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Curb Your Capital(ism)

By Jon Nadler       Printer Friendly Version Bookmark and Share
Nov 20 2009 10:37AM

www.kitco.com

Good Day,

A more robust gain in the US dollar overnight (rising 0.56 on the index, to 75.82) drew additional sales from gold holders and dented values in crude oil as well as other precious and base metals. The US currency gained ground following cautionary words on the state of economic recovery by ECB President Jean-Claude Trichet. US stock index futures were indicating a drop on the day, and risk appetite appeared to be on the wane this Friday morning.

Analysts at Fort Pitt Capital in Pittsburgh distilled the dollar-centric action as follows this morning: Everyone is looking at the dollar right now. Low interest rates are supposed to make investors want to take risks, but that is not happening. People remain very nervous about the economy, and especially about the consumer." Nervous, like Mr. Trichet, who cautioned that it is 'too early to call the [financial] crisis as over.'

Against this changing set of background conditions, New York spot gold bullion opened with an $8 loss, quoted at $1136.70 per ounce. Trade talk indicates a possible dip to the $1100 area prior to a possible renewed assault on the other side of the $1150 mid-point, up to $1180 or $1200. Provided other obstacles do not materialize, of course. In any case, 'corrections' have been ultra-shallow up to this point, despite growing nervousness about the sustainability of the patterns now in place since the first day of September. Thus, we still expect to see attempts at higher levels not only today, but perhaps next week as well.

Contrarian warnings are now habitually disregarded, and news such a Mauritius' (!) purchase of 2 (two!) tonnes of IMF-owned gold are hailed as a harbinger of...more of the same, and then, some more. Ditto, yesterday's news that the UK Mint increased (quadrupled) its coin production levels in the third quarter.

"UK Mint output rose to 32,735.8 ounces from 7,500.2 ounces a year before, according to data obtained by Bloomberg News under a Freedom of Information Act request. Production in the first nine months more than tripled to 100,391.3 ounces, the data show." Okay, let's assume that the British Mint will produce 134,000 coins this year, based on this run-rate. Where is the (conveniently) forgotten news item dated October 29, also from Bloomberg in which one can learn that:

"The Austrian mint, the world's largest marketer of pure gold coins, plans to slash output by 32 percent next year from a record, forecasting the end of the financial crisis will weaken investor demand. Muenze Oesterreich AG aims to cut production of Philharmonic gold coins to 650,000 ounces in 2010 from an estimated 950,000 ounces this year, mint President Kurt Meyer said in an interview in Tokyo.

"The crisis is over, and economies are recovering," Meyer said yesterday during a visit to Japan to promote sales of a new 20-ounce version of the coin. "Gold investment stimulated by concerns about the financial system will subside," he said. The coin design depicts musical instruments representing the Vienna Philharmonic Orchestra, according to the mint's Web site. "Gold rallied on speculation that the dollar will weaken because of low U.S. interest rates," said Kazuhiko Saito, chief analyst at commodity broker Fujitomi Co. in Tokyo. "If these conditions change, the metal's advance will come to a halt."

In so many words, were the UK Mint's output to even double in 2010 (to 260,000 ounces) - (something which it obviously will not do), and this would still NOT make up the 300,000 ounce decline in output by the Austrian Mint. Just to put things in perspective. Perspective is, however, something that normally lacks when euphoria rules.

Speaking of euphoria –of the stubborn variety- Marketwatch’s Marc Hulbert finds that: “The average gold timer is now more bullish than on each of the past four occasions in which the gold market has topped out. This suggests to contrarian analysts that the yellow metal has more than the usual amount of vulnerability to a significant decline.

Consider the Hulbert Gold Newsletter Sentiment Index (HGNSI), which reflects the average recommended gold market exposure among a subset of short-term gold timing newsletters tracked by The Hulbert Financial Digest. As of Thursday night, the HGNSI stood at 68%.

The highest that this sentiment index got at the top of the previous four gold market rallies was 65% and bullion dropped markedly following each of those tops.

Date of gold market’s intermediate-term top

 Highest level to which HGNSI reached

Magnitude of subsequent gold market decline

March 2008

65%

15.5%

July 2008

64%

24.8%

February 2009

61%

11.7%

June 2009

57%

7.2%

To be sure, the current lack of a strong sentiment foundation doesn’t automatically doom gold’s rally. The final blow-off stages of a rally, which are usually accompanied by high levels of enthusiasm and excitement, often last longer, and go further, than most would have imagined. At the same time, however, markets in which there is such a high level of enthusiasm tend to drop precipitously at the first sign of trouble. We saw a taste of this earlier this week, in fact: Gold for December delivery on the Comex dropped nearly $20 from its high on Wednesday to its low on Thursday – just one day later.

