Taylor On US Markets & Gold
The Paper (Financial) Markets
Bullish Markets
The Giant Sucking Sound
Actually one point we would like to make that we think Mr. Gross has still
not focused on, but which Dr. John Whitney and now finally Stephen Roach of Morgan Stanley is focusing on is that one of the major reasons why the U.S. companies are in trouble is because of an exceptionally overvalued U.S.
dollar. We know this is true because capital intensive bulk commodity
products (as opposed to labor intensive products) are pushing American
producers out of their own markets. There are virtually no cost advantages
for the Chinese on these products since they use the same kind of capital
intensive production measures as the U.S. uses. And then they have to ship
these heavy products half way around the world through a couple of canals
which is a very costly process. The only way these products can force
Americans out of their markets is by way of an overvalued dollar, which in
effect is a major tax on American consumers. - the only explanation is that the dollar is much too strong. Moreover, the Chinese currency is pegged to the dollar so that even when the dollar declines in value vis-à-vis the Euro or Japanese yen, there is no return to a trade weighted fair dollar as far as China is concerned. And so we are hearing the giant sucking sound that Ross Perrot warned us about.
So why don't we hear about an overvalued dollar as a solution to our problems? I believe it is because the policy makers of America no longer care about America. What they are working very hard to accomplish is a one
world government. And judging the apparent elimination now of legislative
bodies, which are now subject to court rulings, how can anyone deny that we
are no longer a republic, but an emerging dictatorship?
- GOLD - Gold Bullion remains bullish and I continue to believe we are in the very early stages of a multi-year bull market in gold. The spot price of gold at $321.60 is above the 20-day moving average of $319.72, the 50-day moving average of $316.67 and the 200-day moving average which is at
$305.72.
We really need to get through about $330 to see higher prices taken out. In
the mean time, a moderately rising gold price is allowing some of the major
mining companies a chance to unwind their hedge positions before an explosive rise in gold springs forth. In any event, we would much rather see an orderly rise in the gold price. After building such a long term base, the gold charts are looking exceptionally healthy.
- GOLD SHARES, as measured by the XAU on the other hand have been
displaying some weakness. As of the close of business yesterday, the XAU
was at 67.16, just slightly below its 200-day moving average of 68.01. You
will recall earlier in this bull market, the gold shares were leading gold
bullion. I believe the current slow down in the shares may simply be a
correction of the shares which had gotten ahead of themselves and gold
bullion. Of course, we take it as a given that intervention in the XAU is
definitely a possibility by some of the gold bullion banking firms who hate
gold at the very core of their being. After all gold is to bankers what a
nun is to a whore house. Gold and the nun are both a deterrent to deceit
and dishonesty. The critical support level for the XAU is at about 55 which
was reached back in July and 50 reached in November 2002.
Bearish Markets
- STOCKS as measured by the Dow and the S&P 500 and virtually any other
broad based index you care to name is bearish and showing considerable
technical weakness. Both the Dow and the S&P are not only substantially below their all important 200 day moving average but also very far below
their 20-day and 50-day moving averages. And both are very close to long
term support levels. For the Dow that support level is at about 7500. For
the S&P 500 it is at about 800. A decline by either or both of those
indexes would likely mean a very substantial and possibly a very quick
decline to much lower levels. I still think it is possible that we could see 5000 before the end of this year on the Dow.
- THE DOLLAR - as measured by the U.S. Dollar Index is at 107.16 vs. its
20-day moving average of 107.36, its 50-day moving average of 107.52 and
its 200 day moving average of 111.01. There has been a great deal of
intervention in this market. Unlike gold, the government does not deny that it manipulates the currency markets from time to time. So why don't they
acknowledge they are doing it with gold too? Because if the markets
understood that the gold price was lower due to intervention rather than
natural market forces, the private sector would begin betting against the
government. In the end, the markets will win any way. And we think the
early stages of the bull market in gold is evidence that the time of gold
price fixing by the Fed and other central banks may be near at hand. And
when policy makers are no longer able to manage the gold price, they will
also likely lose control of the currency markets too because what we are
talking about here is systemic risk. Gold is the money that is outside of
the fiat money system and hence the place to be given the growing
vulnerability of our dollar based global fiat money system.
