US$ Teeters, New Lows Imminent
Gold prices could
be set to turn up again.
You couldn't tell by Monday morning's selloff
on the TOCOM (Tokyo Commodities Exchange) overnight, and the action in
gold shares recently. But after watching the major US stock averages stumble
early in the session, witnessing a firming of silver and base metals prices,
and observing fresh slippage in the US dollar, against currencies broadly,
we're set to get right bullish on the metal in the short term (we've been
less bullish in the short term since the day gold prices reached our $390
target).
After
consolidating for the past month, the Swiss Franc surged to new highs
Monday, followed by the Euro - though the new high is more marginal there.
The US dollar index has been consolidating its sharp 2002 losses over
the past 30 days, also, but currencies such as the South African Rand
and Australian dollar continued to soar throughout. Both made new highs
against the greenback again Monday - the Rand gained nearly 2% to new
2 year highs, while the Aussie rose 1% to new 3 year highs.
Last week, the Canadian dollar no doubt
finally turned heads when it reversed a three year bearish sequence by
breaking out of an intermediate chart bottom. Monday it also traded to
more than two year highs.
In Japan, the Bank of Japan shocked most
pundits last week when it chose a traditionalist to replace BOJ chief
Hayami, who's stepping down this month, over an inflation targeter. The
move was no surprise to us.
Obviously,
a central bank can't really be independent of its government, but it still
has to put up the facade (of independence). If it doesn't, confidence
in the currency and market system deteriorates more quickly. Many economists
argue that deliberating a devaluation in currencies is a legitimate stimulus
to real economic activity. I suppose we haven't shipped enough of them
off to any one of the numerous developing countries still pursuing backwards
inflationary policies as that. They should know better.
Anyway, whether it is deliberate or not,
it is entirely possible that one aim of dollar policy is to undermine
foreign currency purchasing power by promoting inflationary policies such
as (yen) weakening or quantitative easing, abroad.
'Sure, free trade, great, but you should
weaken your currency to subsidize your export sector... make more money
that way you fellow capitalist you.'
I
know, it doesn't sound like anything US policy makers would stoop to.
So why is that advice then plastered all over the financial press?
Who knows what the idea of reform is in
Japan, or what the US' role is in it, but if it's to make for a sounder
or freer market system of production, the idea of weakening the yen is,
well, wrong. Besides, the dollar's too weak. The market won't allow it.
That was the verdict that yen bear (reformist) Shiokawa, Japan's finance
minister, admitted to after last weekend's G7 meet. So after being
held back over the past six months by rhetoric, and despite new lows in
the US dollar index, the yen too is finally on the verge of a major breakout.
The breadth of the move against the dollar
is on the rise, and it appears to be gaining momentum. If the Yen manages
to break out of the prospective two year (head & shoulders)
bottom, the development would be very bearish for the US dollar. Maybe
that was behind the Dow's forfeiture on Monday, to a degree.
The
US dollar index has had trouble bouncing during its consolidation. It
hasn't in fact. And the fresh bullish momentum in the currencies it is
composed against now argues for new lows in this index. Further weighing
on the dollar is the renewed weakness in stock prices as well as falling
yields over the past month.
Gold Bears Fail to Keep Focused on the
US Dollar
Last week, stock bulls were excited about
a strong durable goods number and upward revision in fourth quarter GDP
that implied a rebound in manufacturing. However, Monday's release of
the ISM index (used to be the NAPM - National Association of Purchasing
Managers) for February dampened that enthusiasm, because it contracted
to 50.5 from 53.9 in January, well below forecasts exceeding 52.
In terms of measuring economic activity
in the first quarter, this is an early indicator, though stuff like this
never moves markets all by itself. What may be more important for investors
is Friday's February employment report. Weekly jobless claims figures
have looked dismal all month long, though who knows what the magicians
will do to the monthly number.
