CPM Group's Jeffrey Christian on why he believes the Gold Price has hit a cyclical peak...
BACK IN 1986, Jeffrey Christian founded precious metals consultancy CPM Group after serving as head of commodities research at J. Aron & Co., which was acquired by Goldman Sachs. CPM was formed in turn through a management buyout of the commodities research group of Goldman Sachs.
Christian, a frequent media commentator, is recognized as a leading authority on gold and in commodities in general. In this interview with Hard Assets Investor, Jeffrey Christian explains why he thinks the Gold Price has hit a cyclical price peak, how rising interest rates will be good for gold and how Gold ETFs offer a daily snapshot of the gold market...
Hard Assets Investor: In the CPM 2012 Gold Yearbook, you state that gold is at a cyclical price peak. Can you explain please?
Jeffrey Christian: We do a bottom-up, microeconomic analysis of the individual market, looking at every aspect of the market: supply, components, demands, central banks in the case of gold, investment demand. And then we do a top-down macroeconomic view of where the world is going. Now, with gold, the primary factor determining prices is investment demand. And investment demand is, in turn, driven by investors' perceptions of economic conditions.
Economic conditions are important in flavoring those perceptions. But the perceptions can diverge from economic reality, and in significant ways. We're saying the gold market has been in a very strong bull market for 11 years now, driven by investors who have felt compelled to Buy Gold because of one economic or financial or political disaster after another, just going back to the tech-stock boom & bust and subsequent stock market crash and then the recession of 2000-2001, which then went to the 9/11 crisis, and then just one thing after another.
Going forward, we think investors are going to continue to want to buy historically large amounts of gold, as they have over the last 11 years, but that they will become more price-sensitive. And what you saw last year was that investors were Buying Gold in a price-insensitive fashion: "I must Buy Gold today, regardless of the price because tomorrow, the Euro or Greece or the ECB or the Dollar or the Treasury or international banking is going to collapse."
And you really saw that in July and August. In the first half of last year, prices were rising at a relatively steady, nonvolatile fashion. And then in July, people said, "Wait a second, we're a month away from the debt ceiling deadline in the United States and these guys [lawmakers] aren't doing anything." Then we had this joke of an agreement on Aug. 2, and then on Aug. 5, the Treasury was downgraded for the first time in history. People were in a panic, they were Buying Gold and drove the price up from $1,500 in the beginning of January to $1,900 in the beginning of September.
By mid- to late-September, I think investors sort of collectively heaved a sigh of relief. You had this sea change in investor attitudes where people said, "You know what? The world is faced with really major problems and these problems are long term in nature. And the solutions are going to be long term in nature. It's not that I had to Buy Gold today, because tomorrow everything is going to collapse. I need to Buy Gold and hold it for a long time to come, because these problems are going to be with us a long time."
What we've seen since September is that investors have become extremely price sensitive. When the price spiked down in late September, investors stepped up and they bought a lot of gold — coins, ETFs, physical gold. When the price spiked up in late October/early November, they backed away. When it came down in early December, they bought more. When it went up in December/January, they backed off.
So we're seeing investors continuing to buy a lot of gold. But they're doing it in a much more price-sensitive way. They're buying on the dips and they are also pulling back. In late February, when the price of gold shot up to $1,792/oz., investors were just not buying. It wasn't that they were selling, they just weren't buying. When the price came down $100 in the ensuing two weeks, you saw a surge in coin purchases. You saw a surge in investment — and we had 1.2 million ounces of gold added to ETF holdings in one week, in the middle of March. And that's incredible. So that tells us that we were right to think that investors are shifting to this longer-term perspective with greater price sensitivity.
HAI: Do you think interest rates will rise this year? And what impact will that have on gold?
Jeffrey Christian: I think rates will rise very little this year. We're looking for rates to rise further in 2013, 2014, 2015. And I think the initial response may be a little bit of a jolt to the Gold Price, knocking it down. But then investors will turn around and it will be a positive dip for gold. What investors will realize is that rates are not rising in a vacuum. For interest rates to rise, we have to have a much stronger economy. We have to have some fear of inflation on the part of monetary authorities.
The man on the street — in fact a lot of men on the street — are very much concerned about inflation. But monetary authorities are looking at things in a much more studied and nuanced fashion. They haven't been concerned about inflation. In fact, they're still more concerned about deflation than they are about inflation. So, for interest rates to rise significantly, I think you would have to see that monetary authorities are worried about inflation.
You also have about a 3 percent negative real interest rate in many parts of the world right now. Or, in the case of China, it's about zero percent. So if the interest rate rises 3 percent in the United States, yes that's a significant increase, but you're going back to a zero percent interest rate on an inflation-adjusted basis.
No one is going to buy Treasurys because they're going to lose money on it. They're going to wait until interest rates are 6 percent or 9 percent before they really pour into Treasurys.
HAI: For all the waxing and waning we've seen in Gold Prices recently, investors have really stayed in gold ETFs as a whole, particularly in SPDR Gold (NYSE Arca: GLD). Does that help with the price floor?
