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Interesting that Acacia is in play again:
Sibanye confirms it will not make an offer for Acacia
http://www.bdlive.co.za/business/mining/2016/07/28/sibanye-confirms-it-will-not-make-an-offer-for-acacia
Baiyin owns a stake in Sibanye, so why would they support a takeover of Acacia when Banro could be takeover for much less ?
http://www.iol.co.za/business/companies/sibanye-to-acquire-gold-one-assets-1565623
>>
Neal Froneman, Sibanye's chief executive, formerly ran Gold One where he oversaw its acquisition by a Chinese consortium that included Baiyin Non-Ferrous Group, a subsidiary of the CITIC Group, China's biggest state-owned investment company, and the China-Africa Development Fund.
<<
Kevin Jennings use to be the CFO of Acacia when it was known as African Barrick. Wonder where he is going now ?
Axmin Inc (axmif) is a gold stock that is also a value play because it has $2 million/yr gold royalty stream and market cap is only $5 million. Below is my DD summary:
-Market cap is only $5 million and they are now receiving C$2 million/year in royalty income from Teranga Gold:
From the 2016 Q1 report: Royalty income in the amount of $457,259 has been recognized in the three months ended March 31, 2016. Over 4 quarters this works out to nearly $2 million or .013 cents per share. This income is from Teranga Gold's Gora gold mine in West Africa and is a 1.5% NSR on 75,000 oz/yr gold production which is expected to continue for several more years:
http://web.tmxmoney.com/article.php?newsid=82540801&qm_symbol=AXM
There are also additional highly prospective but less advanced exploration properties under a similar 1.5% NSR terms with Teranga Gold that could kick in after the Gora deposit is mined out.
-market cap is currently under C$5 million and this use to be over $100 million in the past. Also Axmin has raised and invested over $100 million into their gold projects all over West and Central Africa:
http://bigcharts.marketwatch.com/advchart/frames/frames.asp?show=&insttype=Stock&symb=AXM&x=60&y=17&time=13&startdate=1%2F4%2F1999&enddate=7%2F23%2F2016&freq=1&compidx=aaaaa%3A0&comptemptext=&comp=none&ma=0&maval=9&uf=0&lf=1&lf2=0&lf3=0&type=2&style=320&size=2&timeFrameToggle=false&compareToToggle=false&indicatorsToggle=false&chartStyleToggle=false&state=8
-Stock was lying dormant and below the radar for a couple of years and is now due for a rerating for the following 2 catalysts:
1)$2 million royalty stream has just kicked in
2)Their flagship gold project is in Central African Republic which is just coming out of a period of strife after having recently had a free and fair presidential election. And the IMF is now supporting the CAR:
http://www.cpifinancial.net/news/category/investments/post/36949/imf-approves-115-8-million-arrangement-for-the-central-african-republic
-Only 130 million shares million shares outstanding with 63% of shares outstanding held by 3 insiders:
http://apps.cnbc.com/view.asp?country=US&uid=stocks/ownership&symbol=AXM-V&country=CA
The 2 biggest shareholders are Chinese and my thinking is that they are looking to sell the project to a Chinese SOE. The third shareholder Jean-Claude Gandur is an European billionaire who sold his African oil company to the Chinese for $6 billion almost 10 years ago and so could also draw on his chinese contacts to help sell the company to them.
-John Embry of Sprott use to like Axmin a lot in the past:
http://www.stockchase.com/company/view/116/0/Axmin-Inc/AXM-X
-There are no plans for further share dilution until they are ready to resume work on their flagship Passendro gold project, thanks to the $2 million/yr royalty income stream. Passendro is a 200,000 oz per year gold mine with a Bankable Feasibility Study already completed. It is currently on hold until they can negotiate a license extension with the Central African Republic (CAR). This is only a matter of time since the CAR just completed what was widely acknowledged to be a fair election for a new president a few months back. Millions of low cost open pit gold oz in the ground must be worth something even in the CAR, with the price of gold headed back to $2000. Axmin is a first mover into the CAR and has invested over $100 million into the country since they first got involved 15 years back to get their Passendro project to this stage.
-The Passendro project was shown to be very robust at US$1100 gold price with a $340 million NPV, 32% IRR and low cash costs of US$484 per oz. Passendro should be worth another C$10 million (or US$7.5 million) right NOW at least would you say ? This should give a no brainer total valuation of 15 cents per share to Axmin today.
http://www.northernminer.com/news/south-african-dealmaker-roach-finds-us-100m-for-struggling-axmin/1000535923/
>>Should the debt and equity financings go ahead as planned, Roach figures Axmin could put Passendro into production by the end of 2013. With production forecast at 205,000 oz. gold over years one to three, and an average of 163,000 oz. gold over an 8.3-year mine life, Passendro’s economics look robust, even assuming a US$1,100 gold price. The recently updated feasibility study considers conventional open-pit mining using an owner-operator mining fleet, and a 2.8-million-tonne-per-year gravity carbon-in-leach process plant. It estimates an internal rate of return of 32%, a net present value of US$340 million using a 5% discount rate and fairly low cash costs of US$484 per oz.<<
Looks like the IFC was/is intending on sponsoring and helping the Passendro project:
https://www.imf.org/external/pubs/ft/scr/2012/cr12240.pdf
>>
Box 1. Strengthening Natural Resource Management1
C.A.R.’s natural mineral resources have not been tapped on a large scale. Mineral exploitation is currently entirely dominated by artisanal production and concentrated mainly on diamond mining and, to a lesser degree, gold. There are proven deposits of diamonds, gold, and uranium. Oil exploration is underway in some parts of the country.
The Passendro Gold Mining Project. Located in the south central region, 170 miles northwest of the capital, Bangui the project features a 25-year mining license covering
137 square miles and two surrounding exploration licenses covering 386 square miles. The total capital costs of the project are expected to be about US$270 million. The International Finance Corporation (IFC) is considering participating in the project with US$50 million equally divided in equity and debt to a Canadian-based company, AXMIN, which has a strong presence in central and western Africa. IFC’s involvement in the development of this gold mining project is consistent with its ongoing engagement in bolstering postconflict reconstruction efforts in C.A.R. The IFC has agreed to play a lead role in coordinating the overall financing package for a group of development finance institutions. The IFC's commitment to arranging this financing package is subject to satisfactory technical, legal and environmental due diligence, execution of acceptable terms and documentation, as well as obtaining final Credit Committee and Executive Board approvals. IFC has already started the process of appraising the project.
Expected Impact. Successful development of the Passendro Project would likely catalyze mineral exploration in C.A.R. and create incentives for other mining companies to explore business opportunities in the country. As the first industrial mine in the country, the project can also establish benchmarks for environmental, social, and community practices, in line with IFC’s Performance Standards. C.A.R. has demonstrated a commitment to extractive industry revenue transparency by attaining EITI compliant status in March 2011. Although revenue flows to the government arising from the project are expected to be moderate, the project will contribute to broadening C.A.R.'s limited revenue base. In addition, the mine is expected to employ between 615 and 670 workers, mainly local hires. The project will generate employment throughout the supply chain as well, an effect which could be magnified with technical assistance from the IFC’s Advisory Services through IFC's linkage programs. It will also support community development initiatives to increase the percentage of locally distributed revenue.
Framework for Natural Resource Management. TA will be provided by the IMF and other organizations to assist the authorities in putting in place legislation that is in line with international best practices and would ensure C.A.R. gets the most out of the exploitation of its natural resources. In particular, the Fiscal Affairs Department of the IMF will provide a desk- based assessment of the mining code and determine further TA needs, based on the conclusions of the assessment.
<<
-As of July 2015 in this country engagement report (CEN), it looks like the IMF is still intending to proceed with their support for passendro project:
http://documents.worldbank.org/curated/en/726401467991967379/text/96209-CEN-P155053-IDA-R2015-0208-IFC-R2015-0212-MIGA-R2015-0059-Box391505B-OUO-9.txt
Also volume was below average which means the market took this news in stride.
