The CPM Gold Year Book - Jeff Christian
According to the CPM Group's Jeff Christian gold is unlikely to fall much below $1,400 during the next decade but investors are likely to start focusing more attention on gold stocks
Posted: Wednesday , 28 Mar 2012
GEOFF CANDY: Welcome to this week's edition of Mineweb.com's Gold Weekly podcast. Joining me on the line is Jeff Christian - he is the managing director at the CPM Group. Jeff you've just released the 2012 edition of the CPM Gold Yearbook and it focuses on the fact, in your view that gold is at a cyclical peak within a secular bull market. What exactly does that mean?
JEFF CHRISTIAN: Well we've seen gold prices rising for a decade now and it's gone from $270 to $250 an ounce 12 years ago to as high as $1920 last September and our view is that gold prices may not continue to rise, that they may have reached a cyclical peak and they could actually come off - and they have in fact come off since last September, over the last six months. But that they're going to stay high and that later, maybe 2015 or later, we expect gold prices to resume their increase. So we think that there's a secular bull market. Investors have been buying more gold than ever before in history of mankind, over the last 10 years and we think that's going to continue, and that's going to keep gold prices high and ultimately, later, drive them higher. But we think that within the context of that broader upward move in gold prices, that we may have reached a cyclical peak and we may not see gold prices go back up over $1920 which was the intra-day peak last September.
GEOFF CANDY: That being said then, is there a way to begin to start gauging where perhaps the floor for gold prices might be?
JEFF CHRISTIAN: The floor - the ultimate floor is provided by the cost of producing gold in the ground and if you look at the full all-in cost - gold on average is about $600 an ounce to mine on a cash cost basis and about 95% of the world's gold production comes into production at prices below $900 an ounce - maybe add $100 to $150 on top of that for general administrative costs, amortisation, depreciation and so maybe you're talking about $700 average cost - $1000 for 95% of the production. That presents a long-term floor for prices. Now there are two things about that long-term floor. First off is - you don't necessarily expect the gold price to hit it because it's not mine production and production costs that determine the gold prices. It's ultimately investment demand and there's no economic law that says price has to fall to $1000 or lower in order to turn off some of that production. So that's your long-term absolute floor. The second thing is somewhat contrary to that and that is that the price can actually fall below that production floor for an extended period of time because you have two billion ounces of gold and bullion held by investors and central banks. Let me just give you an historical analogy. From the early 1980s until 1997 we were saying that the floor price was $320 an ounce - that below $320 an ounce, gold was unsustainably low. Mining companies weren't expanded, they actually shut down mines. Jewellers used more gold per piece, investors would buy more gold. In 1997 you saw the gold price fall below $320 and our comment at the time was okay on a long-term basis prices below $320 are unsustainable but the short-term could last for five years. And in fact it did. It wasn't until 2002 that the gold price went back above $320 on a sustained basis. And so on the one hand there's the cost of producing gold is a long-term floor, but there are these provisos because gold is unique and you do have these two billion ounces of gold lying around in bullion form, relatively available to the market.
GEOFF CANDY: It raises a number of interesting questions and something that I did want to get your comment on, was the sense that we've seen since we saw at the end of February, that $100 dip in the price of gold, on the back of the announcement by the Federal Reserve that they weren't going to be looking at QE. There did seem to be a feeling almost of a change in sentiment that perhaps gold's run wasn't inexorable and wasn't always necessarily going to go up, and I wanted to get your sense of that - in your view has there been a sentiment change, and over and above that is there the threat perhaps of some of the investment demand that has been driving prices higher, coming off?
JEFF CHRISTIAN: Yea, there's clearly been a change in sentiment, and actually there's quantifiable evidence of the change, and the change really started to emerge in the middle of September, and the way I qualitatively describe it is the world woke up - everybody was buying gold hand over fist in July, August and early September because the euro was going to collapse ‘tomorrow', the ECB was going to collapse ‘tomorrow', we have revolutions throughout Europe, the United States was going to go back into a depression - there is this incredible fear of financial calamities, so buy gold today because the euro is gone tomorrow. And August came, we had the debacle of the US debt ceiling negotiations, we had the US Treasury downgrading, and the European governments continued to fiddle while Athens burned. And in the middle of September there was this shift in attitude from this view of buy gold today, regardless of the price because tomorrow the euro falls - to this attitude... like well its mid-September, the US Treasury has been downgraded which is something we've been worrying about for 30 years and I still have a job, the sun still comes up, I'm still eating, I'm still getting paid, the banks haven't collapsed, maybe CPM Group was right all these years. It's not an issue of imminent collapse, it's an issue of well we have these long-term structural problems that are going to take decades to squeeze out of the global economic and financial systems, and it's not imminent financial collapse that I should be worried about, its what's going to happen to my livelihood, my savings, my ability to live a good life over the next 10 to 20 years. So you saw investors shift - it wasn't like "I'm going to sell gold, I'm going to stop buying gold". It was "I'm going to continue to buy and hold gold, but I can be price sensitive". Now you did see some short-term investors back out and you got statistics to show your massive liquidation into ETFs by some short-term momentum-trading hedge funds, and total ETF holdings basically stayed high because as they were selling they drove the price down twice in last year, and then in February - you'd see these spikes down, and every time you saw that spike down, you'd see investors buying physical gold. You've seen a big reduction in the open interest on the Comex, gold futures and options contracts - that reflects some of those shorter-term momentum-driven, technically orientated traders getting out of the market. But you're still seeing relatively decent gold coins purchases. So what you're starting to see is price sensitivity on the part of investment demand. We actually expect investors to buy about as much gold this year as they bought last year in total, but we think they'll do it in a much more price conscious fashion.
