Four Views On Gold And Gold Miners (#gold, #investing, @atyantcapital, @valresproj)

1.) Atyant Capital, “What is gold saying?”:

Gold stocks lead gold and gold leads currencies and currency moves correlate with stocks and bonds. Gold stocks have been declining for two or so years now. This is in part due to unavailability of capital and credit for gold mining projects, but in our assessment, not the whole story. We believe gold stocks are also correctly forecasting lower gold prices.

Long term readers know my gold pricing model puts fair value at $1100 per ounce (Alpha Magazine Aug 24, 2011). So at $1700-$1800, gold was about 60% overvalued, floating on a sea of credit. Gold declining now tells me the sea of credit is receding here and now. This should translate to a higher US Dollar and pressure on asset prices globally.

2.) Value Restoration Project, “Gold miners – Back in the Abyss – An Update“:

Gold mining stocks remain cheap by almost any objective measure.

One way to look at mining stocks is to compare them to the price of gold itself.

Comparing miners to the price of gold itself, show miners are cheaper today than they have been in decades.

[...]

Today, gold appears undervalued relative to the growth in the monetary base that has occurred up to now, and in light of the monetary expansion the Fed and other central banks are currently undertaking, gold appears more undervalued. The Fed’s current quantitative easing program probably won’t be curtailed until households stop deleveraging and the government can handle the rising interest expense on its expanding debt.

Yet, in the face of all this, many gold mining stocks are now selling at valuations that suggest the market has priced in a decline in the price of gold back to 2007 levels, before the Fed began expanding its balance sheet during the financial crisis. Many gold mining stocks are now selling near or below their book value, which is the market’s way of saying that these businesses won’t be able to add shareholder value in the coming years by mining gold and silver. If the price of gold were to decline below $700 or so, it would certainly be the case that most mining companies wouldn’t be able to profitably sell gold. Yet such a decline in gold is the main implied assumption being priced in by the market today, and this has sent valuations of gold mining stocks to their lowest levels since the current bull market began.

3.) Robert Blumen, “What is the key for the price formation of gold?“:

The gold price is set by investor preferences, which cannot be measured directly. But I think that we understand the main factors in the world that influence investor preferences in relation to gold. These factors are the growth rate of money supply, the volume and quality of debt, political uncertainty, confiscation risk, and the attractiveness (or lack thereof) of other possible assets. As individuals filter these events through their own thoughts they form their preferences. But that’s not something that’s measurable.

I suspect that the reason for the emphasis on quantities is that they that can be measured. Measurement is the basis of all science. And if we want our analysis to be rigorous and objective, so the thinking goes, we had better start with numbers and do a very fine job at measuring those numbers accurately. If you are an analyst you have to write a report for your clients, after all they have paid for it, so they have to come up with things that can be measured and the quantity is the only thing that can be measured so they write about quantities.

And in the end this is the problem for gold price analysts, you’re talking about a market in which it’s difficult to really quantify what’s going on. I think that looking at some broad statistical relationships over a period of history, like gold price to money supply, to debt, things like that, might give some idea about where the price is going. Or maybe not, maybe you run into the problem I mentioned about synchronous correlations that are not predictive.

Part of the problem is that statistics work better the more data you have. But we really don’t have a lot of data about how the gold price behaves in relation to other things. The unbacked global floating exchange rate system has never been tried before our time. How many complete bull and bear cycles has the gold/fiat market gone through? My guess is that when we look back we will see that we are now still within the first cycle. Our sample size is one.

[...]

I do think we will have a bubble in gold, although it may take the form of a collapse of the monetary and a return to some form of gold as money in which case, the bubble will not end, it would simply transition over to the new system in which gold would go from being a non-money asset to money.

I have been following this market since the late 90s. I remember reading that gold was in a bubble at every price above 320 dollars. I very much like the writings of William Fleckenstein, an American investment writer. He has pointed out how often you read in the financial media that gold is already in a bubble, a point he quite rightly disputes. Fleckenstein has pointed out that the people who say this did not identify the equity bubble, did not believe that we had a housing bubble, nor have they identified the current genuine bubble, which in the bond market. But now these same people are so good at spotting bubbles that they can tell you that gold is in one.

Most of them did not identify gold as something which was worth buying at the bottom, have never owned a single ounce of gold, have missed the entire move up over the last dozen years, and now that they’re completely out of the market, they smugly tell us for our own good that gold is in a bubble and we should sell.

So, I don’t know that we need to listen to those people and take them very seriously.

