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USAGX’s Denbow: Gold In Middle Of Key Price Points for Producers

By Allen Sykora Kitco News
Wednesday September 3, 2014 12:00 PM

(Kitco News) - The next big move by gold could have significant ramifications for mining companies, since current prices are in the middle of where many are simply “doing OK” or are generating meaningful cash flow, said the manager of a major gold mutual fund.

After trading near $1,325 roughly a week into August, the yellow metal has put in daily lows below $1,265 each day so far this week. As of 11:50 a.m. EDT Wednesday, Comex December gold was trading at $1,268.20 an ounce.

“The difference between their profitability from $1,250 to $1,300 gold is quite significant,” said Dan Denbow, assistant vice president of equity portfolios at USAA Investments and manager of the $1 billion USAA Precious Metals and Minerals Fund (USAGX). “We’re kind of on the cusp of real cash flow blossoming for these companies. At $1,250, they are doing OK and are at survival rates. But if you get to $1,300…they really start generating cash flow. You get to where that profitability really starts to kick in.

“I think that number is really important for the gold companies.”

A decline below $1,250 could lead to lower output by some producers, he said. It could also mean junior mining companies could become “capital starved” if they are unable to find projects capable of attracting investment capital.

“Unless they have a project that is worthy of being financed, it’s going to be hard to see many projects moving forward,” he said. “I think investors are going to be much more selective on the types of projects they will allow the companies to finance and move forward.”

The performance of mining equities may well hinge on gold prices. But, Denbow said, many companies also took necessary steps to help their shares.

“Mining equities have had a good year, as they’ve proven out they can survive in this environment,” Denbow said. “They…are cutting costs, and they’ve reduced capital expenditures on projects that are marginal at best. As they’ve done that, investors have become more interested. We’ve seen demand come from other places – not just your traditional gold funds.”

Abatement Of ETF Selling Enables Range-Bound Gold To Stabilize

One major factor that has worked in gold’s favor has been the abatement of the huge exchange-traded-fund selling from last year, Denbow said.

 “Other than July, we’ve seen pretty good inflows into the gold ETFs,” he said. “So that has been supporting the market, whereas last year we had 900 (metric) tons overall come out from the gold ETFs, which is essentially (equivalent to) a 30% increase in mine supply. We’re not fighting through that pressure.”

Gold ETF shares trade like a stock but are backed by metal put into storage. That means gold is taken off of the open market when investors are buying into ETFs, but gold is getting dumped on the market during times of liquidation – which is no longer occurring at a frenetic pace as when the price was selling off last year.

“Even though China’s economy is a little slower and demand over there has been a little slower, we’re able to absorb that (ETF outflows) in the market….All we really needed to stabilize it (gold) was just to have the selling to stop,” Denbow said. “That (2013 ETF outflow) was just incremental gold on the market that had to find a home.”

A few years ago when gold was steadily rising, many investors were probably using gold ETFs to chase prices higher. Many probably were more heavily allocated into gold than they normally would, Denbow continued.

“Therefore, the ETFs were where the selling was,” he said. “We seem to be at a more stable allocation among most of the fund managers. Therefore, unless there is another reason to shift down their allocation to gold, the demand should remain stable.”

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Denbow said gold is still in a trading range as the market focuses on geopolitical events and expectations for Federal Reserve monetary policy. He sees more range-trading in the next few months.

“It continues to look for a catalyst. I’d say it’s in a trading range from $1,250 to $1,350,” he said. “It’s caught in a battle between Janet and the geopolitical.”

More specifically, the market is focused on expectations for future monetary policy from Federal Reserve Chair Janet Yellen and other voting members of the Federal Open Market Committee, and expectations for eventual tightening have held back gold. Conversely, geopolitical events such as the Russia-Ukraine crisis and violence in the Middle East have been supportive for gold.

Worries about the eventual start of rate hikes could continue to weigh down gold. But there could be a catalyst for fresh buying if there are more geopolitical events or there should be a “hiccup” in the improving U.S. economic data, Denbow said.

Looking out a year or two, he sees potential for gold to rise again. In particular, he sees the global debasement of currencies as supportive.

“Everybody is in a race for zero for their currency, trying to support demand for their goods and services,” Denbow said. “That is going to remain out there for an extended period of time. So that should be good for gold prices.”

When asked if there might be some aspect of the gold market that is underappreciated or not understood by the general public, Denbow listed gold’s role as a currency.

“For example, last year Turkey purchased gold to buy oil from Iran because they weren’t allowed to use dollars or something else because of the embargo against Iran,” Denbow said. “I think that points to how gold functions as a currency in a global market. I think it will continue to have a place as that going forward as a facilitator of transactions globally, maybe when some other reserve currencies are coming under pressure.”

Silver Prices Could Catch Up With Gold

Denbow said he sees a potential opportunity in silver since the price is weaker than its historical norm when compared to gold.

The gold/silver ratio currently stands around 66 to 1, he pointed out. This is the number of ounces of silver it takes to buy an ounce of gold. Historically, Denbow said, the ratio tends to be closer to 55 or 60 to 1.

As the U.S. economy improves, industrial demand for silver should pick up, which would be significant since this accounts for roughly half of silver demand to begin with, Denbow pointed out.

“And they are finding new uses for it,” he said. “I’m not saying it is going to go crazy. But I do think there is an opportunity for it to close that ratio, and therefore a place for investors to maybe do better than they might do in just a strictly gold investment.” 

By Allen Sykora of Kitco News; asykora@kitco.com



Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals 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 Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.
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