Axmin Inc (AXM.V/AXMIF) - Currently trading for PE of under 3:
-From the 2016 Q1 report: Royalty income in the amount of $457,259 has been recognized in the three months ended March 31, 2016. Over 4 quarters this works out to $1.8 million or .013 cents per share. This income is from Teranga Gold's Gora gold mine and is expected to continue for several more years:
http://web.tmxmoney.com/article.php?newsid=82540801&qm_symbol=AXM
-market cap is currently under C$5 million and this use to be over $100 million in the past:
http://bigcharts.marketwatch.com/advchart/frames/frames.asp?show=&insttype=Stock&symb=AXM&x=60&y=17&time=13&startdate=1%2F4%2F1999&enddate=7%2F23%2F2016&freq=1&compidx=aaaaa%3A0&comptemptext=&comp=none&ma=0&maval=9&uf=0&lf=1&lf2=0&lf3=0&type=2&style=320&size=2&timeFrameToggle=false&compareToToggle=false&indicatorsToggle=false&chartStyleToggle=false&state=8
-Only 130 million shares million shares outstanding with 63% held by 3 insiders:
http://apps.cnbc.com/view.asp?country=US&uid=stocks/ownership&symbol=AXM-V&country=CA
The 2 biggest shareholders are Chinese and my thinking is that they are looking to sell the project to a Chinese SOE.
-There are no plans for further share dilution until they are ready to resume work on their flagship Passendro gold project, thanks to the over $1 million/yr royalty income stream. Passendro is a 200,000 oz per year gold mine with a Bankable Feasibility Study already completed. It is currently on hold until they can negotiate a license extension with the Central African Republic (CAR). This is only a matter of time since the CAR just completed what was widely acknowledged to be a fair election for a new president a few months back. Millions of low cost open pit gold oz in the ground must be worth something even in the CAR, with the price of gold headed back to $2000.
-John Embry of Sprott use to like Axmin a lot in the past:
http://www.stockchase.com/company/view/116/0/Axmin-Inc/AXM-X
looks like we are in the process of successfully retesting the breakout around 39-40 cents.
Loncor which is also in the DRC now has 1/5th the market cap of Banro. It is up 10x in the last 5 months. At this rate, in another 5 months they could buy out Banro:
https://finance.yahoo.com/quote/LN.TO
Oh wait, this would give them revenues and earnings and allow the stock to be analyzed by conventional metrics and this would cause the stock to fall.
Don't let the door bang you on the way out!
BAA breaking over the neckline today
https://goldtadise.com/wp-content/uploads/2016/04/baa-4-25.png
TA indicates BAA breakout
https://goldtadise.com/?p=367570
Banro is one of top 3 picks by Cecil Musgrave:
thanks bullforever, I really appreciate your sharing of your analysis of BAA trading.
http://www.bloomberg.com/news/articles/2013-08-20/china-gold-mine-deals-at-record-after-price-plunge-commodities
>>“What is often not understood is that the Chinese approach to metals is strategic and, in the case of gold, also has the added element of being involved in Chinese reserve asset management,” the Gold Council’s Grubb said in an interview.<<
http://www.brookings.edu/research/articles/2014/06/11-whatever-became-china-inc-downs
You are correct to focus on enterprise value and not market cap. But you have lost me on how you came up with BAA valuation being $6/oz. Enterprise value is now $300 million and so has only dropped to 1/3rd the former $900 million:
https://finance.yahoo.com/q/ks?s=baa+Key+Statistics
bullforever, I would agree with your 10 rating IF this leads to Baiyin refinancing the $175 million debt due in March 2017.
Your thoughts make sense. Any share accumulated by stealth at current prices means one less share needing to be purchased at a 5-10x premium a year or two down the road.
From the poster spock on another site:
http://goldtadise.com/wp-content/uploads/2016/02/gold.png
THE PARADIGM SHIFT
-> Posted by Spock @ 1:27 am on February 5, 2016 3 Comments on THE PARADIGM SHIFT
Spock strategy going forward for the PM miners:
1. Always hold a core long positions, no matter what happens, or what anybody “thinks” will happen next.
2. Do not naked short the sector, as surprises will now happen on the upside, not downside
3. Hedge the core long positions when appropriate
4. Take selective profits on the hard runners, but deploy funds back in on pullbacks
5. Buy the pullbacks and dips. Do not short the rallies or “tops”, as you may lose your shirt.
6. Biggest mistake will be holding naked shorts extra-day (overnight). Roadkill.
7. Focus most of trading funds into the PM miners. Fortunes will be made.
The DUST days are gone. Do not even think about it. Look for NUGT setups.
To put this bear market into perspective, its been the second worst bear market in gold stocks in 150 years. 150 years…5 generations. It was the perfect storm for the sector, having been hit by everything from soaring $USD to plunging oil prices to outrageous QE by insane bank-sters, who have now created by their actions another perfect storm in the other paddock. Everything that could possibly go wrong for the PM miner sector did go wrong.
It was exhausted and capitulated on 19th January. That was THE low for $HUI and $XAU and $GDM. Spock has no doubts whatsoever about this, and will now trade accordingly, on that basis.
There are some amazing opportunities now in the gold miners. I sold 11 positions yesterday in US and Canada, and have already re-deployed overnight a good part of the funds already into selected Aus gold miners, where some of the setups are extra-ordinary. The AU:XGD index is about to explode to the upside. I already posted the chart yesterday.
Expect HUI at 200 – 250 range within 5 to 7 months. Based on previous major lows.
Follow what I do. i pulled 7 figures out of the last PM miner bull market. I have no doubts I will do it again. But get in early with me, be confident you are on the right side of the trade now. Long.
There is still remaining the issue of refinancing the $175 million debt that comes due early 2017.
I am supportive of management being cautious here. No point in promoting the stock until all your ducks are lined up for a sustained multi-year move up in share price. Otherwise you are only creating a pump/dump type situation that rewards the penny flippers and shorts.
http://mg.co.za/article/2015-02-20-dealers-fleece-diggers-desperate-for-a-share-of-drcs-illegal-gold
>> A recent study by the Organisation for Economic Co-operation and Development (OECD) on the Mukungwe artisanal gold mine near Bukavu in South Kivu, reports that the mine was heavily militarised for years because local families competing for control of the mine employed FARDC commanders to fight their battles for them.
The notorious warlord Bosco Ntaganda, indicted by the Inter–national Criminal Court in The Hague for war crimes, was paid for terrorising the enemies of the family that hired him in Mukungwe, according to the OECD report.
The report found, thanks to the efforts of the Observatoire gouvernance et paix, a South Kivu-based NGO, Mukungwe has been largely demilitarised.
Mukungwe lies in the permit area of the Banro Corporation, a Toronto-listed industrial gold miner. Banro also mines at nearby Twangiza, where it managed to move diggers from the main pit but the company has not succeeded in doing the same at the Mukungwe site. The policy of the South Kivu government is that the Mukungwe diggers must relocate to another mine, but finding one as productive as Mukungwe has so far proved impossible and the diggers do not want to leave.
The OECD study said diggers called for Banro to buy their gold, but, fearing it will be accused of buying conflict minerals, Banro has resisted doing so.
Despite the tough conditions and the diggers’ precarious livelihoods, they are determined to stay.
“This country is rich,” said one digger. “Why can’t we all profit from it?”<<
Some historical context of the long ongoing conflict at this very rich gold mine:
https://books.google.com/books?id=TvNWCgAAQBAJ&pg=PA50&lpg=PA50&dq=Mukungwe+gold+mine&source=bl&ots=-s-Zt55a7l&sig=KJHVa1kM0ADWM9eECD5tFA2FmuI&hl=en&sa=X&ved=0ahUKEwiSvObgyN7KAhUN8mMKHddvAT0Q6AEIWzAM#v=onepage&q=Mukungwe%20gold%20mine&f=false
Here is a nice article that gives some background on South Kivu gold mines and Mukungwe in particular:
http://www.oecd.org/daf/inv/mne/Gold-Baseline-Study-2.pdf
II.
