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COMMODITY FUTURES FORECAST
Prepared by Philip Gotthelf
Has Gold Reached a Bottom?
(December 5, 2013) Once again, experts are calling for the end of the gold “bubble.” Gold’s precipitous slide since last year in comparison with record-breaking stock indices begs the question, “Why invest in gold?” It is a legitimate argument when considering gold has no yield like bonds, not rental income like real estate, and no dividend potential like stocks. You can’t survive on gold and you cannot use it to run your car or heat your home. Gold is about the most useless metal every placed into the cosmos.
Similar arguments may be made for silver, but for its various important industrial applications. Still, entire cultures are drawn to gold and government treasuries have a new propensity toward gold accumulation. Obviously, I have shorted gold along with the consensus and have taken out profits from short silver positions, too. I am not one to buck the near term trend, but I have not liquidated physical gold positions. It may sound like a contradiction, but moving into and out of physical gold is not as easy as it was thirty years ago.
The daily chart is far from encouraging, but gold cannot be technically viewed in a vacuum. As much as I am a technical advocate, fundamentals should not be discounted. Notice the support line at 126000 in February gold. Prices have definitively broken down below this level, but there has been strong intermittent support since the June ’13 reference low below 120000.
Gold has supported above 126000 to form a basing formation. The highs have declined to suggest less upside enthusiasm, however we should be cognizant of potential congestion. The “small investor” is switching out of gold in favor of equities. Sovereigns are moving into gold to balance sales with fresh demand. Demand from treasuries has been sufficient to offset the exodus from ETFs.
I maintain close relationships with bullion dealers who insist inventory remains tight and demand is brisk. Clearly, the volume of retail physical sales is no match for the volume of ETF liquidations that weigh against the cash market. There are two different investment philosophies in play. Those who truly believe in gold and those who view gold just like any other stock.
It is important to keep the fundamental perspective in focus because there are several demand dynamics in play. The three dominating forces are sovereigns, ETF investors, and retail accumulation. On the supply side, it is easy to understand why major producers went all-out to build new capacity. The story is revealed in the monthly continuation chart.
From 1985 forward, gold traded within a narrow range from $250/oz to approximately $425/oz. Obviously, mining companies were able to make a profit from these prices. The industry average cost for extracting an ounce was reported to be a 25% discount to spot. Since the range was considered wide, this discount was an amorphous number.
If a company could make money with gold at $250/oz, how much more could be made at $1,700/oz? When gold erupted above $600/oz, mining numbers were looking pretty sweet. The boom was on. The monthly continuation chart continues with the story as prices moved to touch above $1,900/oz during the debt ceiling standoff in the summer of 2011.
Mining companies took on huge debt and capital expansion. They built expensive staff and bit off substantial exploration commitments. In short, they stretched capital and operating budgets in excess of the high price offerings. Now, they are suffering under burdens based upon assumed prices above $1,500/oz. Industry analysts are scratching their heads and asking, “If you could make money at $600/oz, what’s wrong with twice that at $1,000/oz?”
The overhead resistance experienced from 2008 through 2009 suggests a test of $1,000/oz support is possible. This is the level probed during the financial crisis. If we are in a recovery, the probability of a bust below $1,000 is diminished. This is why gold bugs continue to buy even as prices decline. They are in it for the long haul and accumulation is a defensive strategy. Our government’s propensity toward watching transactions makes gold accumulation vulnerable to the one thing gold bugs communally fear… confiscation.
Who Does It Belong To?
There is a great deal of complacency about the actions of sovereigns and, in particular, the U.S. government. Unfortunately, any discussion inevitably leads to political ideology, but objectiveness may still be found in observing actions. The Cyprus Confiscation appears to already be fading from memories with the exception of those Cypriots and Russians who watched 10% of their wealth loped off by the European Union. All of Europe has declared war on the wealthy with proposals to raise tax rates and impose confiscatory “wealth taxes.” (Alleged one-time hits on accumulated assets above a predetermined amounts.)
Now, President Obama has announced his remaining agenda of wealth equalization. Taking his lead from a de minimis number of super rich who advocate higher taxes, President Obama has a remaining 3-year stint directed toward returning to pre-Regan tax brackets with a European twist… a U.S. wealth tax. On the surface, it seems reasonable for ultra-wealthy families to pay more toward the greater good. Yet, exemptions for the super rich abound within the Obama plan while targeting the upper middle class appears to be the ultimate goal. As wealthy as the super rich may be, taxing 10% of their accumulated wealth will fund our government for less than a month. To call it a “symbolic gesture,” is to mock any form of government action on taxes. The real flesh is the small business owner whose accumulated wealth can be arbitrarily determined by some conspicuous government formula designed to break the bank.
