Gold's New Friends
by David Coffin and Eric Coffin
Press rumors of planning meetings to shift crude
pricing away from the US$, plus a 0.25% increase
in Australia’s bank rate, has put some serious
bounce in gold and silver prices. The yellow
metal has convincingly moved past its old high,
in US$ terms, and we expect that move to
continue. Whether the details of the meetings
reported in London’s The Independent are
accurate in every detail or not, markets have
had no problem accepting the basic point that
the greenback cannot expect long term support as
the globe’s reserve currency.
Commodity prices, especially gold and silver,
are very much currency stories. The US Dollar
continues to lose face for a variety of reasons,
with more rapid growth in the creditor and
resource producing nations being the latest.
This, not inflation concerns, has been our
focus. Australia’s increase in its bank rate may
be duplicated in a number of other economies
before Washington gets around to it. This would
continue the downtrend in the Dollar and uptrend
in precious metals no matter what inflation
Lack of high yield alternatives, plenty of
frustrated money on the sidelines and the
potential for “good” earnings (at least by
comparison with the past 12 months) may drive
the major bourses higher yet. This will add more
strength to the already outperforming metals
The biggest potential short term risk is that
Dollar Distaste reaches the bond market and
drives yields higher. That could turn the Dollar
and the stock markets around quickly. Be happy,
but keep an eye on those Treasury yields.
Copper stocks continue to pile up while the red
metal sustains price against US$ weakness. Over
half the stockpile taken down earlier in the
year has now come back into the market. Some of
the stock on offer would likely disappear on a
price decline, or if the current Dollar weakness
turns into a rout. But that has to happen before
we are comfortable with this year’s price gains.
The message since mid July has clearly that
users think the price move has been “too far—too
That remains the case for most commodities.
Traders are playing musical chairs to a tune of
weak Dollar fundamentals against a melody of
uncertainty for demand sustainability.
Notwithstanding our belief that the greenback’s
decline is a longer term phenomenon, we don’t
look for anything to trade in one direction
permanently and this move will be to a new
trading level. We doubt the guy in the last
chair of this round will celebrate for very long
before shifting direction with the herd.
We should note again the continuing calls by the
government for closure of Chinese smelters. This
is due to both inefficiency and overcapacity.
Current stockpiles aside, excess smelting
capacity is not the same as excess metal
producing capacity. The two roughly equate for
some metals, such as aluminum for which there is
a ready supply of input minerals in coastal
regions that could use development funding.
Foundry capacity, or overcapacity, will not
govern iron ore supply for the time being. Most
prospective ore regions need infrastructure to
coastal shipping ahead of any expansion. Longer
term iron ore supply will come from regions that
put that infrastructure, and longer term
contracts, in place. We do still see opportunity
in iron ore, partially because of the politics
that surrounds it.
Medium and longer term copper capacity will be
governed by mine supply, and the long time
frames for large copper mines to come on stream.
Smelters can’t process concentrates unless mine
supply is sustained. The same holds for zinc and
to a lesser extent nickel. We don’t view China’s
push to reduce smelting capacity as a sign the
metals bull has run out of steam. It simply
makes sense for China to shut in costly,
polluting smelters when there is capacity next
door in more efficient Korea and Japan.
Japan’s new government has referenced abandoning
the weak Yen policies of its predecessor several
times now. Given it is supposed to be part of
the talks cited by The Independent and that the
Yen (along with gold and the Yuan) are supposed
to be part of a new “basket” for oil settlement,
that stance is making more sense.
More importantly, Japan’s new leadership has
stated it favors stimulating domestic spending
in order to end a deflationary malaise the
country has lived with for most of the past two
decades. Cheaper inputs for its resource poor
citizens are therefore more important to it than
cheapening the exports market of its high end
producers by devaluing its currency.
These pronouncements have aided the cause of
price support for Dollar denominated global
goods. But, markets are and will continue to
have a tough time with deflation’s poster child
righting itself in the current environment. That
is entirely reasonable given deflation’s shadow
slowly creeps over the western landscape.
However, PM Hatoyama is quite deliberately
shifting sentiment away from a western focus of
the past half century.
At worst this is pragmatic recognition that the
customer base for Japan’s goods has ended its
buying spree. The real message is that Japan is
wealthy and able to chart its own course, once
it has detoxified its bureaucracy from spinning
funds into their retirement companies. There
will be no quick fix from this policy shift, but
it makes more sense than a failed policy
requiring western sales points for its goods.
We can’t overstate the potential importance of
these moves in Japan. This is the second largest
economy on the planet in nominal terms, and yet
one for which concern that a lack of raw
materials supply could hamper its growth spurt
is very much a living memory. It has also seen a
massive growth in ore processing to meet this
concern overtaken in large measure by
neighboring South Korea. We believe a shift is
building in Japan to a much greater emphasis on
its domestic economy, and equally to more focus
on its regional economy. That should mark a
major shift in the geography of country risk,
and a greater acceptance that “Asia rising” is
the global boon we perceive it to be.
So, how does that impact the current gold boom?
It should simply give it a greater head of
steam. Missing from the weakening Dollar
equation was how the other side of that equation
shapes up. Much of Europe was happy to jump on
the cheap debt = housing boom bandwagon, and so
is in no better shape than the US. So the Euro
can sustain only so much upward pressure.
Currencies in the less weakened industrialized
“west” — AUS, CDN, NZ— simply don’t have the
scale for the job. There has been only one
We have said in the past that the only equation
that made sense was Yen strength as a proxy for
Asian growth economies. Most wrote off the
notion because of Japan’s export model. Now that
Japan has a government that is willing to play
that card, the pieces are truly in place for
quick shifts in the FX market. Gold and silver
will benefit smartly from that, and no the world
is going to end as part of the process.
Right how we are seeing a major catch up going
for undervalued asset based companies in the
precious metals space. This part of the up tick
could surprise even rabid bulls. Some more
speculative companies that had been strong
gainers appear to be flagging because of this,
but that won’t be permanent. Speculative gains
should be moved to companies with more solid
outlines, but as the asset based companies get
closer to full price funds will flow back to
If you are a trader, the shift from one play to
the next could get dizzying. If you aren’t, then
view this as a “stay the course” moment for
precious metals. Expect some significant pull
backs as traders take gains, but these will be
in the context of a rising market for some while