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V-Bottom in place – New highs coming!

by Barry Dawes

Key Points

  • US$ gold rebounds to US$1400/oz
  • V- bottom in for gold stocks
  • Bull market resuming for gold and gold stocks
  • Commodities following gold
  • Change in government in Australia to boost resources stocks
  • ARE YOU ON BOARD!!
  • Contact Paradigm if you are not. bdawes@psec.com.au
The past two years have been such an extraordinary time of weak sentiment towards gold and commodities despite the very clear underlying fundamentals that are finally coming into daylight.  Economic data and commodity prices are confirming what was obvious all along. The major decline from the April 2011 highs in most things commodity and resources stocks has so often shouted irrationality that you really do wonder what drives markets and how can the majority of investors (particularly large investors) be so superficial in their analysis. The 77% fall in ASX gold stocks (XGD), 70% fall in Small Resources (XSR) and the 55% fall in the major indices like XMM from those April 2011 highs defy rational belief.  Especially given that gold and commodity prices in A$ were as just good as those in April 2011. It is hard to imagine that such a major capitulation low occurred just because of sentiment rather than a collapse in demand, a major recession or a systemic disaster.  But it has. And as Dawes Points of 13 August noted, apart from a few minor hiccups, most gold producers and developers are doing just fine.   The pause certainly cleaned out some overpriced services, materials and labour so everyone will be better prepared next time. The gold price has probably bottomed, and again as noted previously in the 8 July edition, the extremes experienced in the gold shares and their relativities to gold, NPVs, PERs and to general shares have probably provided the enduring evidence that the low is in. And if the low is in for this correction then the bull market will be continuing and that will mean new highs!!  And probably a multi year bull market with much higher prices. If the low is in for gold then, my word, what is in store for gold shares!! Let’s go through the usual graphics here. We need to start from the basic premise that gold is international and so are better quality gold shares. So let’s begin with the Philadelphia Gold Index XAU and the gold shares ETFs GDX and GDXJ for the juniors and mid caps. XAU had a 64% fall from April 2011 into the June low and has had a 35% rally. GDX had a 66% fall and a 35% rally GDXJ had a 79% fall and a 59% rally The gold share ETF (GDX) matches the stocks in the XAU Index so should be the same but the GDX Juniors did an ASX:XGD performance (we were down 77%!) too but has since rallied 59%.  XGD is only up 48%!! Yes, the XGD was blown backwards to 2002 levels.  All that exploration, development, resources, infrastructure and mines are now free in today’s prices.
And the embattled and dispirited Canadians with their more diverse TSX-V Index (CDNX) were down 50% and are just starting a rally that is showing the signs of the first extended accumulation base since the highs in 2007. The sector relativities such as XAU vs gold and XAU vs S&P 500 are now very important to follow because they gave the greatest extremes. XAU is now stabilizing against gold so should begin a major outperformance against gold bullion over the next 3-4 years. So with the ratio now at 0.80 and hopefully moving back up to around 0.15 within the next four years would mean the XAU would be 210 or 88% higher at today’s gold price. With a gold price at US$1600 in four years the XAU would be 240 or 114% higher. If XAU traded at the long term ratio of 0.25 then at today’s gold price it would be 350 or 213% higher.  This table gives values for XAU and gains at a range of gold and ratios. I would suggest 0.25 will be seen again and that gold will be over US$2,000 as well. That would be XAU at 500 and a 346% gain. These sorts of gains are well supported in the Eric de Groote long term S&P Gold Shares graphic going back to 1922 (sorry but this graphic is now a little out of date).  The 2013 pull back came down to the 1922 uptrend (who would have thought of a decline of that magnitude would occur!) and XAU should now rally back to around 160, consolidate and then it should move up very strongly. This next graphic shows the long term outperformance by the XAU against the S&P500.  The 11 year outperformance to 2011 was 600% and 16%pa cgr until the 2011-2013 sell off.   This graphic suggest a rally back to about 0.15, which would be over 100%. At Paradigm we do the Think Global, Act Local stuff so the global picture strongly suggests higher gold and gold shares and the global funds will be back here chasing local stock so you should get in early and before them. The stocks to choose are the leaders mentioned last time (NCM, RRL,BDR, KCN, PIR, SBM and SLR) but the really high performances will come from the small plays.  You will need to contact me (bdawes@psec.com.au) for those as they are volatile and time sensitive and besides, those recommendations are just for account clients! I come back to my hobby horse of the ongoing discussion on Participation in the markets. The falls in the resources share markets in 2008 and over 2011-13 can only be explained by market sentiment.  Sure 2008 was a bit special and more recently Europe is a bit wobbly still (but growing) and the US is OK but not great but China is still proving the doomsayers wrong and Africa, MENA and Sth America are doing well.  Certainly not bad enough to pull down resources stocks >70%.   Just sentiment really. And continuing poor sentiment has kept large (and small) investors out of the market.  Market turnovers confirm this. I still can ask audiences at presentations whether they have held gold shares or even, shock horror, if they hold any gold.  The response is invariably muted and only a few even admit to holding either.  So lots of new buyers. So the volatility is the key feature of these thinly traded markets on the way up and on the way down. Hence resources stocks will not be properly valued and will remain volatile until the market has more participants. But I now think that this participation is going to start very soon.  In earnest. I have generally refrained from commenting on politics but with the election underway and a high probability that we will say good bye to the ALP for a very long time, I think Australia is about to enter into a truly Golden Age. I have continuously reviewed the Federal Budget and have graphed Receipts and Expenditures for some years now.  The picture has not been pretty and the waste and incompetence has been breathtaking. Expenditures rose from A$250bnpa under Costello’s last budget to almost A$400bnpa today under the ALP.  You may well ask what we got for it.  The answer would have to be `not much!’ The deficits are between the lines, red above blue. In contrast to Costello’s surpluses of blue above red. Taxation receipts have climbed, mainly through personal income tax, but company taxes have been flat since 2008. Resumption of the resources boom will help that and economy-wide company investment and manning plans will quickly be dusted off under a government that isn’t driven by ideologues and union hacks.  And expenditures will be readily cut to weed out waste. So come 9 September there will be changes. Overseas investors will also see the changes and with the abandonment of the MRRT and the Carbon Dioxide Tax, Australia’s Sovereign Risk ranking will recover.  So watch this space! The Think Global gold price will be looking better and the Act Local action will start to really pick up after an extended buyers strike. Australia has over A$1,500 billion(yes billion!) in bank deposits sitting by whilst its resources industry has massively increased its capacity in iron ore, coal, petroleum and LNG. Much of this was financed by retained earnings and offshore debt and equity. The local commentariat has universally hailed that the new supply would crash prices and that world demand would fall away.  China’s Asian Century was being studied by the minute for clues whether growth would be +/- 0.1% of targets.  All the history of China’s remarkably successful Five Year Plans that carefully set out directions, pathways and goals was tossed aside in trying to find that tiny issue that would prove China was about to collapse and iron ore with it. The commentariat (most have not even been to China) ignored the inputs from the mining industry executives who repeatedly confirmed increasing demand for their products.  The comment on 8 August from the ABC’s 7:30 Report is typical.  In response to BHP new CEO Andrew MacKenzie's advice that the Resources Boom was still in train and that demand for commodities could possibly be 75% higher in the next 15 years, the comment was ` that is obviously a different view to what we’re hearing from the Government at the moment with them saying that the resource boom is basically over’.  Entrenched ignorant Groupthink.   And have you seen Rudd’s advertisements saying the boom is over! No wonder the more thoughtful economic commentators trashed the two recent economic statements as being lazy and inconsistent.  My own observation after detailed analysis of those statements was that many of the forecast numbers had just been made up.  Just look at the MRRT numbers!  And how much the two statements varied.  No idea. So the view that the bull market for gold and commodities was over has been well entrenched and a global hell hole was beckoning.  And hence the build up into a massive mountain of bank deposits.  The build up is seen in term deposits of course but look also at chequing accounts, savings deposits and building societies. Over A$1,500,000 million in total.  And of this, A$723,000 million in deposits of all kinds by households! And Australia deserted the non-Tier 1 players in its resources industry by starving it of capital.   Where are our hundreds of fund managers cashing in on the resources boom and funding the projects? Those that are playing with our A$1,500bn in superannuation funds. So much money chasing so few targets.  If I hear another investor say that a particular project has to be ignored because won’t be able to get funding ……… And recall the swipes taken at resources sector management for adding to capacity when the markets still needed the products.  Look at the prices of most important commodities such as iron ore US$140/t, oil US107/bbl, copper US$3.35/lb and gold US$1,400/oz.    These gold producers will be soon making so much money it will be embarrassing.  And of course the commentariat will soon be wanting more output because of the obvious shortages. Newcrest with its vast gold resource base will become the market darling again. So the concept of the V- bottom is alive and well and it is likely to be matched on the upswing as it was on the down. And finally, to those A$ bears, just have a look at this. Taking a long term view it is clear that the A$ has broken a 90year downtrend against the US$. Some backing and filling of course, and long term trends aren’t exactly precise now that we don’t have a gold standard, but break out then retracement back to support is normal. And the driver of the A$/US$ is global commodity investor-related as this graphic shows. The A$/US and the XAU (Philadelphia Gold Index) have a lot in common. The V bottom in the gold sector should bring this back into line and be pushing the A$ higher. A strong currency forces public spending cuts, forces improved productivity, forces down inflation, forces down interest rates and makes Australians wealthier.

