China’s Gold Investment “Infrastructure”

Gold Investment in China is booming as a store of wealth and form of saving...

EMERGING MARKETS have revolutionized the demand-side equation for dozens of commodities, writes Index Universe managing editor Olivier Ludwig for Hard Assets Investor.

Nowhere has the change been followed quite so closely as in the gold market. China and India have had a taste for gold jewelry for decades, but evolving income distributions and a tumbling US Dollar have turned gold into an attractive financial investment for the first time for millions of new buyers.

The trend shows no signs of slowing anytime soon, says Jeff Nichols, managing director of American Precious Metals Advisors and senior economic advisor to retail Gold Dealer Rosland Capital. Nichols is a widely recognized expert in precious metals and global economics, and has worked with several mining companies on financing and investor relations.

Recently, I chatted with Nichols about his thoughts on the global gold markets, including what's really driving Chinese and Indian demand, why South Americans aren't buying and why he thinks gold could go to $2000 an ounce – or higher – soon.

HAI: So what's your sense of the gold market in general at this time?

Jeff Nichols: I think the Gold Price is going to go much higher over the next few years based on a variety of forces at play currently or in the near future. What's really important, apart from US inflation, are the fundamentals as they're being affected by things going on in India and China, and elsewhere in Asia. Those are trends that will simply overwhelm the gold market in the next few years.

HAI: Are you talking about these countries increasingly turning to gold to park their reserves? Or are you talking about growing industrial demand?

Jeff Nichols: Both. Most important is the nature and size of investment demand in India and China and the potential that demand has to affect the world market for gold.

China, for example, legalized private Gold Investment only about two and a half years ago. For many decades during the Communist era, private citizens were prohibited from investing in gold. That doesn't mean they didn't Buy Gold jewelry and consider that an investment. But there was no real investment market. About 2 1/2 years ago, the government changed all of that and subsequently went so far actually as to endorse private Gold Investment. I think the government sees gold accumulation by its citizens as a form of national wealth.

In the last couple of years in China, we've seen the development of what I call a Gold Investment infrastructure. There were no outlets for gold a couple of years ago. If you wanted to buy a gold bar, there wasn't a mechanism in China for somebody to do that. But now, a Chinese individual can go into a bank across the country and buy a small gold bar or a gold coin. Or the working-class person with not a lot of funds can open up a passbook- or a savings-type account denominated in gold and make very small contributions or deposits into that virtually of any size. You might find somebody adding a few grams every month.

HAI: Are Chinese buyers purchasing gold because they perceive it to be a better investment or a better way to preserve wealth?

Jeff Nichols: Part of it is the cultural phenomena in which gold has for centuries been perceived as a store of wealth and a form of saving. So if income is rising in China, and savings are increasing, then I think there's a natural inclination for some portion of that savings to find its way into gold. It may not be necessarily that Chinese are concerned about hyperinflation or political upheaval. It's simply a natural thing for them to do.
 
HAI: How does the gold culture in India differ?

Jeff Nichols: For many years, India has been a sponge for gold. But what's happening is that the Indian market was very fragmented and sort of nonrational, until changes begun in the last few years have modernized and Westernized the market.

Still most of the investment demand in India is for gold jewelry at high caratage, often 22 or 24 carat gold. So it's pure gold, but in the form of bangles and bracelets and chains and necklaces and the like. And it's been culturally the custom to give dowries in gold or as a gift on the birth of a child or a wedding or some other important event. It's considered propitious. To have gold is considered to be not only a symbol of wealth but something that brings good luck.

HAI: Is that phenomenon spreading?

Jeff Nichols: Incomes are rising for more and more people. So, as in China where rising incomes find their way into gold, so does it in India. But in India, what we also have is the market going from a sort of archaic form where you would go into a bazaar and stop at a jewelry shop to Buy Gold jewelry, to the popularization of investment products that might be more common in the United States or Western Europe. In Mumbai there's now a gold ETF, and gold is now being offered not just in jewelry shops, but by brokerage firms and insurance companies and over the internet.

