It's All Better Now
Source: Neil Charnock, GoldOz (5/13/10)
The European rescue package is not a done deal—there are all kinds of caveats to clear first.
The European rescue package is not a done deal, as there are all kinds of caveats to clear first. Markets have appeared unconvinced this will either happen or actually help at all in the longer-term. Economic rules that control inflation are out the window and confidence in the euro is hitting very low levels, providing a powerful uplift to gold. There is talk of the weaker nations being evicted from the euro, and talk of the stronger ones leaving to save their own hide. None of this is good for confidence in European economic output or the currency. There is also the strong sense of futility; they might be able to borrow, but may not be able to repay the debt, leaving the system even more exposed to default in the future.
Gold is now the only alternative to the USD, and I know which one I trust more. Of course there has to be a place for currencies in the current system, so I don't think the USD is finished at this stage. China will sell euros, as it will need less of them for exchange purposes in that depressed area. What will it buy but a mixture of other currencies and gold? The interesting thing is that we now have the USD standing as the default paper currency for international funds and banks.
Gold could be approaching overbought levels shortly and might take a brief pause, or it may continue the current sharp rise higher. Nobody can tell at present because of emerging fundamental events and the accompanying spin from the authorities and vested parties. Markets do take note of even numbers and spot gold nudged very close to $1,250 yesterday, which makes this a higher-risk trade at present.
Is this an important test for gold? The breakout is real; however we probably have to test the former resistance ($1210) at some point soon. I now favor a choppy ride on gold for a few weeks as we sort through the profit-taking and establish some price support around these levels from $1,200–$1,300.
There is still deleveraging in the stock markets, property, Europe and the AUD as the global credit stranglehold starts to tighten. Credit crises are a slow-motion force, and very powerful. They unfold slowly, creating a creeping gradual negative. Banks and funds have to lighten up in order to adjust reserve ratios, so bouts of selling are a certainty over the coming months. This will include stocks and potentially even gold, which could be the catalyst to bring us back to test the former resistance level.
The unwinding on the AUD is also real and has been starting to unravel over the past month, as previously predicted and discussed. This has been affecting our gold stocks (along with our Super Profits Resource Tax proposal) and this carry trade closure may well continue as an influence for the next several weeks or months. The resultant capital outflows are mainly affecting credit markets down here and lending has stopped almost completely, but we are not alone. I am hearing the situation is very similar in the U.S. and Europe.
We had a positive jobs figure out today adding some speculative support for the Australian dollar; however, I think this support will quickly be overrun by global issues and capital flows. The outlook for China is softening and any bad news on this front will lead to an anticipated and real decline in the Australian economy. This will also make some of the assumptions made in the Australian 2010 Budget this week look very shaky.
As we specialize in the gold stocks here, we have to consider any effect on this sector our prime concern. The XGD rose another 2.2% today after rising 4.73% yesterday, making it the outstanding sector this week. I prefer to show you a more balanced view than the weighted XGD, so here is an unweighted chart of 20 emerging gold producing companies. This can enable you to more accurately assess how inexpensive these stocks are. The resources tax is overdone now, considering we have AUD gold at $1,373.
So we are in a mixed environment for investment in the gold stocks Down Under, however, they are cheap, especially when you factor in the gold and AUD trends. The Resource Super Tax is seen as a 'maybe,' and unacceptable to the industry. The government is now in 'consultation' with the industry. Investors in this sector are rightly annoyed, and experienced unnecessary losses.
Our leading gold producer assessed the tax as having a 3%–8% negative effect on their NPV, depending on the detail. The good news is that this has been factored into share prices across the XGD here already. At GoldOz, we forge ahead with the knowledge that gold will remain incredibly important in the months and years ahead. This means the gold stocks we cover will be essential to any portfolio, too.
Following is the long-term chart of the AUD gold price. Compare this to the previous chart to see where relative valuations are. So what can you see, and what do you think?
It all comes down to your entry point on these stocks and the foreign exchange rate at the time you either bring in funds or repatriate them back to your home location.
Global Economic Comment
"It's all better now," now that we have thrown some more money at Greece and hope the problems will go away. The central banks are obviously worried about the financial fire spreading to the U.S., Japan, UK, Spain, Portugal, Italy and even China. So they have come up with another massive debt plan for Europe to fix the unwinding of the debt bubble (wow). Does that sound logical, or is this just another measure to buy time? But now we can get back to a rally; the U.S. is OK, we won't see any contagion and the banks are in great shape—ha, ha.
Does this sound like a load of piffle to you? I can assure you dear reader, with the greatest respect to anybody who wants to believe differently, it does to me. Somebody has to pay! The giant omission is that we don't have any plan to repay the debt. The elephant is standing in the room and as hard as some people try to not see it, the more it just stays there.
The debt can get transferred onto another part of the balance sheet as many times as you like, but this one fact remains—it has to be repaid. It does not matter how you spin it either, because the problem is not gone. It will not go away by adding fuel to the fire or through the use of spin any time soon. We face the largest debt bubble in known history. It has to burst, and dire consequences will be made worse by excessive stalling.
There is a glaring problem not being addressed, and that is that Greece is going to take years or even decades to repair itself. This makes for an interesting example of a situation in play that many countries will have to face. Somehow we have to absorb much higher interest rates and raise additional taxes to reduce unsustainable deficits in a zero-to-negative growth environment. What sort of a bad joke is this?
Higher taxes and reduced spending are required to reduce deficits, and this will hit growth. Higher sovereign interest rates, which are rising due to a renewed factoring of sovereign risk, will hit disposable income for governments further which will also impact growth.
Course of Action—Own Gold and Gold Stocks
This will depend on your location and currency positions. AUDs can be safely deployed now and in the coming few months, if careful selection of the stock is made (obviously). Offshore investors who want to buy excellent value in zero-debt cash-positive gold producers have to assess the Forex situation.
Their question will be whether or not the AUD can fall faster than the gold stocks rise, and if this will reduce their returns. Perhaps the pullback to test the old resistance in the gold price will be a better opportunity for them. I still look to the July timeframe (approximately) for this event.
I am working on the new version of the GoldOz Ratings Tables, and this time I am including special analysis on the ASX-listed gold producers and their offshore projects. This is necessary due to the proposed tax, along with additional weighting on debt due to the increasing cost of capital. This is a trend, and we are adding a great deal of analysis on debt markets for readers and clients alike because of the importance in this for your financial survival.
Good trading / investing.
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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.