Freddie’s Loss is Gold’s Gain
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by John Lee, CFA
August 22, 2008 Sometimes people are so caught up in short-term action that we don’t look at the long-term picture.
I have said it before: gold goes up not because of inflation (defined as money supply growth), but because of a loss of confidence of in the paper money system. Loss of confidence can occur for several reasons, from creeping up cost of living, rising commodity prices (aside from gold), or feelings that the integrity of the money system is compromised. I have seen how people refuse to acknowledge the demise of GSE’s when it was written on the wall in 2007 (see my Nov 2007 article “Freddie’s insolvency“:http://www.goldmau.com/marketupdatenov23.php).
For those holding Freddie since Oct 2007, their stupidity has cost them 95% of their money as the stock has gone from $65 in Oct 2007 to $2.60 today. I believe the same thing is happening now regarding gold, but in the opposite direction. People are refusing to believe that the dollar has lost its status. Furthermore, they think the Euro is the new reserve currency and that gold is expensive at $800. All those beliefs will be turned upside-down in 2009. When lending giants like Fannie and Freddie go down, and the government having to guarantee trillions of dollars of their collateralized debts at par which are currently selling at steep discounts, there are moral hazards to the extreme. I wrote extensively about this topic last November in an article titled “Subprime Mortgages Lead to Subprime Currency”: http://www.goldmau.com/marketupdatenov13.php Technically, gold ran ahead of itself in late 2007 as it raced from $650 to over $1000 in late 2007. This was panic buying from smart money that understood the problem with the dollar and GSE’s. Gold needs to climb above $850 to start the next wave. When is it going to happen? It could be September, later this year or not until next year. I have ceased trying to time the market. The smart money investors have already positioned themselves in gold. And when gold rises again over $850 and above the 200 DMA (red line), this will signal the start of the retail wave and it will be panic buying from the stupid money who buy gold because everyone else is. The way Freddie went down with a sudden rush could easily be the way gold goes up in a phase of manic buying. |
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John Lee http://www.goldmau.com |
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1.800.965.6404 View ArchivesJohn Lee is the founder of Goldmau.com and editor of the John Lee’s Stock Chart of the Week investment newsletter. Previously a student of James Turk, John is a regular speaker at resource investment conferences. Goldmau.com publishes its FREE Pre-Market Daily to keep subscribers informed about overnight news and overseas market movements. Goldmau.com subscribers also receive all of John’s articles the moment they’re published. Click here to sign up to Goldmau.com’s free Market Update mailing list now. |
Bear Comparison: Today’s Junior Resource Sector vs 2001’s Nasdaq
- Jesse Livermore, Reminiscences of a Stock Operator In October 2002, few stock traders doubted that technology was creating value and changing the face of the Earth. Even so, the Nasdaq was priced at 1/4 of the value of its March 2000 peak amid the rubble of the tech crash. Six years later in 2008, the Nasdaq has gained 100% from its 2002 bottom. Such a swing speaks to the short-term irrationality of the market. Today’s resource junior sector offered the same types of glowing promises as the technology startups did in early 2000. With record commodity prices and mining producers looking to replenish depleting reserves through acquisition, the value proposition of junior companies is clear. For the last few years, investors bought into junior mining companies for the elusive, 10-bagger discoveries. While there were some success stories, most junior mining investors have found disappointment so far. A glance at the TSX Venture Composite Index (junior resource index), shows that the index is trading at a nearly 3-year low, which begs the question: “what is going on?”
