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“You have to be patient these days”
On occasion of the
publication of his seventh annual “In Gold We Trust“ report, renowned gold market analyst Ronald Stoeferle discussed for
Matterhorn Asset Management / GoldSwitzerland some aspects of his latest
report and the larger picture, inter alia: the current bad market sentiment
in gold; the rather strange fact that gold is traded like a currency but
analyzed like a commodity; the question if it’s a problem that gold is traded
now below average cash costs for mining companies; and the most contrarian
call at the moment: gold mining equities.
By Lars Schall
Ronald Stoeferle,
managing director of Incrementum AG in Liechtenstein is a Chartered Market
Technician and a Certified Financial Technician. He was born October 27, 1980
in Vienna, Austria. During his studies in business administration and finance
at the Vienna University of Economics and the University of Illinois at
Urbana-Champaign in the U.S., he worked for Raiffeisen Zentralbank (RZB) in
the field of Fixed Income / Credit Investments. After graduating, Stoeferle
joined Vienna based Erste Group Bank, covering International Equities,
especially Asia. In 2006 he began writing reports on gold. His benchmark
reports drew international coverage on CNBC, Bloomberg, the Wall Street
Journal and the Financial Times. Since 2009 he also writes reports on crude
oil. Recently, Stoeferle and his partners incorporated Incrementum AG in
Liechtenstein. He will soon launch a global macro fund, based on the thoughts
of the Austrian School of Economics. Furthermore, he is now senior advisor to
Erste Group Bank and a lecturer at the “Institut für Wertewirtschaft”
(“Institute for Value-based Economics“) focusing on the Austrian School of
Economics.
Lars Schall: Mr. Stoeferle, your
new report is called once again “In Gold We Trust”. However, the sentiment in
the market is currently extremely bad. Why so?
Ronald Stoeferle: Well, we’ve seen a massive price
drop and in the course of the recent gold crash the market has definitely
demonstrated once again its tendency to maximize pain. The fact that
sentiment is by now at the most negative level since the beginning of the
bull market, gives us cause to be clearly positive about the long term.
Sentiment indicators like e.g. Market Vane, the Hulbert survey and Rydex precious
metals fund cash flows show that the gold price is miles away from excessive
euphoria. According to the Hulbert Financial Digest, the allocation
recommended by gold newsletter writers was recently at minus 44%, an all-time
low.
Therefore, I think we’re at the point of maximum
pain at the moment, the sentiment is as bad as it can get. From a technical
point of view, massive technical damage has been inflicted and I am
convinced, that repairing this damage will take some time.
However, from my point of view, gold, and especially
gold mining shares, at the moment are the ultimate contrarian investment.
L.S.: So you’re still confident in the prospects of
gold?
R.S.: From my point of view, we’re witnessing
monetary policy experiments more or less on a global basis – have a look at
the “monetary Harakiri” happening n Japan for example, have a look at the UK…
There exists no back-test for the current financial era. If there ever was a
need for monetary insurance, it is today.
I am seeing very strong similarities between the
recent correction and the so called mid-cycle correction between 1974 and
1976. From my point of view, we’re seeing a deflationary backdrop at the
moment, very similar to the situation in the 70ies when gold dropped from USD
180 down to 100 and everyone called the end of the gold bubble…
However, let’s have a quick look at the general
monetary climate. Since 2008 there have been more than 500 interest rate cuts
around the world. Non-standard monetary policy measures seem to have become
standard procedure. Tapering and exiting from QE will be much more difficult
than market participants currently envision. The current QE program is the
most massive put ever written by Ben Bernanke. Both the extent of the current
asset purchase program as well as its temporal horizon are unlimited. The
Bank of Japan’s policy is also increasingly expansive and will double the
monetary base over the next two years in order to produce an inflation rate
of 2%. Relative to economic output, Japan’s QE package in the amount of 7.5
trillion yen per month is approximately twice as big as that of the US. If
one adds up the monthly (!) QE amounts in the US and Japan, assets amounting
to $160 billion are being bought with newly created central bank money. By
way of comparison, this equates to far more than the annual gold production
by mines, which is currently valued at $125 billion (2,700 tons). Again: This
is the monetary endgame from my point of view. Let me quote Gottfried
Haberler: “…there is no record in the economic history of the whole world,
anywhere or at any time, of a serious and prolonged inflation which has not
been accompanied and made possible, if not directly caused, by a large
increase in the quantity of money.“
L.S. In your report you write “The April crash
showed how important it is to differentiate between the ‘gold price’ and the
‘price of gold’.” Could you elaborate on this, please?
