14 Karat Facts About Gold
Considering the big breakout in gold, I thought I would share some of the tidbits I gleaned from a meeting with UBS's gold commodity strategist and gold stock analyst, both of whom I had the pleasure of meeting with recently.
1) Commodity gold futures open interest is at record highs, with speculative (non-commercial) positions likewise at all-time peaks. This would normally be considered bearish.
2) The current gold rally has been narrower than the spring run up. Gold coin buying is well off the speculative highs of last year, when UBS's gold coin supplies were sold out. Many "macro" hedge funds were not particularly long gold when it ran away to the upside in recent months. They are potentially "waiting for a chance to get in."
3) Gold is no longer a risk mitigation trade as it was during the financial meltdown, but rather a risk-taking asset, which rallies when the stock market rises.
4) Gold is historically a very poor investment....except when inflation is rising.
5) Gold has performed less well in non-dollar terms during the current rally vs. the run up in the face of a strong dollar which took place in the spring.
6) Gold has become a weak dollar trade. UBS sees a pullback in gold coming unless the dollar gets materially weaker from here. The dollar is not too far off its pre-Lehman failure bottom.
7) Commodity futures traders appear to be taking positions in gold ahead of expected CFTC rule-making relative to speculative position sizes in energy commodities, believing that there is unlikely to be a political backlash against gold speculation (a victimless crime), thus leaving gold as the sole alternative for inflation hedgers and trend following commodity trading advisors (CTAs).
8) Gold stocks have been trading at a premium to the value of the gold they have in the ground (NAV). This has motivated gold company managements to sell shares to pay the cost of closing out hedge books (which limit the upside to their NAVs from higher prices, but cap their downside) in order to get that NAV multiplier on a bigger un-hedged asset. They are essentially selling the value of their gold at a premium in stock markets, to buy back hedging contracts in the futures market.
9) Contrary to "gold bug" rumors, China is not promoting gold ownership to its populace. However, they have liberalized gold ownership rules in the last decade. There is a government-owned enterprise that fabricates gold bars and they are running consumer directed advertising, though they are independently operated.
10) John Paulson's hedge fund has been offering a "gold share" option, where investors' returns are indexed to gold (hedge funds return + or - the return on gold vs. a basket of currencies). This option is being offered due to investor requests.
11) Gold prices peaked a couple of years after oil prices during the last great commodity bull market of the late 70s and early 80s.
12) Gold production of 2,500 tons/yr. is only a drop in the ocean of existing gold supply. It compares to 30,000 tons of gold held by investors, 30,000 tons held by central banks and 90,000 tons of gold jewelry owned by consumers. New jewelry demand equates to about 2,000 tons per annum. Increased investment demand for gold is generally satisfied by gold scrappage as owners of old jewelry "cash in" their gains.
13) The IMF is offering to sell 240,000 tons of gold. If China were to buy it, it would be considered a slap at the U.S. Treasury and the U.S. government's profligacy.
14) A proliferation of gold share classes offered by hedge funds would be a huge boost to investment demand, if it became a big trend.
The author has recently sold about 25% of his gold position, which should be taken as an all clear sign for the commodity to go much much higher.
Posted by sechel
Sun Oct 11th, 2009 06:23 AM
Only #7 was interesting....
Posted by rootless cosmopolitan
Sun Oct 11th, 2009 06:42 AM
Jeff,
This is very interesting. Giving sources for all these factoids would be helpful for dummies like me for further research, e.g. where do I get such information on the amount of gold production a year, how much gold is being held by the different parties, or the demand for gold to be used as commodity in production? But also for the other points. Thanks.
rc
Posted by mh23
Sun Oct 11th, 2009 08:08 AM
I am no expert on gold, and in fact I made my first foray into GDX and SLV about six months ago based, in part, by the arguments proffered by Noah. I have since sold my GDX, but bought GLD and added to SLV, and I have done a good bit of research into gold and when and why it performs well. One point I would take issue with is when you say that gold does well during periods of "inflation". That is not correct, Mish, who I am sure you are familiar with, has made a compelling, if not irrefutable, argument that gold does best during periods of "DEFLATION", or times of crisis, if you prefer. I would refer you to his site for the full text of his argument.