At any rate, the chalk marks (chart activity)
remain bearish for most equities around the world - except parts of Asia
perhaps. The bears look set to take back all that the bulls have gained
since 1996/1997, in both the Dow and the US dollar. The US averages look
very shaky, and a look at the components only makes us more bearish. The
Dow looks ready to take out October's low at 7200, which would be a new
almost six year low. The significance of it is whatever you might attribute
to leaving behind the 1998 low.
In this teetering backdrop, gold prices
should reach our $425 - $450 medium term target easily by the first half
of 2003. We could be right on the edge of just such a move. But much depends
on just how much of the decline in the dollar index has been factored
by the move in gold to $390 during February.
Our target for the Dow is 6000 on a break
through October's low, plus or minus. Our target for the dollar "index"
is about 91. Gold should break through its 1996 high of $425 on such moves,
which incidentally, would almost complete the medium term objective of
gold's December break out from what many believe to be a five year double
bottom - if it were a true double bottom, the implied objective is actually
closer to $450.
That may sound conservative to some gold
bulls. It is in our view too. It's certainly not as aggressive as our
long term (approx.. 5 year) target - $2000.
|
Author's Note:
the war premium is a marginal "behavior," not unrelated
to the fickle outlook for the dollar. I don't buy the idea it can
be calculated. We only ever use it to describe the focus of a particular
trade. In other words, it could be considered a description of human
action.
Individuals can be rational
until they're thrown into a group situation. Point being, that a
group has to be considered in terms of the whole rather than the
sum of its parts... as though it were one individual for instance.
Whether it's rational or
not, on some days, this market (crowd) discounts the impact of the
war outlook on things. The discussion of a war premium, however,
should go no further than describing the focus of activity.
|
Moreover, as is typical during the early
stages of any bull market, there is still widespread media and industry
skepticism / criticism of the gold arguments. Most of them sound like
this: gold is overvalued due to the speculative war premium.
Few of them ever note that gold essentially
forecast the US dollar's breakdown last year, probably because their eyes
were off the correct ball. But also, probably because few of them would
like to imagine the consequences of further dollar weakness at this point
- higher inflation/interest rates, and lower stock valuations.
First there was the Barron's article entitled
"Fool's Gold" in mid August 2001 where the author made
the case that gold was only up due to the Argentina crisis that summer,
and that it was overvalued as a result. Then 9-11 happened and gold went
down.
Interestingly, the bull market peak in
the dollar index occurred just one month before the Barron's article showed
up. The long awaited dollar reversal was at hand we wrote in July of that
summer. In fact, gold had already begun its ascent in the spring of that
year. Barron's had it wrong. Gold wasn't up because of Argentina. That
was driving it only at the margin. Gold prices were already forecasting
trouble ahead for the dollar.
Before
you knew it, Japanese traders were loading up on gold futures, while producers
such as Anglogold began buying back their bearish hedge position.
The next round of verbal assault - by the
bears - came one year later in June (2002). Analysts at Barclays called
what was happening in the gold market a bubble, as if they were experts
on the subject (of bubbles) or something. All year long last year, one
political conflict or another was
cited as driving gold demand. Recently
the rows with Iraq and North Korea
have been pinned for gold's glitter.
It stands to reason that if all these unpredictable,
unconnected, exogenous things drive gold higher or lower each time they
occur, investing in gold must be unpredictable.
However, what the bears fail to understand
is how all that news always only impacts gold prices (or any asset price
for that matter) at the margin. The core driver is the deteriorating outlook
for the dollar, which happens to be a little more predictable, and to
an extent, also responsible for the series of events that often fuel buying
at the margin, unbenownst to many in the crowd at the time perhaps.
The Outlook for USD = Outlook for Real
Returns
The United States economy requires the influx of a large amount of foreign
savings each year, or demand for the dollar, in
order to sustain the current account deficit at today's exchange rates.
Historically this meant higher interest
rates as this demand moderated. But in the nineties we saw it wasn't simply
yields that determined exchange rates. We learned that even speculative
stock market gains could increase the dollar's foreign currency purchasing
power. So the model had to be adjusted.
