Australian Gold Sector – Cash balances surging and likely dividends strong. Cycle low BUY

Key Points

Macro issues

I am RINGING THE BELL!!! to buy gold stocks in this Super Cycle low over the next month or so!!  Value is here and goodness knows when the actual low will be achieved but this is STRONG BUY time.  Will stocks pre-empt the lows in gold itself or will gold drag them up?

Whatever the gold price does from here it is clear that the past year has been an outstanding one for Australian gold producers with FY15 gold output up 14% for the 22 companies in the Paradigm Universe of Gold Stocks (`PUGS’).  Cashflows are up strongly.  The total balance sheet cash level is up about 50% to >A$1,800m and debt is generally down but A$600m for Evolution’s acquisitions have otherwise pushed this up to A$1,800m.

The industry has also made significant progress with cost reduction and the PUGS’s unweighted average AISC (All In Sustainable Cost) structure is about 10% lower at A$1070/oz. For PUGS the current price of around A$1500 gives a margin of about A$425/oz x 5.0moz and over A$2,000m in pretax operating earnings.

The weaker US$/A$ rate has boosted A$ gold prices so that A$1400-1500/oz looks sustainable to base forecasts on.

Investors should know that prices of stocks are supposed to be all about earnings, dividends and NPVs of cashflows so rising numbers here should support much higher stock prices ahead.

The PUGS stocks are now showing particularly attractive EPS, dividend yields and NPVs.  And mine life extensions through recent resource increases. What is there not to like about the better gold stocks on ASX?

Of course Dawes Points has been saying this for some time and the November 2014 lows will probably prove to be the bottom in the bear market for gold stocks here on ASX.  But this bottoming process will be anything but clear and understandable for a few months yet because of market crosscurrents and universal pessimism.

Have a close look at this PUGS matrix.  Lots to like.  Low PERs, cash building and production growth.  And growing dividends.

Look at the global figures in the PUGS for the various price levels.

Look at the global figures in the PUGS for the various price levels.

The market place remains very volatile but the Paradigm Dec 2014 portfolio (17 stocks from PUGS) is still up 34.7% for the unweighted portfolio and 44.4% for the weighted portfolio against the XGD which is up 23.5%.

Have a look at the performance of ASX gold stocks.  The low was in November last year.

Look at where we have been. A real rollercoaster but there is a strong pattern here that suggests new highs are coming.

Don’t forget that gold stocks fell 80% against the A$ gold price from the April 2011 highs to the bottom in Nov 2014.  And so now they are cheaper than when gold was US$250/oz in 1999-2001.

Market share of gross turnover is also bottoming for gold stocks.  PERs and dividend yields are changing this.  The numbers for some gold stocks are now far superior to most bank stocks (which we don’t own and which have also fallen almost 20% from their 2015 highs).

The operational aspects are coming together again and Australian gold production growth is resuming.

Source:BREE Paradigm Sec

I was on CNBC recently talking about why the recent fall in gold prices have offered a buying opportunity for investors.

The bear market in gold stocks in North America however has continued and the indices there have made new lows in 2015 below those of 2008’s GFC despite the gold price being 55% higher in US$ terms and now the latest sell off has taken them down to 2001 levels when gold was just US$250/oz. Go figure!  Of course higher costs from new low grade projects and too much debt there hasn’t helped.

But this weakness is Ringing the Bell to buy gold stocks in this quarter!  Buy this extraordinary value!!  Can you believe this sentiment indicator?  Zero percent bullish for market sentiment in gold stocks!!

As bad as in the 2008 GFC and the thump in April 2013. Everyone has sold.  Value is created, bulls have capitulated and sold out and the short sellers need to buy back.  It can only go one way from here and that is up.  Note the misery can extend for a few months before turning up again so it might not turn immediately.  So just add to those positions in our favourites over the next month.

US Gold Miners Bullish % Index

North America has certainly ended any love affair with gold stocks.

