Falls schon vorher gepostet, sorry... aber sehr interessanter Bericht, darum stelle ich ihn hier (nochmal 
ein:
The Risk To Gold Equities Grows
To: New Orleans Conference
From: Frank Veneroso
December 6, 2004
The following presentation is a write up of the notes I used in making the concluding speech at the November New Orleans conference. As I have been writing these notes up into a full blown text, much that is relevant has transpired, so I have taken the liberty of including some of this to strengthen the presentation I gave that Sunday in New Orleans.
The Big Picture
Last year at this conference I discussed the subject – inflation or deflation ahead. I argued that the current global economic recovery was driven by two locomotives: U.S. consumption and Chinese capital spending. The rest of the world was carried forward by these two locomotives.
I argued that there was something untenable about this recovery. Both locomotives were driven by unsustainable increases in debt relative to income. As long as debt is expanding rapidly, income will grow. But the rising level of indebtedness becomes a huge deflationary weight on economic activity once debt growth seriously slows.
Over the last year we have seen outsized increases in the indebtedness of households in the U.S. and the indebtedness of businesses and households in China. China is moving to slow its debt growth and its economy. The U.S. is not. But debt growth and economic activity have slowed somewhat anyway.
Europe, Japan, Korea, and some other economies recovered only because of the booms in U.S. consumption and Chinese capex. Now that these locomotives have slowed these economies in their train have slowed sharply.
The odds favor that the dynamics of over indebtedness will lead to further slowing in the global economy. The threat of inflation will give way to the threat of serious disinflation and perhaps even deflation.
Somewhere in the midst of all this policy makers around the world will panic. There is too much debt in the U.S., Japan, Korea, China, U.K., and even core Europe for serious disinflation or deflation. Then policy makers will move to unconventional measures, to helicopter money, to deliberate debt confiscation.
The coming shift to disinflation is the background for a serious correction in commodities and gold within the context of a very long bull market. The move to unconventional measures will mark the beginning of the second leg up which will be led by gold.
Introduction
I have been a speaker at this conference for almost a decade now. When gold was moving toward the bottom of its bear market and everyone was wicked bearish on gold, Jim Blanchard and I hatched the idea of the Gold Book which Jim and Brien published. In those days, amid all the gloom at $280 gold, I used to give rousing bullish speeches on the coming bull market in gold.
I am still a long run gold bull. But I now manage a European gold certificate that focuses on investing in small cap undervalued junior golds. We recognize the extreme risks of such an endeavor as junior gold stocks are not exactly seasoned equities. We try to avoid those issues which Doug Casey refers to as “burning matches” – exploration companies with no delineated asset who are burning cash in an effort to find one. But even those juniors with clearly delineated assets are volatile and even can be perishable during periodic downswings that can punctuate an overall gold bull market. For this reason, we have the ability to hedge our risk extensively in order to manage the periodic large price risks that are created by such wide oscillations characteristic of a gold bull market.
Almost everyone at this conference is bullish on gold – a far cry from the environment of years ago. I must say, as a manager of a certificate program focusing on small cap gold equities, I am not a happy camper. The junior golds act horribly. I could never have imagined such poor price action and lack of liquidity this far along in a gold bull market. This, plus all the other things I will talk about to you, will be marked by caution and concern. I am the final speaker at this conference. I hope my transformation from uncompromising bull to concerned long term bull is not too much of a disappointment.
Warning Signs Everywhere
We are long term gold bulls. But gold bull markets experience severe corrections. In the great 1970’s bull market in gold the price of gold corrected by more than 50% from the end of 1974 to 1976. Noted gold analyst, John Doody, has looked at the length of major bull moves in gold since 1971. Based on his analysis the current bull run in gold is slightly longer than any of the prior ones. There is nothing conclusive about this; it does not necessitate an end to the bull run now. But, it stands as a warning that the bull run in gold in recent years is much extended in terms of time.
Over the past several decades oscillations in the price of gold have been correlated with a host of indicators of sentiment and investor positioning. All these indicators are now at great extremes- extremes which have coincided with market tops in the past. Many of the other analysts at this conference like Ian McIvity have documented this better than I can.
