by David Galland: The
the news most days, it's hard not to feel like Bill Murphy's character
Day. In the event you are unfamiliar with the movie, in
it Murphy's character becomes trapped in the same day
In the current
circular condition, we have the powers-that-be assuring us that
the next high-level meeting will finally produce a permanent fix
to the broken economy, essentially solving the sovereign debt crisis.
Then, in no more than a few days, or at most a couple of weeks,
the fix is revealed to be flawed and the crisis again sparks into
flames. Followed shortly thereafter by yet another high-level meeting
and the cycle begins anew.
While the characters
may change one week it is Greece, the next it is Spain, the next
it is France, the next it is the US, the next it is Greece again,
etc., etc. ad nauseam the detached observer who steps back to
a distance sufficient to view the larger picture can only come to
the conclusion that we are now well outside of the bounds of the
normal business cycle.
As we here
at Casey Research have written on this topic at great length, I
don't intend to dwell on this topic today, but I did want to loop
back in just long enough to comment on the recent price action in
commodities, especially gold, in the face of the continuing crisis.
Today, a glance
at the screen reveals that gold is trading for $1,565. For comparative
purposes, as revelers warmed up their vocal chords to sing in the
New Year on the last trading day of 2011, gold exchanged hands at
$1,531. And exactly one year ago to the day, gold traded at $1,526
for a one-year gain of a modest 2.6%.
A year ago,
the S&P 500 traded at 1,325, while today it trades at 1,318,
a small loss. Yet, have you noticed we don't hear much about the
imminent collapse of the US stock market, as we do about gold? This
perma-bear sentiment about gold on the part of what some people
lump together under the label "Wall Street" is especially apparent
in the gold stocks.
Using the GDX
ETF as a proxy for the sector, we see that the shares of the more
substantial gold producers are off by an unpleasant 24% over the
last year. More on the topic of gold shares momentarily, but first
let's round things out by also looking at the price action of a
couple of other core components of the global economy.
a year ago, a barrel of WTI crude sold for a tick over $100. A couple
of weeks ago, it was still selling for $102, though it has slid
a bit to $91 today. Even so, that is still considerably higher than
where it traded as recently as New Year's 2008, when it was just
$38 per barrel. Since that low, the price of oil has made a steady
advance and for the last year and a half has traded right around
is the matter of base metals. Copper, for example, traded at $8,980
per tonne a year ago, and is today at $8,289, a loss of almost 11%.
Likewise, the iron ore price is off by 15% over the last year, and
zinc is off by 13%. Even the minor monetary metal with industrial
applications, silver, is off 8.39%.
With that "baseline"
in place, I would like to now turn to the current outlook for gold,
and touch on some of the other commodities as well.
In the context of its secular bull market, and given that absolutely
nothing has gotten better about the sovereign debt crisis only
worse gold's correction is nothing to be concerned about.
I know the technical types will point to levels such as $1,540
as important resistance points and there's no question that
if gold was to break decisively below that level, and especially
below $1,500 that a lot of autopilot trades would kick in and
put further pressure on gold.
Yet, when you view the market through the lens of hard realities,
which is to say, by focusing on the intractable mess the sovereigns
have gotten the world into
in Europe, in Japan, in China and
here in the US
then viewing gold at these levels as anything
other than an opportunity is a mistake.
Stocks. As far as the gold stocks are concerned, I consider
today's levels to be extraordinarily compelling for anyone looking
to build up a portfolio, or to average down an existing portfolio.
I say this for a number of reasons, starting with the contrarian
perspective that this may now be the most unloved sector of the
stock market. No one wants anything to do with gold stocks, and
hasn't for some time now. As a consequence, the sellers will soon
dry up, leaving almost nothing but buyers to push the sector back
to the upside.
This contrarian perspective is important because in today's world
literally thousands of competent equities analysts plop down at
the desk each trading day with the sole purpose of searching for
prospective investments. Many of these analysts are backed by
huge firms with billions of dollars at risk in the markets, and
so are armed with high-powered computational tools of the sort
that was unimaginable even a few years ago. All of these analysts,
armed with all their computational power, habitually scan a universe
that totals about 4,000 publicly traded companies. Realistically,
however, even a thin analytical screen will weed out all but perhaps
400 of those companies as being potentially suitable for investment.
