In The Lead – See PM Fundamentals as Seen By CPM – Part II


Precious Metals CommentaryThe final precious metals trading session of this week started off on a mildly positive note as commodities overall firmed up and as the US dollar slipped to under the 79 pivot point on the trade-weighted index. Month and quarter-end book-squaring were seen as dominating the action for the remainder of the day but yesterday once again presented a headache for gold bulls who had become somewhat emboldened by certain words of Mr. Bernanke’s earlier in the week.

The first quarter’s performance tally shows gold being ahead by 4% since the first trading day of the year. Platinum, on the other hand, is some 17% higher than it was on January 3rd. A quick survey of equity indices indicates the S&P 500 is ahead by nearly 12% while the Nasdaq Composite is up by almost 19% on the quarter. Such gains would normally be nice enough if they were the tallies for a full twelve months. Stock market participants continued to receive decent US economic news this week as well; consumer spending climbed above forecasted figures, jobless claims continued at a four-year low level, GDP was un-revised at 3% for the final quarter of 2011.

Analysts at Standard Banks (SA) opine that while commodities had a nice start for first few weeks of the year, players in that space are well-advised to keep an eye out for developments from China. Setbacks in that country’s economy have dampened the strong out-of-the-gate performance in commodities since they first became publicized. Key metrics such as bellwether copper demand, cement production, electricity output, and manufacturing activity in China are critical watch-list items at this juncture.

Standard Bank also reminds us that the principal price-moving agent in commodities in Q1 has been speculative activity of the long kind (save for gold, whose open interest as a percentage of net length fell somewhat) based on QE3 expectations by a crowd that has become more habituated to easy money than Charlie Sheen had been to certain…substances. Practically every gold perma-bull now blames the Fed’s reluctance to provide QE dough to play in the markets with for the souring of the mood in gold. Seeking "salvation" from the US central bank may not prove to be the wisest strategy at this juncture, as you will see below.

Spot dealings opened with a bid-side quoted at $1,667 in gold and at $32.50 in silver. While there is still scope for attempts at taking out overhead resistance near $1,680 and $1,704 in gold (with a possible $1,730 end-target) the going has been anything but smooth amid an absence of not only QE3 but bullish news on the physical or ETF front as well.

Over in India, the near fortnight-long strike by that country’s jewelers continued but Finance Minister Mukherjee, according to Marketwatch, "has so far given no hint that the government intends to review the import taxes on gold. "I don’t think the government will change its position," said Badruddin Khan, an analyst at Angel Broking. "In general, when they do adjust parts of the budget, it’s for essential commodities, not for bullion."

New Delhi first slapped a 2% hike on gold in January to start plugging the holes in the government’s finances and the country’s current account deficit, a measure of the nation’s debt to foreign creditors. Gold demand was also cited as a factor in the slide of the rupee last year, which lifted the costs of India’s import bill."

Swiss Bank UBS yesterday trimmed its 2012 gold price forecast by a hefty 18%, down to $1,680 per ounce, as it sees gold as being "at risk" from the US recovery, dollar strength, and the dissipation of QE3 hopes. UBS had previously pegged a $2,050 target for gold for the year. The biggest concern appears to be the fact that, as we have stated here many times, gold has become over-dependent on a single type of offtake- that from investment.

UBS opines that gold is at risk precisely because "it needs persistent inflows of investor money to keep on its upward trajectory." Such inflows have been -to say the least- tenuous since last year’s volatility in prices increased and following September’s price peak above $1,900. Gold ETF demand tonnage in 2011 sank to the lowest annual level since the launch of such instruments in 2005. Several high-profile funds liquidated part or all of their gold holdings in the latter part of last year.

If there is any good news in the ETF space lately, it might be the fact that not too much gold tonnage has leaked out of such vehicles in the wake of the recent price declines that erased bullion’s February gains and then some. Of late, the strengthening perception that the Fed may be done with the handing out of ‘free money’ in the form of QE accommodation has rattled the confidence levels among gold bulls who expected 2012 to simply be ‘more of the same’ of what we have seen in the market since 2008.

