Friday, November 13, 2009

More Good News For Gold

Until recently, Gold and Silver have been all but ignored.  One reason, undoubtedly, has been the inflation/deflation debate.  Another has been the experience of 2008, in which a supposed safe haven got walloped along with everything else but cash.  Some folks just plainly don't understand the reason Gold has value.  I think it was John Maynard Keynes who called it a "barbarous relic".

Things are changing.  Gold bottomed last November, months before the overall market and has outperformed it ever since. In February, companies began to access the capital markets and liquify their balance sheets.  But the most recent refinacing, American Barrick (ABX) has been the most telling. 

Gold companies break down in several ways: explorers, miners, majors, intermediates, and juniors. In additon, dozens of micro cap companies trade on the Toronto Venture Exchange. Another VERY important distinction is whether a particular miner hedges future output by preselling at the prevailing fixed price.
Hedgers want to "lock in" a certain price upon delivery to avoid selling at a loss.

Barrick and many other of the majors are hedgers.  The impact of hedging is that as key mining costs such as energy rise, which they inevitably do, the price realized stays fixed and the company's contracts do not keep up with the appreciating asset. This scenario can create large losses.

Barrick is a major,  meaning big. In fact, as measured in market capitalization, Barrick is currently the largest. The company also mines and explores.  Other majors, such as Anglo Gold also hedge.  Last quarter alone, Barrick took a "charge" of nearly $6Billion against earnings as the result of losses on hedges.

Barrick has decided, after the rise in Gold price, that it needed to buyback their hedges. In order to achieve the buybacks, Barrick recently raised approximately $5Billion in  debt and equity offerings.  It's my bet, that other hedgers will, or are in the process of,doing the same. With sovereign nations turning to buying as opposed to selling, this sets up greater odds for a rapid spike up in price.

A second development, mostly unnoticed, is the creation of a new exchange traded fund, or ETF's as they're known, to purchase smaller cap miners. It will hold a basket of approximately 30 juniors and smaller intermediates - giving investors yet another way to participate in the smaller up and coming companies.  ETFs trade like a stock, but they are also similar to a mutual fund. They're advantages are a lower cost to operate because the holdings are mostly fixed and don't require active management. ETFs also save the less-informed investor who doesn't have the inclination to pick individual stocks and wants instant diversification.

The GDXJ, which is the symbol of the new ETF, started trading today and will create a new source of demand for gold related companies. Because it holds smaller companies, this indicates a growing appetite to take risk in this sector.

One could argue, and many do, that this represents the sign of a top.  However, mining shares publicly traded in Gold and Silver companies  are worth less combined than Microsoft.  Rather than the sign of a top, this strikes me as the sign of growing demand in a very small sector. It wouldn't take much new money to drive these stocks substantially higher.

Finally, gold supply is on the decline. Output has been declining since 2000 on a world wide basis and the quality of recent finds have been less "rich".  I don't doubt that higher prices will begin to incentivize companies to continue to explore, but most of the "low hanging fruit" has been picked. Therefore, the scramble to acquire physical Gold and Silver and quality companies is likely to accelerate.

Marko's Take


  1. This is a very good analysis, Marko. I especially like the explanation of ETFs. Is GDXJ a recommend, in your opinion?!
    There is a lot of buzz about gold now since it's over $1K and climbing with not a lot of informed information being offered in the MSM.
    Keep up the clear headed work. It's refreshing and helpful in this uncertain time.

  2. Thanks Holly....I believe we are directly in the face on another bubble that will make people rich.


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