Is this gold surge the real deal?

 Frank Holmes, CEO and Chief Investment Officer for US Global Investors gives us three reasons why he thinks the current gold price surge is sustainable, and perhaps the start of something bigger.

If you don't own gold, you know neither history nor economics. Ray Dalio.

Gold prices peaked at $1,900 per ounce in September 2011. It was the end of a spectacular, decade-long bull market, during which the precious metal’s value increased a phenomenal 645 percent.

Since then, gold has struggled to regain momentum as an ever-climbing stock market has drawn more and more affection from investors. But after posting three straight years of losses, it looks ready to shake off this trend.

Not only is the metal trading at seven-month highs, it’s also on course for its longest winning streak since the glory days of 2011. What’s more, it’s broken clean through its 200-day moving average, a key indicator of growth.

Breakout! Gold Rallies Above Its 200-Day Average
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In a recent report, HSBC suggests that we could be in the early stages of a new gold bull market, one that will “probably” usher the yellow metal back up to at least $1,500. This “forthcoming market,” says the bank, “has the potential eventually to exceed the speculative frenzy seen in 2011.”

Bold claims indeed, but there are signs that this gold rally is “stickier” than previous ones.

Stocks Are Making Investors Nervous

Historically, gold has had a very low correlation with stocks, meaning that in times of equity pullbacks, the metal has tended to hold its value well.

We’re seeing this unfold right now. While S&P 500 Index stocks have slumped nearly 10 percent so far this year, gold is shining bright at 12.7 percent. Even normally reliable tech stocks, including Netflix, Facebook and Amazon, have disappointed in 2016 so far.  [Ed: Since Frank penned this article, gold has surged further and is currently up around 16% year to date]

In addition, the number of companies trimming or altogether suspending dividends surpassed 2008 levels last year, according to Bloomberg. Nearly 100 more dividends were cut in 2015 than in 2008, suggesting further trouble could be brewing. Goldman Sachs reports that in the last three months alone, at least 20 oil companies have adjusted payouts down as crude prices continue to drag.

Dividend Cuts in 2015 Surpassed 2008
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The same pain is being felt in China, one of the two largest gold markets, alongside India. With the Shanghai Composite Index having lost 46 percent since June 2015, many investors are rotating back into gold.

Global Demand Is Scorching Hot

Speaking of China and gold, 2015 was a red-letter year for demand. Physical delivery from the Shanghai Gold Exchange reached a record 2,596 tonnes, representing more than 90 percent of total global output for the entire year.

Physical Gold Delivered from Shanghai Gold Exchange (SGE) vs. World Mining Output
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The country’s central bank also continues to buy gold at an impressive pace. Kitco News reports that the People’s Bank of China added 16.44 tonnes, or 580,000 ounces, to its official reserves in January as it seeks to support its currency, the renminbi.

In 2015, and so far in 2016, sales of gold coins in both the U.S. and Europe have been nothing short of breathtaking. Sales of American Eagle gold bullion coins reached 124,000 ounces in January, up 53 percent from a year ago. And last year at the Austrian Mint, one of Europe’s largest, consumers bought up 1.75 million coins, four times the volume sold in 2008 before the financial crisis.

I always say to follow the money, and right now American money managers and hedge funds are increasing their bets that gold prices will continue to climb. According to data from the Commodity Futures Trading Commission (CFTC), as of February 2, net long positions on the metal are at a three-month high of 100,566 after rising by 4,821 contracts in only a week’s time. Short bets, on the other hand, declined by 7,412 contracts during the same period.

Negative Interest Rates in the U.S.?

In December, the Federal Reserve bumped up interest rates 0.25 percent, the first time it had done so in nearly a decade. But that doesn’t mean it can’t reverse course, and there’s growing speculation that rates could be dropped below zero into negative territory.

We’ve already seen this occur elsewhere, most notably in Sweden, Switzerland, Denmark and Japan.More than a fifth of global GDP—23.1 percent, to be precise—is now produced in countries governed by a central bank with negative interest rates, according to the Wall Street Journal. In a world where you’re charged interest to put your cash into government bonds, holding gold as a store of value suddenly becomes much more attractive.

I’ve discussed many times in the past that the yellow metal shares an inverse relationship with real interest rates, which is what you get when you subtract inflation from the federal funds rate.

Real Interest Rates and Gold Share an Inverse Relationship
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Negative nominal rates in the U.S. might seem like a far-fetched idea, but the Fed has already hinted that banks should prepare for such monetary policy. (And JP Morgan suggests rates could fall to as low as negative 1.3 percent.) It would be prudent for investors to do the same.

For more, make sure to watch my interview this week with Alix Steel of Bloomberg Television.


