Resource Maven

Free Articles

I'm Not A Gold Bug But... Part II

In my last missive I made the long-term gold argument. That's great – but it's easy to make claims without timelines.

Sure, at some point in the future the US dollar will no longer dominate global trade. At some point it will be supplanted by a yuan backed by stacks of Chinese gold. As for when – I don't know.

It will take many years. Paradigm shifts do not happen overnight. Comfortable in their established structures, society fights against dramatic change even when change is needed.

That fight will push the process one step back for every two steps forward, and occasionally the other way around. Every time the dollar resists its demise gold will give up some of its gains.

But overall gold will rise. The dollar owes its recent strength to being the best of a bad lot. As currency dynamics shift – as the renminbi gains acceptance, as gold regains strength, as the petrodollar system dissipates – the dollar will face increasing competition as a safe haven investment and an international trade facilitator.

But I am getting lost in the long term again. What I really want to discuss is what is happening with gold right now.

Key in gold right now are negative gold lease rates suggesting physical shortages, a slowdown in shorting and a pending surge in covering, and gold miners trading at historic discounts relative to the price of gold.

First, gold lease rates.

The orange line is the 3-month GOFO rate; blue is the 6-month GOFO. GOFO is Gold Forward, which is the difference between the spot gold price and the futures price as a percentage.

Gold owners have long put up their gold as collateral to borrow dollars. They pay the GOFO rate to do so, which is usually positive because the dollar lender is giving up on interest and taking on the cost of storing gold.

Positive GOFO is the norm. From 1989 to mid-2013, GOFO rates were negative for just seven days. Out of about 5,000 days. As in, hardly ever.

Why? Because central banks have long leased gold to bullion banks, which create leveraged paper derivatives that they dump on the futures market. All this paper gold suppressed futures prices, keeping them below spot and thus the GOFO positive.

Now that is changing. Central banks are hoarding gold, afraid to lease it out in case it never comes back (talk to Ukraine or Germany for more info). Without a steady supply of physical gold available for lease, bullion banks can't manage the futures price.

The result: instead of reflecting banker's control over the futures price, the GOFO rate is actually representing the availability of physical gold to meet demand.

And there ain't enough, not if even a small proportion of all the paper gold certificates were redeemed. Some reports suggest there are now over 100 paper claims for every physical ounce of gold.

That is ok as long as everyone keeps trading in paper and no one demands delivery, which is situation normal. However, a gold price bottom after three years of decline and amidst a flurry of central bank buying and repatriating – today is not situation normal.

As consensus consolidates that the bottom is in, interest in physical gold is rising and revealing just how tight supply is. The one-month GOFO rate turned negative in early November for the first time since 2008. A week ago it hit its most negative level in over a decade.

Negative GOFO means the market is willing to pay more to borrow gold than to borrow cash, despite the associated costs of holding gold. For GOFO to go this far negative suggest a serious shortage of gold on the institutional and bank level.

In fact, for a week there the entire curve through six months was negative. This is highly unusual: the three-month GOFO rate has not been negative since 1999. Even the 12-month GOFO rate dropped to only the tiniest bit above zero – its lowest rate ever.

This all suggests that the big players expect the gold supply shortage to last until the end of 2015.

In recent days GOFO rates have turned upward, correcting this highly unusual situation. Perhaps central banks saw negative GOFO rates and, unable to resist the opportunity to make some quick cash, increased their gold available for lease again, if for a short time.

But the fact that rates spent a month in negative territory revealed cracks in the gold situation. Physical supplies are limited.

The second current happening of significance: shorters are getting exhausted.

Short sellers bet on declines, rather than gains. Gold shorters borrow gold they don't own and sell it. If prices fall, they can then buy back the gold and repay the debt, keeping the difference.

Shorters sell when prices are high, so shorting dampens price increases. Dampening can become full downward pressure if enough shorters are in action.

Gold short selling is easy to understand when gold is hot, since that's when a fall is likely. But gold has lost almost 40% in three years.

There aren't a lot of speculators out there will to bet such a downtrodden asset will fall farther. That means, as Adam Hamilton explains in Gold Shorting Exhaustion, that "gold futures short selling is finite and self-limiting."

The more that shorters push the price down, the fewer among them are willing to keep betting on a continued slide.

In addition, as the crowd of short sellers thins, downward pressure eases and shorters start buying gold to cover their gamble. With buying replacing selling, the gold price can turn around sharply.

It has happened before. The best example comes from the second quarter of 2013. It was gold's worst quarter in 93 years and it was accompanied by the greatest episode of short selling since 1999.

When gold stabilized, short sellers had to buy, buy, buy to cover their contracts. Over the next 16 weeks gold gained 12.8% despite other downward pressures.

Let's compare that event to today. Gold dropped dramatically in early November to US$1,140. Was there short selling? Absolutely: between mid-August and mid-November speculators sold 90,600 contracts, boosting the total speculative short gold position by 126%.

That works out to gold sales totaling 280 tonnes in three months, more than actual global physical demand.

Sales of that magnitude hammered gold, pushing it down almost $200 an ounce. But remember: the more short positions there are, the more long positions are pending, because as soon as they lose their nerve shorters have to buy to cover their bet.

That suggests a whack of buying still to come. The last Commitment of Traders report showed some short covering, but also showed a large speculative short position still outstanding, a clear near-term bullish sign.

This stuff about GOFO rates and shorting exhaustion boils down to this: players are leaving the paper market. Without piles of highly leveraged paper bets pushing it around, the gold price is increasingly able to represent fundamental forces – and those forces are upward.

