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With the Bre-X scandal still on the minds of many Canadian investors and the price of gold mired in a nearly 20-year funk, I half-jokingly asked the question to a precious metals analyst in 1999: ‘got any junior tips?’ The silence was palpable.
 8-years later and PricewaterhouseCoopers recently reported that for the year-ended June 30, 2006 the top ‘juniors’ on the TSX Venture Exchange attracted more than $1.2 billion in capital, or nearly triple the amount raised only one year earlier. Could these massive inflows into the largely speculative ‘juniors’ be the result of a unsustainable investor frenzy? Few seem to think so. In fact, one of the most prominent precious metals managers today, Sprott’s John Embry, recently had this to say (transcript):
“I really do believe that when the gold market takes off from current levels that these [juniors] are the stocks that are behind the market. In fact, I find many juniors as cheap and shunned as they were at the bottom of the market – at the out set of the whole bull market.”
In reaction to the above bold it would logical to conclude that Mr. Embry doesn’t realize that as recently as 1999 mere mention of companies drilling wholes in the ground was cause for laughter. However, given that Embry has been with Sprott since 2003 and “has researched the gold sector for over thirty years”, it is more likely that he is appraising companies based upon his expectation for an even higher price of gold.
The Case For Rising Gold
The main reason for a stronger price of gold is that the U.S. dollar will weaken further. As Embry recently noted, “In reality, it isn’t the price of gold that changes but the value of the paper currency in which it is denominated.”
Beyond the inverse correlation to USD, the next potential drivers are the ‘fundamentals’: central banks have, reportedly, less gold to sell, investor demand is expected to pick-up this year, commercial de-hedging is expected to continue, and mining supply is expected to remain flat. Should these fundamentals hold the price of gold could trade higher in the coming months. Another, albeit unquantifiable ‘fundamental’ worth considering is that of central bank reserve diversification. The general trend here has been for banks to hold more Euros and gold (as a percentage of reserves) versus fewer USD.
The final potential driver of gold is the destruction of a massive naked short position. It has been strongly, and convincingly, contended for a longtime (by the GATA, Embry, Venreoso, and Butler), that precious metals prices are secretly manipulated by central banks. The story goes that as, not if, these manipulators lose control of the market prices will head higher in dramatic fashion because the paper gold short in the market can not be readily covered with the psychical metal.
Concern Amidst The Bullishness
Whereas 8-years ago another precious metals analyst or commodities arm being sacrificed led to the contrarian speculation that a bottom in precious metals was close, today every bug seems perfectly at ease with the fact investors and analysts are nearly universally bullish on precious metals. Part of the rational supporting this bullishness seems to be that a commodities supercycle in play; that while the pendulum may have swung from pessimism to optimism the commodities uptrend ensures that it has not swung nearly far enough. Echoing this belief is not only Mr. Embry, but the likes of Merrill and Goldman, not to mention the much watched GFMS Survey.
“It’s looking pretty certain that the record in terms of the annual average, $614.50 back in 1980, is going to fall this year. I’d also be far from surprised if this year we saw the market moving above the 2006 high of $725….I’d certainly expect the upward price trend to continue on into 2008”.
Philip Klapwijk, chairman of the independent precious metals research consultancy. GSMS
Along with a basic ‘contrarian’ argument - or that with so many bullish the outlook could turn bearish – there is also the observation that precious metals ‘manipulation’ may not be so much a positive going forward as a negative. Indeed, if central banks really are in collusion to keep the price of gold under wraps, is it really wise to bet against them? (to note: the phrase is central banks – plural – meaning the monetary system as we know it must be destroyed/altered in order for this collusion to end).
Bug Sentiment Shift Looms
If gold prices stay at current levels for the next week, the price of gold will register a year-over-year decline for the first time since January 2005 and only the second time since the gold bull began in 2002.
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Don’t get me wrong, I still own gold/silver, and the last 12-months could certainly turn out to be a healthy consolidation before another wave of new investors arrive and chase gold to record heights. After all, with the threats of protectionism, stagflation, and central bank reserve diversification intensifying, the day when a mad rush out of USD transpires could be near.
Even so, as Embry* displays shades of Blodget and is applauded by many investors as being the ‘Godfather of Gold’, it is worth remembering that a contrarian bet precious metals are most certainly not. And although it may be naive to suggest that the gold bull has expired simply because prices are flattening on a year-over-year basis, a prolonged price pause nonetheless increases the odds that the investor rush into precious metals has already peaked.
In short, we are at the stage when with so many investor’s expecting record highs, record highs are the required ingredient to sustain current price levels. And with gold once again eyeing $700 an ounce – a level previously attacked by COT – what happens in the coming days, not weeks, may ultimately determine whether bugs enter summer with a feeling of disappointment or elation.
* I happen to think that Mr. Embry is one of the most knowledgeable precious metals/juniors analysts in the business. That he is still exceptionally bullish on gold and silver is undoubtedly why he ignores the contrarian perspective.
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