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What if … a rising gold price forces a short cover rally ???

by Barry Dawes

What if ... a rising gold price forces a short cover rally ???

Key Points

  • US equity markets at all time highs again
  • Asian markets still surging
  • Gold price jumps from recent 54 month lows
  • Gold stocks surging from 10 year lows
  • Coal market turning?
The US equity markets have continued to make new highs on strong earnings and economic data and on improving employment sentiment measures.  The stocks performances in the US are encouraging their counterparts in Europe and Asia along, as the various market indices also hit all time or new rally highs. Economic data in the US, Europe and Asia are encouraging but are generally at odds with what has happened with the out of favour basic industries and commodities.  Growing GDP and Industrial Production usually is good for commodities and the supply/demand pictures for most commodities are generally in balance, but there has been obvious new supply in commodities such as iron ore, coal and oil that has coincided with a short term slowing in demand from some quarters and the recent surge in the US$ has encouraged some market players to conclude that commodities must fall more.  But if the recovery is now quite clear should there be further falls? Market action is now suggesting that the 44 month decline (basis CRB CCI) in commodity prices may now be bottoming out with agricultural commodities generally making lows in September, industrial commodities (LME metals, nat gas) in October and oil, coal and precious metals in November. # gains from November lows Interesting to see that agricultural commodities fell about 15% to make their lows in September while the USDX rose 4% and subsequently recouped all their losses while the USDX rose.  Industrial commodities made their 6-12% lows in Oct and then rose with the USDX.  Precious metals and oil made lows in November and sharp gains have been made since those lows. The markets have had at least 44 months to play the bear side and now the world is fully convinced that war, plague and debt will continue to cut demand, China will slow down sharply and Europe will be in recession for ever.  And of course that the silly mining industry will continue to increase supply. But what if?   What if the Dawes Points view that the US is doing very well as indicated by a strong stock market and GDP data and that positive attention might now be paid to commodities as demand is seen to no longer be falling? Short cover rally anyone?  Note the very positive action in the US equity markets this week. What is a Short Cover Rally?   Well, some traders have sold assets that they hope to buy lower and make a profit.   If you are `short’ in futures or securities markets you have to buy them back or face unlimited losses.   Other have sold and gone to cash.  Others have just not bought so are underweight or underrepresented.  To cover `shorts’,  stock needs to  be bought back.  Underweight investors need to add to positions and then new money comes in.  Can be explosive.

What could this short cover rally actually mean?

First, there should be a bottoming in gold which is a proxy for all things commodity.  Did we get that last week when, as the last Dawes Points suggested, that gold was being `hammered into an important low’?  Demand is so strong and physical metal is hard to find.  Coins have been sold out from the mints. The extreme low valuation positions of gold equities give a lot of credibility to that possibility of an important low.  Platinum also made a key daily 'reversal' of making a new low then closing above the previous day's high on Friday. Higher gold might solve a lot of problems. Then other commodities should start to improve.  As shown above, sugar, wheat, corn and soy beans have already jumped well off their lows.   The LME metals and natural gas are higher today than in their October lows. Oil may have also made a very important low last week after a 32% fall since July, and note that the oil majors Exxon, Conoco and Chevron made their lows in mid October, a month before this low in oil.  US Lumber made its 2014 low in June and now could be very strong as housing starts continue to pick up. Iron ore looks to be still weakening through oversupply. I was amazed at this graphic.  Housing starts have fallen so much that it will take years to catch up to the need for another 1.5 million new units per year. The Philadelphia Housing Sector Index made an 11 month low in October but has bounced back to almost make a new all time high. Housing starts The industrial sensitive stocks and mining stocks should start to rally as short positions are unwound and bought back. Alcoa, Boeing, US Steel  and Caterpillar are all bouncing.  BHP, RIO and Freeport have improved from recent lows. Then the bond market needs to reassess itself.  Those holding low yielding bonds will be asking questions about how they will be able to sell them.  And where will the money go? And where will all the cash sitting on corporate balance sheets go?   Where will the bank deposits go?  Probably chasing real assets.   These numbers were discussed in the last Dawes Points. The amounts of cash and bond holdings are way bigger than equities today.  A short cover rally could ignite a much stronger market response.  What will the remainder of the year bring us? I understand many `value investors’ have reduced equity holdings in the US.  These may be forced to change their views, especially since the Dow Theory is now bullish. Where will the US$ sit in all this?  Where will the A$ go? You know my views.  Now, let the markets do the talking.

Let’s talk commodities

Commodity prices should be all about supply and demand, and these factors are far more important than the level of the US$.  Since the beginning of 2012 the USDX has risen 10% and the CCI has fallen 20%.  Since the latest 10% rally in the USDX since 1 July, commodities, as shown by the CRB Index (basis – CCI), have fallen 12%.    Not much of longer term correlation and the relative performances of agriculturals etc as noted above doesn't give much to rely on. At the margin, lower prices increase demand for commodities and reduce supply.  This is happening now.  Individual commodities have their own market patterns and the September lows of the agriculturals may be telling us something here. The industrial production data for China was >8%pa for Sept Qtr and India is looking at a GDP number in 2015 at >8%, higher than China.  These two great nations are important keys in commodity demand. Demand for gold from China and India has most recent data running at extraordinary high levels and has kicked the gold price up an important US$50/oz. The world is generally short raw materials and despises gold.   Gold shares hit a low last week and the ASX Gold Index was down to 83% below the April 2011 highs. Australian investors, however, are significantly underweight resources shares.

What about Equity Markets

The US markets are making new highs again today in what can be called a `bull hook’ -  the left side of an inverted parabola that then just surges! Many of these US stocks are truly remarkable given their earnings and their strong performances over the past few years.  The Dow Jones 30 Industrials have done well as has the S&P 500 but don’t forget that the Wilshire 5000 shows great strength in its breadth. Looking at the breadth and gains of these stocks it is hard to see how the market place could be negative on the US economy.  It is worth reviewing the Dow 30 to see what is there now. Gains by Dow Jones 30 Stocks    Market cap US5.0 trillion  PER 15.75x
14 Nov 2014 US$ 4 years 3 Years 2 Years

2104

Communications
AT&T

35.90

22%

19%

6%

2%

Verizon

51.50

44%

28%

19%

5%

Consumer
Disney

90.80

142%

142%

82%

19%

Home Depot

98.24

180%

134%

59%

19%

Coca Cola

42.73

30%

22%

18%

3%

MacDonalds

96.21

25%

-4%

9%

-1%

Nike

95.50

124%

98%

85%

21%

Proctor & Gamble

88.11

37%

32%

30%

8%

Walmart

82.96

54%

39%

22%

5%

Financial Services
American Express

90.67

111%

92%

58%

0%

Goldman Sachs

189.98

13%

110%

49%

7%

JP Morgan

60.28

42%

81%

37%

3%

Travellers

102.43

84%

73%

43%

13%

Visa

248.84

254%

145%

64%

12%

Health
Johnson & Johnson

108.16

75%

65%

54%

18%

Merck

59.07

64%

57%

44%

18%

Pfizer

30.34

73%

40%

21%

-1%

United Health

95.11

163%

88%

75%

26%

Manufacturing

 

 

 

 

 

Boeing

128.86

97%

76%

71%

-6%

Caterpillar

101.34

8%

12%

13%

12%

Du Pont

70.80

42%

55%

57%

9%

Gen Electric

26.46

45%

48%

26%

-6%

MMM

158.85

84%

94%

71%

13%

United Technologies

107.45

36%

47%

31%

-6%

Petroleum
Chevron

116.32

27%

9%

8%

-7%

Exxon

95.09

30%

12%

10%

-6%

Technology
Cisco

26.32

30%

46%

34%

17%

IBM

164.06

12%

-11%

-14%

-13%

Intel

33.95

61%

40%

65%

31%

Microsoft

49.58

78%

91%

86%

33%

Average

 

70%

59%

41%

8%

Dow Jones 30

17634

52%

44%

35%

5%

Russell 2000

1173.81

50%

58%

41%

1%

Some of the performances of these stocks are extraordinary and it is just about only the basic industries that have done badly in 2014. (IBM is the exception with its crazy stock buy back programme!).  This table is worth spending a few moments on. As the economic numbers improve it should be these activity sensitive stocks that do better.  And resources stocks. Asian markets are continuing their surges and Australia will eventually be following.

Gold

This has been discussed in Dawes Points but the extreme low levels for gold stocks are telling us that the lows for gold are probably very close (and probably behind us). The 23% rally from the lows here is probably signalling a major change. Also, gold in other currencies looks ready to continue the long term uptrend, especially in Yen. Gold is now all about demand from India and China.  This demand is unprecedented and will change the way gold is viewed.  Much higher prices are coming.

Resources stocks in Australia

The activity and optimism obvious in recent trips to China, Singapore, Kuala Lumpur and Bangkok contrasts greatly with the deep pessimism in Australia and the holdings and activity in resources stocks are well down on long term averages.  You might say they are hated.  Certainly despised. Some fund managers no longer hold BHP. It is now only 6% of market turnover- down at least 50%. Mining and Mining is down 50% or more.  Ignored. Small Resources.  Irrelevant. Gold.  Clearly despised at just 1.5% of turnover!

 A turn coming in coal?

A final note.  If gold is despised then coal is truly hated. But just look at these.  Maybe a turn coming in coal. A coal ETF had an October low. Coal stocks in the US are looking to turn up after long declines. Walter Energy Consol Energy Let’s hope this all happens.

CBG Capital (ASX Code:CBC)

by Alison Sammes

About CBG Capital (ASX Code: CBC)

CBG Capital provides an opportunity to invest in a portfolio of Australian listed shares in companies both within and outside the S&P/ASX200, managed by Ronni Chalmers and the team at CBG Asset Management.

Offer of shares in CBG Capital ASX-listed investment company

Paradigm Securities is focussed on the Resources Sector and whilst the sector has been very difficult for some years Paradigm still considers that an upturn is not too far away. This focus has meant that Paradigm does not usually give advice on general stocks outside the Resources Sector. Paradigm is however, pleased to be able to recommend participation in a new listed investment company that holds a balanced Australian equity portfolio. It is seeking up to A$50m in an Initial Public Offering in a proposed ASX listing. CBG Capital is run by former BT Australia investment manager Ronni Chalmers who set up his own boutique funds management company, CBG Asset Management, in 2001. The company’s two funds have consistently outperformed the ASX 200 accumulation index since inception. In the latest Mercer survey the CBG Australian Equity Fund was the fifth best performing fund out of 95 fund managers. CBG Asset Management was awarded the Sky News Business Golden Calf Award in 2013 for the Best Boutique Australian Equities Manager. CBG Capital is seeking to issue up to 50 million shares at A$1.00 each and will have a 1:1 separately listed attaching A$1.00 two year (Sept 2016) option. The minimum of 16m shares has already been achieved. The fund can have up to 25% outside the ASX 200 and so has been able to select smaller growth stocks that can give additional portfolio performance. The listed fund should replicate the stocks in CBG’s existing funds and should achieve an attractive fully franked dividend yield of 4-5%. The fund offers a stable long term (5-7 years) horizon for capital growth and income within the Australian Share market. The issue closes on 20 November. Attached are links to three documents:-
  1. Description of CBG Capital and its proposed ASX listing fund
  2. The CBG Capital Ltd LIC fund prospectus
  3. An application form to complete and send back to me at Paradigm Securities (bdawes@psec.com.au)
Application monies can be sent by cheque to Boardroom Pty Ltd GPO Box 3993 Sydney NSW 2001 Or Paradigm Securities Pty Ltd GPO Box 5263 Sydney NSW 2000 Applications can also be completed and emailed to me with funds sent electronically to the Paradigm Securities Pty Ltd Trust Account BSB 082 067 A/c 14-201-6796 Please call me if you have any query on this offer. +6 1 2 9222 9111 10 November 2014 Barry Dawes

Head of Resources BSc F AusIMM MSAA MSEG Follow me on Twitter @DawesPoints

Dawes Points Where are we now

by Alison Sammes

Where are we now?

