Today's Market Observation 10.26.2009 Mon Tue Wed Thu Fri Allison Archive
Mainstream Logic
by Tony Allison | october 26, 2009
Now that gold has topped $1,000 per ounce and is garnering some public attention, the mainstream media figures that this lofty price means that the gold “bubble” is ready to burst, and return to its proper (i.e., lower) price level. Fortune Magazine recently published “Beware the Gold Bubble” emphasizing the fundamentals point to an end of the “gold fever”.
It is interesting that Fortune looks at gold like any stock or commodity, with similar supply and demand characteristics. But gold is just gold, a substance that has been a store of value for thousands of years. Its worth is measured against paper currencies, which have no intrinsic value and can be created at will in unlimited quantities.
Purchasing power comparison
A bubble would indicate a wild over-valuation, but look at the fundamentals of the relationship between gold and the dollar since 1971, when the link between the two was severed by the Nixon administration. The dollar’s purchasing power is down 5 fold since 1971. Your 2009 US dollar is worth a pitiful 20 cents in purchasing power compared to a 1971 dollar. That’s one reason why the middle class can’t keep up, why they are more and more in debt up to their eyeballs. The purchasing power of an ounce of gold however, is four times greater than 1971.
Hat tip to Mike Hewitt at DollarDaze.org
Global currency debasement
Given that the dollar’s value has shrunk by 80% since 1971, why would $1,000 per oz. be considered an “overheated” amount? The mainstream media always thinks in terms of dollars, and always assumes that a dollar today is the same as it ever was.
It’s not just dollars that are consistently losing value, but other currencies as well. Since the global financial crisis of 2008, governments around the globe are just getting started in earnest in depreciating their currencies through printing well in excess of their growth rates.
The US government admits to projections of trillion dollar deficits for the next ten years (which means the situation is probably worse than that). That money will get printed. It must, or the game is over. What do you think the US dollar purchasing power chart will look like in 2019?
Given time, more and more people will discover that the extraordinary acceleration in fiat money creation will accelerate the decline in their purchasing power as well. Where will those people go to stem the bleeding as they struggle to retain their purchasing power (and lifestyle) in a shaky currency?
Demand fundamentals
On top of a rapid decline in purchasing power in the dollar, the current zero-interest-rate climate adds to gold’s favorable fundamentals. As savers scramble for paltry 1-2% short term yields, they are taxed on those yields twice, first as income, secondly through inflation. Taken together, this makes the meager return a losing investment in an already depreciating currency. Opportunity costs for holding gold as an investment have never been more favorable.
Fortune quoted gold analyst Jon Nadler who sees “some of the poorest fundamentals I’ve seen in the market for a long time.” Nadler has been top-calling gold for years, without much success. He prefers to view gold as a momentum-driven commodity like any other, as opposed to a global currency substitute that is not consumed like a commodity. Investor demand is what drives the price of gold higher. Demand is driven by factors such as money supply growth rates, real interest rates, fiscal deficits and confidence in a country’s fiat currency. Both individuals and nations (particularly creditor nations) around the world are beginning to understand the dangers of only holding a depreciating currency.
Not a sensible core holding?
According to Rob Arnott in the Fortune article, “gold is not a sensible core holding”. Arnott favors regular commodities over gold. Gold may not be “sensible” enough for Wall Street because they can’t print it, securitize it, or bundle it into a bogus derivative instrument. But for those who have enough common sense to understand that paper dollars will continue to buy less and less in future years, then gold seems not only sensible, but indispensible (for a portion of one’s net worth).
Every market corrects and consolidates and gold is no exception. Gold could certainly correct lower, as it has many times. We may even get another deleveraging “wave” as in 2008, which would likely strengthen the dollar and depress gold. If so, the patient investor should stay calm and use this temporary event as a buying opportunity. But to say gold is a bubble ready to burst is laughable (unless it’s a manipulated Nymex take-down by JP Morgan, which would likely be brief and not be driven by fundamentals). Additionally, a bubble usually requires frothy public participation, while gold is barely on the public radar screen at this point.
Supply growth since 1971
The Fortune article speaks of unfavorable supply and demand issues for gold. Gold’s supply has only increased 1.8 times since 1971, while the US dollar supply is up nearly 17 times. Furthermore, US dollar supply is now accelerating to meet unprecedented debt service and budget deficit needs.
Supply Fold-Increase since 1971 |
Change in Unit Value (%) |
|
Gold |
1.8 |
310.4 |
CHF |
3.8 |
-23.7 |
JPY |
15.9 |
-25.4 |
USD |
16.8 |
-81.1 |
CAD |
15.4 |
-84.4 |
AUD |
33.5 |
-88.2 |
GBP |
12.6 |
-88.3 |
Source: DollarDaze.org
Supply Dynamics
The article points toward increasing gold supply as having a fundamentally negative effect on the gold price. “Kitco predicts that new mining will add 450 tons annually, or 5%, to the gold supply through 2014, enough to move prices lower.” What they fail to consider is the depleting nature of the current large deposits and the difficulty in replacing those reserves. Kinross CEO Tye Burt was recently quoted at a conference on this issue.
