By Neil Charnock
News just to hand informs me that Spain is just about to do a “Greece” as their banking system is without funding. In the end this is not about maintaining global growth or the European Union it is about the survival of the financial system as we know it during this major historic transition. Gold is about to go through the roof and not just in Euro terms.
This is also a de-leveraging environment meaning that there is a scramble once again to sell assets and raise capital and gold stocks are temporarily caught in this downdraft. This is the most opportune distortion of fundamental value I have seen since the end of 2008.
The number of highly significant influences and potential disruptions is staggering during this period. These factors will all effect gold, currencies and gold stocks; therefore we need to keep on top of all this to be successful in our investing activities. This is the missing analysis from most simplified gold stock investment tools and models. This is a world of specialization yet one needs to be an all rounder to really flourish in this environment.
We will be moving the more advanced analysis of this nature into a newsletter that will form part of our Gold Membership subscription service as soon as we can. GoldOz is also in a transition due to political proposals afoot in Australia. We will continue to provide useful free snippets and international gold and gold stock coverage in these types of articles for the visitors of this web site.
History does repeat to some degree however the goal posts as influenced by cross currents, policy decisions and the timing of fat tail events present challenge to market participants. The age old axiom of investing is buy low and sell high. This is made more difficult by changing conditions, extreme movements and distortions at this point in time.
One old model used by all global funds and institutions is now broken. This was the concept of the ‘zero risk’ investment for Government debt. Even this is now broken as evidenced by the recent dip in interest rates on some corporate bonds to below the going US 10 year treasury rate. Some of our biggest companies were rated as a lower risk than the US Government. Do not underestimate the significance of this event as it points to further disruption and trouble ahead.
The first thing to understand about this cusp area in the worlds economic history is the balance between the established economies of Japan, Europe and the USA compared to the emerging economies of China, India and Brazil. Although it is estimated that at least a decade remains until the new ‘normality’ equilibrium is reached the effects are already very powerful economic drivers.
This is the area of hope for the world economy and it will continue to emerge and evolve. The growth in these economies has surprised many pundits both before and since the events of 2008. These areas will continue to see greater capital flows and higher living standards. They are likely to manage the developmental risks and challenges as we move forward and this will continue to influence Canada, Australia and Africa as resource supply giants.
The second factor to get straight is the unwinding of the massive debt load in the mature economies. Balance sheet repair is a subject I have been harping on about for a long time now but it goes much deeper. This debt load is carried at Sovereign, State, corporate, small business and personal levels. This influence will be responsible for the most significant changes in policy, growth expectations and living standards we have seen in over 100 years for the established economies. This risk is what our investor clients are avoiding through gold investments.
This is long cycle change which is why so many investors are going to be caught unprepared. These people are looking back at the past ten to thirty years to explain current events without realizing the true significance of the current events.
This de-leveraging phase will cause muted growth in the mature economies for far longer than most investors and policy makers realize. Cost of capital is going up as sovereign default concerns push higher risk weighting by major investors. The de-leveraging will take a long time and have to be managed as it will constrain the availability of loan capital. Crowding out will continue as SME’s and Governments, corporations and individuals line up for new debt.
Unwinding of debt and de-leveraging will at times get disorderly. This can be exacerbated by policy change at times and we face such a time at present in Europe. We currently await the implementation guidelines for such a mega change in the proposed de-merger of the proprietary trading arms of the US banks. As usual the devil may be hiding in the detail or alternately the Obama administration may find the softest possible implementation strategy thereby managing the risk of blowing up the extremely fragile recovery..
Some disorderly economic or even climatic events will be out of the “normal” probability curve; these are referred to as “fat tail” events. Debt which cannot be repaid will have to be monetised which must result in inflation eventually. The search is on for a clean balance sheet that this debt can be shifted to. By default this becomes a search for the least tainted balance sheet as in the example of Germany and the ECB at present.
Gold & Gold Stock Analysis
The fat tail events and distortions are of most interest to gold investors because this is where we will derive and amplify our profits before serious inflation sets in. Take the plunge in the Euro against the USD for instance and the effect this has produced on the Euro price of gold. European gold investors had been left out of gold price rises during times of strength in the Euro but that all came to a sudden end once the local problems really started to bite.
The same opportunity will be realized in each country in turn which will switch new investors into gold. This was mainly a US phenomenon during the early stages of the gold bull, back when the USD had to come down from extreme highs like what we have recently seen for the Euro and the Australian dollar.
Here is look at the effect on the Euro gold price and how well gold acted as a hedge for Europeans during the past six months.