4.) valueprax:

I don’t know what the intrinsic value of gold is. I don’t think gold mines are good businesses (on the whole) because they combine rapidly depleting assets with high capital intensitivity and they are constantly acquiring other businesses (mines) sold by liars and dreamers and schemers. And I don’t think this will end well, whatever the case may be. So, I am happy to own a little gold and wait and see what happens.

I wonder what the short interest is on gold miners?

 

The Best Interview On Gold, The Gold Market And Investment Implications I’ve Ever Read (#gold, #economics)

In “What is the key for the price formation of gold?” at GoldSwitzerland.com, SF-based software developer Robert Blumen covers a lot of fascinating and, to my eyes, original ground in an interview with the site’s host.

This has got to be the best interview on the subject of gold in general, the functioning of the gold market and the implications for investors that I’ve ever come across. Blumen not only covers these specific subjects related to gold, but also discusses the Chinese economy, the US economy and the state of monetary and fiscal affairs and even the attitudes of value investors, demonstrating thoughtful familiarity with all he touches. Blumen is well-versed in Austrian economic philosophy and applies this theory to the various practical considerations resulting in surprising new perspectives on common themes.

It’s a long interview and it will only fully reward those determined to dive all the way in. Here’s an excerpt:

There are two different kinds of commodities and we need to understand the price formation process differently for each one. The first one I’m going to call, a consumption commodity and the other type I’m going to call an asset.

A consumption commodity is something that in order to derive the economic value from it, it must be destroyed. This is a case not only for industrial commodities, but also for consumer products. Wheat and cattle, you eat; coal, you burn; and so on. Metals are not destroyed but they’re buried or chemically bonded with other elements making it more difficult to bring them back to the market. Once you turn copper into a pipe and you incorporate it hull of a ship, it’s very costly to bring it back to the market.

People produce these things in order to consume them. For consumption goods, stockpiles are not large. There are, I know, some stockpiles copper and oil, but measured in terms of consumption rates, they consist of days, weeks or a few months.

Now for one moment I ask you to forget about the stockpiles. Then, the only supply that could come to the market would be recent production. And that would be sold to buyers who want to destroy it. Without stockpiles, supply is exactly production and demand is exactly consumption. Under those conditions, the market price regulates the flow of production into consumption.

Now, let’s add the stockpiles back to the picture. With stockpiles, it is possible for consumption to exceed production, for a short time, by drawing down stock piles. Due to the small size of the stocks, this situation is necessarily temporary because stocks will be depleted, or, before that happens, people will see that the stocks are being drawn down and would start to bid the price back up to bring consumption back in line with production.

Now let’s look at assets. An asset is a good that people buy it in order to hold on to it. The value from an asset comes from holding it, not from destroying it. The simplest asset market is one in which there is a fixed quantity that never changes. But it can still be an asset even when there is some production and some consumption. They key to differentiating between consumption and asset is to look at the stock to production ratio. If stocks are quite large in relation to production, then that shows that most of the supply is held. If stocks are small, then supply is consumed.

Let me give you some examples: corporate shares, land, real property. Gold is primarily an asset. It is true that a small amount of gold is produced and a very small amount of gold is destroyed in industrial uses. But the stock to annual production ratio is in the 50 to 100:1 range. Nearly all the gold in the world that has ever been produced since the beginning of time is held in some form.

Even in the case of jewelry, which people purchase for ornamental reasons, gold is still held. It could come back to the market. Every year people sell jewelry off and it gets melted and turned into a different piece of jewelry or coins or bars, depending on where the demand is. James Turk has also pointed out that a lot of what is called jewelry is an investment because in some parts of the world there’s a cultural preference for people to hold savings in coins or bars but in other areas by custom people prefer to hold their portable wealth as bracelets or necklaces. Investment grade jewelry differs from ornamental jewelry in that it has a very small artistic value-added on top of the bullion value of the item.

So, now that I’ve laid out this background, the price of a good in a consumption market goes where it needs to go in order to bring consumption in line with production. In an asset market, consumption and production do not constrain the price. The bidding process is about who has the greatest economic motivation to hold each unit of the good. The pricing process is primarily an auction over the existing stocks of the asset. Whoever values the asset the most will end up owning it, and those who value it less will own something else instead. And that, in in my view, is the way to understand gold price formation.

