October 2009 Volume 6 Issue 3
Gold/Silver: The First Global Bull Market
Oct 9, 2009
In September 2009, the price
of gold closed at its highest level in history, on a monthly
basis. And this month, gold has reached its all-time highs.
Gold is the only asset category
I can think of that is higher in value/price at the end of September
2009 ($995) than when the crisis began in July 2007 ($665), except
US bonds but that is only due to massive government intervention.
Gold today is higher than the stocks markets in North America,
Europe and Asia during the same period; higher than real estate
virtually anywhere; higher than the US dollar.
Gold has caught investor attention
now that it is holding above $1,000. Barrick Gold (one of the
largest gold miners in the world) announced that it was raising
$3 billion to close its hedge book. Within days it had to increase
the offering to $4 billion!
It is believed to be the
largest primary common-equity offering in Canadian history!
Why the frenzy? Because Barrick
was losing money on its gold hedges as the price of gold rose.
It clearly anticipates that the price of gold is going much higher
and investors appear to concur.
I believe gold is now entering
its parabolic growth phase in the first global bull market in
history that any investor in the world can participate in relatively
Throughout history, investment
booms have been local affairs. A tulip craze going too far mostly
affected just the Dutch in 1637. The South Sea bubble, American
railroads, etc., etc., affected the people of the country involved
and some rich overseas financiers.
The Internet boom of the late
1990s was the first real global phenomenon (ironically, it was
the internet itself allowing information to be transmitted easily
worldwide that helped fuel that bubble) but a non-US investor
still had to have an account with a US broker (or a major global
financial services firm) to participate.
The global stock market and
real estate boom in recent years? How many of you bought significant
amounts of Brazilian real estate or Taiwanese stocks?
But gold? Gold is potentially
the first real global asset bull market. Sure,
oil went from $12 in 1998 to $147 in 2008 but what did that mean
to a peasant in China as an investment? How do you stockpile
barrels of oil under your bed?
Gold did have a major run in
the 1970s. But the involvement of retail investors, the wealth
creation for the middle classes in the emerging markets, the
scale of global investment capital and flow of information is
so different that the mobilisation of capital in gold this time
will be of a different order of magnitude.
Gold (and silver, as gold drives
the price of silver) is different. As a commodity, it is fungible
(it is the same anywhere and interchangeable). It is not primarily
brand differentiated, it is easy to buy and store, it has universal
appeal as jewelry and as a store of value (and as a safe haven).
It does not take any sophistication to buy gold and it can be
done by anyone who has a little bit of savings.
More importantly, if I own
gold, a peasant buying gold in China can directly affect the
value of my holdings through the increase in demand when he buys
it in his local village since we are both holding the same thing!
Until 2003, it was illegal
to buy gold in China under communist party dictat. Since then,
China is set to overcome India as the largest consumer of gold
in the world in six short years (as well as becoming the largest
producer of gold).
Here's another thought from
Richard Russell. The government of China has recently been urging
its citizens to buy gold and silver.
Here's Russell's take on this
(and it's an intriguing one): As workers have been laid off in
factories and are returning to their villages (China's trade
surplus in August 2009 fell 45% from a year earlier), the government
is concerned about the potential for social unrest due to rising
unemployment. If the government believes that gold and silver
are going higher (knowing that it is itself part of the reason
for that to happen), then it makes perfect sense for it to
almost plead with its citizens to buy gold to create a bit of
wealth that might help ensure stability.
I think he's right.
As Cheng Siwei, a top Chinese
Communist party official said at a monetary policy conference
in Italy recently, "Most of our foreign reserves are in
US bonds and this is very difficult to change, so we will diversify
incremental reserves into euros, yen and other currencies. Gold
is definitely an alternative."
Gold rising over $1,000 brings
new investors into the market. It took oil several years to
reach $100 but then it climbed to $147 within five
months as it caught investor attention.
Gold was $665 at the start
of July 2007, when the crisis first began. When markets melted
in Sept/Oct 2008, it fell hard because, as the massive leverage
in the global financial system began to unwind dramatically,
gold was sold to meet margin calls, redemptions, etc.
After bottoming in October,
it started to climb as soon as the selling stopped. It continues
to rise on the back of US dollar weakness, potential inflation
due to unprecedented monetary stimulus, the potential for a double
dip recession, and supply-demand imbalances.
The point is it performed
well during the crisis and it is doing well with the recovery.
