Massive Capital Wave Approaches Gold
Source: Neil Charnock, GoldOz (3/29/11)
"Buy these dips; you will thank yourself later if you do."
Generally speaking, the fundamental picture for gold, silver, gold and silver miners around the world has never looked better. Australia is a leading global gold producer and the quarry at the base of Asia so our prospects look better than excellent going forward. Many of our miners are making fantastic progress on plant upgrades and new projects. They have been exploring and working with new vigour over the past decade as conditions improved for the industry.
The gold price has also allowed for balance sheet restructure as debt is retired; it has forced the closure of almost all of the old hedging, exposing the industry to the full upside on future gold price rises. It has stimulated a new range of up and coming companies seeking to produce precious metals. We have world class mineral provinces, not all exploited as yet. These companies possess state of the art technologies that will unearth monster mineral deposits in Australia and offshore and make fortunes for themselves and investors.
We have some world class international miners and a range of world class operators in the smaller stocks down through the ranks. This game is heating up. Conclusion: Local gold sector developments and the global financial climate could not be more positive for the local industry, the Australian-listed gold and silver miners. The only problem is keeping up with the changes in this fluid investment climate.
What Will Drive This Capital Flow?
Gold is looking ready to break out and run strongly yet again as debt markets gear up for another round of trouble. A banking crisis could breakout at any time which is why I am keeping at least one foot in this market at all times. One needs a core position in case we wake up one morning and gold has jumped $40 over night at the launch point of a mega run. Massive amounts of debt have to be rolled over in the next three months; Portugal and Spain have come back into the limelight for all the wrong reasons lately.
The European support package is a ticking time bomb; as it slowly runs out of time there is insufficient time or growth to dig many nations out of trouble. QE2 in the U.S. is to be removed in the next few months along with the protection and support this brings to the markets short term.
The central banks are still buying back gold because this essential reserve asset adds stability to the monetary system. The authorities continue to search for a solution to workable regulation that might stop a repeat of the GFC. They are up against a chronic structural imbalance due to the largest debt bubble in history. Now to a story that illustrates this point perfectly.
News just to hand, the new Irish government has come out fighting on the tough measures and interest rate proposed by the EU on its bailout package. Ireland wants the senior bond holders (such as foreign banks, bond funds and insurance companies) of their embattled banks to share in the pain, take a haircut. These banks have been very heavily reliant on the Irish central bank and the ECB for short term funding in recent months. The Irish government wants / needs a longer term solution that also involves recapitalization; they don’t see that the Irish tax payer should take the whole loss via tough austerity measures including rising taxes which do not produce growth.
Maybe reports are right that this is a political ploy by the Irish government to gain a better medium-term deal from the EU; however, there are other complications. The German public has sent a clear message to Chancellor Angela Merkel that they do not want to continue to bail out Europe. Spain is reported to be building a firewall to protect it from the woes across the border in Portugal. This is starting to sound like "every man for himself" as conditions unravel.
Mismatch of policy, for insurers and the banks, between Basel 3 and European Solvency 2 regulations are also creating issues. Solvency 2 policies make longer maturity bonds more expensive to hold for the insurers (as investors) and yet banks need to issue longer term debt to comply with Basel 3 regulations. Thanks to the withdrawal of mega Funds like Pimco and other large players; liquidity is reduced in the debt markets. Talk of haircuts and default equates to devastating losses for bond investors that have put up real money.
This is a deleveraging cycle as the debt bubble slowly (we hope) deflates. Is there really any hope this will unravel slowly enough to avoid a rush for the exits? There is simply less money in the debt markets, decreasing supply yet demand for debt is increasing. Old debt has to be rolled over and new debt still adds to the load. That’s a serious structural disequilibrium, a delicate balance is required—not a free for all which would result in a crisis very quickly.
Yet rising demand and the more accurate factoring of risk are pushing up yields. Rising yields reduce the value of bonds. This is what we are facing—massive competition for capital and a rising cost of capital. The central banks do not control this type of interest rate rise they only have their own policy to control. Rising rates in this case means rising credit spreads between the CB rates and what investors demand in order to take on the risk of investment.