Low in Gold and Gold Stocks

by Barry Dawes
Key Points:
  • Demand for physical gold continues strongly.
  • June End of Financial Year Sale provided great bargains.
  • Gold Index up 32% from low but still down 69% from highs.
  • "V" bottom likely to have been established in June.
  • Seasonal activity likely to give outstanding short term.
Well, the irrational End of the World for the Australian Gold Sector (ASX XGD) ended itself on 27 June 2013 in the End of Financial Year Sale frenzy. Note this date.  It will probably be like 21 January 1980 when gold peaked at US$887/oz and may be like 23 September 2012 when gold hit US$1923 but certainly like the 24 Oct 2008 XGD low in the GFC at 2674. The 77% fall in the XGD from 8499 on 11 April 2011 to 1984 on 27 June 2013 was in just over 26 months.  And the A$ gold price extreme low on 27 June 2013 was A$1293* - just 8% lower at this XGD low than the A$1397* at the XGD high.  (* Note volatile intraday movements and can be at variance to these numbers from data services figures.) It is now at A$1446 and 3% higher than in April 2011. The XGD has risen 32% from the June lows but is still down 69% from those highs. Of course it was just bad management by the mining companies and they obviously did not deserve the previous rating.  More of that later. But really, experience in markets strongly suggests the extremes referred to in Dawes Points of 8 July 2013 provide good evidence that a major low is in place and V bottom is likely to eventuate.  Expect some rapid acceleration soon. In previous Dawes Points reference has been made to this Corrections graphic that had shown the typical bull market corrections of ~25%. After each correction the XGD rallied and went on to make new highs.  Reference was also made to the 63% fall by XGD into the GFC lows in October 2008 and the subsequent rally that took the XGD up 218% to new all time highs again in just 30 months.  Reference, too, was made to that after the completion of this last extraordinary fall (77% lower over 26 months - but who knew when and at what level it was going to stop over that period!!) that the XGD would again make new alltime highs within just a few years.   Nothing has changed to alter this view! If gold is still in a bull market then it is yet to make its highs.  Commodity markets tend to have considerable volatility and usually end in some spectacular blowoff phase.  Gold has some very special emotional characteristics and the debt issue is still with us and with the immense volumes of liquidity that have been pumped into the global financial system it would be strange to think that it is all over.  So expect a very much higher gold price in the years ahead.  And greatly higher prices for good gold shares!   If XGD did rise to new highs as I expect then the XGD would have risen 325% from the lows. The rally from the 27 June low has been 32% to date.  The EOFY Sale was a wonderful low entry for those with some cash. Up 32% for XGD, up 100% for SAR, 75% for MML, up 73% for  EVN, 60% for NST, 56% for BDR,  and even 35% for NCM. Gold itself looks very robust and seems to be beginning that strong short cover rally. To me, this says the first downtrend has been broken, gold has come back and supported on that first downtrend line, is testing the new downtrend and today has surged upward to US$1345. Targets are US$1350, US$1400, US$1420, US$1470 and then US$1600. After that it will be new highs. These chart targets are useful and help piece together the puzzle of whatever the outlook is for resources markets around the world.  It is all connected, we just need to work out how. Fundamental analysis rarely seems to work nowadays and it seems that there is too much loose capital sloshing around that has provided volatile market actions that defy logic and therefore unsettle investors and cause their withdrawal from markets. Fundamental analysis of supply and demand (record physical demand, large obvious short positions, record sovereign debt etc, little growth in mine supply, concerns over who actually has the gold etc) and the reasons for buying or selling gold (household hoarding, central bank buying etc) seem to have had little impact over the past couple of years since the Sept 2011 highs so it is necessary to just view the market performance.   And the market performance says Bull Market! In Japanese Yen terms Gold made new highs in April 2013, almost 18 months after the highs in US$ gold in Sept 2011.  That is a Bull Market in the world’s third largest economy. Coming back to the issue of strong demand for physical gold, recent data has confirmed earlier indications that China has overtaken India as the largest demand bloc for gold and together their combined absorption has been over 3000tpa in 2013.  Shanghai gold deliveries of 708t in June Half 2013 were 54% higher than in 2012. Mine production is just 2700 tonnes. It would not be irresponsible to suggest that the physical market for gold is now really tightening up and the shenanigans being played by hedge funds and bullion and investment banks may just be coming to an end. These graphs of total and registered gold in warehouses at COMEX tell one story. but  there might  be more to it than that  as this next graphic shows. COMEX inventories certainly rise and fall with the gold price but it is where the gold is going now that matters.  Falling COMEX inventories at a time of lower gold prices suggests to me that investors are taking delivery here and limiting access to players in the futures markets. If it is being shipped off to Asia for sale at a US$20/oz premium or minted into coin and bar also at a premium then it is saying that freely available gold is likely to be drying up.  Gold has also had recent periods of backwardation when future month prices are below spot.  As gold is currency, it almost HAS to be in contango to reflect its interest-rate related carrying costs. This means gold supply is very tight. 170,000t of gold is sitting above ground and is of course always available for sale at any time but the character of the gold market is strongly suggesting that apart from the Roladex market manipulation of last April (that appears to have been aimed at spooking late entry holders of the gold ETFs to sell their gold back to the shorts) no one really wants to sell their physical gold anymore. The matter of fiat currencies with their bonds at grossly inflated values will be coming home to roost over the next decade so expect higher interest rates (although still probably negative real rates) to run for decades from the recent lows.  And it will be the capital flows from bonds that will drive funds into equities and hard assets like property, art and antiques and also into commodities as people strive to keep up purchasing power of accumulated wealth.  This is certainly happening. The rise in gold and bond yields does not need to be negative for the economy overall but there will certainly be winners and losers.  As pointed out earlier, bond yields (interest rates) rose for 39 years after the last cyclical low in 1942 and it was only 1974/75 and 1982 that experienced major dislocations. There is much more debt of course but floating currencies since 1971 have a wonderful way of easing some of the imbalances.  Indications of just how currencies will perform over the next decade might become much clearer by end 2013. In recent presentations I have discussed my fascination in Google and Facebook as major business platforms in the revolutionary new global economy.  Not Social Media for teens and twenty somethings to exchange photos and idle chit-chat but as platforms that will deliver dramatic improvements in productivity and global enterprise especially in marketing of services and products.   Ignore these major platforms at your peril. Back here in Australia, the 27 June 2013 low took the XGD back to the levels of 2003 and undid a decade of exploration, discovery, resource estimation, reserve proving, establishment of mines and building of plants.  Many A$ billions spent and then discounted and ignored. Who would have thought it possible? So the June 2013 low is a very important low. The issue of participation comes back yet again.  If Australia had a more effective capital market with more participants active in the resources stocks then the volatility would not have been so great.  A hundred money managers with a hundred different views would be enough to stabilise the resource market.  Not just a dozen or so playing in the bigger stocks.   The concentration of shareholdings in small and midcaps by directors, executives, workers and suppliers (mostly in WA) was probably the most unfortunate issue.  Cutbacks to non essential capex, exploration, operations and mining and engineering services would have affected many so the rush for liquidity by mining sector participants would have been substantial but was not matched by a largely cashed up market eager to seek the bargains.  At least until after July 1. The mining industry had certainly experienced a boom as shown by capex, exploration data and wages growth.  The Australian mining industry has had great cost increases as it pushed on with developments and dragged in tens of thousands of new workers.  ABS data shows that over 200,000 people were employed in the mining and oil and gas industries at June 2012.   Average weekly earnings in the Mining Sector were A$2426 as of Nov 2012, 66% high than the average for all workers. Coming back to Australian gold stocks it could be argued that great expectations had been built into gold stocks prices into 2011 after the GFC sell off and gold's subsequent strong rise.  A sense of discovery, resource upgrades and new plants was dominant and a renaissance in the role of independent producers was developing beyond the North American giants who now dominate the Australian Gold Production scene after the great asset sell off in the 1990s.  Heady days.  Many new entrants who hadn't built or run a mine previously or players from big companies that didn't quite get the small company imperatives of cash and survival meant that many things were not done quite right.  And of course the suppliers to the mining industry had a field day with gouging everywhere. The past couple of years in a bear market may have provided the wringing out of expectations but in doing so has re-established value.  Reports from the miners express the view that pricing on so much from drilling, mining contracting, geotechnicians and mining wages have been brought back sharply and often by more than 20%.  Many recent graduates have been put off after the mad scrambling of the 2010-2012 rush and more sober expectations have been re established.  But while the demand for inputs to new projects will continue to rise the project managers will be more experienced and will overlay reality on expectations.  We hope. Rises in operating and capital costs had gone too far but lower grades and rising diesel costs can only mean a higher cost base has  been established and that gold mining globally needs much higher gold prices.  And I think they are coming.  US$2000/oz is now needed for marginal and frontier new mines.  Financiers will probably demand it for major new projects. Back to the stocks and I am very impressed with the drive for new discoveries in Australia and particularly beyond the immediate Yilgarn Achaean Greenstone Belts in WA centred on Kalgoorlie. This region is by far Australia's biggest gold producer but its highly fractured and altered rocks aren't always readily mineable and so it can be a high cost region.  The infrastructure, workforce and mining services bring about ease of operations that makes overall costs lower and very competitive. Discovery and development have brought Independence Group in its Anglo JV at Tropicana, Regis with its 10moz at Duketon, Gold Road with Central Bore, Breaker Resources has some early results at Dexter some others are looking in the outer reaches of the Yilgarn. Other important developments in WA provinces are Gascoyne in the Gascoyne, Northern Star in the Ashburton, Mutiny Gold's Deflector project around Gullewa and a few companies are sniffing around Telfer and the Musgraves and there is ABM Mining in the Tanami.  Signature Gold is looking for Intrusion Related Gold Systems(IRGS), a relatively new exploration target concept,  in Qld. New South Wales is stealthfully creeping up and efforts returning to the alluvial goldfields of the 1850-70s has come up with some major resources and mines.  Newcrest's Cadia Valley with 24moz reserves from a resource base of over 130moz produces over 400kozpa rising to as much as 800kozpa for 2017.   The Peak Gold mine at Cobar produces 100kozpa with a resource of 800koz.  Lake Cowal is still looking good for a few more years yet. Special mention needs to be made of the remarkable Mt Adrah discovery by Sovereign since its acquisition of Gossan Hill Gold.   1000m of continuous mineralisation could indicating something a lot more than the current 3-4 moz targets.  This is another IRGS deposit and I think we will be hearing a lot more about this deposit style. The performance of the XGD falling 77% from its high would ordinarily expect devastation to have fallen over the sector.  Lower gold prices and mine closures etc etc. Well what actually did happen? Of the 38 stocks in the XGD only a few companies had real problems while another handful had to make adjustments.  Focus Minerals being a high cost producer has suspended some operations, Tanami Gold suspended Coyote to reappraise operating procedures, Newcrest had a few minor issues with Gosowong temporary low grades and with Telfer being a difficult and high cost mine, Silverlake had some acquisition teething issues and Alacer was  having problems with its WA high cost mines.  Perseus had mill problems at its Sissingue mine but Edikan was OK.  Kingsgate restructured ops at Challenger. The lower gold price caused many boards to play it safe and write down values of recent acquisition or the market values of listed stock held at 30 June.  The Newcrest A$5.8bn was most obvious but the net effect for it would be to have no impact on cashflow, tax or debt positions but would reduce amortisation charges and increase net earnings.  Alacer made writedowns on its Australian operations and has put them on the market. Oceanagold and Kingsgate made operations write downs whilst NST, RSG and ALK wrote down carrying values of investment in listed companies. Many companies have prudently cut costs and deferred capital in the manner described above as reality is allowed back into input pricing.  The issues relating to industry wide acceptance of total all up costs is certainly forcing the reality and the market should expect a more determined industry to do things better. The bottom line though is, as the table below shows, almost all companies produced in line with expectations, and other than the obvious of reducing revenues and operating cashflows the impact was minimal.   A$ gold prices averaged around A$1600 for about 18 months to end 2012 and probably A$1440 so far in 2013.   The 10% reduction in A$ gold prices should not have had the overall impact of a 77% fall in the XGD. (click here to open the below table in a separate window) Most of these companies should therefore recover and many look very good. The leaders will lead (NCM, RRL, BDR, KCN, NST, PIR, SBM and SLR) and the rest will follow.  Some will do very well.  The smaller stocks will also have their turn and should provide exceptional performances. The US$ gold price is moving up and the End of Financial Year Sale prices are quickly receding! Get aboard 13 August 2013

