Market hits gold hard — stocks to follow?

  • Gold to fall…or not
  • Invest or speculate?
  • In the mailbag

What a night for gold.

The price fell below US$1,300 an ounce for the first time since June this year.

It was the biggest single-session fall since 2013.

What’s up with gold?

An interest rate rise is coming…that’s what the experts say.

According to Bloomberg:

Fed Bank of Richmond President Jeffrey Lacker urged the central bank to raise rates to head off a likely pickup in inflation that wold force bigger increases later. On Monday, Fed Bank of Cleveland President Loretta Mester said she expects the case for a hike to remain “compelling” at the next review in November. The dollar headed for the biggest gain in two weeks against a basket of currencies, curbing the appeal of gold as an alternative asset.

The market has now factored in a 21.4% chance of a rate rise at the Fed’s November meeting. If the Fed doesn’t raise rates then, there is a 61.2% chance of an increase at the December meeting.

Is either of those outcomes likely? We’ll give you our take below. First…

Markets

Overnight, the Dow Jones Industrial Average fell 85.4 points, or 0.47%.

The S&P 500 dropped 10.71 points, or 0.5%.

In Europe, the Euro Stoxx 50 index gained 31 points, or 1.03%. Meanwhile, the FTSE 100 closed up 1.3%, and Germany’s DAX index added 1.03%.

In Asian markets, Japan’s Nikkei 225 index is up 32.23 points, or 0.19%. China’s market remains closed for the National Day holiday.

In Australia, the S&P/ASX 200 is down 29.3 points, or 0.53%.

On the commodities markets, West Texas Intermediate crude oil is trading for US$49.16 per barrel. Brent crude is US$50.87 per barrel.

Gold is US$1,269.83 (AU$1,667.76) per troy ounce. Silver is US$17.79 (AU$23.36) per troy ounce.

The Aussie dollar is worth 76.14 US cents.

Gold to fall…or not

Investors piled into gold after the 2008 financial meltdown.

There was a sound reason to do so.

Governments were in a lot of debt. Businesses were in a lot of debt. And individuals were in a lot of debt.

Further, central banks had begun to print money and buy assets as a direct (and indirect) way of saving and stimulating the world’s economies.

As a result, gold surged to an all-time record high. In 2011, it hit over US$1,900 per ounce. At the time, many folks thought gold would go on to trade at US$2,000, then US$5,000, and even US$10,000 or US$20,000 per ounce.

Of course, history shows that didn’t happen.

After reaching the record high, gold moved into a year-long wide trading range. After that, it has been mostly downhill for gold.

In 2012 and 2013, talk of reduced bond buying from the US Federal Reserve emerged for the first time (as well as the prospect of higher interest rates).

With that background, gold fell. That was until earlier this year, when, after the Fed finally raised rates, the market started to doubt that it would, or could, raise rates again.

But rarely do things stay the same forever. Now the market view appears to have changed. Based on bond market futures prices, the market has priced in a 61.2% chance of a rate rise in December this year.

Why does that matter for gold?

The argument goes that higher interest rates are bad news for gold, because cash or cash-like investments, which pay an income, are better for investors than gold, which doesn’t pay an income.

That may be true…or it may not. For a start, it assumes that investors naturally make a choice between holding cash and holding gold. By that we mean: Are the investors who are most likely to also own gold the types who will now view gold as a bad investment, and cash as a good investment?

We’re not so sure about that.

We’re more inclined to think that most investors who buy gold have done so because they can see severe problems with the world’s financial system.

We can’t believe that a mere (potential) 0.25% rise in interest rates will cause those investors to think that the reasons for holding gold no longer apply.

As we mentioned before, gold soared because of rising government debt, rising business debt, rising personal debt, and an explosion in central bank money printing.

On every level, as far as we can tell, debt at all levels is higher than it was in 2008. And even though central banks have slowed down their money printing programs, make no mistake, they’re still printing money.

The US Federal Reserve has vowed to keep its balance sheet chock-full of US government debt for as long as necessary. And every sane person knows that the Fed will print again, if required, at a moment’s notice.

So we continue to wonder: What has changed?

But that’s not all. Whenever we can throw a stone at the evil that is Conventional Wisdom, we will do so. Mainstream commentators and analysts insist that rising interest rates (if you believe interest rates will actually rise) is bad news for gold.

In response, we provide Exhibit A before the court:



chart image

Source: Bloomberg
Click to enlarge


The green line is the US Federal Reserve’s Fed Funds Rate. The white line is the gold price.

You’ll notice the red boxes. All up, the periods covered by red boxes account for half the timeframe from the beginning of the chart in 1990.