Key Points

  • US equity markets hit new all time highs
  • Asian markets surge
  • Economic data showing robust growth in many countries
  • Global cash levels still very high
  • Commodity prices may be readying for a surge in 2015
  • Chinese steel production still over 820mtpa and 820mt YTD (+5.3%)
  • Iron ore imports into China up 15% YTD and likely to exceed 900mt
  • US$ still strong for now
  • Japanese yen breaking down
  • Global bonds have spike high then sell-off
  • Gold price hammered into an important low?
  • All these indicators say BUY RESOURCES  STOCKS!!
Interesting and volatile times we live in!  As hoped, the recent stock market decline wasn't one to be concerned about after all and now we have all time highs in the US and market surges in most places from India to Shanghai, Tokyo and even Australia.  What are these markets telling us about where we are now?  The thought of the global economic boom is still there in my mind and these actions give me more confidence that the likelihood is increasing. Don't laugh.  Look at the data. Dawes Points has continually emphasised that the markets are telling us that the outlook is far better than the commentariat would have you believe and the markets last week certainly gave some evidence that more is to come.  The Dow Theorists, mostly bears, now have to turn bullish because all three Dow Indices (Industrials, Transports and Utilities) are at all time highs and have confirmed the next leg of the Bull Market is underway.  Many other bears will be forced to change their stances. The 4.8% jump by the Nikkei, and >1% by Mumbai, Shanghai, Singapore, Hong Kong on Friday followed the lead from the US and are likely to be firmer again this week to reflect Friday's US action.  Shanghai is up 21% since June and India is up 21% since May in the latest stage of these moves. The US economic growth numbers of +3.5% for the Sept Qtr are part of a line of results that have given 4 of the past 5 qtrs at above 3.5% (5qtr ave 2.8%pa) and a general uptrend for the past two years and certainly don't suggest the end of the world. United States GDP Growth Rate Corporate earnings for many companies in the US have been good and FactSheet reports for Sept Qtr 2014 that, for the 362 companies it follows, 78% have had earnings above the mean estimate and 59% had sales above the mean estimate. EPS figures for these companies are 7.3% higher than a year ago and about 28% higher than in 2007 pre GFC. The good US economic growth data have been above expectations and many other countries are also providing this better data. More recent data and IMF forecasts* for 2015 paint a positive picture although much of the recent data in UK and Europe are better than IMF forecasts* and its very recent outlook downgrades.
% GDP growth

2014

2015*

US

3.2

3.1

Japan

0.9

0.8

UK

3.2

2.7

Germany

1.4

1.5

China

7.4

7.1

Taiwan

3.9

4.0

India

5.6

6.4

In contrast to the strength of so many markets and all these positive economic and business data it seems the world still is in love with defensive positions in cash and fixed income.  Australia has A$1,640bn in bank deposits and recent discussions in SE Asia and China suggest investors and businesses currently have 35-50% of investable assets in cash. A survey by UK firm Hogan Lovells has an interactive website that uses Bloomberg data to give corporate cash balances for the top 1000 global corporations. Data for August 2013 was US$5,623 billion, up 39% from US$4,044 billion in August 2012. Look at these numbers in US$bn and what they might be now.
Region August 2012 August 2013

+%

Now??

Nth America      1,850      2,462

33%

3,000??

Asia Pacific      1,100      1,790

63%

2,000??

Europe         837      1,033

23%

1,100??

UK         147         186

27%

200??

Latin America           71           97

37%

110??

Other           39           55

41%

60??

Total      4,044      5,623

39%

6,470???

It seems highly likely to me that the rising stock markets and quite reasonable economic growth figures will be giving a great boost to confidence in the corporate sector and this should be flowing into the consumer and SME sectors.  And the first change will be for new orders for inventory to meet anticipated or received increased demand. These large cash inventories should be very important in determining economic activity everywhere over the next few years This issue of inventory really fascinates me. In the resources sector we are all familiar with the inventory data for metals on LME, COMEX and Shanghai Metals Exchange and export and import port stockpiles.  We all currently expect mine stocks to be minimal and sometimes data is available for smelter and steel mill raw and finished inventory. But inventory in the hands of users/developers/intermediaries/resellers can be difficult to ascertain.  And all these people see the same papers, TV, blogs, trade journals and watch the daily markets as we do.  Fear affects everyone's mood. Dow down 250 points means everyone buying a little less this week to ensure cashflows are OK. It has always been clear from previous cycles that when a recovery takes hold and business and consumer confidence picks up then demand exceeds consumption as downstream inventories are rebuilt. If copper is used as an example, the International Copper Study Group is forecasting copper consumption in 2014 to grow 4.4% from 20,525 ktonnes to 21,429kt, being about 900kt.  Refined copper production is expected to rise by about 1,100kt so that a net surplus of about 200kt is expected in 2014 on top of a surplus of 400kt in 2013. At current consumption rates the world uses almost 60kt per day. 410kt per week. Current LME copper inventories are just 160kt whilst COMEX is 30kt.  Total identifiable inventories are about 1,100kt. Should the processing stream decide to increase copper inventories by three days or 180kt then the demand for metal would rise not by 4.4% in 2014 but by 5.4% and the current LME and COMEX inventory would be absorbed. The mountains of corporate cash could easily find the US$1.2bn to fund this increase. Recent reports have suggested UK hedge fund Red Kite has already acquired more than 50% of these LME copper inventories. This extra demand can often remove a sizeable chunk of LME inventory and change the market balance for the year ahead. Note that LME inventories for copper, aluminium, zinc and tin have been declining in 2014 and have to be considered to be tight.
000t

1-Jan-13

1-Jul-13

1-Jan-14

1-Jul-14

current

Jul-13

Jul-14

Copper

320

665

366

155

162

-75.6%

4.8%

Zinc

1220

1061

933

668

698

-34.2%

4.5%

Lead

320

198

214

194

227

14.4%

16.9%

Tin

12

14

10

11

10

-25.8%

-8.8%

Nickel

139

187

262

305

385

106.0%

26.4%

Aluminium

5210

5435

5458

5046

4429

-18.5%

-12.2%

Price would then be set by willing buyers and sellers and not unwilling buyers and desperate sellers. Many of these commodities could benefit. Speaking of inventory, it certainly seems that investors holdings in resource stocks are very low and will need to be increased!

Commodity outlook encouraging

Commodities have been weak recently with iron ore, oil and gold as good examples. But it is notable that many commodities and other markets (especially the A$) have had declines but are bouncing off on a long term support line.  Many agricultural commodities have had typical selling exhaustion patterns (as if from liquidation of long positions) and fit along these support lines. Should these commodities bounce then the uptrend can be quickly re-instated. Much has been made of the influence of a strong US$ but individual supply demand patterns are more important than just a currency adjustment. Oil and natural gas need to be closely followed because a strong US$ won't have much of an impact on these prices.The Islamic militants in Iraq may affect oil and gas fields and also may try to intercept tankers in the major choke points such as Straits of Hormuz to give some supply problems for the West.  Also US natural gas inventories are relatively low ahead of what could be another cold winter.

Steel in China

Consumption of steel is forecast by the China Metallurgical Industry Planning and Research Institute in Beijing (Sept 2014) to peak in 2017 at 763mt and decline to about 696mt by 2025. China Crude Steel Production was 779mt in 2013 and should be 820-830mt in 2014 and 850mt in 2015.  It should peak in the mid-term of 13th Five-year Plan Period (2016-2020) in 2017 at approximately 870mt before declining to 850mt by 2020 and 800mt by 2025.  Note that RIO and BHP have a longer term growth rate that takes crude steel production above 1,000mtpa. The most recent World Steel Association data gives 821mtpa for September for China but this should slow seasonally ahead of the 2015 Spring Festival to give the 820-830mt for 2014. To achieve this crude steel production rate, iron ore imports have been surging and are up about 15% YTD and have exceeded 1,000mtpa on a monthly basis.  The full year should be about 10% higher than in 2013. Domestic magnetite concentrate production should decline by as much as 140mtpa by 2018 such that total imports should exceed 1,150mtpa basis 62%Fe and with lower grade iron ores around 58% Fe this figure should exceed 1,200mtpa. Source: China Metallurgical Industry Planning and Research Institute I continue to be amazed at the incessant calls for crude steel production in China to decline sharply and to hear that demand for raw materials into China is slowing.  15%pa growth in 2014 after 10% in import growth in 2013 is a decline? Nevertheless, the iron ore price has slipped below US$80/t causing hardship for high cost producers, especially those in China.  This graphic suggests about 85% of China magnetite concentrate production is losing cash.  Perhaps 30% is losing over US$40/t. The steel mills do not appear to have yet rebuilt depleted inventories and port inventories are now declining and are at a 7 month low.  Some of the ore accumulated for low cost financing and placed on these port stockpiles may have now been already sold off and might reduce the additional pressure on the market. The major producers from BHP, RIO, FMG to Vale have been aggressively producing and selling ore to hurt the Chinese producers and to place pressure on potential new entrants.  What is really interesting is the indications that iron ore production costs are coming down rapidly for these big players and should all be below US$60/t CFR basis 62%Fe. US$80 should be an important level but Chinese steel mills inventory actions will have the final say by the end of the year.

US$ strength

The rise in the US$ against most currencies has been seen to be the main driver behind the decline in commodity prices and that the market place sees a strong US$ as deflationary. This is all very nice but look at these numbers.  The CRB Index (basis CCI – graphic above) has been declining in US$ since highs in March Qtr 2011 but despite the strong US$ it is actually up for most currencies in 2014! CRB Index rebased to 100 for 2011 highs in each currency, with Dec 31 and current figures.
  2011 High

2011

2012

2013

2014

From high

2014

US$

100

82

80

74

70

-30.0%

-5.1%

Euro

100

88

85

75

78

-21.8%

4.5%

Yen

100

74

82

91

93

-7.2%

1.7%

SF

100

82

79

71

72

-27.6%

2.7%

A$

100

81

78

84

81

-19.5%

-3.6%

This graph of the CRB Index in Euros says something more.  This is likely to break upwards as global demand improves.  Copper has been rising gently in Euros since the March Qtr. While the US$ has been strong the Yen has not and the Yen makes up 13.6% of the USDX.   The Euro makes up 57.6% of this US$ Index and a close look at the cross rates doesn't suggest the US$ is going a lot further from here although it might not fall back much for a while.  The Yen is certainly going to be weaker but probably not many other currencies will. A weaker Yen is also obvious from this graphic says the A$ should be very strong against the Yen. Outflows of capital from Japan must be expected.  The gold price in Yen is also looking quite strong.