Also, small Gold Coins are now being sold through the postal service. In many of the rural and agrarian areas of India, it's really more like a Third World country than a newly industrialized country. In some of these areas, there are no banks or financial service firms. So the postal service is offering gold throughout the country, particularly in these areas that are not serviced by other providers.

HAI: All this spells very real Physical Gold demand?

Jeff Nichols: Right. And that's very important that we speak of it as being physical demand. It means that there is real off-take from the market. Much of this will never come back, at least never in the next few years to come. When an Indian buys gold, or, more importantly, when the Chinese gold buyer accumulates gold, they have a much different view. They're not buying it in order to sell it next week or next month or even next year at a higher price.

And that's truer of China than it is of India. There's always been an important, secondary supply coming from India, with jewelry trading to some extent. So, if prices jump up, you'll see some gold coming back into the market – profit taking, if you will – or if economic circumstances are poor, there may be selling of gold. But these tend to be temporary phenomena rather than people exiting the market permanently.

HAI: But it's not just China and India that matter when we talk about the emerging markets, right?

Jeff Nichols: Given the size of the populations, they're important. But what I've said is equally true for Thailand, Vietnam, Indonesia, Malaysia and Singapore. These countries are all seeing the same sort of rising Gold Investment span that was in China. Even Vietnam has an important Gold Investment interest.

HAI: What about in the Americas, like Brazil, Chile, Mexico? Any significant shift as it relates to the demand pull on Physical Gold?

Jeff Nichols: Not in the sense that it really is a big deal. I'd have to guess that there are people in these countries that are buying more, because their economies are doing well and incomes are rising. But it's not anything that compares to what's going on in Asia.

HAI: What about the supply side in gold? How does that fit in?

Jeff Nichols: That's another building block for the bullish outlook. Mine supply has been decreasing gradually for the last 20 years or so. And even though there was a little hiccup last year and maybe again this year, the trend remains down, at least for the next five years.

Beyond the next five years, there may be a recovery in mine production, prompted by higher prices, affordable deeper mines or more expensive mines. Also, China, which is now the world's largest gold mining country, still has about half the country which has never been explored.

Over the next 10 years and beyond, other countries like Russia are growing in importance as Gold Mining countries and have great prospects for a very long time. But it takes a long time to explore, develop, finance and bring a significant mine that really makes a difference in terms of supply.

So, even though prices have been rising and may rise rapidly in the next couple of years, the consequences of all that is still further out. In the meantime, we have rather limited new supply that is not elastic in the short term, short term being measured in a few years.

HAI: So do you think this run in prices has a good half-decade left in it, at least?

Jeff Nichols: The supply constraints contributing to higher prices now and in the next few years are not going to be overcome, at least for five years, hopefully longer.

The other bullish building block that's quite important is central bank attitudes towards gold. Last year was the first year in a couple of decades that central banks as a group were net acquirers of gold. For the last 20 years prior to last year, they sold on average about 400 tons of gold a year.

In the aggregate, central banks will be acquiring gold over the next several years, in part because of their fears about Dollar devaluation. They hold their reserves in Dollars principally, and so they're worried about the Dollar. To the extent that they can diversify, they will.

HAI: Given all these variables around the globe, where does it all take us?

Jeff Nichols: I think gold can go to great heights, even without the United States seeing double-digit inflation and the Dollar falling through the floor, simply on the basis of rising demand in these foreign markets.

Now, that said, I think we're going to have a significant rise in inflation over the next few years. I think the economy could best be described as moving towards a stagflationary type of scenario, in which economic growth in real terms remains very low and unemployment remains high for an extended period. And inflation is a problem. I don't know that we're going to see double-digit inflation. Maybe we will, maybe we won't. But it is certainly going to be inflation that is a problem. When I look at the growth in money supply over the last couple of years as measured by monetary base, it just leads me to believe there's no way we're not going to have higher inflation.

