Light at the end of the tunnel for gold-mining investors. But first...
ERIC COFFIN, editor of the Hard Rock Analyst family of publications, was one of the first analysts to point out the disastrous effects of gold hedging and gold loan-capital financing in 1997.
Long-time editor of the HRA Journal, Coffin also predicted the start of the current secular bull market in commodities based on the movement of the US Dollar in 2001 and the acceleration of growth in Asia and India.
Today, in this interview with The Gold Report, Coffin implores gold equity investors to ask: Is the project financeable in this market?
The Gold Report: In the Nov. 10 issue of the HRA Journal under the title, "Janet's Kool-Aid Stand", you set your sights and took some shots at US Federal Reserve Chairman Janet Yellen. All the while, her policies have helped bolster the US Dollar, the US stock markets have stabilized after an August swoon and seem poised for further gains. What's not to like?
Eric Coffin: Janet Yellen has done an okay job. The biggest mistake the Fed made was not raising rates in early 2014. The simple truth is that the Fed has cornered itself. It has a major credibility issue given how markets reacted to its wimping out in September. If the market stops believing in its guidance, it has a bigger problem.
Frankly, I'm not as sold as everyone else is on the amount of upside the market has right now. I'm concerned the timing may turn out to be fairly bad for this rate increase even though the Fed doesn't really have much choice.
TGR: What do you think the Fed will do?
Eric Coffin: I don't think this is going to be a traditional tightening cycle where you see a rate increase at every meeting – far from it. After its 25 basis point increase yesterday, the Fed is going to go to extraordinary lengths to convince the market that it's going to be a very slow upward move in rates. It doesn't want to spook the market. It could be quite a while before it raises rates again.
TGR: Can the US Dollar Index reach 120? And if that happens, what happens to gold?
Eric Coffin: If the US Dollar Index goes to 120, the US will go into a recession. The current Wall Street thesis that we're going to see 120 on the Dollar index and a rally on the S&P 500 is utterly delusional. The US Dollar Index could reach 120 but I don't think there's any chance we'll see both. In a recent issue of the HRA Journal, I included a chart from a presentation given by US Federal Reserve Vice Chairman Stanley Fischer. Part of his presentation was on the impact on gross domestic product (GDP) from increases in the US Dollar value. Fed modeling says that a 10% increase in the US Dollar leads to a cumulative decrease of 1.5% in GDP over 12 quarters. If you take the current US economic growth rate, take into account that we've already had a 15% move in the Dollar, and then plop another 20% on top of that, you get a recession.
TGR: And how would gold fare?
Eric Coffin: If the Dollar index goes to 120, gold would be $1000 per ounce ($1000 per ounce), maybe as low as $900 per ounce. But if the market and the economy go lower, I think we're going to see gold move back up again. But just to be clear: I'm not in the camp that thinks the US Dollar Index is going to 120 – that's not going to happen. Odds are that the US Dollar Index may have already topped out. I'm quite aware that I'm a minority of one when it comes to this call. I'm either going to look really smart or really stupid in a couple of months.
TGR: No one talks about bottoms more than gold equity investors. Is this the bottom?
Eric Coffin: Hah! Let's put it this way – if I'm right about the Dollar index, then it may be. Over the last couple of years the tendency among analysts, especially technical analysts, is to keep extending the trend lines. The ultimate bottom has gone from $1100 per ounce gold to $1000 per ounce to $900 per ounce. We're below the level where we're likely to see a meaningful increase in gold production because few projects are going to get financed. But that doesn't matter in the short term.
In the short term, the gold price is mainly sentiment driven. The one positive is that sentiment is so terrible that we have positioning in the futures markets the likes of which we haven't seen since the gold bull market started 14 years ago. Again, that doesn't guarantee it's a bottom but does position us for a rally. In early December Speculators were essentially zero net long, and Commericals (hedgers) were essentially zero net short. It is extremely unusual to see hedgers long and speculators short. That's the opposite of normal market positioning.
TGR: You follow macroeconomic indicators more than most newsletter writers. What are two or three things that Eric Coffin is most focused on?
Eric Coffin: In the US I watch the Institute for Supply Management indicators, both manufacturing and service. The manufacturing index turned negative in the last couple months; service is still fairly strong, although it has dropped too.
I watch the Cass Freight Index because that's a bit more of a coincident indicator. Everyone obsesses about the US payroll numbers. Obviously, payrolls are important but there's a three- to four-month lag there in terms of what the economy is actually doing today.
I'm also nervous about the divergence between the equity markets and the higher yield market. I realize a lot of that is about what's happening in the oil and gas sector because a lot of the high-yield debt is loans to the oil and gas sector. But the divergence is becoming quite large. In my experience it's quite often the debt guys who see market problems first. I'm not saying problems in the debt market guarantee that the equity indices are going to roll over but it's foolish to ignore it.
