Gold/Silver: The First Global Bull Market
15 October 2009
In September 2009, the price of gold closed at its highest level in history,
on a monthly basis. And this month, gold has reached its all-time highs.
Gold is the only asset category I can think of that is higher in value/price at
the end of September 2009 ($995) than when the crisis began in July 2007 ($665),
except US bonds but that is only due to massive government intervention. Gold today
is higher than the stocks markets in North America, Europe and Asia during the same
period; higher than real estate virtually anywhere; higher than the US dollar.
Gold has caught investor attention now that it is holding above $ 1,000. Barrick
Gold (one of the largest gold miners in the world) announced that it was raising
$ 3 billion to close its hedge book. Within days it had to increase the offering
to $ 4 billion!
It is believed to be the largest primary common-equity offering in Canadian history!
Why the frenzy? Because Barrick was losing money on its gold hedges as the price
of gold rose. It clearly anticipates that the price of gold is going much higher
and investors appear to concur.
I believe gold is now entering its parabolic growth phase in the first global bull
market in history that any investor in the world can participate in relatively easily.
Throughout history, investment booms have been local affairs. A tulip craze going too far
mostly affected just the Dutch in 1637. The South Sea bubble, American railroads,
etc., etc., affected the people of the country involved and some rich overseas financiers.
The Internet boom of the late 1990s was the first real global phenomenon (ironically,
it was the internet itself allowing information to be transmitted easily worldwide
that helped fuel that bubble) but a non-US investor still had to have an account
with a US broker (or a major global financial services firm) to participate.
The global stock market and real estate boom in recent years? How many of you bought
significant amounts of Brazilian real estate or Taiwanese stocks?
But gold? Gold is potentially the first real global asset bull market.
Sure, oil went from $ 12 in 1998 to $ 147 in 2008 but what did that mean to a peasant
in China as an investment? How do you stockpile barrels of oil under your bed?
Gold did have a major run in the 1970s. But the involvement of retail investors,
the wealth creation for the middle classes in the emerging markets, the scale of
global investment capital and flow of information is so different that the mobilisation
of capital in gold this time will be of a different order of magnitude.
Gold (and silver, as gold drives the price of silver) is different. As a commodity,
it is fungible (it is the same anywhere and interchangeable). It is not primarily
brand differentiated, it is easy to buy and store, it has universal appeal as jewelry
and as a store of value (and as a safe haven). It does not take any sophistication
to buy gold and it can be done by anyone who has a little bit of savings.
More importantly, if I own gold, a peasant buying gold in China can directly
affect the value of my holdings through the increase in demand when he buys it in
his local village since we are both holding the same thing!
Until 2003, it was illegal to buy gold in China under communist party dictat. Since
then, China is set to overcome India as the largest consumer of gold in the world
in six short years (as well as becoming the largest producer of gold).
Here's another thought from Richard Russell. The government of China has recently
been urging its citizens to buy gold and silver.
Here's Russell's take on this (and it's an intriguing one): As workers have been
laid off in factories and are returning to their villages (China's trade surplus
in August 2009 fell 45% from a year earlier), the government is concerned about
the potential for social unrest due to rising unemployment. If the government believes
that gold and silver are going higher (knowing that it is itself part of the reason
for that to happen), then it makes perfect sense for it to almost plead
with its citizens to buy gold to create a bit of wealth that might help ensure stability.
I think he's right.
As Cheng Siwei, a top Chinese Communist party official said at a monetary policy
conference in Italy recently, "Most of our foreign reserves are in US bonds and
this is very difficult to change, so we will diversify incremental reserves into
euros, yen and other currencies. Gold is definitely an alternative."
Gold rising over $ 1,000 brings new investors into the market. It took oil several
years to reach $ 100 but then it climbed to $ 147 within five months as it caught
investor attention.
Gold was $ 665 at the start of July 2007, when the crisis first began. When markets
melted in Sept/Oct 2008, it fell hard because, as the massive leverage in the global
financial system began to unwind dramatically, gold was sold to meet margin calls,
redemptions, etc.
After bottoming in October, it started to climb as soon as the selling stopped.
It continues to rise on the back of US dollar weakness, potential inflation due
to unprecedented monetary stimulus, the potential for a double dip recession, and
supply-demand imbalances.
The point is it performed well during the crisis and it is doing well with the recovery.