US T Bonds  - Surge then selloff

The remarkable surge in bond prices in mid October seemed to be a last gasp run and the decline since then still makes these bonds very vulnerable as global economic growth improves and deflationary risks recede. These bonds will also provide much of the capital that will join with cash to move into equities and commodities. The parallel of US TBonds with the US$ still needs to be considered. The US$ must follow its bond prices.

Gold price hammered into an important low?

Gold and gold stocks have been a hard road to follow but I think the fundamental arguments for a strong gold price and much higher gold shares remain. Governments destroy currencies by spending too much and racking up debts.   People who have lived through violent currency depreciation know the value of gold and the two biggest populations in India and China are showing this by buying as much gold as they can get their hands on.  Central banks are buying gold again.  Demand is stronger than mine and scrap supply so it can only be banks and hedge funds selling volume. How much do they have left? The evidence is clear that this uptrend has been broken.  A fair technical target could be US$700/oz if you wanted to be bearish. But this is also valid technical support with yet another market having three bounces along the support line. And this graphic is back to crisis levels.  Back below 2008 lows and back to 1986 levels.  Extreme long term support here for the US Gold Index! And to clutch at some other straws the sell off in the GDX ETF has been on massive volume and back to this pervasive and remarkable three point downtrend support line that we see  in so many markets this year. And when we look at gold shares against gold it suggests that this is the final selling and capitulation stage - or else gold is going to US$700 and most of the gold industry will close. This just screams that we must be near the end of the 42 month decline in gold shares. I particularly like NST, MML and DRM here as low cost producers and GOR, ABU, KGD, BLK and CGN as developers. Paradigm has opened an account with a bullion dealer which allows clients to invest directly into gold with delivery or to be held in storage.  Talk to me about it if you are interested. Stocks to BUY The major resources stocks BHP, RIO, FMG, WPL, STO, OSH are attractive opportunities and so many of the juniors are so cheap and very good value where currently funded. The Dawes Points Outlook is for this market to run for many years to the upside so there will be many opportunities coming through. For those seeking a general exposure to non resources stocks I can recommend the new A$50m IPO of CBG Capital LIC with a manager whose two funds have outperformed the ASX 200 reliably over the past 8 and 12 years respectively. Good growth and a fully franked dividend yield of 5-6%pa.   The minimum of A$16m has already been reached and the offer has a closing date of 20 November. A flyer on this will be circulated this week, but please call me on +612-9222-9111 if you'd like to discuss this. 5 November 2014  

Is this decline of concern?

by Barry Dawes

Is this decline of concern?

Key Points

  • US equity market in correction mode
  • Bond market frenzy but at levels well below the July 2012 highs
  • Many commodity prices down 15-30% since July 2014
  • Oil price down on output increases and soft demand
  • Shanghai stock market still rising and up 18% since June
  • Iron ore price showing signs of recovery
  • Major resources stocks bottomed last week!
  • Gold prices starting to stabilise and probably moving up
  • A$ bouncing back
  • Copper and zinc prices holding up well
  • Some small cap resources still looking very robust
The current sharp correction underway in the US has brought out significant pessimism on the economic outlook, the valuation of equities and the implications of the global debt position and the current tight liquidity.  The pull backs have been hardest for the sectors that had been strongest and the US `small caps’, the oil and gas and some technology sectors have taken the brunt of the selling. US T-Bonds have had a major fling over this last period.  10 year yields at <2% and 30 year <3%.  After 30 years of bull market. Scary action that is related to the US$ strength and action that strongly suggests an important turning point has now been reached.  This has been expected for some time but not with any success but it still needs to be closely watched.  When set against the background of action in other markets these bonds do look scary. Iron ore and oil have been on the front page with their declines but it is probably just as notable that almost all traded commodities from silver to soy beans have seen similar or larger declines since July.   Many may have bottomed last week. Many of these declines seem irrational against the near term fundamentals so it could be concluded that it is more a matter of liquidation by hedge funds and the like rather than a collapse in overall demand. In particular it is worthwhile to note iron ore imports for China are still strong and growing and in September exceeded 1,000mtpa again.  The last Dawes Points highlighted low steel mill inventories were and that port inventories were coming off again and at just 33-35 days imports these are 40% lower than at the time of the last peak in port inventories.  The iron ore price had all the hallmarks of a final sell off to end a 12 month decline that left about 200mtpa of Chinese magnetite concentrate production losing cash.  At least 125mtpa will soon close so imports for China can only increase. Iron ore prices are rising again now.  It will be interesting to see if they do the unthinkable and rise strongly through a squeeze. Oil is something different and has seen rising US crude production with higher output from Saudi Arabia and Russia meeting softer demand from Asia and a shortage of refining capacity in the US. The unconventional oil output from the Eagle Ford and Permian Basins is too much for US refining capacity and with the US Export Embargo from 1975 still in place the oil is banking up. Oil has the combination of new production, softer demand in some regions, a currency play, production market leadership tussles, substitution and efficiency drives and some good old Middle Eastern geopolitics that could get very ugly.  Trying to work out the fundamental drivers needs some good crystal ball gazing. Nevertheless, the US production growth from shales where technologies are improving recoveries from about 5 to +12% means fields sizes (Estimated Ultimate Recoverable – EUR – reserves) in the important Eagle Ford and Permian Basins are growing from about 350kbbl to about 550kbbl/well and with about 35-40% coming in the first year that is US$8-20m revenue per well.  The fall in oil to about US$80 will make it very hard for the marginal plays but prime Eagle Ford could work down to about US$60.   We need to note that this business is very capital intensive and new wells need to be drilled consecutively to maintain output.  A fall in net operating surplus will delay the next well.  We also need to be careful that this sector has not leveraged itself up to much.  The US E&P Sector has been a great performer as has been pointed out here several times but the sharp fall could be placing some players under great pressure. The Shanghai stock market performance (up 18% since June while Wall Street is down 10%) and the record import of iron ore by China last month doesn’t tell me China is falling over. There is the technical issue of Shanghai Exchange now synching with Hong Kong to make Chinese equities more attractive but I consider it is showing much more. The higher iron ore price last week allowed the big miners to bottom LAST WEEK and hold up well in this Wall St sell off.  Note that this was what happened in 2008 when resources stocks, commodities and China all bottomed in Dec Qtr 2008 whilst the Dow, S&P, All Ords and FTSE etc bottomed in March 2009. The big oil stocks also seemed to make their lows LAST WEEK as well.  Before the big low in oil prices.  Could be significant. Gold is showing very encouraging signs of wanting to move higher with trades at US$1250.  As noted in the last Dawes Points, gold is strong with a strong US$ so it is rising in other currencies even faster. Gold stocks are also starting to move again.  It has been painful these last few years but the ASX Gold Index XGD bottomed in Dec 2103 as did the GDXJ (small caps gold stocks ETF)  even though the major XAU (US Philadelphia Gold Index) and the GDX (its ETF) recently made new lows. Clutching at straws maybe.  But maybe not.  Just check out the performance of the two precious metals royalty companies Royal Gold and Franco-Nevada.  No new lows here.  Strong signals. Much more coming here.
The A$ recently had a sharp pull back to just under US$0.87 but it simply came back to the 100 year downtrend again.  The A$ and gold (especially gold stocks) are closely related.  High gold and gold stocks will mean a higher A$. The A$ on the cross rates tells that same story. LME metals have held up well during this crisis.  Supply/demand factors are playing here more strongly than the market action with gold and silver.  Not a lot of new capacity and LME inventories for most metals are still low or declining.  How can you not like zinc, tin, aluminium, copper and cobalt.  Supply side crunches area likely with some of these over the next year or two. And then there are the small caps resources companies here on ASX.  Many with early stage projects are in strife with not much money and limited expectations.  But many with good projects and some funding look very attractive whilst some lucky companies and their shareholders have done very well and are getting more funding.  Scores to choose from. I have stayed the course on this bullish tack because most things I see confirm what I have been saying in these notes for the past two years.   The market has not agreed on many of these points but equity markets ARE heralding better times as are commodities. So, the best way forward is to add to that portfolio of stocks with dividend paying gold stocks, some iron ore plays, some LME metals companies, high yielding oil and gas plays, onshore petroleum E&P companies, some technology metals companies and of course some explorers. Note that the major resources companies have very attractive yields of 3-6% and are at very low risk entry points (BHP 3.8%, WPL 6%, FMG 5.5%, PNA 3.1%, RIO 3.7% , NST 2.9%, OZL 5.0%, ORG3.5%).. The keys are correlated with bonds, currencies, equities and commodities (especially gold) all providing guidance for what the future holds. The right combination of market moves may soon give the signal that cash is too staid, bonds are too risky and commodity related equities are just far too cheap. All these features are telling me that it is not the end of the world, that resources are outstanding value and that resolution of this current bout of pessimism will produce a much clearer and positive outlook that was really always there.  This decline is not a concern but a real opportunity.

Short term selloff creating value

by Barry Dawes

Key Points

  • Pessimism calls very strong again
  • US markets recently made new highs
  • Asian equity markets breaking out upwards
  • Shanghai stock market up 17% since July
  • Chinese steel production running above 810mtpa
  • Activity in the smaller caps continues to improve
  • Sharp falls in commodities now overdone?
  • Could be an important low developing and creating value
The past few weeks has provided a salutary lesson in the volatility in the market place and early calls for the market upturn in all things resources.  The fundamentals of economic growth still look very good and recent market gains for many small cap resources appeared quite constructive.  Stock markets around the world are still signalling much better days ahead. But pessimism is again strong globally and the short term trading trends continue to spook these thin markets where traditional investors are still holding onto defensive positions and lots of cash. A surging US$ has recorded a 7% rise in the USDX since mid July and sent the world looking for deflation/catastrophe havens again due to ISIS and also the tensions in the Ukraine. And whatever else. Most commodities came off more than the rise in the US$ and the continuing chants of Down with China and China Down reached another crescendo despite the Shanghai stock market surging 17% since July and the PMI remaining a good 51.1! The iron ore price and the A$ sank together. So is it all over now for resources? Let’s just review the evidence and consider with the graphics from the last Dawes Points. First
  • The world’s largest securities market, US T Bonds, peaked in July 2012, over two years ago. Higher bond yields are now surely coming because the deflation is over and the US economy is expanding. Cash levels are still high.
  • China’s economy continues to grow at >7%pa with crude steel production likely to be up >6.5% in 2014 with 8mth YTD figures up 7.6% and iron ore imports at new records approaching 1,000mtpa and up >16% YTD.
  • China steel industry data also show a 35% increase in steel exports. The rise in port iron ore inventories gets a lot of attention (note these may have peaked and are now falling) but inventories of iron ore and finished product at steel mills are very low indeed
  • Many commodities have fallen 15-20% since July in a market that reeks of hedge fund forced selling.  Some much more. Interestingly, Sugar has experienced a sharp fall but it has reversed and is now heading higher.  Is it a leader?
  • The current high volatility into lows for in the US equity markets could be suggesting a trend change – to up!
  • Gold in US$ is still doing OK but during this time of dollar strength we have gold prices in most currencies breaking 3 year downtrends and turning up.  Encouraging but there is very bearish sentiment.
  • Most metals have low or declining inventories and several like tin, zinc and nickel have medium term structural deficits that MUST result in squeezes. Many other metals are just tight.
  • The A$ in most of 2014 had been consolidating after its last selloffs in 2013 and then in January.  This last pullback of 7% matches the US$ rise and very interestingly is just back to the support on the 100 year downtrend line of A$ vs US$.
  • So many markets have broken the 2011 downtrends with good rallies only to fall back to support on these important downtrends.
My travels in the past few months have taken me to site visits in some exotic locations but also Singapore and just now Melbourne for IMARC. I delivered a paper at IMARC on an outlook for the A$ with key conclusions being
  • Resources exports having risen from A$50bn in 2014 to almost A$200bn in 2014 will get another big kick from the new LNG plants that will increase this to A$280bn or more by 2020.
  • The LNG exports will stimulate a major surge in activity in onshore oil and gas.
  • The A$ looks very good on the cross rates against Yen, Pound and Euro.
IMARC also brought out the extraordinary productivity gains in mining technologies such as Orica’s amazing new blasting techniques that can separate overburden from ore and also cleverly use chemical energy to fracture rock to smaller pieces rather than using slower and more expensive mechanical energy. RIO, too,  is well on the way to higher productivity in iron ore mining with driverless blast drilling, driverless excavators, driverless truck and of course driverless trains. The productivity benefits are only now being felt but you can be assured that the blow out in costs is being rapidly wound back and that Australian mining companies will again be very competitive. All these market actions seem to me to be suggesting a short term panic that has just about run its course and is leaving outstanding value on the table.