(Click on images to
Two primary demand factors
driving investor interest in gold are protection against currency
debasement and future inflation.
The US Dollar is caught in
a vicious cycle. As the US funds its unprecedented intervention
in the economy, it has to print dollars and bonds in gargantuan
supply. As it does this, it lowers the value of the dollar and
risks a potential blow-up of the US debt market through a crisis
of confidence that the debt will become too large to repay.
As the dollar falls, US assets
become less attractive (especially low yielding US debt).
This is why, despite record
low interest rates, the US is not locking in investors by issuing
mostly 20 and 30 year bonds. In Feb 2009, the Treasury Advisory
Borrowing Committee noted that, "The average maturity of
the debt has already fallen from a range of 60 to 70 months which
existed from the mid 1980's until 2002 to a level of 48 months
The red bars in the chart below
represent net Treasury bills issued which have a maturity of
less than 1 year and represent about 45% of net debt issued in
the last year. What this means is that, on top of the enormous
issuance of new debt for which the US must find investors, it
also has to recycle significant amounts of existing short-term
debt that will mature within the next two years.
The Japanese opposition party,
the Democratic Party of Japan, just won the elections. Except
for a brief 8 months in office in the 1990s, they have not been
in power for 55 years!
While I give them credit for
sheer tenacity, it is what the chief finance spokesman told the
BCC during the campaign that is interesting. Masaharu Nakagawa
said he was worried about the value of the US dollar and Japan
would only buy US dollars if they were denominated in Yen - the
so-called samurai bonds.
Interestingly, the BCC report
cited observers as saying that the move would be a remarkable
policy shift but unlikely to happen as the DPJ was not likely
They were wrong and a party
that is far less friendly to US and corporate interests than
Japan's Liberal Democratic Party is now in power.
Japan and China are the two
largest holders of US debt (almost half of the US debt that is
held by foreign governments). While it is in their interest not
to upset the global order precipitously, they are clearly reluctant
buyers of new US debt.
But here's the problem. If
the two largest US debt buyers are likely to go on strike in
the future (China sold a net amount of $26 billion US bonds in
June 2009), and the US is issuing record new levels of debt,
who's buying it?
I suspect that there are simply
not enough buyers to fund multi-trillion dollar new Treasury
issues and the Fed's Quantitative Easing program is acknowledgement
of this reality. So the Fed is stepping in to buy US debt as
needed to keep yields under control.
Gold is responding as a monetary
asset to this currency debasement and the previously unimaginable
levels of stimulus which should translate into much higher inflation.
Warren Buffett predicts that inflation will exceed the levels
we saw in the 1970s (which ran over 20% per annum). Alan Greenspan
is concerned that inflation may swamp the bond market.
On the other hand, in 2008,
despite record gold prices, gold production fell to a 12 year
low! The easy stuff
has been mined, it is harder to find new discoveries to replace
existing deposits that have been mined, and costs have risen.
So, supply from production continues to decline.
Another bullish factor for
gold is central bank sales. In August 2009, 15 European banks
renewed their agreement (CBGA) to limit their gold sales to 400
metric tons a year (which includes the proposed IMF sale). The
current 5 year agreement (which expires Sept 26) was for 500
tons a year, but the banks sold far less than permitted (only
343 tons in 2008 and on course for lesser sales in 2009). So
while European sales are falling, other Central banks (Russia,
China, India, etc.) are increasing gold in their foreign exchange
While stock markets are rallying
and the economy seems to be recovering, the reality is that this
is simply due to massive intervention by governments in their
local economies, based on running record deficits.
In 1937, the Federal Reserve
tried to withdraw its stimulus after the New Deal and the market
promptly crashed. This lesson will not be lost on Bernanke. So
while the G-20 may talk about ending the easing to prevent high
rates of inflation in the future, it is all talk until housing
and employment turn positive.
In fact, Bob Janjuah, the RBS
credit strategist who predicted (in June 2008) that there would
be a global crash in September 2009, has just warned that the
economic data needs to turn positive (not just less bad than
previous periods), or else the markets could crash again in the
fall, with the SP500 dropping to as low as 500, from its current
Stocks of gold mining companies
will leverage the rise in the price of gold as they come out
of an 8 month consolidation. Thus the frenzy for Barrick stock.
And, from now through 2011, gold mining stocks will provide excellent
returns for investors.
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