Indicators Predict Gold Trend to Continue: John
LaForge
Source: Zig Lambo of
The Gold Report
(4/23/12)
http://www.theaureport.com/pub/na/13164
Many forces influence the gold markets today, sometimes
producing confusing indicators of what may lie ahead. In this
exclusive interview with
The Gold Report
,
John LaForge, commodity strategist at Ned Davis Research Inc.,
talks about the numerous and sometimes not-so-obvious factors
that he considers in his research and how they influence the gold
markets and, ultimately, mining shares. As long as there is no
significant improvement in the world monetary situation and real
interest rates don't rise dramatically, he believes the gold
price trend remains positive and gold stocks should shine
brighter.
The Gold Report:
The recent price performance of gold has probably left many
investors puzzled about what's going on amid all the conflicting
background news. What's your broad-picture view?
John LaForge:
Gold is telling many stories at the same time. Recently, though,
one of the main issues has been seasonality. Gold tends to do
best toward the end of the fall, right around the Diwali wedding
season in India, up until about now. Springtime through fall is a
good time for accumulating, but not to expect big price
rises.
The second factor impacting the price recently has been the
new Indian taxation issue. India has a trade deficit, and one of
the ways it is dealing with that is by trying to tax gold coming
into the country. India has been the largest gold buyer for a
long time, although China finally did surpass it last year. The
two account for about 43-44% of all world gold demand. The Indian
tax proposal was met with resistance and strikes. So there has
been weaker demand for physical gold in the last few weeks from
India.
The third piece is much more macro-oriented. Real interest
rates affect the carrying cost of gold. Low real interest rates
are very good. When they get up to around 3.5% on a real-rate
basis, that's not good for gold because that's the carrying cost.
Right now, we're between 0 and 50 basis points, which is very
good for gold. But the rate of change in the real rate has slowed
and has stopped becoming more negative.
TGR:
How big a tax is India proposing?
JL:
It's 2%, which doesn't sound like much, but it did cause dealers
to strike for the whole week and shut up shop, which is a big
deal. In the U.S., it would be something like Starbucks shutting
up shop because coffee prices had risen too high. In the longer
term the tax should have very little impact on the price of gold
because gold is an integral part of the culture in India. Any
type of tax eventually just gets worked into the price and the
consumer just ends up buying a little bit less, but still
buying.
TGR:
Many gold bugs are predicting gold prices ranging up into the
$5,000-10,000/ounce (oz) range in the coming years. How realistic
do you feel those numbers are and what combination of
circumstances would it take for gold to hit those prices?
JL:
Both are truly out-of-the-air type numbers, but, in fact, we once
published something on $5,000/oz that was based on time, since
the 1970s. When Nixon went off the gold standard in 1971, gold
rose from $35/oz to over $800 in 1980. If you apply the current
cycle to the 1970s cycle, with gold starting this cycle at
$250/oz, the same type of performance would equate to 5,000/oz.
today. That's where the $5,000/oz comes from, but we've never
actually predicted $5,000/oz.
The $10,000/oz scenario I've seen was equated to money supply.
To back all the money out there today with some form of gold,
even at just, say, 10% (or whatever percentage used), a
$10,000/oz value was reached. If consumers and investors do not
trust their governments to stop printing money and governments
continue to do so, gold does have a shot at much higher levels
than $1,700/oz or $1,900/oz, but I don't know about $5,000/oz and
$10,000/oz.
The West is dealing with debt issues and the East is dealing
with growth issues and trying to compete with countries that are
devaluing their currencies. China doesn't want to increase the
yuan too quickly because it makes exports less competitive.
From what we know about commodity cycles going back into the
1700s, the average bull cycle lasts about 17 years. This
commodity cycle has now gone 11 years. Typically the first 10
years of those cycles is when a lot of that easy money is made.
That's when things like gold go up seven times from $250/oz to
$1,700/oz. If gold increased seven times from $1,600-1,700/oz,
that would equate to $10,000/oz. To get another seven-fold
increase from here would be tough.
TGR:
Wouldn't it take some dramatically bad economic circumstances,
panics or some combination for people to run it up to those
prices in any shorter period of time?
JL:
Yes. What you're describing is a fear-based environment with
people coming to the realization that all of this paper money
floating around is not worthy. History is littered with paper
money that has gone bad, whether it's Germany's famous Weimar
Republic in the 1920s, or more recently the Hungarian pengo, the
Zimbabwean dollar and Argentina's peso. Most Westerners,
particularly Americans, don't think much about the value of the
currency in their pockets.
