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08 July, 2013
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- Why I'm not selling my physical gold
- Could the FTSE hit 7,000 this year?
- How to value a company using discounted cash flow
- Friday’s close: FTSE 100 down 0.7% to 6,375... Gold down 2.14% to $1,223.20/oz... £/$ - 1.4890
From Dominic Frisby, in London
Dear Buzzhairs Buzzhairs,
When I first bought gold - way back when - I bought physical metal, mainly in the form of old sovereigns.
I did this for three reasons.
First, because, being legal tender, they're exempt from capital gains tax.
Second, the coins were all Victorian. Despite being over 100 years old, they were selling at little more than the value of their bullion content. Rightly or wrongly, I figured that one day, being antique, they might fetch some kind of premium or ‘numismatic’ value.
Third, and most of all, because I know what I'm like.
What do I mean by that?
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I bought gold coins deliberately, because I wanted to have something that would not be easy to sell. I couldn't just click on a mouse. I would have to travel miles and miles to the distant wilds of the north, find the tree ten paces north of where my hoard is buried, dig it up, and then take it in to a bullion merchant.
I did this to prevent myself from selling too early, or being shaken out of my position. It was an insurance against myself.
Earlier in the year, I said that if gold breaks below $1,500 an ounce I would sell, because I didn't want to give back all the gains I had made over previous years. But in April, when the gold market plunged through that level – falling by over $200 in just a few days - the market moved too fast for me to do anything. In fact, I still haven't got my act together to dig up said gold and sell.
What I've done, unwittingly perhaps, is to turn myself into what is known as 'a strong hand'.
I may be quite easily influenced - most of us are – but the fact is that selling my gold would be such an undertaking that this is gold that is very unlikely to ever come to market. I'm going to really need the money for something else before I sell it. In fact, I'll probably end up just passing it on to my children.
But the guy who's spread-betting gold, the guy who's buying and selling futures and options, the guy who's trading exchange-traded funds (ETFs) - these are all ‘weak’ hands, because the positions are so trade-able.
I remember one occasion when I used to spread bet gold. I walked out of my house, resolutely determined to stick with a position. By the time I'd got into the car I was on the phone to MF Global (yes, them) telling them to sell. That’s not what you'd call a strong hand.
Gold is moving from ‘weak’ hands to the strong
I'm saying all this for a reason.
Since the end of 2012, a huge amount of gold has been sold. I’m going to ignore all the derivatives – the options, the CFDs, the spreadbets and the futures – because that is not real gold.
But the gold sold by the ETFs is real gold. And the ease with which one can buy and sell it means that it is ‘weak hand’ gold - even if the person who bought is strong-minded and resolute, it’s easy to evacuate in the grip of panic.
Since mid-February, about 550 tonnes (around 19 million ounces) of gold have flowed out of ETFs, according to Natixis analyst Bernard Dahdah. Barclays Capital has the number at 500 tonnes. That's just under a fifth of current annual production (around 2,600 tonnes - a number which is going to be a lot lower next year).
The largest ETF of all, GLD (NYSE:GLD) – which was at one stage not just the largest gold ETF by market cap, but the largest ETF of all – has since December 2012 seen its holdings fall by nearly 400 tonnes, from 1,353 tonnes to 965 tonnes (around 31 million ounces).
For every seller, there’s a buyer. All that physical gold has been bought by someone.
It's hard to know exactly who. Some funds, such as David Einhorn's Greenlight Capital, are believed to have sold ETFs and rolled their position into allocated physical. Central banks are net buyers too.
And, of course, many retail buyers, particularly in Asia, have increased their positions quite dramatically since April, swamping bullion dealers.
Although the most recent sell-of has not met with the same volume of physical buying, in April Chinese consumption was 137 tonnes, double a normal month. In other words, the incredible volume of gold that has traded hands over the last few months has seen a transfer from ‘weak’ hands to ‘strong’ – and probably from west to east as well.
Even central banks can be considered strong hands. Despite our own experience with Gordon Brown, central banks do not sell gold lightly. It takes meetings and approvals and goodness knows what else. It’s not something that’s done at the click of a mouse.
Not all ETF gold will get sold. But more of it will be, if gold's declines continue. If all of GLD were liquidated and bought buy Asians, 31 million people would have to buy an ounce each; or 3.1 million people ten ounces. It would take a while, a year maybe, but the numbers aren't so impossible. China's imports in 2012 were 27 million ounces while India's were 30 million (a number which will fall in 2013 due to its new import taxes).
What happens when people need gold again?
