Gold Outlook 2010: Gold Resuming its Historical Monetary Role – as the Anti-Currency

Monday, January 11th, 2010

Keynote Speech Presented by Nick Barisheff at the Empire Club’s 16th Annual Investment Outlook Luncheon

Thursday January 7, 2010

To download the PDF version of this article, click here.

Good afternoon. As always, it is a privilege to speak at the Empire Club.

Each year for the past three years, I have returned to share perceptions about the precious metals industry and specifically about gold. Generally, this forces me to step back and assess the previous year’s events and then to speculate about what they may indicate for the coming year. Choosing the seminal events this year has been more difficult than usual. Lately the pace of gold-related news has accelerated exponentially with gold’s rising price. While 2009 was an exciting year for gold, setting a new average high of $1,088, 2010 promises to be even more exciting.

In 2009 gold resumed its historical monetary role - as the anti-currency. Therefore, the influences and events that affect its price are not simple commodity supply/demand fundamentals, but the more complex global monetary issues.

To summarize some of the important key events, I thought it would help to separate them into three categories.

First, there are the obvious events-those whose implications for gold are self-evident.

Second, there are the events that require some interpretation and, finally, there are the events that we might call “incipient”. These events and stories are in their early stages of development. They may amount to nothing, or they may develop into tectonic forces that completely disrupt the gold-related financial landscape.

It is more than a year since Wall Street made some very bad bets that resulted in unprecedented losses, losses that were passed on to the American taxpayer. For their incompetence and greed, most of the company heads responsible were rewarded with generous severance packages, or with new jobs commensurate in pay and status to the ones they left behind. Even more surprising, perhaps, is that one year later many of these people continue to advise the US government’s financial policy makers. My associate, trend analyst Richard Karn, likens this particular situation to a group of chickens getting together and consulting with the foxes about a problem that is plaguing their community-the rapidly decreasing chicken population. Since the same key figures remain firmly in charge of US fiscal policy, we can assume the status quo will continue until the ship finally hits the iceberg.

So let’s start with the obvious gold events of the past year.  It was the first time in 20 years that gold purchases for investment purposes outpaced gold purchases for jewellery demand.  However, in terms of significance, central bank buying of gold this past year upstaged all other events. For the first time in over 20 years, central banks became net buyers rather than net sellers of gold. This is a watershed event.

India’s central bank purchase of over 200 tonnes of IMF gold in the fall of 2009 demonstrated that large central banks were willing to pay the market price for gold. This removed the concern that official sector sales could cut short any meaningful rally.  Although the central banks have been selling less gold each year lately, the threat of IMF sales had continued to weigh on the market.  Russia and China further dispelled this fear with the disclosure that they too have added 130 and 454 tonnes respectively.  Several smaller central banks such as those in Sri Lanka and Maritius also added to their gold reserves. Therefore, central bank buying was clearly the significant gold event of 2009 and will likely continue to be in 2010.

The next level of news events had implications that might not have been so obvious at first glance. On October 6, Robert Fisk, a veteran Middle East correspondent writing for the UK’s Independent, published an article entitled “The Demise of the Dollar.” The article described how “Arab states have launched secret moves with China, Russia and France to stop using the US currency for oil trading.” Although the central banks immediately rejected these rumours, the market treated their denials as a clear admission of guilt and gold broke through year-long resistance at $1,020 an ounce into an entirely new trading range that day.

The Iranian oil bourse, which allows oil sales in several currencies except the US dollar, is another indication that this trend will continue.  In addition, the US’s greatest supporter of the petrodollar, Saudi Arabia, announced that it would no longer trade oil futures on the NYMEX. And on October 19 a related event occurred that received almost no mainstream press coverage; in fact, the only mention I could find of this story at first was at Al Jazeera Online. This was an agreement between ten member states in Central and South America and the Caribbean to use the sucre rather than the dollar for intra-regional trade. Venezuela, one of the West’s largest oil suppliers, is also a member of this new alliance.

