The Shot Heard Round The World

by Scott Causey, GWP Resource Correspondent

Call one “Black Swan” event in markets with correct timing and accuracy, and you’ll forever be a legend in the minds of many. These seminal moments have historically not come along that often. In recent years, however, they’ve become more and more frequent; the market crash of 1987, the bursting of the tech bubble, the market crash of 2008-2009. Any name on Wall Street associated with foretelling these events beforehand has made a very comfortable living in perpetuity after the event. Not just from their positioning within the market for said event, but also because of the reputation they garnered after the fact for being such a brilliant market observer.

Oh really? Just how freaking brilliant do you have to be to see that Germany’s announcement to repatriate gold from multiple countries is going to change the world as we thought we might have known it? Many other countries are now in the news for having either decided to repatriate gold reserves to home country or for having started an open debate about doing so. These countries would include Ecuador, Switzerland, and Holland. Before you think, “Big deal! These are all small countries with small gold reserves.”, let’s touch on that.

First of all, Jeffrey Christian from CPM group is one of the most trusted names in precious metals; both him personally and the company he works for. What that tells me more than anything else is just how downright ignorant and uninformed the majority of precious metals “investors” are. Mr. Christian is on the record stating that precious metals trade in multiples of 100 times the underlying physical metal. The “spot” price that you see listed when you want to buy actual physical metal is a price driven by these paper markets. What this means in layman’s terms is that should even 5% of the holders of these futures contracts demand physical delivery of metal instead of rolling the paper contract month to month like it is traditionally done, the Ponzi scheme that it is would be obvious to even the most naive or casual observer.

See for yourself in this video.

I truly believe this was a massive slip of the tongue for Mr. Christian, a former Goldman Sachs employee, as you just heard. The actual leverage within these markets is extremely hard to determine as most of these transactions are almost impossible to track in the wild wild west world that is the OTC derivatives market. But for the sake of argument, let’s consider the implications of Mr. Christian’s statement of 100x leverage. That would mean that if Germany, Ecuador, Switzerland, and Holland ultimately decided to repatriate a paltry 500 tonnes of gold, that essentially, in paper market terms, means that this would be 50,000 tonnes of gold! For comparison, 2,600 tonnes of gold is mined annually around the globe. Are you beginning to see why these markets are in absolute panic mode to obtain more physical metal to continue the veil of legitimacy for awhile longer? Would it surprise you to learn that futures market participants who have requested physical delivery have already been asked to settle in cash instead?

Where there is smoke there is fire. Never just one cockroach. Actions speak louder than words. We hear these things repeatedly and yet somehow, for most of us, when it comes to fiat bank notes, everything suddenly changes. The visceral emotion ingrained into our minds since birth of “the value of a dollar”, is a powerful emotion that must be overcome at all costs. In order for something to retain its value, it must not be easily replicated. Every paper asset in the world can be replicated. Even the best stocks face dilution when companies invariably issue more common shares. More debt i.e. bonds can and will be issued especially at today’s interest rates, because the economic system we currently operate under demands it to sustain the broken path along which we currently walk. The United States dollar, Euro, and Japanese Yen are all being printed like they are going out of style … BECAUSE THEY ARE GOING OUT OF STYLE!

These central banks are in the business of doing what? Providing a free public service for the betterment of all human kind? Hell no! They are in the business of creating something from essentially nothing and then charging your government, and by extension, you, for the privilege. So they sell by interest payments’ paper bank notes and they hold reserves in what asset? Gold. The very thing that Chairman Bernanke spends so much time “teaching” us is a “barbarous relic”. The paper currency that they push is the dope to the heroin addict that is the global economy. QE3 is the biggest shot of monetary heroin the world has ever seen. If monetary heroin is such a wonderful fix, then don’t you think after QE1, QE2, Operation Twist, that the global economy would be booming? In case you haven’t noticed, the poster child for global growth is off the rails. The Chinese stock market is at multi-year lows.

Meanwhile, cost push inflation is slaughtering margins, free cash flow, and thus earnings in the biggest names in gold and silver production. Barrick Gold, the largest name in the gold industry, announced a bloodbath of 3rd quarter “earnings”. Barrick saw 3rd quarter earnings decline 55% compared to the same quarter one year ago. Year to date, Barrick had a NEGATIVE free cash flow of 772 million dollars, as compared to last year’s first 3 quarters, showing a POSITIVE free cash flow in excess of 1 billion dollars. Unless central banks are planning on diverting some QE in the direction of these miners, it’s painfully obvious that something has to give.

So while the more impatient among us may bemoan the knock down days in metals prices, I, personally, find it hard not to do cartwheels and drool on myself. Ore grades from the top 5 gold producers from 2005-2011 have declined 27%, or roughly 3.8% per year. Silver ore grades have declined 33.5%, or roughly 5.6% from the top 5 largest producers. As a quick reminder, ore grade is nothing more than the amount of earth that must be moved and processed before a given amount of metal is obtained. So these mining companies are facing the devastating one two punch of dramatically increasing costs of doing business, as well as less and less metal for their efforts. Then just to take one more good shot to the balls, the product they sell is being held at an artificially low price. While that may be horrible news for the liar standing at the entrance to a hole in the ground (Mark Twain’s definition of a gold miner), it’s like picking up free wealth for those educated on what is happening today.

Sentiment is, again, very pessimistic with gold again under $1700 and silver back towards $30. What a difference a few weeks makes! Nevermind the fact that nothing has changed. Nevermind the fact that this is exactly how a market that is not in a mania phase acts. If you’ve been doing your own homework and have been looking for an opportunity to get involved, this is the week to finally pull the trigger. Any further weakness this week should be bought aggressively. Gold will most likely test $1650 this week. Silver appears ready to re-test the $30 dollar level yet again. Those nearing retirement, or looking for the more conservative allocation, would be highly advised to buy this gold weakness. Personally, however, if I see silver with a 2 handle again, I’m gonna break out my gymnastic shorts and keep something to wipe my mouth with nearby.