Barry Dawes

Head of Resources

BSc F AusIMM(CP) MSAA MSEG

Follow me on Twitter @DawesPointsBarry Dawes’ expertise in the Australian resources sector is based on his knowledge as a geologist combined with over 30 years’ experience in the resources investment sector. Prior to founding Boutique Investment Firm “Martin Place Securities” in 2000, Barry had worked in senior executive roles of investment management with BT Australia, equities research for Bain Deutsche Bank and equities research and corporate finance for Macquarie Bank. He is currently a Director of a number of unlisted public operating companies. Barry has a substantial depth of knowledge and experience in the international resources industry and is well known for his views on the sector. 

 

   

The Forrest Review

by Barry Dawes
I had the honour of hearing an inspired presentation yesterday in Melbourne by Andrew Forrest on his proposals to "create parity" for indigenous people in Australia. The proposals aim to improve the health and education of indigenous people through hands on programmes that restore personal self esteem and offer employment prospects. Andrew Forrest's Fortescue Metals already spends well over A$1,000m on services from companies owned and run by indigenous people, and has seen first hand the major reductions in alcoholism, other drug problems, and  in domestic violence as indigenous Australians gain employment and even run their own businesses.  He has also seen improvements in health, well being, education and overall employment prospects of indigenous Australians.

Self help is the best help

It is clear that Andrew Forrest has very wide support amongst indigenous Australians for his recommendations to be accepted.  One such person here in Melbourne gave an impassioned plea for support for the recommendations.  He said that his broad family of just over 200 had experienced the, mostly premature, deaths of 38 family members in the past decade.  Alcoholism, drugs and domestic violence and near perpetual unemployment were standard in his family. I consider that this is a worthy issue deserving widespread support. The Forrest Report on Indigenous Jobs and Training Review provides 27 recommendations for consideration and adoption. Public comments on this Review are invited but the closing date is today Friday 26 September. I invite you to participate in this debate by visiting the website and making a submission. I suggest you do three things:-
  1. Read the PowerPoint Presentation summary
  2. Review (if you have the time) the full report.
  3. Visit the "how to get involved" section of the website and complete the “Have your say" form:
If any of the links are not working, please visit:https://indigenousjobsandtrainingreview.dpmc.gov.au  

Gold Market

by Barry Dawes
  • Gold bull market set to resume uptrend
  • Sovereign markets for gold, currencies and bonds confirming a positive resources outlook
  • Gold demand still robust
  • Islamic State issues concerns increasing
  • Gold bullion account established for investing or trading
  • Australian gold equities still very cheap
Gold prices have just travelled sideways in US$ for almost 15 months since bottoming after the April-June 2013 sell off despite strong physical demand from China and India and continuing takeup of gold coins. US$ gold has generally held its price since then but is down 34% from its high of US$1923/oz in Sept 2011 but well off the Dec 2013 sub US$1200 lows. The picture for gold itself also is far more encouraging when viewing it in other currencies and when the sovereign bond markets are brought in we can see some fascinating trends developing. Gold in the major currencies appears strongest in Yen terms with gold in Euros and Pounds not far behind.  The Yen looks curiously very weak against most currencies. A$ gold is steady. The US T Bond market peaked in July 2012 and the recent falls in yields are interesting, particularly in European bonds, but it all suggest a major generational low in yields is coming soon and then everything looks dangerous to be in bonds for at least the next decade.  How will these bonds ever be repaid? A new issue for having the security of gold is arising with the actions in Iraq and Syria that could have a major positive impact on gold prices in the very near future. Risks of the Islamic brotherhood revolts spreading into Muslim countries around the world are high and the oilfields in the Middle East and, more importantly the oil States themselves, are vulnerable.  The risks go further.  Nigeria, Libya and Pakistan are all vulnerable. Gold shares suffered a more severe battering in their 32 month bear market from the April 2011 record highs but they too made their lows in December 2013 and many have since rallied nicely. Bringing these all together still provides a positive trend for gold and the extreme lows in prices and cross-asset relativities for gold are considered to be well behind us now. Gold and shares in Australian gold producers are good insurance and the markets seem to be agreeing with this.  Paradigm can help you here. Paradigm has set up a dealing account with Capital Bullion to allow you to buy and sell gold and bullion gold coins and have somewhere safe to store them. Please call me to discuss. As noted above, gold in US$ has been trading in a relatively narrow band between US$1200 and US$1400 for over a year while holding a 13 year long-term uptrend of sorts and still oversold.

 

In the shorter term the action can be seen as within a relatively narrow band but has shown some violent action within it. It should be expected than the violent action will continue when the next market direction is confirmed.   Nevertheless the action seems to me to be very constructive and should soon be resolved with an upside break out. Gold in other currencies is also encouraging with Euro Gold close to E1000/oz. Gold in GBP has broken a downtrend. Gold in Yen seems to be leading.    Something is odd with Yen just now, could it be energy dependency? Or something else? I will come back to this later. Gold in A$ is steady but a break to the upside is due soon. And just as an aside, it is worth noting silver.  A moment of truth coming up here.  A big break seems likely here.  Up or down? The supply and demand says break upwards.  But let’s just see. Some very interesting graphics here to consider with the macro picture . First.  Gold  has some long term seasonal influences .  This graphic courtesy of Dmitri Speck suggests that from September until December an average seasonal move of about 3% could be expected.  So after this seasonably sharp early September decline we could see US$30-50 rise by Christmas.    On average.  Pity this graphic didn’t include the 2013-2014 volatility. But it is what it is and it is helpful. On other interesting points to consider are the US$’s recent rapid move into the Top Channel after 8 years of trying.   Is this of significance?  Should be, with improving global economic outlooks and the US leading.  The shale gas revolution is certainly helping with US energy costs and competitiveness but I still think the emerging global recovery is better for other countries than just the US. The short term for the US$ is very much overbought with it surging 4% in two months and all momentum indicators signalling overbought. It is also noteworthy that this US$ index is rising whilst the US$ is actually weakening against the Chinese Yuan and the A$. And with the various European bond markets rallying into parabolas it must be now saying that it is very close to the end of the global bullmarkets in bonds. US 30 year T-Bonds had a fall in yields but it is very hard to see lower rates here. Note the low in yields here in the 30 year was two years ago in July 2012. Especially when the recent lows in yield were not confirmed by similar strength in the 10 year bonds.   From the commodities and resources viewpoint it will be the flows OUT of these bonds that push up equity markets and commodities.  The data shows about US$80,000bn in bonds global bonds. The local Australian resources market would be a very happy recipient of just 0.1% (US$80bn) thank you.   In the gold shares the US Philadelphia Gold Index (XAU) has bottomed and turned up after basing along a major longer uptrend. The market action can be seen better through the two ETFs GDX (the XAU) and also through GDXJ which is the smaller cap stock ETF. Gold stocks in North America are still at only 30% of their long term relative value against gold itself but recent action suggests a turn is underway after bottoming and moving up. The fall in gold stocks against the general market has been even more horrendous but that fall is over now and should start to move up again to give significant outperformance. Here in Australia the gold sector is recovering and some excellent gains were recently made by some of the Paradigm favourites but the index has again drifted back to levels equal to the 2004 and 2005 lows. Looking at the performance of the ASX XGD it is still more than 70% below the April 2011 highs. I still like NST, GOR, ABU, SAR and SAR with BLK and ATV very cheap. The bottoming process is still underway as can be seen from the ASX  Small Resources but the character of the market is showing strong performances by many small resources stocks (that may not yet be in the  XSR) and a considerably stronger market that is taking capital raisings again.   This is clearly the time to be bullish. And to leave you with a few other things to be positive about:
  • The Chinese stock market, along with the rest of those in Asia, is gaining real strength.  It is hard to reconcile the continuing negativity about China with performance of Shanghai and almost all the other Asian stock markets.
  • The TSX-Venture Index is now showing some life and its direction will support the ASX Small Resources.  A break above about 1100 on this index would be very positive.
  • And finally this one really intrigues me.   What is happening with the Yen?  The A$ looks to be about to make a strong upmove against the Yen over the next year or so.  The Yen is also showing (see above) a much stronger gold price than in US$.  Keep watching this.
Barry Dawes 8 September 2014 Disclosure: Barry Dawes holds GOR, NST, ATV, BLK. 

It’s all happening now in this Bull Market!!

by Barry Dawes

Key Points

  • The Dark Side throwing in the towel?
  • Shanghai finally joins the Global Bull Market
  • All Ords breaks 5500 and joins in too!
  • BHP is a Paradigm SUPER stock on oil and copper
  • Expansion continuing with ASX  XSR small resources up 8% in July
  • Dawes Points 2014 resources portfolio up 64% for 1 January - 30 July
  • Gold in super bull market  with demand rising from India and China
  • Oil and gas exploration activity in Australia stepping up
The Dark Side of Pessimism, Commodity Price Terrorism and China Envy appears to be finally throwing in the towel to surrender to the massive tide of global economic expansion as the aspirations of the world's rising middle classes prevail.  Expansion with record levels of global cash to fuel it. And what an event this is.  It is one to savour and to pass on to your grandchildren.  I have said that before but it is and it is all happening according to the Dawes Points script.  It is crystal clear in the markets now that China is not collapsing, the European banking system is not melting down and the US economy is not falling into the Greater Depression. If the world has done this well despite the pessimism, what will now happen as the Dark Side changes its view?   Are you ready for it?  What will happen with the extraordinary high levels of cash on the sidelines flow back to markets? And from the bond markets? You have been forewarned so are you fore-armed? The Dark Side has for years churned out a never ending torrent of warnings based on China slowing or Europe collapsing and the ensuing oversupply of commodities that was going to push down iron ore, copper, coal, LME metals, silver and, of course, gold.  The Super Cycle Bull Market in commodities was over and also was the strength in the A$.   Oh yes, also buy US T bonds! And build up cash! And all this has proven to be false prophesy.  What can you say about their professionalism? But the false prophesies have been enough to all but destroy the capital markets for resources stocks along with careers, opportunities, livelihoods and wealth.  Yours and mine.  FOR NO REAL REASON! And we still hear it.  Investors should build up cash and chase yield. Not capital growth.  So why then have the Russell 2000 Small Caps and the S&P600 Small Caps done so well and have led this market up since the March 2009 lows? The market facts tell it clearly.