Most disturbing is the behavior of the gold equities. A serious divergence between these equities and the dollar price of gold began in October when the price of gold reached the 420 level and the HUI gold stock index reached the 240 level. Since then gold has worked itself higher in dollars. At the same time gold equities failed to make and hold a major new high. More recently, over the last two weeks, the price of gold has worked significantly higher while the gold stock indices have broken down in a rather ominous fashion.
Gold
HUI Amex Gold Bugs Index
It has often been remarked that the gold shares lead the price of gold. We have not been able to statistically document the validity of this claim over long periods of time. But, a cursory examination of the charts over the last decade would suggest that there is some validity to it. To this degree the ominous looking top in the gold stock indices stands as a warning.
What Is Wrong With The Gold Stocks?
We publish a letter to the holders of our gold certificate. We discussed this issue in our last letter to investors. We believe that there has been record hedge fund herding into short dollar future and forward trades. These same speculators have taken on record long positions in gold futures and forwards as another variant of their short dollar trades. The CFTC data shows that the net spec long position in Comex gold futures is slightly below the record peak at the beginning of April just before the break in the gold price. However, we hear from the major dealers that most fund positions today are classified as commercial and not speculative positions. On this bull run in gold the Comex open interest has moved to an all time high, well above April’s peak. We believe this indicates that spec positions on both Comex and the much larger global OTC forward market are also now at record peaks.
We have warned that funds and prop desks that trade in gold futures and forwards are pure momentum players who follow short term trends. They have no investment commitments to any of their markets. When these trends falter they often all try to exit at once and together. This is illustrated in crashes that occurred in silver in April and copper in October. We see something similar but less dramatic in the break in oil that occurred after the peak in October.
Silver
Copper
Oil
For such momentum traders, all poised to exit their market before “the other guy”, liquidity is of the essence. That is why their preferred habitat is the gold futures and forward markets which are among the most liquid in the world and which trade around the clock, allowing instant exit at virtually any point in time.
Gold shares are far less liquid than gold futures and forwards. They also trade only during appointed hours when their respective stock exchanges are open. Large cap gold equities are reasonably liquid. Intermediate cap issues are less so and small cap issues are not liquid at all. Momentum traders cannot afford to touch the latter. There ownership is dominated by true gold investors with a long term time horizon and with a commitment to gold as an asset class.
In our last letter to certificate holders we noted that the smaller the market cap the poorer the performance of gold equities. Most distressing in recent months has been the depressed trading volumes of the small cap shares. This is virtually unprecedented. New highs in the price of gold after an extended bull run have always brought the public into the gold shares. Typically the small cap issues lagged at the beginning of a bull move but became star performers with huge trading volumes once the move became extended. Just the opposite has happened this time. Although some junior gold issues have achieved popularity with investors and have performed well, most of them have been surprising laggards. We have found that new companies with new developments but no real established asset values have tended to be among the better performing issues, while companies that have been around a long time and have established but now familiar assets of real value have been generally neglected. I remember Doug Casey
saying this market only likes “fresh meat”. The fallen angels of yesteryear, even if they now have good assets, often tend to languish. In any case, on average the small companies have underperformed, and, most importantly, trading volumes are well below the levels of late 2003.
Here at the New Orleans conference we probably have the largest number of noted gold analysts. I know many of these analysts well from having attended these conferences for many years. All have been struck by the lack of interest in the junior gold equities. One noted analyst has told me that he posed the question to a large assembly of you attendees: How many of you have bought a gold stock in the last month? Only two raised their hands.
I have found something of a consensus as to why the junior gold equities are doing so poorly. First, the gold companies issued a flood of equity paper in 2003 and 2004. Second, the gold sector is not attracting new followers. Several analysts have stressed, the constituency for gold investing is graying. The attendance today is still the older cohort. Those investors are already fully invested. What buying power they had has been met by the flood of paper issued by the gold companies. Now they are long, under water on their investments, and trapped in issues with poor liquidity.
