A Yuan for Gold

By @ibtimes on

Good Morning,

Yesterday's mini-correction in gold lasted barely until the market's close and turned into trend resumption during the overnight hours. The recapture of the $1k mark came relatively easy during Monday's session, making the brief foray to lower levels as shallow as every previous one lately. Then again, we could just say that the dollar's mini-rally turned sour as soon as speculators decided that -despite imminent FOMC and G20 meetings- the appetite for risk presents an overriding motivation at this time. More like a ravenous feeling.

Thus, the greenback was pushed back to the low 76s on the index, and was nearing 1.48 against the euro as Tuesday's trading unfolded in Asia and Europe. Yesterday's declines in crude oil also turned into $1+ gains as today dawned, spurred by the same signs of continued dollar weakness. Gold thus rose for the first time in four sessions and was seen once again targeting the peak near $1020 reached last week, as well as possibly the figure it achieved March one year ago.

New York spot bullion trading got off to an energetic start this morning, with the yellow metal posting a $14.00 gain while quoted at $1017.00 per troy ounce. In turn, silver reclaimed the $17 mark and opened with a 41-cent advance quoted at $17.24 an ounce. Platinum rose $12 to start at $1329 and palladium showed a $4 rise opening at an even $300 per ounce. Targets are pegged at $1023 and $1034 on the upside, whilst support remains (thus far) visible in the $990-$1K channel. The dollar will continue to be the focal point of the day. FOMC and its effect on the greenback will become tomorrow's obsession.

Nothing of note changed in the background fundamentals. Physical demand continues to be anemic, scrap sales remain fairly visible in the wake of high prices, and the timetable, quantity, and adoptive parent(s) of the IMF's 403.5 tonnes of metal remain unclear. For the moment, the word from Beijing is: No thanks, we do not need gold from the international markets. We have a better source: our own mining industry. China has claimed the number one spot in global gold production recently.

As for piling gold on top of its dollar reserves while getting rid of some greenbacks in the process, analysts at Minsheng Bank Corp. feel that using good old yuan to buy the metal from domestic producers is a better option than using dollars to buy the stuff on the open market. The bank also feels that the hype surrounding China and physical metal buying may be just that -hype.

Minsheng also dismissed putative Chinese central bank or man-in-the-street gold shopping sprees as 'rumour.' The real increases in gold interest and activity -says the bank's head of precious metals, Ms. Lila Lu, will come from 'paper gold' and margin trading in future years. Ms. Lu's bank traded over 200 tonnes of gold, or about 13% of the Shanghai gold bourse's total last year. Not exactly a light-weight.

Structurally, the longs on this side of the ocean have built up a mountain-sized position of paper gold on the exchange - a factor that has more than one trading specialist reaching for their Xanax. Nevertheless, a very bold forecast of upcoming outperformance by mining shares vis a vis the underlying metal was issued by the San Antonio-based USAA Precious Metals and Mineral Fund. The firm feels that for every 1% gain in gold bullion, stocks of companies involved in digging it up will rise by 2 or 3 percent. The return of the classic leverage factor? Yes, it would be high time.

However, other analysts are less bullish, according to Bloomberg: [They are] forecasting a drop to $750 by 2013, according to the median of seven estimates compiled by Bloomberg. The economic fundamentals don't support what we have been seeing, Miguel Perez-Santalla, sales vice president at Heraeus Precious Metals Management in New York, said in a telephone interview. The dollar may firm up and gold may drop in the coming months because inflation fears are overblown, he said.

Apparently, Mr. Perez-Santalla - a veteran gold trader with more than 30 years of buying and selling the stuff under his belt, and the Bloomberg-surveyed professionals are not alone in raising cautionary statements at this same juncture. Canada's own Globe and Mail -while it is sure to get plenty of irate comments from permanently gold-bullish readers- via its Boyd Erman piece today, alludes to euphoria versus facts and tries to caution latecomer investors to the downside risks in the same manner as the aforementioned Bloomberg survey.

