Precious Metals

While it is early to determine if the ongoing breakout is finally in anticipation of upcoming episodes of direct and indirect monetization by the Fed, ECB, or any of the many other pathological currency diluters in circulation, it is obvious that precious metals have found a new bid in recent days. Is this then, the beginning of the next surge in gold and silver to record highs? It remains to be seen, but one entity, the Duet Commodities Fund which was one of last year's best performers, has already made up its mind. 'Our central forecast in gold remains constructive as our long term view targets $2,500 in 2012. Our core view is that gold will head higher to the $2,500 range driven by consequential USD weakness once the EU crisis dissipates and the US steps into the limelight. A weaker USD is not undesirable in the world order as everyone (especially China) understands that the US consumer is the driver for global consumer confidence and consequential consumption led demand." Wow - someone in this market can actually think one step ahead of the inevitable ECB LTRO/monetization, and realize that the Fed will in turn have to escalate to that escalation. Gold, er golf clap.

A peek into the 60's manipulation and why the CFTC is a joke.

One reason for the severity of the financial crisis, and the losses incurred by banks, is that bankers and financial analysts were using linear tools in a non-linear, highly complex environment otherwise known as the financial markets.The models didn’t work. The problem we face now as investors will end up being existential for some banking institutions and sovereigns. Our (uncontentious) core thesis is that throughout the west, more debt has been accumulated over the past four decades than can ever be paid back. The question, effectively to be determined on a case-by-case basis, is whether bondholders are handed outright default (which looks increasingly like the case to come in Greece) or whether the authorities, in their understandable but misguided attempts to keep the show on the road, resort to a policy of inflation that could at some point easily spiral out of control. As Rothbard wrote, “The longer the inflationary boom continues, the more painful and severe will be the necessary adjustment process… the boom cannot continue indefinitely, because eventually the public awakens to the governmental policy of permanent inflation, and flees from money into goods, making its purchases while [the currency] is worth more than it will be in future.” “The result will be a ‘runaway’ or hyperinflation, so familiar to history, and particularly to the modern world. Hyperinflation, on any count, is far worse than any depression: it destroys the currency – the lifeblood of the economy; it ruins and shatters the middle class and all ‘fixed income groups;’ it wreaks havoc unbounded… To avoid such a calamity, then, credit expansion must stop sometime, and this will bring a depression into being.”

The world's biggest primary silver miner, Fresnillo, had flat silver production in 2011. Output is only expected to remain stable in 2012.  African Barrick Gold said on Wednesday fourth quarter gold production fell 11% and missed its annual production targets. Despite price rises seen in 2011, gold and silver mining is remaining static contrary to claims by gold bears that higher prices would lead to increased production and therefore increased supply. Geological constraints may be impacting mining companies ability to increase production of the precious metals. Standard Bank has said it lowered its average 2012 gold price forecast by 6 percent to $1,780 an ounce, but continues to expect prices of the precious metal to touch new highs in the latter half of this year.  "We maintain that gold will reach new highs this year but, given our dollar view, we believe that these highs will be reached only in the second half of 2012," the analyst said in a note. Standard Bank expects the U.S. dollar to gain strength, especially against the euro, over the next quarter. A few other banks have recently lowered price forecasts for gold, including ANZ and Credit Suisse – however the majority remain bullish on gold’s outlook for 2012.

The great lie that drives the fiat global financial locomotive forward is the assumption that there is no other way of doing things.  Many in America believe that the U.S. dollar (a paper time-bomb ready to explode) is the only currency we have at our disposal.  Many believe that the corporate trickle down dynamic is the only practical method for creating jobs.  Numerous others have adopted the notion that global interdependency is a natural extension of “progress”, and that anyone who dares to contradict this fallacy is an “isolationist” or “extremist”.  Much of our culture has been conditioned to support and defend centralization as necessary and inevitable primarily because they have never lived under any other system.  Globalism has not made the world smaller; it has made our minds smaller. By limiting choice, we limit ingenuity and imagination.  By narrowing focus, we lose sight of the much bigger picture.  This is the very purpose of the feudal framework; to erase individual and sovereign strength, stifle all new or honorable philosophies, and ensure the masses remain completely reliant on the establishment for their survival, forever tied to the rotting umbilical cord of a parasitic parent government. 

Recently, public interest in gold and silver and gold/silver mining stocks has been at multi-year lows. And that is a super bullish contrarian indicator.