There might also be another explanation as to why the Swiss bank cut its gold price outlook so dramatically. It has to do with capital flows. While UBS did not label the above-mentioned rising gold price formula with anything remotely resembling one Mr. Ponzi’s former scheme, there is one Marketwatch Trading Deck contributor who believes that, even at this juncture, gold is overvalued by 74%. Taking into account the Gold:GSCI (Goldman Sachs Commodity Index) and the Gold:CCI (Continuous Commodity Index) ratios and their historical patterns, there are a couple of conclusions to be drawn.

The first one is that the 2.37 Gold:GSCI ratio (as of March 23rd) was 35% higher than the historical average of 1.75 and that gold is probably 35% overvalued with respect to crude oil. The second inference is that a Gold:CCI ratio of 2.89 (also as of March 23rd) is 74% higher than its 1.66 historical average. And, yes, there is a chart for that metric, over at Insider Monkey. The last time that ratio was at 1.66 was on the day of the collapse of Lehman Bros. The PM Fix in London that day was $775.00 per ounce.

Platinum and palladium also moved higher this morning, with the former posting a $16 gain to $1,640.00 per ounce and the latter advancing by $4 to the $648.00 per ounce mark. PGMs are continuing to be supported by supply concerns which are once again becoming manifest owing to on-going labor action at the Anglo American Platinum and African Rainbow Minerals’ mines down in South Africa. Management and the unions have been engaging in daily talks, but "progress is elusive" according to reports.

According to Bloomberg News, investors are loading up on palladium at the fastest clip in over a year as perceptions that the noble metal will outperform gold this year are gaining traction. The combination of rising autocatalyst demand and falling Russian official sector supplies are making the investment community very interested in the metal; to wit, palladium ETF holdings have risen by 14% this year. That kind of addition in balances is something the gold ETF niche only wishes it could be witnessing. Recently made price projections call for an average of $850 per ounce for this year for palladium. That would be a 31% gain from present values, more than double of what is expected in gold by surveyed analysts.

We now continue with our dissection of the most recent facts and figures from the gold market as brought to us by CPM Group New York’s latest Gold Yearbook 2012. This most valuable publication is, in our estimation, the most accurate source for an individual investor to obtain the required knowledge for making better investment decisions and to dispel some of the many erroneous myths being propagated by parts of an agenda-driven community of hard money publications.

CPM goes to great lengths to educate the investment community about the actual goings-on in the marketplace. For example, in Wednesday’s post we examined gold CPM’s take on investment demand (down 5.8% last year), the myths of gold as an inflation hedge, and related issues. When it comes to gathering all the pertinent information, the firm’s researchers are without peer. It is also worth mentioning that when it comes to making reasonable price projections for precious metals, one of the CPM analysts, Mr. Rohit Savant, has come out on top of the LBMA’s 2011 list of the most accurate forecasters for gold and for platinum.

The total supply of gold climbed once again in 2011, rising to 3,372 tonnes, owing primarily to gains in mine output and secondary recovery from scrap gold (up to 1,275 tonnes). The world’s miners dug up 2,538 tonnes of new gold as strong jumps were recorded in Mexican (up 22.2%), Canadian (up 17.3%) and Chinese (up 5.9%) production. Consider those metrics the next time you hear one or another mining firm CEO warning about peak gold and vanishing production. The cumulative world production of gold now stands at nearly 156,500 tonnes and prior to 1800 only some 4,800 tonnes of the metal had been produced in aggregate.

Even hitherto falling South African mine production experienced a smaller decline in 2011 – roughly half of the level at which it was contracting in 2009. At current cash cost-to-market price margins it is a safe bet to fathom that the gentlemen will keep finding a way to produce the precious metal in abundant quantities. Consider the more than $8 billion that was spent on gold exploration in 2011 — an amount more than 51% higher than that tallied in 2010. There should be no doubts about how much influence the lofty price of bullion has had, and is having on such expenditures, and that they will most likely bear more "golden fruit" at the end of the day.

