Jon Nadler: Gold's Current Highs Not Sustainable In The Long-Run
Even though gold has backed off a bit in recent days, it's still hovering around historic highs, closing at $1,224.10/oz on May 17, 2010. And given the recent euro crisis, interest in the yellow metal—from both individual and institutional investors—is at a fever pitch.
But don't get swept up in the hype, says Jon Nadler, metals market analyst and PR head for Kitco Metals, Inc. The precious metals expert says gold's real fundamentals support a much lower price, one we'll soon return to once the euro crisis is over.
With over 30 years' experience in precious metals markets and investment, Nadler is a well-respected authority on gold. He writes a popular daily gold market commentary for Kitco, and his metals expertise is frequently sought out by the Wall Street Journal, Bloomberg, Reuters, the Associated Press, Financial Times, CNBC and more.
Recently, HAI Associate Editor Lara Crigger discussed gold fundamentals with Nadler, including why everyone needs a 10 percent gold allocation, what a demise of the euro would really mean for the economy and why he sees gold closer to $800 than $8,000.
Crigger: So why do you think gold's back up near its historic highs? Is it just the euro crisis, or is something else fundamental going on here?
Nadler: Volatility and nervousness are both on the rise. We did see a fresh high last week at about $1,250, so it's backed off of that. But let's not ignore the rest of the metals complex here. Silver's off $.50 [as of May 17, 2010], platinum's off more than $60-$65 and palladium's down $20. The dollar continues to be quite strong, and oil's down almost another $2. So there's definitely a lot of turmoil in the markets, which is primarily related to the euro situation. But I think the focus here is once again misplaced.
Last fall, I cautioned about the non-imminent demise of the U.S. dollar, which everyone was promising us. Back when gold went to $1,226 in early December, we were guaranteed that this is a currency in its final stages of demising, and that it would be done away with as the reserve currency of the world, and this was the reason that gold would actually land on the moon. Obviously, none of that happened. And not only that, but the dollar has risen very substantially since then. It remains the benchmark for settlement of global trade, and is still represents more than 60 percent of global reserves. It's not demising. It's not about to go away.
Crigger: Of course, now we're starting to hear the same sort of talk around the euro.
Nadler: Right. The same talk that was directed at the U.S. dollar is now (curiously) being repeated, just that now, such talk is aimed at the euro and by the same people who said the dollar would fall off the proverbial cliff. They're saying: "It's OK that the dollar's rising; we'll take that. It'll die later."
So what are these people really telling us? Are they really proposing that all of these currencies are really dying in concert, and that we're going back to gold as the only viable currency? I'd love nothing more than for that peg to be re-established, but sadly, since 1968, that's been a process largely undone. As much as we love gold, the reality is that it's been marginalized in the global system. It only represents 0.6 percent of total private global wealth. So, it will not, and it can not, be the total panacea to cure what currently ails the world.
So the present driver of gold prices is this European debt crisis. There may not be as much concern about it spreading as there had been in the past two or three weeks, but rather, concerns remain about the efficacy of the rescue package that has now been put into motion, about possible future defaults, and, of course, about whether the euro will demise and be replaced with national currencies again. So over the past week or so, I think it has come down to a battle of the wills: the speculative funds versus the financial officials in Europe. It's a game of chicken. One side is calling the other's bluff.
Crigger: I really can't see the euro being abandoned so easily.
Nadler: Yes. At the end of the day, there's a lot of pride, hard work and credibility that went into the EU and the euro currency. For that to happen, I think you're really asking for such an Armageddon scenario that much worse things would happen first; namely, another contraction of the global economy. Is that really what we want?
There are a lot of side issues here as well. Yes, maybe Greece wasn't ready to get into the EU when it did. Yes, maybe German taxpayers feel that despite the fact that they're generally very frugal and orderly savers, they are being asked to subsidize other "spendthrift" countries. But they're all in the same union now, and there is little choice but to help each other out.