Back in August 2010, we presented an idea proposed by our friends at SK Options trading for a very simple trading strategy: being long gold in the overnight session, and shorting it during the day. At the time of writing, such a strategy would have returned $2.16 billion from a $100 million initial investment in 10 years, a 37.46% annualized return. Today, we provide a much needed follow up to this quite stunning divergence. As SK notes: "we have revisited the article and written an update. Not only does the discrepancy still exist but it has been actually increasing. That fund would now be worth $5.26B, way up from $2.16B when we last wrote about it - in other words an increase of 143% in just over a year. When we wrote about this in August 2010, the annualized return of the Long Overnight/Short Intraday gold index was 37.46% since the start of 2001. However if we measure from now the annualized return since 2001 is 43.24%, with the annualized return of the Long Overnight/Short Intraday gold index standing at roughly 64.4% since 2009." So for those who wish to layer on an additional alpha buffer on top of what is already the best performing asset of the past decade, the SK Options way just may be the strategy. As for the reasons for this gross arbitrage - who cares. Is it manipulation? is it the early Asian buying offset by London pool selling? It is largely irrelvant - the point is that this is "the divergence that keeps on giving" - kinda like a Stolper trade, or an inverse Tilson ETF, and until it doesn't, or until something dramatically changes in the precious metal market, it is likely that this trading pattern will continue for a long time.

2011 was a merry-go-round of more bailouts, more deferrals and more denial. Everyone is tired of the Eurozone. It’s not fixable. There’s too much debt. The politicians don’t know what’s going on. Nothing has structurally changed. We’re still on the wrong path. There’s more global debt than there was a year ago, and it’s the same old song: extend and pretend, extend and pretend,… around and around we go,… and it isn’t fun anymore. Just as we wrote back in October 2007, and again in September 2008, we feel compelled to state the obvious: that the financial system is a farce. It’s a complete, cyclical farce that defies all efforts to right itself. This past year continued the farcical tradition with some notable scandals, deferrals and interventions that underscored the system’s continuing addiction to government interference. With the glaring exception of US Treasuries and the US dollar (which are admittedly two of our least favourite asset classes), it was not a year that rewarded stock picking or safe-haven assets. Many developments during the year bordered on the ridiculous, and despite some positive news out of the US, we saw little to test our bearish view. If anything, our view was continually re-affirmed.

Last week, the US government’s Financial Crimes Enforcement Network (FinCEN), an agency of the US Treasury Department, published its 2011 annual report. There are a few numbers that are pretty startling. We’ve discussed before that FinCEN is the executive agency tasked with ensuring that every US banker is an unpaid government spy through Suspicious Activity Reports. A Suspicious Activity Report, or SAR, includes details of any transaction that may be deemed ‘suspicious’. Naturally, there’s no clear guidance on what is/is not considered suspicious. Banks, brokerages, money service businesses, precious metals dealers… even casinos are required by law to fill them out. If you withdraw an unusual amount of cash from your bank account, that could be deemed suspicious. If you set up a new payee in your billpay service, that could be deemed suspicious. Anything and everything is fair game. Banks and other businesses who do not fill out SARs face hefty penalties, including imprisonment. If they disclose to a customer that s/he is the subject of a SAR, they have hefty penalties, including imprisonment. When push comes to shove and they have to choose between a nasty penalty, or submitting a SAR about your unusual cash withdrawal, which option do you think they’ll pick? Unsurprisingly, nearly 1.5 million ‘suspicious activity reports’ were filed across the US banking system in 2011, well over twice the number reported in 2004. On top of this, there were an additional -14.8 million- ‘currency transaction reports’ filed in 2011, a 6% jump over last year. It’s an unfortunate trend which highlights not only the end of financial privacy, but also the massive amount of data being collected by the government to keep tabs on its citizens.

Gold registered its eleventh consecutive annual gain, extending the bull market that began in 2001. The yellow metal gained 10.1% – a solid return, though moderate when compared to previous years. Silver lost almost 10% year over year, due primarily to its dual nature. Currency concerns lit a match under the price early in the year, while global economic concerns forced it to give it all back later. Gold mining stocks couldn't shake the need for antidepressants most of the year, and another correction in gold in December dragged them further down. Meanwhile, those who sat in US government debt in 2011 were handsomely rewarded, with Treasury bonds recording one of their biggest annual gains. In spite of the unparalleled downgrade of the country's AAA credit rating, Treasuries were one of the best-performing asset classes of the year. The driving forces there are expanding fear about the sovereign debt crisis in Europe, combined with the Fed's promise to keep interest rates low through 2013.

Back in mid-May just after the market had topped for the year, in a post titled "The Great QE Unwind Compression Trade(s)" we told readers to "focus purely on Utilities and Consumer Staples as the long leg in a compression trade, while shorting Industrials and Consumer Discretionary, leaving Financials alone (John Paulson's projections of Bank of America hitting $30/share by the end of 2011 notwithstanding)." Granted Financials were by far the worst performing trade of the year although with the possibility of a Fed bailout around every corner, it was imprudent to be short the sector (rather going long various unique opportunities such as MBIA proved to be a 100% return in months if not weeks). Instead, we referred to precious metals, namely gold, as a natural hedge against any potential Fed (and global central planner) stupidity. So how did anyone who followed our 2011 advice do? Well - the above three suggestions represented three of the five best performing sectors in the year (with the shorts not offsetting any gains). As can be seen below. Which we merely bring up to those who, counterfactualy, desire to brand this site as some fringe lunatic goldbug asylum. Which we are not saying it isn't: we urge most people to stay out of stocks entirely: the possibility of another flash crash is always present. For those for whom capital preservation is of paramount importance, precious metals are the way to go. But we realize there are those for whom career risk means being involved in stocks, and we realize that they represent a substantial portion of our readership. Which is why we try to be of use to everyone who comes here.