All that being said, now is a time to watch these precious metals closely. If fears about a currency crisis continue, they will rise, if the dollar rallies in a meaningful way (witch I believe will happen in the next few months) they will fall.
I did appreciate your other observations and found them most helpful.
Posted by stephane
Sun Oct 11th, 2009 12:03 PM
Gold is NOT an inflation hedge. It is a CURRENCY RISK hedge (you can have inflation w/o currency risk like in the late 90's)
That's why it does well in CURRENCY PB INDUCED inflation/deflation. like at this time.
we face a SERIOUS currency event (devaluation), in the US at THIS TIME.
Asking gold advice from UBS is akin to asking the mafia about trash collection in Brooklyn. Is this a cruel joke or unbelievable naivete.Who owns UBS?
GDX and CEF are good. GLD and SLV are scams (they own only a portion of the PM they claim).
Step 1 is PHYSICAL OWNERSHIP (as in coins).
It WAS a mistake to sell (physical ownership makes it harder to fall for this trap)
Posted by henry
Mon Oct 12th, 2009 04:36 AM
http://canon.ibibo.com/jokchari/Selling-Gold-May-Help-with-Financial-Times.html
Posted by henry
Mon Oct 12th, 2009 04:39 AM
http://canon.ibibo.com/jokchari/Selling-Gold-May-Help-with-Financial-Times.html
Posted by Alexis Jameson
Mon Oct 12th, 2009 05:49 AM
Really good information ! Thanks a lot for this useful post !Good post!
You should write more about this!
Posted by Jeff Bernstein
Mon Oct 12th, 2009 09:13 AM
All the info in the article came from UBS - sorry if that was not clear. As far as gold's performance goes, the analysis UBS showed was an efficient frontier. Does gold improve the performance of a portfolio of stocks, bonds and cash on a risk adjusted basis. The answer is that it only helps in an inflationary environment. In a deflationary environment bonds kick the pants off gold with less volatility. Maybe it will be different in the future, but that's what UBS' study showed.
Posted by Fred
Mon Oct 12th, 2009 10:49 AM
I'd like to point out that last Wednesday when the USD was sliding hard, several Asian central banks, including South Korea, Singapore, Thailand and the Philippines, all intervened to purchase the greenback. Why? Everyone loses, especially China, if the US market becomes too expensive to sell into relative to the USD's purchasing power. In other words, it's not about fiat currencies, but consumer spending / access to markets and trade balance. The latter of course is the big poison pill against any country, China especially, who thinks it's in their interest to not defend a relatively strong, stable USD. Granted, China may just think it can grow sans the US market but I think they would be idiots to pursue that trade strategy too far and all indications are that China is desperate to maintain FDI inflows and a weaker yuan. Remember, the great asset of the US is innovation via free market enterprise; China has people and coal and possibly an aircraft carrier or two in the works......Jeff, quick question: the IMF has 240,000 tons of gold? Is that accurate? thx.
Posted by anonymous
Mon Oct 12th, 2009 12:39 PM
All this speculation about gold means that all of these past trends are mostly irrelevant. Speculation can drive the asset in any direction, and will most likely end with a crash. (I wish I could predict when.) All of this efficient frontier crap is also useless. It's analysis like this that told us that all real estate markets couldn't fall in tandem because of negative covariance, etc. It works in the short run because everybody beleives in it and invests off of it, but in the long run, it always breaks down and proves irrelevant, especially because asset volatility is a poor proxy for risk premium.