This trend is significant to gold because, since 1973, the US has been able to accumulate huge deficits thanks to an agreement with OPEC to price oil in dollars exclusively. This system worked until the 2008 financial crisis, which many felt weakened the dollar’s inherent worth beyond repair. The petrodollar experiment, which started in 1971 with the removal of the dollar’s peg to gold and continued in 1973 when the dollar was essentially backed with oil, is coming to an end after only 36 years. However, given the weakness of other currencies and the fact that no other paper currency currently threatens to replace the US dollar, the process may take years to complete. The end of the petrodollar’s hegemony, which is inevitable in my opinion, will have significant implications for gold.

Another event whose implications may require some extrapolation was the move by the Chinese government to encourage and facilitate gold buying by the Chinese public. China watchers know the Chinese have a long-term love for gold. In fact, on December 9, Reuters announced that China had surpassed India as the world’s largest gold buyer, for the first time in recorded history.  The Chinese have also demonstrated a strong propensity for saving. With their government making no secret of its displeasure with the US dollar, and with few other safe investment options available, the Chinese public could provide the fuel to move the gold price to new highs. One ounce purchased by each of the 80 million middle-class Chinese would equate to 2,500 tonnes of gold.  It is important to remember that during the last gold bull, the Chinese public was unable to participate. This is a story that definitely bears watching.

Finally, in the third category, is the news we might compare to the first spark of a match that either extinguishes uneventfully or ignites a raging, out-of-control forest fire. Most of us in the gold industry have discovered that we ignore these flickers at our own peril. Many of the stories that started as hints or rumours a few years ago are now accepted as fact. The first of these issues we are watching is the imbalance between gold derivatives and paper proxies and the amount of physical gold in existence. This is important because despite its best efforts, Wall Street still cannot print gold.

Since almost all the gold ever mined remains in existence and gold reserves and production estimates are monitored meticulously, such discrepancies will show up faster in the relatively small gold market than they might with other commodities. As Wall Street churns out new gold investment vehicles, people are starting to do the math. If it becomes apparent that financial institutions have sold more paper gold than actually exists in physical form, then the price of paper gold and physical gold could diverge.

This year, many analysts began to apply increased scrutiny to the gold and silver ETFs. In mid-July, hedge fund giant Greenlight Capital announced they were moving assets out of the world’s largest gold ETF - SPDR Gold Shares - and into physical gold. Greenlight is an industry leader whose movements are carefully studied and often emulated. Although Greenlight’s manager, David Einhorn, claimed it was cheaper to own and store physical gold than it was to pay the ETF fees, the fact that a major, industry-leading fund would move to physical bullion set off many alarm bells.

Since ETFs do not actually purchase their assets, there is nothing prohibiting Authorized Participants from contributing baskets of borrowed gold. The amount of borrowed gold held by ETFs is a matter of speculation.  With multiple claims on the bullion, ETF investors may suffer unexpected losses under stress conditions when they need their gold the most.

So with these events of 2009 in mind, I am often asked, “How high might the price of gold go?”

Let’s look at some figures.

We know that the US must refinance at least two trillion dollars of debt in 2010. They can raise this money in one of three ways:  through the sale of bonds, through increased taxation, or through monetization by the Federal Reserve. Foreign investors showed decreasing appetite for US treasuries in 2009. Rising unemployment along with an aging population makes increased taxation a poor option. Therefore, the US Fed will be forced to monetize the ballooning debt, further eroding  confidence in the dollar as the world’s reserve currency.

This will encourage central bankers, especially those of the developing countries, to accelerate their accumulation of gold. Stephen Jen, a managing director at hedge fund BlueGold Capital and an expert on sovereign wealth funds from his days at Morgan Stanley, estimates that the percentage of gold held by the Chinese, Indian and Russian central banks is just 2.2 percent. This compares with 38 percent held by Western central banks. According to Jen, they would have to buy $115 billion dollars worth of gold at current prices to raise their bullion to just 5 percent of total reserves, and $700 billions’ worth to reach just half of Western levels.