Mar 2009 Low

30 July 2014

% change

S&P 600 Small Caps

131.54

475.25

360

Russell 2000 Small Caps

355.91

1146.57

321

S&P500

695.27

1970.07

282

Dow Jones 30

6709.61

16880.36

251

And Google, Tesla and Face Book are hardly high dividend yield stocks. So in great contrast to these strong highs, resources stocks are priced for the end of the world which is clearly not happening.  So if not, then there should be some `normalisation' in the terms of Wall Street Wallys.  That is, a major upward rerating of resources. So, where to start with the plethora of positive market signals in July. We could focus on any of the following:- Stock Markets
New All time Highs So Close to All time Highs Pre 2008 downtrends broken 2011 downtrends broken
US
Canada
Germany
India
Sth Korea
UK
Japan
Singapore
Taiwan
Europe
And how about these for commodities
New All time Highs So Close to All time Highs Pre 2008 downtrends broken 2011 downtrends broken Waiting
Palladium Silver
Bauxite Moly Platinum
Cobalt Copper
Oil Zinc
Nickel Lead
Tin Gold
Uranium Aluminium
Resources stocks are not reflecting these conditions at all. And then there is gold.  It was covered in the last Dawes Points and gold stocks are performing well. Just note the basing and reversal in the GDX ETF of the XAU (Philadelphia Gold Index). Note that gold stocks in North America are still about just 30% of their `normal’ rating against the general market and are turning up again.  Big % gains to come. But the clearest signal is the economic data coming out of China. The 7.5% pa GDP growth rate is being maintained and the various Purchasing Managers Indices (PMIs) are now all pointing up. Expect an acceleration from here.   Overall, China never really slowed overall and never as much in most sectors as the commentators expected, as we saw through the crude steel production data. And the US had 4% growth for June Qtr! My four visits to China from Sept last year gave no obvious indication of a real slowdown and in fact reinforced my views of an increasingly sophisticated and complex society so keen to improve living standards.  And the infrastructure and technology standards are so high that Australia is not keeping up. With economic expansion in China comes an increase in everything but particularly the demand for energy.  In a slower 2013, BP Datashows energy demand only grew 4.4% and took China to 23% of total global energy consumption and 25% higher than the US. Importantly, gas consumption in China increased 10.6% in 2013 but it is still only 5.1% of total energy consumption in China whereas the total global average is 23.7%.  Coal is still around 68% in China and 30% globally.   The demand for gas in China has so far to go from this 5.1% to at least 20% to get anywhere near the world's 24% and 30% in the US.  This graphic tells us a lot about the economies of China and the USA and the changes since 2006. Focus on the gas numbers because China will be a major importer of gas via pipeline from Iran and from Russia and can be also expected to greatly increase LNG imports as well as develop its own shale gas resources.   China needs to increase gas share from 5 to at least 20% in a growing energy consumption profile over the next 20 years. See how the US has increased gas by 25% to a level of 30% from just 24% in 2006 and reduced its coal consumption by 20% from 24% to 20%.  All from that shameful fraccing!!  So much more garbage from the Greens. Now just look at the markets. My last visit to China provided strong signals that share ownership in China is not highly regarded.  It seems much money was lost after 2007 with a steep index fall of 70%, a rally, then a grinding 45% decline over five years and a retreat to the levels of 2001.   No one owns shares anymore.  Its all in property and shadow banking high interest loans. Unfortunately the property developers can't quite make the payments on the 25-35% loans so the cash will likely go elsewhere.  Shares maybe? The markets are showing that the bearishness is now turning. The US$15,600bn market cap Shanghai SEC Index is up 13% in the past year and is on a PER of 10.1x. The 2007 downtrend is broken after the Index bounced off the 22 year uptrend. This FTSE China 25 Index ETF is also pushing against the 2011 highs which are also post 2008 highs. China had been holding back Australia but we are now leading Shanghai and with the break through 5500 the All Ords will now try to catch up the world. These improvements have been anticipated by some of the better opportunities in the market and are reflected in the 30 stocks Dawes Points Nov 2013 Non-trading Portfolio which is now up 64% since the beginning of 2014.   Big gains by LNG (4% of initial book value), LMB (0.8% ibv), AQA(4.3% ibv) and WSA(4.3%ibv) have helped significantly. Here is the portfolio.  Big caps have finally started to move but stock picking in the smaller end has produced stellar results.  Much more to come. Now one of the things that has been embedded in my brain since entering the financial markets is that the market in Australia can only go where the market leader goes.  And this is BHP. So if the market leader is not going higher then the market will find it difficult to move higher. We all have been bombarded by the iron ore bears who equate the iron ore price with the future of the Western and Eastern Worlds.  It affects BHP of course and RIO and then we have the numerous experts who have shorted FMG. But the operational and production responses and the market action of BHP are not of the character of a company, and hence a market, going nowhere. Note this extraordinary comment from a local fund manager who told Reuters:- "At the end of the day, BHP's fortunes are tied to the iron-ore market," said ………., chief investment officer at ………. Asset Management, which recently sold its shares in the miner after holding the stock for close to 15 years. "The stated strategy of the majors is to squeeze higher cost production out of the market," he said. "We're just not sure that maximizing production is as sensible as they think it is." So he is sold out.  Yet the stock is at 12 month highs so something else is happening. This is the `Generals and the Maginot Line’ concept referred to in the February Dawes Points. If the market for BHP is holding up and the iron ore price isn't that bad maybe this something else is happening. How about the something else being copper? Copper prices have broken the 2011 downtrend and LME inventories are just 144kt for a 21mtpa market and are at 6 year lows. The Dark Side has tried to tell us that the inventory has just been moved from LME warehouses to others in China and that financing of this inventory will bring us all unstuck.  Garbage! BHP will produce a net 1.8mt of copper in FY15 and at US$7000/t this is US$12.6bn in gross revenue.  At US$7700/t this is US$1.26bn more.   Escondida and Olympic Dam, each growing. Now to another something else. The 2011 acquisition of Petrohawk's Eagle-Ford and Permian oil and gas acreage and Chesapeake Energy's gas at Haynesville by BHP was derided by the cognescenti at the time as an over-priced and strategically dumb acquisition.   Gas prices fell after the acquisition so it was a big joke with writedowns on Cheaspeake's Haynesville assets.  Another Magma Copper.  HBI.  Ravensthorpe.  Failure. But wait a moment. Look at these numbers for gas which show a doubling for BHPP since the acquisition.
Year end June (BCF)

