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Intro
Before diving into the Weekly Recap, we present an abbreviated version of our Comparative Analysis Table for your reference and ours. It compares the operations of 12 of the top gold producers as measured by market cap.
It is a sampling of our in-house analysis, customized to capture key metrics of the gold mining business. The complete table, available to subscribers, encompasses a list of mid to large-cap producers and a mountain of painstaking data gathering that we keep updated on a monthly, quarterly, and annual basis as the information is released.
(Click the image to enlarge)
Backward What?
We begin this week’s recap by directing your attention to the gold market, where events over the past several months have led to a relatively rare occurrence in the futures market known as backwardation.
For those of you who are unfamiliar, commodities normally trade on futures markets in a state of contango. Bear with us, it gets clearer from here.
Contango is a peculiar word associated with commodities trading that simply means it costs more to purchase and take delivery of a commodity in the future than it does today.
This makes sense because there are costs incurred by the seller associated with storing, or carrying, the commodity until some future date, as opposed to completing the transaction today and instantly receiving the cash.
In contrast, backwardation refers to the unusual instance that occurs when today’s price is higher than the future price. When a commodity is in backwardation it suggests a situation in which demand for immediate physical delivery is high, and interest in future delivery dries up or is suspected to be risky.
This situation is rare, and typically doesn’t last long because those who own commodities can make a quick risk-free profit simply by selling at today’s higher price and buying it right back at a cheaper price for future delivery.
The fact that this is the current situation in the gold market tells us that something very important is going on and that market participants prefer to pay more for gold today than paying a cheaper price for a paper promise of future delivery.
The $64,000 question is, why are gold market participants willing to pay more now? I’ll give you our answer in a minute…
First, I wanted to mention another, likely interrelated, development in the gold market that is also hinting a significant market dislocation is underway.
For the first time since the Lehman crisis in 2008, 1 and 3 month GOFO rates have gone negative. GOFO stands for Gold Forward Offered Rates and represents the official daily rate at which the Market Making Members of the LBMA (e.g. ScotiaMocatta, Goldman Sachs, and JP Morgan, among other bullion banks) are willing to lend gold.
We have questions and theories on where they get the gold to lend, and who they lend it to, but this is a consideration for another day.
What’s important to take note of is that a negative GOFO rate, like backwardation, is also a rare occurrence. In the past, it has served as the proverbial canary in a gold…uh, coal mine, heralding a turnaround in the gold market. When GOFO last turned negative in 2008, it almost exactly marked the bottom of the gold market.
See the chart below for an excellent graphic showing previous negative GOFO rate occurrences and what happened to the gold price afterwards.
Commenting on this unfolding drama, William Kaye, a very prominent Hong Kong based hedge fund manager, shared in an interview with King World News that a gold raid is underway in which western gold inventories are flowing into Asia on a large scale.
He further indicated that significant amounts of this gold flow are passing through Hong Kong. Once there, it is being melted down, tested for purity, and recast under new Asian branding, after which much if it is being shipped to mainland China.
He shared that his fund is also a buyer and has had gold recast for his firm’s ownership and storage in Hong Kong. Of course we can’t confirm his story, but we think he’s as credible a source as anyone in the financial press, if not more so, and he’s in a position to know.
If you are interested in what we think, we believe the backwardation in the gold market is the result of large-scale demand for physical gold and, along with many others, feel that confidence in the paper gold market has been severely shaken. Because of this, investors far and wide want physical gold with a delivery date of yesterday!
China to Buy Barrick Gold
China’s policies of dramatically growing their official gold reserves to match that of western rivals and encouraging their citizens to own gold are widely known. These policies are reflected in China’s growth and hording of domestic gold production, growing global gold demand seen through historic import levels, and the establishment of gold exchanges.
For perspective on just how much Chinese global gold demand there is, if you annualize the amount that it has purchased year-to-date, it is equivalent to 50% of world mine production.
In addition to this already extraordinary volume of physical gold purchases is the fact that China is the number one gold producer in the world and they don’t export a single ounce!
With the gold supply currently constrained and the paper gold market in an uncertain state, one question that arises is, with eastern physical demand depleting western physical gold stocks, how will China continue to source its ever expanding gold demand?
Securing adequate supply to support demand is likely a major concern for China. This realization has led us to speculate that they may soon look to satisfy part of their enormous gold appetite through the acquisition of at least one of the major gold miners.
As a group, the shares and market caps of gold miners are at levels not seen since the Global Financial Crisis in 2008 and the current challenges faced by the sector are well documented by industry observers. One company that has been hit especially hard is the world’s largest gold producer, Canadian miner, Barrick Gold Corp.
Using information drawn from our comparison table above, one share of Barrick, a company that has 140 million ounces of proven and probable reserves, 7.3 million ounces of annual production from 27 mines in 9 countries, and US$2.3 billion in cash, is worth approximately $15 today, which represents a paltry market cap of just $15 billion.
By the measures just mentioned, Barrick is much larger than its nearest competitors, far more geographically diversified, and is one of the lower cost producers on an all-in cost basis. They do, however, lead the industry with a massive debt burden.
The gold reserves in the ground are alone worth roughly $180 billion at current prices. And, although it may not be profitable to mine all these ounces at today’s prices, you probably don’t care if your primary goal is locking up long-term supply and are bullish on the gold price.
Furthering our case, if you compare their current enterprise value of $26.5B with the $180B in reserves, along with the other attributes just discussed, it presents a tempting target for someone that has China’s trillion USD bank account… just sayin’.
Although it might surprise the market, in our view, an acquisition of this sort is very plausible.
To close this discussion, there have been two recent attempts by foreign firms to take-over large Canadian corporations, one successful and one not. The two Canadian target companies were, oil and gas giant Nexen and Potash Corp. of Saskatchewan respectively.
Using these acquisitions as a guide, should China attempt to acquire Barrick, the Canadian government might be inclined to approve the deal.
Like Nexen, Barrick’s mining operations are largely outside of Canada and spread around the world. Therefore, it has little direct impact on Canadian natural resource ownership and security. In contrast, the Potash Corp deal involved large scale deposits of a critical global resource located within Canada’s borders.
So remember, you heard it here first… China to buy Barrick Gold!
Gold This Week
Gold started the week at US$1,218.40 and began an orderly rise until the Wednesday release of the Fed minutes which catapulted the gold price to just shy of US$1,300.
The minutes revealed that many reserve officials want to see further signs of an improving economy, before any type of tapering of the Fed’s monthly $85 billion bond buying program. Chairman Bernanke himself said that the U.S. needs “highly accommodative monetary policy for the foreseeable future.”
The gold chart, moving in a positive direction, upwards and to the right for a change, is below. Gold, as I submit this week sits at US$1,280.
Gold Miners This Week
Even though the gold price marched steadily higher, the gold miners, represented by the HUI index, did not experience the same price appreciation until Thursday. You can see on the chart below that on Thursday the HUI experienced significant interest, climbing an impressive 8%.
That’s it for this week, I hope you have a great weekend and join us again next week so we can gloat about China announcing its bid for Barrick.
Best Regards,
By RJ Wilcox
kitco news
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