant and equipment back up to snuff.  So mining companies try to avoid shutdown at all costs.

Part their planning tends to make over/undersupply worse rather than better.

As the gold price rises, mines continue to process the same amount of ore, but switch to lower-grade areas.  This means they produce less gold, increasing the supply squeeze.  Conversely, when prices being to fall–the situation we’re in now–mines routinely shift to processing higher-grade deposits.  The idea is to keep their revenue steady–and therefore the mining crew together and the mine profitable.  But putting more gold on the market tends to depress prices further.

waiting for the weak to falter

Experienced mining firms also know how any market downturn will play out, even if no one voluntarily withdraws supply from the market.  At some point, the gold price will drop below the cash outlays of the highest-cost mines.  When red ink causes enough of these to cease production, supply will shrink, restoring equilibrium.

So…

…the gold price bottom question boils down to what cash costs for gold miners are and at what price do high-cost gold mines begin to die.

the Thompson-Reuters report

On April 4th, Thompson Reuters issued its 2013 Gold Survey.

TR says current average cash costs for the gold mining industry are $738 an ounce.

Average cash costs in 2009 were well under $500 an ounce, suggesting that that price level is highly defensible.   The addition of high-cost South African supply (averaging over $1,000 an ounce) and cost increases in Australia (much of it currency-induced, I think) are responsible for most of the rise since.

my take

Relative to nine months ago, gold looks cheap.  But supply probably isn’t going to be withdrawn from the market until the gold price falls below $1,000.  And rock-bottom (sorry) is probably $600 or so.

That’s a long way down.

To my mind, no one other than dyed-in-the-wool gold bugs will be interested in gold today.

the FT’s “listen to gold” op-ed

May 22, 2013 By in Constructing a Portfolio, Current Market Thoughts, Gold, Portfolio management, Strategy Tags: , , , , , , , , , 3 Comments

The other day the Financial Times carried an op-ed column titled “We should listen to what gold is really telling us.”  It was written by regular contributor Mohamed El-Erian, the  marketing voice of bond fund giant, Pimco.

I usually skip over what Mr. El-Erian writes.  His prose style is weak and the solution to every economic or financial worry he discusses is to buy more bonds.  In this case, I made an exception.  I was curious to see whether Pimco would be in the old-school camp that says gold is money or whether, like me, Pimco would maintain that it’s an industrial metal that new mine development has put into chronic oversupply (just like in the 1980s).

The article isn’t really about gold, though.  It’s about the fact that when more money than is needed is sloshing around in the world economy–and central banks around the globe continue to print new money at a rapid rate–some (all?) of the excess finds its way into speculative investing.  Sometimes, according to Pimco, even though the overall speculative tide has not yet crested, some prices become so divorced from reality that localized bubbles still burst.  Three examples:  gold, AAPL and FB.

At this point in the article, I thought what would come next would be an assertion that these three are harbingers of the behavior of all sorts of financial investments once monetary stimulus starts to be withdrawn.  If so, I thought to myself, Pimco will have a hard time ducking the issue of the popping of the biggest bubble of them all, the bond market.

That’s not the tack Mr. El-Erian takes, though.

He asks what happens if all the global monetary stimulus fails to reignite economic growth.  Put in a different way, what happens if world economies begin to roll over and enter recession?  The money taps are already wide open, so there’s nothing central banks can do to cushion the fall.  Fiscal policy is the only tool available.  But that takes time to work–and requires well-functioning legislatures to understand what’s going on and act both appropriately and quickly.  Fat chance.

This is a really scary scenario.  There’s absolutely no current evidence I can see that it’s likely.  El-Erian just poses the question and doesn’t say what he thinks.

Still, from a financial planning perspective, it’s something we all have to consider and be on the alert for the signs of.  Of course, conveniently for Pimco, this is the only situation I can think of where it makes sense to be holding government bonds.

what do gold and AAPL have in common?

April 22, 2013 By in Gold, hedge funds, Recent Market Action, Stock ideas, Technology, Wireless Tags: , , , , , , , , 1 Comment

common factors

–they’re both large positive bets (large holdings) of hedge funds–and of many retail investors

–both have delivered weak performance over the past year, after extended periods of substantial gains.  And the losses have occurred during a time of generally stable conditions for the world economy, with ample liquidity and strong inflows of money into financial products

–recent trading in both seems to me to be giving signs of forced or distressed selling

are these factors connected?  