2011

2012

2013

2014

Bass Strait

107

112

124

109

North West Shelf

125

144

131

128

US onshore

36

448

479

449

Other

137

118

140

153

Total

405

822

874

839

US onshore %

9

55

55

54

  US Onshore provides almost 55% of BHP Petroleum's gas production but at the current US$4/mmbtu at Henry Hub its not too exciting. But more importantly however, the unconventional oil and liquids mostly from Black Hawk and Hawkville  in the Eagle-Ford shales provided 26% of BHPP's FY14 net liquids output and 31% in the June Qtr at a rate of 28mmbbloepa (80,000bbloepd). BHPP has advised a 17mmbbl liquids increase for FY15 and it had spent US$3.9bn in FY14 to achieve this. So taking a steady growth of +2.5mmbbloe per qtr growth rate to give just 15mmbbloe extra in FY15 then the June Qtr FY15 could be producing at a rate of over 60mmbbloepa (170,000bbloepd).  What will FY16 look like?   Can't really know today but BHPP has said 200,000bblpd by 2016(>70mmbblpa) so expect higher numbers in FY16. What may be known is that BHPP is probably getting one year IRRs of over 70% and 60mmbloe pa gives annual revenue of US$6,000m and at a conservative 50% EBITDA margin this adds a lot to BHPP's earnings.  Like about US$2bn in FY15 and US$3bn in FY16. The technology changes in drilling are bringing down drilling costs, improving reservoir recoveries and boosting returns.  BHPP `is testing high-temperature gels for better proppant transportation, different stage spacing to maximize stimulated rock volume, and reservoir modeling to simulate stress capture and optimize well sequencing.'  (UOGR April 2014) BHP also reported that field trials achieving are 10-40% higher than production for comparable surrounding wells. The rapid technology changes in unconventional oil production (now really a `manufacturing’ business rather than exploration) are suggesting increases in oil recovery from about 3% to as much as 6%, with about 50% recoverable in Year 1. Getting 400,000bbls @US$100/bbl in Year 1 is US$40m revenue with $8m op costs for a US$10m well is over 100% Year 1 IRR.  Try 150%.  And BHP is spending US$4bnpa.  The above BHP numbers might be low. So here are two major Divisions of BHP in cashflow growth mode that will offset any earnings weakness from any lower prices there in iron ore with its 10% higher FY15 225mtpa output, costs reduction and revenue of US$20bn. It seems that the world has just focussed on BHP's iron ore and ignored Copper and Oil.   BHP's share of All Ords market turnover has been at the lowest level for over 10 years suggesting it is very much underowned.  Turnover in recent weeks has jumped up sharply suggesting BHP will again lead the market higher. Other markets are giving BHP a better ranking so have a look at BHP in US$.  More action than in Australia, possibly. The raison d’etre for the establishment of DawesPoints in 2012 was to advise clients and the world in general that the real economy was operating at very different level to the financial economy. And that the real economy was doing far better than the financial community has been giving credit for. The continual reference to the US markets has been a core activity of DawesPoints because these are far more liquid markets with vast numbers of buyers and sellers with different goals, views, responsibilities, time frames and of course attitudes.  The Australia market appears to me to be concentrated with strong convergent groupthink views and guided by a generation of advisors investors with contrasting time frames compared to the real economies' requirements.  Risk averse commentators driving investors away from equities and to overweight positions in bonds and cash. The Australian investment market of course has had the luxury of being able to invest in a vast number of overseas markets with stocks such as Apple, Google and Tesla not available in the local market. So rightly competition for capital is substantial.  However, it is a pity bank deposits have won this section of the race with their A$1,606bn balance. How is it that our Australia prefers to back the banks and mediocrity or overseas companies rather than backing its citizens in their visions and endeavours?  Why would you back XYZ Bank Ltd to invest in 4.8% mortgages rather than to invest in Ken Everyman who has uncommon drive and a great idea about how to produce and sell a better front door lock?  What about Dr Phil Brown and his biotech innovation in a field that Australia is an acknowledged leader (did you know that the local George Institute is THE leading medical research unit of the world!!). Why indeed would you not invest in Bill Brilliant who has a copper deposit that he has assessed as worthy of further development? Or John with his iron ore opportunity?  Or Frank with the acquisition of a major exploration target from large international mining company for whom the target no longer met corporate goals.  Real ideas, real drive and real assets from real people. Australia does have the world’s largest listed mining company in BHP and a range of other and its banks are world class with all the big 4 with AA ratings The scope of this is vast and extraordinary.  From gold to iron ore from new mining technologies to unconventional oil and gas. Opportunities everywhere. And yet still the large investment banks are still vying for the title of the most bearish.  How many of them have even been beyond Hong Kong into China.  Not many, it would seem. And the fixation with a lower iron ore price and the collapse in the steel industry in China as it goes to yet another new record high (yes, new record of 843mtpa in June!!).    Oh, puulease. So what is really happening now?  The Bear Case of overwhelming debt leading to a US Depression with European banking collapse and China falling over has very simply failed to eventuate.  You can say QE and other injections of liquidity have prevented the collapse and that unless we get more then it will still happen.  Maybe. The much proclaimed collapse in commodities hasn’t arrived yet and apart from the ridiculous preoccupation with the iron ore price it appears it won’t. What is going to happen to these people who have been preaching Armageddon and worse?  And to those who have listened? I saw some `unverifiable’ data from a US columnist that showed that ten major global economies (including US, UK and Australia) had current savings rates in excess of 40%.  No wonder global growth has been slightly anaemic. But what does A$1,606bn in bank deposits suggest to you?  How could Treasury, most banks, the disgraceful `asset allocators', a growing army of risk averse financial planners and scared ordinary people with the conventional wisdom of Cash is King be on the right side of the market?   A thirty year bull market in bonds has certainly sucked in everyone, especially governments who think that the markets will always be there to take over priced paper. But note that the tide has already turned with major US bond funds reporting a full year of redemptions as the risk of holding low yield, balance sheet-challenged government paper just keeps growing. And here, the latest RBA data shows that although total bank deposits are still rising ( up 0.7% to a new record A$1,606bn) in June the Term Deposits category had the biggest ever monthly fall (A$7.9bn)  to just A$529bn and at -1.5%, the largest % fall since deposits began to rise sharply in 2007. Funds flowing from bonds and term deposits is now well underway.  Into investments, property and soon into retail consumption.  For us that is into equities and commodities and into resources equities (read small cap resources stocks!). Well if you are reading these DawesPoints you know these have been my views and you have had it consistently straight and true. Bull market for resources and commodities. And these views haven't changed in the past two years. Now some more facts for you to consider. Resources sector bottomed in the GFC in Nov 2008 and the broad markets Dow, S&P, All Ords, FTSE and DAX bottomed  almost 4 months later in Mar Qtr 2009. Say that again. The Resource Sector (XMM.ASX) bottomed in Dec Qtr 2008 and the broader market bottomed in March 2009. So technically we have been in a bull market uptrend in resources for almost six years now!  Hasn’t felt like it has it? The resources market rallied into April 2011 then weakened into June 2013 for the first major pull back.  A 53% fall was some pullback.  Ouch. And 71% for Small Resources was ,..  er,..er,.. um,.. some pull back.  But it is bottoming! The poor old gold sector after making a magnificent 230% rally from the GFC into 2011 then fell 80.0% to Dec 2013.  Mere details!  And of course the small caps became microcaps and then nanocaps and worse.  Quite few 95% falls here.  More than OUCH. All these share price collapses for no real macro economic reason.  Just misinformation, groupthink and fear. But what value has been created!! And strong stock and portfolio performances in 2014 reflect that.  So much more to come. I have referred to the `stealth’ bull market in Australian oil and gas exploration that is well underway now.  The new LNG projects in Australia will be export conduits for many new gas fields in Australia and will change the entire industry. I particularly like the key Cooper Basin stocks (BPT, DLS and SXY) and also those in the NT and parts of WA.  Hopefully a full report might be available very soon.  The implications are very great and the opportunities will be very rewarding. There are hundreds of companies with quality projects that need to be financed and I am happy to recommend dozens of them.  This is going to be an extraordinary Bull Market for the next decade! So the opportunities in Australia now start with our preferred leaders. BHP and FMG (SUPER stocks) with WPL, OSH, STO, WSA, ORG as leaders. Onshore oil and gas led by BPT, DLS, SXY in the Cooper Basin and then AJQ, CTP and REY. Gold stocks NCM, NST, ABU, GOR, SLR, SAR, BLK Copper stocks CDU, PNA Industrial metals TRO, AMI, IBG, Technology metals ORE, ALK, LMB, VXL, KNL, CNQ Metals explorers SIR, CZI, KGL, Many more as this market moves up, as we discover new opportunities and as relative values warrant switches. So what happens now for the supporters of the Dark Side? This is a very important question. If the end of the world hasn’t happened by now what might be the options for them?
  • Wonder what to do with A$1,606bn in bank deposits?
  • Get even more bearish?
  • Actually go to China and see it first hand rather than pontificating with propaganda of envy?
  • Look for undervalued sectors?
  • Concluding resources and Australia look very appealing?
All of the above. And that suits us just fine! I own shares in BHP and FMG, STO, DLS, AJQ, CTP and REY. NCM, NST, ABU, GOR, SLR, SAR, CDU, TRO, AMI, IBG, ORE, ALK, LMB, VXL, KNL, CNQ and CZI.  7 August 2014 Sydney