Geopolitical issues in the Middle East continue to add upward pressure to oil prices and, therefore, inflation. Weather events and drought continue to cause havoc to food prices adding additional inflationary pressure. Everything is perfectly aligned for gold and gold stocks at this point in history. So where are gold stock s right now and are they already overbought? The short answers are; nowhere much and no. Of course, in any liquidity crisis equities normally sell off; so the gold stocks can be subject to short-term selling. If or when this happens, it is time to buy aggressively.
It is a long call to assume that I or any other commentator can predict the exact launch point for gold or the Australian gold sector. I am on record announcing the exact break out for gold on a number of occasions in the past 5 years however this is not to say my record is 100%. It is much easier to analyse short term bounces and pullbacks as achieved in my newsletter on occasion. I can say with certainty that gold is very well supported near these levels and that these gold stocks are undervalued by comparison.
When the HUI rallied in late 2007 into March 2008 the Australian gold sector was selling off. We failed to reach new highs as the ultra-savvy international investors bailed out of Australia. Debt market conditions had deteriorated badly in the second half of 2007 and this increased risk on Australian assets. Funds were liquidating assets ahead of the massive GFC selloff, which saw Australian gold stocks get hammered.
The Australian gold stocks reversed sharply off the 2008 lows and have still not regained the share price levels attained in the highs of May 2006. Many individual stocks have gone on to new highs I am just talking about the sector as a whole. My thesis, based on continued gold price rises, increased earnings and new resource upside is that this sector will reach these old highs at the top of the rally directly ahead of us now. It may not start for a few months and then again who can tell exactly?
Here is the point I am making in visual form—the red circle at the top of this chart is at 200, whereas the current level of the emerging producers is at just 112! The 200 level was the pinnacle of a 12 month rally whereas the current level is sitting toward the middle (or end?) of a consolidation period. Gold topped at US$730 and AUD$960 in March 2006, well below current profitability levels with gold hovering around AUD$1400. Put it another way—gold was AUD$960 with this index at 200 in early 2006 and now with gold at around AUD$1400 we see the index languishing at 112.
We are sitting on a rising support trendline and all this tells me this sector is cheap right now. Our full data base, newsletter updates and other investment tools are for members only. Even deeper research is reserved for our gold members in our educational portfolio, which is developing in real time along with investment rationale for these sorts of investments. I can reveal to you that the only thing holding this gold segment back is sentiment. (Gold membership is currently on special and we have added new payment options in our store. Old clients are still on the database and are entitled to a client loyalty bonus.)
We are currently marching up strongly and only just above that major rising support line marked in red. All three subsector charts at GoldOz, like the one you see in this article are sitting on or near this type of support. They are in the free area of GoldOz. Will the current manifestation of the debt imbalance in Europe drive gold demand sharply higher soon? It did last year when the Greek situation broke out as fears of contagion took hold of sentiment. Gold was very heavily bought in Europe. Imagine what would happen if panic buying took hold in China! Physical demand will spill over into the gold stocks sooner or later it is just a question of timing. This is what we work on as this situation evolves.
The gold stocks in Australia are trading well; from juniors to larger producers I see price behaviour consistent with the beginning, or preliminary stages of a broad rally. I am up sharply this year and the educational portfolio I am detailing in my newsletter is now up nearly 13% in two months using an average of only 1/3rd of the capital. This has been achieved quite comfortably in a flat gold stock environment as the sector gears up for its run. The amount of capital invested here is growing as selected stocks reach safer buy levels. As an educational point I am selecting a range of stocks, techniques and strategies within the portfolio.
If you are not in gold or gold stocks this is a great time to act—do not delay. This is not a time for the faint-hearted. If you are partly or fully invested, do not get shaken out of the quality stocks. Buy these dips; you will thank yourself later if you do. Investors and traders can make great gains even in current market conditions—we are proving this weekly. Keep a close eye on these gold websites for updated intelligence from my peers, most are great thinkers and work hard to bring you their research and technical analysis.
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.