Resources Boom Resuming

by Barry Dawes
Key Points
  • Bond yields bottoming
  • US$ rally failing?
  • Equity markets renewed upswing
  • Gold bull market resuming?
  • Oil prices break 2008 downtrend
  • Outstanding value in resources and resources small caps
Believe it or not this graphic is still on track!  Look at the evidence. The past two years have provided some major volatility in most markets and it would be fair to observe that high volatility is often present at major turning points.  Something of a truism but you have to ask which market is living the turning point?  It is not always what you think. In my experience of watching markets I have noticed that there is often a fair degree of interconnectivity between markets but that needs to be qualified by noting that the interconnectivity is often not what you expect and is often between markets that you don’t always follow. The market to watch today is that of the global bond markets.  Outside of currencies, bonds (debt) are the world’s largest market and can be categorised simply into government bonds (from US Treasuries to the lowliest municipal bond) paying for expenditures that economies can’t immediately pay for and the corporate bond market where companies trade off their capital requirements between debt and equity. The bonds are much bigger than equities so changes to this market, and the capital flows to and from, can have exaggerated impact on other markets.  The results aren’t always what you might expect. My understanding of bonds is that the largest holders are pension funds and insurance funds that have long term liabilities so can match income and return of capital at maturity with the actuarial requirements of retirement members or life expectancy.  Central banks also hold each other’s bonds. It has been interesting to note the strong demand for bonds in recent times with investors seeking to ensure income during weak economic periods and to observe how bond prices have been bid up so high and how yields have fallen. My recollection of some published work a couple of years ago by economist and commentator Don Stammer showed that Australia had one of the largest per capita pension fund systems and one that had strong commitment to equity through shares and property (roughly 70%) and relatively low levels in fixed income and cash (The numbers for Australia were A$1,400bn at 30 June 2012 with the default portfolio having 51% stocks, 10% property and 15% fixed income plus another ~9% cash.  The gross figures must be now closer to A$1,600bn after A$100bnpa inflow and +5% returns).  Very many other countries had no established organised pension systems and many that did had an extremely high proportion of bonds and cash with very little equity. This long term bond yield history below has been a sort of road map for me but the past seven years has been anything but a clear guide. This Yield History for a composite of 20 years and 30 years (from 1977) maturity US Treasury Bonds covers what should be an entire cycle of about 70 years since the previous isolated verifiable low in yields in 1942 and asserting that the most recent low in July 2012 was indeed the next major cyclical low. This chart has very significant ramifications if this analysis is correct. Note first the time frame.   39 years of rising bond yields (i.e., 39 years of bear market in bonds) to 1981.  Then 31 years of falling bond yields (i.e., 31 years bull market in bonds) to 2012. The graphic covers the periods of Inflation (1965-1980) with rising yields, Disinflation (1980-2008) with falling yields and Reflation (2009- ?)- where money supply growth has been large but inflation underreported - which are defined here for illustrative purposes as rising prices, falling prices and rising prices again respectively.   The only period of deflation identifiable in the markets by methodology used here was from 1996 and into Dec Qtr 1998 which turns out to be the beginning of the current commodity bull market.  You can observe the co-ordinated sell offs in all things commodity (A$, C$, Oil, copper, gold, coking coal) and a strong rally in US TBonds because of …of…of ……well, no reason I could find at the time or even today).  Check out levels of LME inventories, metals consumption and A$ trade figures over this period.   Now just when has that happened before?   Surely not just now? So coming back to T Bond prices the chart is suggesting that a change is now underway.  The recent weakness in bonds has brought capital losses of 8-15% within just a very short time. The bull run in bond prices is clearly very mature and the Euphoria period may have been in mid 2012 and has just passed by.  This market is probably in the final `buy the dip’ period for one last rally before the market begins to unwind that 30 year uptrend and provides perhaps another 30 or so years of rising bond yields.  But note that now commentators in the US are talking about the Great Rotation out of bonds and into equities. It is obvious that central banks and governments have intervened in these markets and have brought short term interest rates down which have forced longer term yields down as well.  Purchases  of bonds out along the yield curve has helped to bring down rates. The concentration of so much capital into this asset class is now probably quite dangerous. The other aspect of the bond market is that of the underlying currency because government bonds are essentially currency with an interest rate coupon.  With the peaking of bond prices and rising of yields some might consider that higher interest rates will attract more capital and so will push up the currency.   Unfortunately history does not have much confidence in such considerations.  The US$ Index here might lure some into thinking that a dollar rally is underway but it just might not turn out that way.  These long term channels typically have strong long term technical influence. History has generally shown that a weaker currency needs higher yields to keep it from falling further.  And equity markets tend to rise with falling currencies to maintain international value.  Let’s just watch these markets very carefully over the next few months. So after this review of the roadmap that had been so helpful until about five years ago (when someone not only removed the signposts but the road as well!) it is now likely that the road has been found again and the signposts are visible and clear. In presentations in 2011 and 2012 the theme was `follow the money’.  Very large cash levels had been built up around the world by those with income and assets and by the very large injections of funds to support the world’s banking system.  In Australia these funds as measured by RBA’s Total bank deposits and Household bank deposits of A$1,500bn and A$723bn respectively are very large compared to Australia’s GDP (~A$1400bn) so are not likely to keep growing there for too much longer.  Australia could have a sort of Great Rotation of its own.  From cash to equities. This graphic from the brilliant `In Gold We Trust’ annual publication from Ronald Stoeferle of Incrementum shows total global financial assets at US$233,000bn with bonds at 53% (around US$123,000bn) and 43% greater than the equities.  The US has US$17,000bn in T Notes alone plus municipal bonds and corporate bonds. So when this bond market does decide that the best is behind it the flow of funds will become very interesting.  The holders of municipal bonds in Detroit may be feeling uncomfortable and may now be considering to become part of the general exodus from the fixed income assets classes. And could it be that these funds through this Great Rotation are already flowing into equities as evidenced by the all time highs in US and some other equity markets? The performance of the small caps in the US has been impressive and offers and alternative view to the conventional wisdom of the rise in equities is driven by yield. The strength of technology through NASDAQ and strong market breadth through the Wilshire 5000 would suggest earnings and asset growth. So this brings the discussion to resources. If the interest rate cycle is turning as the evidence suggests, the likelihood is that gold is still in a bull market is very strong. Previous Dawes Points have highlighted the strong demand for physical gold from China and India (subject to recent import duties legislation that attempts to halt the inflow of gold that is upsetting India’s current account) alone in the June Half of 2013 has been greater than global mine production.  This is no big deal given that total gold stocks of about 170,000tonnes dwarf 2700tpa mine supply but physical demand of 1400t from Asia more than offset 500t sales from gold ETFs. The last Dawes Points on gold highlighted extremes in relatives of gold stocks against gold and gold stocks against general stocks and recent market action in gold and gold stocks suggests an important low has been achieved.  And today gold is above US$1315. What is also encouraging is GDX (note volume) and the $CDNX showing the first life in a year and a market pattern that strongly suggests a rally is now underway. Now this is all very nice but look at some other things. Like oil.  Downtrend from 2008 highs broken. And like iron ore.  All the bears on iron ore and forecasts of sub $100/t - where are you now?  The comment in the May Dawes Points that maybe a new high in iron ore prices was coming might not be so silly after all. At these times it is always useful to recall one of he many quotes sourced to funds manager Sir John Templeton (1908-1998???) Bull markets:
  • Born in Pessimism..
  • Grow on Scepticism..
  • Mature on Optimism.. and..
  • Die in Euphoria
This quote clearly related to the moods of the markets and investor sentiment and turning these observations into market performance we can get •          Wave 1  Disbelief .. –         Little interest..false dawn.. value unappreciated •          Wave 2  Pessimism  •           - Told you so...end of the world •          Wave 3 Optimism  –         Increased participation.....climbing wall of worry •          Wave 4 Opportunity –         Market values known...soft markets say buy the dip •          Wave 5 Euphoria –         Taxi driver tips and wacky market action...overleverage This graphic was developed and has been included in many of my presentations since presented at Mines and Money in November  2008 at the bottom of the GFC for resources and at a time when market actions, price falls and abandonment of value made no sense.  Much like now for that matter! Note that this graphic is only for the Resources Sector so it may be out of sync with other non-resource markets. An idealised graphic of course but let’s look at it in reality. First let’s look at it in terms of commodities… Looks good there. We have already seen oil and iron ore above.   So how about copper?  Yes, it still looks OK. And amongst the stocks, Exxon-Mobil and other major oil companies are even leading this market whilst the Non-ferrous Metals are like copper and lagging a little. And the All Ordinaries is looking the same!! So much for the bigger indices and stocks but what about the Australian Resources Sector? Well for ASX Metals and Mining (XMM) it still fits OK. The Wave position still looks good. Even after the past year of misery. But for small resources  (ASX XSR) there has been a slight detour with a rally of Hope turning down into a fall of Despair. And for the ASX Gold XGD it was even worse, DESPAIR IN CAPITALS. So what is the conclusion. For me the peaking in the bond market really means that the days of low interest rates and bond yields are coming to an end (may be one more cut in Australia) and that probably means the US$ will be weakening again.  So if the flow of funds model is correct then the flow into equities will continue for quite some time yet. How to play it? Well, BHP and the leaders first and a strong commitment to oil and gas as described last week.  Then the second liners but given this extraordinary time of savagely discounted small caps everyone should be looking at the penny dreadfuls with reasonable cash levels.  These lesser stocks include operating mines with gold, copper, diamonds, iron ore, coal or a range of other commodities as well as oil and gas producers.  Then there are numerous opportunities in uranium, rare earths, fertilisers, tin, unconventional oil and gas, coal, iron ore, silver, technology metals and the industrial metals.  The list goes on. Certainly most of these companies are short of cash but Australia will soon have its own Great Rotation out of its cash stash into the capital-starved development sectors.   And keep in mind that the record shows over A$800m was raised by MPS during the Disbelief stage with some outstanding results before the GFC in Dec Half 2008. Fortunes are being offered to the astute.