Overall we think Stephen Roach has properly diagnosed the disease that is
at the heart of a growing systemic global risk. Stephen points out how the
entire world is dependent on the U.S. to continue living beyond its means. But at some point in time, the pathological behavior displayed by the U.S. will cause it and the entire global economy to self destruct. Dr. Roach is quite rightly calling for a decline in the dollar back toward a fair trade weighted balance. Unfortunately, Wall Street is more concerned about retaining overvalued capital markets for the sake of preserving its own wealth than about longer term health of U.S. markets. As such, there is little likelihood in my view that policy measures to allow the dollar to return to a fair value on the basis of trade will be allowed to take place. Indeed, Dr. Roach noted in a recent essay that he had taken a great deal of heat over the suggestion that the dollar should decline by 20% or so.
Unfortunately this is a game of chicken that not only policy makers but all of us will be victims of. Those who protect themselves by investing outside of the system, will fare better than others. But make no mistake, gold and gold share profits will by no means offset the overall pain we are likely to suffer in the Kondratieff winter that has just begun.
GOLD
Further information related to the potential for junior mining companies
facing the threat of property loss due to gold hedging by joint venture
partners with project financiers was provided by James Sinclair at the
beginning of this week at www.lemetropolecafe.com. With the permission of
Bill Murphy of GATA, I am herewith reprinting Mr. Sinclair's comments.
"Let's reason together. As a junior exploration and development company,
you have an exciting property. Hedge Hog Gold, a major Canadian producer,
likes the property and after a long negotiation you come to a 30% you and
70% Hedge Hog Gold, JV agreement. HHG, the major gold producer, finally
finishes exploration and contracts with a major engineering and economic
geological consultant to provide a positive bankable feasibility study.
"You, the junior, in your JV agreement with Hedge Hog Gold, the major gold
producer & now property manager, as is the industry standard, agrees with
the lender as permitted by you to place your 30% and Hedge Hog Gold's 70%
of the property up as collateral to the development financing. Financial
entities that fund development loans will never fund a fractured asset.
100% of the asset must collateralize the funding.
"In today's world it has become common for financial entities to offer
non-recourse funding for mining development projects if the project enters
into a derivative hedge that sells all gold production forward, thereby
guaranteeing the ability to pay back the loan by locking in the profit for
the term of the loan repayment. That term is normally 10 years. Now, you
can see why certain companies CANNOT close their hedges, as they are
mandated by the loan agreement that provides non-recourse financing.
Non-recourse financing means that the lender will not, in the case of a
failure to repay, look to any asset of either the junior or the major
except the underlying property pledged.
"The problem is that the junior rarely has anything else anyway. Hedge Hog
Gold, like all majors today loves non-recourse financing because they have
many other projects operating. They do not want the failure of one project
to impact any other project. Therefore, the form of non-recourse financing
has become almost 100% of the gold project financing over the past six
years. This is one of the reasons that hedging has become so popular in the
gold mining industry.
Now it stands to reason that the junior in this 30% / 70% JV, who places
its property as collateral for the loan package would have 30% of the
Derivative Risk. It is the Derivative setting the price of the gold sold
for the project, therefore the junior is benefiting from the Derivative
part of the loan package, if gold declines. It stands to legal & logical
reasoning that you cannot benefit from the derivative placed by the major
as part of the loan package and avoid the liability of that derivative.
"The junior benefits in two ways. First, the junior benefited from the loan
package itself which built their 30% of plant and mine. Secondly, if gold
declines, they benefit from the hedge position. My position is, if gold
rises and the Derivative melts down, Hedge Hog Gold is going to look to the
junior for 30% of the loss. It is the industry standard that if you receive
a cash call from the major that you cannot meet, it triggers a dilution
clause, usually to 10% of net profits. In English, 10% of net profits in a
JV with a major gold producer = practically no $.
"Therefore in what I have demonstrated to you, any junior gold producer or
explorationist in a JV agreement with a major gold producer who is also a
hedger probably is in danger of losing their asset to the major.
"You can find out by asking your junior. It may be a revelation to them but
they and you need to know. Copy my letter and this answer to a reader in
www.financialsense.com and send it with a polite note asking your gold
junior to have their legal counsel read this and check to see if they have
this liability.
"Your junior (if it is in a JV with a major as described) may be and
probably is exposed to a derivative risk that they do not know about by
what is called in law -- a Negative Pregnant. That means the obligation
exists, even though not clearly stated in the agreement, because it is
simply a provable legal obligation even though it is not clearly stated. I
believe in such a circumstance as I have outlined you have? a "Negative
Pregnant" therefore the junior has the obligation on the derivative simply
by definition. Your junior is obligated to answer your question.
October 5, 2002
Jay Taylor, Editor of J Taylor's Gold & Technology Stocks
www.miningstocks.com
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