In the charts above, I have aligned the Nasdaq’s peak in March 2000 with the peak of the Venture Index in May 2006. You can see striking similarities in those two charts after the peaks. Technically, the Venture index just broke through the green consolidation range and is in its final bottoming phase. Fundamentally, junior companies without prospects are selling at or close to cash value. Those with real deposits are being acquired, as witnessed by recent $ billion+ takeover of Aurelian (by Kinross) and Gold Eagle (by Gold Corp). This picture reminds me exactly of where the Nasdaq was in late 2002, where companies were either trading at cash value or being bought out. I can’t say the bottom will be in August for sure, or that a surging rebound is around the corner. There are already casualties and many outfits won’t make it through this correction above water. For me, this is housecleaning time, there is no exact formula in what to sell, switch, and keep, and I oftentimes consult experienced brokers for some emotionally unattached advice. Wall Street can stay irrational longer than you can stay solvent. Regardless of when the rebound comes, I wouldn’t mortgage the house to buy junior stocks now, or ever. However, with the all the reasons for investing in the junior mining sector still intact, for those with pennies to spare, now is the time to average in. As Warren Buffett puts it: “You should be happy; the hamburger you want to buy just got cheaper.” |
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John Lee http://www.goldmau.com |
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jlee@goldmau.com 1.800.965.6404 View ArchivesJohn Lee is the lead contributor at and founder of Goldmau.com. Want to learn more about the Junior Mining sector? Don’t know how to tell the good stories from the dogs? At Goldmau, we’ve got all the resources you need. Click Here to sign up for our free Market Update mailing list, or better yet, Subscribe Now risk-free to John Lee’s Stock Chart of the Week. You’ll get in-depth technical stock analysis and insight on junior mining stocks that you can’t find anywhere else. |
Primer in Mining Equity Investment
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In the past paper, we talked about the vast performance disparity among metals, and offered our take on which metals to buy (Gold, Zinc) and which to avoid (Copper) going forward. Not all metals are created equal - metals review: In this paper, we will provide the rationale behind mining equity investment, how to choose between metals futures or metals miners, and conclude with which mining sectors to buy and which to avoid. Rationale behind mining equity investment: The key to investing in mining equity is leverage. Suppose a copper miner’s break-even point is 70 cents a pound. The company wouldn’t have been worth much when copper was 70 cents as it couldn’t turn a profit. At a $1.00 copper price, however, the company will make 30 cents per pound of copper produced. And at $4.00 copper, its earnings will go up eleven times over to $3.30 cash earnings per pound. Mining vs direct commodity investment So the theory is that if copper prices go up 4-fold, copper mining stocks would go up 11-fold. In fact, this is pretty much what has happened since 2002. As copper went from 70 cents to $4.00, giant copper miners such as BHP went from $8 to $90. BHP
If BHP’s case were universal to miners, would all investors jump on the mining bandwagon to take advantage of booming commodity prices? Only if the case is so clear cut; indeed, if we look at Oil and Gold mining equities, a different picture emerges. Crude went from $22/barrel post-Iraq War to now over $130/barrel, yet Exxon Mobil has merely doubled from $40 to $80. Exxon Mobil:
Gold went from $250/oz in 2001 to $970/oz today, yet Barrick, world’s largest gold miner, has merely tripled from $15 to $45. Barrick Gold:
So why have gold miners and oil companies underperformed relative to gold and oil respectively? We can only speculate:
The point here is that the success of BHP, while not unique, is not the standard throughout the entire mining universe. Junior Mining Sector in the dog house If one looks for the speculative extreme in mining equities, the junior mining sector, a dire case could be made against investing in mining. The sector has utterly failed to live up to the expectations of investors. Junior resource equities are supposed to provide greater leverage than major mining producers. However, the nature of the business requires a constant injection of capital to discover and develop deposits before the eventual handsome operating cashflow is realized. This model is vulnerable to sudden and occasional credit/liquidity crunches like the one we’re experiencing now. The Toronto Stock Exchange Ventures Index, which is a proxy to junior stocks, merely doubled from the bottom of 1,000 to trade at 2,300.