The market sentiment is poor here in Australia but it must be just awful there.  Bullish gold Investment participants are almost non-existent and the short positions in gold futures taken up by small speculators and hedge funds has been at near-record levels.

EFT gold holdings have barely changed at around 680-700t in the past year so it is not these investors adding to selling pressure.

And then we had that 700,000oz of gold that just had to be sold in 30 seconds.  It certainly knocked the market but then a very large fund or central bank would find a US$billion or so just chump change and had no fiduciary duty to get the best price (or even the daily VWAP!!) for the client.  Yeah, right.

The negative commentary is still being unceasingly pumped out so the signalling of a massive short covering is quite near.

This last fall in the US gold indices is almost final capitulation but the fall has been so sharp towards the 2000 lows that there may need to be even more panic and bloodletting there before the short covering begins.

Can you believe that this index is down so much despite so much new capacity added and even the royalty companies Royal Gold and Franco Nevada have been beaten down.  Have costs risen and debt expanded so much that this index has lost US$800/oz operating margin?

And the Unhedged Gold Index without copper producer Freeport has held up better.  Expect the 100 level to be the spring board for a long term bull market.

And the GDX large cap gold stock ETF is bottoming on massive volume.  Look closely.

Looking at the poor performances of the North American indices the conclusion is that the weakness is now assuming a parabolic decline that must soon end and should finally provide the low in this 4 year diabolical bear market.

Nevertheless it is a bottoming process underway out there and I am sure the upturn is now only a short time away but there is still sure to be a rocky road still in between.

Who knows, but buying when everyone is panic selling ensures value is at its best.

The underlying fundamentals of strong physical demand from India and China in that now well established flow of gold from West to East underpins everything so that much higher gold prices are certainly coming.

Asian demand with India and China the prime movers is very obvious from the available data and the combined demand vastly exceeds mine production.

And only modest mine supply growth is expected.

The weaknesses in Nth American gold stocks have been the most puzzling aspect and the reasons for this have eluded Dawes Points for some time but some answers are now becoming clearer to me.

Look at this.  The weakness of gold stocks against gold (down 85% since 2007) is just bizarre.

And against general equities, well, since 2011 it has been just diabolical.

Sure, Apple, Facebook and Google have done brilliantly but I had never thought of markets as selling gold and gold stocks to buy these companies.  Maybe they just have.

But I think I have finally found the ANSWER to this bizarre behaviour!!!

I am fully aware that, despite the strong currency related surge in PUGS and other resources stocks since the November 2014 lows, Dawes Points has clearly been on the `wrong side of the market’ in the Bull Case for commodities.

In Edition # 37 on 6 June I reviewed what had gone right and what had gone wrong.

The economies had done far better than the Bears had forecast, as had commodities, but resources stock price performances were awful.

Gold was very disappointing despite the China and India demand and physical metal strength.

Clearly the market was thinking of something else.

We all shouted ` Manipulation’ as the sharp falls in 2013 and even the very recent last 700,000oz and US$2.8bn 30 second sell off showed.

The Banksters and the scamsters and whatever else were to blame.  Of course!

But what if the Gold Bugs were right about everything but the rest of the market just didn’t care?

Gold has a sort of hedge against inflation status.  We would all agree there.  I would say it is a currency protection asset mostly but that is splitting hairs.

So if the world’s wealthiest economy doesn’t have any apparent inflation then you have much of the active market against you.  If this big market isn’t bullish and there is no inflation then gold is a BIG short sale opportunity.  `Let’s just fill in all those gold bug cult loonies with COMEX paper futures because we can’t lose!’   And so they have and they have been winning.   The short sellers probably can’t believe their luck in such an easy market.

The ANSWER to our misjudgement might just be here.

Have look at these graphics.  You have all heard of the John Williams Shadow Statistics that take the US CPI inputs from the 1980s and 1990s and apply them to today.   The graphics below show the US CPI is much higher than the official figures.  For the 1980s basis it is 7% today vs the reported 0%.

