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Hinde Capital: “Gold Is Trading At 75% of Its Production Cost---That Has Never Happened”

July 23, 2013

Despite a lacklustre summer for precious metals and mining equities, both groups moved up very strongly this week. In response, Mark Mahaffey, Co-Founder of Hinde Capital and Co-Manager of the Hinde Gold Fund, was kind enough to share comments on the short and long-term view of the market.

Here are his interview comments with Bull Market Thinking’s Tekoa Da Silva:

Tekoa Da Silva: Mark, you might be the only person out there speaking towards what you describe as the 'speculative cycle'---reflecting a potential top in the equities market, along with a potential bottom in gold. You've described this cycle in your most recent blog piece entitled, "Where has all the gold gone?" Can you share those thoughts with our readers?

Mark Mahaffey: That is the right word, “potential”. There are some signs in the market that suggest the high level of speculator longs in US equities and the low level of speculator longs in the gold market should have people concerned that this trend has just about run its course.

The sentiment cycle never changes; at the top, total confidence, delusion and irrational exuberance gives way to hope, anxiety, panic, despair and total disgust at the lows. That’s when valuations would suggest the reverse.

TD: Is that what we saw yesterday Mark, the first step in the process of a reversal in that cycle?

MM: Whenever you have extreme bearish sentiment with low net long speculators the path of least resistance is clearly upwards. I believe the low for this move is in and we will work our way to higher prices over the rest of the year. The current backwardation in the gold market and declining COMEX inventories should have the shorts on guard for a potential squeeze as well.

TD: Circling back around to a potential top in the equities markets by way of speculator longs---what internal data are you looking at which brings you to that conclusion?

MM: Well in the equity market you can take the level of margin on the NYSE as a quick view to see the speculators at work currently with borrowed money. Here is a chart illustrating that:

In the gold market, you can look at the outstanding shares on the GLD, the largest gold speculative vehicle, and the COT data from the Comex. Both show that the level of speculative longs are at multi year lows:


TD: Mark you've also spoken towards the idea that there's no new supply of either gold or equities---but that they're simply being  exchanged from one group of people to another at either higher or lower prices (or what some people might call from ‘smart money’ to ‘dumb money’ and vice versa). What are your thoughts there?

MM: I don’t really subscribe to the “smart money, dumb money” idea, but I agree that with relatively little change in net issuance in equities or total gold stock, these assets are just changing hands at different price levels. For every buyer of a stock at new highs, there must be a seller of the same nominal amount of shares, no matter what the new value is. For example, speculator A buys 1000 shares on margin from long term pension fund B at new highs. In the gold market, speculator C might have just sold his stale long position of 1000 ounces equivalent in GLD to long term holder D, an Asian central bank, at the lowest price in several years.

So you could say as a broad assumption currently that longer term investors own gold and short term investors own the equities. History would suggest that investing with the long term holders is a better strategy.

TD: Does that concept (after looking at yesterday’s performance in gold) suggest a sharp reversal is occurring in the gold to equity ratios in your opinion?

MM: I can’t say that by itself means that a sharp reversal is imminent, but from asset allocation perspective I would definitely be decreasing my equity exposure and increasing my gold exposure here considerably with respect to the valuations and speculative positioning.

Sentiment towards gold is clearly of total disgust and the confidence of owning equities is supreme. The media has done a great job on getting gold to exchange at lower prices and equities at higher prices. It often pays well to be contrarian at these extremes. I think yesterday’s price action is a clear sign that the balance of conviction is moving toward the long term holders and the break of $1300 an ounce will have the shorts on the back foot.

TD: What do you think of the numerous media reports recently of gold’s ongoing demise and the calling for much lower prices, even back to $300 an ounce as one writer is forecasting?

MM: I think many people are missing the reason why prices change in the first place and write about gold in isolation. I read recently in the FT that gold was still much higher than its 20 year long term average. With that line of reasoning, most assets are substantially above their long term averages. When I first started in this business in the early 80’s , the Dow was at 1000, oil at $20 a barrel, London real estate traded at 1/20 of today’s prices and my £4000 annual salary was more than adequate for me to live very nicely in central London.