What if the euro does demise? We wouldn't be switching from euros to "nothing," and we wouldn't be switching from euros to "gold bars" as the new currency. We're also not about to give the dollar global hegemony over the global currency system. Thus, if anything, you could see a rehabilitation of the previous national currencies. At which point, I might add, the German mark would be quite a solid alternative.
Crigger: So is gold's current push really sustainable? Are we really looking at a long-term upward movement here, or should we expect gold to retrace a bit, once the euro crisis is resolved?
Nadler: The latter. I project that the crisis clouds will pass, just as the U.S. "perfect storm of 2008" also dissipated, and gold will eventually return to more "realistic" price levels; ones that satisfy jewelers, producers and even individual investors in terms of its presence and purpose in a portfolio. We're really looking for an eventual evaporation of the fear and greed premium that's permeating the market at this moment, and has been present therein since last fall, but one which has risen given what's happened over the past few weeks.
To me, when you see a 975-tonne long position of speculative money in the gold futures and options markets, well, we know it's got to be the hedge and spec funds. It's a fund push, capitalizing on fears that are legitimate, but I don't think you can carry such apprehensions to the dire conclusion that this is some "huge realignment" in the financial order of the world.
To some extent, when you reach a new price high, one that's printed in the headlines in bold font, of course the man in the street's going to think, "This is it; this is the end of the world. I better go run out and buy a lot of gold." But that's exactly the time when they should think of holding off, if they didn't buy some in the past. Of course, they should have. We always tell people to consider gold as a core insurance, to make sure they have some. We also say: "Don't obsess about the price; this isn't about price gains or performance; this is about a percentage allocation of your portfolio." You take that formula home, and you're not going to be bothered by a media blitz that proclaims: "This is it!" because, really, it's never "It" as we have repeatedly learned by now.
Crigger: Separating out the hype then, what do you see as a more reasonable direction for where gold will go?
Nadler: Just look at the situation we have now, where the production cost of gold is just under $500 in cash cost terms; with a 7 percent mine supply increase, as we know from the latest GFMS stats from last year. The scrap supply of gold rose to record levels last year; it jumped 27 percent, and there's a 21-year low in global jewelry production. India was a net exporter of gold for a full quarter last year, and it imported the lowest gold tonnage in a dozen years in 2009. All of these things eventually do come together, and the only bright spot remaining in the market last year was ETF-driven demand, but investment demand was characterized as having fallen off sharply in Q1 this year vis a vis last year.
I think one of the reasons we didn't get going in earnest to much higher levels during the initial phases of the "Greek drama" was the fact that ETFs were, by and large, dormant from June of last year to very recently. They've only started accumulating again in the past few weeks. That's a curious case. So even the absence of modest buying from that now all-important demand source held a lid on prices.
So what happens if a wave of ETF-based redemptions hits the market, something to the tune of 200 to 300 tonnes out of the 1,200-plus tonnes that they have now? I don't know. We've never seen these funds' effect in a sideways or downward phase of the market, so we don't know what would happen. To the gold price, of course, it would do significant damage, because there's physical gold behind these funds, and that physical gold would flow into the market in case of redemptions. And this market, at this time, given current fundamentals of supply/demand, is totally ill-prepared to absorb such sizable potential outflows.
The other question it raises is: What if one of these PIIGS countries finds itself in a situation where it has to mobilize its gold? I mean, what was the point of having these gold reserves in the first place? It's about defending a national currency, maintaining public trust and confidence in a currency, and you have gold as an asset of last resort. You mobilize it when it's a rainy day, and it's been pouring rain in Europe lately. So what if Portugal finds it necessary to ask the central bank signatories to allow it to "step in front of them" and use/mobilize some of its reserve tonnage, because it needs the funds? It's a potential issue. It may seem like a rhetorical question, but mobilizing gold to save one's hide is not an unknown phenomenon in the annals of central banking history.
