Feed the Ducks
6 April 2009
MARCH 30: ANYBODY who has ever tried to sell a large position in a junior mining stock will know that it has to be done while the stock is rising and demand is strong. As they say, “feed the ducks while they are quacking”. Once everyone else turns seller too, prices fall precipitously on very little volume.
The recent collapse of copper is a very good example. The market was pregnant with anticipation of a breakout to the upside above $US9000 per tonne. Everyone who wanted to be long was. They were all waiting for the greater fool to keep buying the China story to take them out of their position at still higher prices.
When it became evident to many of them that perhaps they were the greatest fool, the last in the line, they all tried to sneak for the exit. Copper fell 16 % between the start of August and late September 2008, the scramble for the exit began and it then collapsed 60% in only four weeks. This is a significant international market not a penny stock but the same rules apply if all the interest is to sell, and sell now, the clearing price can fall precipitously.
Of all the metals, gold is the only one not to have had a significant sell off. Looking at the chart above it is not hard to see where it has been getting a great deal of its support. First it was gold producers buying gold with shareholders money to close out hedges and then the buyers of various ETF products (Exchange Traded Funds which back each unit with physical gold) joined in. It is impossible to know how many of the holders of ETF’s are individuals and how many are funds. I am going to hazard a guess that with over 50 million ounces purchased a great deal of it is fund money. What’s the difference between the two? In my opinion it is huge; individuals want to make money but often they want to hold gold come hell or high water. Fund managers only want to make fees and attract funds so they are only interested in relative performance. If they see the potential for better returns they will move from one hot market into the next and right now gold is hot.
When they sell it seems to me that it is because they are not the owners of the money they tend to do it when everyone else is and do it like Lemmings with scant regard for price.
Take a minute to think about these numbers; 56 million ounces either bought back or delivered into hedges by producers and another 42 million ounces bought into ETFs between June 2003 and December 2008 for a total of 94 million ounces. Look at the last 12 months for ETF buying and you will see that the rate of buying has gone almost parabolic, in fact between December 2008 and the time of writing another 14 million ounces has been bought by ETFs! This type of acceleration in demand tends to reflect a mania.
Amazingly, while ETF buying volume has gone parabolic the USD gold price is sideways to lower. Arguably it’s great for the buyers that they have been able to get set without pushing prices higher but what should concern sell-side market participants is the fact that clearly there has been considerable selling offsetting this accelerating demand.
Gold producers are still running down hedging on balance so it’s not them entering into large hedges. Some individual companies have taken advantage of these prices to underwrite projects and we expect more to follow but these volumes are at the margin. Although why more Australian producers weren’t selling a little bit forward at prices over $1500 AUD/oz I don’t quite understand.
The selling that is satiating the surging ETF demand seems in large part to be coming from the traditional gold “sponges”, Turkey, India, Indonesia etc. Some of these countries that have been relentless sources of demand have recently turned exporters of gold as the public cashes out of physical gold accumulated over years if not decades. Please note demand has not slowed; demand has disappeared completely, with the countries becoming net sellers exporting large volumes of scrap. The sponges are being wrung out. Recent currency movements, not unlike that which we have seen in Australia, have pushed gold prices in their domestic currencies up at a time when their domestic equities and asset prices are falling.
If you think houses from Cottesloe to Yallingup look cheap versus 2007 prices then re-price them in ounces of gold. If the house price is down 20% in AUD then it’s down 55% in ounces at today’s gold price. Not the practice here but that’s how these countries look at it because they hold gold as money. This gold being dis-hoarded is part of the savings of these nations being reinvested into other assets. Because currencies often move so much faster than asset prices the sellers of gold in these circumstances gain a unique advantage over the holder of the currency itself.
So what we have is long term second world gold holders selling for cash, which they will likely use to buy hard assets in their domestic markets, to first world asset allocators spending other peoples money following momentum, fashion and fear. Not a good recipe for long term success in my opinion.
If the volume of ETF gold buying continues it may well exhaust this physical selling and prices may well run dramatically, particularly if it breaches recent USD highs. That’s not the point – what the physical holders currently selling down their holdings know from long term experience is that you must sell on the way up because you simply don’t get time to sell on the way down. You have to feed the ducks while they are quacking!
The question I have for gold producers refusing to take modest forward hedge cover through forwards or acquiring puts at these levels is what happens to demand when other markets appear to present better opportunities than gold and these recent ETF buyers try and exit? Who are these little ducks going to sell to and at what price? And if you think you can’t hedge because it’s too expensive to buy puts or forward selling will hurt your stock, talk to a copper producer or an ex-copper producer.
If you’re not going to do anything because you know it’s going higher because the USD must collapse, you might be right but you might be guilty of feeding the chooks.