Others noted that there have been very few exciting new exploration discoveries to ignite new investor interest. I have heard frequent complaints that the new post Bri Ex regulations (43101 etc,) are sapping the money and effort of the juniors and impeding new exploration and mine development.
Many like Billy Murphy find this caution on the part of investors bullish. It would be if these retail investors had cash to put to work, but most appear to be fully committed. This overall situation shares in many respects the characteristics of many equity markets that had an extended bull run that ended in speculative excess. There are technical studies that show that it takes about three years for an equity sub-sector to go from being one of the worse performers to one of the best performers and then another three years to reverse this cycle. Typically, the speculative excess takes the form of a parabolic blow off in prices which surely happened in late 2003 in the minor gold stock sector. During such a parabolic blow off in any equity market there is large new issuance that eventually sates demand, which occurred in the gold sector as well in 2003.
HUI Index
In such speculative blow offs enthusiastic market participants buy, not because of underlying fundamental values and a long term investment objective, but simply because rapid price acceleration creates the allure of instant riches. Many investors get caught holding paper, the fundamentals of which they do not understand. When the correction comes they hope for the inevitable rally to new highs. But enough are chastened that there is very considerable liquidation when the rally comes. This process of distribution is often apparent only in the charts, which show flagging stock price performance even though the original theme associated with the speculative blow off appears intact. Markets like this frequently trace out double tops. When the second rally fails all those who were hoping find their hopes dashed and a serious bear slide often sets in.
The current charts of the gold stocks suggest such a possibility. Of course, everything will depend on the price of gold. We fully understand the bull case. It claims: the U.S. has an unsustainable current account deficit; the dollar will continue to fall; and gold, which has been closely correlated with the euro recently, will continue to rally. Then investors will see in the lagging gold shares value and opportunity and rush in to buy. The gold shares will then catch up to the metal.
This is the reigning consensus among gold investors. It’s what is keeping those investors that are now fully committed, under water and hoping, in the game. Maybe a further rally in gold will bring fresh money to the market and make their hopes become reality. But, under the technical and psychological conditions we have outlined above, the gold shares could be extremely vulnerable if the metal has a significant correction, which is long overdue by many measures.
Gold As A Commodity
What drives the price of gold? First, it has certain commodity dynamics. Investors recognize this. What happens to the price of commodities at large influences the behavior of investors towards gold the metal. From 2001 to 2004 we had a bull run in almost all commodities. Commodities are inherently cyclical – these bull runs do not last forever. In fact, over the very long run, the real prices of commodities tend to oscillate around a declining trend (I want to stress that gold is an important exception to this which is very bullish for the long run).
Grains made decade highs early this year. They have done a roundtrip and are now on five year lows. They remind us that, even though China has a voracious appetite for all commodities, including grains, commodities are inherently cyclical.
Corn
The most important commodity of all is oil. It had a great bull run from after the Iraq War to the end of October. When oil was at its peak gold bulls sighted the long run correlation between the price of oil and the price of gold. The price of gold would rise, they said, because it has been lagging the price of oil. Since its peak oil has fallen and recently it has fallen precipitously. This should be construed as a short run negative for gold.
The global economy is clearly slowing. In the third quarter the economies of Japan, Germany and France slowed to almost zero growth. The U.S. economy has now decelerated to its trend rate. Chinese net imports of many commodities are down. Meanwhile, the supply of many commodities is rising in response to high prices. Though copper has recovered half of its precipitous October decline, an industrial metal like nickel has only stabilized. The history of commodity cycles tells us that, amidst slowing global demand, commodity prices should fall further. This will not be positive for the price of gold. Institutions and individuals allocating funds to commodity baskets will back away. Speculators pushing trends associated with the commodity theme will liquidate their longs. All these commodity trades tend to be somewhat correlated. If this occurs, gold should not go unscathed.
Gold As A Currency
We have noted that there has been a close correlation between gold and the euro recently. Clearly, with oil in decline, the price of gold has been driven largely by the depreciation of the dollar against the major G7 countries currencies. It is very likely that over the short run the price of gold will continue to be influenced by the movements in the dollar. (Someday this will end and gold will rise in all currencies, but probably not now.)