The significance of the red boxes? They cover periods when both interest rates and the gold price fell, or periods when both interest rates and the gold price rose.

Take the period from 2004 to 2008. The Fed increased interest rates from 1% in 2004 to 5.25% in 2006. At the same time, the gold price gained 84%.

Hmmmm.

Or how about from 1990 to 1992? The Fed cut rates from 8% to 3%. At the same time, the gold price fell 17%.

Hmmmm.

Now, of course, we’ll concede that the gold price could fall if interest rates rise. But, going by the correlation between the Fed Funds Rate and gold over the past 26 years, we have to say that it’s a 50/50 proposition.

In summary, gold may fall…or it may not. How’d you like that for decisive financial analysis?

Invest or speculate?

That’s gold, but what about gold stocks?

This won’t surprise you: Gold stocks are down today. Some in a big way.

Of the big players, Newcrest Mining Ltd [ASX:NCM] is down $1.24. That’s a drop of 9.4%.

Northern Star Resources Ltd [ASX:NST] is down 47 cents. That’s an 8.9% fall.

Overnight, gold mining giant Barrick Gold Corp [NYSE:ABX] fell US$1.94, for a drop of 8.7%.

Those are big moves. And, what’s more, because they’re big companies, it’s likely that investors poured big dollars in them, and have subsequently lost big dollars as prices have fallen.

It’s for that reason our mystery gold stock picker refuses to touch these big gold stocks. He says they’re too risky. Got that? Big ‘blue-chip’ gold producers are too risky.

So, what does he recommend that investors buy? Well, let’s scratch the word ‘investors’ to begin with. Our mystery gold stock picker says that this is a market for speculators only.

He says that investors (classified as those looking for relatively stable and long term returns) have no business going anywhere near this sector.

That goes for the big gold stocks and the type of gold stocks our mystery picker recommends — tiny gold stocks. Or as he calls them, ‘penny gold’ stocks.

We won’t say these stocks are lower risk themselves, because they aren’t. That’s why our mystery stock picker insists that this is a sector only for speculators.

However, because speculators understand the risks of these stocks, it’s possible to play them in a way that reduces your overall risk of loss, while still giving you exposure to big gains.

For instance, an investor with a decent sized portfolio may invest $10,000 or more in a stock like Newcrest Mining. The investor would have done well if they bought when Newcrest was trading below $10.

But today, Newcrest is down 9.4%. A $10,000 position in the stock yesterday is only worth $9,060 today.

That’s a big chunk of change to lose. If Newcrest falls a similar amount tomorrow, that would be another $1,000 the investor is out of pocket.

Now picture a speculation in the type of stock our mystery gold stock picker prefers. The speculator that puts $10,000 into a blue-chip stock wouldn’t put the same sum into a speculation.

In this instance, they may only put $2,000 into the ‘penny gold’ trade. Now consider what could happen next. If gold roars ahead, the speculator should expect big returns. (If they don’t get big returns, then they’ve picked the wrong stock.)

But what if the stock falls 10%? Here, they’re only $200 out of pocket. And even if the stock falls further (it is a speculation after all), by, say, 30%, they’ve still only lost $600 on their speculation.

In fact, in order for the speculator to lose $2,000, the speculation would have to fall to zero. Whereas the blue-chip stock ‘only’ has to fall 20% for the investor to take a paper loss of $2,000.

Of course, it’s not exactly a direct comparison. The speculator could fall to zero in a bad market and you’ve done your dough. A blue-chip stock could fall 20% or more in a bad market and then bounce back later.

But we think you get our point. When it comes to gold, we’re unashamedly bullish. But when it comes to gold stocks, we like the approach taken by our mystery gold stock picker.

He thinks investing in gold stocks is too risky. But he thinks speculating in gold stocks makes sense…if you have the temperament to cope with the risks.

You can find out how to get our mystery gold stock picker’s recommendations here.

In the mailbag

It appears your editor has created another firestorm. Subscriber, Helen, writes:

Kris Sayce is generally quite a witty guy, and I mostly enjoy reading his articles.

But when it comes to females he really is a childish, sexist twat, which rather detracts from any respect he might otherwise be due.

This is not the first time Kris’s deprecating attitude toward women has surfaced, but it’s probably the worst I’ve read to date.

He writes: “For a long time, the chorus from the feminist movement was that if women were in charge of the world, it would be a much better place. Apparently, there would be no wars, no inequality, and, well, things would be nice.”

Who the hell ever said that?

Whenever Kris could say “business person”, in his articles, he always says “business man”.

It’s not that hard to be inclusive. I ran my own advertising and marketing business for many years and was never called a business man.