HAI: How much higher do you think gold could go?

Jeff Nichols: Conservatively, I think in the next few years that certainly $2000 an ounce is very likely.

HAI: On the basis of the demand issue alone?

Jeff Nichols: Yes. Gold has not kept up with inflation over the last few decades, measured from the cyclical price of $870 or $875 per ounce that we saw in January 1980. If you extrapolate that price and adjust it for inflation each year since then, the price of gold today would be approximately $2,400. And, if you believe as I do that actual inflation is higher than the reported statistics, that price today of $875 adjusted for what might be a truer measure of inflation would be several thousand Dollars higher than that.

I'm not suggesting that gold is necessarily going to go to $6000 or $7000 or $8000, but I'm just trying to demonstrate with these numbers that to think of gold at $2000 or $3000 a few years from now is not a crazy idea.

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“Go 10% Gold, Regardless of Price”

Who cares about price? "Just start Buying Gold," says this long-time dealer's analyst...

EVEN THOUGH GOLD has slipped back in recent days, it's still hovering around historic highs, writes Lara Crigger at Hard Assets Investor.

Given the ongoing Euro crisis, interest in Buying Gold – from both individual and institutional investors – is at a fever pitch. But don't get swept up in the hype, says Jon Nadler, 30-year gold-market veteran and long-time metals market analyst and PR head for Canada's Kitco Metals, Inc, the refinery and precious metals dealership.

Nadler says gold's real fundamentals support a much lower price, one we'll soon return to once the Euro crisis is over. But he also advises putting 10% of your wealth into gold, regardless of price, as insurace. Find out why in this Hard Assets Investor interview...

HAI: So why do you think gold's back up near its historic highs? Is it just the Euro crisis, or is something else fundamental going on here?

Jon Nadler: Volatility and nervousness are both on the rise. We did see a fresh high last week at about $1250, so it's backed off of that. But let's not ignore the rest of the metals complex here.

Silver's off $0.50 [as of May 17, 2010], platinum's off more than $60-$65, and palladium's down $20 an ounce. The Dollar continues to be quite strong, and oil's down sharply. So there's definitely a lot of turmoil in the markets, which is primarily related to the Euro situation. But I think the focus here is once again misplaced.

Last fall, I cautioned about the non-imminent demise of the US Dollar, which everyone was promising us. Back when gold went to $1226 in early December, we were guaranteed that this was a currency in its final stages of demise, and that it would be done away with as the reserve currency of the world. This was the reason that gold would actually land on the moon. Obviously, none of that happened. And not only that, but the Dollar has risen very substantially since then. It remains the benchmark for settlement of global trade, and is still represents more than 60% of global reserves. It's not demising. It's not about to go away.

HAI: Of course, now we're starting to hear the same sort of talk around the Euro...

Jon Nadler: Right. The same talk that was directed at the US Dollar is now, curiously, being repeated, just that now, such talk is aimed at the Euro and by the same people who said the Dollar would fall off the proverbial cliff. They're saying: "It's OK that the Dollar's rising; we'll take that. It'll die later." So what are these people really telling us? Are they really proposing that all of these currencies are really dying in concert, and that we're going back to gold as the only viable currency?

I'd love nothing more than for that peg between Gold and money to be re-established, but sadly, since 1968, that's been a process largely undone. As much as we love gold, the reality is that it's been marginalized in the global system. It only represents 0.6% of total private global wealth. So, it will not, and it can not, be the total panacea to cure what currently ails the world.

The present driver of Gold Prices is this European debt crisis. There may not be as much concern about it spreading as there had been in the past two or three weeks, but rather, concerns remain about the efficacy of the rescue package that has now been put into motion, about possible future defaults, and, of course, about whether the Euro will demise and be replaced with national currencies again. So over the past week or so, I think it has come down to a battle of the wills: the speculative funds versus the financial officials in Europe. It's a game of chicken. One side is calling the other's bluff.

