Don Coxe
Don Coxe, a contributor to Globe Unlimited's Inside the Market, is chairman of Coxe Advisors LLP and is an advisor to several commodity funds. He has been consistently ranked as a top portfolio strategist.
This is the season when miners and investors get together in two of the world's major global conferences: the BMO Global Resources Conference in Florida, followed by the Prospectors & Developers Association Convention in Toronto.
For most of the past 13 years, optimism was in the air at those meetings. Even in crash-shocked 2009, there was cheer in the perceptions of strengthening demand for precious metals, copper and iron ore.
Last year, metals - particularly precious metals - were entering major collapse at convention time. By year-end, the leading global experts in precious metals polled by the Financial Times were the most bearish since 2002. Some investment banks even predicted that gold could break $1,000 an ounce. Miners were announcing slashes in their profits and in their reserves. (Companies have to adjust their values for economic reserves to recent metal prices. Among the majors, there are almost none who could produce sustained profits with $1,000 gold.)
That Stygian pessimism helped convince us to turn optimistic on the precious metals, raising exposure sharply in the portfolios on which we give advice.
The crowd can be right or, more often, can become even more wrong (about the long-term) before the tide turns, but there is more to our bullishness than crusty contrarianism. As things got gloomier, even some sensible strategists pondered aloud whether the leftist economists who long predicted that gold would disappear as a store of value would prove prescient. "Who needs gold?" was the oft-quoted headline in many articles interviewing experts whose genius was finally proven in the laboratory of the marketplace. (Even Paul Krugman has to make a correct forecast some time.)
Gold has, in fact, been priced by political elites throughout history. Demand for decorating palaces and paying armies was a sturdy stimulus to gold production over the millennia. Alchemists who claimed the ability to create gold from dross had tenuous and, usually, temporary employment priced off the real thing.
More recently, central bankers have fulfilled the role of creating money not backed by gold on conspicuous - and conspicuously successful - scale. Nevertheless, central bankers as a group have been huge buyers of gold in this millennium.
One of the few central banks to abandon gold has been the Bank of Canada, and it has hurt neither the loonie, nor the perception that Canada is cautious and prudent. Among the biggest holders of gold are Italy and Russia, and they have far more trouble commanding respect than goldless (but not yet Godless) Canada.
Indeed, the loonie's dive into troubled waters last year coincided (on an appropriately modest and subdued scale) with gold's spectacular plunge, and it seems to be sticking with gold on the upside. Against the greenback it fell from par to 89 cents (U.S.), but it has rallied with gold to 91 cents - while the tarnished yellow metal was bouncing from $1225 to $1327.
A month's rally is insufficient evidence to proclaim the end of gold's worst plunge in 33 years. In Churchillian terms, it may not be the end of the bear market but it may be the beginning of the end.
Why? Let me count the ways.
1. Bear markets usually end with the public castration of some prominent, (but financially prudent) bulls, and the public slaughter of their heavily-levered brethren. Bears, are not, by their nature, restrained when their prey is defenseless.
2. The consummation devoutly wished by leftist economists - the apparent demise of gold - has come because of and despite the most massive continuous printing of money in human history. That high-risk experiment of injecting financial heroin into the financial system was launched by the Fed and friends in 2008. It has continued until long after the crisis was past and a muted - and frequently maddening - recovery began.The grossly mismanaged and overleveraged banking systems in the USA and Europe needed all the heroin they could get. But in recent years, they have been prospering by taking the near-zero-cost money from the Fed and reinvesting it in low-risk but conventionally-priced assets to earn mouth-watering returns.
The European and American banking systems (with help from some powerful leftist politicians) caused the second-biggest Crash since World War I. They have been the recipients of trillions in near-zero-cost financial liquidity in return for promises to rebuild their deflowered balance sheets. Yet, according to the Bank for International Settlements, they are far behind their promised growth in shareholders' equity and financial liquidity - but substantially ahead in bankers' bonuses and stock buybacks. The last crash ultimately sent gold prices north 75 per cent. The next one - whenever it comes - should be even more rewarding to gold owners, because the financial heroin flows have been so massive.
3. Gold exists as a financial asset, and has been used for centuries to restrain governments and central banks from backing bankers in the bad behaviour that brings busts. In this cycle, it has been ridiculed, marginalized and sidelined while the supply of paper money keeps expanding and being reinvested in short-term loans, thereby releveraging the banking system back toward its grotesque scale of 2007. Compared to the supply of paper money and leverage in the global financial system, gold is expanding barely above the growth rate in supply in Old Master paintings: but that market is unconstrained and those Old Masters are costlier by the year.
4. Like known Old Masters masterpieces, the supply of gold in the world is catalogued and is increasing minimally. Apart from the gold in galleons below the Spanish Main, new gold is to be found mostly in low grades in remote locations in countries with miserable records for protecting investors. Even $2,500 an ounce would not produce a wondrous gold stream of new production to constrain further upside movement in bullion prices.
5. The Chinese have displaced the Indians as the biggest bullion buyers. The Indian buyers are almost purely people, whereas the Chinese buyers also include the government and opaque government-controlled entities. Historically, rising political powers liked to bulk up on bullion before taking on established military powers. Perhaps China's recent policy switches - from buying Treasury bonds and making friendly with its neighbours, to selling Treasurys and talking tough with its neighbors - reflects its newfound real wealth.
6. In this Millennium, after completing its 20-year Triple Waterfall Crash, gold has far outperformed major stock markets. Adjusted for intervening inflation, gold prices no longer loom large in 1980 stagflationary terms. Paul Volcker and Margaret Thatcher used double-digit short-term rates to smash inflation and promote sustained economic growth. As evidence of the inevitability of the success of their stringent policies unfolded, gold prices collapsed. How could one justify holding gold priced at $800 an ounce with interest rates in high double digits when less than decade earlier it had traded at $36 an ounce?
7. Gold's price increase since 2000 roughly approximates gains in such industrial commodities as crude oil, copper, and iron ore. That doesn't make it cheap, but it doesn't make it expensive.
8. If there had been a known - but expensive - antidote against Black Death, the well-off would surely have bought it and kept it around even if the plague had not returned in decades. Gold is a proven antidote for extraordinary financial events produced by bad banking and political governance: its price rose from $20.67 to $35 after the Depression arrived; in the 70s it soared from $35 to $800 when inflation climbed from 2 per cent to 14 per cent; it has outperformed stocks since the 2008 Crash.
How to own it?
Bullion is bland in a bull market for gold compared to owning well-managed mining stocks with large unhedged reserves in politically-secure areas of the world. You get the upside leverage of reserve restatements as bullion prices rise. Laugh not: there are many well-managed gold companies - and the rest have been taught expensive lessons.
Whom can you believe?
Me - or those 32 experts who, only weeks ago, said don't buy gold?
A $110 rally proves almost nothing. There are still far more of the disbelieving experts than there are who agree with me.
File this column away for later re-reading when you know how the story turned out.
Or tiptoe into the chilly waters and buy some good gold stocks.