Mukungwe case study
Mukungwe is situated in South Kivu’s Walungu territory, in the Mushinga groupement of the Ngweshe collectivité
.
Figure 3
.
Mukungwe mine, South Kivu
The mine lies within Banro’s industrial exploitation permit 43. Banro has expressed interest in exploiting Mukungwe’s rich resources industrially but at the time of research had not yet
commenced a full evaluation of the orebody to confirm its viability for industrial mining due to its focus on higher ranking exploration targets at other deposits and
to reduced exploration activities based on the current depressed gold price.
In addition to its artisanal mining population, which numbers up to 10,000, Mukungwe is also one of the most fought over gold mines in South Kivu. The mine was validated in 2012 and certified ‘red’, because of the presence of FARDC and FDLR. As such, Mukungwe may seem an odd choice for a case study of a mine where the OECD D
ue Diligence Guidance could be implemented. Yet Mukungwe has
also been the focus over the past two years of intense efforts by the national and provincial governments and the Congolese NGO
Observatoire Gouvernance et Paix (OGP) to address its problems and
mediate between the parties to the conflict. These efforts have achieved significant results, though reconciliation between
all the parties to its conflict has not yet been achieved. In
addition, an important disagreement that must still be resolved at Mukungwe is that while Banro and the national and provincial governments want artisanal diggers to vacate
the site and relocate to an as yet unidentified ZEA, the diggers want to stay on the mine. Banro states that vacation of the site by diggers would be done following prior consultation with all
stakeholders as per the company’s practice.
Gold has crossed over the 200 dma. It has to stay over this 200 dma on a back test, or else this rally in gold is dead in the water.
GDX was up over 7% today on high volume, so may be the rally in gold has legs.
Volume was only 2/3rd's of avg daily volume, so not impressive at all.
Here is a chart that is supportive of the idea that there has been captitulation in the gold stocks sector as a whole and not just BAA:
http://goldtadise.com/wp-content/uploads/2016/01/xau-to-gold-weekly-1.png
trunkmonk, are you still holding your shares in BAA or are you on the sidelines for now ?
Does Matlack know something about Banro that we don't ?
http://www.kitco.com/commentaries/2016-01-25/Metals-Mining-Analysts-Ratings-Estimates-Juniors.html
He shows Banro earning 9 cents in 2015 and projects it to lose 1 cent in 2016 and 5 cents in 2017. It would have been nice if he provided details on how he arrived at these projections. I don't agree with these loss projections and don't see another miner on his list with comparable potential to Banro.
Anyone think there is another miner on this list that has better upside than Banro ?
wall street/Baystreet is no better. Hopefully Blackrock and Gramercy won't let Banro get bought out for anything under $1 ...
I would think there are Chinese investors who understand how RFW and other Chinese state controlled entities operate and what it means when they get involved in financing a small company with tremendous growth potential such as Banro. There are huge flows of Chinese money going out of China now days in an attempt to preserve purchasing power as the Yuan is devalued. This money will be looking for a home and I am sure a small amount of it would be attracted to an undervalued gold miner that has the financial backing of a Chinese state sponsored entity.
Paper Gold: Utopia for Alchemists by John Hathaway
Senior Portfolio Manager
© Tocqueville Asset Management L.P.
January 7, 2016
http://tocqueville.com/insights/paper-gold-utopia-alchemists
>>
We construe the incapacity of the gold-mining industry to be extremely bullish for future gold prices. Notwithstanding the value destruction that has resulted from the carpet-bombing of investors by equity issuance to finance ill-conceived capital programs, we find many reasons to consider investing selectively in gold-mining equities. There are important exceptions to the sins and shortcomings of the industry at large. Value creation, even if currently unrecognized by the market, is in our view taking place in the form of accretive acquisitions by companies with access to capital and good balance sheets from those forced to sell quality assets to address excessive balance-sheet leverage. In addition, there are new mines that have been under construction for several years that should begin to produce gold, profitable even at current prices, at a time when industry production is shrinking. We believe that they will be sought-after acquisition targets as other producers deplete reserves. Other notable exceptions include companies that are still in good financial condition with attractive assets and positive cash generation. Their equities offer dynamic exposure to the repricing of gold that we regard as inevitable.
<<
An acute shortage of readily marketable physical gold is developing that we believe will deepen in years to come. This possibility seems to be unrecognized by those who are short the gold market through paper contracts. The relentless dumping of synthetic or paper gold contracts since 2011 by speculators in Western financial markets has caused the shortage. The steady selling has driven down the price of physical gold, hobbled the gold-mining industry, and drained the stores of gold held in the vaults of Western financial centers. We believe that the shortage will worsen because (1) the precursors of production (exploration, discovery, reserve life) are very negative, (2) the mining industry has little financial credibility and seems unlikely to attract capital even with a big rise in gold prices, and (3) refining capacity limitations tend to create supply bottlenecks when physical demand spikes.
Therefore, absent any significant and sustained rise in the gold price, we expect few new mines to be built for many, many years to replace depleting and aging mine reserves. In addition, refining capacity should remain static for the foreseeable future. At the same time, the pool of vaulted gold in readily marketable form that supports paper/synthetic gold trading has all but vanished as Asian demand has drained inventories in London and other Western storage complexes.
The seemingly endless supply of notional gold coming from the sellers of synthetic is the strongest explanation for the extended, and in our view overdone, decline in the gold price from peak levels of 2011. Quantities of synthetic gold sold are created out of thin air, with almost no connection to physical metal. The negative investment thesis seems to rest upon confidence that central bankers, and the Fed in particular, will steer a course away from radical monetary experimentation that will return to a normal structure of interest rates and robust economic growth. The fact that these expectations have not been fulfilled in the nearly nine years since the initiation of zero interest rates, notwithstanding the recent 25-basis-point Fed rate hike, leads us to believe that investor credulity in central bankers may be stretched about as far as it can go.
The very popular short exposure in gold is, in our opinion, vulnerable to a trend reversal/mega short squeeze. This would occur if gold ETF assets under management (AUMs) were to rebuild or if holders of COMEX futures were to stand for delivery in a big way. Gold ETF AUMs peaked at 2400 metric tons (“t”) in December 2012 vs. 1300 currently. A 200- or 300-t influx to GLD and other ETFs would put a severe strain on London liquidity, which we estimate to be substantially below 1000 t currently. When and why a trend reversal might occur is a matter of guesswork, but a trend change is inevitable (as in all markets), and the dynamics promise to be powerful. In our view, the short interest in paper gold rests on a credit pyramid that is precarious. When a trend reversal occurs, we expect that machine-driven trading, which is agnostic as to investment fundamentals, will serve as a powerful accelerant to the upside, just as it has led to overshooting on the downside.
The Gold Mining Industry Is Severely Incapacitated
Over the past 10 years, aggregate debt of the gold-mining industry increased from $1 billion to $41 billion. (For purposes of this discussion, all figures refer to the ten largest companies included in the XAU index as a proxy for the industry.) The increase in debt was to fund capital expenditures for mine expansion in the expectation of sustained high gold prices. From 2005 to 2011, the gold price per ounce rose from $429.55 to $1420.78; it averaged $803.60 over that six-year period (numbers from Bloomberg). Managements, investors, and lenders were uniformly bullish as the gold price reached $1900.23 in 2011 amid predictions of a government shutdown in August of that year. Following the 2011 peak, the dollar gold price fell steadily to sub-$1100 levels, a decline of more than 40 percent. The decline has severely undermined industry profitability, added further strain to balance sheets, and raised doubts as to future returns on capital committed to new mining projects.
Equity investor enthusiasm enabled the industry to double share issuance over that 10-year period to fund mine expansion and corporate acquisitions. The incremental return on investment from equity and debt issuance has been highly disappointing. Significant increases in capital have spurred little production growth, and share issuance has severely diluted equity investors. Aggregate profits have fallen from a peak of $14 billion in 2011 to negative $5 billion in 2014. Gold production over that same period rose an estimated 13 percent, from 38 million oz. to 43 million oz., while per-share production declined from .38 oz. to .21 oz., or 45 percent.
