In the Lead – QE Or Not QE – That Is The Question. Or, Is It?

by Jon Nadler, Kitco Metals Inc. on August 13, 2012 · 0 comments

Precious Metals CommentaryPrecious metals started the new week with mixed results this morning as the euro remained steady around $1.235 but remained at risk of sell-offs and as crude oil advanced by less than 1% on supply worries.

The US dollar also traded in lackluster fashion, hovering near the 82.50 pivot point while stock index futures remained flat one hour ahead of the opening bell. Spot gold opened at $1,621 in New York showing 50-cent advance on the bid-side while spot silver fell 20 cents to start the day off at $27.95 per ounce.

Platinum climbed $4 to $1,398 and palladium was unchanged at $579 the ounce. Rhodium was also flat at $1,140 the ounce. The PGM sector has had its share of price difficulties of late, owing to the EU’s denizens being preoccupied with day-to-day financial survival as opposed to buying new sets of wheels. Standard Banks (SA) analysts opine that

"at the current PGM basket price of ZAR8,990/PGM oz, we estimate that 14.6% of platinum production (690K oz) is at risk, as well as 13.15% palladium production (353K oz) and 12.9% rhodium production (12.85% oz)."

The PGM basket price has slipped to a two-year low recently.

Late Friday EW analysis continued to allow for the possibility of alternative scenario in which gold and silver make a push towards $1,700 and above $30 respectively. The EW market note deems this week as instrumental in determining the near-term direction in the duo. Last week, a serious number of eyebrows became furrowed in the wake of a Financial Times article by Peter Tasker who suggested that folks "cash out of gold and send kids to college." Bullion dealers and other hard money commentary producers were quick to unleash a plethora of "damage control" articles roundly taking Mr. Tasker… to task.

However, if one ignores the provocative title and suggestions of the author and concentrates on the "meat" found in the piece, at least a couple of truths may jump up and be noticed. First, Mr. Tasker noted,

"investors are running scared [true]. The global flight to safety has seen capital flood into “core” sovereign bond markets, driving yields down almost to vanishing point [also true]. Yet, despite this perfect storm of financial instability, the gold price remains becalmed [quite true as well].. In fact, over the past year gold bullion has behaved like a “risk on” asset, rising and falling in sync with stock markets [yep, that is also true]."

Now, some folks erroneously took Mr. Tasker’s words to mean that he was purposely trying to induce "weak hands" to bail out of gold as it might be in a bubble and that his piece might be nothing more than a perfect contrarian indicator. Seems to us that in fact Mr. Tasker was simply pointing out some obvious patterns that have developed in certain markets and that investors who do not heed them end up learning the hard way what they are all about.

Finally, Mr. Tasker also cautions his readers that, despite assertions to the contrary, there is little out there that can be deemed as a perfect shield against the global financials storms that have been raging for a number of years now.

He asks "So where is the haven that offers protection against the turbulence of markets? " and comes up with the truest of findings: "Guess what: there isn’t one. Everything has become somebody’s idea of an asset class, from dodgy modern art to the copper that burglars strip from church roofs. Everything carries some risk of loss."

Mr. Tasker is evidently not alone in uncovering certain market realities that have developed over the past year or so. Seeking Alpha’s Christian Magoon notes that

"the negative performance of gold as the EU crisis has elevated has been troubling for gold investors. Traditionally a safe haven in times of crisis, gold has been bypassed in favor of greenbacks. The increased value of the U.S. dollar has caused gold investors to suffer in two ways. First it has reduced the demand for gold which obviously pushes prices down. Second, as gold is primarily denominated in U.S. dollars, a stronger dollar has meant gold is worth less dollars. These two factors, along with a variety of negative demand developments in leading gold consumers India and China, have left gold investors out in the cold despite a global crisis heating up."

Meanwhile, gold’s fundamentals remain tilted into bearish territory on account of tepid physical demand. The President of the Bombay Bullion Association remarked that

"Even as the festival season has begun, the demand for jewellery is hardly there. The sudden spurt in prices to over Rs 30,000 is the main deterrent against the demand."