Energy Sector Ready to Surge

by Barry Dawes
Energy Outlook
  • Oil price surges above US$100 breaking 2008 downtrend
  • Oil and gas stocks cheap and ready to rally
  • Global economic expansion continuing with energy demand accelerating
  • Peak Oil issues continuing to emerge
  • Australian onshore exploration boom continuing
  • Four ASX Oil and Gas stocks reviewed
The continuing pre-occupation in the Australian share markets with all things negative seems to be at odds with activity in the real world. Resources sector equities here have been declining since the post GFC rally that peaked in April 2011.  April 2011 was a very important time because it was then that markets began to feel nervous about the economic outlook again.  And 26 months later in late June 2013 we achieved some `extreme’ levels in price, relativities and sentiment. The ASX Gold Index (XGD) dropped a remarkable 77% from that April 2011 into these June lows while the A$ gold price today is almost unchanged at A$1400 compared to A$1409 at the April 2011 highs.  For some reason the direction of gold (or lack of it) resulted in the stocks being smashed with the market place being terrified of the sector. This has happened while demand for physical gold is at a record high. And mining generally is being hit despite firm demand for most metals and a typically low level of LME inventories (other than aluminium and maybe nickel).  Iron ore exports seem to be still making record shipments and the iron ore price at US$128 STILL hasn't collapsed.  Of course it is China, or Europe or the US or Egypt or something that is doing this and making the market place groupthink just so negative. So the Minerals and Mining Index (XMM) fell down 52% from those April 2011 highs and the Small Resources has been slaughtered 70% too.  So many stocks are trading at less than 20% of their NPVs on conservative product pricing with the cry going out that "they will just never get the money".  Of course they won't while Australia sits on A$1484bn in bank deposits and Australia's wonderful compulsory Super Funds sit back with their own A$1500bn in assets that are studiously directed away from the very industries that provide the contributions. Anyway while all this has been happening we have seen something else that is quite remarkable.  Since its high of US$115/bbl in that famous April 2011 period the oil price had been going sideways and basing for another upmove.  It has now begun that upmove by rising above US$100 and breaking the downtrend from the June 2008 high.  Recall that oil rallied up from US$10/bbl in Dec Qtr 1998 to run in a major bull market than ran for almost 10 years to peak at about US$147.   The GFC brought oil crunching back and we heard the calls for oil to plunge down forever to below US$30/bbl.  Remember all that bearish talk when oil was rallying higher later in 2009?  The downtrend has been broken and it not just because of Egypt. The WTI price has climbed to remove the discount it had against Brent prices.  The discount had reflected transport bottlenecks in the US around the new tight oil fields.    Unblocking of the bottlenecks together with more oil being sent into the North Atlantic resulted in the removal of both the discount for WTI and the premium for Brent. What has been also remarkable has been the performance of the US oil majors, Exxon Mobil (XOM), Chevron (CVX) and Conoco-Philips (COP) over this period.  Year after year new rally highs and for XOM and CVX, new all-time highs.   No recession/deflation/China falling over here. The GFC was a yawn. And also just look at the performance of the Exploration and Production (E&P) companies through the XOP Index.  These E&P companies had their own April 2011 moment and the obligatory rapid 40% sell off but are now within 4% of that high and probably about to move sharply higher. So coming back to the remarkable stuff, most will recall my ad nauseumrepetition of Non-OECD energy demand being now greater than that for the OECD and that must mean a strong growth rate in the >50% sector will result in an acceleration of total energy demand.  And that is what we have. The details of the energy mix can be debated but with oil still making up around 33% of the world's primary energy sources and, being the largest single fuel, it is very important.  Particularly for transportation.  And China will have more transportation requirements as its car and truck fleet grows, as its mining sector still grows and as agriculture still grows.  So more oil is required.  Catching up to the US will still take some time. The Peak Oil concept is still with us and most traditional oil producers in the Middle East, Indonesia, Russia, UK, Norway and Mexico are well down on their peaks.  The US is well down too but it is having a renaissance with tight oil but it is unlikely to get back to the previous highs.  The new oilfields in Africa and Sth America are helping and China is increasing output too but overall the trend is a decline for traditional conventional oil despite the growing global reserve base.  Maintaining 90 million bbls per day from current fields is hard and growing it is even harder. Natural Gas Liquids from LNG production is helping meet the 90MMbopd and LNG itself has become a very big business with around 230mtpa being shipped and expectations of about 40% higher at 340mtpa by 2020.  Australia will become the biggest exporter from a current 24mtpa from three WA operations to 60mtpa from seven WA operations (and possibly another 20mtpa from four more) and 13mtpa from the first train in each of three Gladstone plants and double that with each running a second train.   So it could be 90-100mtpa by 2020. Here in Australia these major LNG capacity expansions are probably most famous for their rising capital costs and on the East Coast for their land use conflicts but they will be important generators of export revenue and will deliver versatile gas to mostly Asian buyers. Whilst the West Coast offshore fields will feed specific LNG plants, over on the East Coast it is a matter of new LNG plants being fed initially from the dedicated coal seam methane and then from wherever it can be sourced. This development of an export market for much of the Australia’s underutilised or stranded gas reserves in Central and Eastern Australia is changing the focus upon oil and gas producers away from just the large players. Oil and gas exploration onshore Australia has been difficult for all but the major players as the exploration risk has been high (although it is reasonable in global terms), infrastructure limited and markets for gas even more limited. This opportunity for a larger export markets for gas has totally changed the field economics by justifying new pipelines and thereby offering stranded gas more attractive terms for development. At the same time the onshore hydrocarbon boom is moving strongly with Australia’s own form of unconventional gas and liquids. The Oil and Gas Sector on the ASX has well underperformed its US counterpart so that the local rush-for- liquidity disease overwhelmed the oil price and operating fundamentals.  And the fundamentals should reassert themselves over the next twelve months. It is clear that market leaders Woodside (WPL), Santos (STO) and OilSearch (OSH) are looking good and are well into the LNG business in Australia and PNG but these significant second liners, being Beach (BPT), Drillsearch (DLS) and Senex (SXY), are developing oil and gas businesses from the Cooper Basin that should also include expansion of gas production from unconventional shale gas and tight sandstone gas. Buru (BRU) with a market cap of over A$450m from its Canning Basin operations is a good fourth member of this second liner group. All seven of these look well placed to be given good reratings with higher oil prices. This graphic gives a good breakdown of the activity underway in eastern Australia with major resource potential identified across several basins with the Cooper Basin well positioned to supply local and international markets.. Amongst the second liners the real action is here in the Cooper Basin where principally Beach, Drillsearch and Senex are re evaluating the hydrocarbon potential.   Several newly recognised reservoirs have been identified as exploration has moved beyond conventional structural traps (caused by folding and other tectonic action) that previously had provided about 95% of all discoveries in the Cooper to stratigraphic (trapped by the sediments) and unconventional targets of Basin Centred Gas Accumulations and tight sandstone gas reservoirs.  