Gold Sector having bottomed is NOW moving up strongly

by Barry Dawes

Key Points

  • Gold’s supply/demand picture suggesting major deficit developing
  • Strong physical demand for gold in China
  • Even stronger physical demand for gold from India
  • Technical evidence indicating powerful global move in gold equities
  • Gold stocks are extraordinary value
  • US$/A$ reasserting relationship with gold
  • Is there a whiff of inflation out there due to gross expansion of money supply?
  • Stock BUY recommendations: NCM, NST, OGC, SAR, SLR, MML, BDR,GOR,BLK
Gold has been in a broad uptrend since is its lows in 1999 at US$246/oz and the combination of strong physical demand from China and India, with the usual financial and monetary profligacy of the Western World's banking system, suggests this 15 year bull market still has a very long way to go. The 650% rise to US$1923/oz over 12 years and the subsequent 37% decline over two years to the June 2013 low of US$1198/oz is a reasonable correction to such an upmove.  However, the 65% decline in the US gold indices and the 80.0% decline in the ASX Gold index don't really stack up as corrections that are reasonable. The result though is an extraordinary opportunity to NOW buy highly valuable assets at a fraction of their current true worth and at an obscene pricing against their longer term values.   TALK TO ME NOW! In 2009 I made a very public price forecast that we would see US$5,000/oz over the next few years and now consider that this will come to pass before 2017 as the next leg of the bull market takes hold. So what are the key drivers to make these sorts of claims? Yes, you say I am always optimistic.  Well yes.  I am bullish because of what the markets are telling me.  Gold rallied from the US$248/oz low in 1999 and in 2002 I forecast US$1500/oz would be achieved in the coming bull market.  The price target was exceeded.  Was that being bullish or optimistic?  The US, German and Indian markets are at strong all time highs as I have been highlighting over the past couple of years. Is that bullish or optimistic?  Well, who cares really?  As long as it is a correct forecast it doesn't matter.  Have a look at the performance of most markets from cyclical lows (that are always accompanied by never ending pessimism) and you will be amazed at the percentage gains the subsequent rallies achieve.  Getting the direction right is 80% of the outcome. Chinese steel production reaches new record levels as was forecast despite all the wails of it’s imminent collapse.  Was that Paradigm forecast of strong production growth optimistic or bullish? When the Chinese steel mills finally sort out their inventory policies and the world recognises that record imports of iron ore into China and record exports by Australia against a backdrop of uneconomic Chinese domestic magnetite concentrate production result in a much stronger seaborne iron ore market into 2015, will that be bullish or optimistic? The markets have been telling us very clearly that the claims of US Depression, banking collapse in Europe and China falling over were just wrong. Was that being bullish or optimistic?  Or was it really reflecting the `facts’ that the markets were telling us weren't the same as the `facts' that the Wall Street economists and their ilk were (and continue to do) forcing down our throats. So being negative, optimistic, bullish or bearish is not so very important but what IS important is recognising what REALLY are the major issues as shown by the messages of the markets. The daily evidence of far better than expected economic data from almost all countries puts paid to the bears and their stories of financial Armageddon.  And the bears have much to answer for. But coming back to gold. Well, what are the drivers for the renewal of the gold bull market.  Demand, Supply, Inflation, Wars, Bonds, US$?  All of the above? I much prefer to think about supply and demand because the other issues are more guess work or just market sentiments that can wax and wane. The Goldfields Minerals Services (`GFMS’) and the World Gold Council give some useful data on this supply and demand for gold and I have done some navel gazing and added my forecasts.  Forecasting is always difficult, especially forecasting the future as Samuel Clements (Mark Twain – one of the world’s true geniuses) would say.  Have a look at these numbers from GFMS with Paradigm forecasts. These figures suggest a net change in demand of 1000-1200tpa to be drawn down from inventory is likely to occur over the next few years. These are very large and possibly very important numbers for the future of gold prices. But first let’s look at these numbers now and review what has happened over the past decade. First, look at Mine Production. From 2,504t in 2004 to 3,022t in 2013.  Long term compound growth rate is 2.1% pa.  Several big +5%pa growth years but many as declines or just modest gains.  Sth African gold production has collapsed as the goldfields on the Witswatersrand run out of easy ore and totally out of friendly high risk capital. Major players USA and Australia have also declined with Australia less so.  Peru is rising but it has been China that has surged to become global #1 at over 420tpa. It is quite sobering to review the high level of global exploration expenditure for gold and the low gross discovery results to date. Mine production has only achieved 2.1%pa despite the 12 years of rising gold prices.  However, don’t be fooled by the gross numbers because focussed gold explorers are still doing well in Australia and also in other parts of the world such as Africa, SE Asia and Sth America.  Just watch for the key players mentioned below!  Some explorers are better positioned than others. The net conclusion is that gold mine production growth is unlikely to be able to exceed 3%pa for the next five years from my assessment and primarily because the big players such as US, Russia and RSA are likely to decline and offset strong growth in Africa and Sth America. Unit production costs have been rising due higher input costs, overall declines in mill head grades and increasing operating depth of mines.  Some established mines have suffered from these rising costs but most new mines have been engineered on much lower head grades so will be pushing unit mining costs higher.   The GFMS latest figures for all-in costs have been at over US$1600/oz. Cost pressures are definitely reducing and everyone in the gold mining industry is now extremely cost conscious.  Expect to see significant drops in some operations. Nothing as volatile as gold will allow gold production to grow at a steady 3%pa.  Try up 10% or down 15%.  But let’s use some 3%pa numbers to guess what we think the gold industry might achieve.  3,082t in 2014 and 3,271t for 2017. The next issue in Scrap Supply. High prices bring out a lot of scrap and high prices into 2009-2011 brought about a 100% increase in supply to a peak of over 1,725t in 2011. Gold is a strange beast given that almost all the estimated 170,000t mined in history is theoretically still available as supply yet as gold is shifted into strong hands and as weak sellers are probably exhausted it may be that scrap supply does not increase greatly from here. So total physical new supply is plateauing around 4,400tpa with a modest annual increase expected. Part of new `supply’ was reduction in hedging and eventual netting out of gold sold forward.  Mines had `borrowed’ and sold gold from bullion banks in their hedging and so as they delivered gold into these hedges they were `repaying’ bullion banks and not adding to new supply to the market. Miners are likely to add to short term hedging positions but as these are likely to be `current’ items of less than 12 months it should not significantly add to annual figures. Central Banks used be a part of the `supply-side’ equation but as they are now on the `demand’ side they don’t figure here anymore. So total gold supply, whatever that means, is around 4400tpa and has been growing at about 4.2%pa over the past decade. The demand side is now very interesting. Jewellery demand (mostly high carat (20-24ct) investment chain) is driven mostly by Indian Diwali requirements from rural villages in weddings and dowry gifts. Western jewellery in 18ct rings, watches and the occasional pendant don’t add up to much compared to Indian demand.  India’s love of gold is underpinned by a traditional drive to improve family wealth and as the rising middle classes in India increase their affluence, so the demand for gold can only increase. Indians save about 30% of their incomes and about one third goes into gold with about 75% into jewellery. Quotes from The World Gold Council’s 2010 survey of India include `Gold is an integral part of daily life where purchases of gold jewellery are considered as a form of liquid and tradable investment for the accumulation of wealth.  It is important to highlight that in analysing the gold market in India, traditional perceptions between jewellery and investment demand and demand drivers do not apply.’  And also that the allure of gold is its hedge against a depreciating currency and preservation of wealth.  Jewellery demand is really investment. Primary gold demand in the domestic market in India is almost all in the form of 3.75oz `TT’ bars (10 tolas) and in chain for jewellery. India in 2013 introduced an import tax on gold that eventually reached 10% to try to offset a balance of payments crisis and also required importers to re-export 20% of imports.  The new Modi Government, elected in May 2014, is likely to reduce the tax in stages and allow substantial pent up demand to flow through.  Substantial smuggling of gold to avoid the import tax appears to have been underway through China and Myanmar so the immediate impact may be muted but longer term demand following rising living standards in India is likely to remain firm. The brilliant work from Koos Jensen (www.Ingoldwetrust.ch ) in tracking down Indian and Chinese gold data is truly illuminating and this graph below shows that monthly demand into the Indian market in 2013 exceeded 110t/month. In China where the economy is far more advanced, the demand for gold is also for jewellery but more is for bars.  The character of the Chinese market is fascinating in that government decrees require ALL gold brought into China or sold to the market must go through the Shanghai Gold Exchange.  In 2013 China produced 428t of gold and imported 1,540t to give a demand of about 2000t.  As at the end of May 2014 850 tonnes of gold had passed through the exchange into the Chinese domestic market.  Bars are usually 1kg and 100g bars that have been produced from reconfiguring 400oz London Bullion Market inventory via Switzerland, London and Hong Kong.  Interestingly, gold market participants are not reporting ANY Chinese refined bars in the export markets! Koos Jensen’s numbers on Chinese imports and jewellery are higher than the GFMS data presented above but it is notable that there have been months when Chinese gold demand ( in RED)  has exceeded annualised global mine production (in YELLOW). It is clear that most Indian and Chinese gold demand is primarily for investment so when we add it all up (jewellery, bars and coins) total investment demand it looks something like this:- Jewellery demand is expected to grow by 6% in 2014 as the Indian tax is reduced and then removed and forecast to grow by 4%pa out to 2017. The demand for gold bars for investment and for coins has been extraordinary over the past decade.  215t in 2004 to an estimated 1500t in 2014.  Very strong demand from China and India. Coins have increased from 125t to over 400t and climbing.  Robust demand from all over the world should keep growing for years to come. The EFT phenomenon from 2004 to 2012 saw a massive 2300t directed to these funds and then a substantial 880t drop in 2013.  The numbers appear to have stabilised at about 1800t and may be resuming an upward trajectory.  But EFT demand of 200tpa for gold is tiny compared to that from China and India. In 2014 total investment demand of over 4800t should well exceed mine production of 3100t plus scrap of 1300 tonnes totalling 4400t. If EFTs and Central Bank demand are added then a significant deficit of over 500tpa will be developing from 2014 onwards. This is in great contrast to the substantial `surplusses’ of the decade prior to 2013. *(central banks and ETFs excluded prior to 2010 as were small or negative) These numbers also clearly suggest that gold demand is ignoring `Fed policies’ and Wall Street arm waving about US-centric values and is just getting on with life. Who cares about Fed interest rate policies if the Monsoon harvest is going to be good this year! So what does this mean? Essentially the graphic says that gold is moving from Western inventory to Asia.  The tonnages involved are so large that you have to ask just where is all the gold coming from? It is unlikely that it is coming from retail scrap or from local US `investors’.  Oil prices are high and rising again so Middle Eastern players probably don’t have to sell their gold right now.  Indeed, you can ask, just who are the suppliers of gold now? The gold market is also very suspicious of US activity in the gold markets through intervention by the US investment banks.  The outstanding contracts to COMEX gold inventories ratio recently exceeded 100:1 and it is clear that heavy selling has kept gold prices subdued. The high market shares in the gold market held by China and India have led to concerns over the role of COMEX on price discovery so the establishment of active cash gold exchanges at Shanghai and Singapore may soon leave COMEX as a price follower and not a leader.  We all have seen the lack of connection between physical gold demand and the action in the future markets. Let us just say that it hasn’t made any sense. Looking behind these numbers also strongly indicate the sale of gold from someone’s inventory but the question is whose inventory? And can there be much left? And where would the gold come from if there was no-one left to be selling? Well, let’s ask the markets. The long term uptend is still intact and the indicators are still oversold.  A rally is due now. In A$, gold is not so clear but I consider the supply/demand pressure will soon clarify the matter. Note that the A$ gold price today is A$1,400/oz.  About the same as in April 2011. I can’t discuss the gold outlook without reviewing the US T Bond market.  Rising bond yields can indicate many things but the most important indication to me is the end of disinflationary times that have accompanied the 30 year bull market in bonds.  This bull market is ending in a drawn out saga since the bond prices peak in July 2012 and the rearguard action to hold prices up against the evidence. Rising yields indicate a growing global economy, rising commodity prices and a recognition that far better returns can be made in equities than sitting in low interest rate bonds and face capital losses. And the US$80 trillion global bond market is going to provide a lot of cash to drive up other markets, like gold, commodities, resources stocks and general stocks. The 10 year T Bond just looks ready for a major surge in yields.  Don’t jump to a false conclusion that rising bond yields is bad for the stock market.  Think of it as a flow of funds out of bonds into stocks! Inflationary pressures appear to be building in many areas (other than labour!) and the Middle East issues are exacerbating the passing of Peak Conventional Oil.  I expect higher oil prices to come through and new highs before 2016. Now coming to gold stocks. It is worth starting with the major US gold index, the Philadelphia Gold Index (XAU). Still very oversold but suggesting a bottoming out and a rally starting. And a very long way to go! Even better is looking at the SPDR GOLD ETF GDX which parallels the XAU.  This is an ETF and it shows trading volume. Note the very large volume in Dec Qtr 2013!  This is a classic high octane reversal pattern that supports a major rally from here.  And it is underway NOW!  Up 17.5% from the low. Its junior cousin GDXJ is looking even better!  Note the big volume in 2014 and not 2013.  Early investors went into the large caps first and now into the smaller caps which are up over 20% from the low! Short term moves are classic market-direction changing reversals in both ETFs.  Expect some back and filling in both GDX and GDXJ but NOW IS THE TIME TO BUY FOR A MAJOR RERATING. What was that I heard about someone saying an equities explosion was underway? First in gold stocks.  Then watch oil stocks get another move on up. Then Copper, Zinc and Lead. Here in Australia the ASX Gold Index XGD also had a magnificent 12 year run that took it up 750% to the April 2011 and post GFC highs of 8499 to then retreat 80.0% to just 1703 in Dec 13. As was noted above, the A$ gold price of about A$1,400/oz today is almost identical to the level when the XGD peaked in 2011. And the XGD is now >70% lower. The Index is a proxy for gold sector companies but many non-Index companies have done far worse than the 80.0% decline in the XGD since those highs in April 2011. But overall, the Australian Gold Stock Market presents a fascinating grouping of companies that offer some exciting opportunities to join in on the ride. Focussing initially on the ASX Gold Index which is currently made up of 25 stocks you can find that like any good index it has its performers, also rans, laggards and duds. Of the 25, 5 are in good recovery uptrends, 15 are basing readying for an upmove and 5 are still looking at downtrends. The diabolical performance of gold stocks around the world since April 2011 has never made much sense to me at all and hence the continuing bullishness based simply on value. Extraordinary value exists in ASX gold stocks. The table below looks at the current ASX Gold Index  XGD. I have reviewed these 25 stocks in the Gold Index in a very simple and superficial analysis that that has more to do with price than value.  In my opinion the valuations are so low that the Index could be up 200% before we would need to sort out the best relative value. Most stocks are BUYs because they are so cheap and the current run in gold prices makes them even cheaper. So let’s look at them Note that many stocks have their assets overseas and for most country risk is in the eye of the beholder. With MRRT, Carbon Taxes and restrictive workplace practices many consider Australia a country risk but the rising Middle Classes around the world are making most jurisdictions more secure so country risk is declining everywhere.  Obviously some places in the Middle East and the former Soviet Union are still very risky but most of Africa, Sth America and Asia seem reasonable risks today. A = BUY stocks in uptrend B = BUY stocks needing a pull back before entry   C = Stocks that need time No stock in the XGD is considered a fundamental SELL at present. The strong moves of some stocks against the XGD Index’s 9% since 30 June 2013 are very encouraging and shows the market does appreciate good operating performances, particularly if it is corporate buyers paying a fair value rather than the low participation rate markets just looking at price not value.  Some stocks such as SAR, are up 2-3x from their lows and are well outperforming the Index.  It is indeed a matter of a rerating of the gold stock market.  Fears of a major fall in the US$ gold price are just part of the drivel from Wall Street hustlers trying to cover their large short positions. From these stocks in the XGD and a few more I have put together a portfolio with biggest weightings to large stocks and a collection of mid cap growth opportunities and a selection of more speculative plays.  The stocks highlighted in YELLOW are my SUPER STOCKS that I expect to do very well indeed.