Note: Estimated gold production = revenue divided by average gold price
Source: Bloomberg, FactSet
To us, this cumulative and collective misfortune has translated into a loss of credibility and perhaps an inability to raise significant incremental capital for several years to come. In our opinion, it will require a sustained rise of several years in the gold price to attract capital for new mining projects, assuming that such projects even exist in light of the severe reduction in industry exploration expenditures and discovery rates. In the absence of a sustained rise in the gold price, the most likely outlook over the next two to three years in our opinion is for the industry to continue in a survival mode of balance-sheet repair and running in place to remain positioned for a future rise in the gold price.
Future Mine Production Will Begin to Slump
The nuclear winter of the gold-mining industry will have inescapable intermediate to longer-term effects on future mine supply. Financial constraints, investor bearishness, and the ever-lengthening time cycle to build new mines will in our opinion lead to a moderate to severe decline in global gold-mining output before the end of the decade. Discovery of new ore bodies has declined significantly since 2006 (chart below). Without discovery, there can be no new mines. Exploration spending, down about 60 percent from the peak, has been among the prominent casualties of the industry’s hard times.
The requirements for building a new mine go well beyond exploration success, however. The hurdles for permits, social licenses, host-government approvals, engineering and construction, and most importantly, financing, are high and going higher. We believe that the time from discovery to production for all significant new projects is five years, optimistically, and more realistically ten or more years. An added headwind is the seemingly steady trend towards more onerous conditions set by host countries for extractive industries in general, and the seemingly steady erosion of the rule of law in locales once thought to be safe for new investment. At the very least, these trends argue in favor of higher hurdles for new investment.
Note: Gold discovered is based on deposits containing >2 Moz
Source: BMO Capital Markets, Credit Suisse, SNL Financial
Reserve life has fallen to precarious levels, in our view; the lowest in 30 years (chart below). The current estimated mine life of 13 years is calculated on the assumption of a gold price of approximately $1,200/oz. That assumption will most certainly be revised, as required by the SEC, to a lower number following 2015 year-end assessments. Not evident in such calculations is the extent to which the practice of high grading (mining of the highest-grade ore) has further gutted the sustainability of industry production at current levels. We estimate that the industry reserve life would be shortened by one to two years based on an assumption of a $1000 gold price.
Source: Scotiabank
Global mine production for 2015 is expected to reach approximately 3200 t, a very slight increase over 2014. For 2016, we project production to be essentially flat. We believe that the winding down of industry production will be gradual initially, and much more rapid by 2018, reaching a decline of perhaps 25 percent by 2020. A revival of the 10-year complex and arduous process to expand industry production will not occur, our opinion, merely because of a spike in the gold price of 30 to 50 percent from current levels. Many might regard such a spike as a bear market rally to be followed by even lower prices than current lows, based on deeply ingrained bear-market psychology.
We construe the incapacity of the gold-mining industry to be extremely bullish for future gold prices. Notwithstanding the value destruction that has resulted from the carpet-bombing of investors by equity issuance to finance ill-conceived capital programs, we find many reasons to consider investing selectively in gold-mining equities. There are important exceptions to the sins and shortcomings of the industry at large. Value creation, even if currently unrecognized by the market, is in our view taking place in the form of accretive acquisitions by companies with access to capital and good balance sheets from those forced to sell quality assets to address excessive balance-sheet leverage. In addition, there are new mines that have been under construction for several years that should begin to produce gold, profitable even at current prices, at a time when industry production is shrinking. We believe that they will be sought-after acquisition targets as other producers deplete reserves. Other notable exceptions include companies that are still in good financial condition with attractive assets and positive cash generation. Their equities offer dynamic exposure to the repricing of gold that we regard as inevitable.
London Pool of Liquid Gold Is Dry
According to the World Gold Council, the above-ground stock of gold mined throughout history amounted to 183,600 t as of year-end 2014. In theory, because gold never gets used up and can be recycled infinitely, above-ground stocks overwhelm shrinking mine supply as a consideration for predicting future gold prices. We regard this thesis as totally false. All but a small percentage of above-ground gold exists only in illiquid, non-marketable form and cannot influence market prices in the short to intermediate term. Above-ground gold is held in the form of jewelry (50.5 percent), private investments (18.7 percent), government reserves (17.4 percent), and various industrial applications (13.4 percent). Governments have on balance been net buyers of additional reserves; thus, aside from the newly mined and refined gold, additional supply can only come from existing private investments and jewelry recycling. Much of the former has been relocating to Asia, where gold is bought as a strategic long-term holding and is unlikely to be sold in the near to medium term. Some jewelry becomes available when prices rise substantially, but jewelry recycling takes time, effort, and refining capacity. In the past, refining and minting capacity limitations have invariably caused shortages of marketable gold whenever demand spiked.
The pool of liquid, marketable gold that could have an immediate price impact if sold is vaulted mainly in London and to a lesser extent in COMEX warehouses in North America. These supplies have been depleted by Asian demand, which alone exceeds annual mine production. The chart below illustrates this reality: Demand vastly exceeds mine supply. Flows into four nations alone – China, India, Russia, and Turkey (Silk Road) – have often exceeded monthly production in recent years. In addition to these four countries, there is substantial demand from the rest of the world amounting to 2400 metric tons in recent years.
The depletion of marketable physical gold stocks is depicted in the chart below. In 2011 an estimated 9000 t was located in Bank of England or commercial gold vaults. Of this, 5586 t was the property of other central banks, stored (earmarked) at the Bank of England for safekeeping. While this gold can and has been leased to bullion banks for commercial purposes (often for hedging purposes by the mining industry), this practice has diminished significantly in recent years due to compliance and regulatory considerations affecting the practice and behavior of bullion banking. In addition, a heightened sense of counterparty risk has decreased the willingness of central banks to allow their gold to be leased.
Earmarked gold declined from 5586 t in 2011 to 5134 t currently. The residual supply of potentially marketable gold is vaulted in bullion banks (much of it at HSBC for the GLD ETF) and non-bank commercial storage facilities such as Brinks, Malca Amit, etc. It is here that we can see a precipitous drop in liquidity, from 3414 t in 2011 to only 1122 t in 2015. As of 12/7/15, the largest gold ETF, GLD (State Street SPDRS), was backed by 638.4 t, or 56.8 percent of non-official gold vaulted in London. According to the GLD trust prospectus, gold bars that are held in allocated or unallocated form “are the property of the trust and cannot be traded, leased, or loaned under any circumstances.” This leaves only 483.6 t, most of which includes gold held for other gold ETFs, and therefore also not in play. Heavy net export of gold from the UK over the past three years (chart below) is consistent with the view that the pool of gold liquidity is dry.
The picture is similar for gold vaulted in COMEX warehouses. Inventories have dropped by 43 percent since 2011, from slightly below 11,500,000 ounces to 6,446,930 ounces (182.8 metric tons) as of 12/15. The ratio of COMEX open interest to total gold warehoused has held fairly steady, rising from 5.6x in 2011 to 6.1 currently. However, the ratio of gold standing for delivery – the process by which a futures contract can be settled for physical gold rather than cash – rose exponentially into early December and has since fallen significantly but remains at historically high levels:
The standard COMEX response would be that the overwhelming majority of futures contracts are simply rolled over at expiration into a future month or settled in cash. Therefore, the issue of delivery of physical gold rarely comes into play. Even if it does, the process of re-categorizing warehoused gold from registered to eligible for delivery is simple and expedient. In addition, gold can be resupplied by J.P. Morgan, ScotiaMocatta, or other warehouse agents to meet physical demand should the need arise.
On the other hand, the rise in the ratio of open interest to eligible gold is unprecedented. It suggests to us that the idea that COMEX is an intermediary between physical and paper gold is more pretense than reality. The official description of the COMEX market’s raison d’être by CME group states, “Gold futures are hedging tools for commercial producers and users of gold.” There is no mention of high-frequency trading (HFT), which the CME has encouraged and by some estimates accounts for nearly two-thirds of COMEX activity. COMEX, which mirrors much larger-scale paper trading in London and OTC markets, appears to be an arena for speculation in the “idea” of gold, settled in cash, and completely divorced from physical gold. Speculators include macro hedge funds, commodity traders (CTAs), bullion banks (although to a much reduced extent since the failure of MF Global), and central banks.