Jeffrey Christian: First off, ETFs account for about 15-20 percent of physical demand for gold. So you still have the bulk of gold not being bought through ETFs. One of the interesting things about gold ETF investors is that they Buy Gold, they don't sell it. They very rarely, as a whole, are net sellers of gold.
I'll make two comments when it comes to gold ETF investors. First, we don't know who exactly these people are. It seems like they are new investors to physical gold. So we don't know how committed they'll be. If they are like the other 80 percent of the gold investment market, they'll probably be very sticky, and they'll keep the gold. But we really don't know. So there is that risk there.
Now, if you look at the last six months, after the price peaked and came down, you saw some the hot money, the technically driven, price-momentum-driven hedge funds getting out of ETFs. But the total amount of gold held at ETFs basically stayed flat during that period of time, because other investors were stepping up and buying it. We think that these investors are probably going to prove to be pretty sticky holders as a collective group. The second thing, which is the other issue, is that ETFs give the gold market what it's never had before: a daily count of physical demand. Maybe not all physical demand by investors, but at least it's a portion of it.
Gold ETFs have an outsized influence on investor perceptions about Gold Prices. Now you've got 15 percent of the market showing the market what they are doing. And a lot of people assume that that represents 100 percent of investment demand.
HAI: Bank of America is still calling for $2,000/oz. gold this year. Is that just a bridge too far in your view?
Jeffrey Christian: At the beginning of the year, our view was that gold could ostensibly spike up to $2,000 an ounce. We don't think it's going to happen now. We think that gold probably might spike up to $1,800 or $1,820 or something like that. But it's probably not going to get up to $2,000 at this point.
HAI:I want to talk a little bit about US debt and its effect on gold. Projections show, obviously, an increase of debt going forward. Why isn't that enough to support Gold Prices alone?
Jeffrey Christian: Well, first off, there are two issues. The first one is the debt. And the debt is problematic. From a long-term perspective, you should look at not only US federal debt, but total debt around the world, including Europe and Japan. And you should say, "This is a big problem that suggests that Gold Prices should be supported."
And understand, we're not looking for gold to fall back to $1,000 or even $1,200. We're looking for gold to stay above $1,400 for the next decade. The debt problem should be seen as being supportive of Gold Prices, but not necessarily driving it higher. The reason is that the US economy has a tremendous capacity to pay down that debt. We're not using that capacity, but if you go back to the 1990s, the marginal tax rate was raised from 35 percent to 39.6 percent. And we went from a $300 billion deficit to a $300 billion surplus on the federal level.
We could raise our marginal tax rate back to the Clinton 39.6 percent rate and lop a third of our deficit off right there. We could get our troops out of Afghanistan, and the rest of them out of Iraq that we secretly still have there, even though we say we've already pulled them all out, and that would take off another third of our debt. So we have the capacity. And we could change our tax laws, so that corporations get taxed.
Then, all of a sudden, you have a surplus again. We have the capacity. And I think investors around the world know that. So there's not this panic about the US debt, it's a concern. Now, I'll throw out another trite fact.
People talk about how half of the US Treasury debt is owned by foreign investors. That's actually a misnomer. Half of the US Treasury debt is owned by offshore investors. Most of those are actually US corporations, pension funds and high-net-worth individuals who are holding their money offshore. So when people say, "If the Chinese get disgusted with us, they'll sell their US Treasurys and it will really whack the market." The Chinese are not the guys holding this debt. They do have a lot. But the bulk of it is held by US corporations offshore to avoid taxes.
Obviously, debt affects the Dollar. But the Dollar is reciprocal of other currencies.
Eighty-five percent of the world's wealth is held and denominated in US Dollars. There is no alternative that's readily liquid. You can have the debt problem continue to be an issue and a problem. But it may not affect the Dollar immediately.
HAI: Do you think central banks will continue to be net buyers of gold over the next few years?
Jeffrey Christian: Yes. In our 10-year projections, we have central banks buying about 100 million ounces of gold over the next decade. The problem is that you can't say when.
HAI: You're more bullish on gold miners, I believe, than most people. Is it because of what you just talked about, in terms of gold buying slowing down?
Jeffrey Christian: Yes. I would qualify it and say that I'm more bullish about some gold miners. I think you've got to be very selective. Gold Mining stocks have suffered for a couple reasons, one of which is that investors haven't had a lot of confidence in the management of many Gold Mining companies. And that's going to continue to be a problem.
But if we're right, and the Gold Price has reached a cyclical peak — but it's going to stay above $1,500/oz. and the average Gold Mining cost is about $660 on a cash basis — $800 on a fall-in basis, at $1,600/oz. and $800 fall-in cost, the average mining company has a 100 percent profit margin. At some point, that profit margin should be reflected in dividends and acquisitions, and also further business growth.
If you think that there are some mining companies out there capable of running their businesses, they should do very well in an environment where the Gold Price stays approximately 100 percent higher than their total cost in production.
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