This Could Be Big for Gold Prices
One of the most respected fund managers and gold experts on the planet just published a major report on the sector. His conclusion? Despite a beatdown of historic proportions, he feels that gold prices and gold miners have nowhere to go but up—way up. Here is his reasoning:
Bankers and Ice Cream Don’t Mix
A true story: In the early 1980s, two young Chinese businessmen, determined to show the world that ice cream was originally invented in China—and later brought to the West by Marco Polo—opened a small shop in a northern suburb of Toronto to vend their small batches of handmade ice cream. And in the absolute dead of the Canadian winter.
If you think that is a “recipe” for trouble, you would be wrong. Day after day, customers would line up in sub-freezing temperatures just to get their ice cream fix. “Chocolate Chunk” was the favorite, closely followed by “Mango.” The two entrepreneurs could not keep up with demand.
As it happened, one of their customers was an up-and-comer from Bay Street, Canada’s equivalent of Wall Street. He discretely enquired of the two young men if perhaps they would consider allowing him to “monetize” their idea by morphing their single shop into a publicly traded corporate franchise?
Since one of the most notable benefits of the deal was that the two would never have to work another day in their lives should they not wish to, the boys took the deal. Thereafter, the franchise went public, the two lads retired for life, a great many franchises were sold, and many new ice cream shops opened all over Southern Ontario. Very shortly thereafter, the whole enterprise went bust and was never seen or heard of again.
Well, as it turned out, the new public franchise corporation was able to carry over all the trade secrets and good will from the original shop except for one small thing—the actual ice cream. Since every banker and guru on Bay Street agreed that making ice cream by hand was a complete waste of time, the recipe was sub-contracted to a commercial ice cream factory on a best-efforts basis.
To repeat: the recipe for making small batches of hand-mixed and hand-churned ice cream just the way it was done in the days of Marco Polo—the key to the entire business!—was sub-contracted to a fully automated commercial supplier. And no one on the banking side thought there was anything wrong with that…?
That story is 100% true and does a wonderful job of illustrating what happens when money guys (who think only of where their next dollar is coming from) try to monetize a hard asset that has utility and value outside of the financial arena. (Source: “Who Screams for Ice Cream?” Toronto Star, April 14, 2010.)
Bankers and Oil Don’t Mix, Either
Here is another example you might recognize as closer to home: oil.
Once upon a time, oil was a simple commodity relating to things energy-related, like heat, engines, combustion, plastics, lubrication—oily things.
In the period after 1971—when the U.S. shocked the world by unilaterally and without warning abandoning the gold standard—Washington’s agents had a protracted series of meetings with the Saudis, meetings that effectively turned oil from a simple commodity into a political football and an economic neutron bomb.
One of the many agreements reached, for example, allowed the Saudis (who more or less directed OPEC at the time) to double the worldwide price of oil with the full blessing and permission of the U.S. In return, of course, the U.S. was able to replace their recently abandoned gold standard with their brand-new, shiny, oil or “petrodollar” standard. A trick that, until this decade, worked very well for the U.S. (These days, not so much.)
About 10 years later, in 1983, the first-ever crude oil futures contract (i.e., a paper contract that did not have to be settled by the delivery of actual oil, just cash) appeared at the Chicago Mercantile Exchange (CME). Ever since then, the price of oil has had little if anything to do with demand or supply—and everything to do with political aspirations, geopolitics, financial warfare, backroom deals, and monopoly pricing.
The moral? Financial guys are all about the instant dollar payoff. When they start to monetize and control hard assets, assets with amortizable lifespans and intrinsic utility to society at large, problems invariably occur.
Look at the oil market in 2016. A series of bizarre geopolitical events suddenly re-introduced the antiquated notion of supply into a market that had been dominated for literally decades by paper futures, invisible (off-the-books) derivatives, and equally opaque hedges.
Coincidentally, this happened at a time when demand itself was in decline because of macroeconomic problems seeded (ironically) by the very same financial geniuses who years ago had bent the oil market to their will. Suddenly, to everyone’s surprise, demand and supply were again…relevant. The rest, as they say, is history.
Another “Franken Market” Courtesy of the Bankers: GOLD
John Hathaway is a senior portfolio manager of Tocqueville Asset Management, a firm with some $12.0 billion under its wing. He is also considered one of the top experts in the world on gold. Hathaway recently completed an 8,000-word report on the implications within the gold complex of the usurping of the gold price mechanism by mainly paper exchanges (Comex and LBMA), in complete disregard of the organic drivers of demand and supply.
In his treatise, he focused on the following three areas:
- How did we get into this mess?
- Is the damage to the mining sector as horrific as share prices would seem to suggest?
- What does all this (i.e., the answers to #1 and #2 above) portend for future gold—and mining share—prices?
How Did We Get into This Mess?
“[…] The capital tied up in hedging and risk insurance seems to overshadow that required for [the] transactions in [the] underlying equities, bonds, and commodities.”
“[…] The financial industry has responded to the need by creating ‘products’ that were several steps removed from the underlying assets and the industry earned substantial fees in so doing. Being disconnected from reality, these ‘products’ have been more easily subjected to price manipulation than the underlying assets, and therefore have served as effective policy levers for central bankers to distort reality to achieve their objectives.”
“[…] The relentless dumping of synthetic or paper gold contracts since 2011 by speculators in Western financial markets has caused the shortage. The steady selling has driven down the price of physical gold, hobbled the gold-mining industry, and drained the stores of gold held in the vaults of Western financial centers.”