New nomenclature of oil fields in the Western Flank and tight and other unconventional gas in the Gas Fairways has been adopted. Low 3D seismic coverage (just ~20%), low well densities and low fraccing applications reinforce the Basin's exploration immaturity.  Beach even points out the immaturity of exploration in the Western Flank of the Cooper by showing that the latest discoveries are the largest found to date. Numerous discoveries in what is termed the Western Flank oil fairway are significantly increasing reserves and production as 3D seismic is giving high exploration success rates.  The new Bauer/Lycium pipeline connecting Western Flank oil flows to Moomba is already exceeding its 10,000bopd name plate capacity and the Bauer field could become much larger.  The key to these fields is the high operating margin of over A$80/bbl. I cannot help but thinking this is a rerun of Santos and the Cooper Basin partners in 1979 when at BT Australia we had at least 5% (might have been 10%!!) of Santos at a price of about A$1.10 before it went to an equivalent of A$40/share as the gas fields expanded, the first oil from the Eromanga Basin overlying the Cooper was developed and the Liquids Project was completed by 1981.  Elsewhere in Sth Australia Linc Energy’s Arckaringa Basin permits may also be providing a major unconventional hydrocarbon source with risked shale oil prospective resources of 3.5 billion barrels. Northern Territory has some good potential with the Beetaloo and Georgina Basins attracting strong international interest.  The numbers here could be very large indeed. In WA it is the Canning Basin with Buru Energy’s Ungani field coming into production with large additional regional potential.  The Perth Basin also is adding to the activity with NWE looking attractive. Other areas are emerging and will add considerably to market interest as this boom continues. Overall, it is important that investors appreciate the scale of these resources and that the tenements are massive in comparison to those one square mile sections (640acres) in North America and junior companies can still own over 50% and be funded by some of the world’s largest hydrocarbon companies.  In previous oil booms 5 million barrels was a lot of oil for a small company.  This time we have companies with large prospective gas resources where each 1 TCF is equivalent to 180 million barrels. Take a close look at these. Beach Petroleum Beach is a Cooper Basin-focussed company producing over 8MMboe through 4MMbopa oil and 25PJpa of gas.  2P reserves are over 90MMboe whilst combined 2P and 2C are over 550MMboe.  Resource upgrades are due in the Dec Half of 2013.  BPT is in the Sth Australian Cooper Basin (SACB) JV (20.2% - STO 66.6% and Origin 13.19%) and SW Qld (SWQ) JV(20-40%) which owns the older Cooper Basin oil and gas fields and the Moomba and Ballera gas treatment facilities and also pipeline facilities including the Moomba-Port Bonython oil pipeline. BPT is also in the Western Flank with DLS, SXY and Cooper Energy (COE). In addition it has interests in onshore unconventional plays in the Otway and Bonaparte Basins as well as strategic plays in Africa and Egypt. BPT has made a very large commitment to the Cooper and to unconventional hydrocarbons with the expectation of delivering additional reserves to meet expected domestic demand and a very large increase from the East Coast LNG projects. Chevron joined BPT in PEL218 (BPT 100%) and ATP855 (BPT 60%) (in Qld) to earn 60% in BPT's interests and assist in the development of the extensive unconventional potential in  a US$350m programme that included cash payments to BPT of US$160m.   Extensive testing to date through a number of wells has proved potential thickness of 1000m of gas charged sediments in the Permian of the Basin.  Confirmation of a large resource here would be very important to the East Coast LNG plants. BPT’s JVs with DLS, SXY and COE cover extensive areas with developing fields on the Western Flank.  The recent Bauer discovery in PEL 91 amongst others has highlighted a very prospective fairway on the Western Flank.  JVs are PEL 104 and 111 with SXY (40% to BPT), PEL 91 with DLS (40%), PELs 106B and 107 (50%), PEL 92 with COE (75%).  Exploration/development well numbers are increasing as are reserves and production. All fields are benefitting from 3D seismic and other new technologies. Senex Energy SXY has a diversified asset base with a major asset portfolio in the Cooper Basin (14 operating fields) and CSG tenements in Qld.   The company has been very active with resource upgrades, extensive 3D seismic surveys and a Cooper Basin exploration/development programme of 30 wells.  Oil production exceeded 1.2MMbblo in FY13. SXY has major tenement interests along the under-explored Western Flank and in the deeper unconventional gas fairway in the Permian sediments. SXY has upgraded its 2P oil reserves to 10.8MMbbl and 3P to 21MMbbl from its Western Flank fields PEL 104 and 111 with BPT (60% to SXY). SXY also recently announced major contingent resource upgrades to 5.5TCF from recent analysis and interpretation of gas exploration results in the gas fairways in the Cooper. The resources included 2.4TCF 3C (396MMboe) of tight gas from the stratigraphic Hornet field that flowed 2.2MMCFD,   2.1TCF 3C from Sasanof in tight sands in the Patchawarra and Murteree formations and 1.1TCF from the CSG at Paning.   Associated gas liquids are also expected in some cases. The Qld CSG reserves of over 300Pj net to SXY will feed into the BG Gladstone LNG plant and as these are non-core assets SXY expects to monetise them in the near future. SXY may like to join its Cooper Basin peers by admitting a larger JV partner to accelerate activity. Drillsearch DLS is Cooper Basin focussed where it has 22 permits and operates 14 with 2P reserves of 18MMboe and growing production currently around 2.5MMboepa.   Prospective recoverable unconventional gas resources are as much as 32TCF.   DLS has BG Group as an 8.5% shareholder and 60% JV partner in its unconventional projects. Exploration is increasing with focus on 3D seismic acquisition and growth in reserves and production. The company has three business units of Oil, Wet Gas and Unconventional. DLS's Oil Business is well represented in the Western Flank in SA with PEL 91(DLS 60%) and PEL 106B and 107 (DLS 50%) and also in the Inland-Cook Oil Fair way in SW Qld with growing production of over 6,000bopd.  DLS recently acquired a further 29% of the Tintaburra Block in SW Qld from Santos to take its interest to 40% and assumed operatorship. Oil prospective resources are 33MMbbl and a programme to double output to 3000bopd is underway. Wet Gas has two fields in production and several more to come online after recent discoveries and prospective resources are over 86MMboe. Unconventional resources cover shale gas (2C of 24TCF), tight sandstone gas (8TCF) as well as potential for CSG. BG has farmed into ATP940 for 60% by spending A$130m with DLS being carried for A$90m of the first A$100m expenditure.  BG is looking to use Cooper Basin gas to be delivered 1200km to feed a possible third train of 8.5mtpa of LNG. Buru Energy BRU is focussed in the Canning where it operates over 64km2 (16m acres) in a frontier basin area with multiple plays in proven oil and gas systems.  Mitsubishi entered into a JV with BRU in 2010 to earn up to 50% in unconventional hydrocarbon projects by spending up to A$150m of which over A$100m has been spent.  BRU had earlier entered into an agreement with Alcoa to supply gas to its alumina projects south of Perth from discoveries in the Canning Basin.   BRU currently has three Canning projects with Ungani, Laurel and Goldwyer/Acacia. The Ungani field discovery in dolomite reservoirs is part of a trend that has high quality conventional reservoirs and prolific source rocks providing over 150 prospects. The underlying Fitzroy Graben hosts the Laurel Formation which has extensive and continuous tight gas accumulations.  Additional shale oil and wet gas potential is recognised at Goldwyer and Acacia. Ungani expects to be in production at 5,000bopd in June Half 2014 from around 10-20MMbbl recoverable but potential for is recognised as drilling along trend has confirmed thick 40m oil columns and additional contingent resources. The Laurel Formation has been independently assessed at around 100TCF in a Basin Centred Gas System with 2 billion bbls liquids (47TCF and 1 billion bbls net to BRU) whilst the Goldwyer Shale has 7.2TCF and 4 billion bbls net to BRU.
These four companies offer some of the best opportunities for increased activity, rising reserves and resources and higher production.    At a time of rising oil prices and a lower A$ the revenues should be significantly higher.  A$ prices for Brent pricing is more than 11% higher than three months ago.
 