HAI: So you can't see the Euro being abandoned so easily...

Jon Nadler: At the end of the day, there's a lot of pride, hard work and credibility that went into the EU and the Euro currency. For that to happen, I think you're really asking for such an Armageddon scenario that much worse things would happen first; namely, another contraction of the global economy. Is that really what we want?

There are a lot of side issues here as well. Yes, maybe Greece wasn't ready to get into the EU when it did. Yes, maybe German taxpayers feel that despite the fact that they're generally very frugal and orderly savers, they are being asked to subsidize other "spendthrift" countries. But they're all in the same union now, and there is little choice but to help each other out.

What if the Euro does die? We wouldn't be switching from Euros to "nothing", and we wouldn't be switching from Euros to "Gold Bars" as the new currency, either. We're also not about to give the Dollar global hegemony over the global currency system. Thus, if anything, you could see a rehabilitation of the previous national currencies. At which point, I might add, the German Mark would be quite a solid alternative.

HAI: So is the current push into Buying Gold really sustainable? Or should we expect gold to retrace a bit, once the Euro crisis is resolved?

Jon Nadler: The latter. I project that the crisis clouds will pass, just as the US "perfect storm of 2008" also dissipated, and gold will eventually return to more "realistic" price levels; ones that satisfy jewelers, producers and even individual investors in terms of its presence and purpose in a portfolio.

We're really looking for an eventual evaporation of the fear and greed premium that's permeating the market at this moment, and has been present therein since last fall, but one which has risen given what's happened over the past few weeks.

To me, when you see a 975-tonne long position of speculative money in the Gold Futures and options markets, well, we know it's got to be the hedge and spec funds. It's a fund push, capitalizing on fears that are legitimate, but I don't think you can carry such apprehensions to the dire conclusion that this is some "huge realignment" in the financial order of the world.

To some extent, when you reach a new price high, one that's printed in the headlines in bold font, of course the man in the street's going to think, "This is it; this is the end of the world. I better go run out and buy a lot of gold." But that's exactly the time when they should think of holding off if they didn't buy some in the past. Of course, they should have been Buying Gold in the past. We always tell people to consider gold as a core insurance, to make sure they have some. We also say: "Don't obsess about the price; this isn't about price gains or performance; this is about a percentage allocation of your portfolio." You take that formula home, and you're not going to be bothered by a media blitz that proclaims: "This is it!" because, really, it's never "It" as we have repeatedly learned by now.

HAI: Separating out the hype then, what do you see as a more reasonable direction for where gold will go?

Jon Nadler: Just look at the situation we have now, where the production cost of gold is just under $500 in cash cost terms, and with a 7% mine supply increase year-on-year, as we know from the latest GFMS stats 2009. The scrap supply of gold rose to record levels last year; it jumped 27%, and there's a 21-year low in global jewelry production. India was a net exporter of gold for a full quarter last year, and it imported the lowest gold tonnage in a dozen years in 2009. All of these things eventually do come together, and the only bright spot remaining in the market last year was ETF-driven demand, but Gold Investment demand was characterized as having fallen off sharply in Q1 this year vis-a-vis last year.

I think one of the reasons we didn't get going in earnest to much higher levels during the initial phases of the "Greek drama" was the fact that Gold ETFs were, by and large, dormant from June of last year to very recently. They've only started accumulating again in the past few weeks. That's a curious case. Even the absence of modest buying from that now all-important demand source held a lid on prices.

So what happens if a wave of ETF-based redemptions hits the market, something to the tune of 200 to 300 tonnes out of the 1200-plus tonnes that they have now? I don't know. We've never seen these funds' effect in a sideways or downward phase of the market, so we don't know what would happen. To the Gold Price, of course, it would do significant damage, because there's physical gold behind these funds, and that physical gold would flow into the market in case of redemptions. And this market, at this time, given current fundamentals of supply/demand, is totally ill-prepared to absorb such sizable potential outflows.