It’s hard to know, since global hedge fund disclosure is incomplete–and there’s ample evidence that what disclosure there is can’t be relied on.  However, I think it’s reasonable to assume they are.

if so, what does this imply?

In my experience, a professional investor goes through a three-step process as he realizes he’s made a mistake–or that his previously good idea is no longer working.  He:

–stops adding to the position when new money comes in, effectively shrinking its relative size,

–begins to sell, to further lessen the negative effect of the position on performance, and

–accelerates the selling when the position is small enough the extra visibility and extra downward pressure on price make little difference.

A professional investor can go through these states in the blink of an eye, or it can take a long period of time. A lot depends on style, self-awareness and how ugly the underperformance is.  Anyone who operates on margin may also get additional feedback from his lenders.

Many retail investors, in my experience, just panic–very close to the bottom.

Recent price action in gold and in AAPL strike me as Stage-Three end-game activity–some combination of panic, response to margin calls and/or dumping of the remainders of positions being sold over long periods.

is this an opportunity to buy?

gold: 

For me, the answer here is easy.  It’s “No.”  The key supply-demand issue is whether central banks in emerging markets will continue to buy gold in the aggressive way they have done over the past several years.  I have no idea.  So I’m clearly the “dumb money” in this arena–the strongest reason there is to stay away.

AAPL:

We’ll have more information tomorrow, after AAPL reports its latest quarterly earnings.

The stock is now trading at less than 9x historic earnings and yielding 2.7%.  The shares have underperformed the S&P 500 by more than 50 percentage points since last September.

The company has no debt and its cash holdings are approaching almost half the market cap.

If there’s anything “wrong” with the stock, it’s that its fall from grace has been so extreme.  That prompts the question, “What must sellers know that I don’t?”

How do you overcome aversion, based on an extended decline, to a stock that looks like a $100 bill lying on the street?  The first step, I think, is to look for signs that the waves of selling that have pummeled AAPL are over.   This means having AAPL announce bad news and have the stock go up, rather than sell of further.  That’s why tomorrow’s earnings report may be important.

.

commodities cycles

April 18, 2013 By in Capital-intensive firms, Current Market Thoughts, Gold, Industry Analysis, Mining, Trading Tags: , , , , , , , , , 2 Comments

commodity rhythms

agricultural

The co-owner of one of the smaller investment companies I’ve worked for was a farmer.  He made me realize that there are no long cycles for most agricultural commodities.  If prices for a particular crop are high, farmers will plant more–usually a lot more–the following season.  That virtually guarantees that prices will either level out, or more likely fall.  The opposite happens–supply falls, and prices subsequently go up–if prices are currently low.

Considering that many crops have two or three growing seasons in a year, price adjustment comes swiftly.

metals

Metals mining, especially base metals mining, is just the opposite.  Mines tend to be gigantic projects, costing billions of dollars and designed to last 20 years or more.  Most of that money is spent up front:  for the mine itself, for all the drilling machines and other earth moving equipment, for the ore processing plants, for the roads or rails to tap into a country’s established transport infrastructure, and maybe even for new sources of electric power.

Because the optimal project size is “humongous,” mines tend to spew out very large amounts of output when they open.

Because–unless you’re very unlucky–the running costs are low relative to the initial investment, projects seldom shut down once they’re up and running.  They normally don’t even consider doing so unless the output price falls below out-of-pocket extraction costs.  And even then a mine may not shut down.  Miners always identify pockets of especially rich ore that they set aside for a rainy day.  So the first response to weak pricing it to turn to these high-grade areas in order to keep going–and spewing even more price-depressing output on the market.

In addition, some emerging countries run their mines to create employment and get foreign exchange.  Because whether they make money or not is a secondary concern, such mines almost never shut down.