Qtr 31 Dec 2012 31 Mar 2013 30 June 2013 16 July 2013
US$/A$ 1.039 1.042 0.914 0.918
Brent 110.4 109.8 102.0 107.9
A$ oil price 106.2 105.4 111.6 117.6
Index in A$ 100 99 105 111
The onshore oil exploration boom is surely well underway and the share prices should soon better reflect these fundamentals and send these stock much higher to follow their North American brethren. It is also clear that the new unconventional oil and gas focussed companies are approaching important milestones in exploration, development and production. Expect a major rerating of these companies including Armour Energy (AJQ), NWE and Falcon Oil and Gas (AIM/TSX/Dublin). Other companies in the oil and gas business that look good are Cue (CUE), Horizon (HZN) and Petsec (PSA) which show outstanding value with large cash reserves, increasing production and exploration activity and LNG Ltd (LNG) that is utilising its LNG technology in much lower capital and operating cost LNG plants in Australia and the US.

End of 77%-off end of Financial Year Sale

by Barry Dawes
Get in quick- get 9 years of industry activity free!! Production, reserves, resources and exploration since 2004 all thrown in free. Nothing more to pay.  (Steak knives coming as well!)
Gold fundamentals still positive
  • Physical demand for gold still very strong
  • Available gold inventory declining
  • Extreme readings on all momentum and value indicators
  • ASX Gold Index trading value and volumes increasing
  • “V” bottom likely
The month of June 2013 in the future will be seen as a time of extremes.  Most of it extremely bad.  But the other side is that extremely good value has been created. Market Action charts The extreme fall of 76.7% in 26 months is a Crash all right, worse than 2008 and 1987, and right back to the 2004 levels but it is hard to see the reason for it.  Gold in A$ today is A$1377 which is just 2% lower than the A$1409 at the April 2011 XGD Gold Index market high.  Hardly extreme enough to warrant this selloff. Global equity markets are at or near all time highs and economic activity is still bubbling along steadily.  Bearish talk on the global banking system is still with us and the never ending reports on the collapse of China are still front page, so what are the key reasons?   And don’t tell me that gold is falling because of the Pollyanna global economy or that inflation is falling.  Just note too, that the oil price is through US$100 and breaking the 2008 downtrend as referred to in my last Dawes Points.  Egypt or not, this is not the sign of a deflationary environment at a time of accelerating global energy demand. The extremes are also notable in:
ASX XGD:A$ Gold ratio US XAU: Gold ratio US XAU: S&P 500 ratio
Extremes were also evident on the market sentiment levels with the whole world aggressively bearish on gold, major short positions in the COMEX gold futures and the lowest bullish consensus in this bull market’s history. Extremes were also seen in the investment patterns of Asian gold buyers and particularly from Chinese and Indian demand which showed physical delivery in the June Half of 2013 to be greater than global mine production over the same period.  The extremes continued in the US, Europe and Australia with mints working overtime to keep up with surging demand. This 28 June 2013 chart from Koos Jansen clearly shows the year to date delivery of gold from Shanghai Gold Exchange at 1044 tonnes was 80% of all world mined gold (~2700tpa) and with about another 800tpa from India the physical demand from these two countries alone is greater than annual mine production.   Reports still show strong demand for coin and bar in US, Europe and Australia and delays in delivery are being experienced everywhere. Image: Physical gold delivered on Shanghai Gold Exchange vs world mining production And inventories are drying up with COMEX warehouse gold down over 30% since end 2012.  The focus there is on JP Morgan which has had a disproportionate decline in its holdings as its clients have taken delivery. Comex Gold Inventories 62513 What are we to make of all this?   I can suggest that the market sentiment is just not right for a bear market to have happened nor to continue. Gold stocks in Australia (XGD) and North America (XAU) seem to be assuming a gold price under US$800/oz and that gold will stay down forever.   The XGD fell 76.7% to its low of 1984 and the XAU fell 64%.  XGD fell back to 10 year lows.   All of the efforts of the past 9 years have just evaporated. Yet gold is still US$1250.  Certainly it tripped under US$1200 for a moment and is now back up to US$1265.  Is US$1250 a good price for gold producers?  Ok for some, but new projects will need US$2000 to justify remote or difficult terrains. It seems that we investors in gold stocks have experienced the proverbial round trip in that the ASX Gold Index ran up 310% over 7 years from 2004 and as now given it all up in a 26 month debacle that brought the index down 76.7% to the lows there in late June . Gold company managers have received strong criticism from investors for cost overruns and technically affected projects and bear markets have that effect of providing no hiding place for problems in any operation.  So most companies are cost cutting, selling assets and deferring capex to optimize cashflows.  This will be beneficial for everyone, especially shareholders, in the future. The markets have declined but note the volume increases in XGD with both value and the number of transactions increasing.  This market is under accumulation.   Note that stale bull selling seems to also be increasing as the number of shares is rising but at lower prices.   The decline in average transaction value from A$20,000 to <A$3,000 also suggests not a lot of institutional interest yet. ASX Gold Index charts: Market turnover and Transaction sizes These 75% off lower prices must end very soon so you should take advantage of the opportunities.  It is hard to believe that entry prices will get any better. So what did we get for all that effort of the last 9 years? Looking at the 38 stocks in the ASX 300 Gold Index we find some interesting stuff. In 2004 only 8 of these 38 stocks currently in XGD were producers.  Today these 38 stocks include 21 producers and substantially higher aggregate resources, reserves and production. The whole Australian Gold Industry spent more than A$5bn in exploration in Australia over the next 9 years (ABS stats) from 2004 and probably >A$15bn (A$4.3bn in FY12) in mine capex.  It needs to be recognised that Australia’s large mines spent at large part of these funds but were sold off to North America and so are not in the XGD. So the round trip was all for nought. The collapse in the gold price from US$1400 to US$1200/oz seems to have made everything worthless.  The market assumes no one could be making money. It is strange that so many commentators are calling that the gold bull market must be over.  Despite all the physical gold demand from those Chinese and Indians who have recently been buying about 1300 tonnes per year and in the first half of 2013 at about 3000tpa rate that exceeds global mine production.  Despite all the public demand for coins and small gold bars. Despite the main reason for buying gold being continuing increase in fiat currency issue, continuing government budget deficits and growing government debt levels.  Some group is selling and it is not just from the North American ETFs.   Yes mine production has exploded to a ten year growth average rate of 0.7%pa to 2800t and all those central banks have stepped up selling such that this year is likely to be a net buying of about 400t and the highest in about 30 years. This is a huge increase in supply. Minus 400tpa. Yes all the key buyers who take up about 140% of annual mine supply have got it all wrong because the US investment banks and hedge funds just know better.  "There are 170,000 tonnes of gold out there in the market and we can sell it all at any time. We showed you what we can do.  We sold a year's mine supply (2800t) in an afternoon by just spinning our Rolodex!!  Yes and just as those 170,000 tonnes turn into 5.5bn oz of gold it shows that we have over US$7 trillion of fire power.    Yes, and we have US$17 trillion in bonds to protect so you guys can just sit back in fear." - major Investment Bank. "What's that?  