The cumulative of about 5%pa for over 20 years is horrific.

Now the real impact is seen in official CPI numbers affecting COLAS (cost of living adjustments).  Low inflation means government entitlement schemes and pensions have lower outlays.

Low inflation means low government interest rates.

Social democrat governments believe they can run deficits forever and the bond markets will give them all that free money at miserly interest rates.

And of course this is fine until you `run out of Other People’s Money’ as Lady Thatcher so clearly described it.

And so here is the ANSWER and the basis of the BIG CON.

Global bond markets have recently peaked after more than 30 years of Bull Market.

US 10 Year bonds peaked in July 2012 but the 30 Year T Bond peaked in 2015.  European, UK and Japanese bonds peaked with insane ultra low yields in the June Half of 2015.  Dawes Points has highlighted these moves over the past six months.

How could such low rates have been achieved?  Because the markets believed there was no inflation.

Why do we still have 2.1% yields on 10 Year US T Notes and 2.8% on 30 Year US T Bonds?

Because the big players believe there is no inflation.

How can the US Fed have 0% Fed Funds rate?

Because the big players believe there is no inflation.

Why are gold shares and gold being beaten up in Nth America?

Because the big players believe there is no inflation.

So we can point out all the pro gold facts and figures but the general market and the big players believe there is no inflation.

Dawes Points had failed to grasp this and has clearly been on the `wrong side of the market’.

So being on the wrong side of the market is a sentiment issue.

But what does misreported inflation really mean?

Economists have shown that technology has boosted productivity immensely and that declining TV and computer prices at a time of rapidly improving functionality and processing speed has cut the cost of living substantially.  Never mind that road use tolls are rising at 4-6%pa, medical bills are rising, rents and housing are up and bananas are costing more this year.  Most stock markets are up.

The qualitative gains in motor vehicles’ many technologies, HD TV and super fast computers unfortunately are only used by the same bodies, the same pair of eyeballs and the same typing hands.  For a highly productive individual this can be wonderful but for many a 9-5 clockwatcher keeping up to date with complex systems and manuals diffuses the gains.

The cost reductions in the CPI are probably illusory even if they are not politically motivated.  How can you really measure the true value of cost reduction when the operator’s wages are flat or rising?

So sometime soon the questions are going to be asked, when bond prices are really falling, about what is the actual true inflation rate.  Answers are likely to be unconvincing and it will likely accelerate bond price weakness in skittish markets.

Again, what does misreported inflation really mean?

Firstly, impoverishment of pensioners and most workers as rising taxes everywhere and rising true costs cut disposable income and purchasing power.

Secondly, vast misallocation of resources into public sector bureaucracies and services that are funded by mispriced borrowings.  Most programmes would never have been funded if borrowing costs were 2% over Shadow Stats’ 7% current CPI.

Thirdly, consumer activity is subdued because real net wages are too low to boost consumption and new capacity investment by companies is discouraged.  Wages relative to corporate profits have been squeezed.

It has been a GREAT BIG CON that politicians have flaunted as expenditures have soared and as government debts have ballooned.

The peaking of the global bond markets now will help to show that the party is now over.

So coming back to gold and commodities.

The `Right side of the market’ has been to sell gold because there has been no apparent inflation.

The peaking of the global bond markets is heralding a change to which side is going to be the `Right Side’.

The facts are clearly there.  The sentiment just needs to change.

If we look at many commodities we can see that supply deficits are developing. Copper, gold, zinc, nickel, lead, aluminium are all in deficits now.  Iron ore has seen about 60mt in inventory drawdown throughout the supply chain.  Oil is in oversupply but China demand was up 800,000bopd in the June Half of 2015. India and ASEAN up too.  Iran has 50mmbbl of stored oil in embargoed VLCC tankers in the Gulf that are now slipping out into the markets.  Is this already priced in?

