"When misguided public opinion honors what is despicable and despises what is honorable, punishes virtue and rewards vice, encourages what is harmful and discourages what is useful, applauds falsehood and smothers truth under indifference or insult, a nation turns its back on progress and can be restored only by the terrible lessons of catastrophe." … Frederic Bastiat

Evil talks about tolerance only when it’s weak. When it gains the upper hand, its vanity always requires the destruction of the good and the innocent, because the example of good and innocent lives is an ongoing witness against it. So it always has been. So it always will be. And America has no special immunity to becoming an enemy of its own founding beliefs about human freedom, human dignity, the limited power of the state, and the sovereignty of God. – Archbishop Chaput


Tuesday, January 17, 2012

Gold stocks continue being plagued by the hedge fund ratio trade

The HUI continues to lose value against the price of gold bullion as evidenced by a continued deterioration in the ratio of the price of the HUI to the price of an ounce of gold.

We are reminded continually of two things that have led to this abysmal performance of the gold shares which are rapidly losing speculative interest in favor of the ETF.

The first is the risk of investing in companies that are subject to surprises which happened to Hecla and recently to Kinross. Hedge funds and other large investment groups or players seeing this say to themselves, "Why risk this sort of thing when we can get LEVERAGED EXPOSURE" to the gold price by buying the gold ETF on margin".

There is no such risk inherent in the ETF. No one worries about nationalization of the ETF or environmental lawsuits or some bureaucratic agency shutting it down to clean up debris in a mine.

Secondly -this then leads us to the ratio spread trade. Buy the actual metal either through the ETF or the physical stuff (or even the Comex) and take a corresponding short position in some of the mining companies to further minimize the risk of investing in gold.

This shows up in the rotten performance of the gold shares in general as they continue to decline against the price of bullion . Note that the line goes nearly straight down since the beginning of 2011 with a brief exception of a lousy two months last year.

If one wanted to devise a mechanism to deliberately depress the price of the mining shares they could not have come up with a better mechanism to do so than the gold ETF. The lesson in this is that investors must be extremely selective in choosing gold mining companies to invest in and not just blindly throw money into the sector and thereby hope to be successful. As long as the Gold ETF is in existence, the hedge funds are going to use it as the long leg of these spread trades and actively seek out the weaker gold mining companies to short. At this point I am not sure what it is going to take to reverse this trade as traders will stick with a strategy as long as it works and not a day longer. Long suffering gold mining share owners should continue to press management to take the steps necessary to make it more difficult to short their shares successfully. Failing that they can always pray for a takeover or acquisition!

GFMS reports substantial offtake of Gold by Central Banks

Dow Jones news is carrying a report this morning from GFMS (formerly Gold Fields Mineral Services)detailing the amount of gold purchased last year by the world's Central Banks. It was indeed a formidable number.

The net purchases of the yellow metal came in near 430 tons, a more than 5-fold increase on the previous year. It was also the highest level recorded since 1964.

To give you a sense of the significance of these purchases - the amount of NET purchases by Central Banks in 2010 was a mere 77 tons!

Surprising to me was the fact that Mexico was the largest buyer as far as the official monetary sector goes. GFMS reports that they added almost 100 tons of gold to their reserves. I would have thought it would have been China to lead the pack.

The other surprising fact was that signatories to the Central Bank Gold Agreement ( this was set up to limit the amount of gold sold by European Central Banks ) sold less than 10 tons for 2011.

The summary - Central Banks are now absorbing a significant amount of world gold production. This should continue to provide very good downside support for the metal on price retracements lower as these banks do NOT CHASE PRICES HIGHER but are there to buy at levels they consider gold to have "value".