As more and more of this money is printed everywhere, not just
in the U.S. but also in the Eurozone, Japan, China and elsewhere,
there's going to be a realization sometime in the next three to
five years that maybe the $20 sitting in a pocket isn't worth
what it used to be. How do I protect myself? People are going to
start looking more toward hard assets. Gold is one of those. Land
could be another one. But gold is clearly something you can pick
up and move. It's definitely a place to hold some value and
protect wealth. It's not going to be the next Apple. You're not
looking at a $15 stock that goes to $600. That's not what gold is
for. It's there to protect wealth from this erosion of all of the
paper money that's sitting out there.
TGR:
From a trading standpoint, what do you see as a downside for gold
in the near term?
JL:
The major one would be if confidence comes back that governments
are going to stop printing money and be held accountable. That
will happen one day, which could be tomorrow or 10 years from
now. One thing we do know is that secular cycles do end. Stocks
will go through a 20-year bull market, and then they have a bear
market. Commodities do the same thing. Gold will do the same
thing. The gold cycle of people being fearful of all of this
money being printed will end. That might be at $3,500/oz, and
then it just fades for 10 years and settles around $2,500/oz. You
still would have made money if you bought it today.
Confidence is the big factor. One way to track confidence is
to look at gold in multiple currency terms: the euro, the yen,
the rand-not just the dollar. Gold is rising against all
currencies in the world. What would worry me is when that stops.
As long as the current uptrend continues, I'm a happy camper.
TGR:
It appears we're in the midst of a near-term correction or maybe
on the upside of one that just occurred. Is there some more
potential downside?
JL:
Yes, there is. From our technical work, if gold can't hang in the
$1,660-1,670/oz range, the next support level is $1,565/oz. Then
there is another support level around $1,480/oz, and finally a
big one around $1,300/oz. We don't think $1,300/oz is in the
cards because we would need to see some pretty dramatic
confidence come back in governments worldwide. But $1,565/oz is
definitely a possibility. Gold currently sits below both its
200-day and 50-day moving averages, which is technically bad
news. It's basically showing that the trend has slowed and gold
is consolidating. That goes with one of the first points we
talked about: seasonality. From a yearly perspective, this is one
of those times where gold usually takes a breather every
year.
TGR:
The Chinese seem to be pretty excited about gold. One of the
charts in your research shows that Chinese imports of gold really
took off dramatically last June and have continued doing so. Do
you expect this to continue and what are the implications for the
market if it does?
JL:
It probably will. Everyone assumes that China is a big buyer of
all commodities. China is also the largest producer of gold in
the world and hasn't really tried to buy much gold outside of the
country. Most has been produced and consumed internally, although
it's hard to get data on what it owns. The chart you're
referencing reflects Hong Kong import numbers I've been looking
through and shows that the Chinese are now starting to buy gold
in droves through Hong Kong. This tells me that it is basically
consuming everything it can internally and now it's looking
outside. That is a game changer.
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A year ago China imported about 5 tons (t) gold a month
through Hong Kong. That's been fairly consistent over time. We
can track 5-15 t/month through Hong Kong. But around last June,
it suddenly jumped to 25 t for the month. Then it went to 40 t.
Then it went to 55 t. In November, it peaked at 100 t. If it kept
up that pace, which it probably won't, that would be 1,200
t/year. That's about 45% of yearly mine supply in the world. So
China is one of these wild cards because it hadn't really been
out there in the market like this.
If China does with gold what it's been doing with other
commodities, it could keep that 11-year positive cycle going by
looking for gold outside its borders. We're going to get a better
picture of how much it truly wants to buy. The numbers could be
pretty staggering and could be multiples of what we saw last year
and the year before.
TGR:
Is there any way of knowing how much of that would be official
government buying versus retail buying?
JL:
Unfortunately, the numbers aren't broken out into how much is the
People's Bank of China (PBOC) and how much is consumer. I think
it's pretty safe to say, though, that to have such a big jump,
from 5 t to 100 t/month, the PBOC is somehow buying some of that.
It's hard to believe it's all consumer driven.
TGR:
Most of our readers are mainly interested in the mining stocks
that have really lagged metals price performance. It's a
frustrating scenario that has been going on for some time now.
What do you think are the main causes for this disconnect?
JL:
One is production where a lot of the larger and mid-cap miners
just don't have the production growth. If you're an investment
manager running $1 billion and you see the price of gold going
up, you have a couple of options. One is just to get long the
price of gold through the SPDR Gold Trust Fund (
GLD
) or physical exchange-traded funds (ETFs) or just buying
physical metal.
Gold miners have to worry about production and energy costs.
They're not producing at the levels that they'd want because a
lot of the ore grades are now much lower than they were 30 to 40
years ago. That's a classic example of a "peak" commodity. Peak
oil or peak gold doesn't mean we've run out. It just means we've
reached that point where the easy stuff has been found and now
it's just going to be harder to find the rest, either in
countries you don't want to be in or because the ore grades are
down.
