Australian Gold Sector Dynamics
Source: Neil Charnock, GoldOz (3/14/11)
"This is a long-cycle wave—a debt bubble twice the magnitude of 1930."
The great news is that there are always attractive gold stock investments in motion that are capable of generating capital growth. Before I look at some of the key drivers I suggest that all investors need to be aware of monetary history and long-term cycle waves. Anybody that bases their investment decisions on minor pullbacks since 1930 is going to come unstuck. Forget about 1974, 1982, 1987, 1992, the Asian crisis, 2000, the 2008 crisis or any other minor (?) hiccup since 1930 as you formulate your investment strategy for the next 10 or even 20 years.
This is a long cycle wave, a multigenerational change. This is a debt bubble twice the magnitude of 1930. Without this key factor plugged into your investment models you cannot get an appropriate investment strategy. I guess I am mostly 'preaching' to the converted, those willing to look at the situation and or fortunate enough to listen.
Many will not look until it hits them square on, and then they will claim they did not see it coming, which will be sad but true. This crisis has been unfolding over the past 10 years and has not been resolved as this second group have been told. The fundamental flaws are still there, even if time has been bought, the debt bubble is even larger now. The problems are obvious to trained observers however, thanks to masterful spin, smoke and mirrors the general public still has no real idea about the magnitude of what we face. As a result they take risks with asset classes they assume are safe and sound. Many wrong assumptions have been made based on the minor pullbacks in the past 80 years.
To briefly illustrate my point consider the bond markets. We have recently seen rising yields (interest rates) because of increased risk and due to major bond funds are withdrawing from the markets due to risk (e.g., Pimco). Bond investors are demanding higher returns; yields are not rising due to bullish economic conditions. The European Central Bank (ECB) is currently the buyer of last resort providing a secondary market for sovereign bonds that might not otherwise be bought at all. In other words many bond funds and bond investors would not buy this debt at auction if the ECB were not providing a guaranteed exit for this high yield investment class.
Euro nations created the European Financial Stability Facility (EFSF) on the 9th May 2010 for three years in response to crisis in Greece and Ireland. The facility became fully operational on August 4 2010. The ECB were hoping the EFSF would step up and agree to assist with secondary market bond purchases at a meeting on Friday and were disappointed. This is not a good sign or indicator of things to come. Are these sovereign states closer to default now or has the threat receded? If you look to the news you will discover that nothing has changed except time itself. The problem has not gone away. In the event of a sovereign default gold will go through the roof.
Massive central bank bailouts and "unusual measures" are in place to prolong the inevitable so that time can be bought. This is still a banking problem. The strong are positioning themselves and the authorities are desperately trying to put some measures in place to rectify the situation. Default and restructure are inevitable—gold is going to go through the roof and we will see a massive gold stock rally as earnings soar in the sector.
The social and economic shock waves are already beginning; ignore them at your own peril. Unfortunately, most people also underestimate contagion across economic regions and asset classes. This is understandable because we have not seen economic conditions like this in nearly 100 years. Interest rates have to rise and asset prices have to fall. This is the new normal; poor economic growth, upheaval, regulatory restructure and debt default—followed by a long economic rebuild.
So why gold? Never before has the financial sector taken such a disproportionate share of total business activity. Complex financial instruments and games have put the real economy at great risk. The real economy encompasses supply and demand of goods and services, manufacture of goods and supply of services, both to match consumption. The financial sector and money itself were originally intended and designed to facilitate trade and commerce. It was never supposed to be a means to itself to this degree. Yet this has gone on long enough for the average person to consider it all normal. The driver of this obscene and dangerous game was debt. Debt and the financial system got out of control, they are bubbles and you know how bubbles end don't you?
As this monolith implodes and unwinds asset prices will fall, fortunes will be made and lost, interest rates will rise and most people will suffer.
This change is actually already an established trend where the shocks come in waves. They are causing gold and silver to rise and rise. This is not over by a long shot it is just getting started. These issues I write about here are the macroeconomic drivers of the gold bull market and ultimately gold stocks. All the authorities can really do is to rearrange the deck chairs on the Titanic. On the other side of this period in history we will find a greater equilibrium across the global economic system. Now the trick is to protect yourself through the transition phase, hopefully to benefit.
The key price driver for share price upside is liquidity. This liquidity is money flow directed at any given company or sector. It is about buying pressure which overwhelms sellers forcing the share price higher. Buyers need a reason to abandon their natural conservatism and commit funds to any investment. Once they realize gold, silver and gold stocks are one of the few safe havens left they will jump aboard.
Many will jump to cash and lose money gradually as inflation eats away at real returns. Inflation will remain higher than interest rates offered by banks, perhaps throughout the whole crisis because they are rebuilding their balance sheets.
Many favorite asset classes over the past decades will decline—those that depend on credit for purchase in particular. Investors don't weight credit supply in their over simplified shorter term views on real estate for example. You can have all the demand you want but if the banks are overweight domestic property loans and risk is increased due to softer economic conditions, along with a rising cost of capital you soon see property prices cannot remain high. This is simply because borrowers that qualify are fewer and the amount they can borrow is reduced. So they have to pay less.
The situations I describe in the bond market are dire. We face a long-term upward trend in interest rates so investors will continue to exit as best they can. The money has to be invested elsewhere but the question is where do they go? We cover this in depth in the GoldOz newsletters. Sovereign defaults and corporate bankruptcies will cause continued fear and currency instability. This is one of the reasons the central banks have become net buyers after many years on the opposite side of the ledger. The outlook for gold is changing across the savvy end of the investment spectrum and this will drive gold and the stocks ever higher at some point.
All this money creation, the quantitative easing as we call it, creates inflation. The genie is out of the bottle—look at food prices. Gold thrives in this type of environment. The gold market is small so if you think we have seen all the upside think again. As investment and even sovereign funds take a position prices will soar due to the weight of funds entering this small market. Massive amounts of capital compared to its limited size.
A rapidly appreciating gold price can affect many gold stocks at this same time pushing them higher. Fail to do enough homework and you can miss out on gains by buying the wrong stocks. I have generally found that scientific analysis methods work poorly. Measure Enterprise Value and large deposits without greater understanding and you can still end up with underperformers. The numbers don't tell the story they are only part of the story. Buying the cheapest stock can be the worst decision you could possibly make because investors may have been selling it off for all the right reasons.
Liquidity will flow towards stocks that are making progress towards larger deposits, higher earnings, higher production, significant balance sheet improvements or growth through acquisition. It can flow even in negative macroeconomic phases where gold is correcting or consolidating at a given level. Stocks that have been underestimated and undergo such change present the greatest opportunity for capital growth—these are the "five baggers" or better that can multiply your money fivefold in a relatively short space of time.
Consider how long it would take for money in the bank to double. There is still low-hanging fruit in this gold sector it is just harder to find. Significant undervaluation can and does exits and persist over prolonged periods confounding many investors. Only comprehensive work will alert you to the opportunities so the bad news is that it is hard work to achieve stellar gains. Only research that combines undervaluation analysis with experience and then times the entry with heed to internal progress or macro analysis can earn you the gains you seek from this sector.
We are releasing a special GoldOz report to educate investors this week. This also corresponds with a special discount offer on 3-, 6- and 12-month gold membership at GoldOz if anybody is interested just visit our store page for details. Dips like the current one we are experiencing in the gold stocks are fantastic buy opportunities.
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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.