He also cautioned that August’s Indian gold imports could come in at some 30-32 percent under last year’s levels.

While on the subject of India, that country’s Chairman for the Prime Minister’s Economic Advisory Council, Mr. C Rangarajan, pointed to gold imports as one of, if not the — culprits for the high current account deficits that were tallied in 2011. India’s CAD came in at a three-decade high and amounted to 4.2% of GDP in the 2011-2012 period. Mr. Rangarajan remarked during a lecture he gave in Hyderabad on Saturday that

"gold imports in the previous year (2010-11) were USD 40 billion. The increase of USD 20 billion is partly attributable to high level of inflation. If you exclude that USD 20 billion, which I considered to be an excess, then the current account deficit would have come to moderate levels."

Background gold industry news from Peru indicate that while the unrest and controversy surrounding certain gold mining projects continue to define the scene across the country, the nation has now come to rely on gold as its principal export item. Peruvian gold sales amounted to $2.57 billion in Q1 of this year and the yellow metal constituted 23% of the country’s exports of just under $11.4 billion. The achievement prompted one local industry official to say that

"gold has become the principal Peruvian export product and this performance is explained by the marked rise in the price of the precious metal on international markets."

Also in the mining niche we learned that shareholders of Anglo-American are unhappy enough with the strategy and leadership of the firm’s chief executive, Ms. Cynthia Carroll, that they are demanding her ouster. One of the largest (institutional) shareholders recently told the Daily Telegraph that

"the company is suffering from bad execution, a poor strategy, and a crisis of confidence in the leadership. We haven’t been happy for a while but the last set of results was the coup de grâce.”

On July 27 Anglo announced that first-half earnings had fallen 46% to $3.7billion, an event whichtriggered a fall of 3.6% in the share price.  Anglo’s shares are around 20% lower than when Ms. Carroll became chief executive in 2007 and 45p%lower than their peak in May 2008. Ousting under-performing CEOs instead of letting them get carried away with $5K gold predictions in front of microphones is becoming the fashion of the day in the mining niche. Given what has happened to gold since 2001, investors want some "cake" as well.

The new trading week also commenced last night on the back of news that hedge funds and other commodity players scaled back on bullish bets for the first time in nine weeks. For more than two months, the spec crowd boosted its long positions in various commodities based on the expectation (make that: near-certainty) that central banks, led by the Fed, would "cave in" and launch a further round of monetary accommodation in order to prop up the various parts of the global economy that seem to be faltering. More on the topic of "to QE or not QE" will follow later.

Speculative long positions were trimmed in 18 different futures and options contracts relating to a slew of commodities. The CFTC positioning reports noted that market participants slashed gold holdings by 11% (their second reduction in three weeks). However, other commodities also suffered a shrinkage in long positions; among them copper and soybeans. The underlying sentiment shift for such a diminution in bullish bets appears to be related to the growing realization that, despite the ever-present hopes for central bank easing, there is only so much that the official sector can do to revive certain economies that are flagging, and that certain crises are far from resolved and they continue to undermine growth.

Specifically, the troubles in the EU continue to weigh heavily on the minds of speculators in "stuff" as commodities obviously rely on economic growth for performance, and, given the current state of Europe, such growth remains elusive, at best. BoE Governor Mervyn King noted in an article published on Sunday by the Mail Online that

"the problems in the euro area continue with no obvious end in sight."

When you have one central bank leader making such remarks only a couple of weeks after the ECB’s chief asserted that "whatever it takes" will be done and that problems will be thoroughly addressed, well, you can see the [lack of] confidence issues that are abundant in supply out there. Of course, Mr. King was addressing the touchy issue of the UK’s hampered economic growth when making that remark, but he did seize the essence of the EU’s crisis; i.e., its’ seeming "open-endedness." One money manager bluntly warned that

"Europe needs to be mended before commodities can really take off."