Some (for example, Princeton Economics) argue that the decline in the price of oil will lead to forced divestment of gold holdings by sovereign wealth funds, estimated by The Wall Street Journal (12/23/15) to manage $7.2 trillion. Many of these funds are located in oil- or commodity-producing nations. However, the same article states, “many of the funds don’t disclose their size, holdings, or investment strategies, making it hard to gauge what risk, if any, they pose to the global financial system.” As to gold holdings, nobody can know for sure. However, based on our first-hand experience, admittedly anecdotal, the investment strategies of sovereign funds are conducted by managers oriented to the Western zeitgeist: They are designed to provide diversification away from commodities in the form of commonplace or exotic instruments that mimic “smart” hedge fund managers in the West. Lack of transparency notwithstanding, we believe that sovereign wealth funds hold very little physical gold.
Synthetic Gold: Mechanics and Plumbing
The volume of paper gold trading dwarfs flows of physical metal. According to the London Bullion Market Association (LBMA), the daily volume of notional metric tons (transfers) traded is 3248. This compares to world daily production of 7.5 t plus recycling supply of 3t for a world daily total of physical supply of 10.5 t. Based on LBMA statistics, the ratio of paper to physical gold traded is therefore 309:1. Even allowing for the fact that some paper trading, as on COMEX, is for normal commercial hedging purposes, the extraordinary discrepancy suggests to us that, as on COMEX, pure speculation, day trading, front running, and other forms of gaming exist on a very large scale.
Most, if not all, paper gold contracts are settled for cash. This explains how and why the disconnect between synthetic and physical gold can persist. It explains how the supply of paper gold can depress the price of physical gold despite the fact that synthetic sellers do not possess any gold to sell. Short sellers of gold do not borrow gold and then sell it. Therefore they do not need to deliver gold to buyers should their speculation on lower prices turn out to have been ill considered. Untethered (it would appear) from the laws of supply and demand, paper gold is a make-believe substance that trades according to rules written by HFTs, macro hedge funds, major banking institutions, and central banks. Of course, this works only so long as the buyers remain willing to settle in cash, rather than ask for actual gold.
The transformation of the structure of the gold market that has taken place over the past few decades in our view mirrors a broader and highly significant characteristic of all present-day financial markets. The capital tied up in hedging and risk insurance seems to overshadow that required for transactions in underlying equities, bonds, and commodities. Derivatives, such as futures contracts, forward contracts, options, warrants, ETFs, and swaps are estimated by Jeff Desjardins of The Money Project to range in size from $630 trillion to $1.2 quadrillion. The link provides a vivid portrayal of the hierarchy of global financial and real assets. Even at the estimated low end, derivatives dwarf underlying values of equities (global stock market value estimated at $70 trillion; global debt market of $199 trillion; gold at $1.8 trillion). Derivatives are contracts between counterparties that derive their value from the performance of an underlying asset, index, or entity. According to Mr. Desjardins,
…banks typically use high amounts of leverage to attain these positions. Some derivatives, such as commodities, are traded on regulated exchanges such as the Chicago Mercantile Exchange (CME). However, the majority of derivatives are traded outside of exchanges between private counterparties, and are called “over the counter” trades.
These positions are often not reflected on bank balance sheets.
Synthetic gold traders appear to share three things in common: no gold, little or nothing in the way of margin requirements, and no knowledge of or interest in the fundamentals of physical supply and demand. In this synthetic world, gold is just another index that can be used by issuers of derivatives and risk managers seeking correlations across asset classes in a quest for risk protection, greater leverage, and trading profits.
The most transparent venue for notional gold trading is COMEX, which mirrors the much larger and more opaque OTC derivatives market. CME, of which COMEX is a division, is similar to other exchanges, such as NASDAQ, NYSE, and BAT, that have gone public in recent years. CME, formerly the Chicago Mercantile Exchange, went public in 2003. HFTs are a major source of income for public exchanges; therefore, their presence is encouraged. Public exchanges provide incentives to high-frequency trading activity by providing superior data packages, and thus the timing advantage that is essential to HFT success. Public exchanges compete heavily for volume from traditional investors by granting rebates on their trading activity. The business rationale of bulking up volume is to provide superior data packages to HFT trading firms, a business activity that public exchanges regard as highly profitable. A vast array of derivatives across all asset classes – including commodities, currencies, bond and equity indexes, volatility (VIX) contracts, Fed fund futures, and more – trade on the CME. Central banks are encouraged to trade through a discounted commission schedule. While central-bank CME and COMEX trading activity and position sizes are difficult to ascertain, we believe their presence to be significant.
The Swiss National bank is perhaps the most transparent of major central banks, but we believe their actions are mirrored by others such as the ECB and Japan. Unconventional central bank assets include exposure to equities of $40.3 billion, or 6.7 percent of the total. Major positions include Facebook, Apple, Amazon, and Google. Under “Investment and Risk Control Process” on the SNB website: “External asset managers are used to obtain efficient access to specific investment categories…. Risk management and limitation is carried out by means of a system of reference portfolios, guidelines and limits.” The website does not discuss whether this is utilized as a convenient venue for currency manipulation or risk limitation, but it is well known that the SNB has been heavily engaged in fixing the price of the Swiss France in order to weaken the currency for the benefit of the export-dominated Swiss economy. It has done so by creating Swiss Francs out of thin air to buy assets denominated in euros or dollars.
While accounting for approximately two-thirds of volume, HFT firms do not show up as any part of open interest. This is because HFT capital is employed strictly to profit from day trading. A frequent complaint voiced by traditional traders on COMEX and other exchanges is that public exchanges cater to those interests above those of traditional investors. Accusations of price stuffing, front running, order spoofing, and other forms of price manipulation are understandable.
HFT tactics, used aggressively, can strengthen a price signal through entry of multiple orders in parallel markets, including public and over-the-counter exchanges. Think of it as the financial equivalent of shock and awe. The notional amount of all HFT orders placed far exceeds the amount that is actually executed. While HFT is directionally agnostic, and is essentially engaged in trend spotting rather than trend enforcing, HFT clients may, and probably do, have an economic interest in affecting price outcomes of indexes, which affects valuation of derivative contracts. HFT firms are tools of these interests.
HFT technology is widely available and understood by HFT clients; therefore, institutions placing orders are most likely well aware of the tactics necessary to achieve desired outcomes. Price manipulation caused by HFT trading would seem to be short-term in nature, as the firms act exclusively as agents and day traders. That cannot be said of the clients who originate the order flow. Flooding a market with fake orders in the real world – for example, copper, oil, gold, or cattle – would quickly become a laughing matter. It is a much easier task to affect the price of cash-settled instruments notionally backed by real underlying assets in rigged exchanges that court hyperactive turnover.
Market depth, critically important to investors…suffers in the world of high-frequency traders. Startling evidence for the lack of robustness in today’s market comes from a 2013 Securities and Exchange Commission report that found order cancellation rates as high as 95-97 percent, a result of high-frequency traders playing their cat-and-mouse game. Market depth is an illusion that fades in the face of real buying and selling (Jonathan Macey and David Swensendec, The New York Times op-ed 12/24/15).
A 12/16/15 letter to the SEC from Norges Bank Investment Management (The Norwegian sovereign wealth fund) states,
In our view, innovation by exchanges in recent years has focused overwhelmingly on latency reduction and on services such as novel order types that tend to benefit market participants with shorter return horizons [their emphasis]…. Trading firms manage [our emphasis] the prices they quote on exchanges to control their risk, and having faster connections to the exchange makes the process easier.
