Wednesday Kitcommentary From Kitco Metals Inc. – Value Judgements

by Jon Nadler, Kitco Metals Inc. on December 15, 2010 · 0 comments

Bullion Bars

Boring (read: predictable) as the Fed meeting results turned out to be, the expected dollar free-fall and corresponding gold spike did not materialize in their wake last night.

Bullion fell to an overnight low of $1,385.30 on the bid side of spot prices as the greenback gained ground on the rising conviction that the US economy is indeed on the mend, and as it was also helped by the on-going ‘review’ of Spain’s debt rating by Moody’s Investor Service.

The rating agency, which has been in a downgrading ‘mood’ of late, did in fact take its scalpel out overnight and did cut Vietnam’s rating from B1 to Ba3 given what it sees as difficult conditions for that country. Yes, it (downgrading) can happen in Asia as well, even as the skies continue to darken over Europe somewhat more. Agence France-Presse reports that Greece was brought to a standstill today as some 15,000 angry protesters marched against their government’s austerity measures. This was the country’s seventh general strike this year.

Gold prices opened the midweek session with a modest $3.90 per ounce loss, quoted at the $1,392.00 level as scattered selling ahead of year-end and the US dollar at 79.69 on the index continued to exert pressure on the yellow metal this morning. Gold-oriented ETPs lost nearly 5 tonnes of metal from current balances yesterday. Silver fell 32 cents on the open, starting the day off at $29.18 the ounce. Holdings in silver ETPs rose once again yesterday, in contrast with the aforementioned gold ones.

ABN AMRO’s most recent price projections for the precious metals group call for peaks some 3 months from now, at $1,485 gold, $31 silver, $1,750 platinum and $815 palladium. Easy math. You have a 7% potential in gold, 14.8% in silver, 3% in platinum, and 8.7% in palladium. The "problem" — if any? The firm projects the 12-months-from-now levels to be: $1,375, $27, $1,700, and $750 per ounce, respectively.

The bank also notes that "The US dollar cannot be singled out as the root cause of the latest gold rally either since it is no weaker than a month ago and the gold:dollar correlation is moving ever closer to positive territory. Nor is it necessarily concerns over eurozone debt levels, although the gold:dollar correlation does imply an element of risk aversion."

"So while the gold price remains strong, we are a little concerned that if a correction comes it may not be signaled before the event. This gold rally appears very much sentiment based and investment demand in all regions and in most currencies is very strong. Any change to this current status quo could therefore see a sharp correction" concludes ABN AMRO’s VM Group.

Platinum dropped $12 to open at $1,693.00 while palladium lost an equal amount to commence trading at $747.00 the ounce. Rhodium was static at $2,280.00 the troy ounce. Today’s focus –more of the same- will be the US dollar and how it behaves in the wake of the release of November’s consumer prices and US manufacturing data.

The former rose 0.1% last month, driven largely by food and energy costs (both of which gained 0.2% in November) Core CPI rose 0.1% for the first gain since the middle of this summer. As things stand right now however, overall US CPI is still stuck below Fed targets of from 1.6 to 2 percent, and it remains at 1.1%. Repeat after the Fed: Inflation? What inflation?

The inflation data gave the US currency a further boost as of 8:40 NY time and helped drag gold back to near the $1,380-$1,385.00 area. As for the Empire State manufacturing index, it rose 22 points this month, following a lackluster (read: negative) November showing. It now stands at +10.6 on the back of rising new orders and shipments and a decline in inventories.

As noted in yesterday’s article, there is a school of thought that sees the dollar not suffering from the so-called ‘naked money printing’ campaign (as some have labeled it) being waged by the Fed. If bond markets are any indication, the greenback’s supporters may have fresh ammo to be confident that the US currency will be aiming higher still. There is a yield story here; one that is conveniently being swept under the rug by the dollar’s quite vocal morticians.

Even after a 6 percent rally from nearly one-year lows, the greenback remains undervalued when gauged against ten out of the sixteen majors it trades against, based on metrics compiled by the OECD. For example, the US currency is thought to be some 27% below ‘fair value’ against the Japanese yen, and about 35% under same vis-a-vis the Swiss Franc. Such ‘fair-value’ estimates indicate that in the G-3 group, it is the dollar that offers the best value currently.

In essence, the inflation-adjusted (real) yields on ten-year US instruments are currently higher than those offered by, say, Germany, or Japan, or the UK. That, plus the perception that -having gone into the economic maelstrom first- the US is the likeliest one to also climb out of it first, is helping attract capital from overseas. Such capital is in fact ‘writing the cheque’ on the $1 trillion US deficit at the same time as Mr. Bernanke’s Fed engages in the $600 billion program to buy bonds.

The recent gains in interest rates have spooked bond investors and have (somewhat) confounded the Fed (as mentioned in yesterday’s article).

The Washington Post notes that "The rise [in rates] is partly because of good news: The outlook for growth has improved, putting less pressure on investors to keep their money in ultra-safe bonds. When there’s less demand for bonds, their interest rates — or yield — go up to attract more investors. And the better economic outlook could allow the Fed to pull back sooner than expected on the extraordinary steps it’s taking to keep rates low."

Switching to the ‘overvalued’ side of the asset equation, there is still a school of thought that places gold squarely in the lead of that group. That would be the fundamental analysis-oriented school.

A detailed Seeking Alpha article by Richard Moheban looks at gold from the angle that holds that "Fundamental analysis for investing in any kind of asset involves estimating its inherent risks, and also estimating the probable return the asset will generate. Note that "return the asset will generate" means return that is organic to the asset itself — separate and apart from any change in the asset’s market price. If you do forecast this organic return accurately, sooner or later its market price will follow."

The author sees $1,400 gold as the result of the rush by certain investors classes to seek protection in an asset that they see as essential in the perceived "great unravel" that they are sure is coming to a currency near you.

Mr. Moheban concludes that "Once gold price deflation has clearly become established as the new trend, many gold investors will switch from being confident to being fearful and sell."

Mr. Moheban notes that: "Gold buyers at these historically high prices are momentum investors, not value investors, so many will be fickle once the momentum is clearly downward" albeit he does not provide a timetable for such a switch in investor mentality.

At the very least, he does debunk certain myths (gold vs. inflation, gold vs. stocks) in the process. Price performance obsession is precisely what one ought to steer away from when it comes to the asset of ‘last resort’ (also known as ‘pis aller’ in French, it means an expedient adopted only in desperation). If that’s how one envisions things, then…Someone better help us all…

Until tomorrow,

Jon Nadler
Senior Analyst

Kitco Metals Inc.
North America and
Article: Value Judgements

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