R.S.: Yes. The gold price refers most of the time to
the price of a gold futures contract, e.g. at the COMEX. The price of gold by
contrast is the price one must pay if one wants to buy physical metal.
These spot and futures prices are connected via
arbitrage and for that reason can not, in
principle, move diametrically away from each other. Nevertheless, an
understanding of the link between these two markets is necessary to correctly
interpret events in the markets. In the present environment, there are for
example considerable mark-ups, supply bottlenecks in the physical (cash)
market.
Many aspects of the April crash were unusual. For
the first time, record high, anti-cyclical demand in the physical market
could be observed on a global basis in the course of a large price
correction:
However, I always said that the true importance of
gold lies in its possession, not its price. A gold price decline or increase
by 5% barely has an effect on physical possession, since probably only a
share amounting to tenths of a percent of the total available stock changes
ownership. The paper market by contrast consists of countless promises issued
by a vast variety of counterparties. One should therefore refrain from
equating participation in a price movement with ownership of an asset. There
is for instance a fundamental difference between ownership of a cattle
futures contract and being a farmer who raises cattle.
L.S: We have heard a lot of talk about tapering and
the coming exit strategy by the Federal Reserve. What’s your take on that?
R.S.: I think the current developments clearly show
how addicted markets are to cheap money and more QE. Just one number: Rising
yields in the US will lead to an increase in monthly loan payments for a 30y
credit by 20 to 25%. This will definitely have a large negative impact on
real estate numbers. If the Federal Reserve wants to go cold turkey, please go
ahead. But we’ll see a massive crash in bond markets and in equities, and I
don’t think – as they always referring to the so called “wealth effect” – I
don’t think that they are really going to do it, so it’s only tough talk from
my point of view. The last time the Fed allowed the money supply to suffer a
year-on-year drop was in 1981, under Volcker….and that was followed by the
biggest year-on-year money supply expansion of the entire post WW2 period in
1982.
We have to emphasize that the monetary inflation has
already occurred! According to Austrian Business Cycle Theory the prices of
capital goods (= asset price inflation) increase first in the course of an
inflationary process, while consumer price inflation (= rising consumer
prices) only ensues later.
L.S.: In your report you’re addressing the special
characteristics and virtues of gold in a portfolio. Please talk about those
features.
R.S.: Countless studies confirm that gold as a
portfolio addition lowers the volatility of a portfolio and thus improves the
statistical portfolio characteristics. If one compares the monthly return of
the S&P 500 with that of gold since 1971, one notices this
diversification characteristic quite clearly. Apart from these quantitatively
provable characteristics, gold has in addition the qualitative characteristic
of being a debt-free investment asset. Gold is pure wealth, pure possession
without any counterparties attached.
But by far the most important factor when it comes
to gold is the stock-to-flow ratio, and what I call the “relative scarcity”
of gold versus fiat currencies. I’ve got a number of charts in my report
showing this, for example between 1868 and 2011 growth rate of the
monetary aggregate M2 was 6.6 per cent, while the stock of gold grew only by
2.1 per cent. So from this point of view you can tell that gold is relatively
scarce compared to fiat money. But the interesting thing is that the
volatility of monetary supply is that enormous — it ranged from minus 15.6
per cent to plus 26 per cent, while if you compare it to gold it ranged only
between 1.4 and a maximum of 3.5 per cent. So I think the reason why people
have trust in gold is because of this relative scarcity.
L.S.: In your report you’re writing again once again
about the stock-to-flow ratio of gold as something that distinguishes gold in
the commodity sector. Please talk about the meaning of it.
R.S.: Well, it’s the absolute crucial factor for
understanding gold. Unfortunately a lot of people within the gold sector do
not really understand it. There is a clear difference between commodities,
which can be explained by a consumption model – examples would be crude oil,
copper, agricultural commodities –, and goods that are bought in order to be
held, like gold for example. While the economic utility of a consumable good
is created when it is destroyed or used up, the utility of investment assets
lies in their possession and later resale. Industrial commodities therefore
have low stock-to-flow ratios, this is to say, inventories usually only cover
consumption demand for a few months.
The stock-to-flow ratio of commodities, for example
oil, is much lower than the stock-to-flow ratio of gold. That means that the
inventories of gold, which is officially something like 170,000 tons, are
extremely high compared to annual production, which is roughly 2,700 tones.
If you compare that to oil for example, there are inventories, but they are
definitely not any near as high as when it comes to gold, it’s probably a few
months of production. Therefore, we have to say this discrepancy between annual
production and the total available supply is probably the most important
factor when it comes to gold.