“[…] COMEX, which mirrors much larger-scale paper trading in London and OTC markets, appears to be an arena for speculation in the ‘idea’ of gold, settled in cash, and completely divorced from physical gold. Speculators include macro hedge funds, commodity traders (CTAs), bullion banks…and central banks.”
“[…] OTC options are created out of thin air by market-making shops. There are no size limits and no margin requirements. A 1000-contract lot is the equivalent of 100,000 ounces of gold. Durations of contracts extend up to three years. Position sizes of 40,000 to 50,000 lots, or four to five million ounces, are [created] through the stroke of a keyboard… Hedging a gold short with an exchange-traded product (ETP) from which gold cannot be delivered is but one illustration of the possibility of weak risk-management practices in the OTC options market.”
“[…] Untethered from the laws of supply and demand, paper gold is a make-believe substance that trades according to rules written by HFTs, macro hedge funds, major banking institutions, and central banks. Of course, this works only so long as the buyers remain willing to settle in cash, rather than ask for actual gold.”
“[…] The short exposure to gold that can be easily achieved through the synthetic market would be impossible to achieve in the physical market.” (Source: “Hathaway Report on Paper Gold,” Tocqueville Asset Management, last accessed January 15, 2016.)
Hathaway, an acknowledged gold guru with years of experience, presents some of the most articulate arguments ever put on paper as to why the invention of “paper gold” has resulted in price discovery for the yellow metal that has little or no relationship to the real world we all live in.
His essay also raises grave concerns about the current trend in banking and investing where, literally, any option will be explored that results in a short-term profit today, as opposed to a longer-term benefit for society and its citizens as a whole. (Source: Ibid.)
How Much Damage Have the Miners Taken?
“[…] The nuclear winter of the gold-mining industry will have inescapable intermediate to longer-term effects on future mine supply. Financial constraints, investor bearishness, and the ever-lengthening time cycle to build new mines will in our opinion lead to a moderate to severe decline in global gold-mining output before the end of the decade.”
“[…] An added headwind is the seemingly steady trend towards more onerous conditions set by host countries for extractive industries in general, and the seemingly steady erosion of the rule of law in locales once thought to be safe for new investment.” (Source: Ibid.)
Hathaway feels that even if the price of gold did rebound, the mass psychology right now is so pervasive and so negative, the market would initially assume that such a “pop” was merely a temporary counter-trend within a long-term bear market. Ultimately, he emphasizes, this artificially accelerated decline in gold supply—within an industry that is already nearing “peak gold” and dwindling new Bonanza-grade strikes—will drive up prices and result in rapid share appreciation for producers who will still be able to deliver product to market.
He does, moreover, express even more optimism for those junior mines that were courageous enough to have gone into production during the 2011+ bear market and believes these producers, in particular, will have all the demand they can handle.
What Does this Mean for Future Gold (and Mining) Prices?
“[…] An acute shortage of readily marketable physical gold is developing that we believe will deepen in years to come. This possibility seems to be unrecognized by those who are short the gold market through paper contracts.”
“[…] We believe that the shortage will worsen because (1) the precursors of production (exploration, discovery, reserve life) are very negative, (2) the mining industry has little financial credibility and seems unlikely to attract capital even with a big rise in gold prices, and (3) refining capacity limitations tend to create supply bottlenecks when physical demand spikes.”
“[…] When a trend reversal occurs, we expect that machine-driven trading, which is agnostic as to investment fundamentals, will serve as a powerful accelerant to the upside, just as it has led to overshooting on the downside.”
“[…] We construe the incapacity of the gold-mining industry to be extremely bullish for future gold prices.”
“[…] There are new mines that have been under construction for several years that should begin to produce gold, profitable even at current prices, at a time when industry production is shrinking. We believe that they will be sought-after acquisition targets as other producers deplete reserves.”
“[…] China’s strategic vision for gold is quintessentially anti-synthetic; if successful, it will both erode the international standing of the dollar and elevate that of gold.”
“[…] Ownership of physical gold outside of the financial system seems to make more sense than ever. Gold-mining equities, which have been severely depressed by the four-year decline in the gold price, should also participate. We believe that a [market] trend reversal could prove explosive for the entire precious metals complex.” (Source: Ibid.)
Hathaway sums up with a bullish call for gold and the miners. He also suggests that even self-proclaimed market experts have not fully understood that China is a game-changer for the gold market in the days, months, and years to come. He is bearish on the buck and believes that any major trend change in the equity markets will spark renewed interest in the yellow metal. (Source: Ibid.)
The Bottom Line on Gold and the Miners?
There is a saying that “fish have no opinions about water.” A year offers about 252 trading sessions on the NYSE. For many professional traders, that is a lifetime. Consider that many pros have now gone almost five full years watching gold prices get hammered by mysterious sellers every time the precious metal approaches a breakout; watching the mines get beaten to a pulp even while demand for yellow metal remains strong; listening to the constant whine from the government elite pointing that gold is a barbarous relic that has been in a 5,000-year bubble…?
Against that backdrop, it is refreshing to hear the views of a respected, senior trader, an expert in his field, an individual whom strangers have entrusted with billions of dollars of their money.
John Hathaway’s take is clear and unambiguous: gold is not so much in a bear market as it is in an artificial market created by distortions in the market mechanism that the regulators are simply not addressing.
In fact, in his report he goes even further and suggests that the overseers themselves are actually encouraging this behavior, because HFTs and similar customers are a major source of income for the exchanges.
The result is mal-pricing leading to a coming shortage—which is bullish. This is the time to buy gold, John Hathaway suggests.