Meanwhile we have the issue of mining. The dreaded words 'care and maintenance' are appearing more and more frequently across mining company news releases. Mines are being shut down the world over. Funding has dried up. Projects are being axed.
Even though industry figures suggest that it costs about $1,200 on average to get an ounce of gold out of the ground, the reality is quite different, as Mark Mahaffey of Hinde Capital argues so eloquently on his blog. When you factor in all costs, including cock-ups, the break-even price on gold mining - ie the price at which companies are left with free cash flow - is $1,750 per ounce.
Most gold miners cannot survive for much longer without dramatically higher prices. In other words, production is going to fall by a lot.
However, there will come a time – maybe not next week, nor even next month – when people are going to want gold again. Perhaps we’ll see a fresh spate of bank runs, triggered by the end of quantitative easing. Perhaps all the printed money will finally hit the real world and give us consumer price inflation. Or perhaps the People's Bank of China will finally announce how much gold it has, and the number will be surprisingly high.
I don't know what the trigger will be. But suddenly all that gold that was sold is going to be in strong hands: including idiots like me who never get round to digging up their stash.
What's more, new supply from mines will barely exist. What happens to the gold price then? Those kind of situations are the foundations on which bull markets are built.
For now, I'm not convinced this sell-off is done. We may even have to go back to $1,050 or, heaven forbid, $700. Gold is so incredibly loathed and unwanted just now. A strong downtrend is in place. Counter-trend rallies are anaemic.
But I don't know for certain where the end will be, and nor does anyone else. It could be that the selling is all done already. Meanwhile the foundations for another bull market are slowly falling into place.
So, my current view is, given the expense involved, the time, and the magnitude of this bear market so far, it's just not worth selling your physical gold, unless you really need to. Better to carry being a stronghand.
Finally, a quick word on my book, Life After The State. I'm delighted to say that, finally, it is making its way to the lay-out people and the printers. But you can still order one of the special first editions, and get your name printed inside, before the trade edition comes out. Just click here and sign up - Many thanks!
Editor's note: If you're interested in holding gold as insurance against financial catastrophe, I think you should see what our 'City Insider' Tim Price has to say. An asset manager in charge of more than £1bn, Tim believes there are three major threats to your wealth right now, with gold being one of the assets you should hold onto for dear life. You can take a look at his free report about it here.
Got a comment on this article? Leave a comment on the MoneyWeek website, here.
Until tomorrow,
Dominic Frisby
MoneyWeek
Our recommended articles for today…
Could the FTSE hit 7,000 this year?
- Looking at the FTSE 100 from a fundamental valuation perspective, there's every reason to believe it can blast through the 7,000 mark, says Bengt Saelensminde. Could the FTSE hit 7,000 this year?
How to value a company using discounted cash flow
- Every investor should have a basic grasp of the discounted cash flow (DCF) technique. Tim Bennett explains how it can be applied to valuing a company. How to value a company using discounted cash flow.
And for Friday’s market update, see below…
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Market update
Click here for the latest stock market news and charts.
The FTSE 100 fell back on Friday after upbeat jobs data from the US increased the likelihood that the Federal Reserve would scale back its stimulus programme. The index closed down 0.7% at 6,375.
Miners were the hardest hit. Glencore Xstrata was the day's biggest faller with a 6.5% drop, while Polymetal lost 6.2% and Antofagasta, Fresnillo, Randgold and Vedanta fell between 6.1% and 5.3%.
In Europe, the Paris CAC 40 fell 56 points at 3,753; and the German Xetra Dax was 188 points lower at 7,806.
In the US, the Dow Jones Industrial Average and the S&P 500 each rose 1% to 15,135 and 1,631 respectively, while the Nasdaq Composite was also 1% higher at 3,479.
Overnight in Asia, Japan's Nikkei 225 and the broader Topix index each fell 1.4% to 14,109 and 1,172 respectively. In China, the Shanghai Composite lost 2.4% to 1,958 and the CSI 300 was 2.8% lower at 2,163.
Brent spot was trading at $107.27 early today, and in New York, crude oil was at $103.03. Spot gold was trading at $1,226 an ounce, silver was at $18.91 and platinum was at $1,335.
In the forex markets this morning, sterling was trading against the US dollar at 1.4896 and against the euro at 1.1606. The dollar was trading at 0.7791 against the euro and 101.17 against the Japanese yen.
And in the UK, confidence among businesses is at its highest for 13 months, according to a survey by accountants BDO. A separate report by Lloyds TSB suggests business activity in England is rising at its fastest since January 2012.
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