Cash is king in uncertain times, and we like cash in gold. We live in uncertain times. GSE’s (Freddie Mac and Fannie Mae) are on life support with the Federal Reserve Bank of New York. All together, GSE’s back $5 trillion US of low yield (5%-7%) assets. You have to wonder what the global asset managers holding those debts are going to do. Real estate is cooling off worldwide now, from Singapore and Thailand to Vancouver. I am not seeing, nor do I think that housing will crash, though. The Asians are running in a mad panic over inflation and yet we have interest rates at 2-3% from Hong Kong to Singapore, Thailand to Japan, Korea to Taiwan. On top of that, we have global equity indices rotting with most down by double-digit percentages, with some, such as Vietnam’s down some 70% this year. The point is there’s nothing stronger to invest in at the moment than gold. We are now seeing a nice gold run as interest rates begin to trend up. Conclusion: This four-page paper is no means exhaustive, I hope however it served as a high-level overview on mining. The Barrick and junior resource camp may be glad to know 10-bagger success does happen to miners, as BHP demonstrated. The BHP camp might take caution in that mining isn’t all risk-free glorious business. We didn’t have the foresight to put all our money in BHP, and instead we focused on juniors exploring for gold in exotic locations such as Africa. Being a Feng Shui student, I learn that every dog has its day, and perhaps finally it’s time for the past dogs of Barrick and other gold miners to shine? |
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Not all metals are created equal – metals review for 2008 and 2009 (part I)
Close examination of correlation between various metal prices reveals a very different story, as we shall illustrate. (most charts here are from my friends at Kitco.com)
Phases of a market
“There is nothing new in Wall Street. There can’t be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again.” - Jesse Livermore, Reminiscences of a stock operator
Each market invariably goes through different phases of a bull. Starting with bottom, accumulation, rise, mania, rolling over, crash, sucker’s rallies, and then it starts all over again. People can attribute various reasons along the way for the rise and crash. The fact is price patterns are repetitive and can be observed time and again. Let’s start with oil:
Mania
Does oil seem stretched and entering a short term mania phase? Yes. I wouldn’t go short, but I would certainly put a tight stop if I were long.
Rolling over
Copper seems to be rolling over and unable to convincingly overcome the $4 level. $200 oil (possible, but not too probable in my opinion) could propel copper past the $4 level. Conversely, a correction in oil could break copper back to $3 in a hurry.
Crash
Lead staged a spectacular crash in early 08 as prices went from $1.80 to now 80 cents in under 6 months.
Sucker’s Rally
Nickel resembled Lead, except the peak was established in mid-�07 instead of early �08. Since the $23 peak, Nickel has staged several sucker’s rallies and seemed to be settling down at the $10 level.
Bottom-Accumulate
Zinc peaked ahead of Nickel at over $2 in late 2006. Since then many have lost their shirts calling for Zinc’s bottom. Given Zinc peaked ahead of lead and nickel, it will likely be on recovery mode faster with less risk of downside from here.
Accumulate - Rise
Gold has been on a steady rise since the bull began in 2001. Throughout the bull it has stayed above 200 day moving averages and yet it has yet to exhibit parabolic action, as oil did; consequently, the chart suggests the blow-off phase for gold is yet to come.
Fundamentally, while gold is not as cheap as zinc when measured in oil, nonetheless, based on historic relationship, a $130 oil calls for a gold price that is substantially higher than today’s $900/oz.
The ratio of Gold to Oil from 1996 to present (sitting at 6 currently). The chart is showing an extreme bargain of gold relative to oil. If the ratio were to restore to the peak in 1999 of 26, today’s $130 oil price will equate to a gold price of $3380/oz.
Here is a chart of where I see various metals markets are:
Correlations between Price and Inventory Unclear
Some accuse me of being overly technically oriented and ignorant of fundamentals. Fine, there are some that attribute base metal price action to inventory levels. If such a relationship is held true, zinc should not be trading at roughly 1/3 of its 2007 high of $2.2/lb, because the difference of inventory levels between now and then is negligible by historical standards. In fact, inventory levels have never been a good forecast for future metal prices.
