Penny gold

  • Japan is a sleeping giant
  • Has the Fed lost its mind?
  • What to buy?
  • Could gold really hit US$10,000?
  • Beyond Brexit — more earthquakes on the way

Jason Stevenson, Editor, Resource Speculator

Kris is taking the week off from Port Phillip Insider. He’s working on some of the final details for the upcoming Port Phillip Publishing investment conference, The Great Repression, which begins one month from now.

As for me, Resource Speculator readers know that I recently attended an institutional agriculture conference in Japan. Some of Japan’s biggest institutional investors were there. Japan Post, the country’s largest bank and insurer, with US$1.7 trillion under management, took up the entire back row of seats.

With economic output collapsing around the country, Japan’s economy faces plenty of serious issues. The entire country is dead broke, and that’s why the pension funds are looking for new ideas.

In reality, it probably won’t matter what their pension funds do. Around the country, cities are turning to dust (more on this shortly). Their pension funds are in big trouble, and will probably face massive losses in the years ahead. That won’t be great for many investments…except one. More on that in a moment, but first, let’s look at the markets…

Markets

Over the weekend, the Dow Jones Industrial Average fell 131.01 points, or 0.71%.

The S&P 500 fell 12.49 points, or 0.57%.

In Europe, the Euro Stoxx 50 index dropped 19.38 points, or 0.64%. Meanwhile, the FTSE 100 fell 0.03%. Germany’s DAX index fell 0.44%.

In Asia, Japan’s Nikkei 225 index is down 106.9 points, or 0.64%. China’s CSI 300 index is down 0.77%.

In Australia, the S&P/ASX 200 is down 4.2 points, or 0.08%.

On the commodities markets, West Texas Intermediate crude oil is trading for US$44.80 per barrel. Brent crude is US$46.28 per barrel.

Gold is US$1,333.84 (AU$1,751.00) per troy ounce. Silver is US$19.54 (AU$25.66) per troy ounce.

The Aussie dollar is worth 76.19 US cents.

Japan is a sleeping giant

A sleepy former mining town in northern Japan is becoming a ghost town.

Since its peak in the post-war economic boom of the 1960s, the population of Yubari has plummeted by 90%. 10 years ago, it became Japan’s first municipality to declare bankruptcy.

It won’t be the last, either…

By 2040, about half of Japan’s municipalities face extinction, according to Bloomberg.

With economic output collapsing around the country, Japan’s debt is a ticking time bomb.

Within the next several months, like most other nations around the world, Japan will either default on its national debt entirely, delay its interest payments, or extend its maturity dates. This probably won’t help revive Yubari, a coal-mining town.

Unlike coal, however, Japan’s coming sovereign debt crisis, combined with most other countries around the world, should put a rocket under the gold price in the long term. That’s because, when governments start to default on their obligations, it makes sense to us that people will lose confidence in government-issued money and debt.

Imagine if Yubari was leveraged to the gold price. It could be a different story.

Has the Fed lost its mind?

After years of losses, gold has delivered strongly this year. The precious metal is up about 24% from its December low. If you were brave and bought near the low, you deserve a pat on the back!

But even better than the gold price has been the price of gold stocks. The best gold miners have delivered mouth-watering returns this year. We’ll look at a few examples in a tick…

But sticking with the gold price for a moment, the spot price has been quite volatile. It remains locked within a two month range spanning from about US$1,300 to US$1,359 per ounce. The range is shown on the weekly chart below within the black lines.



chart image

Source: Tradingview.com; Resource Speculator
Click to enlarge


This is a very dangerous market for commodity traders. You can get ‘faked out’ on the downside and upside. In other words, gold could appear to break out — and then turn viciously south. Or it could look to plummet, and then shoot sharply higher.

That has kept gold miners in a tight range, too…until last week. The Sydney Morning Herald reported this morning:

Gold stocks enjoyed a phenomenal rally last week as the precious metal rose to a two-week high following the Fed meeting and that is stemming the recent losses for local miners.

“You can’t ignore the fact that the majors dropped off from their highs in late July, and quite frankly they were expensive,” says Ryan Armstrong, mining and resources analyst at Taylor Collison. 

Big players like Newcrest, which was 71.5 per cent higher this year in July, Evolution Mining, which was up 121 per cent, and Northern Star, which had enjoyed a 109 per cent rally, have all come off in the order of 20 per cent.

“They were trading at multiples that people weren’t used to seeing gold and that made people a bit nervous, particularly with the thought the US was raising rates soon,” Mr Armstrong says.

The Fed decision was hardly a surprise…

In Money Morning last week, I argued that the Fed wouldn’t raise rates, and that the decision could put a rocket under the gold price in the weeks ahead.

The Fed’s communication style has been atrocious. Remember when it raised rates in December?