Along with many others in the gold industry, we have noticed that fund managers are starting to buy gold as long-term insurance, which they intend to hold for several years. By one estimate, if the world’s pension funds and hedge funds moved only five percent of their assets into gold, which these days seems quite conservative, gold would trade above $5,000.  With leading wealth managers such as David Einhorn, John Paulson and Paul Tudor Jones allocating significant amounts of their portfolios to gold, the process may have already begun.

In conclusion, the events of the past year bode well for the price of gold in 2010. At the recent highs of $1,200 many thought that gold was overbought. For those who feel this way, I would like to close with some recent words from investment legend Richard Russell who said, “If gold is going parabolic, then there’s no such thing as ‘overbought’,” Almost any of the events of 2009 I have highlighted could trigger such a parabolic rise. Right now the Chinese and Indian public, the non-Western central banks, the sovereign wealth funds, the pension funds and the hedge funds of the world are all looking for ways to increase their long-term gold holdings. The pull-back from the recent highs of $1,200 seems to be over, providing an attractive entry point for investors. In 2010 we will likely see prices rise to at least $1,300 to $1,500.

It is important to understand that this isn’t a typical bull market. Unless governments around the world stop creating massive amounts of new money, the price of gold will continue to rise.

There is a famous investment axiom that states, “Now is always the most difficult time to invest.”  To that I would add, “But now is also the best time to insure the wealth we have accumulated is protected through the ownership of gold.”

Thank you.

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Canada on the Cusp of Something Big - Forget about inflation for now

Friday, September 25th, 2009

Canada is on the cusp of something big. A boom in commodities means Canada will outperform the US over the next decade. Our recovery and upward trajectory is tied to global demand coming from China and India, and the rest of the developing world. And with attractive risk/reward fundamentals, sound fiscal position, and strong banking sector, Canada  is destined to become a darling of global investors. At this time, Canada resides in a sweet spot of long term investing opportunity, but not for the one reason - inflation - that gets cited most often. Not yet anyway.

Mark Carney says Canada’s economic recovery is merely a ‘consequence’ of  unconventional measures. And, his report cites that prices are still falling in Canada.

This flies in the face of all the hoopla surrounding the inflation-motivated theme of investing in commodities and/or commodities producers. Investing in commodities producers is by no means a bad idea; its the rationale for doing so, by way of inflation, that may be flawed. Investing in commodities falls under the aegis of inflation protection, because if indeed we find ourselves in inflationary times again, we will be happy to own real things, such as commodities and real estate.

In the U.S. however, is it really a big surprise that the G20 meeting is yielding a “strong dollar” consensus? China, and other dollar reservists, Brazil, Russia and India, have been squawking about the faltering greenback, threatening to take measures to reduce its appetite/dependency on the US dollar since before the crisis began. If you listen to the Michael Pettis interview regarding China, you’ll get the idea very clearly that China is in no position to undo its marriage to the US. At least not anytime soon. Un-pegging from the greenback would have destabilizing consequences for China, not too mention the global economy, if not because of its effect on China, then due to its effect on the US economy. The US/China relationship is a  symbiotic one. In the meantime, we will watch the U.S./China economic ballet continue.

Therefore, as the G20 has reached a strong dollar consensus, the Canadian, Aussie and NZ dollars have all pulled back. It preserves balance for the dollar, yen and euro economies, and more importantly it keeps everyone happy politically. As for the Canadian dollar rising in value, it’s not a good development for the Canadian economy, but rather a by-product of the demand for what we produce. Its terrible for our non-commodity exports. So, balance works for us too, in the long run.

Kathy Lien: The Canadian Dollar tumbled against the greenback as investors took profits ahead of G20 meeting. Oil prices also fell more than 4 percent while gold prices closed below $1000, providing no support for the commodity currencies. The Canadian government returned to easier monetary policy after Canadian Finance Minister Jim Flaherty proposed an expansion of mortgage buy-backs to C$125 Billion or $116.4 Billion. The proposal comes on the midst of yesterday’s comments by Governor Mark Carney who claims the recovery is not “self-sustainable” and is a mere consequence of unconventional measures. If they proceed further with this, we could see a turnaround in the Canadian dollar.