Buy Low - Sell High
To borrow the overused Buffett line, “buy low, and sell high”. This is particularly applicable in commodity investment since metals such as zinc will never be made obsolete in my lifetime. Against rapid currency debasement and $4 trillion held at central banks of emerging-growth countries around the world, my view is:
Oil and Copper - risky investment
Gold and Silver - Good value and entering a blow off phase.
Zinc, lead, and nickel - Current prices will prove to be extreme bargain (particularly zinc at 80 cents) looking back 2-3 years from now.
Metals investment was the focus of my workshop at the Cambridge House Investment Conference in Vancouver (June 15-16). For those interested, the write-up of the conference and my workshop presentation can be accessed here.
In part II, we shall examine how various resource equities (energy, base metals, precious metals) fared against the respective underlying commodities. Stay tuned!
THE CASE FOR USD 1,300/oz GOLD
by John Lee, CFA
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05/27/2008
In October 2007, when gold was USD 750/oz and a US Dollar fetched 7.5 Chinese Renminbi Yuan (RMB), I published an article titled “Gold and RMB – Last Shoe to Drop for the dollar”, in which I said:
For a US family that spends $300 to $500 a month on Chinese goods, a further 40% appreciation of the RMB will translate into a $100 to $200 monthly cost increase. The logic of asking the Chinese to revalue their currency upwards is no different from asking the Saudi’s to jack up their oil price further, which is no logic at all for a US consumer.
Holding Dollars is like playing musical chairs. When the music stops, the one holding the most Green IOUs, loses.
- With a rapidly sinking Dollar vs. western currencies, the Dollar’s supreme image is now very wobbly.
- Having built up a war chest of USD 1 trillion, the Chinese need no more Dollars to shore up confidence in its own paper within the international arena
Combining these two factors, the Chinese government will likely loosen the RMB peg to the Dollar at a faster pace, and we expect a minimum of 20% appreciation in RMB over the Dollar (i.e 5-6 RMB to 1 USD) in the next 12 to 18 months. Gold is international money, and will follow the RMB’s suit and climb to over $1,000/oz over the same period. This gold target is a conservative estimate given that other commodities from oil to copper have all quadrupled from their lows this decade. Gold’s low was $250/oz in 2001.
Gold and the RMB’s rise will be the final chapter to the Dollar’s status as the world’s reserve currency, and the end to an era of low priced Walmart goods made in China.
-John Lee, October 27 2007
Now, 7 months later:
The RMB has since appreciated at the fastest 6-month pace on record, up over 7% and cracked through the psychological 7 RMB/USD barrier to trade at 6.95 RMB/USD. The talk of demanding the Chinese to revalue their currency has all but disappeared.
3 year RMB exchange rate to USD, no signs of slowing down
Gold met our 12 month target in 4 months and surpassed USD 1,000/oz in March 2008.
2 year gold chart, ready to take another crack at $1,000/oz
Fast-rising commodity prices and appreciating RMB are putting pushing up prices of everything measured in USD. Unheard of in the past decade, computer prices are going up for the first time in recent memory.
2009 Gold Target: USD 1,300/oz based on 5 RMB to 1 USD exchange rate
Let’s do an experiment: If we fix the RMB-denominated gold price constant at today’s closing of RMB 6,425/oz, the price of gold will reach USD 1,285/oz should RMB reach our target of 5 RMB to 1 USD by the end of 2009.
There are those who predict a rebound of the dollar index and a protracted USD 800/oz gold price or even lower. They just don’t get the message. Gold is an international market. Physical gold demand is mostly from Asia and as long as Asian currencies keep strengthening, the USD-denominated gold price will keep going up, regardless of what happens to the US dollar index.
Our 2009 gold target of USD 1,300/oz does not factor in external elements such as geo-politics or the speculative herd-following frenzy. I have a feeling this once-unthinkable 4-digit target will turn out to be too conservative.
