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Sep 29

Going to Cash

There was another fairly high profile figure came out with some less than inspiring comments about Europe yesterday. The following came from Attila Szalay-Berzeviczy, global head of securities services at Italy’s biggest lender UniCredit SpA. (UCG), as per Bloomberg.

“The euro is beyond rescue,” Szalay-Berzeviczy said in an opinion piece for index.hu., a Hungarian news portal, which he signed as former chairman of the Budapest Stock Exchange. “The only remaining question is how many days the hopeless rearguard action of European governments and the European Central Bank can keep up Greece’s spirits.”

There is getting to be a fairly long line of high placed officials giving extremely dire warnings about the outcome in Europe. Given the predisposition of people in high places to keep their mouth shut, this is more than a bit concerning. We also have the unnamed BNP Paribas executive:

“We can no longer borrow dollars. U.S. money-market funds are not lending to us anymore,” a bank executive for BNP Paribas, who declines to be named, told me last week. “Since we don’t have access to dollars anymore, we’re creating a market in euros. This is a first. . . . we hope it will work, otherwise the downward spiral will be hell. We will no longer be trusted at all and no one will lend to us anymore.”

On the analyst side we had the following from Jefferies:

The road map for Europe is still 2008 in the US, with the end game a country by country socialization of their commercial banks.

And UBS:

It is also worth observing that almost no modern fiat currency monetary unions have broken up without some form of authoritarian or military government, or civil war.

I don’t think that this is a time where you can reason out an end game. And you cannot look to the economy for clues. I remember saying over and over again throughout September 2008 that the economy looked fine. The numbers were fine, well they suggested slowing but they didn’t suggest a collapse. Coal imports were ok, ag trade was ok, oil demand was ok. You can go back and read my posts in Sept 2008 on the Investors Village vt.to board and see what I said, how I scratched my head over why there was no sign of what the market was pricing in, and how that turned out to be wrong.

In 2008 the stock market was the first thing to collapse and then the economy collapsed. There was no foreshadowing.

And remember, the stock market didn’t collapse until after Lehman. It wobbled and got volatile before Lehman, just like now, but it wasn’t until after Lehman that it really fell hard – I think that was because the market just can’t price in such a tremendous collapse until it actually happens. Until the probability is 100%. It would hedge its bets by falling some, but you can’t price in that kind of event until its taken place.

In my opinion this situation has the potential to have a similar outcome. If one of these sovereigns default and there is not adequate capital provisions and adequate emergency facilities in place then it could turn out badly. And I’m not so sure the market can price something like that in until it happens.

Of course this might not happen. If everyone is fully prepared and banks do not lose confidence in one another, then it may be a non-event. But how can you predict that? Who has enough insight into the banks in question, into the derivitives of the sovereign debt that they do or do not hold, to be able to conclude how it will turn out?

I sure don’t.

I sold a significant amount of stock yesterday. I managed to get out of some of the gold stocks before the price of gold fell further, and I managed to sell some Coastal before it began to fall.

I admit I have been wrong about gold. What worried me is that it is now behaving like a risk asset, like a commodity. Thats why I sold OceanaGold and some Lydian today. If the market isn’t going to view gold as a safe haven, then who am I to argue. I am still persauded by the idea that gold will be a safe haven as this crisis persists, but until it starts behaving like one again (and going up when bad news comes out) I am going to be defensive.

I am now am about 50% cash. And it could go higher.

Sep 26

Week 12 Portfolio Update: Smacked Down

I could be talking about what happened last week, or what happened to gold and silver overnight. My portfolio was doing quite well before Thursday, up since inception while the TSX and S&P were down substantially. Thursday and Friday knocked the wind out of me, and it looks like that might continue today. Mind you gold has come back from the truly panic lows it set in Asia overnight. If gold continues to fall I will be forced to lighten up on my gold stocks. In this market it is seeming more and more to me that I should just lighten up on everything to zero.

Sep 25

Gold Stocks: Am I Wrong?

Last week was playing out just dandy until about 7:30 am on thursday. That’s when the stock market opened and the gold stocks I owned fell along with the rest of the market.

Since the peak on Wednesday afternoon Jaguar Mining is down $1.10, or 16.4%. OceanaGold is down 0.65, or 23%. Argonaut Gold is down 14%. Lydian International is also down 14%.