What does this actually mean? Let us assume that the
price of gold rises considerably in the future and mining adjusts
accordingly, then mining of e.g. 3,500 tons per year would certainly be
possible within 10 years time. If we assume further that annual mine
production grows by 3% p.a. over the next ten years, cumulative mine
production would amount to about 31,000 tons over the period. The total stock
of gold would then amount to approximately 203,000 tons by 2023. If mine
production were to amount to 3,500 tons at that point in time, this would
still only represent an annualized inflation of the stock of gold of 1.7%.
L.S.: We’ve talked about gold as a commodity – and
usually people don’t consider gold as money. In fact, by law it isn’t.
However, at the big banks gold is usually traded at the currency desks. Now,
if gold is just another commodity, why would this be the case?
R.S.: This is not really a discussion for me: gold
is money, and I think the market chose within the last few thousand of years
the perfect money, and that’s gold, and to a certain extent silver, not
paper. It’s interesting what you’ve said, that gold is traded at the currency
desk, and it got a currency code, which is XAU. On the other hand, it is most
of the times analyzed within the commodity department, and that’s pretty
interesting from my point of view, because as I’ve said most analysts analyze
gold as a commodity, so they are focusing on annual supply, annual demand,
which doesn’t have a real impact.
It’s strange isn’t it, that gold is traded like a
currency but analyzed like a commodity – that’s one of the major flaws within
the industry. However, I think what most of the people forget, especially
these days, is the fact that gold is extremely liquid. There was a survey of
the LBMA that I am mentioning in my report, it said
that the average daily trading volume of gold is roughly 240 billion US
dollars, just on the LBMA. That’s probably the reason why gold is often sold
off in environments when people would suggest it should basically rise,
because if there is a rush to liquidity, if people have to get out of
leveraged positions and so on, they often sell their gold, because it’s
extremely liquid, it’s traded all over the globe and around the clock.
L.S.: What are your thoughts on the wealth transfer
in form of physical gold from the West to the East?
R.S.: Well, Lars, I remember we did talk about it a
bit last year, when I wrote it in last year’s report. I mentioned then that
gold always goes where real prosperity and real growth happens. I also
mentioned James Steel, who once wrote that gold goes where the money is. (1)
It came to the United States between World Wars I and II, and it was
transferred to Europe in the post war period. Then it went to Japan and to
the Middle East in the 1970’s and 80’s. And now it goes to places like China
and India.
We all know that history repeats. While France was
the most important critic of the dollar’s currency hegemony in the 1960s
(prior to the collapse of the Bretton Woods system), China appears to have
taken on this role today. France at the time criticized the “exorbitant
privilege”, stopped buying US treasuries, converted dollars to gold and
repatriated gold. China is currently behaving in a similar manner, calling
the dollar’s status a “product of the past”. Based on a number of comments as
well as statistics, I assume that the PBoC is currently massively expanding
its gold reserves and holds far higher reserves than the officially reported
1,054 tons. I sincerely believe it is realistic that China has by now 4,000 –
6,000 tons, and with that the second largest gold reserves worldwide.
However, I think that there are very interesting
things at the moment. For example, you have probably heard about the report
by OMFIF, which is some sort of think tank by the central banks and wealth
funds, arguing in favor of a remonetarisation of gold. (3)
R.S.: From my point of view they released a very
sensational report, because it shows strikingly that real fundamental changes
to the currency system are already being discussed at the highest levels
these days. I mean, OMFIF recommends the inclusion of gold in the Special
Drawing Rights by the IMF, which from my point of view is utterly nonsense. I
think former French President Valéry Giscard d’Estaing once called them
“Monetary LSD”… But the fact that they discuss those things is quite
interesting. There was also a paper for the European Parliament, writing
about gold-backed bonds. (4) And I think that from these little things you
can tell that there is really something going on in the background, and that
this remonetarisation of gold is currently happening.
L.S.: What needs to take place before the turn
around in gold mining stocks really begins?
R.S.: That’s a good question. If you’re bullish on
gold, you’re already quite a contrarian and people will probably laugh at
you, but if you’re bullish on gold mining equities, well, then you’re probably
the ultimate contrarian. I think a lot of things happened within the gold
mining industry recently. They replaced a lot of mining executives, they try
to focus on transparency of costs, the companies have abandoned some
development projects, and I think these are good sign. I mean at the moment,
the ratio of the BGMI, which is the Barrons Gold Mining Index and the price
of gold, so the BGMI-gold ratio is at the lowest point since 1943. So you can
tell that gold mining stocks in comparison to gold are really cheap.