Many of the people who follow and write about this market look at it as if it were a consumption market and they look at mine supply and industrial fabrication as the drivers of the price as if it were tin, or coal, or wheat. People who look at gold as if it were a consumption market are looking at it the wrong way. But now you can see where the error comes from. In many financial firms gold is in the commodities department, so a commodities analyst gets assigned to write the gold report. If the same guy wrote the report about tin and copper, he might think that gold is just the same as tin and copper. And he starts by looking at mine supply and industrial off-take.

I wonder if more equity analysts or bond analysts were active in the gold area, if they would be more likely to look at it the same way they look at those assets.

 

Videos – Hugh Hendry Visits The Milken Institute (#macro)

Hugh Hendry interviewed in a panel discussion at the 2012 Milken Institute Global Conference

Major take-aways from the interview:

• Global economy is “grossly distorted” by two fixed exchange regimes: the Euro (similar to the gold standard of the 1920s) and the Dollar-Renminbi
• China is attempting to play the role of the “bridge”, just as Germany did in the 1920s, to help the global economy spend its way into recovery
• Two types of leverage: operational and financial; Germany is a country w/ operational leverage; Golden Rule of Operational Leverage, “Never, never countenance having financial leverage”, this explains Germany’s financial prudence and why they’ll reject a transfer union
• Transfer of economic rent in Europe; redistribution of rents within Europe, the trade is short the financial sector, long the export sector
• Heading toward Euro parity w/ the dollar, if not lower; results in profound economic advantage especially for businesses with operational leverage
• “The thing I fear” is confiscation: of client’s assets, my assets; we are 1 year away from true nationalization of French banks
• Theme of US being supplanted as global leader, especially by Chinese, is overwrought
• Why US will not be easily overtaken: when US had its “China moment”, it was on a gold standard…
  • implication, as an entrepreneur, you had one chance– get it right or you’re finished
  • today is a world of mercantilism, money-printing, the  entrepreneur has been devalued because you get a 2nd, 3rd, 4th chance
  • when the US had its emergence on a hard money system, it built foundations which are “rock solid”
  • today, this robust society has restructured debt, restructured the cost of labor, has cleared property at market levels
  • additionally, “God has intervened”, w/ progress in shale oil extraction technology; US paying $2, Europe $10, Asians $14-18
• Dollar is only going to go one way, higher; this is like early 1980/82
• “I haven’t finished Atlas Shrugged, I can’t finish it”: it’s too depressing; it reads like non-fiction, she’s describing the world of today
• The short sale ban was an attack on free thought; people have died in wars for the privilege to stand up and say “The Emperor has no clothes”; banned short selling because truth is unpalatable to political class; the scale and magnitude of the problem is greater than their ability to respond
• We are single digit years away from a most profound market-clearing moment, on the order of 1932 or 1982, where you don’t need smarts, you just need to be long
• Hard-landing scenario in Asia combined w/ recession in Europe would result in “bottoming” process, at which point all you need is courage to go long

Notes – Gary North On Inflation, Deflation And Japan (@DrGaryNorth, #inflation, #deflation, #japan, #money)

The following notes cover Austrian economist Gary North’s views on the chances of inflation and deflation in the US and Japanese monetary systems, derived from a 5-part article series on the subject found at LewRockwell.com:

Why Deflation Is Not Inevitable (Sadly), Part 1: John Exeter’s Mistake

• Fed will attempt to stabilize money supply before hyperinflation; “mass inflation, yes; hyperinflation, no. Then deflation.”
• Deflation will not take place unless the CB stops making new money
• When prices fall, you are richer, but you pay no income tax on your profits (deflation is good)
• Not-money: if you pay a commission to exchange, the asset is not truly liquid
• Gold is a mass inflation hedge, not a deflation hedge
• According to Exter/deflationists, gold is supposedly both an inflation hedge and a deflation hedge– the only asset possessing this virtue
• We have never been able to test Exter’s theory of gold as a hedge against price deflation because there has never been a single year in which CPI has fallen (Q: what did gold price of Yen do in 2009 Japanese CPI decrease?)
• Consumer price indexes should be based upon goods and services that are rapidly consumed; not price of homes and other prices of “markets for dreams”
• Central banks inflate, they do not deflate
• “When housing is bought on the basis of ‘I’ll get rich,’ the market begins to resemble a stock market. When it is bought on the basis of ‘I can live here for what I can rent,’ it is more like the toilet paper market”
• The skyrocketing price of housing under Greenspan was not reflected in the CPI; the collapsing price of housing under Bernanke was not reflected in the CPI
• Consumer prices did not fall during the 2008-09 crisis because the money supply did not fall; if the money supply shrinks, there will be price deflation; watch the monetary statistics