You mean that just because we sold the gold futures contracts for gold we don't have and that because all the Chinese and Indians have given it out in 1 oz bars and as necklace jewellery to their families that we might not be able to buy it back?  No way!  You forgot that the ETFs have about 1000 tonnes of gold and we can buy it back from all these suckers!     Gotcha again!!" "So all you investors in gold stocks just better sell out now because you are going nowhere.  Oh, and by the way, if you wanted to sell your good stuff, but not the junky stuff, then I will help you by taking it off your hands right now. Just to help you out.  What are friends for.  No problem." Yes everyone, we have been conned. The proverbial price of everything and value of nothing has brought gold stocks to the level they were in 2004 when gold was US$400/oz. The issues are global. So let's look again at the relatives. Extremes here. In the XAU against gold it is at very long term lows and I have seen that it is the lowest level since the early 1970s.   The ratio is 70% lower than the average of the 25 years to just before the GFC in 2008.  And after outperforming the S&P 500 by 16%pa for 11 years until 2011 the XAU fell 72% against stocks. Long Term Relatives
XAU against Gold XAU against S&P 500
Same story in Australia for weekly closes.
Relative Action charts So what are we to do?  The banking system problems haven't gone away and central banks everywhere are printing money like tomorrow won't come.  Physical demand is going gangbusters and mine supply is finding it very hard to match last year's level.  Low prices below US$1300/oz will mean some players might just not make it.  Overall though, C1 cash operating costs might still be below US$1000 and a bit of tweaking to treat higher grades might help for a while but if gold stays down for too long there would be more mine closures. Share prices at 75% off the April 2011 highs are very attractive and should be tempting everyone to come back to add to positions. But the more important questions in this market surround who are the sellers and who might be the buyers? What has happened here in Australia?  It is clear from reviewing the Top 20 shareholdings of most Australian gold companies that individuals (usually management) are the largest shareholders and, outside of the top 15 gold stocks, any institutional investors are rare inside of the top 10. The major funds are simply not there.  In hindsight this is wonderful.  Few losses in the past two years of misery.  But also few gains on the way up to 2008. I come back again to my pet issues of participation in the market and market breadth.  My assessment is that few players are in these markets and few players mean low liquidity.  And low liquidity means poor competitive valuations.   Few players mean a buyer cannot readily get volume and of course few buyers mean a seller can only move price.   The biggest gold stocks achieved premium pricing but most small companies were just ignored and were given big pricing discounts. My years managing the resources portfolio at hyperactive BT Australia thirty years ago and the subsequent years as Head of Resources Research at Deutsche Bank followed by the same position at Macquarie Bank gave good experience and insights to investment at the highest levels.  But things are different today. Far from being the drivers in investment in the mining, petroleum and agricultural sectors, the institutional fund managers are risk averse and seemingly at odds with their roles of taking long term views to match their risk maturities. Australia in June 2012 had A$1400bn in superfunds.  Contributions have been around A$115bn pa (A$85bn from the private sector) and investment earnings since must have been around 5% so another A$70bn increase is likely.  After subtracting the mining sector losses (only in the SMSFs) we must be closer to A$1550bn today. Paul Keating must be so proud of this massive bulwark of investment assisting Australian companies grow and compete in the global marketplace and bringing joy and wealth to all Australians. The APRA data for 2012 tells it all for default portfolio structures for a large portion of its members:- The default portfolio for APRA funds (making up about 43% (67% in industry funds)  of APRA's A$917bn share of the A$1400bn) shows 28% of asset are in Australian equities and 9% in Fixed Income.  Then there is 23% in overseas equities.  Wonderful.  Diversification into Google, Deutsche Bank and LVHM.  Oh, and there is 5% in overseas Fixed Income securities.  Hmmm.  That makes 28% offshore.  And there is 9% in cash but SMSFs have been much higher.  Probably as bank deposits to allow lending to grow and expand the Australian economy.  And are the banks lending to anyone at present? Did anyone think that taking out A$85bn (6% of GDP) as the Super Guarantee Levy tax ( yes it is a tax  .. no ..no.. it is a supplement to wages.. a tradeoff against higher wages... those union boys have really helped their members) might be contractionary in the economy?  Impossible.  No, how could it.  Think of the productivity gains and trade offs. And the reinvestment into the economy.  Well just look at the numbers. All of just 38% goes back into the Australian real economy. Fantastic.  That other 62% A$52bn that does nothing for Australia or goes overseas. Unlike ordinary taxes that go the government and straight back into the economy.  And so we have the development sector of the Australian economy deprived of funds.  So little for resources, technology, agriculture and biotech. Coming back to participation in the markets, it has been my assessment that the 1998-2008 bull market in commodities was not well supported at an institutional funds management level.  The US$10/bbl to US$147 in crude oil was just a ten year bubble. As for copper or gold or whatever, just not attractive enough. Hence my description of the Disbelief upleg.  Pessimism followed Disbelief and boy did we get it in 2008.  End of  the world stuff.  And "I told you so."  So low Participation and so no-one knew values on the way up and of course no-one wanted to know them on the way down. But after this disaster the ASX Gold Index rallied and went to a new alltime high in April 2011.  This has always impressed me. So looking again to the 75% sell off that has brought us back to the levels of 2004 and bouncing off major extreme technical support.  How can we view this other than as an opportunity of extreme attractive value? And if we decide this is an extreme value low in what in my estimation is a major long term bull market in gold then really, as an entry point, it simply just doesn't get any better. Sir John Templeton was one of the great money managers of the 20th Century (he passed away in 2008 at 95) and amongst his many achievements he was known for his many quotable quotes. One of his best known was Bull markets are born in Pessimism, grow on Scepticism, mature on Optimism and die in Euphoria. Juggled around this can become the first leg is Disbelief, followed by Pessimism with Optimism leading Opportunity and finally closing with Euphoria. Our model here clearly confirms the Pessimism and the subsequent extreme decline into Despair but the fundamentals from my perception still point to a bull market in gold prices and expansion in gold production and earnings.  So we can only conclude that the 75%-off sale is finishing something and morphing to starting something.  That something should be something very big as the opportunity is now there for new investors as trustees of SMSFs to embrace a rising gold market together with a better appreciation of the skills of the managers of this sector.  This will provide the previously missing Participation by more players and also give Market Breadth as more companies are appreciated across the sectors.   That would blend together to underpin the Optimism Upleg I refer to. The last Dawes Points on gold gave us a performance table that was very sad.  Lots of >80 and >90% price falls.  I can only conclude that extremes everywhere are just making for extreme value and strong buy signals. But the opportunity is here and now.  The stocks to play are NCM, EVN, MML, SAR, RMS, PIR, OGC, NST  and BDR.