One of the main reasons why we have been not so focused on paper representations of real currencies (i.e., gold and silver) is that ever since the MF Global debacle, in which it became all too clear that if physical gold can be "hypothecated" via conflicting ownership, then there is no way that paper versions of precious metals are viable and indeed credible. After all, the only real owner at the end of the day is the certificate holder, which as we have explained before, is none other than DTCC's Cede & Co. Good luck collecting when the daisy chain of counterparties starts falling. Which leaves physical. And for a good sense of what the "real" price of the metal is, not one determined by institutions whose interest it is to preserve the hegemony of paper, one can either try to procure gold and silver at a retail merchant, or one can look to the premium of a dedicated physical ETF over spot. Such as Eric Sprott's PSLV which as of today is trading at an all time high premium of 30%! In other words, someone is willing to pay up to 30% over spot for the right to be closer to the physical metal than merely have a paper claim on a paper claim (pre hyper rehypothecation and what not). Incidentally the last NAV premium over spot record was back in April 2011 just as silver went parabolic and the entire commodity complex experienced the infamous May 1 takedown when it collapsed by $8 dollars in milliseconds on glaringly obvious coordinated intervention. Said otherwise, like back then, so now there is an actual shortage, manifesting itself in the premium. And while last time its was the price plunge which eased supply needs, we are not so sure how one will be able to spin a collapse of the current, far lower paper silver price.

In spite of some short-term fixes, there remains no real resolution to the sovereign debt issues in many European countries. We're certainly not spending less money in the US, and now we're bailing out Europe via currency swaps with the European Central Bank. Shouldn't gold be rising? Yes, but nothing happens in a vacuum. There are some simple explanations as to why gold remains in a funk.

1. The MF Global bankruptcy, the seventh-largest in US history, forced a high degree of liquidation of commodities futures contracts, including gold. Many institutional investors had to sell whether they wanted to or not. This is similar to why big declines in the stock market can force funds and other large investors to sell some gold to raise cash for margin calls or meet redemption requests.
2. The dollar has been rising. Money fleeing the Eurozone has to go somewhere, and some of it is heading into US bonds, which means first converting the foreign currency into dollars.
3. It's tax-loss selling season, something that's also impacting gold stocks. Funds and individual investors are selling underwater positions for tax purposes. Funds also sell their big winners to lock in gains for the year and dress up quarterly reports.

These forces have all acted to depress the gold price.

The fact is that the US has been on a slippery slope for decades, and it's about to go over a cliff. However, our standard of living, while declining, is still very high, both relatively and absolutely. But an American can enjoy a much higher standard of living abroad. On the other hand, if I were some poor guy in a poverty-wracked country with few opportunities, I'd want to go where the action is, where the money is, now. Today, that means trying to get into the United States. The US is headed the wrong direction, but it's still a land of opportunity and a whole lot better than some flea-bitten village in Niger...This is one of the advantages of studying history, because it shows you that things like this rarely happen overnight. They are usually the result of trends that build over years and years, sometimes over generations. In the case of the US, I think the trend has been downhill, in many ways, for many years. Pick a time. You could make an argument, from a moral point of view, that things started heading downhill at the time of the Spanish-American War. That was when a previously peaceful and open country first started conquering overseas lands and staking colonies. America was still in the ascent towards its peak economically, but the seeds of its own demise were already sewn, and a libertarian watching the scene might have concluded that it was time to get out of Dodge –

If there is one lesson to be learned from the Japanese experience with deleveraging over the past few decades it’s that deleveraging cycles have there own special rhythm of reflationary and deflationary interludes.  Pretty simple thinking as balance sheet deleveraging by definition cannot be a short term process given the prior decades required to build up the leverage accumulated in any economic/financial system.  If deleveraging were a short term process, it would play out as a massive short term depression.  And clearly any central bank would act to disallow such an outcome, exactly has been the case not only in Japan over the last few decades, but now also in the US and the Eurozone.  We just need to remember that this is a dance.  There is an ebb and flow to the greater (generational) deleveraging cycle.  Just as leveraging up was not a linear process, neither will the process of deleveraging be linear.  Why bring this larger picture cycle rhythm up right now?  The recent price volatility we’ve seen in assets that can be characterized as offering purchasing power protection within the context of a global central banking community debasing currencies as their preferred method of reflation for now, specifically recent the price volatility of gold.