Now I could write a post about how unjustified this is. How these 4 stocks, and gold stocks in general, never began to price in a gold price of $1500/oz, let alone $1800/oz. And about how in the case of OceanaGold and Jaguar Mining, the stock price is significantly lower then it was when the gold price was $1000/oz.

All of this is true, but its not necessarily helpful going forward. What is helpful is to assess the situation and determine if I am best to stick it out, or admit that maybe I am wrong about the direction of gold stocks.

I’ve spent most of the weekend pondering the reasons for gold stocks to go up and the reasons for gold stocks to go down.

I think that the basis of all the arguments for and against come down to the causation of the rise in the price of gold. Now maybe I am simplifying the situation too much, but think you can narrow it down to two contrasting views of why gold is going up. Each view leads to a drastically different opinion of what will happen to the price of gold (and the price of gold stocks) going forward.

These views are:

Gold has gone up on the expectation of Federal Reserve balance sheet expansion
Gold has gone up on fear of the disintegration of the Euro and the EU

The first argument is what is being bandied about the most over the weekend. Gold, and thus gold mining stocks, were pricing in QE3 and that didn’t happen. Operation twist is not quantitative easing. There is no expansion of the Federal Reserve balance sheet and there is none on the immediate horizon. So if the price of gold is a function of the Federal Reserve balance sheet, then gold must return to pre-QE3-anticipation levels. A good starting point would be $1400-$1500/oz. Or perhaps gold goes lower if it overshoots to the downside or if the Fed begins to gain credibility in its balance sheet management.

The second view was invoked quite often over the last month, but it seems to have fallen on deaf ears in the last couple of days. That’s because it doesn’t fit the evidence. the EU is still a mess. The price of gold is falling precipitously.

So does the move of the last two days mean that the Fed watchers are right and that the run in gold is over until there is at least some evidence of QE3 on the horizon? I’m not willing to say that yet. I’m going to re-quote what I paraphrased from Donald Coxe a couple days ago:

The investment case for gold lies in the 500 million people living within 17 different countries that have their savings, pay cheques, and pensions tied to a currency that was based on a theory and seems by the day to have less of a tie to reality.

This argument still holds a lot of water in my mind. There is still no good way to resolve the situation in Europe. As long as this is the case, gold should continue to have a bid. And I can’t see how this will stop being the case. There simply isn’t the money available to resolve the debt issues of the PIIGS. The only solution seems to be the extradition of at least some of the PIIGS from the EU. That is going to be such a messy process, with so many potential pitfalls for both the sovereigns and the banks, that I can’t see how gold would fall in such an environment.

But I remain open to the possibility that I am wrong. I will be watching the price of gold over the next few days and if the weakness continues I will have no choice but to cut my positions. In that regard, I will likely lighten up on OceanaGold first. Both Jaguar Mining and Argonaut Gold are in somewhat envious positions right now. Jaguars mines are in Brazil, while Argonaut Gold has its mines in Mexico. Both the Real and the Peso have been falling lately. This will help bring down Q3 costs and even more bring down Q4 costs.

OceanaGold operates in New Zealand, and while the currency there has began to weaken, it is still above the average levels of Q2.

Lydian I will continue to hold because the story there is really less attached to the price of gold then in the other cases. Lydian is moving forward an exploration project that will be profitable at much lower gold prices. At some point the company will be taken out. So that one I will hold as well.

We’ll just have to see how this next week plays out.

Sep 22

An Afternoon with Donald Coxe

This afternoon Donald Coxe talked at the Hyatt hotel in Calgary. I was fortunate enough to listen to him speak.

Before I get into the details of what he talked about I want to recount something he said on one of his weekly conference calls a couple of weeks back. During the question and answer session, a questioner asked what Coxe thought would be the outcome of the European crisis.

Coxe hesitated and walked around the question for a time, before finally explaining that he had to watch what he said on the conference call since they were now being transcribed. He was worried about being quoted to a comment that might be too candid.

Well I guess that the talk that Coxe gave tonight wasn’t transcribed, because he was very candid and he spoke plainly about what he thought of the situation in Europe.

What he said wasn’t terribly encouraging. Nor was it terribly surprising.

We are in a financial crisis. The economy is taking a back seat to the events in Europe.