Why Deflation Is Not Inevitable (Sadly), Part 2: The Deflationists’ Myth of Japan

• The money supply shrank in the US 1930-33 (Q: Why did the Fed allow money supply to shrink? Does this weaken North’s argument that the Fed will always inflate rather than deflate going forward?)
• The US and Japan had similar CB policies until late 2008, when the Fed “went berserk”
• Japan’s M2 was mildly inflationary from 1992-2009; CPI was slightly deflationary over the same period of time but never worse than 1% in any 12mo period; prices rose 2% 1997 and 2008
• There has been no systemic price deflation in Japan
• Japan is more Chicago School than Austrian
• Statistical conclusions about Japan:
  • CPI in Japan fell little 1992-2009, no more than 1% per annum
  • BoJ did not inflate the currency to overcome systemic price deflation, because it didn’t exist
  • Collapse of Japanese RE prices did not affect CPI
  • Collapse of Japanese stock market prices did not affect CPI

Why Deflation Is Not Inevitable (Sadly), Part 3: Why Currency Withdrawals Don’t Matter

• The Japanese economy is starting to become price competitive; this will have ramifications higher up the corporate command chain
• Estimates of US currency held outside the United States range from 50-70%
• Rise of credit transactions such as credit cards have minimized the role paper currency plays in everyday transactions
• Currency withdrawals from the banking system which are not later redeposited are deflationary due to the reserve ratio mechanism
• Monetary deflation can occur as a result of deliberate Fed policy:
  • increase legal reserve requirement
  • sell assets
  • allow bank collapse to occur by not funding FDIC with new money to offset withdrawals

Why Deflation Is Not Inevitable (Sadly), Part 4: High Bid Wins

• All economics systems are governed by principles of:
  • supply and demand
  • high bid wins
• The increase in the Fed’s balance sheet (monetary base) has been offset by increase in excess reserves held at banks; thus, no price increases
• Deflationists’ claim: “Commercial banks will not start lending until the recovery is clear. The recovery is a myth. So, banks will not start lending, no matter what the FED does. The largest banks remain over-leveraged. They will not be able to find borrowers at any rate of interest, so the capital markets will collapse (except gold), and then consumer prices will fall.”
• North’s response: “the largest banks are making money hand over fist. It is the local banks that are failing. The FED has done what it was set up to do in 1913: protect the largest banks.”
• Inflationists’ claim: “Commercial banks will start lending when the recovery is clear. The FED will probably not contract the monetary base all the way back to August 2008, because this would bring on another crisis comparable to September 2008. The FED will not risk bankrupting the still highly leveraged megabanks. It will therefore not fully offset the decrease in excess reserves. It will not “wind down” all the way, if at all. Bernanke fears 1930—33 more than anything else. So, the money supply will rise. Prices will follow.”
• “The increase in excess reserves has been voluntary. The bankers are afraid to lend, even to the U.S. Treasury.” (Q: Why are bankers afraid to lend, even to the Treasury?)
• “The FED is in complete control over excess reserves. It pays banks a pittance to maintain these reserves. It is legally authorized to impose fees.”
• Why the Fed maintains its current policy:
  • doesn’t have to sell assets
  • doesn’t have to face rising long-term interest rates due to expanding money supply
  • doesn’t have to worry about collapsing housing market as interest rates go to 25-40%
  • doesn’t face a corporate bond market collapse
• Monitoring money supply changes is key to predicting consumer price increases

Why Deflation Is Not Inevitable (Sadly), Part 5: Conclusion

• J Irving Weiss and his son Martin, recommended 100% T-Bills since 1967; it takes $6400 to buy what $1000 bought in 1967
• Deflationists confuse asset prices with consumer prices
• Deflationists believe low interest rates lead to debt build up but lower ones won’t stabilize; cost of capital can fall to zero and no one will borrow
• This is John Maynard Keynes theory, who therefore recommended the government should borrow and spend to avoid this fate
• There is not a shortage of borrowers today, corporate bond rates are around 6%, not 0%, implying there are people looking to borrow at positive rates of interest
• Capital markets — markets for dreams, priced accordingly
• Consumer prices rise comparably to increases in M1 in the US and M2 in Japan
• Deflationists confuse money (in a bank account) with dreams (imputed asset prices in capital markets)
• At the supermarket, prices are slowly rising in the US and slowly falling in Japan