Aussie Dollar and Gold Stocks
Source: Neil Charnock, GoldOz (5/2/11)
"The rising Aussie dollar is muting gold's shine."
Some offshore investors may be selling down their carry trade positions at present and this is currently muting gold stock rises here. Why not borrow cheap money in Japan, Europe and the US before investing it in a resource economy as strong as Australia? Especially in gold stocks which are gradually being recognized as an amazing investment opportunity. A great move however when the currency appreciates too fast it attaches a down side risk, which is being covered at present. Traders are locking profits because this is what traders do.
To support my argument; Eldorado Gold Corporation and AngloGold Ashanti are the only gold stocks not down here on the ASX as I write this article. This is because the ASX is not their primary listing; we trade the CDI's (Chess Depositary Interests) down here for these two stocks. Does this mean Aussie gold stocks are a "sell" right now? Unless you are a short term trader the answer is no. I shall explain why.
So how extreme is this AUD movement? Bollinger Bands (BB's) measure extreme magnitude divergences of price against the moving average—big moves in other words. This current AUD: USD move is an extreme move, more extreme than we have seen for some time. Even the upper monthly BB of the AUD: USD ratio has been exceeded to the upside by over 2.5c (at C), a feat last reached in October 2007 and only the second monthly close at this extreme end of this magnitude reached in 20 years. Here is a 20 year monthly chart of the AUD: USD ratio:
We saw a 10% pullback after that 2007 event ( at B) as this ratio headed for an important pre-GFC top. This ratio exceeded the top BB two other times to this degree, only intra-month during 2007. In the first half of 2003 we saw three tops above the Monthly BB of nearly 2c (at A) a similar magnitude and a 7.35% correction followed.
At the start of a new month often associated with seasonal negativity (May), and with the AUD: USD at an important psychological level (1.10) it is not surprising that some carry trade capital is being taken off the table. My Educational Portfolio did the same last week just in case we do not immediately break the 8400 double top on the XGD (more for subscribers only). We are also sitting on a range of quality growth oriented gold stocks in the Portfolio ahead of a move in the second half of 2011 in this sector. What is going to drive the move?
Before I have to listen to theories that the AUD and gold might keep moving in lockstep take a look at this chart:
My first point is that is hasn't moved in lock step, well not since late 2005 which all Aussie gold bugs remember with frustration. Before that gold was not really in a bull market in most currencies, it was merely recovering from distorted lows below US$420 caused by central bank selling and Barrick shorting the blazes out of hoards of un-mined gold. They had a very special deal indeed and this whole chapter is well behind us now so I will leave it there. Many other companies had to join the shorting frenzy that added downward pressure to gold and caused major harm to the industry as the positions had to be unwound at much higher prices. But gold only really started to take off with any gusto in late 2005 in Aussie dollar terms and this is at the end of the large black ellipse on the chart provided above.
Once we cleared that first red line A it was off to the races, in fact the larger producers took off in March 2005 well ahead of the AUD gold break out. Since the original launch, we can see a fairly orderly rise of gold in AUD just as we have in most other currencies. Line B was the first level up and you can see that the break to level C preceded a correction back to B, which had now become the new support. This pattern has been repeated ever since.
Line C was reached at the early 2008 high for gold and that would have been the high for a time however then we experienced the GFC distortion. The AUD crashed to US60c so I have not bothered to cover this wild spike; it was an extreme currency distortion, a statistical anomaly.
Line D was the next logical step up based on gold in AUD and at the last level over a year ago we reached AUD$1500 gold (at E) for the first time with gold high in USD as well—a broad gold rally in all currencies is underway. Judging by previous AUD POG consolidation periods this is no longer than the last 3 but you have to take that GFC distortion out of view to see it. The important thing to spot is that after reaching a new undistorted high at E, the old top D has been tested, firstly right to the exact line and then a further test that did not reach as deep.
How Undervalued Are Australian Gold Stocks?
I have written before that the Australian gold sector is undervalued, if you live in Australia the stocks carry less risk in the short term because you hold Aussie dollars. In other words no carry trade risk. The Aussie gold stocks are trading well below levels reached back in 2006; the Producers we track are at 500 today compared to nearly 900 in 2006, a 44% discount to when AUD gold was only $900 per ounce. The Emerging Producers are at 105 compared to 200 in 2006, which is a whopping 47.5% discount, and finally the junios are trading at 52 compared to their later high of 78 in 2007. Need I say anymore these statistics are raw and speak for themselves.