HFT firms are liberally populated by former traders from bank proprietary-trading desks and floor traders who team up with technology providers. The fact that Dodd-Frank regulations prohibit proprietary trading by banks is in our view small assurance that these regulations cannot or have not been circumvented by those institutions in the form of equity ownership in HFT firms or participation in dark pools through off-balance-sheet entities. What this means is that the leverage of bank balance sheets has been transferred to the firms that clear HFT trades. The leverage that was once visible on bank balance sheets may now be disguised as a net position held at a clearing firm. The inherent leverage is opaque and invisible to regulators, but in our opinion it is still in the system, and possibly a source of systemic risk that lingers despite Dodd-Frank.
We believe that market-rigging tactics of which banking institutions have been repeatedly accused – and, in many cases, are legal defendants in actions brought against them – have been disguised but are still widely practiced.
That the banks well knew how to profit from the joint manipulation of financial benchmarks, despite any purported differences in interest between and amongst them on a given day, is confirmed by the fact that this [alleged price manipulation of the London Gold Fix] is just one in a series of such behaviors. Many of the world’s leading banks admitted to manipulating the key LIBOR financial benchmark, including by way of collusion between their respective traders. In the FX markets, many of the world’s leading banks admitted that their traders colluded to move the markets in advance of setting key currency benchmarks (from the complaint filed by Quinn Emanuel on behalf of clients in US District Court, Southern District of New York, Case 14-MD-2548).
Since the failure of MF Global in 2011, COMEX gold open interest dropped from a peak of 650,000 contracts to a range of 370,000 to 450,000. This decline can be seen on the Meridian chart below. Since then, options, both COMEX and the much larger OTC market, have flourished in the form of synthetic futures. The exit of banks from commodity trading since 2011 includes J.P. Morgan (which retained only precious-metals trading), Deutsche Bank, Barclays, and Morgan Stanley (which divested energy-related trading). The exit of banks as counterparties for COMEX traders is a major explanation for the rapid growth of options trading. In the options market, transactions are bilateral and based on the perceived creditworthiness of counterparty balance sheets, similar to credit default swaps. We believe that risk-management practices are unknowable, probably variable, and inscrutable to regulators.
Source: MeridianMacro
OTC options are created out of thin air by market-making shops. There are no size limits and no margin requirements. A 1000-contract lot is the equivalent of 100,000 ounces of gold. Durations of contracts extend up to three years. Position sizes of 40,000 to 50,000 lots, or 4 to 5 million ounces, are not uncommon. Such positions represent the materialization of notional metal – approximately the annual production of major mining entities such as Goldcorp or Newmont Mining – through the stroke of a keyboard. Option positions are considered to be square even if the short exposure is backed by a call option on a gold-exchange-traded fund such as GLD. Hedging a gold short with an exchange-traded product (ETP) from which gold cannot be delivered is but one illustration of the possibility of weak risk-management practices in the OTC options market.
The plumbing and mechanics of the synthetic gold market, in our opinion, are symptomatic of a more generalized preoccupation in the financial markets at large for risk mitigation, and a quest for greater leverage during a market phase where returns have been compressed by an excess of capital. We believe synthetic gold has been co-opted by risk managers and speculators as a convenient, high-capacity instrument to offset bullish bets on financial assets, the US dollar, and ultimately on the success of radical Fed policies. The short exposure to gold that can be easily achieved through the synthetic market would be impossible to achieve in the physical market.
The idea that imaginary financial insurance can provide capital safety is sheer invention; it makes no sense when held up to the light of fundamental analysis. Neither does it survive a basic common-sense test: Buying insurance against a market crash from other market participants is no different than buying a policy against a crash of the insurance industry from an insurance company. It is a movie we have seen before: portfolio insurance in the 1987 market crash, forward hedging of gold by gold-mining companies in the late 1990’s, credit default swaps in the 2007-2008 market meltdown, and most recently the liquidity mismatch between junk bond ETFs and the underlying securities. The idea that downside risk can be eliminated from financial-market exposure is a fantasy that never seems to die. The false sense of security conveyed invites and encourages unwise and speculative levels of leverage that in actuality conflate downside risk when these schemes must be unwound.
Through the alchemy of financial engineering, gold has become an index, a policy lever to transmit information. Digitization of tangible and financial assets in the form of ETPs, derivatives, options, and other paper contracts transfigures real assets into abstractions. As with Fed funds, reverse repo rates, Interest on excess reserves, and LIBOR, the price of gold pings an important signal as to risk, the cost of capital, the state of the financial markets, and economic well-being in general. A weak dollar gold price signals that all is well with the high-risk course set by central planners in the Fed board’s Eccles building. The Federal Reserve sets Fed funds, reverse repos, and interest on excess reserves to the levels that the Federal Open Market Committee (FOMC) deems appropriate. It is hard to imagine that the dollar price of gold has been overlooked by those who believe that they know how to make all the pieces of the puzzle fit together. The declining price of gold affirms the collective beliefs of central planners and mainstream investment managers. For them, a bullish trend in the dollar gold price would send a disturbing signal that the greatest high-wire act in financial history is teetering.
China’s Pro-Gold, Anti-Dollar Strategy
China’s strategic vision for gold is quintessentially anti-synthetic; if successful, it will both erode the international standing of the dollar and elevate that of gold. China wishes to achieve reserve currency status for the renminbi (RMB). In September 2015, Party Secretary Song Xin, president of the China Gold Association (CGA), was a keynote speaker at a seminar discussing gold and its role in internationalizing the RMB. He stated that gold would play a pivotal role in “increasing credit” for renminbi internationalization. The agenda includes “rebuilding the international currency system, balancing American hegemony, and positively displaying the due function of gold and the gold industry” (remarks translated and posted by Koos Jansen on 12/4/15). Attendees included representatives from the government; banking, mining, and gold-investment organizations; jewelry companies; and educational institutions.
In 2014 Song stated,
For China, the strategic mission of gold lies in the support of renminbi internationalization. Gold…forms the base for a currency moving up in the international arena…. That’s why, in order for gold to fulfill its destined mission, we must raise our gold holdings a great deal…we should increase step by step towards 8500 tonnes, more than in the US (Sina Finance, 2014, translation by BullionStar).
In 2012 Song’s CGA predecessor, Sun Zhaoxue, published an article in Oiushi magazine, the main academic journal of the Chinese Communist Party’s Central Committee, stating,
Currently, there are more and more people recognizing that the “gold is useless” story contains too many lies…. Effectively, the rise of the US dollar…and later the euro currency, from a single currency to a global or regional currency was supported by their huge gold reserve…. Individual demand is an important component of China’s gold reserve system…. Practice shows that gold possession by citizens is an effective supplement to national reserves and is very important to national financial security (translation by BullionStar).
The chart below shows that Chinese citizens have heeded the call for gold ownership in a significant way. Movement of physical gold from the Shanghai Gold Exchange (owned by the People’s Bank of China) has risen dramatically since 2012, and has reached a cumulative total of roughly 8000 t since then. All of this movement represents transfers to the private sector, and none of it to official-sector reserves. To put this in perspective, global gold-mining output since 2012 has been a cumulative ~12000 t.
Official-sector purchases are not reflected by SGE statistics. We believe these to have been significant but under-reported. In July, China announced an increase to official gold holdings after 6 years of silence. Koos Jansen of BullionStar estimates that official holdings are now 4000 t, vs. the 1709 t reported. Further, holdings of other official-sector institutions such as SAFE and CIC are not disclosed, but most likely significant. In a departure from its secretive past, the central bank began to announce increments on a monthly basis since July. The step towards transparency might have been motivated by a desire for inclusion of the RMB in the special drawing rights (SDR) basket, a goal recently accomplished. It might also suggest that holdings, both public and private, are now of sufficient size that a higher RMB and dollar gold price would benefit the standing of the RMB for use in the settlement of international transactions for parties wishing to bypass the dollar.
Does the movement towards greater transparency represent a new phase in China’s gold strategy? We believe that the shift from secretive to open is among many signs of a shift to an aggressive anti-dollar stance. The process of devaluing of the RMB against the dollar, which began last August, seems to be gaining momentum. We view this development as destabilizing for the fragile US economy, and for that matter, the global economy as well. “China has paved the way for a further weakening of its currency by announcing changes in how it measures the value of the renminbi, raising investors’ alarm at the prospect a new currency war just as the US prepares to raise interest rates” (FT, 12/12/15).
