When I called the bottom as having happened Nov. 5th, I got lots of feedback.
I was called gutsy, bold, overly optimistic,
naïve, and ballsy (my personal favorite), among other adjectives.
Many wrote to me outlining all the deflationary
pressures that will supposedly strengthen the greenback, stifle economic
growth, and hold gold down.
I know I’m the new kid on the block. I am not
an economist and I’ve been in the business less than ten years – but these days
I am finding those deficiencies are my advantage.
Because I don’t have a point to prove. I’m not
a gold bug or a mining bear or a currency warrior or a debt deflator. I’m a
scientist and a journalist, so I research and then reason.
Let’s just think about gold. Where gold goes,
the mining sector generally follows. There are independent forces at work on
copper and zinc and silver and iron ore and so on, but a sustained gold price
rally injects interest and capital into the entire exploration sector, so gold
is a good place to start.
The stack of information around gold separates
into two piles.
One pile is about the supply and demand of gold
as a metal.
The other is about gold as a store of value and
a hedge against fiat currencies and how different nations are using gold to prepare
for the future.
First, the supply-demand story.
For more than a decade, as the price of gold
climbed, miners boosted production for the sake of production by developing
lower-grade mines. Costs climbed across the sector. Estimates vary, but
consensus suggests half of the world’s gold is now produced at all-in
sustaining costs above US$1,200 per oz.
And that’s after several years of cost cutting.
As the gold price declined miners curtailed expansions, reduced sustaining
capital, and improved margins by mining high-grade areas.
These fixes worked in the short term – but now
many mines are in need of repairs, pushbacks, stripping, expansions, and the
breathing room to process lower-grade parts of their ore bodies.
With sustaining capital needed and little fat
left to trim, costs cannot come down much more. That means if the world wants gold
mines to keep producing, the price cannot decline much below current levels.
In addition, we are not replacing reserves anywhere
near as quickly as we’re mining them. SNL Metals & Mining recently reported
that potential future production from major discoveries made over the last 15
years could only replace – at best –
half of the gold produced during
that same period.
After four bear years that ratio has undoubtedly
declined. Exploration spending is down across the board, with grassroots
efforts hit hardest because companies are directing limited dollars to pre-development
projects or operating mines.
Then there’s timing. Today it takes, on
average, 18 years to put a discovery into production. Two decades ago it took
just 8 years. There are many reasons – higher social and environmental hurdles,
more remote locations, higher capital costs, more challenges raising money.
So output is down, exploration is down, and
timelines to production are extended. That is a pretty perfect recipe for
What about demand?
It is strong. North America may have lost its
interest in gold for the moment, but the massive populations in China and India
still love the yellow metal and are buying piles of the stuff. Mainstream
headlines about sagging Chinese gold demand are just plain wrong – imports are
just as strong as they were in last year, when they hit a record 2,200 tonnes.
As for India, the International Monetary Fund
just raised its 2015 economic growth forecast for that country to 6.4% from 6%
and the OECD recently said India is the “only major economy” to see a pick-up
in growth momentum. When their economy does well, Indians buy more gold –
demand is up 39% yoy for Q3. Regulations may curb this, but no certainty on
that as yet.
And when it comes to Indian and Chinese gold
demand, one part of the equation is simple: population. China’s middle class is
expected to grow by 200 million by 2018, to reach 500 million. Based on that
number of rising incomes and growing savings accounts, the World Gold Council
expects Chinese gold demand to increase by 25% by 2017.
That’s mainstream demand. Then there’s central
bank buying – but this is where we leave simple supply-and-demand details and
enter the murkier world of gold as power in a changing world.
The basic story here is familiar: gold is
wealth, pure and simple. When things go wrong, when currencies devalue or wars
disrupt relations or economies falter or governments corrupt, gold holds value.
As the saying goes: He who has the gold makes
the rules. And more than a few nations are stockpiling or securing gold so as
to be in precisely that position as an overleveraged world slides towards a
For years the dollar usurped gold. As the
world’s reserve currency the greenback became the requirement to buy oil and
many metals, including gold, on the international market.
With every nation needing dollars to secure resources,
the US dollar gained value. As the dollar strengthened, the US government
leveraged its dollar stores more and more, taking on piles of debt.
America’s debt became the immense pile it is
because of the greenback’s position as the world’s reserve currency and because
America’s stores of gold backed the dollar’s valuation.
Now China and Russia are leading a push to
dethrone the dollar, by accumulating gold and sidestepping the dollar in deals.
If it works – and China and Putin are pretty good at getting what they want –
the dollar will weaken and gold will climb.
China’s central bank has not reported on its
gold stores in years so levels are not known (last reported at 1,045 tonnes; certainly
larger now) but China Gold Association president and Party Secretary Song Xin
has been vocal that China is working to lift its reserves to 8,500 tonnes.
That is huge! Song outlined why in a recent
Chinese language editorial.