On the official sector front, CPM estimates that central banks did indeed buy a net of about 395 tonnes of the yellow metal last year (not the 500+ tonnes that some over-optimistic sources would have you believe) but it also found that such net purchases were mainly a result of a decline in gross sales, rather than the outcome of a jump in gross purchases. In fact, contrary to popular perception, central bank gross purchases have been trending lower over the past 36 months, falling from 846 tonnes in 2009 to 416 tonnes last year.

Moving to the other side of the gold market’s ledger sheet, CPM’s 2012 Gold Yearbook notes a very modest 0.6% gain in total gold fabrication demand for last year. A total of 2,270 tonnes (268 tonnes less than global mine output) went into the niche in 2011. Jewellery fabrication demand climbed 0.5% from 2010 levels and it continued to show a sector that is highly price-sensitive. In 2011 the US, Japanese, and European offtake for baubles declined, while Chinese, Indian and Middle Eastern demand for such fabrication climbed. Industrial-oriented gold demand (mainly electronics) remained steady (277 tonnes) while dental and medical applications demanded fewer ounces (66 tonnes) of the metal once again.

HSBC reported yesterday that some of the same emerging market central banks that had been identified as buyers last year (Turkey and Russia among them) sold modest amounts of their holdings last month. Thus, the best thing we can say about central banks and gold is that the process of individual policy decisions will continue and that some will buy gold while others sell it. On the other hand, the promises we have been given about massive Chinese or other central bank buyers stepping up and absorbing huge gold tonnage from the market have not, and will likely not materialize.

Speaking of central banks, the Fed, money, gold, and such, let us take a quick walk down Memory Lane and examine what happened (or better yet, what did not happen) when the US went off the gold standard. Authors Simon Johnson and James Kwak, in their new (upcoming on April 3rd) book entitled "White House Burning: The Founding Fathers, Our National Debt, and Why It Matters To You" give us a glimpse of what the US dollar, America’s debt, deficits, taxes, and a host of other currently hot topics are all about.

However, in an excerpt from the book that can be seen on Bloomberg News, we also get a quick history lesson about gold and the gold standard, and why its abandonment did not prove to be lethal to the USA. Yours truly discussed this very topic with Bloomberg’s Tom Keene just the other day. Brace yourselves; here is the link to a good dose of weekend reading and much-needed perspective (worth its weight in…gold), courtesy of MIT’s Simon Johnson and Harvard’s James Kwak. The Honorable Ron Paul might wish to order an advance copy for his own library. We are reasonably sure that Mr. Bernanke already has. A couple of "teasers" to ponder for now:

"Surprisingly, going off gold and abrogating gold indexation clauses did not destroy the [U.S.] government’s credit. The market reaction was almost nonexistent. The convertibility of paper into metal had been suspended often enough under the gold standard that the abrogation of the gold indexation clauses was not in itself grounds for panic. Most importantly, going off the gold standard and devaluing the dollar almost certainly helped the American economy overcome deflationary pressures and begin to recover from the depths of the Great Depression."

"The gold standard was blamed for exacerbating the worst economic crisis of the industrial age. In January 1934, Roosevelt officially reset the value of the dollar against gold at $35 per ounce — a fall in the dollar’s value from $20.67 per ounce, where it had been since 1834. Some of Roosevelt’s advisers were worried about going off gold; budget director Lewis Douglas famously remarked, "This is the end of Western civilization." It wasn’t. Instead, the dollar would replace gold as the backbone of world trade. One of the most important events in modern economic history, the United Nations Monetary and Financial Conference, held in Bretton Woods, New Hampshire, in July 1944, would see to that."

Have a nice weekend.

Jon Nadler
Senior Metals Analyst — Kitco Metals

Jon Nadler
Senior 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. and

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