The other question it raises is: What if one of these PIIGS countries finds itself in a situation where it has to mobilize its gold? I mean, what was the point of having these gold reserves in the first place? It's about defending a national currency, maintaining public trust and confidence in a currency, and you have gold as an asset of last resort. You mobilize it when it's a rainy day, and it's been pouring rain in Europe lately. So what if Portugal finds it necessary to ask the central bank signatories to allow it to "step in front of them" and use/mobilize some of its reserve tonnage, because it needs the funds? It's a potential issue. It may seem like a rhetorical question, but mobilizing gold to save one's hide is not an unknown phenomenon in the annals of central banking history.

HAI: So what is the "right" price for gold?

Jon Nadler: Of course, now we've heard that such a price should be anywhere between $8000 and even $15000 an ounce, but I still think that between $680 and $880, or in that range, gold would be much more in balance with its fundamentals. Eight hundred is a number that you saw come up in the GFMS surveys as a potential target, and they gave it up to two years, even with the potential overshoot of up to $1320. Yeah, that could still happen, but it's all a cycle, a phase in the markets. It's currently driven by a circumstance – Europe – but not some "new dynamic", such as a return to a gold-based world, that has suddenly become the new paradigm.

You also have had Barclays Wealth Management coming out, saying they envision $800 gold by January 2012, and saying in an interview on TheStreet.com that they're "shorting the GLD and buying put options on gold for Jan 2012." Further, what am I to make of Societe Generale, which also said in April of this year that $800 gold is in the cards before the end of 2010? And so on; I am not alone in computing such figures.

HAI: You sometimes get some flak for taking a comparatively bearish stance on gold, but you actually advocate investors hold a healthy percentage of their portfolio in the metal. What's the right allocation to gold, and why?

Jon Nadler: Sometimes get flak? Try all the time, and for the wrong reasons. Frankly, it does puzzle me, because when I say – and I always say this – that you probably should have 10% in gold, that's a percentage that's about 50% higher or more than what most financial experts will tell you. Also, we say that if you don't have gold yet, you should go out and just start Buying Gold. You don't care what the price is.

So I'm not telling you: "Now is the time to sell"...unless, of course, you're inclined to take profits on something that you bought for profit. But I am actually much more generous with my recommended gold allocation than mainstream financial advisers out there who say that 6% is probably more than adequate. I just do not sign up for 50% in gold, or 80% in gold, as those who call me "anti-gold" probably do.

We advocate 10%, regardless of price. That should be a core holding for anyone, of any orientation, whether they believe in inflation, deflation or an unforeseen crisis of any kind. It's an "all-eventuality" type of holding. But I will also say this: Don't overload in gold, with the wrong expectation, at the wrong time, because that can come back to bite you badly. Ask the panic buyer of 1980 how he fared for 30 years.

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Gold-Oil Ratio Redux

Priced in gold, a barrel of oil is sinking fast...

AREN'T GOLD and oil both measures of inflation? asks Brad Zigler at Hard Assets Investor.

Because if so, then why is gold up and oil down? Shouldn't the gold-oil ratio – the cost of one ounce in barrels – stay pretty static?

Well, generally speaking – and that'd be very generally indeed – gold and oil do move in tandem. But wrinkles in the relationship develop because of differing fundamentals and because of differing fears. As the gold oil ratio shows, we're living in a fear-driven market now and that's where gold really, um, shines.

As the Greek debt crisis unfolded and fear of Continental contagion spread, capital streamed to safe-haven investments like the greenback and gold. Meanwhile, the prospect of a further meltdown in aggregate demand tilted an already-glutted oil market – for WTI crude, at least – downward.

