Pater Tenebrarum

About the Author Pater Tenebrarum

I'm an independent analyst and have been involved with financial markets for 31 years. I write economic and market analyses for independent research organizations and a European hedge fund consultancy. I'm the main author of the blog 'Acting Man', which presents articles on the markets and the economy, a mixture of commentary on current events as well as economic theory and history from an Austrian school of economics viewpoint.

Gold and Gold Stocks Beginning to Look Better Again

Gold isn’t doing much in dollar terms – apart from the fact that it apparently still doesn’t really want to stay below the $1,200 level – but it remains quite strong in euro terms. In yen terms it isn’t really doing much lately, but remains well above the lows seen in the past two years. Obviously, the people who either buy gold as insurance or refuse to sell it at current prices (=high reservation demand) remain at work. The source of demand at the margin represented by today’s gold buyers has much to do with concerns that the central bank policy induced party in “risk” will inevitably end. This is to say, these buyers look beyond fundamentals in the here and now toward the day when it insurance may actually be needed (we have first mentioned this last year as it were, and believe it continues to be true). It is a case of better having insurance and not needing it, than one day realizing that one needs it but doesn’t have it.

Lately there are a few signs that the situation is improving from a technical perspective. Not only has gold been quite resilient in the face of generally weak commodity markets, it has also withstood a great deal of US dollar strength and a fundamental backdrop best described as “mixed”. Whether the price will turn up before or after the fundamental data points become clearly bullish remains to be seen – gold is highly sensitive to future changes in the monetary policy backdrop, so at times it will firm up (or weaken) long before these changes are foreseen by most people.

Recently we have seen the net speculative long position in gold futures retreat back to to the vicinity of multi-year lows, which is often a precursor to a period of strength (whether a durable trend change can be achieved is a different question, but one day it will happen, so one has to remain alert). Not only that, but the HUI-gold ratio has recently turned up after putting in a slightly higher low. An uptrend in this ratio is a sine qua non lending credibility to an uptrend in gold-related investments. Of course, it is early days in this respect, but at the very least it appears as though a tradable move may now be in the works.

Below are charts illustrating the situation, beginning with gold in the three major convertible currencies:


1-Gold - currencies

Gold: Not much to write home about yet in USD terms, quite frisky in euro terms and non-committal in yen terms. Perfect protection for the time when the latest experiment in modern central banking blows up.

Here is a chart showing the net hedger position in COMEX gold futures over the long term. The hedger position is the inverse of the net speculative position, so the chart indicates that the net long position of speculators (large and small combined) is currently historically low. Two weeks ago, small speculators were even slightly net short again. A net short position held by small speculators almost invariably coincides with playable short to medium term lows in gold.


2-Goild hedgersNet commercial hedger position in gold futures – click to enlarge.


There has been some M&A activity in the gold sector lately – the most recent example being the merger between Alamos Gold and Aurico. There are rumors that this merger may spark rival bids.

It is a good bet that M&A activity in the sector will increase. There are essentially two distinct time periods that are often accompanied by an increase in such activity. One is when prices are high and managers have finally become convinced that they can only go higher. In these periods we tend to see mergers and buyout offers that usually make very little economic sense.

The other one is when prices have been low for an extended time period and managers fear they may go still lower. Then the hunt is on for assets that make sense even in a low price environment, and the mergers and buyouts are often accretive and do in fact make sense. It seems obvious which of the two periods we are currently in. It can therefore make sense for investors to mull over which gold companies would make good targets in the current situation.

In addition to this, it should be noted that increased M&A activity near lows in gold and silver prices often also precedes a trend change. As an example, in the years 1998 – 2000, we have seen the unbundling of South African gold assets (the old “mining house” concept was abandoned), which sparked a wave of buyouts by aggressive companies like Harmony gold, and we also saw Barrick and Newmont pick up smaller rivals (ABX bought out Homestake, Newmont bought out Battle Mountain Gold). Not too long after the gold market made its lows in 2001, merger activity intensified for a while. Kinross merged with TVX and Echo Bay Mining and later bought out Bema Gold. Barrick merged with placer Dome, Goldcorp with Wheaton, Newmont with Franco Nevada.

The market has not yet really given any credit to the fact that mining margins are improving due to strength in the real price of gold. Management boards of gold companies may be coming around to a different view though – after all, they are acutely aware that the real gold price is the only thing that counts with respect to their margins.


3-HUI and HUI-gold ratio

The HUI and the HUI-gold ratio: beginning to look perky. The obvious lateral support/resistance levels indicated above show what needs to happen to keep an uptrend going – click to enlarge.


Against commodities, gold is close to an all time high. This ratio can be used as a proxy for the real price of gold. It has declined noticeable between 2012 – 2014, but since then has risen strongly again.


Recently trend changes in the gold sector have tended to be short-lived. However, because many gold stocks are trading at very low nominal prices, even a short term uptrend can be quite lucrative (e.g. many low-priced gold stocks rose by 100-200% between November 2014 and February 2015). The same is of course conversely true of short term downtrends as well.

It seems to us that the market errs in overlooking the slow but steady cost improvements that have been achieved in the past two years by many gold companies (often under new management). Moreover, gold itself continues to find support just below $1,200 – while it also remains in a bull market in euro terms.

Lastly, we remain positive on gold in the long term regardless of its short term gyrations. The current global experiment in extreme central banking isn’t going to end well, and when the next wake-up call comes, gold could well rise to prices that seem silly now.

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