Crigger: So what is the "right" price for gold?
Nadler: Of course, now we've heard that such a price should be anywhere between $8,000 and even $15,000, but I still think that between $680 and $880, or in that range, gold would be much more in balance with its fundamentals. Eight hundred is a number that you saw come up in the GFMS surveys as a potential target, and they gave it up to two years (even with the potential overshoot of up to $1,320). Yeah, that could still happen, but it's all a cycle, a phase in the markets. It's currently driven by a circumstance (Europe), but not some "new dynamic" (a return to a gold-based world) that has suddenly become the new paradigm. You also have had Barclays Wealth Management coming out, saying they envision $800 gold by January 2012, and saying in an interview on TheStreet.com that they're "shorting the GLD and buying put options on gold for Jan 2012." Further, what am I to make of Societe Generale, which also said in April of this year that $800 gold is in the cards before the end of 2010? And so on; I am not alone in computing such figures.
Crigger: You sometimes get some flak for taking a comparatively bearish stance on gold, but you actually advocate investors hold a healthy percentage of their portfolio in the metal. What's the right allocation to gold, and why?
Nadler: Sometimes? Try all the time, and for the wrong reasons. Frankly, it does puzzle me, because when I say (and I always say this), that you probably should have 10 percent in gold, that's a percentage that's about 50 percent higher or more than what most financial experts will tell you. Also, we say that if you don't have gold yet, you should go out and buy it—you don't care what the price is. So I'm not telling you: "Now is the time to sell" (unless, of course, you're inclined to take profits on something that you bought for profit). But I'm actually much more generous with my recommended gold allocation than mainstream financial advisers out there who say that 6 percent is probably more than adequate. I just do not sign up for 50 percent in gold, or 80 percent in gold, as those who call me "anti-gold" probably do.
We advocate 10 percent, regardless of price. That should be a core holding for anyone, of any orientation, whether they believe in inflation, deflation or an unforeseen crisis of any kind. It's an "all-eventuality" type of holding. But I will also say this: Don't overload in gold, with the wrong expectation, at the wrong time, because that can come back to bite you badly. Ask the panic buyer of 1980 how he fared for 30 years.
Crigger: Kitco just came out with a new investment product for rhodium. Why rhodium? What's the appeal for investors?
Nadler: Platinum group metals, as a niche (and as opposed to gold), are endowed with decent fundamentals. They've got a tenuous supply of metal, coming primarily out of South Africa and Russia, and decent demand from their primary usage in autocatalysts. These make sense as part of the global economic recovery story. You're talking about a sector (automotive applications) that nobody has figured out substitutions or new technologies for. If the crisis doesn't completely throw the world into a second recessionary dip, then the fundamentals argue that these metals have not only been neglected, but also underpriced.
With rhodium, we looked at even more of a tight market. It's a tiny market of 900,000 ounces per annum, and one where carmakers can't substitute with cheaper metal, because it is the only such noble metal that can remove the nitrous oxide from tailpipe emissions. When you add that together, you get a good picture, especially as the U.S. and European carmakers come out of their "car recessions." And then there's China and India, who are in the driver's seat in the recovery of auto sales.
It's also a market that doesn't have futures or options trading available at the moment. But because of that, it's a bit thinner and a bit more volatile, and the spreads are wider. But it doesn't mean that an individual investor cannot participate in it. Our situation was that we had pool accounts in rhodium for years, but we saw increasing interest from investors for this in the longer- to medium-term trade, three to five years. So since it's really costly and difficult to create 1 ounce coins, we decided to take the really basic refined material (called "sponge"—a gray powder, really) that the refiners use and literally bottle it, seal it and put it into safekeeping with a custodian.
It's not for everyone, by any means. You should definitely understand the market and where the supply and the demand come from. But as a recovery play, and as a medium-term speculative play, I think it deserves a closer look.
Hard Assets Investor
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