The problem that he described is well known and one that I have brought up myself numerous times in the last couple of months. It has guided my own investment decisions, those perhaps not enough.

Along with the euro came a strange presumption among banks and ratings agencies that countries of disparate histories and lifestyles could now be considered to behave as one and that the same terms of credit could be applied to their debt. At the extreme of this conclusion was Greece, whose bonds were valued a mere 10 basis points above the Germans, and whose debt was triple A.

Unfortunately the historically profligate countries lived up to their reputation. Equally unfortunate is that so many European bankers fell for this ruse. The problem that we now face is not so much that Greece and the other PIIGS cannot repay their debts, but that the holders of those debts are European banks that do not have the capital to cover the losses of default.

In the question and answer session the same question that had been posed on the call was posed to Coxe again: How was this mess in Europe going to turn out?

Coxe, being free of transcription, was much more candid in his answer.

First, he said that the process, whatever it may be, was bound to be messy. He pointed out that the EU has no escape clause that allows for a country to leave. It is the quintessential “roach motel”. This lack of a way out makes it very difficult to map out the sequence of events that will precipitate from a default.

But defaults, at least in the case of some of the PIIGS, is inevitable. Thus, a recapitalization of some of the banks (he made reference the French ones) is inevitable too.

The tax paying public of the European countries who will have to anti up for these bailouts are not going to be happy. How strong the response is we can only speculate, but Coxe did point out that each of the 5 French constitutions written in the countries history were, like the EU, devised without a clause for their unwinding. In each case the constitution was eventually unwound by “the mobs of Paris”.

But that was not the end of Coxe’s forthright appraisal. When the dust settles, Coxe said he would not be surprised if the Eurozone rolled all the way back to its beginning, and was reduced to its original 6 member nations.

I’m not sure if the audience grasped the gravity of that forecast. The Eurozone is right now 17 countries. That means he sees potentially 11 countries leaving the EU and returning to currencies of central banking of their own. One can only shutter at the dislocations that would be involved in such tectonic shifts.

Well, in a world where the earth is moving miles under our feet and where the admittance that the debt the PIIGS owe will not be repaid must be owned up to, what does one do?

Invest in the asset class that is the opposite of such un-payable liabilities.

Gold. And gold mining stocks. Gold is no one’s liability.

Lately we have had lots of commentary attributing the movements in gold to what the Fed is going to do or what the US economy is not going to do. Well tonight Donald Coxe did not mention Operation Twist once in his primary comments, nor did he mention Bernanke, and he only once mentioned the US economy, but it was in a passing comment, one that actually was referring to the reality that it was not the economy that would drive the direction of the markets in general, and gold in particular, going forward.

To Coxe, trying to peg each movement of gold to a Fed comment, to operation twist or to a disappointing economic data point is akin to predicting the movement of the poles by watching which way the wind blows.

There are far greater forces at work.

The basic point that he made was that the reason to invest in gold and gold mining stocks right now is not the traditional one. It is not the expectation of inflation, or the anticipation of a clever monetary trick by Bernanke. The investment case for gold lies in the 500 million people living within 17 different countries that have their savings, pay cheques, and pensions tied to a currency that was based on a theory and seems by the day to have less of a tie to reality.

Coxe does freely admit, however, that the move up in the bullion must be consolidated. With gold having risen dramatically, Coxe feels that the gold mining stocks are the better place to put your money. He said that this kind of disparity between the bullion and the mining stocks has only existed one time before in history. So while he feels gold will go much higher, he also believes that more value lies in the gold stocks at the moment.

In particular Coxe passed along his usual recommendation: look for companies with long life reserves in secure areas of the world. Put less emphasis be put on near term earnings and more emphasis on long term asset value. And if possible, find companies that have large peripheral deposits that will become or have recently become economic with the rise in the price of gold.

As Europe slowly and painfully gets resolved, Coxe thinks that gold is going to work its way back into the monetary system. The Keynesian economists are going to fight it, and they are not going to like it, but in the end the only way to reinstate solvency in these otherwise bankrupt and soon to be currency-less countries is going to be to accept that gold must be used in some form to bring some confidence back to their system.

Coxe was short on words to describe how this process may play out. But he did say, quite emphatically, that it would happen at a much higher gold price then the price we have today.