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Firstly let
me wish everybody a happy, healthy and prosperous New Year. I also apologize
to the gold sites and public readership for being off air the past few months
as I buried myself in research, forum exposure and membership delivery work
on my own site.
I also had
the privilege of being asked to report on three exceptional opportunities
last year and these in-depth reports can be found for free on the front page
(top section) of GoldOz now if you wish to visit.
One of the stocks is a re-start of a large mine in Ghana set for first
quartile cash costs; it was left behind by a major when gold prices were
circa $500 per ounce. Another is located in the central Kalgoorlie
gold belt and currently valued well under mill replacement cost. With 6M
ounces in this location this is hard to imagine. The third is a major growth
play spread across three operational centres in WA
and flying under the radar of most investors, over 4M ounces and in a growth
phase ramping up at several mines at once.
The expected
break out on gold stocks failed to eventuate in 2011 as market leader NCM
headed south during September. Most gold equities here finished the year weak
and ready for a bounce. The elite stocks held in our Educational Portfolio
(as higher weightings) did exceptionally well however, yet the sector
performance dragged back the overall results for 2011.
The tone for
2012 was set in 2011. The Euro and Euro backed paper are currently trading at
a discount in banking circles and Europeans are saving in gold or fleeing
wherever possible. The world is in a deflationary period for many asset classes
due to deleveraging. Histories largest debt bubble is deflating. Europe
emerged as the epicentre of the financial storm in
2011 and this now continues. I do not use these words flippantly, this is
extremely serious.
We also find
ourselves in a liquidity trap and therefore, against all logic austerity is
currently the wrong solution. The time for austerity and balanced budgets was
during the growth years, during the building of the debt bubble not now. This
horse bolted long ago.
Liquidity
traps are characterised by:
- failure of stimulus (QE, Twist
etc.) to create growth
- low interest rates failing to
stimulate growth
- private and corporate savings
rise in response to fear; money hoarding
- expansion of the money base
fails to translate into inflation
- unlimited demand for money - in
this case mostly in the Government sector for Public Sector payrolls, QE
in various forms, debt servicing and debt roll overs
The US Fed
has changed their definition of a liquidity trap and if anybody can make
sense of their document on the subject they are doing extremely well. In my
understanding; if a thesis is not succinct and easily understood it is not
worth the paper it is written on. In my end of year briefing to clients I
explained all this and stated that "it quacks, walks and looks like a
duck - therefore it is a duck". Yes we are in a liquidity trap. Right
now the government sector demand for borrowings is choking off growth and so
many B list clients fail to get funding. The A list gets the cash and the B
list doesn't sending some companies to the wall. We are seeing more of this
now and it will continue in 2012. Gold stocks that are not funded to
production are at increased risk although I have noticed an unsurprising
ability for solid gold stocks and even exploration plays to attract adequate
funds in this economic environment.
Due to the
existence of the liquidity trap and associated economic conditions it seems
obvious that low interest rates and various incarnations of QE will need to
continue. Of course the spread paid by lower class borrowers, over and above
the Fed rate can grow larger pushing up stress levels for these borrowers.
Continued capital destruction will offset new cash creation which will be
soaked up by government demand. This creates all sorts of challenges and
extreme risk of major upheaval, not just default as sovereign borrowing costs
soar.
We also have
a banking crisis due to sovereign debt exposure in this sector in addition to
the deleveraging process itself. As certain asset values fall loans flip to
negative equity. As the spread on loans increase for SME's and other clients
the debt servicing stretches the business or individuals to the limit. This
is not a good environment for business expansion and jobs growth.
What does
this have to do with gold? Everything. Gold was sought as a safe haven and
will be again. As upheaval increases the environment for gold improves. Then
you have negative real interest rates. The interest rates are lower than cost
inflation even if many asset prices are falling (deflation). Inflation for
energy and food combines with deflation to create stagflation. Negative real
interest rates are great for gold.
The current
stagflation will be met by QE, read that as money printing which will also be
needed to fund government debt roll over. Governments will not unwind this it
has to blow up first; this has been the way of history and I see no change
due here.
I interviewed
an officer of a major London bank who confirmed this 'distress and
deleveraging' thesis recently. They are offloading assets and talking clients
into allowing same. They are taking 50%+ haircuts and glad to get this level
of return while they can. Their view on the coming few years is for a protracted
period of deleveraging and default. Other costs are rising, which combines to
increase foreclosures and bankruptcies which are still very high and this
will continue also.
The Ratings
agencies faced a major change to their business model (legal and in effect
operational) in 2010 so they are now forced to apply more honest assessments
on their own clients and financial products. This was seen as disruptive, for
instance USA down grade from AAA mid last year and the recent threat of a
down grade on France and several banks. However they have no choice so expect
this to continue to create 'news headline volatility' and reflect risk more
appropriately.