Moreover it’s interesting that there is some sort of
a mantra of eternally rising mining costs, and from my point of view,
especially these days, where we’re seeing a sharp decline in commodity price,
where we’re seeing sluggish economic growth, we already see that some input
costs for the miners have started declining. The same goes for the big
vehicle tires, explosives, but also labor costs, we’re really seeing a brutal
market adjustment, and that has definitely an impact on the labor costs. So
therefore, I think going forward the costs for producing gold could start
decreasing, and that would surely be a good sign, however, as I’ve said at
the beginning, the sell-off caused some real serious damage to the price of
gold and to the gold chart. If we some sort of see a bottom building in gold,
I think it will still take a few weeks, maybe even months, before the mining
stocks really start rising again, because a lot of people have lost trust in
gold, and more so in gold mining stocks. So I think it is a bit too early to
start piling big time into the gold mining stocks.
L.S. Is it a severe problem that gold is traded now
below cash costs for mining companies? (2)
R.S.: For the miners, but not for gold. Because of
it’s extremely high stock-to-flow ratio, production costs are of limited
significance when it comes to the pricing. They are mainly relevant for the
performance of gold shares. From my point of view, analyses claiming that the
gold price cannot drop below production costs are therefore based on a
fundamental misunderstanding. While from a certain price onwards the
production would turn unprofitable for mining companies, the trade of already
produced gold would not suffer. The mining sector therefore has little
influence on the gold price. However, the opposite is not true: the gold
price has a substantial impact on mining and its profitability.
L.S.: One ratio that we both pay close attention to
is the price ratio between oil and gold. Where is the ratio currently, and
what does this tell you?
R.S.: The ratio is currently at roughly 1:12 (Gold
to Brent Crude), and that shows that we’re basically within the long-term
average – the long-term average is around 1:15. And the fact that the price
of oil is holding up very well from my point of view says that geopolitical
factors are here and probably bigger than we are expecting. But it also says
that the whole fracking euphoria in the United States, all this talk about
energy independency for the U.S., that the U.S. would export oil going
forward, that the U.S. would join OPEC, that kind of crappy analysis – well,
to be honest, I don’t see it really happening, or otherwise the price of oil
would be much lower.
L.S.: In your report you have some interesting
long-term ratios.
R.S.: Yes, as you know I am an “Austrian Austrian”.
According to Carl Menger, the founder of the Austrian School of Economics,
the value of a good is the result of its expected marginal utility on the
part of the valuing individual. He once said that “Value does not exist
outside the consciousness of men”, which is a very central idea.
The value of a good or a service is therefore not an
objective magnitude, but always the result of a subjective act of evaluation.
Since there exist as many preference scales as human beings (and because this
ranking of preferences is also continually changing), is it will never be
possible to ascertain objectively what the value of a thing or a service
should be. It is therefore impossible to calculate a fair value for gold.
However, you can still compare the current price of
gold to other asset classes, monetary aggregates and their possible future
development and so on. In the report, I drew some long-term ratios, for
example between gold and fine wine, between gold and arts, between gold and
housing, and definitely between gold and financial assets like bonds and
equities. And from this long-term analysis you can say that gold is
everything but expensive, it is much below the long-term averages, and as we
all know, a big secular bull market ends in euphoria, and therefore the
ratios would have to be at extreme levels, and As we’re far away from that, I
think that can make you pretty confident about the price of gold. The often
cited argument that there is a ‘gold bubble’ can therefore be easily refuted.
Bull markets end in euphoria, which buttresses our argument that there will
be a final stage in the form of a trend acceleration phase.
L.S.: Mr. Stoeferle, you have no crystal ball;
nevertheless, how will gold perform in the second half of 2013?
R.S.: Well, I am not young enough to know
everything. (laughs.) But we have seen some very bullish divergences by the
miners as well as silver last week. If I am really lucky, then I’ll have
exactly called the bottom last week. However, we shouldn’t expect too much
upward momentum in the short-term. Seasonality will get better in August. My
12 month target is 1.480 US dollars, which isn’t too high, but again: we have
to say that gold took a large hit and it will take time to recover.
L.S.: Thank you very much for taking your time, Mr.
Stoeferle!
(1) Lars Schall: “Gold
goes where The Money is“, Interview with Ronald Stoeferle, GoldSwitzerland,
July 24, 2012, here:
http://goldswitzerland.com/gold-goes-where-the-money-is/
(2) “Gold Drops Below Its
Average Cash Cost“, Zerohedge, June 26, 2013, here:
http://www.zerohedge.com/news/2013-06-26/gold-drops-below-its-average-cash-cost
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