Put simply, oil got cheap, not only in Dollars, but also in terms of Gold Bullion. Recently, as the gold-oil ratio below tells us, an ounce of gold could buy as few as six barrels of crude to as much as 25 barrels...

The gold-oil ration's most recent high followed six months of frantic de-leveraging and was itself followed by basing at the 14-times level as economic fixes were instituted and fears eased

Take a look at the chart, though. We've had a vertical ascent in the ratio this month. We're pushing on the 18-times level now.

The question for traders is whether this is a repeat of the late-year 2008 move or just a short-term blip.

The consensus – a thoroughly unscientific poll as it happens – seems to line up with the blip notion. For now, at least.

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Investing in Biocide Silver

Silver makes an excellent biocide, as this investing analysis notes...

COMPARED TO GOLD and the other precious metals, Silver Investing frequently gets short shrift, writes Lara Crigger at Hard Assets Investor.

Silver is often seen as the "poor man's gold" – a cheap entry point into precious metals investing for those who can't afford to buy its posher yellow cousin.

But silver's hybrid personality – half precious metal, half industrial workhorse – means it can be used in a much wider array of applications. And it's silver's increasing use as a biocide and antimicrobial agent that may be the most promising demand sector of all, more promising yet than new investing demand, says Jessica Cross, CEO of the VM Group consultancy in London.

Working in conjunction with Fortis Bank Nederland, VM Group provides investing research and analysis of the metals and broader commodities markets, including precious and base metals, energy, agribusiness and renewables. Here, in this interview with Hard Assets Investor, Jessica Cross discusses the outlook for silver, including whether faith in the Gold/Silver Ratio is well-founded, why silver recycling is set to decline, and how silver's being used to purify water and gym clothes alike.

HAI: In a recent speech to the London Bullion Market Association, you said silver had been "typecast" by investors. What did you mean by that?

Cross: I think it's been typecast by two completely separate markets. In India, you have a large population of rural-based people, who aren't very high on the income ladder. They'll tend to invest in silver, as far as they can invest in anything, and when they get more wealthy and affluent, they then tend to "trade up" into gold. So Silver Investing is the first point of entry, but gold is what they really aspire to, when their income allows them.

You see this in the US as well. There, I think you have a sector of investors who say, "Well, we can't really afford gold, but we will take silver." So silver is seen as the poor man's gold – which I think is completely wrong, as silver has a huge role to play as part of an investment portfolio.

But apart from that, people also watch the Gold/Silver Ratio. And when the ratio deteriorates out of silver's favor, it's used as sort of a secondary investment opportunity. A lot of people put a lot of faith in the gold/silver ratio.

HAI: Is that faith well-placed?

Cross: Over time, I think there's certainly been a place for that perception. I much prefer to look at them as completely different, even though they're both precious metals. Gold has very limited industrial end use, while silver offers an array of end uses, which are becoming increasingly more interesting. At the end of the day, that silver supply/demand balance is going to get increasingly healthier. So although the prices will sometimes move in tandem, they're really very different.

HAI: What are some of the more interesting new end uses for silver, now that silver-based photography is on its way out?

Cross: There are a number of them, but I think the one that's most going to benefit is using silver as a biocide. So then you're looking at a lot of medical issues, water purification; using silver in food containers to keep things hygienic, and in fabrics, not just for the sporting field but also the leisurewear field. Silver could be used in bandages for hospitals. So there's a huge range of diverse applications for use, just on the biocidal side. I think these are going to be coming into their own soon.

The beauty is, of course, that you eventually throw these items away. And even though the silver in that product that's going into the dustbin is only there in minute quantities, you're still not recycling it.

HAI: That's very different than in the past, where photography led to a lot of recycling of silver.

Cross: It's interesting – silver for photography has dropped quite sharply, of course, because everyone's going to digital. Digital, of course, tends not to use silver in its process. But where you do still see silver used in photographic is for medical and industrial X-rays. That really is a firm growth area.