The result of all this is a supply/demand dynamic somewhat like the farm one I sketched out above.  When times are good and metals prices are high, miners generally spend their cash developing new mines.  This creates periodic overcapacity when supply outstrips global industrial demand as all the new mines open at once.  But, unlike the case with soybeans or corn, excess capacity doesn’t disappear come winter.  Instead, it can stay for a decade.  What cures the oversupply is the eventual expansion of the world economy to the point where it can use all the raw materials being produced.

an example

I was a starting-out analyst when a supply-demand imbalance sent base metals prices skyrocketing in 1980.  I remember copper briefly hitting around $1.40 a pound and bringing previously loss-making capacity back onstream.  The price almost immediately fell back.  It took nine years for demand to expand to the point where it absorbed all available supply–and for the price to regain that 1980 high ground.

Another wave of new capacity pushed the price back down in the mid-1990s, where it stayed again until sharply climbing demand from China absorbed all the new output.  The price began to rise again in 2003.

For most metals, this pattern of feast and famine is common.  It’s not alone.  Chemicals and shipbuilding are the same way.  The common threads are:  commodity industry; long-lived assets with most of the capital in up front; capacity additions coming in large chunks.

Try to find a copper chart that goes back to the 1980s.  It isn’t that easy–suggesting to me that commodities traders aren’t as up on their history as they should be.

investment significance

I think that for base metals, and maybe for gold as well, we’re deep in the end-game transition from fat years to lean.  It has less to do with the state of demand in China than the state of supply among mining companies.  If I’m correct, time–and the accompanying gradual world economic expansion–is the only cure.

a falling gold price–what does it mean?

April 15, 2013 By in emerging markets, Gold, Industry Analysis, Recent Market Action Tags: , , , , , , , , 3 Comments

Back in the day, I was, among other things, a gold mining analyst.  That period left me with an enduring fascination, not about the yellow metal itself, but about gold “bugs”–the people who are obsessed with gold and who buy it as an “investment.”  I have the same complex mixture of feelings about gold bugs that I have about survivalists, Civil War reenactors, model railroad buffs and people from Brooklyn.  It’s not exactly “There but for the grace of God…”, but that’s the general direction.

I really don’t get gold as an investment.  Yes, it’s shiny and there may actually be gnomes in Zurich.  Until the mid-1970s, gold did serve as a kind of money worldwide.  But no longer.  One exception:  developing economies where either there are no banks for businesses to use, or where people don’t want/trust banks to know about their finances.

Contrary to what I think is popular belief in the US, virtually all the demand for gold comes from the developing world.  The US accounts for 5% of purchases, the EU 10%.  Japan is a non-factor.  Last year, as usual, India was the #1 buyer of gold, at 28% of the total.  Greater China took 25%.

Before the Great Recession, the large bulk, maybe 3/4th, of the world’s demand for gold was for jewelry (although much of this did double duty as chuk kam 99.9% gold trinkets). 10% was for technology or dentistry.  The rest was gold bars and coins bought as an “investment.”  The bulk of that demand was supplied by mine production, with the rest coming from recycling and steady selling by central banks in developed countries.

The GR changed that pattern, in two ways.  Demand for gold bars and coins more than tripled.  Central banks in the developed world stopped selling, while their counterparts in emerging economies began to buy gold like there was no tomorrow.  Between 2009 and 2011–which appears to have been the peak of this activity–the gold price doubled in US$.

Gold ETFs?  They peaked in 2009 at about 17% of world gold demand.  By 2011 they had shrunk to 4%.

What’s happening now?

The gold price has been slowly declining for two years, without attracting much attention, as panicky buying by gold bugs has waned.

What’s new is India.  The biggest drain on India’s growing trade imbalance is its citizens’ continuing demand for gold–both for jewelry and because the country’s banks don’t work.  New Delhi has decided to deal with the steady flow of cash out of the country by taxing gold imports.  At least to some degree, this will put the metal’s chief buyer on the sidelines.  That won’t stop mines from churning out the stuff, however, until/unless the gold price drops below their cash cost of production.  That’s a looong way down.

Elsewhere, “investment” demand appears to be waning.  Less significant in the short term, Chinese tastes seem to be slowly shifting away from chuk kam to fashion or statement jewelry with lower gold content.  And, of course, more dentists are using ceramic teeth and PC demand is slowing.

In other words, the supply/demand picture for gold is looking less favorable for prices.  The price decline has nothing to do with inflation fears in the US or EU subsiding, or renewed faith that either area is suddenly on a sounder economic footing.