“Gold is a monetary asset that transcends national sovereignty;
is very powerful to settle obligations when everything else fails, hence it’s
exactly the basis of a currency moving up in the international arena,” he
wrote. “When the British Pound and the USD became international currencies,
their gold reserve as a share of total world gold reserves was 50% and 60%
respectively; when the Euro was introduced, the combined gold reserves of the
member countries was more than 10,000 tonnes, more than the US had.
“If the RMB wants to achieve international status, it must
have popular acceptance and a stable value. To this end, other than having
assurance from the issuing nation, it is very important to have enough gold as
the foundation, raising the ‘gold content’ of the RMB. Therefore, to China, the
meaning and mission of gold is to support the RMB to become an internationally
accepted currency and make China an economic powerhouse.”
While it grows its gold store, China is pushing
the renminbi in other ways. For example, the Shanghai Gold Exchange now settles
gold trades in renminbi and the Shanghai-Hong Kong Stock Connect will soon give
foreign investors access to Chinese pubcos and enable Chinese investors to buy
into Hong Kong-listed stocks.
Russia is helping. In the first nine months of
2014 settlements in RMB between Russia and China increased ninefold in annual
terms, according to the Chinese Ministry of Economic Development. BRICS
countries have also been signing currency-swap deals that sidestep the
Russia is not doing this for China’s sake, but
to destabilize the dollar. At the APEC Summit last week Putin said it is his
desire to “end the dictatorship of the dollar”. Pretty clear.
A diminished dollar, and more generally a
global currency reset, would definitely be good for gold. But that’s a future
possibility. In the meantime, Russia is buying.
Russian Central Bank Governor Elvira Nabiullina
announced last week that the RCB bought 150 tonnes of gold in 2014, boosting
its gold holdings to 10% of Russia’s reserve holdings, a tripling in ten years.
The announcement was significant for two
reasons: because the RCB has never before announced its gold purchases and
because that’s a lot of gold. Both point to a Russia trying to devalue the
dollar and promote the yellow metal in its place.
Other central banks are also worried about
currency wars. How do we know? Because instead of keeping it stored in
international vaults, several central banks are bring their gold home.
The latest such move came from the Netherlands,
which surprised the world by announcing it repatriated 120 tonnes of gold from
the vaults of the Federal Reserves in New York to Amsterdam.
That’s 4 million ounces or $5 billion worth of
gold. And the Dutch specifically said they are keeping their gold shipping
route secret “in case more gold needs to be repatriated”.
Why would they need to repatriate their New
York gold? The stated rationale was to restore public confidence in the Central
Bank. That thing is, that means the public only trusts physical gold held
within the country – a complete snub to fiat currencies and to the Fed as a
safe repository of wealth.
The Dutch Finance Minister also noted that,
after the 2008 crisis, the Netherlands looked at re-establishing the guilder if
the euro collapsed. I would posit the Netherlands is not the only EU member to
have a currency contingency plan – and, like China and Russia, every currency
plan starts with gold reserves.
Germany wanted to repatriate a bunch of its
gold from New York too, but the US pressured it endlessly to leave well enough
alone and the Germans gave up. Conspiracy theories abound that German’s gold is
gone. I am no conspiracy theorist but I do know that the physical gold market
is getting tight.
One clear sign: the gold forward (GOFO) rate is
negative. That means traders are paying for the right to trade their cash for
gold; usually they
get paid to hold
gold instead of cash, because gold doesn’t pay interest. A negative GOFO rate
means traders are having a hard time getting their hands on gold.
The rate went negative just as outflows from
gold ETFs slowed down. Those outflows had filled rising Chinese and Indian
demand. Now the question is: who is going to supply the gold?
“We’re starting to sense and we’re seeing it in
terms of the tightness in the metal market here in London that people are
getting nervous about physical gold,” said James Turk, author of the
Gold Money Report
the people or entities who own paper gold are getting nervous about not being
able to convert their paper gold into physical gold.”
The physical gold market is getting tight.
Years of cost cutting have reduced production and made it nearly impossible to
boost output in the short to medium term.
Meanwhile, consumer demand from India and China
– home to a third of the world’s population – remains strong while central
banks are amassing gold, either through purchases or repatriations.
And all of that is happening in the context of
a dollar loaded with reasons to falter, including immense government debts,
dethroning pressure from China, Russia, and others, and trillions of dollars of
QE cash that will leak out once interest rates rise.
Everything is aligning for a gold run. I think
that run has started. The initial stages will come in fits and starts, but the
overall direction will be up and the price will not drop below US$1,148 per oz.
for many years.
Gold’s run will lift gold miners dramatically.
It will also breathe new life into the stagnant metals market, where many other
metals are also facing supply constraints after years of limited exploration
and production cutbacks.
Perhaps I am missing something, or
oversimplifying, or just too hopeful. Perhaps – but perhaps not. If I am right
that we hit bottom on Nov. 5
th, bottom fishers better get their bids
in. If I am wrong – well, things literally cannot get much worse from here
before miners just stop mining, so we have to be really close.
For my rationale on why Nov. 5th was
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