Market sentiment in the general Materials Sector is horrific! As pessimistic as in the depths of the 2008 GFC.  For what and for why?  China?  US economy? Europe?  ISIS?


Why would this be happening?

Because the big players believe there is no inflation.

All the conventional wisdom spiel says slowing world growth.  China slowing yet oil consumption was up 7.3% yoy in June Half 2015.  China Personal Disposable Income is up 11%pa. India is accelerating to >10%pa.  ASEAN is growing better than forecast.  Just sentiment.

This graphic is perhaps the kernel of the whole matter.  June 2015 had the second highest ever figure for crude steel production in China.  How many times have you heard China is slowing/has crashed/is dying and that steel production is falling and raw material demand has dropped?  Iron ore imports surges 13.8% in 2014 when we were told demand had fallen. Imports will be over 900mt in 2015 and probably a new record. Steel output growth should still see 900mtpa in the next few years.  Laughable really.

The Baltic Freight Index has been used as a pawn in recent years but I think vessel supply/demand is coming closer to balance again for dry cargoes.

Crude oil storage pushed up the prices for VLCCs but with the Iran blockade ending those rates should fall again as vessels are freed up.

The entire global picture is also showing inflation in stock and property prices.

Now look at US Housing Starts.  They are not falling over and they need to pick up to at least 1.5m units pa to match population growth plus a back log.  The Philadelphia Housing Stocks Index says the same thing. Property prices are rising.

But the CPI is not reflecting this.

I have also been intrigued by this graph for quite a few years. Velocity of circulation of M2 money supply.  This has been downtrending for almost 20 years despite all the QE activity.

My assessment has been that the FED had provided liquidity to the major US money centre banks who just sold off some bad loans back to the FED and put the rest into US treasury bonds.  No funds were lent out at all.  With the US economy looking better we might see more capital being lent and then this indicator might turn upwards.

The rate of change has been negative since 2010 but the rate has been reducing.  Maybe it will turn positive in the next year.   Of course, a higher FED Funds Rate would provide higher bank margins and encourage bank lending. I can’t see the US economy turning down given all this data.

Dawes Points has often highlighted the resources sector highs of 2007 and the now 8 years of bear market following.  The April 2011 gold equity sector highs have clearly now been shown to be a false breakout and one that that did not even provide new highs when the US$ gold bullion price later peaked at US$1923 in September 2011.

Market sentiment has just been poor.

As I review all the equity, commodity and bond markets that I know I keep coming back to the conclusion that

I remain convinced of the long term inflationary affects to be generated from easy money conditions will begin to become obvious, probably in 2016, and the demand for gold will continue to grow and prices will rise for quite some years to come.

I remain convinced of the long term inflationary affects to be generated from easy money conditions will begin to become obvious, probably in 2016, and the demand for gold will continue to grow and prices will rise for quite some years to come.

Also you should be noting some of the recent explosive moves by exploration companies as discoveries are announced.  This is not the sign of a bear market.

A few months ago I included a graphic (probably too small print size) from an Avi Gilburt who was on the `right side of the market’ and has done well from the short side.

He considers we are now close to the bottom in gold and gold stocks and so I will attempt to again reproduce his graphic.

You might recall my attempts at Elliot Wave analysis for the ASX Gold Index with Wave 1 starting in 1999-2001 and peaking in 2007/08 then the GFC providing A with the surge into April 2011 being a `False Rally’ B wave.  The `C wave’ has lasted over 4 years but it is now completing to finish Wave 2 which leads to Wave 3 which is  the Optimism leg.

Note that the strong B Wave in 2011 is an indication that gold really does has strong underlying fundamentals and the Wave 3 should also be very strong and enduring.

Avi Gilburt has a 300% target gain for the US gold stock HUI index by 2019 and then 10 year bull market to provide a 24x higher target around 2030.  Apologies for the amateur drawing on Avi’s graphic.

Not too different from my expectations.

And finally the A$ tends to follow gold and gold stocks.

Barry Dawes


9 August 2015

Edition #39

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