US investors may like to hold off investment in this sector until the AUD sees a short pull back as indicated above. After that I would expect massive currency appreciation by the AUD against the dying USD over the next few years. This will add to stellar investment returns when combined with rising Australian gold stock prices. The story will be different for each currency, however if you time your entry to your currencies exchange rate against the AUD and you will gain a double bonanza profit.
Given the risk on the world's major economies over the coming years I consider this a prudent hedge in addition to an opportunity. As you repatriate your returns at the end of this coming cycle you will be one of the wealthy, but you have to get your research right and select the right stocks—as always, some will fail completely and some will fail to follow through. Speaking of risk I have to ask if things get as dire in the US and Japan as we fear then will the Governments nationalize the domestic gold miners stealing well deserved profits from investors?
Americans will see their gold stocks within the USA earn massive returns in USD terms, which will become less and less valuable offshore. This will be the negative effect of the sinking USD, reducing purchasing power outside the USA in addition to US inflation as all imported goods rise and rise in price. This is a tragedy in the making and I can only hope US citizens can protect themselves in greater and greater numbers.
Now back to Aussie gold stocks. We have to take the uptrend in the AUD price of gold seriously. After a strong move in this chart for over 6 years now it is clear this is a long-term trend and can be trusted. Many of these producers are very profitable at the current levels of circa AUD$1400 gold and at AUD$1300 as well for that matter. Any of these can see upward share price movement on solid organic growth and move against a mild correctional trend at any time.
Most gold stocks are not going to see significant margin pressure if we go back to AUD$1300 POG however their margins would certainly shrink pulling back their share prices. The lower cost producers would be expected to do the best during such a consolidation but it also depends on who has to sell and how heavily exposed they are. Remember that the largest stakes tend to be fairly stable because it is hard to accumulate a position of magnitude. The explorers, small developers and high cost producers would do worst.
Before you think I have decided this is happening right now let me also state that given the Fed speech the other night gold can keep going up here. Continued negative real rates will continue to put a fire under gold. Add a flare up in Europe or the Middle East (take Syria for instance) and we could see a perfect storm merge for gold right now. It could still roar in all currencies taking the US POG straight to US$2000 and the AUD POG up to the next logical step of AUD$1700 gold. Each step so far has seen an AUD$200 POG step up so I consider the trend is clear and intact. Is there any other possible conclusion from this chart?
In this event the XGD and the Aussie gold sector will perform strongly because the market is gradually waking up to what I have been saying for quite some time. The buying under Goldman Sachs nominees and JP Morgan nominees indicates large fund buying—the big boys are getting set for this now—building a large stake. I greatly admire Sprott Asset Management as well and they are doing the same.
This is the only worthwhile game in town. Forget bonds and real estate - no upside potential just downside risk. This is now becoming evident to the general market and I don't want to see investors get burnt. Forget underperforming gold stocks - same story so there is plenty of work to be done here at GoldOz and at your end too for us all to make the best of a really poor situation for the general economy.
At present in May 2011 the US POG (Price of Gold) is going up because of the continued Fed policy to deliberately debase the currency. It is keeping interest rates (Fed only) at super low levels causing negative real interest rates—inflation is higher than current rates. This level of AUD appreciation may not continue against other currencies however it is likely to continue against a slowly dying USD. The point is that gold will rise against all currencies over time as it has for several years to date—the trend is clear. Until fundamentals change the trend will not change.
My conclusion is that there are times where the currency moves can temporarily hurt the Aussie gold stocks and this is currently a testing time for sure. This is an effect right now; potentially with some offshore selling to lock in share price movement combined with AUD strength gives them a double whammy profit bonanza. A quick 10% correction in the AUD would be a great re-entry if you are confident enough to pull this move off. The trend in gold and AUD gold is clear—and the stocks are still drastically undervalued by this metric.
But we are near a break point right now—poised to consolidate further or rise strongly. The May seasonal factor has not worked in the past few years—this is time to watch very closely. The bellwether signal article I produced seems to indicate the stocks here would be inclined to churn or consolidate here for a while before resuming a strong uptrend into the second half of 2011 and beyond. Our Gold Membership is still on special at present if you want to take advantage of our extensive research and back issues of our Newsletter you need to act now.
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.