Tellingly, however, the HGNSI did not budge in the wake of that air pocket. This suggests that the average gold timer is stubbornly holding onto his bullishness in the face of market weakness. Such stubbornness is another telltale contrarian signal of imminent market weakness. From the point of view of contrarian analysis, the most bullish scenario for the next couple of weeks would be for gold timers, at the next sign of market weakness, to give up any of their stubbornly held bullishness and quickly rush for the exits. In contrast, the contrarian outlook would become even more bearish if the gold timers were to become even more stubbornly bullish in the face of any weakness. We’ll know soon enough. But as of now, contrarian analysis suggests that the gold market is a particularly high-risk bet.”

But, are ‘they’ worried? Nah. Long-time friend, reporter Myra P. Saefong – also at Marketwatch (reporting from Tokyo last night) observes that: “in fact, it’s almost as if gold’s long-term, upward trend is invincible and with such a convincing backdrop pointing toward even higher gold prices, it’s difficult to find a bearish voice in the gold camp. That, in itself, should urge investors to be cautious.

“Cognitive biases are an investor’s worst enemy,” said William Gamble, president of Emerging Market Strategies in Rhode Island, who admits he’s bearish on gold. “The ‘gold story’, like the emerging market story or the China story, is an easy sell. I would be very worried.” The one thing to look out for with gold prices at such lofty levels is “a collapse,” he said.

Speculation against the dollar by carry trade funds and governments is driving the price of gold – and as governments try to diversify out of dollars, they are “basically driving up the price of gold and buying in at the top of the market,” he said. “The problem with governments is that they could simply stop buying,” he said. “They may finally discover they are buying at the top of the market and that the dollar will not fall forever,” triggering a collapse in gold’s price.

So for those who believe that further weakness in the U.S. dollar should fuel further gains in gold, there are some who offer a reality check. “The world is not going to allow forex traders to trash the dollar and distort the value of other currencies,” said Value View Gold Report’s Ned Schmidt, adding that the current gold market is a “’mini bubble’ driven by margined futures traders.”

“Now is not the time to sell, and nor is it the time to buy” gold, Schmidt said. “Gold investors should sit on their profits, and watch with glee as the momentum traders get trashed. I am a bull, but not this week in this frenzy.” 

Silver lost 37 cents on the open, starting the session at $18.17 per troy ounce, and platinum fell $19 to $1424 per ounce. Palladium lost a hefty (for it) $13 out of the starting gate, and was quoted at $354 per ounce as profit-takers took…profit. Rhodium was flat t $2450 per ounce. At last check, crude oil was off one dollar, quoted at $76.47 per barrel.

As regards the IMF’s remaining gold for sale, and with China (the next ‘sure thing’ being bet upon in some circles) thus far having shown little interest in any gold selling for more than $800 (their words), the most recent opinion from BNP Paribas VM Fortis Group –in a just-released market analysis- is that:

“If the IMF cannot find another official sector buyer (and after India’s purchase it cannot be ruled out that it does find another buyer) we expect on-market sales to begin shortly and, for the first year of the CBGA, to be in fact the only major seller. The Fund has said it will inform the market before sales begin, and that it will regularly provide updates on their progress. Sales will be conducted indirectly, via an agent, and an IMF official said that “two or three years or something” (before it knew it could sell half to India) was a likely time frame, with gold sold on a daily or weekly basis, which perhaps rules out the kind of auctions staged by the Bank of England during 1999-2002, and the IMF itself in the 1970s, when it last sold gold. So in our view the most likely outcome is that the IMF will begin on-market gold sales in Q1 2010 and will sell regularly each week at an annual rate of 200t/year, meaning its sales will take about a year.”

In the interim, signs that all is not well for everyone as regards continuing dollar weakness continue to emerge, albeit –as mentioned above- the change in patterns is actively being ignored by drunken with greed carry-traders. Here is a mini round-up from the world press, on the (soon to be possibly headline material) trend towards capital controls in the markets that the ultra-cheap dollar has inflated to cartoonish proportions:

“Easy money in the United States, a falling dollar and growing flows of funds seeking better returns in emerging markets are touching off a round of capital controls in hot emerging markets, a trend that could accelerate and will increase market volatility at the very least. It should not be a surprise, really; loose money in the developed world is helping to spur investment in emerging markets, driving their currencies up and making local exports less competitive for countries that, unlike China, are not hitching free rides as the dollar declines.

