Lessons in proper Gold ownership

KITCO Jon Nadler Analysis  |  2012-10-10 10:00:51   |   By

Spot metals dealings opened flat-to-slightly-higher in New York as Tuesday's sessions got underway. Gold drifted near $1,775 and silver appeared stalled around $34 per ounce.

By John Nadler
We trust you had a pleasant Thanksgiving holiday and/or Columbus Day. Basically, you did not miss much in the way of market action while you were busy with the aformentioned festivities.The markets are presenting us with more post-Fed 'leftovers' this morning as well.

Spot metals dealings opened flat-to-slightly-higher in New York as Tuesday's sessions got underway. Gold drifted near $1,775 and silver appeared stalled around $34 per ounce.

Relatively minor gains were noted in platinum (up $6 to $1,696) and in palladium (up $4 to $660) while rhodium remained unchanged at $1,275 the ounce. Following the first full hour of tradding the gold/silverduo headed into negative price territory while the noble metals trimmed their gains. In the market background, the US dollar picked up some tailwind and bounced 0.30% higher on the trade-weighted index (last seen at 79.84).

Last Friday's US September jobs report managed to stall the QE3-related rallies in various metals. When considering that the CFTC-reported net speculative long positions should have added to rising price momentum, the stall appears to be somewhat worrisome.

In the case of gold, the jobs statistics apparently brought about a technically-based bearish reversal and have reinforced the perception that, for the time being, the $1,800 level does indeed present a fairly formidable resistance point.

In the case of silver, a similar topping price pattern has developed as the overcoming of the $35.50 resistance area was not achieved. Market observer Clive Maund warned that based on the sizeable short position among commercials and the aformentioned topping pattern 'a bloodbath is believed to be imminent in the silver market, now that its cheerleaders have herded their flocks into the corral, ready to be fleeced again.'

This, of course, while we are still being promised that the white metal has nowhere to go but to $100 before the snows of winter 2013 will melt. Promises of hyperinflation here and now have not materialized despite three rounds of Fed QE having been pumped into the markets. Inflation since 2001 has risen 1.33 times while gold prices have risen six-fold-plus. Wait; we take that back: there is manifest hyperinflation taking place right now: in Iran, that is.

However, the gold bears may not see their price hopes materialize either; not unless current support around the $1,737 area is convincingly breached following a possible sell-off in the market. For the time being, the $50 range that extends from that $1,737 support to above the $1,780 marker is what the market participants will have to try to make some money within, absent fresh developments on either the physical side or the financial scene side (central bank accommodations, currency trends, etc.).

Standard Bank (SA) analysts note that they 'still see a physical market that reflects a picture of lacklustre demand across many commodities e.g. stockpiles are not declining substantially and/or spot premiums that have generally remained unchanged since the start of August. The rise in speculative length in the absence of strong real demand opens prices up to downside.

Getting back to the Friday US jobs report, the far better than anticipated decline to 7.8% has given rise to the opposite sentiment among speculators than what we have gotten accustomed to over the past not only few months, but perhaps several years now. Suddenly, the principal preoccupation is with when the Fed might end its easy money campaigns as opposed to how many decades into the future it might extend the availability of such large wads of cheap dough. Just about the only QE-oriented hope that still flickers among commoditu specs is now being pinned on China.

The rest of the world's central banks appear to have depleted such ammo at present. In the case of gold, the computations of current values imply that at least 18 months' worth (and probably more) of QE3 asset purchases by the Fed have been factored into the equation. Thus, it is perfectly logical to ask what happens if that turns out not to be the duration of the US central bank's monetarily accommodative campaign.

At the very least, the unemployment figures have seriously weakened the argument for further Fed stimulus measures to be adopted anytime soon. Even that development does not sit very well with those whose wallets have been fattened over the past four years by seemingly neverending Fed easing. The again, the very numbers that the BLS released on Friday do not sit very well at all with certain factions on the American political scene. No sooner had the ink dried on the 7.8% number that folks like Jack Welch jumped all over it and labeled it as having been 'doctored' to benefit the US President.

NY Times columnist and Nobel Prize-laureate Paul Krugman summed up the conswervatives' employment report conspiracy hoopla as follows: 'The U.S. economy is still far short of where it should be, and the job market has a long way to go before it makes up the ground lost in the Great Recession. But the employment data do suggest an economy that is slowly healing, an economy in which declining consumer debt burdens and a housing revival have finally put us on the road back to full employment.

And that's the truth that the right can't handle. The furor over Friday's report revealed a political movement that is rooting for American failure, so obsessed with taking down Obama that good news for the nation's long-suffering workers drives its members into a blind rage. It also revealed a movement that lives in an intellectual bubble, dealing with uncomfortable reality - whether that reality involves polls or economic data - not just by denying the facts, but by spinning wild conspiracy theories. It is, quite simply, frightening to think that a movement this deranged wields so much political power.'

Also contributing to the difficulties tha have emeged in the bull rallies in commodities after September came to an end is the fact that China and its economic slowdown are still making headlines in the financial media. The latest negative story came to the markets courtesy of the World Bank, which, on Monday cuts its view on that country's growth. Owing to the crisis in Europe and to the fact that the Old World represents some 40% of the export market for China, the World Bank warned that economic expansion in the world's second largest economy might only be tallied at 7.7% for the current year.