In What is Gold to China?, we discussed the idea that gold is a safer long term bet as a result of the “Beijing put,” the notion that whenever gold falls to lower levels, the Chinese come in as strong buyers, bidding gold back up, as they are continually out to diversify their reserves into other currencies. Its all part of a symphony of intervention that is choreographed between the US, Europe, the IMF, Japan, and China to keep the dollar in a fundamentally stable range. Having said that, this too, benefits Canada as one of the world’s biggest gold producers, despite the fact the price of gold is subject to the manipulation of central bankers.

In that vein, Canada, as important as it is in today’s world, is along for the ride. Our recovery will depend upon a stable global recovery determined by steady interest rate policy and coordinated currency balancing.

Herein lies the opportunity; we just need to recognize it, and get our (long-term) peas lined up.

Canada really is the best thing going in the G7. We’ve written about this in the last two weeks in Canada: There’s no place like home, and Canada’s Universal Appeal and Advantage.

The long-term rationale for investing in Canada

Canada has what the world needs (resources), a sound fiscal position, and a strong banking system - So why haven’t the dollar reservists chosen to invest in Canada bonds, as an ultra-safe alternative to US Treasuries? Simple.

Canada has so much of what the reservists (BRICs and other emerging economies) need and want in order to build out their own economies, that investing in our debt would raise the price of the very things they want to buy from us, such as wheat, oil and gas, metals, and minerals. They are not just interested in importing commodities from us; more important, they have their eyes on buying the companies that produce the commodities, as well. Despite this, Canada’s bond market may perform well in the near term, as a by-product of today’s continued price weaknesses. And, the time will come, though not in the near future, when foreign investors will alternatively opt to buy Canada bonds.

Among the great inefficiencies that have plagued Canada is our conservatism (or rather the reluctance among Canadians to invest risk capital in the most strategic areas of our economy), and our complacency. Canadian companies have historically faced shortages of domestic investor capital, and that issue has forced them to look first to the US, and now globally for substantial sources of capital. This has meant that Canadians have foregone the ownership of our homegrown companies to foreign interests. Its this inefficiency that makes the opportunity to invest in our own commodities producers, and other companies so attractive.

By the way, every time something creative comes along to make it easy to raise money in Canada, for example, income trusts, someone in government comes along and shuts it down. There’s no doubt that there was some abuse and stretching of the rules which led to the legislation shutting them down, but then again, it was also one of the most successful equity financing periods in Canada’s capital markets history. At times it feels as though the Canadian government would rather help foreign investors take over our industries, rather than police the tax incentives that make raising capital easier, more fairly. Then again, this too, is part of our conservatism as a society, isn’t it?

Foreign investors are more interested in our companies than we are. As a country and as investors we need to realize that our assets are worth far more to foreigners right now than they are to us. We take our greatest assets, our natural resources, water, oil and gas for granted, because we have always lived in a state of surplus and exported most of what we produce, mainly to the US.

Now that the balance of demand is coming increasingly from the large emerging economies who face massive future shortfalls of materials, water, food, and energy we need to prepare for the geometric growth of demand coming in the next several decades. We sincerely owe it to ourselves to exercise our right to own and nurture these precious assets, before they pass into the hands of foreign corporate interests.

David Rosenberg states in his latest report, out today, that Canada is in the sweetest of spots because we are in the midst of a secular commodities boom. He cites Chindia as the key driver of demand over the next decade, but initially 2009 and 2010, where it is shown that China and India will lead the world in GDP growth, and currently command 21.4% share of Global GDP. This is no big surprise to anyone following commodities, but rather, more confirmation.

We believe that commodities are in a secular bull market, and this is where Canadian outperformance relative to the United States comes into play - nearly 45% of the TSX composite index is in resources; almost triple the share in the U.S. Almost 60% of Canada’s exports are linked to the commodity sector, roughly double the U.S. exposure. This explains how it is that the Canadian equity market has managed to outperform the S&P 500 this year by a cool 2,000 basis points (in this sense, Canada is basically a low-beta way to play the emerging markets via commodity exposure).