I set out earlier the consensus position: the U.S. has an unsustainable current account deficit, therefore, the dollar must fall. In our last investment letter to certificate holders I discussed this issue in some detail. The economics are complex. But I will address it again.
The key question is, does the U.S. have a large current account deficit because its prices are out of line with its trading partners? If they are – that is, if goods are too expensive to produce in the U.S. relative to the cost of the production of goods abroad – the U.S. will experience a loss of competitiveness, deterioration in its trade, and a large current account deficit.
We can measure this relative competitiveness in terms of purchasing power parity (PPP). Such measures suggest that the U.S. is quite competitive with Europe and Japan. Competitiveness in tradable goods markets with these countries is not the source of its overall current account deficit. And, by the way, account for only about 30% of the U.S. current account deficit.
Based on PPP the U.S. is not competitive with China and many other low wage emerging countries. But neither is Europe and Japan. If there is a competitiveness problem for the U.S., there is also such a problem for Europe and Japan. In the long run the dollar will have to depreciate in real terms against the Chinese yuan and the other emerging market currencies, but it certainty need not against the euro and yen. And it is dollar depreciation against the latter that is now driving the price of gold.
PPP, competitiveness, and the relative prices of tradables are not the only things that cause trade and current account deficits or surpluses. There are differences in economic growth rates. If one country is growing much faster than another it will suck in imports and its trade and current account balance will deteriorate. Studies show that over the short run differences in the growth rates of domestic demand have a far greater impact on trade and current account balances than considerations of competitiveness and relative prices.
The U.S. is growing at almost 4%, which is probably above trend. In the third quarter Germany, France, and Japan had almost no growth. This contributes in a large way to the U.S. current account deficit with these economic blocks. Adjustment is not achieved through changes in exchange rates in such circumstances; it is achieved through a return to trend rates of growth by all parties.
There is another way of looking at this. Current account imbalances simply reflect different savings propensities. The U.S is growing rapidly because its government and consumers have been spending more and more relative to their incomes. Other countries have been growing more slowly because their governments are fiscally constrained and their consumers are cautious and are trying to save more. Viewed from this perspective the U.S. current account imbalance exists because it is the profligate in the world, with virtually no net national savings, whereas Europe and Japan have significant net national savings.
The U.S. is growing at or above trend. It does not want to stop. It allegedly is talking the dollar down in order to reduce its trade deficit which helps its economy at the expense of its trading partners. In effect, it is beggaring its weaker neighbors.
In our last letter to certificate holders I made an error in thinking that U.S. policy makers would stick to decades of multilateral cooperation in this regard and respect the weaker economic situations of its neighbors. Apparently, they are not. The struggling economies of Europe and Japan have been lifted only through improved exports. They see in a weaker dollar a threat to their exports which are already beginning to deteriorate. Further deterioration could put their economic growth rates in the red.
The trend downward in the dollar coupled with an alleged U.S. preference for a weak dollar has created giant bearish bandwagon speculation against the dollar. This speculative selling has displaced the dollar from some economic equilibrium, which by implication is presumably higher. The governments of Europe and Japan keep insisting that the dollar’s decline is out of line with the fundamentals. They keep insisting that the problem is not one of exchange rates and relative prices but rather the huge disparity in savings behavior between the U.S. and themselves. The problem is not solved by dollar devaluation; it is solved by the U.S. restraining its profligacy and returning to a net national savings rate that is both its national and the global historic norm.
It is hard for people to understand that, when savings propensities are so disparate, a large current account deficit can be the reigning market equilibrium even if it is unsustainable in the long run. Let me try to illustrate.
Is the dollar overvalued? Against what? Europe and Japan? The depreciation in the dollar against the euro and yen has had little impact on the U.S. current account so far (though some impact is due, given the lags in trade). Most models suggest something like 70 yen/dollar and 1.80 dollar euro are needed to shave perhaps 1% or 2% off the U.S. current account deficit. Does that make sense? Will a cup of coffee in Milan have to go to $16 for the U.S. to correct its external imbalance?
