As usual in these weekly musings we present you with interesting items we’ve come across during the week…
· India buys gold
The big news this week was the purchase of 200 tons of gold by the Central Bank of India…John Maynard Keynes must be turning in his grave at the resurrection of “that barbarous relic”.
· Cost of the Financial Sector Bailout
Max Keiser made an interesting point this week; he suggests that the US Government could have paid off the entire mortgage debt and credit card debt in the US for about 11 trillion dollars – which is considerably less than has been paid out into the financial sector… Compare the stimulating effect of that policy compared to the effect of what has actually been done…
· The Dollar Carry Trade
Last week we talked about the burgeoning US dollar carry trade. The Financial Times has produced a useful little video explaining how this trade works. The link is here.
· Bring Back Bill Black
Professor William Black was the regulator at the heart of the Savings and Loan Crisis of the 80s. He managed to orchestrate the incarceration of hundreds of crooks involved in that fraud – we say that probably the single best thing the Administration could do at this point would be to give Black the authority and the resources to put these modern day Wall St crooks behind bars.
Another one of the nation’s largest lenders has filed for bankruptcy. On the brink for months, CIT filed for Chapter 11 protection on Sunday.
The prepackaged plan allows CIT to restructure its debt while trying to keep badly needed loans flowing to thousands of mid-sized and small businesses. The plan keeps CIT’s operations alive and makes it possible for the company to exit bankruptcy by year’s end.
But here’s the bad news: While senior debt holders will only lose 30% of their investment, we, the U.S. taxpayer, will lose the entire $2.3 billion we lent the company this summer.
William Black, professor at the University of Missouri-Kansas City School of Law is dumbfounded. “We put ourselves on the hook in a completely inept way where we lose first. We lose entirely as the taxpayers.”
Black, a former top federal banking regulator, blames Treasury Secretary Timothy Geithner for negotiating such a bad deal on behalf of the American public.
His argument goes as follows:
The government was in no way obligated to lend the struggling CIT money and, in fact, initially refused to provide it bailout funds. More importantly, being the lender of last resort, the government should have guaranteed we’d be the first to get paid if CIT eventually filed Chapter 11. By failing to do so, “it’s like he [Geithner] burned billions of dollars again in government money, our money, gratuitously,” says Black.
Black believes the problem stems from regulators’ fears that if the banks recognize a loss on the bad assets it will create a domino effect that will wipe out the entire financial system.
“If that’s true we’ve got to get rid of capitalism,” he warns, “because if we can’t recognize losses in a capitalist system we have no future.”
Philanthropist and talented businessman, Pierre Lassonde is recognized as one of Canada’s foremost experts in the area of mining and precious metals. In 1980, Pierre began ten years as President of the gold division of Beutel, Goodman & Company, directing its highly successful gold investment fund.
Pierre co-founded Franco-Nevada Mining Corporation with Seymour Schulich in 1982 and over a 20 year period, provided shareholders with a 36% annualized rate of return. He became post-merger President of Newmont Mining Corporation in 2002 – the world’s largest gold producer. From January to November 2007, Pierre was Vice Chairman of Newmont Mining Corporation.
In 2008, Pierre led a group of investors in bringing back Franco-Nevada to the public market and became its chairman. This week on King World News (link www.KingWorldNews.com ), Eric interviews this colossus of the mining and resource world. Now, over the years, Pierre has made a number of astonishingly prescient calls on the gold market. When a person of his stature offers us his viewpoints on gold and silver investment, it pays to listen carefully. I would urge that everyone interested in precious metals investment check out the complete interview; however we present a summary of the contents below.
Paraphrased summary of the interview:
The purchase of 100 tons of IMF gold by the central bank of India this week is a seminal event in the gold market. This event is reminiscent of the 60s and 70s when gold was a financial instrument and central banks were big buyers of gold. In fact in 1980, central banks bought 2/3 of the entire world’s production of gold. This year, for the first time since 1980, the gold jewelry market will be smaller than the gold financial market. Along with this, for the first time in 20 years, central banks are becoming net buyers of gold rather than net sellers.
To consider the relationship of the gold market to financial markets in general, the single best tool is the Dow/Gold ratio. The vertical scale on the charts below is a log scale.
This ratio indicates the periods of time when it was best to be invested in financial instruments or hard assets.
Notice that between 1980 and 2000 the ratio went from 1 to over 42. This was a fantastic period of time to be invested in financial assets. Notice also that the low value of this ratio was 1.
The Dow/Gold Ratio chart shows the ratio of the price of the Dow to the price of gold. Another way to look at it is the number of ounces of gold it takes to buy one share of the Dow. For example, with the Dow at 10,000 and gold at 500, it requires 20 ounces of gold to buy one share of the Dow, so the ratio is 20. The reason for using gold to measure the value of the Dow is that gold is the most unbiased form of money in existence. Fake government paper money comes and goes, but gold has been money for thousands of years. It is the ultimate store of wealth.
Notice on the second chart that the ratio has been declining steadily since around 2000 down to a value now less than 10. In previous hard asset cycles, the ratio reached as low as 1. Pierre is of the firm belief that this current hard asset cycle – due to last another 5-10 years – will also see a value of about 1 for the Dow/Gold ratio. The US, EU and GB governments are all printing money and thereby devaluing their currencies against gold.
The trend for the next few years is for the price of gold to go up – certainly with hiccups now and then, but the overall trend will be up.
We are now in phase 2 of a normally three phase bull market in gold (and commodities in general). Will there be a manic phase 3 this time around? One thing we know for sure; the Chinese citizenry are being encouraged by their government to buy gold and silver. The Chinese government is sitting on over two trillion US dollars in reserves, and the last thing they want is for their citizens to buy more of the same. In fact Chinese consumption of gold is up 16% this year. Given the predilection for the Chinese to gamble, and the casino quality of the Shanghai exchange, it is highly likely that a mania will develop in gold trading there as the price moves higher.
Now let’s turn our attention to gold mining shares. Quality gold mining stocks are currently undervalued with respect to $1100 gold. Most portfolio managers are underinvested in gold and commodities in general. Many are reluctant to move into the market because of the four-fold run-up already.
On the supply side of the industry, there is consistently less gold being produced year by year. One of the reasons is that funding for junior exploration companies has dried up almost entirely as a consequence of the financial crisis. The situation now is that new supply can’t emerge in any significant quantity over the next 5 years.
Large companies are being forced to bring marginal properties into production. At some stage, likely soon, larger companies will start acquiring smaller ones. Eventually the intermediate sector will be hollowed out.
If you want to get into this market, a good approach is to dollar cost average – don’t try to pick the lows – just assign capital by degrees over time to quality companies. Pierre feels that the seniors are at present the most undervalued.
Royalty companies, like Royal Gold and Pierre’s own Franco-Nevada, look particularly interesting plays.
The bottom line is that we are in a hard asset cycle now – don’t be invested in paper assets; you are likely to get smashed.
Now let’s consider the energy market.
The production of conventional oil (light sweet crude) peaked in 2005. From now on, incremental demand must be met with sour crude and more expensive unconventional sources.
In China, from 2010 onward, every new gas station must be equipped with a natural gas refueling port. The Chinese see the writing on the oil wall – they are preparing for a transport fleet to run on natural gas.
From now on world oil demand will be curtailed by higher prices. Pierre agrees with James Dines and others that this marks the end of the cheap fossil fuel age.