Over the past 12 months, China has become a net seller of US Treasuries. The chart below shows a pronounced downtrend, a reversal of steady purchases since 2012, and possibly the beginning of a divestment campaign. Such a shift would certainly fit in with China’s weakening balance of trade, public statements about gold, and their goal of internationalizing the RMB. The $31.33 billion drawdown over the past year is a drop in the bucket relative to China’s $1.2 trillion holding, the third-largest after the Fed and the Social Security Fund.
Source: MeridianMacro
While China’s stance regarding the future allocation of their FX reserves to US dollars, gold, or other currencies can only be a matter of speculation, we believe that the handwriting is on the wall. Whatever China’s future allocation of US dollar instruments as a component of reserves turns out to be, we are quite certain that it will be lower. As US fiscal deficits begin to widen, who will step up to buy the $158 billion per year that China had purchased from 2012-2015? We wonder whether the negative implications for the strong dollar/weak gold trade have been taken into account by the highly confident dollar bulls. The most recent Commitments of Traders (COT) speculative positions (chart below) suggest otherwise, and a comeuppance ahead for dollar bulls. “Foreigners are half the Treasury market. If we’ve lost one of the biggest buyers – it doesn’t matter if it’s at auctions or if it’s secondary trading – if we lose them that will be very problematic” (Jim Bianco, Bianco Research, as quoted in Bloomberg Business, 12/29/15).
Source: MeridianMacro
The so-called “strong dollar/weak gold” story seems to be a recurring myth that nicely serves the institutional thirst for risk management and leveraged speculation: “Our cross-asset strategy team forecast persistent strengthening of the USD in 2016, in response to rate hikes…a view that implies downside risk for gold over the same period” (Morgan Stanley Global Metals Playbook, 2015). The two charts below show that the supposedly inverse correlation between the dollar and gold is more myth than reality. The relationship is weak even following the “breakout” of the range-bound DXY index in September 2014. The chart below shows a weak correlation of .341 since then. For the prior 10 years, the relationship was even weaker, at .256. Most dollar bulls view the case in relative terms: “It is the best house in a bad neighborhood,” as the saying goes. Nobody really loves the dollar, but everyone seems unequivocal in their dislike for all other paper currencies. We believe that the flaws of other paper currencies stem directly from the flaws inherent in the dollar, which is to say, unlimited supply.
Catalysts for a Trend Reversal
There are numerous catalysts to trigger a change in direction for gold. These include, but are not limited to, a bear market in financial assets, a downturn in the global economy, continued currency turmoil, and of course, bullish supply-and-demand fundamentals. To this list, one must add geopolitical issues; the headlines speak for themselves. We expect these catalysts to interact and feed on each other.
We have suggested over the past year, here and here, that a bear market in financial assets would lead to a loss of confidence in central bankers and an impulsive, uncontainable rise in the price of gold. To us, the dollar price of gold and confidence in central banking are inversely related.
Since 2012, the Federal Reserve has been engaged in a pre-emptive war against financial risk…pre-emptive central banking refers to monetary action in anticipation of future financial stress to avert a market crash before it starts…. A central bank reaction function is now fully embedded in risk premiums…intervention is more important than fundamentals…. The market has ceased to be an expression of the economy…it is the economy. The purpose of a pre-emptive strike on financial risk is to manipulate market psychology to affect fundamental reality (“Moral Hazard in the Prisoner’s Dilemma,” Christopher Cole of Artemis Capital Management).
Since 2009, strong financial-asset returns and confidence in central banking have become intertwined, in our opinion. Many investors with whom we have met over the past two years with seem to understand the potential downside from reliance on this fragile game of confidence. However, to initiate a position in gold or gold mining stocks is seen as potentially career-threatening at this juncture in part because the confidence game has persisted for so long and in part because adoption of precious-metals exposure is seen as potentially harmful to performance. We therefore believe that the latent demand for the risk protection that gold can provide is vast, and that it will be activated in a reflexive, convulsive fashion when confidence in central banking evaporates.
“The combined expected return on stocks and bonds is the lowest in 100 years.” This comes not from an apocalyptic doomsayer, but from Bob Prince (8/3/15), a leading partner of one of the most successful investment firms of our generation, Bridgewater Associates. Investors are all too aware that 2015 has been a difficult year, with most of the popular investment averages showing modest gains or declines, and most active managers having fallen short even of these disappointing benchmarks.
Still, bullishness persists. Even at this eleventh hour, ten leading investment strategists are forecasting a rising stock market for 2016 and improving corporate earnings (Barron’s, 12/14/15). The ability of central bankers, gullible media, and clueless mainstream investors to ignore the prospect of a spreading global recession by propping up market averages has in our opinion reached the point of exhaustion. There is unseen rot beneath the surface calm depicted by the market averages. “If you own the S&P 500, you were bailed out by a handful of giant companies that masked the pain beneath the surface…. At present, just 28 percent of all NYSE names are in uptrends, or less than 1 in 3 stocks. That’s not a bull market” (Joshua Brown in The Reformed Broker, 12/23/15).
We believe that when clarity returns, the financial markets of recent years will be unmasked to have been a comprehensive manipulation made possible by the alchemy of transforming real assets into hyperactively traded derivatives, ETPs, and financial benchmarks. The process was funded by excessive money-creation of radical central banking. The unprecedented growth of systemic liquidity has outpaced the availability of real assets such as bonds, equities, and commodities to invest in. The financial industry has responded to the need by creating “products” that were several steps removed from the underlying assets and the industry earned substantial fees in so doing. Being disconnected from reality, these “products” have been more easily subjected to price manipulation than the underlying assets, and therefore have served as effective policy levers for central bankers to distort reality to achieve their objectives.
Excessive liquidity-creation by central bank policies has created a dangerous liquidity mismatch. “Exchange-traded products introduce self-reflexivity by creating a highly liquid security (listed stock) that tracks a potentially illiquid underlying instrument (e.g. high-yield bonds, commodity futures)” (again, Cole’s “Prisoner’s Dilemma”). Exchange-traded products hold more than $3 trillion in assets. “There is a concern that the power of the indexes distorts markets over time, and…there is the possibility that the structure of ETFs and index funds worsens market shocks when they happen” (FT, 12/28/15).
Much of what passes for financial wealth is in our opinion imprisoned in a matrix from which there is no easy exit. The return migration of capital to real assets promises to be disruptive. The misdirection of capital could well cause losses for many but opportunity for a few. The list of opportunities is short, limited in capacity, possibly complex, and difficult to access. Among the possible opportunities, gold is accessible and straightforward. Gold has a history of responding inversely to the direction of confidence. Gold ETFs, such as GLD, offer the best attributes of self-reflexivity from a bullish perspective. Outflows from the $3 trillion of equity ETFs seem likely to exacerbate downside market risk. The opposite is true for gold ETFs, which must respond to capital inflows by purchasing physical metal. The pool of liquid gold to meet that need has been severely depleted. We believe that the stage has been set for a significant repricing of gold in all currencies, including the US dollar. Ownership of physical gold outside of the financial system seems to make more sense than ever. Gold-mining equities, which have been severely depressed by the four-year decline in the gold price, should also participate. We believe that a trend reversal could prove explosive for the entire precious metals complex.
John Hathaway
Senior Portfolio Manager
© Tocqueville Asset Management L.P.
January 7, 2016
This article reflects the views of the author as of the date or dates cited and may change at any time. The information should not be construed as investment advice. No representation is made concerning the accuracy of cited data, nor is there any guarantee that any projection, forecast or opinion will be realized.
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Author:
John Hathaway
Golden opportunity? The capital cycle is turning
Merryn Somerset Webb Merryn Somerset Webb
Just as global stock markets were beginning to wobble in late 2007, a fund manager told me over lunch that I was wrong to expect a proper crash.
Instead, he said, share prices at that very moment were so cheap that the market was offering me a once-in-a-generation chance to transform my financial future (in a good way). I should take it.