Now think about this from the point of disparities in savings propensities. Assume a U.S. with a historically normal saving rate. Poof. The current account deficit shrinks, and by a lot. Let the ECB ease and stimulate domestic demand. Poof. The current account deficit shrinks further. Then we don’t need an exchange rate equilibrium with $16 cups of coffee in Milan.
Let me illustrate further.
I had two assistants. One was a total spendthrift. Spent every penny she could borrow, with no concern about how she could service the debt, let alone pay it back. I had another that saved 50% of her after tax income regardless of the yield on her savings. The thrifty assistant in effect lent to the profligate one via the banking system. The short and medium run equilibrium was an unsustainable current deficit between the two. Of course, in the end the game would end. But how? The profligate would stop her deficit spending, that’s how. And then the deficit would have to go away.
Well, that is basically the problem with the U.S. current account deficit. Except Miss Profligacy – the U.S. - won’t accept the cold turkey adjustment of recession.
The U.S. has a recession sized fiscal deficit and zero household savings. That never happened before. In the early 1980’s the household saving rate was 9% when the fiscal deficit was this size. The financial surpluses/deficits of the four economic sectors – households, governments, corporations and rest of the world (current account) – must sum to zero. It’s a waterbed world – push down one sector balance and another will have to go up. How are you going to create a new low U. S. current account deficit if you don’t increase the savings of households and government? Reduce the current account deficit via exchange rate depreciation and thereby add to the rate of corporate free cash flow? It’s already at record levels. The labor share of income is already record low. The current account deficit is not an imbalance that requires $16 cups of coffee in Milan to correct – it requires changes in savings propensities in the U.S. and abroad.
Of course, U.S. dissaving is only one side of the problem. The other is that Asia saves and invests too much. These are simply same coin, two sides. Once investment ratios are so high and the capital stock is export oriented, you can’t adjust costlessly. This is China’s problem. Europe and Japan’s currencies are all right. Given their weak demand patterns they might be overvalued against the dollar. Yes, China and the emerging world must eventually revalue. In the past emerging Asia did it by inflating higher than the U.S. But not now. Because the Chinese investment ratio is crazy high even relative to emerging Asia, she cannot take a large revaluation. The crazy high investment ratio would then no longer be validated and growth would have to go negative.
The U.S. current account deficit is not the global imbalance. It is the outcome of deeper global imbalances – dissaving in the U.S. and overinvestment and over saving in China and elsewhere. Correct those and the U.S. current account deficit falls to a level that is consistent with a non explosive external U.S. debt path. Without $16 cups of coffee in Milan.
When one looks at it this way one can see that as long as the U.S. is Miss Profligacy and Europe and Japan and the emerging world are Miss Thrifty the dollar market equilibrium is higher than the current dollar level and it is only huge speculative shorting that has pushed the dollar down.
This is all economic argumentation about a hugely complex subject. I recognize this and do not want to be dogmatic. But, to look at this more simply, the dollar has declined now for eleven weeks in a row. Measures of sentiment and positioning show an extraordinary oversold. On the long term chart the dollar is at a multi decade low with multiple touch points. Even a rabid dollar bear like Richard Russell has looked at this chart and made the following comment:
“How far can the dollar drop? The dollar, like a stock, can do "anything," but note the strong support in the 80 area. My guess, and it's only a guess, is that the worst we will see ahead, at least for a while, will be a dollar drop to the 80 level. And knocking the dollar down that last 4 points to 80, assuming it gets there, will be difficult. Why? The negative facts about the dollar are too well known, and too many people are now on the negative side of the dollar.”
Dow Theory Letters –Richard’s Remarks, Richard Russell, November 9, 2004
I have never seen a two way market in which virtually every participant thought it was one way. The dollar can only go down. For most markets, when psychology reaches this extreme, everyone is on one side of the boat and the boat is ready to tip. I am not alone in this view. Mark Farber, another rabid dollar bear, has recently put out a letter entitled
Sell US Stocks and Buy the Dollar
-Dr. Marc Faber, December 3, 2004
I want to note that there are exceptions to this in currency markets. When a country, like the U.K. or Thailand, whose relative prices are out of line and therefore has a current account deficit, tries to defend a fixed exchange rate with limited reserves, everyone can be bearish on that currency and be proven correct. But when currencies are floating like dollar/euro and dollar/yen this is much less likely to occur.