John Lee, CFA
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NOW IT’S MAY, DO WE SELL (GOLD SHARES) AND WALK AWAY?
by John Lee, CFA
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05/12/2008
Here we are in May, and everyone asks the question, is it time to sell and walk way? Well that depends what you are holding. This article focuses on timing in regard to the junior resource mining equities, for which we use the S&P/TSX Ventures Composite Index as a proxy.
Resource Junior Sector Roller Coaster
Over half of our fund’s portfolio of 50+ junior issues are trading 50% below their peaks, and I suspect many other junior resource investors are in the same boat. Indeed, despite oil and gold trading at all time record highs, the TSX Ventures Composite Index (“Ventures Index”) is trading near its 2 year low. Investing in juniors in the past 2 years has not been for the faint-of-heart and the Ventures Index has made several round-trips between 3,300 and 2,500, highlighted by a stunning and record 33% drop last August.
Good fundamentals of underlying commodities
I have been hearing oil bears talking of a big correction since oil was $40. While I can’t tell you where oil is going, the chance of it ever going below $100 is diminishing rapidly by the day, as the chart indicates strong support at 200 DMA (day moving average), which is $95 and rising.
Gold has been a lagger relative to oil. Gold price is currently sitting at $880/oz and the chart indicates good support at $850, its 1980 high and support at its 200 DMA of $830, which continues to rise. We project the next leg up for gold later this year will be to take out $1,000/oz with ease.
Junior Shares: Buy or Sell?
Below we show the chart of the Ventures Index divided by gold.
This ratio indicates the relative value of junior mining shares compared to the price of gold.
As the chart indicated, resource equity investors did well by selling in April of 2002, 2004, 2005, 2006 and 2007 (red circles). Is selling resource equities the right move again in Spring 2008?
One might think so; however, this chart is sitting at 7 year low since the bull began in 2001 and it is a hard case to argue against investing in the Ventures Index if you don’t see gold and oil staging a spectacular 30%+ crash. Another way to put it: I see the risk of getting in the Ventures index as very low unless oil and gold crash 30% in the next 2 months.
Technically, as we saw before, The Ventures Index is currently trading at 2,500, lurking right beneath its 50 DMA. I track dozens on dozens of junior issues and many are staging similar breakout patterns by Knight Resources (KNP.V) and Independent Nickel Corp (INI.TO) below.
On April 8, I published an article titled “The start of the run for gold (shares)”
http://www.goldmau.com/content/contributors/lee_john/08-04-09.php
From that article:
“It makes no sense that the American mortgage crisis is impacting Canadian gold and resource juniors. One can now margin at 5% to buy oil trusts paying 15% dividend and gold juniors for less than $10/oz in the ground. I am confident the situation will reverse, offset not by higher interest rates but by higher junior stock prices.
Within two months and as soon as we hit the bottom of interest rates, I expect all the hoarded money to spill out looking for a new home as it simply does not pay to park money earning 2% with real inflation running at double digits.
-John Lee, April 9 2008
Now a month and another interest cut later, we are indeed seeing revival of the Ventures Index and I expect it to break out of 2,500 level to test 200 DMA of 2,750 shortly.
John Lee, CFA
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Money, inflation, deflation, and gold
Money, inflation, deflation, and gold
by John Lee, CFA
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05/02/2008
Money serves as a medium of exchange and store of value. Price provides an important clearing mechanism in a society. Here we are going to explore the interesting dynamics between money and price.
In a free market, when the quantity of money is fixed, the fact that the price of an apple is $1 and that of a Parker pen is $2 has tremendous implications. It takes knowledge, ingredients and time to grow an apple while it involves branding, material, and capital to produce a Parker pen. What the market says here is that the total efforts put into producing the pen are worth twice as much as the efforts of growing the apple. There are thousands of valuations communicated through the market by this simple exchange. Over time, with advances in technology, it takes fewer efforts to produce more goods. The same farm that used to grow 10,000 apples can now grow 20,000 in half the time. While the ratio of exchange between apples and pens might still be 2 to 1, since it also takes less to produce a pen, in a world where the quantity of money is fixed the price of both apples and pens should decrease (i.e. 80 cents for an apple, and $1.60 for a pen).