We've found that professional investors are more interested in
just getting access to the price of the metal itself. When
investors buy miners, unfortunately, they are dealing with the
lack of production growth and, at the same time, rising energy
costs. From about 1996 to 2008, the price of oil rose at a faster
rate than the price of gold, which is very surprising to most
people. They think that because gold's been up 11 years in a row,
it's somehow beating every other commodity. That's just not the
case. Gold mining is typically one big dirt-moving operation
that's heavily tied to energy. Additionally, labor costs have
also been killing them.
There is a positive side for anyone who owns miners. They are
now about as cheap as they've been versus gold since the
mid-1980s and may get cheaper still due to ETFs like the GLD.
We're still telling people to stay allocated to the price through
the GLDs, but it's getting to a point where some of these miners
are very, very appealing from a bargain perspective.
TGR:
Do you see any particular catalyst that could actually get people
really interested in buying shares anytime soon?
JL:
Unfortunately, no, unless we start seeing big production numbers
out of these guys. If you can aggregate the group and get some
decent production numbers, I think you'll start seeing people go
back and be very interested. The other thing that could happen,
which we haven't seen yet, is merger and acquisition (M&A)
deals. If you start getting some bigger M&A deals, that could
be a catalyst for people to realize how undervalued these names
are compared to the price of gold. But because we haven't seen
that, there is no premium in any of them for those types of
buyouts.
TGR:
Is it just going to take the price/earnings (P/E) ratios getting
to such low levels that average investors are going to start
buying them on the basis of P/Es rather than the business they're
in?
JL:
You also need a decent stock market. The last six months have
been a little strange because the stock market has gone up, but
gold miners have trailed gold, which is usually not the way it
works. Historically speaking, there have been two drivers of gold
stocks: gold and the stock market. Gold stocks don't seem to be
winning under either scenario right now, unfortunately.
TGR:
In reviewing all of your different research reports, you come up
with some pretty interesting correlations between gold and
various other prices and economic factors. Are there one or two
that you'd like to particularly emphasize that you think might be
the best indicators of what might lie ahead in the gold
market?
JL:
The No. 1 indicator for gold prices is real interest rates-the
nominal interest rate minus the inflation rate. Below 3.5%, gold
is usually good to go. Above 3.5%, it becomes a real issue. The
other piece to that is the rate of change. In essence, the
10-year real interest rate is zero right now. If it starts moving
from here toward that 3.5%, that's typically a headwind for
gold.
The second one, which really has to be watched closely, is
gold in all of these different currencies. Right now, the charts
all look very similar. If gold continues to rise versus all these
different currencies and there's still that fear factor over
money printing, gold is still good to go. If it starts to fade,
that's the signal I'd watch out for that maybe this 11-year run
is due for a breather. We hope we'll have some time to give our
clients some warning that it's rolling over and that the gold
story is done for a little while. But we're not there yet, and
it's all still positive.
TGR:
Would you like to take a shot at predicting where gold might be
going in the next year or so?
JL:
I don't put out a formal prediction. My thoughts at the beginning
of this year were that gold was going to be dead money in 2012
and just sit there after a good run. I didn't have anything to
back that up other than time and the fact that gold was up each
year for the past 11 years. Looking at the Dow Jones Industrial
Average back into the late 1800s, its longest run up on a
consecutive basis was nine years, and that was in the 1990s.
Before then, the most the Dow had ever strung together was five
consecutive positive years. Assets usually don't run up in
straight lines as gold has done.
My prediction for the year was for sideways trading in that
$1,600-1,700/oz range. I was looking a bit like a fool in
February when we were approaching $1,800/oz again, but I still
think that's the case. Europe is the big question and if Spain
becomes a problem like Greece was last year, $1,700/oz is
probably light and it will probably be closer to $1,800/oz or
$1,900/oz. We'll probably look back on 2012 and say it was a good
year to accumulate gold, but not one in which you made big money
in gold.
TGR:
Thanks for talking with us. We'll have to see whether you've been
overly optimistic or overly pessimistic.
JL:
That sounds good. Thanks.
John E. LaForge
leads Ned Davis Research's Commodity Team, which provides
research across the commodity spectrum, including equities. The
team covers the most widely followed energy, metal,
agricultural and soft commodities and equities, providing both
commentary and strategy. Commodities and commodity equities are
global in nature and sensitive to economic realities, so
LaForge works closely with all of NDR's other strategy teams.
LaForge has over 17 years of investment experience, primarily
in asset management. Almost eight of those years were spent
managing $1.2 billion across seven mutual/hedge funds under
multiple client platforms for Phoenix Investment Partners
before he became chief investment officer of SRQ Capital
Management in 2005. Over the course of his career, LaForge has
been a frequent contributor to the media, including CNBC,
Bloomberg and many print media publications. LaForge holds a
Bachelor of Science in finance and Master of Business
Administration from the University of Tampa.
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