Since the majority of small businesses are owned and run by this middle class, they are the ultimate driver for the President’s plan. This raises a sustainability question. Relieving small businesses of excess capital will place constraints upon private sector capital deployment. The FED insists this capital deployment is critical to any sustained recovery. The FED has run out of monetary tools. Any constraints upon the economic driver will adversely impact the economy.
This brings up the issue that was so hotly debated by the Republicans… and, to no end. President Obama inadvertently stated, “You didn’t build that…” when referencing U.S. infrastructure and small businesses. His point was clarified by Democrat spin-doctors who said he meant small businesses could not have become successful without the infrastructure provided by government. Perhaps the inadvertent remarks were prophetic. Now, the question is, “Who does it belong to?”
Logically, if all small businesses have been built on the back of government infrastructure, then the government is entitled to an equity interest in small business. Forget the fact that the infrastructure was built using the tax revenues from small business and employees, Uncle Sam is taking a very selfish and pragmatic view. “We own it, too!” If the Federal Government owns it and hasn’t taken its fair share, now is the time… while President Obama remains in office.
I am not passing judgment on the pros and cons of this approach. I bring it up only as a background for the paranoia within the gold buyers’ community. If you buy ETFs and the government wants to convert them, they are easily matched to an owner. If you have coins or bullion, it is more difficult to confiscate because you need to know it exists, the quantity, and where it resides. The paranoid do not want their gold purchases recorded and they are reluctant to sell because it would generate a paper trail. This means the gold they buy is likely to remain off the market for some time.
The number of individuals who are preparing for the end of our free market as we have known it is very low. I doubt gold hoarders are sufficient to make a substantial impact upon net accumulations. Sovereign accumulation is more likely to play the pivotal role in determining the net outcome from ETF liquidations and private sector abandonment. Yet, I am not laughing at the confiscation scenario. There are enough catalysts that could prompt a panic into gold and a government intervention.
Drama requires us to envision an all-evil government intent upon making us all slaves to the central state. It is a cliché theme that titillates the imagination and stimulates our inherent distrust of governments. If there is anything we know about the reality of this fear, it is that we never see it coming. Even when we do anticipate a problem, we tend to remain in denial until it is too late. This is why I cannot argue with someone who continues buying gold even as the trend is lower.
The reality is that there is only limited private property. Even in those states that have no property taxes, state and federal governments have eminent domain. In states where there are property taxes, see what happens if you fail to pay your tax. You property will be taken and your property will be sold for the benefit of the state. This answers the question, “Who does it belong to?”
To be sure, there has always been polarization between the rich and poor, labor and management, etc. More importantly, the nation has survived far higher top tax brackets than we currently have and certainly higher brackets than we will have as the “Bush tax cuts” expire. There is enormous hyperbole on both sides of the political divide. Republicans need to acknowledge that incremental increases in the high income brackets is not going to undo the nation. On the other hand, a redistribution of wealth from the upper middle class to the lower middle class will undo the economy.
There are no societies without class separations. We are all born with different skill sets and the free economy establishes which skill sets are worth the greatest compensation. It is a fact of human nature. Whether we feel a sense of fairness or unfairness is irrelevant. Those who know how to deploy capital inevitably earn the most. If government curbs the capital available for deployment, it will simply not be deployed. If government hopes to substitute subsidy for capital deployment, it will print its money supply into oblivion.
If anyone approached me in 2005 to say there would likely be a monetary crisis by 2014, I would have laughed. Today, we are very close to a global monetary challenge. This is why I am always more cautious about selling precious metals in the current environment. Aside from the obvious need to create a value proposition the destabilized Middle East throws a war premium into the analysis.
We were stopped out of crude oil on the recent spike higher. This was reflected in a small gold response. Tensions between the Sunni and Shiite sects has escalated into national alliances that involve Saudi Arabia and other “moderate” Arab states. When you see Saudi Arabia align with Israel, you know something is seriously out of whack! Our lack of direction has placed Egypt back into Russia’s court, and it is not likely anything will resolve without one or more serious multi-state conflicts.
Here is another reason gold is not likely to fall completely out of favor. Aside from fancy color diamonds, there are no wealth preservation assets that work in the Middle East. We may feel comfortable within the security of the United States. Trust me… if you’re a citizen of any Middle Eastern country you do not have any sense of security… physical or monetary. The short side for gold and silver may have run the course. I am inclined to wait out the next few days to see.
December 5, 2013
Commodity Futures Forecast
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