The decrease in the price level of goods represents an economic advance and an increase in the value of money. As the human race progresses and wealth is being accumulated, shouldn’t people be able to buy more with less money? Shouldn’t people be rewarded for their savings over time with increased purchasing power of their money? Obviously, the exact opposite is taking place in this world. What’s going on?
A picture is worth a thousand words and the chart above is no different. There is 1,500% more
paper money today than there was in 1970.
Oil Price Since 1960
Hey, where did all this money come from? Doesn’t more money mean more economic progress?
The huge increase in the paper money supply is from borrowing at all levels from consumers, corporations, and government. Every dollar borrowed is a dollar created out of thin air by the banks. The process is legitimized by “the fractional reserve system”, as the bank literally prints dollars in its computer and writes a check to you upon your loan approval.
To answer the second part of the question - there is no positive correlation between the money
supply growth and real economic growth. As we explained, the world can function and advance
with a fixed money stock.
What’s wrong with more money? It stimulates consumer spending, creates more interest-income for savings and promotes higher housing and stock prices. More of everything is a good thing!
To that argument, I say: What if the Fed through its ingenuity and generosity, doubles everyone’s savings account balance? Does that create progress? By the same token, to combat price increases, did Venezuela fix anything fundamentally by issuing a new currency, “Strong Bolivar”, that essentially chops a zero off the old Bolivar? Here are 4 more points to consider:
1. Fairness – Arbitrarily, some are allowed to borrow more than others. Does it make sense for a government to have unlimited borrowing power while it hardly produces anything? And what is so special about a banker in that he can lend to whomever, for however much he wants, with the money that’s not even his?
2. Price Distortion – Since new money is not distributed evenly, the prices of various goods and services increase in a cascading fashion, depending on who gets the money first (like a ripple effect). Think of a lottery winner. He is likely to outbid others for the things he wants, thus causing prices of his desired items to go up first. Let us be clear: The random introduction of new money impairs the role of price as a proper clearing mechanism.
3. Bad store of value – With online banking and credit cards, today’s money is a great medium of exchange. However, the ever-increasing quantity of paper money makes it a terrible store of
value. Remember: Every time someone borrows, new money is brought into existence, diluting the money you and I have meticulously accumulated. Should a retiree rely on the risky stock market to retain his wealth?
4. Moral Hazards – How is it fair that bankers can borrow billions of dollars to spend and invest? And when banks and companies become too indebted but are too big to fail, they are bailed out. How does that serve as an incentive for those who make cars, sew clothes, and plant trees to save?
When unfairness, price distortion, corruption, and loss of true wealth reach the extreme, the result is a loss of confidence in the paper-money system.
I quote John Keynes from 1919:
“There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose. ”
Paul Volker was right when he said in 2000:
“Inflation is related to monetary policy. It’s related to the issue of money. The issue of money is a governmental responsibility predominantly, and to use that authority in a way that leads to inflation is a system that fools a lot of people, and to keep fooling them you have to do it more and more; [that] is a moral issue. I put myself in that camp. “
And Bill Gates said at Davos world economic forum in January 2005:
“I’m short the dollar. The ol’ dollar, it’s gonna go down.
We’re in uncharted territory when the world’s reserve currency has so much outstanding debt. It is a bit scary.”
How do you short the dollar? With ECB printing Euros no slower than the Fed printing dollars, it’s clear that gold is the only refuge of savings. Gold has raced from $428 to $850 today since Bill spoke in 2005. Is it too late to join gold? The right price for gold today is a long topic that’s best be left for another day. However, judging by how oil rocketed from $10 to $100 within the past decade, gold has not nearly reached its potential. We manage a gold fund and have written much about gold and currencies at www.goldmau.com I invite you to read up.
John Lee, CFA
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