Jeffrey Nichols of American Precious Metals Advisors agrees. In his latest letter, titled Any Day Now, Nichols says a small group of players – bullion banks, hedge and commodity-focused funds, and a few institutional speculators – drove the price down in recent years through their dealings in paper gold products.

Meanwhile, retail buyers in India, China and even in the west along with "Swiss gnomes and Arabian sheikhs, sovereign wealth funds and super-rich family offices, and a number of central banks" have been "acquiring huge quantities of physical gold", taking advantage of low prices.

These are buy-and-holders, which means most of the metals they accumulated will not come back onto the market. That's the fundamental reason why the physical gold market is tight: it's a black hole, full of buyers who essentially never sell.

The paper market is shrinking. Interest in physical gold is climbing and supplies are already short. And now forecasters are starting to warn that gold will formally enter supply deficit in 2016.

From Credit Suisse: The gold market will enter a deficit by 2016 as producers cut capex, resulting in reduced supply in the medium- to long-term."

Significant gold price increases are pending. But if you want amplified returns: go for gold miners.

Gold miners are currently trading at the biggest discount to gold since 2001.

As you might recall, 2001 was when the last gold bull market began.

Miners are very undervalued – and this chart is before today's market slaughter (thanks, oil). When this market turns around there is some serious ground to regain.

Gold has now gained more than 5% since bottoming on Nov. 5th, a rise made all the more remarkable given that it happened despite a rising dollar, rising bond yields, another round of record-setting equity prices in America, and a tanking oil price.

The Gold Miners ETF (NYSE: GDX) is up 11%. The Junior Gold Miners ETF (NYSE: GDXJ) is up almost as much. Those are notable gains, given that the TSX is down 3% and the Venture board down 9%.

Gold has bottomed. Oil's nosedive since then hammered Canadian markets, obscuring the fact that metals and miners really did bottom on Nov. 5th.

And there are reasons short term and long for gold to rise from here, bringing the entire sector along.

To learn how to turn resource knowledge into investment success: subscribe to Resource Maven: The Turning Point.

EDITORIAL POLICY AND COPYRIGHT: Companies are selected based solely on merit; fees are not paid. This document is protected by copyright laws and may not be reproduced in any form for other than personal use without prior written consent from the publisher.

DISCLAIMER: The information in this publication is not intended to be, nor shall constitute, an offer to sell or solicit any offer to buy any security. The information presented on this website is subject to change without notice, and neither Resource Maven (Maven) nor its affiliates assume any responsibility to update this information. Maven is not registered as a securities broker-dealer or an investment adviser in any jurisdiction. Additionally, it is not intended to be a complete description of the securities, markets, or developments referred to in the material. Maven cannot and does not assess, verify or guarantee the adequacy, accuracy or completeness of any information, the suitability or profitability of any particular investment, or the potential value of any investment or informational source. Additionally, Maven in no way warrants the solvency, financial condition, or investment advisability of any of the securities mentioned. Furthermore, Maven accepts no liability whatsoever for any direct or consequential loss arising from any use of our product, website, or other content. The reader bears responsibility for his/her own investment research and decisions and should seek the advice of a qualified investment advisor and investigate and fully understand any and all risks before investing. Information and statistical data contained in this website were obtained or derived from sources believed to be reliable. However, Maven does not represent that any such information, opinion or statistical data is accurate or complete and should not be relied upon as such. This publication may provide addresses of, or contain hyperlinks to, Internet websites. Maven has not reviewed the Internet website of any third party and takes no responsibility for the contents thereof. Each such address or hyperlink is provided solely for the convenience and information of this website's users, and the content of linked third-party websites is not in any way incorporated into this website. Those who choose to access such third-party websites or follow such hyperlinks do so at their own risk. The publisher, owner, writer or their affiliates may own securities of or may have participated in the financings of some or all of the companies mentioned in this publication.

Newsletter

In her letter, Resource Maven explains what she is buying and selling, and why. Maven has bought into several of the markets best - performing stocks well ahead of the curve. She regularly identifies exciting new exploration opportunities and manages the inherent risk by selling some into speculative gains. And the mine builder and operator stocks that form the basis of the portfolio give strong, ongoing leverage to the rising prices of gold and silver. She has your precious metal bases covered.

Recent Posts

Testimonials

Thanks for all your hard work, but especially your honesty and integrity. I can feel your desire to take of us through your writing. As you have recently written, that is not always the case in this sector….I’m sure your new subscribers have no idea what they are in store for. I have almost doubled my portfolio since the lows in March. I would have done even better if I could have exited my positions when you recommended them, but I was overseas and unable to act. I was okay with it as I knew from experience it would bounce back. and boy has it AND ITS JUST STARTING!... After many years in the red, all but of a couple of stocks are in the green. The daily rise in my portfolio is unbelievable. And a lot of that is happening is because I trusted you. I’m afraid I’m going to need the benefits of your hard work and wisdom to once again help my family and because of all your hard work I’ll be able to if they need it. I can’t thank you enough for the sacrifices you make to make what you do possible. If your religious at all, you really are doing God’s work. You are making a difference in many peoples lives.

Blessings upon you and your family.

Sincerely,

PM

-PM (June 1, 2020)

"Gwen - I just analyzed our returns for the past month. We had a 36.7% return on our portfolio in one month! Thank you so much for your excellent, thoughtful and timely guidance. 12 of the 18 stocks in my portfolio were recommended by you. 4 were recommended by other MIF letter writers and 1 each by Eric Sprott and Rick Rule. Yes it was a good month for precious metals - Gold was up $50 and Silver $3.90 - but “our" portfolio performance more than doubled the 16% of the GDXJ"

-WJ

-WJ (June 1, 2020)