What we've come up with is that the outlook
for the dollar is determined by changes in relative capital market "real
return expectations," which we refer to as the dollar's investment
premium if it's a currency, or it's liquidity premium if it's discussed
in the context of money.
Since expectations for future returns on
any asset are in part determined by past performance, it took one year
for Wall Street's bear market to translate into a weaker dollar, and it
was postponed also because commodity prices fell during 2001, which sustained
the argument for improving real returns, at the margin, if only superficially.
In 2002, it all came together for the dollar's
bear market - falling performance expectations for US equities, deteriorating
earnings outlooks, falling bond yields, and accelerating commodity (or
real) prices. All of that implies falling "real return expectations."
Then, towards the end of last year, the FOMC continued to lower yields,
despite the dollar's newfound weakness, commodity prices continued to
soar, and now, finally, those gains are making themselves evident in the
government's published inflation series - CPI/PPI.
The case for a bear market in the dollar
is gaining momentum again now after a short hiatus last month. The only
real chance the dollar has is that either the Dow rallies enough
to improve demand - at the margin - or that gold and commodity prices
continue to correct.
The sum of our gold outlook then is that
the model where gold market moves predict counter moves in the US dollar
and same direction moves in the CRB is intact. The correction in gold
prices that began early in February probably both reflected the dollar's
consolidation over the past month and forecast a correction in the CRB.
Gold should continue to lead moves in the dollar. Even in theory, the
main concern of gold traders is always the outlook for the dollar - assuming
they're trading in dollar terms.
Thus, in light of our bearish outlook for
the dollar, the only matter for debate is how high gold is going to go
now if the dollar is set to lose another 10% or so, on average this year?
Assuming we're right, you already know
the answer. We might be wrong, or maybe we're being too conservative.
Only time can tell.
During 2002 gold rallied about $75 while
the US dollar index fell almost 20%, and since the bottom in 2001, gold
has rallied about $100 while the dollar index's fall is roughly the same
at 20%. We might agree that the last 20 point spike in gold prices during
January already forecast a bearish resolution to the dollar's current
consolidation, but would argue that the aftermath of the potential breakdown
has yet to be discounted.
What Else Haven't Markets Considered?
I read Monday that in the event of a US-Iraq invasion, Kuwait might have
to shut off up to one third of its 2.1 million barrel daily production
rate. What I thought was interesting was the press' take on it. They said
that while that may be the case, Kuwait in turn promised to crank production
up to capacity at their other wells in order to help OPEC countries flood
the (oil) market during a possible crisis.
The problem is that according to a recent
report by Merrill Lynch (they're bullish on oil as it happens), they estimate
spare production capacity in all of OPEC to be only 2.1 million barrels
a day at the moment, placing Kuwait's share of spare capacity at only
30,000 barrels per day (data is from their Feb 21st energy weekly).
My point here is that the media reports
I'd read largely omitted that fact, which prompts me to question whether
the market has really considered the entire extent of possible supply
disruptions in the oil market arising from a US invasion of Iraq, which
would just add to the supply problems the market is experiencing as a
result of a collapse in Venezuelan oil exports during 2002, which in turn
has translated to record breaking falls in reported US oil inventories.
The main downside surprise for oil, and
for gold to a lesser extent, I believe is the question few investors might
have considered. The US administration has shown determination to disarm
Iraq, which perhaps has persuaded investors to accept the likelihood war
is inevitable. But the antiwar campaign has been picking up momentum.
Could an invasion be shelved until next
year? I don't know. The pundits say no. Still, the prospects bear watching,
because I think it would be as much a surprise to the markets as anything
else at this point.