There was
also serious trouble in the Credit Default Swap markets in 2011 as Greece was
classified as a voluntary restructure which the banks decided did not trigger
payouts 'on default' to bond holders. This caused bond yields to rise and
increased doubt in the inherently risk adverse debt markets. Debt markets are
in a bubble in the stronger economies as capital was hoarded in this asset
class for 'safer' keeping during 2011. A major top has been formed or is
forming signalling the end of this Bull Run for
this asset class.
This no
longer remains safe when rates are at record lows - nothing but down side
risk for bond holders. This can create a massive wave of capital and disrupt
the debt roll over process forcing monetization of national debt to continue.
This can be classified as QE. Defaults and haircuts will result in massive
capital destruction. The question is where can the wave of capital go? We
have a banking crisis and therefore bank deposits seen as low risk aren't
what they seem to be. First tier banks are a safer option, choose carefully
and spread savings here and across asset classes.
These bank deposits
are nothing more than unsecured loans, in many cases to questionable
institutions who have not maintained loan book valuations at realistic market
value. As an asset class real estate requires demand (in a falling price
environment?) and supply of loans by banks to flourish. Yet banks are trying
to balance bad debt write offs, rising unemployment / fresh loan defaults ,
tighter loan qualification measures and the looming Basel3 capital adequacy
requirements. This last measure forces tighter management of reserve ratios
and higher reserve levels on this sector; thus restricting their loan book
growth and freedom.
Equities may
just surprise investors in this environment. The balance sheets of some
corporations and their current earning spread across China and emerging
economies make them attractive safer havens. Earnings multiples are low
however caution; research will show you that earnings will also fall for some
companies. Many opportunities exist in emerging markets and the equities in
general and this will start the capital flow in this direction once the
bottom is found.
Here lies the
quandary for 2012; where is the bottom? The C wave down appears to be a
foregone conclusion as deleveraging gathers steam. The capital requirement
for the USA and Europe, just to roll over old debt is staggeringly high. This
sucks capital away from business.
Gold has been
correcting after a large rise which failed to stimulate more than the most
elite gold stocks in Australia. Demand for gold and silver in Europe is high
and it is growing in China and in many other areas. Investment demand will
soon re-emerge as investors seek a new safer haven other than the USD and US
Government or other sovereign Bonds.
For now there
is downside risk for gold however this is limited, in part because of the
already mature 20% correction. Gold and silver can both put in major upside
this year due to Europe and so can the other white metals on disruption in
Africa. I am following gold short term for clients and decline to make a
prediction at this stage.
Europe will
falter and if this spreads and becomes disorderly (understatement) then we
can see a forceful deleveraging event pushing the metals to short term lows
ahead of a resumption of the upward trend. If this is not as disorderly then
gold can trend sideways along the lines of the step up fractal pattern which
has characterised the rally since 2001. The outcome
will determine the action on the gold stocks and Australian dollar.
Some
Australian and ASX listed gold and precious metal stocks appear to show signs
of a turn around here. A full run down of Larger Producers and the Mid-Tier
Producers list now follows for subscribers...
Good trading
/ investing.
Neil Charnock
Editor, Goldoz.com.au
REGISTERED ADVISOR – WHO THE ADVICE COMES FROM
IN THE GOLDOZ NEWSLETTER:
Colin Emery is currently a Branch Manger and Senior
Client Adviser of a Stock Broking Company in Queensland Australia. Prior to his
work in Share broking he spent nearly 20 years in Senior Management and
Trading positions in Treasuries for major International Banks such as Bank Of
America, Banque Indosuez, Barclays Bank, Bank Of
Tokyo and Deutsche Bank AG. He spent a number of years as a Senior trader in
New York, London, Singapore, Tokyo and Hong Kong with these institutions. He
also was Global Head of emerging energy, emission and commodity products for
the leading Energy and Commodities brokerage firm of Prebon
Yamane Ltd – Prebon Energy for four years
before moving to Cairns in 2003 to focus on the Stock market and Private
consulting work. The private consulting and advisory work currently
undertaken is with companies involved in Resources, Energy and Renewable
Energy and Forestry.
Neil Charnock is not a
registered investment advisor. He is a private investor who, in addition to
his essay publication offerings, has now assembled a highly experienced panel
to assist in the presentation of various research information services. The opinions
and statements made in the above publication are the result of extensive
research and are believed to be accurate and from reliable sources. The
contents are my current opinion only, further more conditions may cause my
opinions to change without notice. The insights herein published are made
solely for international and educational purposes. The contents in this
publication are not to be construed as solicitation or recommendation to be
used for formulation of investment decisions in any type of market
whatsoever. WARNING share market investment or speculation is a high risk
activity. Investors enter such activity at their own risk and must conduct
their own due diligence to research and verify all aspects of any investment
decision, if necessary seeking competent professional assistance.
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