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  1. Benjamin Cole

    I think gold is dead for many years to come.

  2. DorganG

    Just because gold took a hit, this does not mean that gold is dead. Stocks were beaten similarly in 2008/2009 or in September 2011 with. Gold took its last big hit in December 2011, everybody like you was disappointed. Warren Buffet typically uses the weak and volatile moments to buy equities, “when people think that equities are dead for many years.” We do the equivalent for gold.

    Gold is similarly to stocks an investment that is driven by fundamentals over the longer-term and not by sentiment. Algorithms drive asset prices on day to day basis so that they react to fundamental data (e.g. trade balances, GDP growth). If the fundamentals are good for gold then gold rises, if they are bad then it falls.

    Still one point: Given low global growth, stocks are overvalued. Given inflation risks, bonds are overvalued. What does remain?

  3. Whisper

    This article is certainly an improvement compared to your rather weak article on the so called gold initiative. With all due respect, this blog offers great insight on the CHF and the SNB, but in terms of monetary metals it needs to do more homework.

    First I wanna give some input on the gold initiative article: The gold initiative has it’s intellectual roots in the book “Gold Wars” by Ferdinand Lips, a former executive for the Banque Privee de Rothschild Suisse. It contains of whole chapter on the stupidity of the Swiss federal government and the SNB apparatchicks. In your article, you missed the point about repatriation which would mean that the SNB can no longer lease gold into the market via the NY FED, the BOE in London and their private sector partners JPM and HSBC. Leasing (or even selling) is the only reason to “store” gold abroad in the post cold war age. It’s also the only reason why the German Bundesbank needs 7 years to repatriate a few hundred tons form the NY FED. The impact of a de facto gold standard (at least 20% of reserves in gold, all the time) on the IMF membership of Switzerland was also not understood in that article. If the IMF interprets it’s own charter strictly, Switzerland would have to be expelled. IMF members are not allowed to run a gold standard, thanks to the Keynesian mindset of the IMF. You also didn’t properly explain the impact of potential gold purchases on the EUR/CHF exchange rate in my humble opinion. If the SNB would just use it’s abundant fx reserves, especially EUR, there would not be an impact on EUR/CHF but rather just on XAU/EUR and XAU/CHF, ie gold would go up in both of these currencies.


    Moving over to the current article:

    CPI/gold correlations aren’t very close, as you stated. Gold is not so much a hedge against inflation, but rather against financial repression, ie negative real interest rates. The correlation with the US debt ceiling derives from that, because debt couldn’t grow that much without negative real interest rates. Interest rate costs would limit deficit growth. The FED has now ensured that interest rates can’t be positve in real terms for a long time, because it would mean an imminent debt crisis for the US government otherwise. They’ve taken a one way street called ZIRP and there’s no way to turn arround without blowing up the system. If ZIRP isn’t enough to keep real rates negative, they resort to QE/printing money.

    I’m missing the primary reason why neither gold nor silver prices are going to fall substantially over an extended period of time in your article, though: it’s production costs. It’s hard to believe it after a straight 12 year run, but gold mines have been spending arround $1200-1250/oz last year on average. The high cost producers (top 10% of mine supply) are already deeply underwater right now. Costs had a CAGR of 16.7% over the last five years, rising faster than spot prices. Out of the major gold miners, only Agnico Eagle had positive free cash flow in 2012, with average gold prices way above $1600 (read Hinde Capital’s research on that). The two biggest companies in the industry, Barrick and Newmont were cash flow negative in 2012. The major silver miners had costs arround $23.5 in 2012 (read a great seeking alpha series on that). That explains why the mining shares have underperformed the metals since 2008. They are not making money, because cost inflation is outpacing price appreciation. Even for stable profits yoy, miners need either rising prices or increased production. On the other hand, mining industry participants with fixed cost structures like royalty and streaming companies (FNV; RGLD; SAND; SLW) have outperformed the metals. The diversion between the perfomance of the miners vs the royalty and streaming companies is the best proof for my thesis.

    Now one might say that costs could go down. I don’t think so (watch Pierre Lassonde’s 2012 presentation at the Denver Gold Conference for the following):

    1.) Granted, oil prices could fall. Oil makes up about 25% of costs. That could lower costs. But oil production costs have risen, too. Some say $60/b is the floor. Many OPEC countries, including Saudi Arabia, Iran and Venezuela would collapse socially at $60, though. The ruling classes in these countries can’t maintain their dictatorships with 30-40% lower oil revenue.

    2.) Ore grades (grams of metal per ton mined) will not rise. They have been falling from about 2g/t of gold in 2000 to 0.5g/t currently. This means it takes four times the material to mine the same amount of oz.

    3.) Lower ore grades means bigger projects, means longer development and permitting, means higher IRR/p.a. required to attract capital, because investment horizons are longer and take longer to produce profits.

    4.) Gold exploration during the last decade was one huge desaster. The industry spent record amounts of capital on exploration and yielded minimal discoveries. Replacing depleted reserves is going to very difficult.

    5.) Many major projects are located in developping countries with rampant wage inflation. South Africa is just the tip of the iceberg. Wages are weighing heavily on mining costs. Populists might also nationalisze mines and disrupt production due to their incompetence in running a corporation.

    With regards to your preference for silver over gold: That is a dangerous bet. It has pros and cons.

    a. Cons: Silver is a hybrid. It’s not just a precious/monetary metal, it’s also an industrial metal, too. This is the reason for it’s intensifying correlation with copper. Both copper (LME, COMEX) and silver (COMEX) inventories have grown substantially over the last year. The copper market is on the verge of a breakdown below $3. The chart pattern looks like classical head and shoulders formation. Economic indicators have signalled a global slowdown for a while. If Dr. copper breaks down, it’s gonna drag silver with it. The high silver inventories are going delay the effect of the fact that silver would be trading below production costs.

    b. pros: If gold turns higher due to record physical demand whiich is already recognizable in rising premiums and a flattening forward curve at the LBMA, silver tends to follow with leverage. Speculative short (COMEX futures) positions are relatively high which could trigger a short squeeze.

    If you trade options, you could open a straddle trade (1 atm call AND 1 atm put) in silver, ie bet on volatility rathen than just on rising prices. The risk/return profile seems to be much better on that one. I’d use a 9-12 months duration and Amercan options for the sake of


    Anyway, thanks for writng this blog and have a nice weekend.

  4. DorganG

    Thank you, for the first comment on the IMF see

    As I state in the summary, factor 5 – I call it now explicitly “financial repression” – is the most important factor. Still I insist that the inflation hedge in emerging markets has an often overlooked importance on demand.

    Thank you for the insights on production costs. I already added before some details to the first part of the article. citing sources that the minimum is around 1000$, but the price could fall temporarily under production costs.

    As for your investment recommendation, I also think that volatility will be continue to be high. In times of high volatility, options are more expensive. The point when you should buy the volatility was maybe earlier.

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