It might be more apparent the week after
next when UN security council members are expected to have finished voting
on the new resolution proposed by US diplomats.
| IMPLIED POG - gold price factored
by gold stock valuations in the BGI Gold index (proprietary) |
| Rate conditions |
Easy money |
Neutral money |
| |
15 x C.F.P.S. |
12 x C.F.P.S. |
| Agnico Eagle |
$365 |
$415 |
| Anglogold |
$210 |
$235 |
| Goldcorp |
$310 |
$360 |
| Kinross Gold |
$275 |
$295 |
| Newmont |
$295 |
$330 |
| |
|
|
| Average |
$291 |
$327 |
| |
| This model
is designed to estimate the approximate average 2003 price of gold
anticipated by gold stock investors as they determined the value of
the above shares on Monday March 3rd. |
| |
|
Assumptions:
- latest quarterly estimates of cash costs
of production / ounce provided by the company
- average historic multiples of resultant
cash flows per share = 15, thus we use 15 to reflect easy money
conditions (i.e. low yields, or discount rates) instead of traditional
8, which is unrealistic in practice
- estimated 2003 production rates are assumed
to reflect future production
- value attributed to mine life is excluded
in the calculation
- Newmont and Anglo's lower values reflect
risk premium tied to hedging positions
- cash holdings per share were discounted
to reflect the premium in the stock attributed to them
- implied gold prices in the table above
reflect the average POG for any particular fiscal year
|
Gold Stocks Factor $310/oz.
Gold shares continued their slide Monday. The AMEX Gold Bugs index finally
nailed our first short term downside target (the 200-day moving average),
and appear likely to head lower for another day or so. However, they could
be nearing the end of their countertrend move, particularly if our gold
price outlook is correct.
Moreover, our gold share index suggests
investors are factoring just a $310 average gold price for 2003,
approx.., as of Monday's stock market closings.
That was about the average gold price most
gold producers realized in 2002. Meanwhile, the average gold stock is
down 20% since February's peaks. Our index is down 10% from its peak.
At its peak values in early February, for
instance, Goldcorp's shares implied an average $415 gold price this year
(range was $380 to $450). Today their market is saying gold is worth only
$335 this year ($310 to $360, see table).
We might take it as a bearish indication
for gold prices if the technicals confirmed it with intermediate bear
signals in either the leading gold shares or gold itself.
Instead, we are taking it as a sign of
too much bearish sentiment during a correction.
Since our outlook for the dollar remains
bearish; because the main trends in the gold sector remain bullish; and
because bearish sentiment is both relatively extreme and typical, our
bet is gold stocks are about to put in a bottom. That's a change in our
short term outlook. On February 7th we issued an alert warning for a dip
to around the current level in gold shares - a little lower actually.
By typical I mean in that confidence at
the early stages of any bull market is typically fickle, and so is the
allure of seemingly logical sounding countertrend arguments in the midst
of any correction also typical.
Barrick Dances Around Market's Demand
Still missing from the bullish picture nonetheless is any indication that
Barrick is serious about reducing its hedge position, or that Anglo has
been back in the market since December.
A New York Times article wrote Barrick
up in a bullish light this weekend. But there was no indication by the
author that the company is doing anything much different except perhaps
their 'splaining how their hedges are different than others.
Our comments, which went out to subscribers
by email on Saturday, are published below. They
conclude that whether Barrick proponents expense negative changes to its
hedge book or not, the market should, has, and probably will continue
to.
My question is, who's Barrick trying to
fool with this article? Is there something in the structure of their hedges
that outright prevents them from liquidating them, besides, well, the
fact that futures traders'll probably see them coming from miles away!?!
Ed Bugos
Editor - The GoldenBar Report
www.goldenbar.com
March 6, 2003
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Goldenbar Report: is not a registered
advisory service and does not give investment advice. Our comments are an
expression of opinion only and should not be construed in any manner whatsoever
as recommendations to buy or sell a stock, option, future, bond, commodity
or any other financial instrument at any time. While we believe our statements
to be true, they always depend on the reliability of our own credible sources.
Of course, we recommend that you consult with a qualified investment advisor,
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