The IMF this morning added to such worries among commodities' bulls when it cut its global economic growth forecast to 3.3% - the slowest since the 2009 recession. The institution urged European and American policymakers to try to address their respective short-term economic challenges (debt crisis, fiscal cliff) lest they can expect the 'current bout of turbulence' to possibly turn into 'a more lasting component'.

The IMF now sees an 'alarmingly high' probability of such a deeper global slump occurring. Europe might record a contraction of 0.4% in 2012 while the US grows at 2.2% (higher than previously anticipated) along with a similar pace for Japan. Germany on the other hand might only grow at a sub-1% pace in 2012 while Spain contracts to the tune of 1.3% next year.

The above developments threaten to at least partially undo Australia's 21-year long streak of phenomenal economic success. The country's key resource exports are subject to losses in value as China and Europe contract. RBC Capital Markets economists believe that the Aussie economy is dangerously exposed if the seven-year long boom in mining investment tops out this year or next.

Commonwealth Bank of Australia's head of debt research, Adam Donaldson cautions that 'The end of the commodity price and associated capex boom means more will probably have to be done to stimulate domestic demand.' It remains to be seen how possible future developments in the price of gold might affect the country Down Under, but, as has always been the case, over-dependence on one sector or on one market trend for too long, is not a good thing.

At least in the perception of French bank Natixis, the base case for gold has been subjected to a revision for the current year and for the next one as well. The firm is now projecting an average gold price of $1,675 per ounce for this year, and of $1,640 for 2013. That is a relatively far cry from the $2,200 price objective that large numbers of market prognosticators have recently signed up for in the coming year.

Natixis analysts note that 'having correctly anticipated QE3, the gold market is left wondering whether the implementation of QE3 will offer any further boost to gold prices, or whether there might be other factors that could drive prices back up to, or even beyond last year's high of $1,900 per ounce. In this central scenario we assume that Europe will continue to battle with its internal economic problems, but economic growth, led by developing countries, will gradually shift investors' attention away from the gold market to more risky financial assets.'

As for silver, the bank's research analysists, Messrs. Nic Brown and Bernard Dahdah, sum up the situation as follows: 'Over the medium term, our concern with the outlook for silver prices is that once global markets return to greater normality, investment demand might not only diminish, but could turn into a considerable source of net supply. The 16,160 tonnes of silver held in physically-backed ETFs are equivalent to almost half of 2011's supply of silver and 70% of new mine supply.' Natixis' analysts project an average 2012 silver price of $32 followed by $30 per ounce next year. The team is more optimistic about platinum's price prospects however; it envisions an average of $1,550 for the noble metal in the current year and a $1,700 per ounce average for same in the coming twelve months.

Money Morning Australia's John Stepek posted an interesting article on Monday. What is interesting about it is not the fact that it extols the historical virtues of the yellow metal- the publication has always reflected the heavily pro-gold views of Agora Publishing. 'What's So Important About Gold?' tries to teach a few lessons about gold ownership. It also tries to (correctly) reposition gold as a form of insurance. Here is a most valuable excerpt from Mr. Stepek's 'Gold Ownership 101' posting:

'I like gold. But after 11 years of constant increases, I believe we're nearer to the end of the gold bull market than to the start. This is the stage where more and more people are going to start piling in for the wrong reason. They'll buy gold because it's going up, not because it's a sensible investment. That means that this is also the stage where - even though there are likely higher peaks ahead of us - some people are going to start getting badly burnt in the inevitable panic sell-offs. So it's important to get your rationale for buying gold right. It's not 2001 anymore. You can't just buy it and sit on it, safe in the knowledge that chances are, it will never ever be that cheap again, and that you'll always be able to sell at a profit. [And] If you're hoping to 'ride the bubble' when it comes, put that thought out of your head right now. That way, financial disaster lies. Timing a bull or bear market is painful. No one can know when the final peak or trough will come.

So what do you do? Well, another way to think of gold is as an insurance policy. You don't put your entire portfolio in gold. It's something that you hold to insure the rest of your portfolio against financial disaster. The possibility of such a disaster seems quite high just now, which is why the insurance policy (gold) is more expensive than it once was. So we'd suggest that you invest 5-10% of your portfolio in some form of physical gold (gold stocks are separate – they're driven by more than just the gold price, and they're certainly not insurance). And when you check your portfolio every six months or so, you rebalance accordingly – if gold's share of your portfolio is creeping higher, sell some and invest in something else. If it's dipping, then top it up. That way, you'll profit from the inevitable 'bubble' phase. But you won't be left over-exposed when prices go down, as they one day will. And when the gold bull-run is over, you'll be pleased. Because when the gold price re-enters a bear market, it'll be because the wider economy is finally turning around. And you'll be able to buy cheap insurance again for the next crisis.'

Could not have said it better, Stepek. Question is: who will heed your advice?

Until next time,

(The author is the senior metals analyst - Kitco metals)