Still, that means the whole nature of silver going into the photographic industry is changing. You're not seeing 35 mm film being the predominant product in that sector. You now have more silver going toward medical and industrial X-rays instead, and that means less generation of recycling. If you're not using 35 mm film, you're not sending it out for processing; that silver's not coming out in the wash as they develop it, and so there's no silver being generated for recycling.

So it's a double-edged sword: There's less silver going into photography in the first place, but there's also less recycling going on as a consequence. There's obviously a time lag in there, though...

HAI: Many people think finding potable water will be the next big issue we as a world will need to confront. How will silver's antimicrobial properties play a role in this?

Cross: Silver, as a biocide, can help purify water containers, or act as a purifier. So you can buy a portable water purifier and lo and behold, there's silver in it. Yes, I do think clean water's going to be an issue. Our water system is a closed one, throughout the globe, and we're seeing our quality of water decline, as we pollute it and reuse it. I'm horrified to hear that if you drink water in central London, it's actually been through seven people before it goes through your kidneys.

HAI: That's kind of gross.

Cross: This is the problem. Our water is declining in quality, and silver can play a role in improving that quality throughout the world. I think it's an extremely important usage that will come into its own quite quickly.

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Good & Bad News on Oil

Crack spreads in the oil refining industry just hit their best in a bad year...

TODAY I'VE GOT a "good news-bad news" story for you, writes Brad Zigler at Hard Assets Investor.

First the good news. Oil refining is recovering. So if you own shares of Tesoro Corp. (NYSE: TSO), Valero Energy Corp. (NYSE: VLO) or Sunoco, Inc. (NYSE: SUN), you've probably noted a certain buoyancy in your stock's price over the three trading sessions to Tuesday.

The reason for the upticks? Refining margins held above 15% for those three days, too. Now, that may not sound like big news, but you have to remember that we haven't seen gross profits at this level since last summer.

Summer. You know, driving season...

The margin represents the gross return obtained from cracking crude oil into distillates such as gasoline and heating oil. And to say that refiners are behind the curve this year would be a gross understatement.

We're nearly into May, a month in which margins typically peak for refiners. In mid-May 2006, for example, margins topped out at 33%. A year later, margins crested at 44%. Then, in 2008, came the crash. An oversupply of crude was signaled in June when the market slipped into contango. That produced the best profit of the season at just under 16%.

The subsequent collapse in distillate demand then drove margins southward. And, by this time in 2009, margins were already in decline from a seasonal peak above 19%.


The question in investors' minds now is whether we're due for a crack spread season like 2008 or one like the more historically common 2006.

A very good question indeed. In any event, these are the best of times – amid a bad year to date – for refiners.

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Meat ‘n’ Potatoes Inflation

Too busy Buying Gold and silver to notice the rise in agri food prices...?

IT STRIKES ME as odd that there's so much interest in gold – a substance that investors rarely, if ever, get to actually handle (at least in Bullion form) – and so little interest in foodstuffs and agri prices, writes Brad Zigler at Hard Assets Investor.

You can live without gold. You can't without food. Yet investors' eyeballs don't latch onto the stories that deal with agricultural commodities. It's columns devoted to precious metals that get the traffic.

If that describes you, then you're missing out on a big part of the inflation story – and the hedging opportunity – by skimming over the agri accounts.

Last week's US Producer Price Index report showcased the impact of agricultural commodities on price inflation. You could say last week's numbers were the "meat-and-potatoes" of inflation. Well, meat and vegetables, to be more accurate.

Fully 70% of the March hike in wholesale finished goods was attributable to food. And a large part of that was due to soaring meat prices. I believe the parabolic rise in livestock prices, especially in lean hogs, is setting up a massive short. But for now, the appetite for meat among consumers and investors remains unsated.