“We may be in the midst of a perfect storm in terms of price and industry dynamics. The gold industry is facing a crisis of declining reserves as investor demand outpaces supply. Globally production has been in decline since the peak of 81 million ounces in 2001 to 77 million ounces last year, and we see that decline continuing long term.”
Low hanging fruit is gone
Mark Davis, writing for BNW News Wire, makes the case for limited gold supply downstream.
“Only a tiny handful of huge gold discoveries have been made worldwide in the last decade, which experts say is because virtually all the juiciest low-hanging fruit has been picked some time ago. All this new reality promises to help edge bullion prices increasingly higher.
The scarcity of world-class gold discoveries is already taking a toll on the mining industry’s bottom line. Global gold output has been dwindling by nearly 5% per annum since it peaked in 2001, even though bullion’s spot price has more than tripled since then.
An even more pronounced downtrend can be seen in North America. This is where output has dropped over the last decade from 17.06 million ounces in 1998 to 10.59 million ounces in 2008.
According to Mickey Fulp, a geologist and exploration analyst with over 30 years experience all over the world, ‘geologists are running out of virgin geological terrain that is prospective for the discovery of giant outcropping ore bodies. Much of the earth has already been trod many times by exploration geologists.’
Consider the fact that the world’s top trio of producers (Barrick Gold, Anglogold Ashanti and Newmont Mining) each generate between 5 to 8 million ounces of gold per annum. That means that at least one new multi-million ounce deposit needs to come on-stream every year just to replace this output. This isn’t happening.
Moreover, the advent of $1,000 plus gold prices still won’t speed up 3-7 year mine development timelines, ones that invariably involve time-consuming regulatory hurdles.”
David Einhorn on gold and the dollar
David Einhorn of Greenlight Capital had some insightful comments on gold and the dollar as keynote speaker at the recent Value Investing Congress. His firm has made significant purchases of physical gold in recent months.
“I have seen many people debate whether gold is a bet on inflation or deflation. As I see it, it is neither. Gold does well when monetary and fiscal policies are poor and does poorly when they appear sensible. Gold did very well during the Great Depression when FDR debased the currency. It did well again in the money printing 1970’s, but collapsed in response to Paul Volcker’s austerity. It ultimately made a bottom around 2001 when the excitement about our future budget surpluses peaked.
When I watch Chairman Bernanke, Secretary Geithner and Mr. Summers on TV, read speeches written by the Fed Governors, observe the “stimulus” black hole, and think about our short-termism and lack of fiscal discipline and political will, my instinct is to want to short the dollar. But then I look at the other major currencies. The Euro, the Yen and the British Pound might be worse. So, I conclude that picking one of these currencies is like choosing my favorite dental procedure. And I decide holding gold is better than holding cash, especially now, where both earn no yield.”
Beware the bond bubble
Despite the repeated application of mainstream media logic, gold does not appear to fit the classic bubble profile. However, there is a bubble to be concerned about, and one massively larger in scope; the US Treasury bond. Trillion dollar US deficits and 3.5% 10-year Treasury bond yields will not co-exist forever, at least if you want foreign investors (who currently own nearly half our outstanding T-bonds). For now, the bond bubble just continues to inflate. How long must we wait for Fortune to expose that can of worms?
Quote of the day:
Today Congress is constantly besieged by [special interest] groups seeking benefits from the public treasury. Often these groups control enough votes in many Congressional districts to change the outcome of elections. And so Congressmen find it difficult to persuade themselves not to give in to pressure groups. With no bad immediate consequence it becomes expedient to accede to a spending demand. The Treasury is seemingly inexhaustible. Besides, the unorganized taxpayers back home may not notice this particular expenditure, and so it goes …
The Hon. Howard H. Buffett
The Commercial and Financial Chronicle
June 5, 1948
Today’s Markets
A strengthening dollar and worries about an overheated market pounded stocks on Monday. Shares started the day higher but turned sharply lower at midmorning as interest rates rose and a rebound in the value of the dollar stalled a rally in commodities. Early gains in prices for oil and other commodities had pushed up shares of energy and materials companies.
The Dow fell 104.22, or 1.1 percent, to 9,867.96. The broader Standard & Poor's 500 index fell 12.65, or 1.2 percent, to 1,066.95. The S&P, which is the basis for many mutual funds, is down 2.8 percent from its recent peak a week ago. The Nasdaq fell 12.62, or 0.6 percent, to 2,141.85.
Oil for December delivery fell $1.82, or 2.3%, to $78.68 a barrel by the close of floor trading in New York. The contract had earlier reached a high of $81.59 in electronic trading on Globex.
Gold futures ended lower Monday, part of a broad decline in commodities, as the U.S. dollar advanced on fresh worries about the financial sector. December gold futures Monday fell $13.60, or 1.3%, to $1,042.8 an ounce at the close of floor trading in New York.
Wishing you a good evening,
Tony Allison
Registered Representative
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