He was completely wrong of course: 2008 saw a full-blown market collapse (which presumably transformed his own future in a bad way). But nonetheless the phrase “once-in-a-generation chance to transform your financial future” rather stuck with me. I’ve been on the lookout for such an opportunity ever since.
Given what has happened in the first few trading days of the new year, you’ll probably be thinking 2016 isn’t really the year for this kind of thing. It is more likely to be the year when the unsettled scores of the financial crisis come back to haunt markets; when central bankers find they are out of monetary ammunition; and when the post-crisis recovery goes from stall to dive. Best perhaps to step back, hoard cash and hope this crash is quicker than the last.
But what if the opportunity this year is in a sector that has already seen prices fall about as much as it is possible for them to fall without bankruptcy being a certainty?
A few weeks ago I got an email from one of my favourite City old hands Peter Bennett of Walker Crips. This century has so far offered only three “major investment gimmes” (things it is perfectly obvious you must do), he says. Those were to sell ahead of the two big crashes and to buy Japan when the Nikkei hit 8,500 (and was stupidly cheap). But number four may be just ahead of us. It is gold mining shares.
I can hear tittering at the back — particularly as regular readers will know that I have a long-term soft spot for gold. But hear me out. The gold miners have performed abysmally over the past four years. They have underperformed all other sectors and most other commodity stocks. And they have underperformed emerging markets as badly as they did even in their worst days of the late 1990s.
If you do one thing with your money in 2016?.?.?.
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On average they are down about 75 per cent, something that takes them almost back to their lows of the last century and about as far as anything ever goes (the Nasdaq was unusually awful in falling 78 per cent).
This is clearly partly to do with the fall in the price of gold in the last four years. But there’s more to it than that: look back over the last decade and you will see that the while the miners have more than halved, the gold price itself has doubled. The problem? Not the gold price, but, as investment strategist Edward Chancellor succinctly puts it, the fact that most gold mining firms are run by “blithering idiots.”
The industry’s biggest problems are all about management incompetence. Think lousy acquisitions, endlessly awful misallocation of capital and the prevalence of a volume mindset (let’s mine as much gold as we can, whatever it costs) over a moneymaking mind set (let’s dig this stuff up as cheaply as possible so we can sell lots of it on at the highest margin possible).
Look at the total cash flows for the sector and you will see what I mean. Through all the best years of the great gold bull market they were negative: instead of focusing on how they could create conventional shareholder returns, miner managements were pouring cash into new and increasingly expensive production. The average cost of extracting an ounce of gold from the ground rose from $300 in 2000 to $1,200 in 2012. Fool’s gold, indeed.
"Over the past three years, supply has been falling as high-cost mines have begun to shut down (when the price of gold falls substantially below the cost of extraction, even idiots eventually stop digging)"
- Merryn Somerset Webb
In the past you could put most of this idiocy down to the fact that most managers of most gold companies have been gold bugs, say the analysts at Marathon Asset Management. They (like many of their shareholders) want gold not because you can sell it for cash, but for its own “palliative properties” — that way they feel its status as a real asset and a currency in its own right protects them from the coming implosion of the fiat money system. So for them, a gold company should be valued not on how much gold it sells but how much it still has. Think of it as a bit like “owning Procter & Gamble and insisting they produce as much Pantene as possible but hold off actually selling it.”
That’s the bad news. The good is twofold. First, the capital cycle is doing its job in the gold market. Over the past three years, supply has been falling as high-cost mines have begun to shut down (when the price of gold falls substantially below the cost of extraction, even idiots eventually stop digging). And second, there are hints that the industry is beginning to evolve.
Newcrest — one of the lower cost producers — has hired a new chief executive who is starting to normalise the way the firm works. He is focused on costs not ounces, says Marathon — prioritising free cash flows and adjusting management incentives so everyone else does the same. The result? Something radical: Newcrest no longer spends more on digging gold out of the ground than it makes on selling that gold.
Price falls of this kind of volume combined with general revulsion for the sector in question; with a turn in the capital cycle; and with a new management competence are exactly the conditions that create great bull markets. So much so that even some of those expecting huge falls in the wider markets are still keen on gold miners.
Marc Faber (author of the cult newsletter Gloom Boom and Doom) reckons that gold mining is one of the very few sectors around — “probably the only one — that could double and treble in price very quickly”, and UBS is looking for it to bottom this quarter too.
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Are you left feeling this could be the fourth “gimme”? Me too. I think the best funds in sector are the BlackRock Gold and General and the Tocqueville Gold Fund. Marathon holds Newcrest and Mark Faber is an investor in Barrick. I hold (and am topping up) BlackRock. I also hold the metal itself. The story I’ve told you here isn’t about the metal — it’s about the miners. But if wider stock markets crash; if we see a new wave of deflation coming from China; and central banks react to that with more money printing and negative interest rates (the only route they think they have) gold at $1,100 is going to look pretty cheap too.
Merryn Somerset Webb is editor-in-chief of MoneyWeek. The views expressed are personal. merryn@ft.
Deflationary times such as we are in now are a very favorable environment for profitable gold producers. Gold price does well in deflation, but even going sideways would be a relative out performance as the prices of everything else declines. Margins for gold producers will increase while margins for everybody else decrease:
http://www.forbes.com/sites/panosmourdoukoutas/2016/01/10/the-real-reason-behind-the-crash-of-chinese-equities/?utm_campaign=yahootix&partner=yahootix
https://finance.yahoo.com/news/u-crude-oil-prices-drop-005349600.html
How did your brain dead cheerleading work out on AEZS ?
Congo, how do you come up with 20% arbitrage ? Looks an order of magnitude less to me:
TSX closed with bid/ask at 28.5/29.5 cents, last at 29
NYSE close was 20.46/20.90, with last at 20.45
29 cents Canadian * .7084 exchange rate = 20.54 US cents
Interesting post on BAA from another site by a respected poster with a following:
http://rambus1forum.com/wp-content/uploads/2016/01/baa.png
whats hot
-> Posted by Spock @ 6:58 am on January 3, 2016 5 Comments on whats hot
there is a lot of cheap stuff out there. most of it will get cheaper. some of it can be bought now.
this week i am buying back into Richmont Mines (RIC.TO) for a 5% position. The other current positions are as shown, and were purchased last week. I am going to add as and when a buy signal is generated and/or an outstanding candidate is identified.
Whats hot: Banro (BAA or BAA.TO) and Integra (ICG.V). Banro has cut a deal last week with the Chinese in order to realize their extensive resource bank. Currently, the market values their gold resources at about $3 per oz. They have a second mine ramping up and expect positive news this month, regards their second mine reaching steady state commercial operation. Although it has debt on the balance sheet, the Chinese have effectively underwritten the company future. Banro wants to mean revert on the chart and I expect it to get re-rated over coming weeks. I will go on a limb and say its bottomed and in stage 1 basing now.
Integra is now entering a stage 2 uptrend. This is the stock you just have to own. The numbers are compelling. Its an agressive gold development company, sitting on a potential company maker deposit, in elephant country…where you find elephants. The Abitibi greenstone belt in Quebec called “valley of Gold”. It has that name for a reason. Based on current resources, and their fully operational and owned mill, which they acquired for $8 million, and its worth $100 million, the internal rate of return for the mine should be about 77%. Thats based on the current resources, but they have 7 drill rigs on site and will expand this to 10 early next year. Eldorado and Sprott are shareholders.
Here is the current table and positions. The theme is juniors. Not seniors. Stay away from the ETFs. Most of the companies in GDX and many in the GDXJ are zombies or just dogs, like Barrick. Own individual companies of outstanding potential. That is where the big bucks can be made. The theme is also stage 1 and stage 2 companies. Stay away from the stage 4 stuff, as they are still in bear markets. All the ones I have bought are stage 1 and stage 2 as you can see.
Second theme: Forget about what the gold and silver prices are doing. There is so much value now in some of these companies, the metal price is almost irrelevant.
Elections are for Republic of Congo not the DRC