Booms, Busts, Asset backing (over Earnings) and what a 2016 Bust might mean for Gold

By Fraser Murrell

A contributed article from Dr Fraser Murrell in Australia, together with an added comment from me at the end on what Dr. Murrell’s thesis might mean for gold. Dr Murrell is an Australian mathematician and quantitative analyst with substantial experience in the financial sector as analyst, broker and trader.

Today, stocks are usually measured by the “Price to Earnings” or P/E ratio. For example, a P/E ratio of 20 means that each extra dollar of Earnings E (per share) increases the Price P of that share by 20 dollars. But this (on its own) is both a volatile and deceptive measure of value.

Another metric is the “Price to Asset”, or P/A ratio. This measures Price relative to the net Asset backing of the share. Assets are the things which companies use to generate Earnings and use to post as collateral to borrow money.

But since 2009, under ZIRP and the direction of Wall Street, many companies have chosen to consume both their Earnings and cheap debt to buyback their stock, rather create long term Assets. Of course, stock buybacks boost the (short term) share price and the director’s remuneration, but do nothing for the long term solvency of the company. With the increase in debt and the lack of Asset creation, most companies are now in a much weaker position than they were prior to the last downturn in 2009, despite that being a near-death experience providing reason to repair balance sheets.

My point is that when Earnings next falter and/or interest rates “normalize” the increased debt will not be serviceable and many companies may suddenly go bankrupt – because they don’t have sufficient unencumbered Assets to use as collateral for fresh borrowing. Equity raisings and the junk-bond market are the last resort for companies needing money and when these markets seize up (as is currently occurring), the collapse begins and then spreads through the economy as the dominoes fall. Only those with sound assets that generate reliable earnings survive.

A more useful investor model is : P = P/E  x  E/A  x  A
As a measure of solvency, some investors (like me) focus more on the quantity and quality of the Assets (A) and on the Earnings on the Assets (E/A) – rather than on the Price to Earnings (P/E), which can jump around (or disappear) from quarter to quarter.

But if we value SP500 companies today (or indeed the USA as a whole) by the metric P/A rather than P/E, then one comes to the conclusion that (because of the current debt levels), when the economy next falters and Earnings fall, the result will be far worse than in any previous downturn. This is because companies have run down or off-shored their productive assets to China and elsewhere and because available earnings have been squandered on share buybacks which fuelled the last boom.

This example makes the point clear. Suppose you buy a house worth $500,000 by borrowing 100% (as Wall St would do) at say a 5% interest rate. Then you have zero  net Assets A = $0 and a negative Earnings E = ($25,000). Now suppose create a business from home that generates an income $65,000, so that your net Earnings are now positive E = $40,000.

Regardless of the assets held, Wall St would (on average) price your enterprise using a P/E ratio of 20 based on your Earnings, making your net worth P = 20 x $40k = $800,000. Or in the case of Face Book and many other companies, it might use a P/E = 100 in which case your net worth is a staggering $4,000,000!  All with no Assets held and a business that could fold at any moment.

But then the next downturn comes and your business not only fails, but your house price drops by 10%, so that you now have both negative Earnings E = ($25,000) and negative Assets A = ($50,000). Which means you are forced to declare bankruptcy.

This is the miracle (or rather insanity) of Wall St – that a company with nothing (except a temporary earnings stream wholly consumed by the company) – can be sold to the public for billions of dollars – based on questionable “P/E ratios” using dodgy Earnings – only for that same company to go bankrupt because it never had or created any Asset backing. The money made by company directors and the losses taken by the general public over history are staggering. That said, there are a few (like Warren Buffet) who do focus on the assets and have been able to create long term value for their shareholders.

What this might mean for gold if markets collapse again

A very concise look by the editor at what could happen to the gold price if the implications of the above article lead to yet another collapse in equity prices as in 2007-9 – or perhaps worse!

The Great Global Financial Crisis of 2007-2009 should still be in the memory of most serious investors although we think the lessons that should have been learned from it have been largely forgotten in the Fed-fuelled euphoria of seemingly endless rising equity prices – well, seemingly endless until last year when prices flattened and have come back sharply in the first couple of weeks of 2016..  As pointed out in  my latest article here:Equities tank, dollar down, gold up, 201 6 is already showing the potential to become an annus horribilis for equity investors should the downturn continue – or horror of horrors, accelerate – particularly if the realisation of what Dr Murrell has noted above begins to sink in.

Let us go back to 2007 – the start of the GFC (although like now the seeds for massive declines had been sown in the years before.).  Here follows a chart taken from The Sovereign Investor website which shows the relationship between the performances of the S&P 500 and the gold price from the beginning of 2007 to the end of 2009.  This just about says it all.  Gold did take a dip in October 2008, mainly due to margin calls with institutions and investors having to sell good assets along with bad to stay afloat,    But it fell less, and recovered far faster, than general equities (and went on to double again in price in the following two years before retracing around 40% from late 2011 up until the present.)  Could we be heading for ‘deja vu all over again!’

sovinvjpgbeen sown in the