Gold Stocks End of Financial Year Sale – 65% Off!

by Barry Dawes
Key Points
  • Gold stocks 65% off April 2011 highs in End of Financial Year Sell Out
  • A$ Gold price 3% higher than April 2011
  • Tax loss selling period offers excellent entry point
  • Probable low in place in US$ gold prices
  • Major short covering rally likely
  • New highs still expected by 2016 giving notional 250% Index gains
The market place certainly has ganged up on gold and gold stocks these past couple of years and put them both to the sword.  "Barbaric relic" they say and, anyway, the gold mining sector is full of poor managers with third rate projects and a egotistical drive to spend money on more third rate projects or even, shock horror, exploration to increase resources.  Costs have risen out of control!  Lifestyle companies, so sack all the CEOs!  Stop spending shareholders money there and give us dividends.  Now!  Don't you know that the global equity markets are only running on dividend paying stocks because interest rates are staying at zero and investors need income! Well, all thirteen fund managers who still had gold stocks in their portfolios voiced their displeasure at the lack of earnings and dividends and the thousands who didn't cheered them along anyway.  And those wonderful investment banks joined in with an orchestrated bear raid on gold and gold stocks. Yep, they knocked down the gold sector stocks 57% in North America and 66% in Australia in just two years.  And the US$ gold price then was US$1480 so is down about 5% from the April 2011 levels whilst in A$ it is 4% higher at A$1460 compared to about A$1400.  Go figure! So gold stocks at today's prices are indeed at bargain basement prices – don’t miss out of the June Sales! Reviewing the long term history of the North American gold stocks (Philadelphia Gold Index "XAU") it can be seen that it certainly is volatile and the past sell off has a manic character about it.  Sort of hate the sector.  Get me out!  And let's short them because gold has no place in the low interest rate environment that is encouraging global growth. So this price history shows that the index is back to the levels of almost 30 years ago despite gold being almost 300% higher.  And the reasons behind gold being in a bull market are still there.  Haven't gone away and indeed are even stronger. The momentum indicators on this index are deeply oversold and a rally is due. The two major gold indices in North America (the "XAU" and the Gold Bugs Index("HUI"))   are showing strong signs of reversal after their two year 57% falls. Note the "gaps" in the break us from the lows.  Up 10.6% and 12.2% respectively from the May 20 lows. And the two important ETFs GDX (almost the XAU) and GDXJ (gold juniors) are showing similar signs of bottoming with the same gaps and expanding volumes and up 12.6% and 15.6% from the lows. And the actions of big two, Barrick Gold and Newmont, up 14.9% (up 20.8% from its April low) and 13.1% from the lows respectively showing strong performances as market leaders. Spare a thought for the TSX venture Exchange Index ("CDNX") where it with all its small cap resources and other sectors is down 61%.  But it seems to be bottoming and note the declining wedge being formed during the decline from April 2011.  A great deal of improvement is required in this index but a 16% upmove would trigger a very sharp rise and it has already rallied 5% from the lows. Here in Australia the story has been the same only worse and we all know that as Newcrest fell 66% many other XGD stocks fell even more.  And we have also watched in disbelief as a few of our more speculative plays had a 9 in front of their falls.   Ouch indeed!  But if they have cash they should survive and their assets will eventually be recognised again.  Be careful but don't despair. The 66% fall by the Gold Index has been savage but note carefully that every sell off in this bull market since 2000 has been followed by NEW HIGHS!!!  In considering the state of the gold market itself I still consider that we will again see all time highs in gold stocks over the next couple of years. The performance of gold equities against gold is even more extraordinary.  After spending over 20 years trading about 0.25 against Gold (left chart), gold stocks are now just 0.07   - less than a third of what they were.  The issue of PE ratios and dividend yield are different matters but the PERs are now almost single digit compared to 40s and 50s in the 1990s. The picture is similar here in Australia.  After significantly outperforming both equities and gold itself we find gold stocks have fallen a long way.  Where was the gold boom? So now let's look at gold itself. You have all been told that gold is dead along with inflation and that 2% yields on 10 year US Treasury Bonds and 3% on 30 year Treasuries are the places to be.  Just don't worry about there being US$17 trillion of them and plenty more where they came from! It is hard to pass by the obvious that the Treasury Bonds are being defended by US investments banks loaded up to eyeballs in these bonds and funded by the US Fed's ultra low short term rates.   Sort of 1-2% “risk free” income and geared 100%.  Borrow short from the Fed at 0% and lend long at 2%.  Fine while rates stay steady and low.  Wildly leveraged when bond yields rise and bond prices fall. Imagine the capital losses on 2% 10 year bonds should yields be forced to 2.5%.  Try 5-8%.  And 100% geared.  Goodbye banks' balance sheets.   From the lows of 1.4% in July 2012 for 10 year Notes to Friday's 2.16%.  From a price of 135 to 129.88 is a 3.8% capital loss and about 2.6% net of income loss.  On a million that is OK but on 10 billion that is 260 million. How many 100 billion did these banks buy?  But of course it is US Government guaranteed!! How about on the 30 Year Treasury Bond? Down 8.1% from 153 in July 2102 to 140.6 on Friday.  Corresponding yield rise from 2.40% to 3.30% on Friday. Net capital loss over 5% in 10 months.   On 100 billion of bonds that is US$5bn mark to market loss.  So with a US$17 trillion bond market at risk it is worth having a $US150bn crack at selling 100m oz of gold as was carried out over two days in April this year.  Yields on 10 year Treasuries fell from 2.1% to 1.6% in a successful but short term move over all of three weeks.  Now back up to 2.16%.  So it didn't work.   Will have to buy the gold back. Gold bugs were heartened when the response in the physical market was so strong.  USA, Europe, Hong Kong, China, Middle East and India could not believe their luck.  Demand for physical gold went up strongly.  As gold is money (a currency really) here was free money.  What were they thinking? This cartoon explains it so well.  Thank you Merk Investments.      Junk currency for gold bars. What were they thinking?  It is easy to see who will win. The World Gold Council showed that March Qtr 2013 was very active.  Demand from China was strong at 110t and well above previous quarters.  Coin and bar demand was 12% higher at 378t and central banks acquired a further 109t.  Total gold demand was 19% lower than Dec Qtr due to the outflow of ETF holdings by a large 177t.  Bloomberg reported that China’s imports through Hong Kong in March alone was a record 223t, more than double that of a month earlier.  And this was all before the April sell down that has set off the very strong demand around the world for gold at discounted prices. We are also told that gold's 2009 uptrend in US$ has been broken and the US$ is king again.  Well maybe. The short term from 2009 was certainly broken in US$ but the seven year uptrend is still intact and markets are significantly oversold. But gold in so many other currencies has held the uptrends and in the case of Japan actually made a new high in March 2013.  The 2005 uptrend has broken in Swiss Francs but new monthly closing highs in 2012 were seen in both the Swiss Franc and the Euro but not in US$ after the September 2011 high so gold still has strength in these currencies. And two rather interesting histories of commitment of traders show record short positions in place (data from 2006) (courtesy of Tyler Durden)… … and a long term very low short position held by commercial users and producers(lowest since the GFC in 2008/09). Thank you Dennis Gartman.  Could be particularly unlucky for some holding those short positions. The market will do what it will do and we are just onlookers in these savage war games between buyers and sellers. Here in the Australian market we can view the XGD and its fall from grace from the April 2011 highs.  From the day of the high at 8499 on 11 April 2011 we have had the following performances.  There are certainly some bargain basement stocks out there.
Max close Date of Price Change
Ticker: (A$) Price Max 03-Jun-13 (%)
XGD 8,436 11-Apr-11 3,018 -64.2%
RRL 5.87 03-Oct-12 4.11 -30.0%
BDR 1.12 03-Dec-12 0.71 -36.3%
NGF 0.27 09-Aug-12 0.17 -38.9%
OGC 3.65 01-Jan-11 1.96 -46.3%
NST 1.57 27-Nov-12 0.80 -49.2%
MOY 0.04 17-Jan-11 0.02 -53.7%
PGI 0.21 27-Apr-11 0.09 -55.2%
UML 0.20 01-Nov-11 0.08 -60.5%
EVN 2.14 24-Oct-12 0.84 -60.7%
PIR 1.97 18-Oct-12 0.77 -60.9%
MRP 0.45 02-Nov-12 0.18 -61.1%
TRY 5.05 29-Feb-12 1.90 -62.4%
RSG 2.16 07-Feb-12 0.79 -63.4%
NCM 42.66 21-Apr-11 14.99 -64.9%
ABU 0.08 14-Nov-11 0.03 -65.0%
EVR 2.64 15-Dec-11 0.90 -65.9%
GDO 0.56 05-Dec-11 0.18 -67.6%
SIH 0.25 04-Jan-11 0.08 -67.6%
DRM 1.57 03-Nov-11 0.50 -68.2%
AZH 0.97 01-Mar-12 0.30 -69.1%
MML 8.71 31-May-11 2.57 -70.6%
SBM 2.52 14-Nov-11 0.68 -73.1%
PRU 4.00 09-Sep-11 1.06 -73.5%
RED 2.35 10-Sep-11 0.62 -73.6%
TGZ 2.89 21-Jan-11 0.70 -75.8%
SLR 3.96 10-Oct-12 0.82 -79.3%
AQG 12.10 14-Nov-11 2.30 -81.0%
PEN 0.15 17-Feb-11 0.03 -82.0%
KRM 1.83 11-Apr-11 0.31 -83.3%
KCN 10.88 01-Jan-11 1.80 -83.5%
ALK 2.61 15-Apr-11 0.42 -83.9%
SAR 0.93 08-Dec-11 0.15 -84.1%
IAU 2.34 12-Apr-11 0.33 -85.9%
FML 0.10 07-Mar-11 0.01 -87.2%
RDR 0.71 06-Jan-11 0.07 -90.3%
RMS 1.70 10-Sep-11 0.16 -90.4%
GRY 2.11 11-Apr-11 0.19 -91.2%
TAM 0.98 19-Sep-11 0.08 -91.8%
Average: -69.1%
Median: -68.6%
These certainly are bargains on relative performance and Paradigm recommendations here would be:-
  • Evolution
  • Kingsgate
  • Medusa
  • Northern Star
  • Oceanagold
  • Regis Resources
There are of course dozens on non-XGD gold stocks that might provide some better leverage and we will be happy to share them with clients. It is rare that one sector of the market should so significantly underperform the rest of the broad market (apart from XSR Small Resources) and I can only conclude that a 65% off sale is very attractive. Even better than buying on eBay or Grays Online!!

Morning Market Brief

by Alison Sammes

Overnight Headlines

  • The final Eurozone PMI for Sep'12 rose to 46.1 from 45.1, revised up from a preliminary reading of 46. The most notable single nation PMI cake from France where the index fell to 42.7, from 46 the previous month.
  • The number of unemployed in the Eurozone rose to 18.196m in Aug'12, up 34,000 from the previous month and to the highest level on record. The unemployment rate remained unchanged at 11.4%. Notably, Spanish unemployment hit 25.1%.
  • Late on Friday, the Spanish banking system showed it required £59.3b for recapitalization plans, which was in line with expectations.
  • Moody's stated that Spain's bank recapitalization plan is "credit positive", but ultimately may be "insufficient".
  • Bernanke gave a speech to Economic Club of Indiana overnight in an attempt to shed some light on QE3, stating the basic monetary policy strategy is "the same as its always been".

Resources Snapshot

  • Xstrata recommended Glencore’s revised £20.5b takeover to its shareholders.
  • Indonesia's new mining laws that came into effect in May'12 and relate to exports have had a profound effect on cutting exports, particularly to China. For example, Chinese imports of nickel from Indonesia in Aug'12 fell 39% to 1.48mt.
 

International Equity Markets

  • DOW JONES: Up 0.58% (or 77.98 points) to 13,515.11. Markets across the U.S. gained overnight on upbeat manufacturing data, but pulled back from session highs as Bernanke spoke about the Fed's decision to launch QE3. In economic data, the U.S. ISM manufacturing index rose 51.5 last month from 49.6 in Aug'12, the highest reading since May'12 and an unexpected return to expansion. Additionally, the Commerce Department reported that construction spending fell 0.6% in Aug'12, well below the 0.5% gain expected. 26 companies gained with 7 topping 1%. The financials had a strong run with American Express and Bank of America gaining 1.5% each. The notable fallers included Caterpillar and Microsoft.
  • FTSE 100: Up 1.37% (or 78.38 points) to 5,820.45. European markets noted their strongest one night gain in recent weeks overnight as better than expected U.S. data boosted investor sentiment. The banking sector was notably higher with RBS, Lloyds, HSBC and Barclays gaining between 2.5% and 3.7% respectively. Additionally, heavyweight mining companies rose with BHP and Rio gaining 2.6% and 1.8% respectively. Fresnillo, Kazakhmys and Randgold Resources followed higher. Xstrata gained 2.4% after the Board recommended the revised Glencore offer. Lastly, energy companies BG Group and Shell gained 2.3% and 0.9% respectively.
 

Overnight Summary