When the Fed pushed rates higher in December, most Federal Open Market Committee (the body that sets US interest rates) members were in sync. They effectively communicated to the market their intention to raise rates. The market had the prospect of the move at 91%, despite some shaky economics at the time.

The Fed’s latest policy meeting was never likely to result in a rate rise. The Fed is divided, and the market priced in just a 20% chance of a rate lift. If they plan to raise rates at all this year (my bet is on December), they will need to do a better job of communicating their intentions to the market.

But who knows what will happen?

The Fed may backflip, yet again…

What to buy?

The Wall Street Journal reported on 11 September:

Assuming investors do want to jump on the gold train, what options do they have?

One way is to simply buy gold in the form of bars or coins. Some investors prefer this, says Niladri Mukherjee, managing director at Merrill Lynch Wealth Management, because they like to be able to see and touch the asset. Some of these investors may have a particularly bearish outlook on the economy, he says, and view holding physical gold as safer than investing in a fund that owns gold or the shares of gold miners. Others may conclude that gold-related financial products and their issuers are too complex, he says.

Owning gold can be expensive. You need to pay to store it somewhere, which can have its own risks, such as asset confiscation. Remember, governments are dead broke. Franklin D Roosevelt confiscated gold in 1933. That could happen again.

Physical gold is worth owning purely as a hedge against government and central bank manipulation. That said, aside from the extra costs, it also tends to be an ‘illiquid’ way to store your wealth. If you want to buy it, you have to pay a premium above the spot price to the mint or merchant — and when you sell it, you’ll receive a discount to the spot price. Unless the price rises sharply, that can result in less money in your pocket.

The Wall Street Journal continued…

Another method is to invest in a fund that owns gold. The easiest way to do this is to buy shares of an exchange-traded fund that holds the metal, says Mr. Mukherjee. Kiril Nikolaev, an analyst at ETFdb.com, a website that covers the ETF market, points out that gold ETFs generally charge investors lower fees than mutual funds.

However, gold ETFs also have their drawbacks. Investors’ gains from funds that hold gold are taxed at the rate for collectibles, meaning a maximum of 28%, says David Perlman, ETF sector strategist at UBS.

One way to avoid this, while still having exposure to the metal, would be to invest in equities—buying shares of gold miners, either individually or through a fund. Gains on these shares are taxed as long-term capital gains if the shares are held for more than a year, at a maximum of 20%, “so there could be an advantage,” Mr. Perlman says.

In my view, the best way to gain exposure to gold is by buying stocks. Gold stocks are normally more liquid, have lower holding costs, and are more leveraged to the spot price.

Of course, the risks are different. If you own gold, you own a physical asset. If you own gold stocks, you’re relying on the performance of the underlying company. But that’s why, if you back the right gold stocks, you can achieve a big outperformance compared to just owning gold.

For example, the Aussie dollar gold price is up a respectable 20.3% this year. The VanEck Vectors Gold Miners ETF [ASX:GDX] is up 88.3%

Given that performance so far this year, consider what could happen to the price of gold stocks in the years ahead if gold heads to Jim Rickards’ forecast of US$10,000 per ounce.

And in our view, the best way to trade gold stocks is by focusing on what we call ‘penny gold’ stocks. These are the companies that hungry speculators who are searching for the market’s biggest gains should buy today. ‘Penny gold’ stocks don’t care about macroeconomics — they just care about making a major gold discovery. If the company finds it, the share price can go up thousands of percent. And again, imagine the returns if gold hits US$10,000 per ounce?

As it happens, three of the best ‘penny gold’ stocks are listed right here on the ASX. The details on how to get hold of those stocks are here.

Could gold really hit US$10,000?

Now, you may have one question: With gold at ‘just’ US$1,333 per ounce, how can Jim Rickards justify a future gold price of US$10,000 per ounce?

Who better to answer this than Jim himself? I’ll pass you on to him right now…

Cheers,

Jason

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Beyond Brexit — More Earthquakes on the Way

Jim Rickards, Strategist, Gold Stock Trader

On Monday, 20 June 2016, I stood in the London Eye Ferris wheel. I was just across the Thames from the UK Houses of Parliament, standing with a film crew to record an urgent warning. I said that the Brexit vote, coming just three days later on 23 June, could produce a financial earthquake.

I recommended the exact strategies to avoid losses and to profit from the catastrophe to come. These strategies included shorting sterling, buying gold, and increasing cash allocations so our readers could ‘go shopping among the ruins’.

I wish that were the end of it, but it’s not. New earthquakes are coming soon, as part of the Brexit aftershocks.



chart image

Your editor recording a video message aboard the famous London Eye Ferris wheel on 20 June, 2016. The iconic Big Ben and parts of Westminster can be seen in the background through the London fog. The video warned of the financial earthquake coming three days later from the Brexit vote and its aftermath. Now we see new earthquakes coming.


