Thursday, December 19, 2013

An Early Christmas Present in Gold

One day after the Fed announce it would slow QE from well over $1 Trillion per year to a slightly less obscene $900 Billion per year gold was hammered down $45. Its now retesting its July lows.

Its been another crushing year for those who believe in fundamentals. Last quarter showed slowing earnings with most companies failing to meet earnings expectations. Never mind. The stock market keeps going up. Meanwhile, the Fed printed $1 Trillion in new money, devaluing our US dollar. Yet gold continues going down. It makes absolutely no sense from any sort of macro economic perspective. But it makes perfect sense if you are the Federal Reserve. From their perspective, they want to see the stock market higher to create an artificial wealth effect that will spur consumers to go out and spend more, stimulating the economy. What they don't want, is for people to bail on their currency and move into an unproductive alternative currency like gold or silver. For that reason, I think we have seen the Fed is intentionally blowing a stock bubble while suppressing the price of precious metals. That artificially low price is a gift to people who know this will all end very badly.

But it sure hurts right now.

As of today, US stocks (as measured by the S&P) are up 27% while gold is down about 29%. Right now stock investors are feeling pretty smart while gold investors are ready to throw in the towel.

Below is a graph with emotions we often feel as our investments move up or down.


The point here is that our emotions bring out the worst investment actions. People often pile into investments when they feel optimism, excitement and thrill, right when the risks are the highest and the likely rewards are the lowest. Conversely they often sell at the bottom when they feel desperation and panic, just as a bottom is about to be hit.

Ideally, as sophisticated investors we seek to BUY at the despondency level and SELL at the euphoria level. Before 2008 I used this method to consistently beat market averages by buying asset classes that had been out of favor for 2-3 years and selling asset classes with 3-4 years of market outperformance. And though endless QE has inflated most every asset class, gold and gold stocks remain unloved due to gold price suppression. But as I've tried to document here many times, it cannot go on forever. The Western Central Banks are running out of the physical gold needed to keep the price down.

Before they could have kept the price down nearly forever using paper derivatives. Now, China is relentlessly buying up physical gold and emptying Western vaults. See the short video below:

And where is that gold going? To China. The month of October, for which we have he most recent data, was the second highest import of the past two years of 148 metric tons, dwarfing the previous year.

We also know this through Swiss gold refiners. You've got to read this from Alex Stanczyk:
 What was the purpose of your trip to Switzerland?

The purpose was two fold. We go to Switzerland once a year as part of our governance, we’re required to have an annual inspection of the gold, that was the main purpose of the trip. But in addition to that we also liked to talk to the refineries. It was myself, it was the managing director of Anglo Far-East mister Philip Judge, and Jim Rickards went with us, he sits on our advisory board.

We met with the managing director of the largest refinery in Switzerland and spend about two hours talking to him, we learned some very interesting things. Whats going on in the gold market as far as the price, is I think very counter intuitive. Everybody understands, knows and believes the price should be higher than it is, but it isn’t. There’s confusion in the marketplace, and there are two reactions; the reaction in the west is fear, confusion and uncertainty; the reaction in the east is buying. Now, this gentleman we were talking to probably has a better idea of physical gold flow than anybody else globally. He sees what is coming from the mines, he sees what is coming from the UK, and all over the world, as well as where its going. He indicated the price didn’t make sense because he has got so much fabrication demand. They put on three shifts, they’re working 24 hours a day, and originally he thought that would wind down at some point. Well, they’ve been doing it all year. Every time he thinks its going to slow down, he gets more orders, more orders, more orders. They have expanded the plant to where it almost doubles their capacity. 70 % of their kilobar fabrication is going to China, at apace of 10 tons a week. That’s from one refinery, now remember there are 4 of these big ones [refineries] in Switzerland. 
That makes sense because withdraws from the Shanghai Gold Exchange vaults are 40 tons a week on average this year.

Well, there you go.

…At this Swiss refinery there have been several times this year on which they were unable to source gold, this shocked me. They’re bringing in good delivery bars, scrap and dore from the mines, basically all they can get their hands on. This gentleman has been in the business for 37 years, he was there during the last bull market in the late seventies. I asked him when was the last time this has happened, that he was unable to source gold, he said never. And I clarified it, I asked: let me make sure if I understand what you’re saying to me, in the last 37 years you’ve worked in the gold industry this has never happened? He said: this has never happened.

…There was one other comment that was fascinating, he said sometimes when they get gold in, it’s coming from the back corners of the vaults. He knew this because these were good delivery bars marked in the sixties. This is a huge supply squeeze and its worse than anything that has happened in the last four decades. At some point there is going to be a massive squeeze on the price.

…All four Swiss refineries combined may be doing as much as  [supply China] 2000 tons this year. That doesn’t include what the Perth Mint ships to China, it doesn’t include the 400 tons the Chinese mined domestically, and it doesn’t include what they mined offshore with the mining companies they own all over the world. I suspect that total Chinese demand can reach as much as total global mining production this year.
…He also noted, in China there are 6 LBMA refineries but he has never seen a Chinese gold bar, they’re keeping it all. Gold that goes into China is like going into a black-hole. I don’t think it will be available on the market for decades to come, which only tightens the physical supply.

…The Chinese aren’t buying it for trading, they’re buying it as part of their wealth foundation for future generations. When the communists came to power in 1949, Chiang Kai-shek and the nationalist army fled the country and took all the gold with them. On that moment China had no gold, although they had thousands of years of history with gold, they had to start all over. I think the importance of rebuilding their gold reserves had been there in the last decades, but it accelerated the last three years or so, encouraging their people heavily to buy.
Why the refining? Well in London good delivery bars are 400 ounces and must be .995 pure gold. The Chinese are having the gold refined and recast into .9999 pure Kilo bars. Those bars will not be going back to London any time soon.

So as the price of gold has declined, China has merely accelerated their buying. Think they know something? Well they know their holdings of US Dollars have been diluted by $1 Trillion this year alone. They know now that it will be just slightly less at $900 Billion next year and that the reality is The US Fed will likely have to increase QE in the future rather than continue the taper. Why?

You may recall the US Fed's stated policy was to buy US Treasuries to keep interest rates low. But the ten year yield has gone from close to 1.5% this last May to almost 3% today, nearly doubling! Either interest rates are going up which will crush the stock market at some point or they will have to increase their purchases of Treasuries to keep the US Treasury rates low.

If you own stocks you've had a great year. Take some money off the table and reallocate your portfolio.

If you believe, as I do, that this will all end very badly, buy gold as China and JP Morgan are doing to take advantage of the Western central bank subsidized price.

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