But even if the dollar is overdue for a bounce, what would precipitate it?
The European and Japanese policy makers, fearful that dollar weakness will throw their weak economies back into recession, have been pushing the U.S. to engage in coordinated intervention to reverse the speculative positions of the dollar bears. The U.S. has refused. As a consequence anger is rising among these policy makers and it is spreading to encompass the likes of China and other emerging economies. We are hearing strong and angry language on this issue from the U.S.’s trading partners like we have not heard for many many years. Efforts are now being made by these countries toward a very broad coordinated intervention that may exclude the U.S. but may encompass China and many others.
Will such intervention work? The speculators who are short the dollar say no. But the historical record says otherwise. When speculation and the dollar are at extremes intervention works. It turned the dollar down on March 1st, 1985 – the day of the dollar high. It turned the yen down against the dollar on the yen high in 1995. It set in motion the big dollar rally in 1996.
Why does intervention sometimes work? Because speculative bandwagons displace currencies from their short run economically determined equilibria. Speculators are trend followers. If their positions are extreme, intervention, by changing the price trend, can cause speculators to unwind positions en masse.
Speculators in today’s markets are more short term momentum oriented than in the past. Hedge funds are judged by monthly returns. That is why we see so many charts in which prices follow a trend in a very narrow channel. But, once that trend is broken a crash ensues. Look back at those charts of silver, copper, and oil.
If intervention in the currency markets comes and it is successful, even for a while, the odds are that gold, which is itself in such a narrow channel, will break hard. This should not be hard to imagine, as it happened a mere eight months ago.
Conclusion
There is a growing body of evidence – both technical and fundamental – that the gold equities are rolling over and that gold the metal may correct. The latter will, of course, pull down the former.
The key is the disappearing dollar. Years ago when gold was making its multi year bottom and I wrote the Gold Book everyone to a man was positive on the U.S. tech miracle and the dollar. Gold as an asset was universally consigned to the dust bin of history. Today there is a similar universal consensus that is bearish the dollar and bullish gold.
But careful analysis suggests that, whatever the long run outcome for the dollar, it could have a significant rally off multi decade chart support. Even famous dollar bears concede this. Given the ominous technical pattern of gold equities a perfectly typical correction in a gold bull market could create very large price declines in illiquid gold shares.
What would I recommend to you? In our gold certificate program we have reviewed the evidence and are very cautious. We have kept a large Euro cash position. Recently it has outperformed gold shares in euros and is far safer and liquid. We are poised to hedge our certificate index against any significant downside break in gold’s relentless but very narrow uptrending channel.
We are not dogmatic on this point, however. We understand the potential for a greater dollar decline and a catch up move by the gold shares. If the dollar index breaks long term chart support at 80, that could occur. If we judge that will be the case we will increase our gold equity exposure. But markets are all about probabilities, and the probability of a significant perfectly typical correction in the long term bull market that we envision is also significant, so we must exercise some caution and be willing to hedge in order to keep our index intact for a better day.
Is there anything else that would change our position? Yes. In our view the large cap gold shares are fully valued to overvalued on a net asset value basis. More importantly, we regard many of them as wasting assets. Production is depleting their reserves and many of them cannot find new deposits to replace their production. The junior golds have deposits and they are valued cheaply by the marketplace. Because the juniors are cash constrained their deposits tend to have large growth potential. At some point the majors will move to acquire the juniors. That is what we are hoping for. But so far the majors have been restrained. When they eventually do move the juniors will be revalued upward en masse. We are ever watchful for this eventual positive development.
For you the audience I can only recommend what we ourselves do as investors in our certificate program we have deeply undervalued small cap gold shares. That is where the value is in the gold sector. One can buy today huge numbers of ounces cheap. But the junior gold sector has always been an inefficient and volatile market, and it is even more so today. One cannot prudently manage this risky sector without an eye to risk of serious loss and there is clearly a threat of that at the present time.