As you see six months ago the two scales on either side of the chart above matched in terms of the price of gold at about 800 Euro and US$1200. This is where the axis were set of course but the point is that gold has not moved in USD terms however it has risen as much as 25% in Euro terms. The recent 1000 point plunge on the Dow is another example of the kind of distortion I refer to.
We have been warning that the AUD would fall and this process has begun as the AUD carry trade unwinds. This is a massively positive distortion for the local price of gold and a powerful influence on the local gold stocks. However the gold stocks are presently weak heading into the last week of May and June as we said they would be.
This is due to de-leveraging and some hang over from Rudd’s Unworkable Super Tax (RUST). There is nothing further to comment on in regard to this proposed tax because the detail is not yet formulated. I am not making a political comment or taking sides here. The current Federal Government has to get re-elected first as well and they have lost a lot of friends in Queensland and Western Australia just for starters.
It is interesting to note the distortions of the AUD: USD ratio and the effect on the AUD gold price because this has been an important medium term influence on our gold stocks.
As you see above the gold rally in both currencies moved in lock step until about April 2007 when currency gyrations began to become more extreme. The relatively poor gold stock behaviour in Australia was obviously influenced by the rise in the AUD which depressed the rise of the locally priced metal. Higher interest rates in Australia had set up ideal conditions for a carry trade creating additional demand for AUD driving it higher. Because we are now heading in the other direction at present it is worth looking at what happened when the AUD fell in the past.
At the end of 2008 the Australian gold stocks made one of their best moves for the entire gold bull to date accompanied by that spike you see for the AUD gold price to nearly $1600 per ounce. This was on a significant fall on the AUD as we are currently seeing. The large gold producers that quadrupled from panic lows in late 2008 did so very quickly because they were wildly profitable at that time. Many of the leading producers have flat lined into a large trading range ever since due to the recent carry trade and ever rising AUD to the 94c level against the USD.
The AUD is currently under US81c as I write this article and the AUD gold price is over $1,470 even with the fall in USD terms. This is once again wildly profitable for our gold miners. Here is the strategy for our offshore investors.
The AUD still has some down side however this is diminishing thanks to deterioration in global economic conditions. This has taken the pressure off our prime rate as the RBA may not have to raise rates more to curb housing prices. Retail is weak and domestic mortgage rates are set to rise even without the RBA moving a muscle. This is because the vacuum created by the exit of the carry trade has removed billions of dollars from the local banking system. The local banks now have to go offshore and bid for more expensive capital for an estimated 50% of their lending requirements.
As we have been warning, and the news on Spain will only increase this problem, the COST OF CAPITAL is rising. This makes our debt analysis on the local gold stocks more important than ever and we will be increasing the focus on this soon. Zero debt and low gearing are becoming more and more attractive.
Heightened risk factoring and the remainder of the unwinding of the carry trade will send the AUD down further making a truly exciting entry point for foreign capital some time soon. If this capital were to find a home in our cheap emerging and established gold producers sector it would set up the best investment opportunity I have seen since October and November 2008. Cheap dollar and cheap oversold gold stocks; it does not get any better than this. It is very close to the perfect time to start layering your gold stock trades Down Under.
When these gold stocks next peak you should be able to take a currency profit and a share investment profit if you get this end of it right. As a contrarian I am now extremely excited about these stocks. I have deployed approximately 30% of my own share investing capital at this stage.
We have just completed our latest version 8 rating table file and included the proportion of onshore production. There is unique analysis provided to make sense of gold stock valuations and tables with all the essential data on the producers. This is available to Gold Members at our site and I hope to see you there so we can assist you if you are interested in this opportunity.
Good trading / investing.
GoldOz has developed a basic Member area (news only) and a Gold Members area with substantial investment tools. GoldOz web site is a growing dynamic resource for investors interested in PGE, silver and gold companies listed in Australia, ASX share quotes, Aussie Gold Index charts, brokers, bullion dealers in addition to the company research via our paid Membership services.
Neil Charnock is not a registered investment advisor. He is an experienced private investor who, in addition to his essay publication offerings, has now assembled a highly experienced panel to assist in the presentation of various research information services. The opinions and statements made in the above publication are the result of extensive research and are believed to be accurate and from reliable sources. The contents are his current opinion only, further more conditions may cause these opinions to change without notice. The insights herein published are made solely for international and educational purposes. The contents in this publication are not to be construed as solicitation or recommendation to be used for formulation of investment decisions in any type of market whatsoever. WARNING share market investment or speculation is a high risk activity. Investors enter such activity at their own risk and must conduct their own due diligence to research and verify all aspects of any investment decision, if necessary seeking competent professional assistance.