Gold & the Dollar: What Changed?

Negative interest rates, which the Dollar now offers, are always bullish for Gold...

ADRIAN DAY, a pioneer in global investing with a reputation for discovering big winners, is president of the eponymous asset management company, running investment portfolios in resource and global equities.

   Here he gives The Gold Report his insights on Gold and what the junior gold miners need to get going again.

The Gold Report: So what's your take on where we are with the markets...you think we'll see a change soon?

Adrian Day: People are still very, very concerned about the Dollar and inflation, and rightly so. The core Consumer Price numbers were up 0.7% in one month – a high number. That may have been a monthly anomaly, but it's very clear that the trend in prices is up.

   We are seeing a pick-up in inflation just in the United States – and this is what's important – but all around the world. I realize, of course, that rising prices are not the same as inflation. But we are seeing rising prices in pretty much all areas of the world, and they are going up faster than the central banks themselves have targeted.

   With all the credit problems we've seen over the last 18 months and all the money that's been put into the system, I don't think that's going to change in the near term. So that's a bullish sign for Gold. Inflation is a factor we haven't had in the Gold Market for quite some time.

   The Dollar is even more important, certainly for the next six to twelve months. And, again, in terms of the long-term fundamentals, I don't see that anything has changed. All we're seeing in the Dollar is a very overdue correction to the long-term downtrend.

   To me it's much more a correction in the strength of the Euro than a correction in the weakness of the Dollar. I don't think anyone's rushing into the Dollar because they think our economy is strong and getting stronger. They are perhaps cautious on some of the foreign currencies, which have simply moved too far, too fast. It was an overdue correction, which came a lot later than I thought it would. And it would be a mistake to expect it to turn around after just a couple of weeks.

   But if we look at the long-term fundamentals, the US economy is still fundamentally weak and it seems like with every passing week there's more bad news that's worse than the news before. We are a long way from the bottom in both the economic decline and the credit crisis in the United States, and there's no particular end in sight.

   The Dollar has to go down over the next 12 months and that's going to be positive for gold, no question. The low interest rates and the higher inflation numbers mean that at the short end we have negative rates right now. There might be a bit of a lag, but negative rates are always bullish for Gold.

TGR: September is here. The Canadians are going to be returning from summer holiday. Do you think this year is going to be similar to past cycles, where in the fall we see increases in Gold purchases and the juniors, or do you think there's going to be a disconnect this time?

AD: That's a good question and a bit imponderable. Usually it's very strong in the fall, and we should have already bottomed. What's happened this time that's different is we've got the Dollar correction and, a correction in the strong Canadian Dollar as well. And that's come at the time when you would otherwise expect Gold and gold stocks to be seasonally strong.

   Canada has housing problems and credit problems like the US, although not to the same extent. There might be a different mood this time and there's no evidence so far that we're seeing buying returning to the junior gold mining sector. And, remember, it's not as though the juniors were strong before the summer started, so I'm a bit concerned that we may not see that increase in the junior market.

   With Gold itself, the weaker Dollar does actually have one huge benefit – an obvious one – which is that it makes physical buying of gold actually cheaper. The Indian market especially tends to be fairly price sensitive. When gold went over the $950 level on the way to $1,000, there was very strong evidence that the Indians started holding back purchasing. Now that gold has fallen under $850 again in the last few weeks, there's evidence that the Indians have started buying again in heavy numbers. So a stronger Dollar will actually help the Gold Market, but it may not help the gold stocks.

TGR: So you're saying the stronger Dollar would help ETFs, coins or actual Gold Bullion?

AD: It would help them all because of foreign buying. I don't know about Gold Coins, but it would certainly help the Gold ETF, of course, which simply reflects physical gold.

TGR: So we've got political crises, major deficits, and central banks printing money. You would think gold would be at an all-time high. What type of event has to occur to change this? It seems like we're in a perfect storm.

AD: It's important to give it some historical perspective. There have been a lot of graphs appearing recently showing how gold broke through its 50-day moving-average, then its 100-day moving, and finally its 200-day moving-average. I looked back to the middle of 2000, however, and what really stood out on that graph was that for four or five years gold moved up and down, but very close to a basic straight line, a trend line that was moving steadily upward.

   Then, at the end of '05, it started moving above that trend line, until in the middle fall of '07, it just shot up. What is happening right now is reversion to the mean. Gold simply overshot – it wasn't necessarily completely clear to all of us in the gold market, watching it day-by-day, week-by-week, month-by-month.

   Taking a longer-term look, it becomes abundantly clear the gold way overshot and went parabolic. Now it's simply coming back to that long-term trend line. So I'm not overly concerned about gold.

   The seasonal thing has thrown all this for a loop. If this had all happened three or four months ago, I'd have been firmer in what I was saying. I don't think we can necessarily expect it to turn around suddenly after the kind of damage that has been done. I don't think a particular event's going to do it.

   Going back to the long-term graph, if gold just does some time between, say, $750 and $870 or so, whether it's three to five weeks or maybe two or three months, gold will be ready to move back up again because all the fundamentals favor gold. The bigger concern for us is the gold stocks. And you have to look at the seniors separately than the juniors.

   It's a little easier to see all the reasons why the senior gold stocks as a group, with some exceptions, of course, have not really kept up with gold. The gold miners have not had such an easy time of it of late.

   It's been more difficult to raise money and get permits. Permits have been delayed, mines have been expropriated. Mining is a much more difficult business than it was and it's much more costly. So as gold moved up, so too did all of the input costs; primarily, energy, which is the number one input, and number two, the costs in local currencies – the Australian Dollar, Brazilian Real, Canadian Dollar...all of those are very strong currencies in big Gold Mining countries. So the margins were not expanding the way that you would think they were.

   And that's only talking about the cash cost of producing an ounce of gold out of a producing mine. There's also keeping a sustaining business going, finding a new deposit, and so on.

   The juniors are the more problematic because, in most cases, there simply isn't volume in these stocks. The occasional stock will do well based on some particular exciting prospect, but they are becoming increasingly few and far between.

   As we all know, the irony is that sometimes companies will release relatively good news and the stock goes down. It just reminds people that they own the thing. And then there are other companies, of course, that don't have particularly good news to put out. There just isn't any volume; the only volume I see are in stocks that are going down.

   So the question really is when that is going to change and what we do about it. Certainly, if gold goes back over $950 or $900 and stays there, we'll see more interest, especially if everything else is still relatively weak. Typically, people are attracted to the gold stocks when gold is strong and other things are not so strong. But if the tech stocks are strong and the Dow is strong, people tend not to invest in junior gold stocks to the same extent. Similarly, if Gold is strong, but everything else is very weak and people are worried about the overall environment and looking for liquidity, you can't expect the junior gold stocks to get that liquidity. That's fairly obvious.

   The other thing that's going to happen increasingly is larger companies taking over juniors and explorers. We know they are looking; they need the reserves and many of the explorers are very inexpensive. A few takeovers in rapid succession will likely bring interest back to the sector.

   The good thing is that investors can buy truly good quality juniors at remarkably cheap prices. If you can focus on companies that you know don't have to raise money and they're cheap and you're patient, you're going to do very, very well indeed.

TGR: Adrian, this has been great per usual. We appreciate it.