As far as mending Europe goes, at the moment, the focus might as well be on preventing its total breakdownAccording to PIMCO –the largest global bond fund- the capital flow patterns manifest in that crisis-ridden region appear to reveal an exodus of growing proportions and the possible advent of yet another financial "event." The fact that the euro has lost 8% in value against the US dollar since just the start of the month of May has evidently not been lost on investors. More telling is the fact that the open-ended problems of the region have given rise to a whole new set of tangible actions, and not just feelings of angst.

While PIMCO does not quantify it, the flight of sizeable amounts of capital within the troubled eurozone has taken on a new and troubling direction. Instead for worried money flowing from, say, Greece to Germany in a quest for safety, the cash that is currently sprouting wings seems to be leaving the region altogether. You already know that one obvious beneficiary of such a "winged migration" has been the, by now, supposedly "dead-and-buried" US currency.

While the hope that the US dollar will finally roll over and do some folks a big favor by croaking in the wake of a much-awaited QE3 gesture by the Fed is alive and well, some analysts beg to differ on the efficacy of such easing. Deutsche Bank analysts suggest that, in fact, QE3 "could do more harm than good for gold prices." In a recent note to clients, the bank points to the fact that

"Gold trading volumes have tumbled recently as investors supposedly wait for more clarity on central bank policy."

As we know, central banks have been less than eager to pull the monetary easing lever despite some signs that certain economies are faltering of late. Deutsche Bank’s note goes on to remark that

"gold bulls must be mildly frustrated at policymakers’ reluctance to move so far. However, very few dwell on the reasons for this caution, namely the fear QE might do more harm than good for the economy. Mightn’t it do more harm than good for gold prices too? For instance, due to the still diminished risk appetite, QE (in the way it has been conducted up to now) simply adds to the tightness in the safe-haven bond markets. Some money market investors are already facing negative yields and are being made poorer as a result of QE. It is difficult to see how this could be good for gold prices."

However, Deutsche Bank is not alone in questioning the outcome of a possible QE3 on gold prices. Reuters intrepid reporter Jan Harvey, in her brilliant piece available at Canada’s Financial Post website asks whether "[A post-] QE3 gold rally be the metal’s last hurrah?" Ms. Harvey notes that

"Investors banking on a third round of U.S. money-printing to push gold back to record highs this year are taking a risk, not least because the metal’s other pillars of support look shaky."

Ms. Harvey surveyed several market analysts and came up with a few less than enthusiastic takes on the side-effects of a possible fresh round of Fed monetary easing. Noted Societe Generale analyst Robin Bhar warns that

"the upside to gold with more QE [is] maybe US$1,800 — certainly not new highs. You have got some disillusionment setting in," while Royal Bank of Scotland analyst Nikos Kavalis relays that "We’re of the view that we’re getting close to game over for gold. From there (a QE related rally) onwards, I am struggling to see where the kind of volumes of investment that we got in 2009 and 2010 are going to come from."

That intense need for fresh money in the investment niche in gold is heavily underscored by GFMS Thomson-Reuters’ own Phillip Newman:

"You do need to have fresh money coming in day in, day out. You need to have continual inflows, not just one or two institutional players such as pension funds to make that decision to come in."

By one estimate, that required daily flow of dough into the yellow metal — just to keep things ‘afloat — might be as high as $500 million. Five. Hundred. Million. Dollars. A day.

We close today with a quick trip into… outer space. Again. We recently brought you news that asteroid mining for certain precious and noble metals could become a reality in the not too-distant future. Now, it seems that the story is getting expanded coverage and that despite some still-raised eyebrows among media members, the folks with money on the line in this emergent business are dead serious about their pursuits. Here is an excellent video primer on the subject, courtesy of Bloomberg News.

Until Wednesday, look to the skies… even if the Perseid meteor shower has peaked and the London fireworks have died down…

Senior Metals Analyst — Kitco Metals

Jon Nadler
Senior Metal Analyst

Kitco Metals Inc.
North America

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.

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