Stock

Holding

Price (A$)

Location

Comments

Large caps

   
NCM

10.0%

  Australasia Big cap market leader
NST*

10.0%

  WA Yilgarn Major rerating
OGC

10.0%

  Philippines Growing production
Mid caps        
SAR

7.5%

  WA Yilgarn Low cost growing output
SLR

7.5%

  WA Yilgarn Rationalised operations
MML

7.5%

  Philippines Low cost growing output
BDR

7.5%

  Brazil Very low cost producer
SBM

7.5%

  Australasia Overcoming issues
Small caps
GCY

5.0%

  WA Gascoyne Developer
ABU

5.0%

  NT Producer/Explorer
ATV

5.0%

  Canada Developer
RMS

5.0%

  WA Yilgarn Producer
GOR*

5.0%

  WA Yilgarn Explorer
BLK*

5.0%

  WA Yilgarn Developer
TRM

2.5%

  NT Explorer
         
Total

100.0%

     
*Super stocks Let’s monitor this portfolio over the next six months or so.  I am not a trader so the portfolio won’t change.  WYSIWYG The implications of a strong gold price and strong gold stock market come back to the A$.  This graphic tells me a lot. And this one even more. A$ long term from 1913. The short term is looking very good. Don’t be worried about a high and rising A$.  You will just become wealthier. For exporters, Australia’s structure of high labour and other costs is simply unsustainable.    Current work practices just have to collapse and become totally flexible.  The rising A$ will ensure big changes are going to have to be made. And finally to those who don’t think that an equities explosion is underway, try these two Paradigm SUPER STOCKS that I have been referring to over the past 9 months or so.   So much more to come! Barry Dawes Follow me on Twitter @ DawesPoints I own NST SLR MML ABU ATV GOR BLK TRM LNG LMB

Equities and commodities explosion now really underway

by Barry Dawes

Key Points

  • Equity markets around the world making new record highs
  • Activity in large scale mergers and acquisitions rising
  • Velocity of money circulation now turning up?
  • Institutional investors short and wrong
  • China growth intact
  • ASEAN bloc of 617m people adding to growth surge
  • Commodities showing strong demand but limited supply
  • Metals markets much tighter than you are being told
  • A$ looking firm
  • Just BUY resources stocks - see list below

New record highs in important equity indices fuelled by better earnings data and some major M&A activity provide strong evidence that the Dawes Points synchronised global economic boom is on track to flourish in 2014 and the Year of the Horse and beyond.  The sidelined cash built up in most economies around the world will now start to flow into investment and consumption and add significantly to economic growth.   Several good years are ahead of us all and the opportunities everywhere are boundless.

Would you believe the GDP growth rates of 5.9%pa for Japan in the March Qtr and forecasts of 4% pa for the US in June Qtr? Some technical reasons here of course but nine months ago you would have said I was on drugs if I had said that.  You probably did anyway!

Well it has been almost 18 months since Dawes Points made strong suggestions of a global economic recovery that would bring boom conditions back to the resources sector in 2014 and beyond.  The US equity market boom led by the small caps (the Russell 2000)  and the broader market (Wilshire 5000) has been followed by the S&P 500 and the Dow Industrials in keeping with better economic and earnings data.

The mergers have added to this but what is interesting is that the velocity of circulation of cash (GDP divided by M2 money supply) has been falling for some years and has really decelerated since the GFC in 2007/08 while everyone (individuals, corporates and banks) have built up cash levels in very defensive stances. 

Even here, RBA figures show the A$538bn in term deposits and A$572bn in savings accounts in a total ofA$1572bn.  ATO data suggest SMSFs have 31% in cash, 15% in property and only 32% in shares.  This cash buildup has contributed to weak data on retail expenditures and also on the lack of interest in general investment especially higher risk ventures such as mining stocks and junior companies in particular which have lagged here in great contrast to the performances of the major US indices.

Could it be a change is underway at last?   Most definitely YES!!

The new mergers mania may be changing this velocity of circulation. US banks have had a record 26% of net equity assets held as cash and have held back on lending.  The current M&A surge with bank lending support may get this index moving the other way at last.  Let's keep watching it.

Velocity of M2 Money Stock USA  - Federal Reserve Bank of St Louis

You have been advised of this growth outlook for quite some time at Dawes Points so why was it that Dawes Points was able to say this whilst all the massive brainpower of local and global investment banks said otherwise.  Experience, knowledge and vision I think is the catch phrase. This was the motto of MPS almost 15 years ago.

The more recent comment has been to heed the markets not the commentators.

Forty-something Western Generation Xers who have been brought up in an environment of entitlement, compliance and communication can only respond within that paradigm.    

However, the paradigm for six times their number in China, India, ASEAN, Africa and Sth America is something far different. 

A rise in domestic living standards is imperative and they know it can only come from someone being able to sell something to someone else. And by George that is occurring almost everywhere. People feeling pleased with what has been bought, sellers pleased that they have sold a quality product at an attractive price that makes a profit but importantly one that will entice a return customer and everyone wins.  It  is a pity that all socialists and bureaucrats seem to think about is a crappy product(mostly government services) and care nothing about repeat customers because they usually have a monopoly.  Just jack up prices, pay the bureaucrat more and who cares about the service, outcome or recipient.

Anyway, the US equity markets now really like what they see and the recent breakouts show the markets around the world also really like what they see.  But not everyone it would seem.

Have a look at these next two graphics.

The first shows that institutional clients of BofAML sold a cumulative net US$50bn of equities since 2007.  Assuming BofAML has a 10% market share and that its clients are no different from those of any other Wall Street broker then just maybe about US$500bn has been sold on market by institutional clients.  Hedge funds are also out/short.  Just the man in the street building up his holdings as the market surges to record highs and US corporates now on a buying spree recognising the great value there.  And a myriad of new technologies.  Who has got it right?  Who has got it very wrong?

So many professional fund managers are scared and short!  Sell shares and buy bonds for goodness sake?

And then what about this?

Record highs accompanied by rising short positions.  Not the psychology of market highs.

Think of what this means.

Market psychology should tell us that peaks in markets are accompanied by participants believing that the new plateau of prosperity will continue forever, higher Share Index targets are rolled out daily and that market shorts should be overwhelmed and ridiculed.  It's not happening that way.  Caution, caution, caution is the mantra.

I attended the annual Resources Information Unit conference in Sydney this week. Some wonderful opportunities offered and so cheap!  But almost all of the resources sector summation presentations said the same thing!  Caution, caution and caution. Commodity prices are going nowhere for at least another 18 months.  Maybe 2016.Don’t know about gold. Too hard. Sure do some stock picking by crystal ball gazing and impute resource potential from a few drill holes but don't do anything before a JORC figure is given.   Just ignore the drawdown of inventory for copper and lead/zinc and tin.  New supply is coming. Not sure about where from, but it is probably coming from Africa.  Or Sth America/China. Somewhere.  But it's not Australia just now. 

But now look at what the markets are saying.

New highs in the US equity markets.  I have been talking about this for over two years now for the US to lead the world out of misery.

And the economic boom rolls to the East.  First to Europe that obviously did not collapse.

Then further East to India, where growth and now a change of government suggest much more to come.

And the Far East. Hong Kong is a proxy for China and it is all good here.

Sth Korea is relying on Japan and China. KOSPI up 2.63% last week. Would love to buy stocks here!

UK catching up after some major changes. Almost a year of indecision but it will run well soon.

Commodities starting higher.  Agricultural commodities might be leading but watch energy.

Brent looks like it is ready to run.  I sure like oil and gas stocks in Australia! From WPL at the top to STO, OSH, BPT, SXY, DLS, BUR, AJQ, CTP and HPR. Get aboard!

Then metals to follow.

Copper looks very strong after the scam selloff.

And look at these LME copper inventories.  Down 72% in 11 months.  LME stockpile is declining at more than 15% per month now. Just 191kt. Just 3.6 days consumption. What Purchasing Manager is now going to sit tight while thinking about `oversupply'. Buy copper producers! 

What we see in copper is replicated in lead, zinc and tin to a lesser extent but all show production declines and very tight markets out a year or so.  Falling LME inventories to critical levels of under 2 weeks supply will force prices higher.  Aluminium and nickel have been in oversupply difficulty but may now be also showing demand exceeding supply so their inventories might continue to fall from current quite high levels.  It is the direction that counts and the momentum then builds.

Have at look at bauxite prices into China. Lots of alumina/aluminium capacity. Not much bauxite. There may be an analogy for bauxite and aluminium with iron ore and steel.  We saw a big jump in iron ore vs steel.  Just might get a jump in bauxite vs aluminium.   Watch this space.

As Dawes Points has said ad nauseam, the crude steel production numbers out of China say very clearly growth is continuing.  Output was a record 827mtpa in March.  I hear over 830mtpa in April. Who are the conmen here?  Take a bow US investment banks with an anti China agenda and their collapse in China steel production.  I maintain my forecast of new highs in iron ore prices within the next two years.

 

You should listen to the iron ore company executives.  They know what their clients are saying and wanting.

Funny how so much oversupply in iron ore has Chinese ships arriving at Australian ports to take every tonne they can get while prices are low. Record exports from us.  Record imports from them.

And port inventories are high but mill inventories are low.  The stocks to import ratio at about 35 days is still 40% BELOW two years ago. 

Fortescue (ANZ Research) shows these new mills being built on the coast to take imported hematite ores, not much local magnetite required here. Imports will soon make up over 80% of iron ore demand in China.

And look at Shanghai.  Trying very hard to move ahead against the bearish environment but major structural changes are afoot to help.  SOEs are now encouraged to tap massive savings in China and take equity to replace debt and to start to really free up business strategies from just providing a social service to creating earnings for shareholders.  PER of 9.8x is very attractive now.  Same price level as 2001 but about 30x PER lower. Go China!

I mentioned ASEAN which now includes Vietnam, Cambodia, Laos and Myanmar within the new ATIGA free trade agreement.

Look at this result for 617m people and 50%<35 years of age.  Better demographics than China and no One Child Policy. Almost as important as India and Sth America.  

Note, too, the energy consumption and growth rate of MENA (Middle East and North Africa)!  MENA energy consumption is one third that of the US and growing at over 4%.  US energy demand growth is negligible!

These are impressive numbers using BP data.

And look at the ASEAN economic growth rates stats from the IMF.  Not far behind China with almost 50% of its population.  Mostly English speaking peoples too so good rule of law!  I hope you are getting the full picture here.

US Bonds have peaked and yields heading higher. Dawes Points has not got this right yet but the latest rally sure suggests they are just grasping at straws. This will be a major source of funds to the equities and commodities bull markets as participants move out of an overvalued sector in a very tired 30 year bull market that has already peaked almost two years ago.

And the US$ is breaking down.  What a rear guard action over the past couple of years.  Truly grasping at straws here too.

While the US$ is fighting for relevance the A$ has finished its correction.  Next stop is US$0.95, then higher.

I mentioned attending the RIU Resources Conference last week. I saw about 40 company presentations and a few industry commentaries.  Of the 43 companies I would be happy to invest in about 20 just on the  basis of outstanding growth prospects and another 10 or so on just ridiculous valuations.

Of course there was the caution, caution, caution, commentary but I really don't think there is much time left to be cautious.  This a great bull market that is developing and there really isn't much time at all.

So I will make some suggestions.

  • BUY graphite stocks - I expect them to become market leaders
  • BUY gold producers.  I have a very select list.   
  • BUY copper producers and explorers.
  • BUY nickel producers and explorers.
  • BUY lead/zinc producers and explorers
  • BUY Musgrave Range copper/nickel explorers
  • BUY NSW copper/gold/lead/zinc developers and explorers
  • BUY Rare Earth developers/explorers

I will also make some other suggestions.

  • BUY Cooper/Eromanga Basin producers/developers
  • BUY unconventional oil and gas explorers in NT, Qld, Sth Aust and WA.
  • BUY iron ore producers and selected hopefuls

And finally yet another plug for old favourites

  • LMB  expect over A$2.00/share
  • LNG expect over A$5.00/share
  • BLK  expect over A$1.30/share
  • FMG  expect over A$7/share
  • CTP expect over A$2.00/share
  • HPR expect over A$1.00/share

I have a list of about 20 Super Stocks for clients. Major outperformance expected. Contact me if you are interested.

I own BHP, FMG,CTP, BLK, HPR, LMB, LNG, DLS, AJQ, Fo.V

Sydney

18 May 2014