Gold News

Gold $1400 Within a Year

But only with a risk of $900 first, says this mining fund manager...
RANDALL ABRAMSON, CFA, is CEO and portfolio manager of Trapeze Asset Management Inc., a firm he cofounded in 1999 shortly after founding its affiliate broker dealer, Trapeze Capital Corp.
Named one of Canada's 'Stock Market Superstars' in Bob Thompson's Stock Market Superstars (Insomniac Press, 2008), Abramson now freely admits that we are living through the summer of discontent in "Commodityland". Which is why here, in this interview with The Gold Report, he says investors should step back and look at commodities, especially gold, from a macroeconomic and historical perspective...
The Gold Report: July 13-20 was an unusual week in the gold market. In a May newsletter to Trapeze Asset Management clients, you argued that the glass is "half full" for investors given current macroeconomic signals. Much water has traveled under the bridge since. Has your view changed?
Randall Abramson: Our view has not really changed. We rely on certain macroeconomic tools to show us red flags. One is our economic composite that looks at both the US economy and economies around the world. Our economic composite tool currently forecasts smooth sailing with no red flags.
From a stock market perspective, our relative indicator momentum, which is our other macro tool, only shows Brazil and Russia on sell. The only other market on our watch list recently was the Chinese market. It came down to the bottom of its TRIM line but didn't break through. In fact, it did a perfect bounce off of the bottom. I'm hoping that indicates that what we've seen recently in commodity prices is overdone.
That said, we do not like recent action in the Australian and Canadian Dollars. Both currencies can portend further economic weakness because both countries are essentially hewers of wood and drawers of water-economies based on the extraction of natural resources – and we are cognizant that the commodity-hungry Chinese economy is clearly slowing, though it is still performing at a significantly higher rate than those in the rest of the world. Perhaps that's causing some of the weakness in "Commodityland." But according to the signals, the glass still seems half full.
TGR: How do you explain the recent 4% drop and five-year low of the gold price to Trapeze clients?
Randall Abramson: That drop happened in a flash – a veritable flash crash, almost 6% – then gold rebounded to be down only half that amount on July 20. The timing and size of the multi-billion-Dollar order responsible for that drop made it look as if it was designed to spook the market. I'm not sure whether it was forced or orchestrated selling.
TGR: What's your best guess?
Randall Abramson: It looks orchestrated given the timing, but I'm more focused on the second part of your question – the five-year low. What happens on a day-to-day basis is difficult to put into perspective. It's easier to put into perspective where we've come from and where we are today. We came from a place where a number of commodities were overbought in 2011 because they had bounced significantly from their respective lows in 2009. Gold and silver, in 2011, were selling above their marginal cost of production and way above the average cost of production – gold normally sells for its marginal cost of production, which is usually about a 30-40% premium to the average all-in production costs.
Today, the gold price has fallen back to the average cost of production. That's unusual. That means that on average there is essentially no free cash flow being generated by producing gold. We've overshot to the downside. Could we have a further overshoot? It's possible. If gold broke much below where we are today, it could go to $900 per ounce or slightly below. I don't believe that's going to happen because it would be virtually unprecedented, especially when we're not living through a major dislocation like a global recession, for example.
TGR: Do you expect further weakness in the Chinese economy to bring further weakness to Commodityland?
Randall Abramson: If there is significant further weakness, the answer is yes. There is still significant physical gold demand in China, both from the central banks and the public. If there was further economic weakness there, perhaps gold demand would further increase.
TGR: Do you see gold's drop as a US Dollar story given that the gold price has fallen 40% in US Dollar terms from its 2011 peak versus, for example, a 20% drop in Australian Dollar terms over the same period?
Randall Abramson: It's a combination of factors. The first factor is that inflation is low. We still have inflation, but each year over the last few years, the inflation rate has declined. So we have disinflation but not outright deflation. Maybe the commodity prices are telling us that we're about to have deflation, but that's something the central banks would fight tooth and nail, so I don't think it's a likely outcome. But that doesn't mean that it couldn't occur, at least for a short period.
The gold price coming down is a function of low inflation, which affects demand at the margin because there's less hoarding. The other factor is that the gold price went too high too soon in 2011. Financial markets always tend to overshoot and undershoot around the mean. Gold will eventually go back up to about $1400 per ounce again because that's where it needs to be to meet yearly demand.
TGR: How long do you expect that to take?
Randall Abramson: I think it's going to happen over the next 6 to 12 months; I just don't know whether it's heading lower first. I suspect not. At the margin, exchange-traded funds have been dumping gold because hoarding has been shunned with the price declining. That's not necessarily a bad thing. That could be a sign of a capitulation. Gold has not really behaved all that differently than oil, which was also above its marginal cost of production, reverted to it and then went down through it. The difference is there was an oversupply of oil in the US, which is now being alleviated. The US Dollar has clearly been a factor in the low gold price too, but I don't think it's the driving factor.
TGR: You said gold could hit $1400 per ounce in the next 6 to 12 months. Do you see it higher than that in the medium term?
Randall Abramson: If history is any guide, the gold price is typically 30-40% above gold's all-in sustaining costs of production. And if the all-in sustaining costs today are somewhere around $950-1050 per ounce industry-wide, then $1400 per ounce gold is where we should be. In the months to come, that's the magnet that's going to pull the gold price higher. After that, it should rise by the inflation finding costs, which over the last 15 years or so have grown by about 7-8% a year. The main reason for that has been higher energy costs. And there have been few major discoveries, so that alone drives up the cost per ounce.
TGR: The flash gold sale and some gold reserve numbers out of China seemed to spook the market, but was it part seasonal, too?
Randall Abramson: Possibly, yes. But August is almost always the best month for gold. I'm hoping that we get a nice big bounce into next month.
TGR: The last time gold was this low relative to the S&P 500, it signaled that it was time to buy gold. Do you see the recent gold selloff as another buy signal or do you see further downside risk?
Randall Abramson: Unless there's something that's going on that we don't know about like outright deflation, this is the time to be buying gold.
TGR: Reuters says about $3.2 billion in mining mergers and acquisitions (M&A) has occurred this year versus roughly $4.4bn in all of 2014. Will the drop in gold push the pause button on M&A?
Randall Abramson: Probably, because normally boards of directors tend to react when things are going well. That's when business combinations take place. M&A often marks the top, not the bottom, of a cycle in virtually every industry unless a company swallows up somebody in a distress situation.
TGR: What is the best strategy for gold equity investors at this point?
Randall Abramson: The best bet is always to have low-cost producers with solid balance sheets because both of those items will give you staying power.
TGR: We are in the dog days of gold's summer of discontent. What would you say to the remaining investors in the space?
Randall Abramson: Unless we're into something different this time – which could be an outright deflation because I can't think of anything else that would cause everything in Commodityland, not just gold, to suddenly start trading below their respective average costs of production – then we should be seeing the lows right here. It does not appear that we are in a global recession. Au contraire, there are signs of a global acceleration after the mid-cycle slowdown we've been living through.
August is typically a good month for gold and the US Dollar appears set to peak given that it's overvalued, stretched, and the US government and US Federal Reserve probably would prefer a weaker US Dollar. The average global all-in sustaining costs to produce gold are always growing and normally support the low in the price of a commodity. We are at or slightly below that mark. If the global economy even slightly picks up here, perhaps that leads to a little more inflation and allows the supply and demand equation to rule the day.
TGR: Thank you for your insights, Randall.

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