We’re not “ladies”, Kris, but women. And having a dozen or two women in positions of influence does not mean women are running the world, and I don’t think I’ve ever heard anyone argue that they should. I think equal opportunity and equal respect is all that has ever been asked.

I hope if Kris ever has a daughter that he will encourage her to take on the world, to be the best she can be and not be held back by her gender. I hope he will not disparagingly call her one of the “ladies” and taunt her about being “nice”.

Kris obviously forgets that many women subscribe to Port Phillip Publishing; that it’s not a boys’ club as far as they are concerned.

I’m sure he’ll ridicule me for my complaint. I can take a joke, but it has to be said that after hearing this stuff for a lifetime, it’s just not funny.

Kris is letting down the intelligent, informative and fair-minded people who write for PPP, and I hope one of them has the courage to set him straight.

First, perhaps Helen isn’t familiar with a 2004 book titled, If Women Ruled the World. And she therefore probably isn’t familiar with the foreword of the book, which runs:

Often in my work, I hear people say that the lack of women in leadership is an issue that pales next to world crises — global terrorism, fragile economics, inadequate health care, access to quality education, corporate greed. They see no connection between the frightening situations we’re in and the fact that few women sit at the table to determine the solutions. No wonder we’re where we are today.

This fundamental imbalance, with men running the world and women mostly spectators (or victims), is not a trivial detail. It is the problem. It is also the one solution we have not tried and the one most likely to work.

A search on Google or any other search engine will turn up many instances of serious and, admittedly, light-hearted articles about what the world would be like if women were in charge.

For example, in a Q&A in Glamour magazine, war correspondent Janine di Giovanni suggests:

Women are learning to be better negotiators, and we have more compassion — crucial to ending conflicts.

Hmmm. Stereotypical, much? We wonder just how much more compassion women have than men? 10 percent more? 20 percent more? We wonder. We’re sure an economist with a PhD can quantify it for us.

As for being a ‘childish, sexist twat’, I can’t, with hand on heart, say that I’ve never had a sexist thought. I can’t say that I’ve never had a racist or prejudiced thought, either.

Do I automatically assume that all doctors are men, and that all nurses are women? For a brief moment, I do, before correcting myself.

Whenever I see a woman holding the stop sign at roadworks, do I automatically assume that she’s only there due to some kind of politically correct union demand for gender equality, rather than because she was the best person for the job? Yes, I do.

(Although, it’s worth remembering that trade unions spent the better part of a century trying to keep women out of ‘men’s’ jobs, even though private businesses would have been happy to, and did, employ them.)

When I was driving back to Baltimore from a conference in rural Maryland two years ago, did I feel anxious when I took a wrong turn and ended up in a predominantly black neighbourhood at 11:00pm?

Yes, I did. Did I turn up my collar, put the seat back, lower the brim of my baseball cap, and move my pasty white hands to the bottom of the steering wheel as I drove through the area? Yes. Guilty as charged.

Was that irrational, even racist? Possibly.

Would I have felt the same anxiety driving through an equally deprived, but predominantly white neighbourhood? I can’t say for sure, but, in truth, probably not.

But back to Helen’s letter, we would remind her that we’ve been just as deprecating about men in power as we have about women in power. But we won’t say that we’ve deprecated one gender more than the other.

We show no favour to either side. Rather, we call out nonsense, flummery, and misguided actions whenever we see them, regardless of who says them.

We’re not sure that anyone felt the verbal back of our hand quite as much as Dr Ben S Bernanke while he was in charge at the US Federal Reserve.

We also think we did a pretty good job of pouring scorn on Kevin Rudd and Wayne Swan on their ‘super profits tax’ policy. We were never sure (and still aren’t sure) whether either really had an understanding of the concept of profits to begin with.

Not to mention our childish name-calling of Mr Rudd as the ‘Fairy Ruddfather’ for the stimulus cheques mailed out in 2008 and 2009.

And just as much as we believe that Ben Bernanke was — and will be proven to be — a disaster of a central banker, we believe the same fate awaits Janet Yellen.

Should we have drawn attention to the gender of Yellen, Merkel, Lagarde, May and Clinton in yesterday’s email? Wasn’t it wrong to use gender to criticise them? And would I have used gender to criticise them if they were men doing the same role?

The answers in order are: yes, no, and maybe.

By the way, we still find it amusing that since its creation in 1984, women have held the position of Sex Discrimination Commissioner almost exclusively, with the exception of John von Doussa, who held it in an acting capacity for a few months in 2007.

Are we really to believe that there have been no suitable male candidates for the role during the past 32 years?

Just asking.

Cheers,
Kris