Posted by bird watcher
Mon Oct 12th, 2009 02:18 PM
the imf does not have 240,000 tons of gold. not even close - more like 3,217 tons. to my knowledge, the US is the largest holder of gold in the world.
http://www.imf.org/external/np/exr/facts/gold.htm
Posted by Fred
Mon Oct 12th, 2009 02:37 PM
Birdwatcher, thanks. thought it seemed way high. i would also add that the gold held by Treasury has a cost basis of like 1/20th current market so the reported values way underestimate its worth.
Posted by In Debt We Trust
Mon Oct 12th, 2009 09:03 PM
Jeff,
Can you address the issue of debt vs. equity? After all, aren't equities also an inflation hedge (judged in nominal terms).
The big question a lot of people are asking now:
Is it time to shift from buying debt to buying equities?
Suppose for argument's sake that yes it's time to load up on stocks and dump bonds:
In that case, co.'s will spend more on the things typically associated w/expansion - e.g. stock buybacks, dividends, pickup in m+a deal flow, cap investment, and (always lastly) increase hiring. All this activity will be reflected on a co.'s balance sheet and industry publications.
Here is the kcicker - till now, the corp bond mkt has favored the big names while equities have favored total trash (see zerohedge daily rants about casinos, pool cleaning companies, pet hotels, ec.)
If you believe in worldwide recovery then sell bonds and buy stocks. But if you are a believer in the opposite camp, well treasuries on a dip is your style right?
For my part, I highly doubt we will see the corp expansion - we are entering the new normal phase described by mo-el arian of pimco. All the bullish valuations are the result of carry trades in the dollar and pound (for industrial metals).
Certainly in the corporate legal world, deals are not happening w/the frequency that they used to (unless you are in bankruptcy practice).
*(Apologies b/c I am copying my question wholesale from accrued interest, bond guru, where I asked him the same thing)
Posted by geoff
Tue Oct 13th, 2009 09:04 AM
Jeff,
Question about #8. If I understand you correctly, you are saying that gold companies are selling treasury stock because the stock market is offering a premium. Makes sense, but to which companies are you referring? I haven't seen any sec filings regarding this (although i don't know if the companies would be required to file). thanks.
Posted by Larry Nusbaum
Tue Oct 13th, 2009 05:12 PM
I am a bit surprised that no mention was made about the large sums of money that have poured into Gold ETFs such as GLD as well as closed end CEF.
I actually thought that mining shares have lagged badly as a result of the money held in ETFs. And, too many Jr.s performed even worse.
The commodity bull market cycle that lasts 9 years and occurs every 30 years is due to end in 2010.
What is amazing to me is that if gold only reached $1000 during the greatest financial Armageddon of our lifetime then what real chance does it have to reach $2000 or $2500?
Posted by jeff
Sat Oct 17th, 2009 08:37 AM
Sorry for the late replies guys. Anon - point taken regarding backward looking analysis that goes into thinks like risk models and efficient frontier analysis. What happened in the past is not a very good indicator of the future and ultimately assets that seem un-correlated become correlated very quickly when their is a shortage or excess of money. I was simply relating the analysis I heard. As far as the gold equity offerings I believe that they happen to have been foreign issuers Canadian and South African I believe and those markets do have a number of gold equities.
In Debt - regarding the question of stock market returns vs. inflation, I will take a stab at a likely.n unsatisfying answer. My guess is that in a period of controlled inflation ownership of equities, particularly those that make hard goods, and or hold inventories of hard goods should provide some protection. Will service businesses benefit from inflation?? not if they don't have pricing power...generally driven by wage inflation....which I would not worry too much about in the current environment. But if you make steel to sell to an international market and steel prices are rising in dollar terms, the inventory carry gives the company inflation participation. However, inflationary environments eventually are followed by rising interest rates (as do very weak currency markets) which is kryptonite for stocks, so stocks will protect against inflation until they get hammered by higher rates. However, in a hyper-inflationary environement that comes from currency devaluation/debt crisis my bet is stocks get killed and give you no protection. Gold or foriegn currency is probably a better bet.