TGR: What's a telltale sign when you're looking at that market?
Eric Coffin: If you stick an S&P 500 chart and a high yield index chart side by side, you would notice that they tend to move more or less together. A divergence basically started when Quantitative Easing 3 ended last year, but the divergence has become significantly bigger in the last few months. The S&P 500 has been bouncing along its recent highs, yet the high yield index is probably 15% off its high. That's unusual. Either the S&P 500 is going to new highs and the high-yield index will move up again or the S&P 500 will come down to meet it. Historically, more often than not, the S&P 500 comes down to meet it. Keep an eye on that.
TGR: Gold investors don't want to hear that gold is a long play. Is there a near-term investment thesis for gold investors?
Eric Coffin: There are really only two: find companies that have projects with projected lowest-quartile costs and lowest-quartile capital expenditures (capex) – those will be financeable under current conditions – or a good discovery play. Frankly, there haven't been many of those in the last few years.
And compounding the issue is that as the bear market gets longer, it gets tougher and tougher to finance, which means there are fewer and fewer companies drilling.
Another thesis is to find producers with strong growth stories under current market conditions. Those are most likely to give you gains over, say, 12 months if gold more or less stays where it is. If gold drops another $300 per ounce, all the equities will drop with it.
TGR: Uranium is one of the few commodities that seems poised for gains. Please give us a brief overview of how you see the uranium market shaping up in 2016.
Eric Coffin: We have a mined supply deficit, but ever since the Fukushima meltdown in Japan in 2011 two things have happened: uranium prices have dropped significantly and supply has been coming into the market via destocking by different utilities that no longer require uranium following the total nuclear shutdown in Japan and a partial shutdown in Germany. Prices have been declining almost continuously since Fukushima but if you're running a big nuclear plant, the cost of uranium pellets is a relatively small part of your operating costs. Obviously, you'd rather pay $35 a pound ($35/lb) versus $100/lb, but the big factor for those utilities is that they need to make sure they have deliveries.
Utilities commonly buy uranium with long-term contracts, which normally make up about 80% of the uranium market. But in the last three or four years, utilities haven't really deemed it necessary to sign long-term uranium contracts, preferring instead to buy it on the spot market. There is a lot of unfilled utility demand between now and 2025 – some estimates put it as high as 1 billion pounds. The question is when do these utilities start getting nervous and decide to go back into the market to make certain they have enough. There will probably be a slight oversupply next year when you include destocking supply and mined uranium. But 2017 is the point at which you're probably going to see a real price move.
TGR: At what price do new uranium mines get built?
Eric Coffin: If you want to incentivize mining companies to build uranium mines, you probably need a uranium price in the $70/lb or $80/lb range. At $35/lb, these companies are not going to build uranium mines. There will be no new mine supply.
TGR: What's your advice to equity investors in the throes of tax-loss selling season?
Eric Coffin: Try to identify companies that are going to be subject to tax-loss selling but that don't have to finance in the short term. You don't want to be buying into a deal that's going to get hit on tax-loss selling and then have to do a massive placement a month later. So you want a company that's financed to carry it through next year or farther. You also want strong management and projects that look practical at today's metal prices. Then put in a stink bid and see what happens.
TGR: What are you going to talk about at the Metals Investor Forum and why is this different from other resource events?
Eric Coffin: I'm either going to be talking about why I was right about the US Dollar topping or I'm going to be explaining why I wasn't. I think there's real potential that the NYSE topped six months ago and that things are going to look a lot uglier in two months. It's still a 50/50 proposition. It's a fairly dangerous looking market in the US There are very few companies carrying that rally. I don't think we can ignore the potential for a bear market in the near term. That potential is quite real but maybe Janet Yellen can still save the day.
To address the second part of your question, unlike most other resource investor conferences, the Metals Investor Forum brings you a curated list of companies (such as some of the companies I discussed above) followed by one or more of the newsletter editors that host it. It's invite-only for companies and the number of presenting companies is strictly limited. Just as important, it's invite only for attendees and we use a venue that limits the amount of total attendance. This is not about making a room look full. It's about getting the best list of presenting companies and an audience of subscribers that really want to hear their stories together. You can't just walk in. You need an invitation to register and attend.
After the success and positive feedback from our first event, we decided to add a winter event so that our attendees could benefit from our experts' advice during peak investment season. Serious investors have the rare opportunity to meet the companies' executives in person, ask the hard questions and really get to know the people managing your investment Dollars firsthand.
TGR: Thank you for your insights, Eric.