By now, you’re familiar with the basic outline of the Brexit story. On 23 June, UK subjects voted, by a 52% to 48% margin, to leave the European Union. Markets had clearly priced for a ‘Remain’ victory.

The result was an instantaneous and violent repricing. Gold gained over US$40 per ounce, stock markets fell 4%, sterling crashed almost 10%, and the euro sank 4% all in a single day. These are large percentage moves for a full year. To happen in one day is the financial equivalent of a 7.0 earthquake on the Richter scale.

The key question for investors is whether this is a one-time repricing of assets, or whether it’s the start of something with a long way to run. If the latter view is correct, then it’s not too late to profit from some of our favourite plays, including long positions in gold, gold miners, short positions in sterling, and long positions in US Treasury notes.

We don’t believe that markets are efficient, or that forecasting is impossible. Quite the opposite. Our proprietary models allow us to make long-run and intermediate-run forecasts that give you time to profit ahead of the crowd.

Wall Street will tell you that you cannot foresee shocks, and that you cannot ‘beat the market’. Don’t believe it. While most market participants were shocked at the Brexit vote, we saw it coming a mile away using our proprietary models 

On 2 March 2016, almost four full months before the Brexit vote, I gave an interview to Bloomberg TV in which I predicted that ‘Leave’ would win. Here’s the interview so you can see for yourself.

I use a method called causal inference to make forecasts about events arising in complex systems such as capital markets. Causal inference methodology is based on Bayes’ Theorem, an early 19th-century formula first discovered by Thomas Bayes. The formula looks like this in its modern mathematical form:



chart image


In plain English, this formula says that, by updating our initial understanding through unbiased new information, we improve our understanding. I first learned this method while working at the CIA, and I apply it to understanding the markets today.

The left side of the equation is an initial estimate of the probability of an event happening. New information goes into the right hand side of the equation. If it’s consistent with our estimate, it goes into the numerator (which increases the odds of our expected outcome). If it’s inconsistent, it goes into the denominator (which lowers the odds of our expected outcome). This is the method we used to correctly forecast the outcome of the Brexit vote.

Now we are using it again to forecast the aftermath of the Brexit earthquake. Our expectation is that the pound sterling has much further to fall, perhaps to as low as US$0.80, a full 40% drop from current levels.

I also expect gold to go much higher. Gold was already headed higher for reasons unrelated to Brexit, including the Fed’s new dovish stance on interest rate hikes. But Brexit uncertainty gives added impetus to the uptrend already underway.

What are some of the data points included in the equations behind our updated forecast?

  • Brexit is just the beginning. No sooner were the votes counted than the Scottish National Party began calls for a new referendum for Scotland to leave the UK and remain in the EU. A logical result of this would be for Scotland to adopt the euro as its currency and abandon the pound sterling. This will put more downward pressure on sterling.
  • All of the political parties in the UK are in turmoil. A fight has broken out in the Conservative Party to replace the current Prime Minister David Cameron, who announced his coming resignation after the Brexit defeat. The Labour Party is in disarray because frontbenchers who wanted to remain feel that Labour leader Jeremy Corbyn did not do enough to lead the Remain forces. Finally, the leader of the UK Independence Party, Nigel Farage, has been excluded from the Brexit negotiations with the EU. Farage vows to take revenge in Brussels, where he is a member of the European Parliament and can have a say on Brexit from the other side of the table.
  • The EU is likely to take a punitive approach to the Brexit negotiations. This will be done as ‘an example to the rest’ in order to head off other nationalist movements that want to quit the EU. By showing that there are high costs to leaving the EU, the core EU leadership — Germany, France and Italy — hope to dissuade others from leaving.
  • With the UK out of the EU, the European Central Bank will ban the settlement and clearance of euro-denominated transactions in London. These transactions will have to be settled and cleared inside EU member nations in centres like Paris, Amsterdam and Milan. The result will be a diminution in London’s role as a financial centre beyond what even the pessimists are currently predicting.

The list goes on, but you get the point. Only a small portion of the impact of these events has been priced into markets already. This means that the market trends we identified — short sterling, long gold, etc. — have a long way to run.

Above all, these trends mean uncertainty. Markets have ways to price risk on a probabilistic basis, but they have no way to price uncertainty where almost anything can happen. In these situations, markets go to the safest of safe havens; that means cash, US Treasuries, and gold.

The slump in gold and gold related stocks from 2011 to 2015 is no mystery.

It had to do with the Fed’s tightening policies, and strong dollar policies, after the dollar hit an all-time low in August 2011.

Now that the Fed is pursuing a dovish weak-dollar policy, gold is poised to go much higher.

All the best,

Jim Rickards