Inflation may be a threat for many of these countries, but with the global economy still struggling, it certainly will not feel that way to policy makers. On Wednesday, Russia joined the list of countries considering measures to stem currency speculation and appreciation. Moscow was careful to say it would not impose actual capital controls, which seek to regulate flows of funds into or out of an economy, but the measures it is considering would have exactly that effect, making it tougher or more expensive for money borrowed abroad to be taken into Russia.

Kazakhstan, which has been intervening actively to slow the ascent of its currency, the tenge, has introduced legislation allowing capital controls, but so far has not used them. Indonesia said this week that it would consider curbs on foreign holdings of short-term official debt, sending its rupiah into a brief fall until the governor of the Indonesian central bank, Hartadi A. Sarwono, tamped things down by saying currency moves based on such flows were so far manageable.

Elsewhere across developing Asia, central banks have been intervening to cap gains in the value of their currencies, with Taiwan going so far as to ban foreign funds from investing in local time deposits. Brazil announced a 2 percent tax last month on foreign investment in stocks and fixed-income securities to limit the strengthening of its currency, the real.  Malaysia attracted a firestorm of criticism when it imposed controls after the Asian financial crisis of 1997-98. There was much talk of how investors would go away and not come back, how development would be retarded and Malaysia ultimately would rue the day. None of that has come to pass, and those same investors proved quite willing to come back if the returns looked good enough, as indeed they did.

What will it mean if it becomes not a tool of desperation but a standard policy when money floods into countries? There must be a risk that capital controls become part of an escalating series of beggar-thy-neighbor steps taken by countries fighting over the scraps of a diminished U.S. and European appetite for imported goods. Also weighing on [today’s absence of] risk sentiment have been various restrictions imposed by some emerging-market central banks to limit the appreciations of their currencies against the dollar. South Korea also unveiled several measures aimed at helping local firms better manage foreign exchange risks and reducing imbalances that have made its market susceptible to bouts of volatility. Earlier in the week, reports indicated Indonesia may also be considering some form of capital control to help quell the appreciation of its currency.

“There’s more going on to this than just small little plans that are being made to tweak things here and there to discourage people from speculating in the currency markets,” a BMO analyst said.

“It’s all part of a general theme right now that countries outside the U.S. and China are extremely concerned about the weak dollar and yuan, and are attempting in any way to arrest the strengthening of their currencies,”  Meanwhile, the dollar got another show of support Thursday from Saudi Arabia. The International Monetary Fund’s Special Drawing Rights can’t replace the U.S. dollar as a reserve currency, the governor of the Saudi Arabian Monetary Agency, Muhammad Al-Jasser, said Thursday in Frankfurt.”

Senior officials in India, Indonesia and Thailand spoke publicly about the possibility, adding to speculation that other countries may follow Taiwan and Brazil in introducing restrictions on flows of hot money in search of high yields. E Indonesian rupiah suffered its biggest decline since February, in spite of official attempts to play down suggestions by Hartadi Sarwono, the deputy central governor, that the bank was “studying” restrictions on foreign purchases of short term bank debt.

Authorities from Brasilia to Moscow to Jakarta are moving to curb what they say are ‘hot money’ speculative flows fuelling rapid currency appreciation and destabilizing their recovering economies. With currency market intervention seen as increasingly inflationary, governments are resorting to direct capital controls to prevent local bubbles expanding and bursting. In contrast to controls imposed by emerging economies at the height of the global financial crisis last year, the latest measures are aimed at slowing massive capital flows from investors seeking higher yields amid the persistence of near-zero interest rates in the biggest developed economies.”

Finally, something might make for a good weekend read: a bit of a culturally-flavoured analysis on gold and India, given the recent hoopla about the CBI’s 200 tonne purchase- an event which BNP’s analysts describe as follows: “India is one of the poorest countries in the world. It has spent nearly $7bn on buying gold, and, moreover, at an all-time record price (in nominal US dollars) from the IMF, which is selling the gold in order to help fund its operations and lend to low-income countries. Central banks don’t have a very admirable record when it comes to handling their gold reserves. the UK and Swiss central banks sold gold at the very bottom of the market in 1999, when the price was less than $300/oz; now the RBI is buying at what might be the top, or close to the top, of the market. And the RBI might have bought gold at any time in the last ten years but hasn’t.” 

