Random Thoughts on Gold
This stagflationary environment we find ourselves in is not "Goldilocks" for stocks, it's Goldilocks for gold.
- I've been looking for the gold complex to begin to rally after the dollar index made its first attempt to bounce at this critical 80/81 area. That attempt at a rally by the dollar (albeit pretty pathetic thus far) has been ongoing over the last four trading days.
- Today I saw the gold price make a marginal new low for the move and touch its 50 day moving average in reaction to the dollar index making a new high for the week this morning. At the same, the gold shares opened flat and began to rally even as the metal was down as much as $6.
- Since then, the shares have continued to firm while the metal has recovered to be down only $1.90.
- Could the positive divergence between the shares and the metal be signaling that the complex is finally ready to move up for real and the gold share indices finally "break out" above what has been resistance? I think there's a high probability of that, although I will admit that this sort of a divergence has been much less reliable over the past six months than it has in the past at forecasting important turning points.
- The large cap golds (Goldcorp (GG), Barrick Gold (ABX), and Newmont (NEM)) have been the major drags on indices like the HUI. Outside of those three pigs, many of the other shares have been making new highs (Minefinders Corp. (MFN), for example, made a new high again this morning).
- With ABX having reported earnings up 30 percent year over year (ex a charge for losses related to covering the remainder of its corporate hedgebook) and its pledge to not hedge for the next 10 years, these large cap golds could finally be ready to join the rally and no longer hold back the indices. ABX is up over 5 percent today, so that's certainly a good start.
- I also think there's a good chance that NEM is sold out in the wake of what was a disastrous 1Q. Based on $700 gold and assuming 1Q's higher cash costs going forward (something the company has said would fall as the year progresses), NEM's P&P reserves alone have a simple NAV of $60. So, it's cheap, and despite 1Q's bad news, the stock never took out its October low. The mining business is the real world. "Stuff" happens. There are cave-ins at underground mines, miner strikes, ore bodies that turn out to be not as rich as thought. This is the nature of a business that is trying to pull something out of the ground that it cannot see. But when you have a known asset like NEM's P&P reserves and you can buy them at a huge discount due to what are - at the end of the day - temporary problems (consider all the problems that Golden Star (GSS) had last year and look where it is today for example), this is when you buy them. After all, a higher gold price generally solves all problems for miners, especially cost-related problems, which have been NEM's major problems. I'm already pretty much fully invested in gold mining shares, or I would be buying the stock today myself. But I did nevertheless buy some deep out of the money Dec. calls on NEM this morning (for those that care).
- On the data front, we have the Services ISM tomorrow, and with 80 percent of US nonfarm employment being service related (manufacturing is only about 13 percent), tomorrow's Services ISM is much more important than yesterday's manufacturing ISM with respect to what the Fed is going to do next week. Then on Friday, we obviously have the employment data. Both of these data points are due to disappoint in my view (think about all the mortgage brokers and real estate-related jobs that have been lost over the past couple months, and we all know that GDP slowed mightily in 1Q).
- Should both of these data points come in on the weak side, the odds will greatly increase that the Fed will panic next week and go ahead and try to ease in my opinion. The Fed has already opened the door to easing with March's "neutral-ish" statement. Note today's $1.3 bln coupon passed as well. That's not the sign of a Fed that is worried about the dollar or inflation. These guys have sat on their hands since August while the equal-weighted CRB (CCI) has made two new highs and the dollar has hopped off a cliff (something that is inflationary by definition). Let's not forget that money supply is surging once again as well.
- The bottom line is that the Fed is trapped between the housing bust and rising inflation, and when put to the choice, the Fed will risk inflation potentially accelerating (while hoping that it turns down) in order to try and save the economy from recession and the banking system from a further spread of credit rot emanating from the subprime (and now Alt-A) mortgage meltdown, which poses a very real systemic risk. Despite the Fed repeatedly talking a tough game about inflation, their actions have shown the exact opposite since this past summer, and when it comes to the Fed (like most things in life), actions speak louder than words. And those actions say quite clearly that the Fed doesn't give a hoot about the dollar or inflation, and anyone who thinks differently is likely in for a big surprise in my view.
- Note the collapse in the 3-month T-bill yield (IRX) since mid-March, which also seems to be signaling the Fed is getting closer to being forced to ease (see below).
- The last time we saw a sharp drop in the 3-month T-bill yield like that was in late 2000, right before the Fed did a surprise intrameeting rate cut in early January 2001 (see below).
- The dollar might even bounce on a Fed rate cut next week based on the hope that the US can avoid a recession due to the drop in short rates, but gold is likely to go through the roof. And of course, if long-term rates rise in reaction to such a rate cut (which I would think they would), it will mute much of the rate cut's benefit to the US economy too, which means the dollar's bounce wouldn't last very long.
- We'll have to see how the data comes in and what the reaction is, but the near-term setup is there for a monster move up in gold and its shares in my view.
- At the risk of repeating myself, this stagflationary environment we find ourselves in is not "Goldilocks" for stocks (see past discussions of the Goldilocks myth here, and here), it's Goldilocks for gold.
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