'Gold and Gold Equities - Buying Opportunity?' Belkin Report, July 22


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'Gold and Gold Equities - Buying Opportunity?' Belkin Report, July 22

  1. 1. BELKIN REPORT © 2013 Belkin Limited All Rights Reserved Jul 22, 2013 Gold and Gold Equities - Buying Opportunity? Reuters Jul 22, 2013 Gold futures hiccup indicates demand outpacing supply ‘A dislocation in the gold futures market indicating that demand for physical delivery of the metal is now far outweighing supply has intensified in recent weeks, increasing concern in the market that the change may not be a momentary blip and participants may have become over-leveraged. Gold went into backwardation in comparison to the three-month futures contract in early January, meaning the spot price rose above the short- dated future contact. Now that process looks set to creep out the futures curve to longer-dated maturities, signalling some cause for alarm. "The fact that has remained and widened ... indicates that the physical market has tightened up substantially, a postulation that is corroborated by the growing premiums being paid ... and the ongoing wholesale delays in the delivery of substantial bullion tonnage," wrote Ned Naylor-Leyland of Cheviot Asset Management in a report this month. "What is happening now is that the absolutely inevitable 'run' on the 100:1 leveraged bullion banking system is truly underway." Backwardation is a concern in gold markets because in theory demand for physical delivery should never outweigh supply, since the amount of available gold is a known, fixed quantity. The event is not unprecedented, as it also happened during the financial crisis of 2008 - and corrected itself the following year. The current dislocation indicates that holders of gold futures have begun demanding delivery. But because of the large amount of leverage in the market, participants are not able to deliver on their obligations. "More and more people want their gold today, at a higher price, no matter that they can buy a future much cheaper," said Guillermo Barba, economist at the New Austrian School of Economics in Mexico. The high demand lately for spot physical delivery has played a part in the yellow metal's recent rebound from its low of US$1200 per troy ounce at the end of June to US$1283 on July 18. But analysts say it is difficult to determine both the cause of the backwardation and whether it will persist. "It could be a whole range of factors; a bullion bank may have overcommitted in the physical market, miners have reinitiated hedging programs since the April price dive and have to borrow gold to hedge, and that may have cascaded up the chain of physical demand," said Robin Bhar, commodities strategist at Societe Generale. "With the gold market you don't find out the reasoning or explanation for an event until days, weeks, or even months after the event. What's strange here is that a time of seasonal demand weakness we have strong physical demand and backwardation." ... CREEPING OUT THE CURVE Some believe the current dislocation is only a blip, as in 2009. After all, only the spot versus three-month futures relationship is currently in backwardation, as opposed to spot compared to longer-dated futures contracts. But since January, the short end of the curve has gone into backwardation increasingly earlier and earlier, indicating the trend may soon start to move further out the curve. According to Keith Weiner, CEO and chief economist of Monetary Metals, fund managers and metals analysts, the April 2013 futures contract went into backwardation 30 trading days before April 1, while the June contract went into backwardation 42 trading days before June 1. The August contract turned over 55 days before August 1, and the October contract flipped on July 8, 61 trading days before October 1, Weiner said. Over the short term, some expect backwardation will spark a squeeze on paper investors in the gold market as the physical demand will force traders looking to cover short positions to bid up the spot price in an effort to shore up inventories. "The bullion banks want to get gold back into contango and stop the movement of the remaining inventories by shaking the market lower, using paper leverage to do so," wrote Naylor-Leyland. "It hasn't worked, indeed more and more investors are now seeking allocation, delivery and physical metal at the expense of synthetic products offered by the banks. The squeeze we have been waiting for is closing in, it is always darkest just before dawn."‘
  2. 2. BELKIN REPORT © 2013 Belkin Limited All Rights Reserved Jul 22, 2013 Upgrade on Gold and Gold Equities he model went long gold and gold stocks (names added to outperform list) last week. This week we add the GDX and GDXJ gold mining stock etfs as longs. This is a fresh model signal in a depressed asset class. That is typically a good combination. One obvious side-effect of central bankers’ levitation of equity markets is nothing ever gets cheap. By not allowing natural market liquidations, Bernanke, et al. prohibit buying opportunities. Most sectors, groups and stocks are so utterly picked over that there is no sustainable bounce potential. On the other hand, gold and gold stocks have been nuked. The GDX gold stock etf reached -67% down from its Sept 8th, 2011 peak at its recent June 26th, 2013 low. That exceeds the S&P500 index’s 2007- 2009 -57% bear market decline. Even after its recent bounce the GDX is still down -59% from its two-year peak. The physical gold price fell -37% from its Aug 22nd, 2011 peak (see chart). That represents a buying opportunity looking for a catalyst. As the Reuters article on the preceding page explains, a gold market rally catalyst is apparent in the shortage of spot gold, as evidenced by the backwardation in the futures market (higher spot price vs. distant months). Commodity market veterans will attest that a shortage of a deliverable physical commodity can lead to a big price jump as buyers are forced to scramble and pay up for the actual physical item. It looks like a short squeeze could erupt in the gold market. This represents an opportunity. We are impressed with the model’s upward forecast for individual gold stocks in our database, many of which are bombed out way more than the GDX. Names that stand out currently with a strong upward model forecast include: ANV (Allied Nevada Gold Corp) - 84% from peak, SMF.TO (SEMAFO Inc) - 87% from peak, DGC.TO (Detour Gold Corporation) - 74% from peak and ELD.TO (Eldorado Gold Corp) - 65% from peak. These stocks are not moose pasture speculations, they’ve been previously vetted by a savvy gold sector specialist. Naturally, do your own due diligence as company developments can change. We currently have 20 North American gold stocks on our outperform list, see list for details. Of course, a gold rally has implications for other markets. Gold and gold stocks have obviously been negatively correlated to US equities. The S&P500 is up 43% over the same period that the GDX is down 59%. One might suspect that suppressing gold prices has been one leg of Bernanke’s stock market levitation program. A reversal in gold prices would indicate a slump in confidence in the US dollar. A declining dollar would tend to increase other dollar-denominated commodity prices, such as energy. If markets have been stage-managed as part of the Federal Reserve’s Portfolio Balance Channel, a rising gold price could signal a return to normality. The unintended effects of $85 billion per month of Fed QE might finally arrive the way they normally do when central banks behave badly - good old inflation. In conclusion, we suggest portfolio managers investigate gold and gold mining stocks as depressed rally candidates, as opposed to a global equity market that is anything but depressed. As value stock pickers will testify, the biggest percentage gains can come from the most depressed stocks. A gold stock that is down -87% from its peak could triple and still be down 60%. Gold and gold mining stocks are probably at or near a major cycle low that offers significant upside bounce potential. We recommend accumulating them on brief pullbacks. T Gold 2000-Now -37% Forecast is up. Biggest correction in gold prices in ages is probably over.