However, in a chapter titled “India’s Private Gold Ambivalence” analysts at BNP observe that shifting trends in the country may mean a possible need for the re-writing of some very old rules in the gold market. More specifically:

“The diminished function of gold in the passing on of wealth to the next generation is an inevitable reflection of the modernization of India. Personal savings in the form of gold were once vital to meet long-term needs of families –many of whom grew up in multigenerational households with strict cultural and matrilineal codes. The benefits of gold were clear: not only was it durable, it also transferred from generation to generation with little loss in value and beyond the scrutiny of governments keen on raising taxes. For a fiscally conservative country with an unpredictable currency, this made the metal both symbolically rich and financially rewarding.

Today, gold’s strongest adherents as a component of dowries are largely those in rural occupations, but low income-levels inhibit the capacity to buy very much. Yet social patterns in India are rapidly evolving. The country’s urbanized female population have benefited from greater independence through education and significant roles in a workforce that is increasingly becoming more export-driven, while more liberal divorce laws have eroded the stigma of marriage failure, thus weakening another prop of the dowry system. This is evident particularly in hubs such as Mumbai and Bangalore, where relationship breakdown is no longer subject to the same levels of scornful judgment endured by previous generations. Indeed the entire family structure in urbanized areas has changed.

No longer confined to such strict religious and traditional codes, many couples live in “nuclear” families liberated from the watchful eye of older generations, while a new cultural obsession with romance and personal fulfillment has fostered greater expectations of a happy marriage. Two key structural changes are therefore happening, which combined will have an important impact on likely future gold demand trends in India. First, women within higher social classes and urban cultures are refusing to play a subservient role in marriage and are experiencing greater self-sufficiency, by earning their own incomes; and this segment of India’s female population is certain to expand over the coming years as the country’s economy evolves away from its dependency on agriculture.

Second, and much less tangible (although no less real) is that the new generation of younger Indians are placing much greater emphasis than their forebears on mutual love and respect, eroding old male dominated power structures, thereby leading to a more evenly-balanced marriage relationship that in turn is less interested in the gold component of a dowry. In turn, the way gold is seen in India is subtly shifting. Once valued by its weight and cost, it is now passed from one generation to another as a symbol of tradition and investment towards the relationship, rather than the contractual nature of obligatory duty that it once symbolized. In a world in which relationships and marriages are moving along the liberalizedlines of the West, the concept of dowries, as mentioned are increasingly coming under fire.

The dowry is becoming very much frowned upon in some sections of the population in today’s India there.’ Still no doubt that the value of gold remains’ as a family heirloom that is passed on from mother-in-law to sons, or from mother to bride and daughter. So within the rising middle class of India gold has to a significant degree lost its function as a social/contractual obligatory custom, as it was once thought of in a dowry, and has acquired a symbolic one, in which it is used by families to symbolize love and respect. Moreover, among the different social strata of India vast population gold’s role in the traditional dowry is now being replaced by items which range from an ever increasing choice of electronic gadgets as well as mutual investments, overseas education and training and mortgages.

Gold’s auspicious significance within Indian culture will continue to ensure it plays an important role in weddings there, even as India modernizes. But the threat is that the gold price has become much more driven by speculative investment in the past couple of years than by physical demand.If this new model for the gold price sustains into the coming years then it will, paradoxically, accelerate the waning financial importance gold has hitherto occupied in India’s marriage culture. India’s future gold demand is thus currently caught between two opposing trends.

On one hand, as the dowry becomes increasingly contentious, and the upward social mobility of increasing numbers of people in the country proceeds, India is set to require less imported gold than it has in previous generations. That might mean its relevance would progressively shift from a necessary, binding financial settlement, to being more of a symbolic gesture of heritage and appreciation.

On the other hand, as India’s middle classes grow wealthier, and should some financial assets continue to look precarious, then the demand for gold in the Indian sub-continent could conceivably improve, as a new generation of investors look to defend what wealth they have accumulated. Above all, Indian buyers of gold – whether for marriage gifts or long-term investment - will need a period of diminished price volatility, so that they can be more certain of what they will be able to pass on to generations yet to come.”

swami_000.jpg

“Hello? Yes, buy me 50 shares of Tata and cancel my wheat options…”

Have a pleasant weekend, everyone.

Jon Nadler
Senior Analyst
Kitco Bullion Dealers Montreal

 

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Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Kitco Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.