GEOFF CANDY: What is that likely to mean then, going forward?
JEFF CHRISTIAN: Well I think it means several things for the gold industry. Firstly it probably means that what you'll see is - and you've seen this just in the last three months - whenever the gold price starts rising and gets up to $1780 - $1790 as it did a couple of weeks ago, or it gets over that into $1800 or so, you'll see investors stop buying, and you'll see some investors selling, and you'll see some investors buying puts or going short on the Comex in the expectation that those prices are too high and that there's a short-term profit to be made on the downside. The other thing that we expect to see is because we don't see gold prices going back to $1000 we see gold prices staying basically above $1400 going forward for the next decade. So as a result of that, what we think you'll see is that investors will say, okay the profit potential through capital appreciation of buying bullion is diminished. I still want to have bullion as a capital preservation instrument, but I can't make easy money by buying today at $1200 and selling tomorrow at $1400. So what I'm going to be doing is I'm going to be taking money out of that and putting it into gold shares. Because quite frankly, if the average cost of production is $600 - $700 on a full-in cost basis or $750, and the price stays above $1400, these guys have 100% profit margin. They should be growing, they should be kicking off dividends, gold mining companies should look more interesting than gold and we think that you'll see some investor's cycle out of gold bullion into gold shares. And again, you're starting to see some statistics that point in that direction already.
GEOFF CANDY: Is there any way to gauge whether or not that will be the majors or the juniors or the explorers, or will be across the board?
JEFF CHRISTIAN: I think it will be across the board. People are kind of avoiding the majors because they don't present growth stories. There'll be interest in the mid-size, the mid-tier gold producers a) because they generally speaking have some growth potential, and b) because they're takeover targets for majors. And then the real growth probably will be in the juniors and emerging producers, and to some extent the exploration companies. Because if you go back to the 1980s again, the real money was made by investing in those dozens of gold mining companies that emerged after the gold price had spiked to $850 and come back to $320.
GEOFF CANDY: Is there perhaps with the renewed interest in the gold stocks and particularly on the smaller side, is there perhaps likely to be more or less merger and acquisition activity then from the majors who indeed are always looking for ounces?
JEFF CHRISTIAN: Yes I think there will be and frankly we think that later this year and into 2013 you will see a wave of merger activity because, as the price subsides, people say okay, $1400 - $1500 this is a good price at which to effect these transactions because they'll still be thinking that the price has the capacity to rise again.
GEOFF CANDY: On the demand side of the equation now, we'd be remiss if we didn't talk about China and India, and particularly India at the moment where there have been some interesting developments on the political front, with the increase in duties on imports as well as excise duties, and some fight back by the jewellery sector. How do you see things playing out there?
JEFF CHRISTIAN: Well I think that the tax issues will have a negative impact on investment demand and jewellery demand in India and India has been a very important market for gold into 2011 and before that even. But I think it will be relatively minor - it probably won't be as catastrophic. For one thing, the Indian government has in the past demonstrated the willingness to roll back taxes when they realise that two things happen. There's too much opposition, or what happens is a lot of things go unreported and untaxed. So if you look at the broad history of Indian gold policies, they banned gold imports and exports for many years and everything was being smuggled into the country. So what they wound up doing was legalising it with a tax and all of a sudden they were collecting taxes on the imports and everything was great so they doubled the tax. This goes back to the early 1990s - everybody started smuggling again because they didn't want to pay the 2% tax, so they rolled it back to 1% and everyone started bringing it in legally again. And so the Indian government has demonstrated a facile nature in adjusting its tax policies so as to maximise its own tax revenues and to avoid smuggling, and to avoid too much strong dissent. So I wouldn't be surprised even if the Indian government rolls back some of these taxes that they've imposed. The second thing is that even if they don't do that, the Indian market will adjust and the appetite for gold in jewellery and investment form is probably so strong that people will be willing to pay that tax.
GEOFF CANDY: Just two things to close off with. Firstly, if we look at the rest of 2012 and perhaps into 2013, what is the CPM Group going to be focusing on, what do you see as the main drivers for the market this year?
JEFF CHRISTIAN: Well the main driver will continue to be investment demand and investors are right now, again we think investors over the last six months have moved away from this palpable fear of imminent financial collapse, they're still concerned about the global economy and we think that one of the major trends you'll see over the next 12 to 18 months, is that investors will continue to be concerned about economic factors but you'll have a continued relaxation or subsidence in that concern and that will be reflected in investors redeploying some of the money that they have in cash, bank accounts and bank CDs so that that will probably be good for stocks, it will be good for the overall economy, and some of that money definitely will flow into gold.
GEOFF CANDY: And finally, there does seem to be perhaps an overly simplistic view of the gold market in that if we see an uptick in the economy and things returning to a story of growth, that that would necessarily be a bad thing for gold and we'd see it re-entering a bear market. What is your view - how does that work...?
JEFF CHRISTIAN: One of the things about the gold market is when investors are more sanguine about the economy it's not they sell their gold, they buy less gold. So we think that you could see investors moving toward buying less gold over the next few years, but we don't know that that's going to be a major negative factor on the gold market. So yea we do think that you'll see some investors cooling off ... but again it's like "I don't need to buy gold today, I can be price sensitive". That probably will be reflected in somewhat lower prices, and then we think that those lower prices will be taken as a buying opportunity by other longer term investors who say this is great, I'm glad I didn't buy it at $1900, I'm getting it at $1400...