Of course it’s theoretically possible that gold can drop to $300 an ounce but it should be seen in the same context and possibility of the Dow at 1000 etc.

But prices have changed so much because of the growth in the global monetary base. It has expanded far greater than the population over the last 100 years and continues to do so at an aggressive rate. It is this monetary base that backs the values of assets at higher and higher prices. It is not rocket science, it’s just paper currency dilution. All real assets; equities, real estate, art and gold, have most of their price exchange levels dictated by the global monetary base with a speculative cycle overlay. If the monetary base keeps growing, prices will keep going up, period.

TD: Mark, the Hinde Gold Fund has been one of the world's top performing gold funds, for the reason that in 2011, you invested more of the fund in gold bullion rather than in mining equities. Most other gold funds have been smashed by the terrible performance of gold mining equities since.

What was it that you correctly saw at that time which led Hinde to make that decision? Do you still see major problems which disqualify the mining sector?

MM: Well, as a managed long bias gold fund, it has been a difficult time for us too with the gold price dropping almost 40% since August 2011.

But we did make the decision at that time to reduce the mining equity exposure on our clear belief that there was a disconnect on the stated mining companies costs and presumed profit margin and what the real free cash flow was for running a mining company.

In short, these guys were losing money because their costs were greater than their revenue even at $1600 an ounce, two years ago. The huge top line revenue was hiding the higher and higher full-costs of running a mining business. Not the supposed extraction cash costs or even the new standard of all-in sustaining costs---but the full cyclical costs of running a business that for the most part just digs a commodity out of the ground and sells it.

In our analysis the price of gold that will produce a zero number in the current “Free Cash Column” for the whole industry, (i.e. break-even/cash neutrality whatever you call it), is $1750 an ounce. For all the analysts and CEOs who insist that the costs are $1100 an ounce or lower , I would just say why do you keep having negative numbers in free cash flow year after year.

So at $1280 an ounce today, you are producing at a huge loss. Whether this loss comes from your annual write downs or in total extraction, it doesn’t matter. This loss has to come from somewhere and sooner or later it will come from your market capitalisation.

When I read that mining companies are ridiculously cheap mainly because they are down 80% in the last two years---this isn’t a good argument. Sure, when anything is down 80%, they can have a bounce but unless they can cut their costs to actually make a profit, at this gold price they will go out of business. And when you consider that costs are a roughly 1/3 labour, 1/3 power, and 1/3 materials, it’s not going to be easy to [reduce]. Oil is at $106 a barrel and climbing, labour unions are demanding more money and cost of regulation keeps going up.

When gold traded at $800 an ounce in 1980, the cost of extraction was $100 an ounce. So gold traded at eight times its production cost---now that’s a bubble. Today with gold trading at $1300 an ounce and production at $1750 an ounce and climbing, gold is trading at 75% of its production cost, that has never happened. So companies will fail by the hundreds and production will fall dramatically unless the gold price improves quickly.

Personally, I think the companies need to fail and production needs to fall off a cliff before we see the gold price substantially improve.

TD: As a final question Mark, can you tell our readers about the gold in your vaults, your firm, and how our listeners can follow what you're doing?

MM: Hinde Capital has always focused on physical gold being the bedrock of the gold investment. We have a closed custody deposit account with our private Swiss bank who stores the fund’s gold in their vault and we send in an independent auditor every six months to check it. Our website is completely open to read and follow our thoughts.

Unfortunately we see many more years of crisis and instability that is a result of socialist debt policies and today’s monetary policy responses continuing to misallocate capital. It’s not over yet by a long way, I’m afraid.

TD: Mark, thank you for sharing your comments.

MM: My pleasure.


Mark Mahaffey is co-founder of Hinde Capital and co-manager of the Hinde Gold Fund. He has 27 years of experience in the international markets having held senior posts at several leading investment banks. He trained as a fixed-income specialist at Daiwa Securities before joining Midland Montagu as director of the US government trading desk.

In 1990 he jointly set up the Greenwich Capital office in London where he managed a portfolio focusing on global macro themes, before joining IBJI in 2001.

His most recent appointment from 2005 was managing director of Bank of America’s proprietary trading desk in London.


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