This by no means indicates that the US and the Western consumer will cease to be the world’s top consumer, but rather that we will have to line up with the new consumers from the developing world, to buy the same stuff. That is ultimately inflationary, but not for some time.

Rosenberg points out very nicely that commodities prices bottomed last year at the highest recession levels ever.

And, that prices bottomed at levels above historical peak prices.

This last chart is remarkable, because it illustrates how strong demand has gotten during the last ten years with the rise of China and India. Even after last year’s blow-off, prices are fundamentally higher because of the surge coming from the developing world’ growing appetite for food, shelter and commerce.

Forget about inflation, at least for now, as a reason to buy commodities. There are two overriding themes, that should be front and centre:

1) demand for commodities - Foreign interests wish to lock up supply which means the commodities themselves will be bid up.

2) demand for producing companies - Foreign interests, particularly China and its rapidly developing and mutually rich peers have their eyes squarely focused on our businesses and our natural resources. Mergers acquisitions and hostile takeovers will bid up the prices of Canada’s most desirable commodities producers, and it won’t be only China which comes knocking, though they will likely turn out to be the most aggressive. The onslaught of foreign-sourced capital markets activity is likely to come well in advance of peak prices for the commodities themselves.

What do policymakers think of, in the now wealthier, fastest growing countries of the world, whose nations are facing shortages of materials, oil, water, and food that would be devastating to their economic progress? “What will we need, and what do we have to do to get it?”

Let’s come back to the notion of complacency. Canadian complacency. We have taken our most valuable assets for granted, because they are abundantly available in our backyard. Also, the last year’s turmoil has also made it more difficult for investors to commit long term capital out of fear.

In the period ahead, it is not so much inflation, but rather pure and simple demand for the future supply of commodities that will take centre stage. Inflation, when it re-appears will be the icing. Canadian investors should view any market corrections as opportunities to accumulate meaningful overweight positions in their portfolios in the commodities complex in some combination of commodities and commodities producers.

This period represents Canada’s big chance to get out in front of foreign interests in our own backyard. We have the right to participate in the growth that will come Canada’s way as a result of the massive global economic transformation that is underway or we can choose to be bystanders.

We will continue to write and drill deeper into this subject in the coming weeks and months.

Sources: Kathy Lien | Bloomberg | Gluskin Sheff

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Canadian Dollar: Good But Not Great Data

Monday, September 7th, 2009

Aside from U.S. data this morning, we also had a few important releases from Canada. Canadian employment printed much stronger than expected earlier in this morning and just a few minutes ago, IVEY PMI beat expectations. Last month, manufacturing activity expanded by a faster rate with the IVEY PMI index rising from 51.8 to 55.70, marking the third consecutive month of growth. Aside from the drop in the employment component, the details of the report were encouraging. The contraction in employment was in line with the weakness that we saw beneath this morning’s Canadian employment numbers and is part of the reason why the Canadian dollar has struggled to rally.

Canadian Employment: Weakness Beneath the Headlines

This morning’s Canadian employment numbers were very strong. The market had anticipated the fourth month of job losses but instead Canadian employment rose by 27.1k, the first month of job growth since April. In contrast to the U.S. who reported the 20th consecutive month of job losses, in that same time, Canada only saw 11 months of net job losses and they were not even consecutive.

Part of the reason why the Canadian economy has been so resilient is because of the rebound in oil prices and demand from China. However weakness beneath the headlines is capping the gains in the Canadian dollar. First, the rise came primarily from the service sector and exclusively in part time work while full time employment actually fell by 3,500. So far this year, full-time jobs have decreased 403,700 while part-time jobs have risen 101,100.

When a labor market recovery is driven by part time and not full time hiring, it is definitely not all that positive. The manufacturing sector is also extremely important in Canada and so the lack of improvement in the sector is certainly discouraging.

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