Thus, you have thousands of high-priced and well-armed securities
analysts crunching pretty much the same data on a very small universe
of possible investments. Given this reality, is it any surprise
that securities are so tightly correlated? Which is to say, is
it any surprise that these securities all trade right in line
with the valuations that the analytical screens ultimately derive
that they should? Which means there are really only two possible
circumstances under which any of these stocks move up, or move
down, by any significant degree:
market movements. The saturated levels of analysis mean
that, within a fairly tight range, all the stocks now move more
or less together. Thus, with few exceptions, a big upswing or
downswing in the broader market will send almost all stocks up
or down together. To help make the point, I randomly pulled a
chart of IBM and compared it against SPY (the S&P 500 tracking
ETF) for the last year. Note the lockstep price movements:
- OK, IBM
is a big company, so it will have a lower beta than many companies,
but the point remains that saturated coverage of the stocks greatly
reduces the odds of any one issue breaking free from the larger
herd, unless there is
surprise. All of these analysts, and all of their computerized
analysis, help form a certain future price expectation for each
security based on past financial metrics (earnings growth, return
on equity, and so forth). Other than the broad market movement
just referenced, or moves in line with a sub-sector of the larger
market (e.g., if oil falls, oil-sector stocks will move up or
down in sync), for a company to deviate in any substantial way
from analyst expectations, by definition requires a "surprise"
Of course, such a surprise can be positive, but because these
companies are so closely watched, it is more likely to be negative.
In the former category, a positive surprise might come in the
form of an unexpectedly strong new product launch α la the iPad.
In the latter, less happy category of surprise, it can be the
blow-out of a big well in the Gulf of Mexico
or any one of a
million other unanticipated vagaries of fate.
recognizing these fundamental realities is important because it
points to where above-average market opportunities are most likely
to be found (or not). And that brings us back to the whole idea
of being a contrarian. As I mentioned, "Wall Street" has never much
liked the precious metals, and by extension the gold stocks. Given
the length of the gold bull market which, in our view, reflects
systematic risk in all the fiat currencies, but which Wall Street
views as an indication of a fatiguing trend confirmed by the underperformance
of the gold stocks traditional portfolio managers are unhesitant
in giving the boot to the few gold shares that somehow made it into
their portfolios against their better judgment.
If our thinking
is not clouded by our own bias, then it would behoove us as good
contrarians to buy these shares from the eager sellers at such unexpectedly
favorable prices. So, is our own bias leading us to believe in gold
and gold stocks when virtually the entire army of analysts won't
even consider them? Some inputs:
prices remain near historic highs and that has a significant
impact on the bottom line of the gold producers. Barrick Gold
Corp. (ABX), for example, currently boasts a profit margin of
over 30%, better than twice that of IBM and almost ten times that
of Walmart. While ABX sells for just 1.6 times its book value,
IBM sells for 10X.
rates remain at historic lows, producing a negative real return
for bond holders. Unless and until investors are able
to capture a positive yield a potential stake through the heart
of gold there is no lost-opportunity cost for holding gold.
And bonds are increasingly at risk of loss should interest rates
be pressured upwards, as they inevitably will be.
money printing continues because it must. In today's
iteration of Groundhog Day, the Europeans are once again
meeting in an attempt to fix the unfixable, but the growing consensus
because there is no other realistic option left to them is
that they will have to accelerate, not decelerate the money printing.
Ditto here in the US, where a fiscal
cliff is fast approaching due to the trifecta of the expiring
Bush tax cuts, mandated cuts in government spending from the last
debt-ceiling debacle and the new debacle soon to begin as the
latest debt ceiling is approached. The problems in important economies
such as China and Japan are as bad, and maybe even worse (in the
Weekend Reading section at the end of this edition
is a very worthwhile article on the Chinese economic slowdown.)
at all levels remains high. With historic levels of debt,
rising interest rates are a no-fly zone for governments, because
should these rates go up even a little bit, the impact on the
economy and on the ability of these governments to meet their
obligations would be dramatic and devastating. This fundamental
reality ensures a continuation of policies aimed at keeping real
yields in negative territory, meaning that the monetization/currency
debasement in the world's largest economies will continue apace.
To get a sense of just how bad things are and how soon the wheels
might come off, sending gold and gold stocks to the moon
as governments throw all restraint in money printing to the wind
to save themselves and their overindebted economies here's a
telling excerpt and a chart from a recent article by Standard
& Poor's titled, The Credit Overhang: Is
a $46 Trillion Perfect Storm Brewing?
study of corporate and bank balance sheets indicates that the bank
loan and debt capital markets will need to finance an estimated
$43 trillion to $46 trillion wall of corporate borrowings between
2012 and 2016 in the U.S., the eurozone, the U.K., China, and Japan
(including both rated and unrated debt, and excluding securitized
loans). This amount comprises outstanding debt of $30 trillion that
will require refinancing (of which Standard & Poor's rates about
$4 trillion), plus $13 trillion to $16 trillion in incremental commercial
debt financing over the next five years that we estimate companies
will need to spur growth (see table 1).