It's your money. By all means, own gold. But not too much. By all means, trade it if you have the knack (and discretionary funds). But beware of irrational exuberance. This market has not been vaccinated against it, or its customary outcomes:

It seems a shame to trash the party just when it's finally becoming fun to be a gold bug.

Bullion is flirting with $1,000 (U.S.) an ounce and hoarding the metal is no longer just a pursuit for Eric Sprott and assorted conspiracy theorists with caches of canned food. Even the guy behind the bar at dinner the other night was long gold and happy to expound on why.

It's all about inflation they say, and gold as a store of value. Except for one thing: The facts don't back it. (Unless you're an American buying bullion because you're worried about the inexorable decline of your dollar. In that case, you should be worried.)

Almost every real measure of actual inflation pressure - as opposed to the inflation paranoia inherent in the gold price - shows little in the pipeline. One of the best long-term indicators of inflation expectations for the next decade, the price premium built into inflation-protected U.S. Treasury bonds, is indicating that prices will rise 1.75 per cent a year.

Yet the bullion pushers forge ahead. After 20 years of being wrong when gold was stuck around $350 an ounce through the 1980s and 1990s, they are nothing if not persistent. The key to their argument is the man they call Helicopter Ben Bernanke, the head of the U.S. Federal Reserve, and all the cash he and his peers at central banks around the world are creating to revive growth in the world economy. At some point, that money will sluice out of the banks into the economy, inflation will be upon us like a tsunami, and gold will be treasured as a store of value.

The proof, as gold bugs see it, is in the price of gold. It rises when inflation is a risk, so inflation must be a risk. Get it? The problem is one of simple math: Those helicopter-loads of cash, even if they were making it into the real economy, are not nearly big enough to fill the Sudbury-size crater in the global economy created by the crash in the world's housing and stock markets.

The Fed balance sheet, a focal point of inflation hawks, has expanded by about $1.3-trillion as Mr. Bernanke pumped cash into the lending system. Added to that, the Obama administration has come up with close to $1-trillion in stimulus, the biggest of a global group of packages totalling about $5-trillion. However, the decline in assets is much bigger. The value of global stocks has fallen by more $17-trillion since the markets peaked in 2007 and U.S. housing is down more than $4-trillion since topping out in 2006.

On top of that, the financial institutions that are supposed to push that cash into the economy aren't doing it. U.S. bank lending, by some estimates, is contracting at the fastest rate since the Depression. Bank credit in August in the U.S. shrank at an epic pace equal to 9 per cent a year, according to David Rosenberg, chief strategist at Gluskin Sheff.

The result is a real money supply that's actually shrinking at the same time as the jobless rate is at a cyclical high and factories are idle. Not surprisingly, executives scoff at the idea of raising prices any time soon, with one telling The Globe and Mail not so long ago that it would be very cavalier to even try. That utter lack of pricing power is clearly reflected in Friday's numbers showing that underlying inflation is still slowing on both sides of the border.

To that, many gold bulls retort that central banks are going to miss the transition to hyperinflation when it comes, or be unwilling to fight it with higher interest rates because of political pressure from indebted governments. That seems far-fetched. Central banks have become very good at keeping inflation anchored. In the 18 years since the Bank of Canada adopted the goal of keeping inflation centred between 1 and 3 per cent in Canada, consumer price increases have averaged a 2.1-per-cent pace. Not bad.

There will likely be plenty of warning before inflation takes hold, as capacity use creeps up and unemployment ebbs. Those real facts go a long way to explaining why even though gold is at $1,000, inflation fears have yet to become mainstream, and discussion of exit strategies to pare back government stimulus programs before prices take off - talk that dominated the last big G20 meeting in April - has largely, and mercifully, fallen by the wayside.

Mercifully, because if the gold bulls and their view on inflation really held sway, the exit would already be on. Interest rates would already be rising and the world would be well on its way back into recession. The bugs should be careful what they wish for.

Until later,

Jon Nadler

Senior Analyst

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