Two primary demand factors driving investor interest in gold are protection against
currency debasement and future inflation.
The US Dollar is caught in a vicious cycle. As the US funds its unprecedented intervention
in the economy, it has to print dollars and bonds in gargantuan supply. As it does
this, it lowers the value of the dollar and risks a potential blow-up of the US
debt market through a crisis of confidence that the debt will become too large to
repay.
As the dollar falls, US assets become less attractive (especially low yielding US
debt).
This is why, despite record low interest rates, the US is not locking in investors
by issuing mostly 20 and 30 year bonds. In Feb 2009, the Treasury Advisory Borrowing
Committee noted that, "The average maturity of the debt has already fallen from
a range of 60 to 70 months which existed from the mid 1980's until 2002 to a level
of 48 months more recently."
The red bars in the chart below represent net Treasury bills issued which have a
maturity of less than 1 year and represent about 45% of net debt issued in the last
year. What this means is that, on top of the enormous issuance of new debt for which
the US must find investors, it also has to recycle significant amounts of existing
short-term debt that will mature within the next two years.
The Japanese opposition party, the Democratic Party of Japan, just won the elections.
Except for a brief 8 months in office in the 1990s, they have not been in power
for 55 years!
While I give them credit for sheer tenacity, it is what the chief finance spokesman
told the BCC during the campaign that is interesting. Masaharu Nakagawa said he
was worried about the value of the US dollar and Japan would only buy US dollars
if they were denominated in Yen - the so-called samurai bonds.
Interestingly, the BCC report cited observers as saying that the move would be a
remarkable policy shift but unlikely to happen as the DPJ was not likely to win.
They were wrong and a party that is far less friendly to US and corporate interests
than Japan's Liberal Democratic Party is now in power.
Japan and China are the two largest holders of US debt (almost half of the US debt
that is held by foreign governments). While it is in their interest not to upset
the global order precipitously, they are clearly reluctant buyers of new US debt.
But here's the problem. If the two largest US debt buyers are likely to go on strike
in the future (China sold a net amount of $ 26 billion US bonds in June 2009), and
the US is issuing record new levels of debt, who's buying it?
I suspect that there are simply not enough buyers to fund multi-trillion dollar
new Treasury issues and the Fed's Quantitative Easing program is acknowledgement
of this reality. So the Fed is stepping in to buy US debt as needed to keep yields
under control.
Gold is responding as a monetary asset to this currency debasement and the previously
unimaginable levels of stimulus which should translate into much higher inflation.
Warren Buffett predicts that inflation will exceed the levels we saw in the 1970s
(which ran over 20% per annum). Alan Greenspan is concerned that inflation may swamp
the bond market.
On the other hand, in 2008, despite record gold prices, gold production fell
to a 12 year low! The easy stuff has been mined, it is harder to
find new discoveries to replace existing deposits that have been mined, and costs
have risen. So, supply from production continues to decline.
Another bullish factor for gold is central bank sales. In August 2009, 15 European
banks renewed their agreement (CBGA) to limit their gold sales to 400 metric tons
a year (which includes the proposed IMF sale). The current 5 year agreement (which
expires Sept 26) was for 500 tons a year, but the banks sold far less than permitted
(only 343 tons in 2008 and on course for lesser sales in 2009). So while European
sales are falling, other Central banks (Russia, China, India, etc.) are increasing
gold in their foreign exchange reserves.
While stock markets are rallying and the economy seems to be recovering, the reality
is that this is simply due to massive intervention by governments in their local
economies, based on running record deficits.
In 1937, the Federal Reserve tried to withdraw its stimulus after the New Deal and
the market promptly crashed. This lesson will not be lost on Bernanke. So while
the G-20 may talk about ending the easing to prevent high rates of inflation in
the future, it is all talk until housing and employment turn positive.
In fact, Bob Janjuah, the RBS credit strategist who predicted (in June 2008) that
there would be a global crash in September 2009, has just warned that the economic
data needs to turn positive (not just less bad than previous periods), or else the
markets could crash again in the fall, with the SP500 dropping to as low as 500,
from its current 1,000+ level.
Stocks of gold mining companies will leverage the rise in the price of gold as they
come out of an 8 month consolidation. Thus the frenzy for Barrick stock. And, from
now through 2011, gold mining stocks will provide excellent returns for investors.
email: info@acamar.ca
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