(Click on image
You can read
the full article here. While the authors of the S&P report
try to find some glimmer of hope that roughly $45 trillion in debt
will be able to be sold off over the next four years even their
base case casts doubt on the availability of the "new money" shown
in the chart above. Note that this is the funding they indicate
is required to fund growth. Which is to say that should the money
not be found, the outlook is for low to no growth for the foreseeable
It is also
worth noting that the analysis assumes that something akin to the
status quo will persist which is very unlikely given the pressure
building up behind the thin dykes keeping the world's largest economy's
intact. The landing of even a small black swan at this point could
trigger a devastating cascade.
We have said
it before, and we'll say it again: there is no way out of this mess.
At least not without acute pain to a wide swath of the citizenry
in the world's most developed nations. While this pain will certainly
be felt by sovereign bond holders (and already has been felt by
those who owned Greek issues), it will quickly spread across the
board to banks, businesses and pensioners in time wiping out the
lifetime savings of anyone who is "all in" on fiat currency units.
In this environment,
gold isn't just a good idea it's a life saver. And gold stocks
are not just a good contrarian opportunity, they are one of the
few intelligent speculations available in an uncertain investment
landscape. By speculation, I mean that, at these prices, they offer
an understandable and reasonable risk/reward ratio. Put another
way, every investment even cash has risk these days. With gold
stocks, you at least have the opportunity to earn a serious upside
for taking the risk
and the risk is much reduced by the correction
over the last year or so.
Now, that said,
there are some important caveats for gold stock buyers.
access to capital likely to dry up, any gold-related company you
own must be well cashed up. In the case of the producers,
this means a lot of cash in the bank, strong positive cash flow
and a manageable level of debt. (Our Casey BIG GOLD
it risk-free here constantly screens the universe of larger
gold stocks for just this sort of criteria, then brings the best
of the best to your attention.)
In the case of the junior explorers that we follow in our International
Speculator service (you
can try that service risk-free as well), the companies we
like the most have to have all the cash they need to clear the
next couple of major hurdles in their march towards proving value.
That's because a company can have a great asset but still get
crushed if it is forced to raise cash these days
and the situation
will only get more pronounced when credit markets once again tighten
as the global debt crisis deepens.
of political risk. Despite the critical importance of
the extractive industries to the modern economy, the industry
is universally hated by politicians and regular folks everywhere.
If your company production or exploration has significant
assets in unstable or politically meddlesome jurisdictions, tread
carefully. And it's important to recognize that few jurisdictions
are more politically risky than the US. This doesn't mean you
need to avoid all US-centric resource stocks but rather that
you need a geopolitically diversified portfolio that you keep
a close eye on at all times (something we do on behalf of our
paid subscribers every day).
your companies. Some large gold miners are also large
base-metals miners. And at this juncture in time, personally I'm
avoiding base-metals companies like a bad cold. While most base-metals
companies have already been beaten down and hard over the
last year and a half, the fundamentals remain poor. Specifically,
they not only have the risk of rising production costs and political
meddling, but unlike gold where the driving fundamental is its
monetary role in a world awash with fiat currency units the
base-metals miners depend on economic growth to sustain demand
for their products. In a world slipping back into recession
or perhaps, in the case of Japan and China, tripping off a cliff
betting on a recovery in growth is not a bet I'd want to make
on longer than anticipated, I will now edge for the exit on this
topic by pointing out that while it is hard to accurately predict
the timing of major developments in any one economy, let alone the
global economy, there are a number of tangible clues we can follow
to the conclusion that the next year will be a seminal one in terms
of this crisis.
there is the next round of Greek elections on June 17, the result
of which is likely to be the anointment of one Alexis Tsipras as
the head of state. An unrepentant uber-leftist whose primary campaign
plank is to tell the rest of the EU to put their austerity where
the sun doesn't shine, the election of Tsipras would almost certainly
trigger a run on the Greek banks, followed by a cut-off of further
EU funding and Greece's exit from the EU. And once that rock starts
to slide down the hill, it is very likely that Spain and Portugal
after that, who knows? As I don't need to point out
(but will anyway), June 17 is right around the corner, so you might
want to tighten your seat belt.
A bit further
out, but not very, here in the US we can look forward to the aforementioned
fiscal cliff. Or, more accurately, the political theatrics around
the three colliding co-factors in that cliff (the approach once
more of the debt ceiling, the expiring tax cuts and mandated government
spending cuts). While the outcome of the theatrics has yet to be
determined, it's a safe bet that the government will extend in order
to pretend while continuing to spend and by doing so, signal in
no uncertain terms that the dollar will follow all of the sovereign
currency units in a competitive rush down the drain.
line: Be very cautious about industrial commodities as
a whole, at least until we see signs of inflation showing up in
earnest, but don't miss this opportunity to use the recent correction
to fill out that corner of your portfolio dedicated to gold and
I own some silver investments and believe it will do just fine over
time but I see no big rush to build a bigger position today as
the metal's industrial applications are likely to be a drag on its
price for the next little while.)
May 28, 2012
is the managing editor of Casey
© 2012 Casey
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