In the soft commodity sector, cotton's bull market gives no sign yet of relenting. After years of low prices and the ensuing switchover to more lucrative crops, global stocks remain tight. The supply situation could become precarious if there's bad weather in the US cotton belt.

July cotton futures jumped a nickel a pound to the 86 cent level last week. Take a look at the chart of ICE/NYBOT Cotton (Jul. '10 contract):

The kindling could have been lit with India's announcement of export restrictions last week. The ban followed a run-up in local prices due to tightening domestic supplies. Now, with the withdrawal of Indian stocks, buyers will have to compete more aggressively for US and Chinese supplies.

With prices clearing resistance at 84 cents – equivalent to a $40 share price for the iPath Dow Jones-UBS Cotton Total Return Subindex ETN (NYSE Arca: BAL) – the market's poised to challenge its decade-long record of 90 cents.

And if the 90-cent level's taken out, you could see a parabolic move upward, like that exhibited in the live hog market.

Better buy your polo shirts and other cotton summerwear now.

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Mining-Energy Trouble in South Africa

South Africa's huge gold and precious metals industry needs more power, fast...!

SOUTH AFRICA is no longer the world's No.1 Gold Mining nation, but it remains one of the world's primary precious metals producers, report Lisa Barr and Lara Crigger at Hard Assets Investor.

It also continues to struggle to meet its own growing electricity needs – and there's little relief in sight, says Eskom, the state-owned power utility. It accounts for 95% of South Africa's electricity supply, which is crucial to Gold Mining and precious metals production. Unless more power plants are built soon, however, the nation could face severe power supply shortages in 2011-13 and beyond.

This would cripple South Africa's precious-metals mining industry, which, according to Johnson Matthey, accounts for some 78% of the world's platinum, 35% of its palladium and 87% of its rhodium supply. And Eskom's announcement could impact the precious metals market well before 2011, says Jessica Cross, CEO of VM Group.

Working in conjunction with Fortis Bank Nederland, VM Group – which produces the annual Yellow Book of Gold Price and mining research – provides research and analysis of the metals and broader commodities markets, including precious and base metals, energy, agribusiness and renewables.

Here, Jessica Cross tells Hard Assets Investor about South Africa's power troubles, including what ripple effects the news could have on automakers, how platinum-group ETFs have affected the market, and what difference a flooded mine shaft makes.

HAI: What consequences would ongoing power disruptions in South Africa have on the precious metals markets?

Jessica Cross: It could be very serious, particularly for the PGMs [platinum group metals], not so much for gold. Well, South Africa is not the biggest gold producer anymore, but it is still up there, so any loss of production will certainly impact that market, too. But the real question is, what happens to PGMs? The world needs PGMs for autocatalysts, and primarily, South Africa is the main producer.

So obviously, any break in power supply to the mines is of very serious consequence, particularly for your deep hard-rock mining. If you have a prolonged power cut, chances are that those mines could flood, and the cost of trying to de-flood them is enormous. So it's not just a question of the power going out and coming back on tomorrow, and it all gets sorted out; this has long-term consequences for PGM and gold capacity. It's very serious.

HAI: When a mine floods, how long does it take to de-flood it?

Jessica Cross: Well, very often, they don't even do it, because it just proves to be so expensive. It depends on the age of the mine, the depth of the shaft and how much life is left is in that shaft. In the end, you really, really don't want to flood a shaft. It could take months to get that right, and everything – basically, your equipment, the shaft – all gets decommissioned.

So any announcement from Eskom along these lines makes one sit up and think what's going to happen to PGM prices.

HAI: Something like that would certainly lend long-term support to PGM prices.

Jessica Cross: Absolutely. And I'm sure PGM producers are in intense discussion not only with their management, but also the government. Obviously, mining is crucial to the South African economy; it's all intertwined and interrelated. It has implications in South Africa for employment. But a regular and reliable source of power is core to that industry and the economy, and really they can't afford to have a problem like this re-emerging.

HAI: It's interesting, because the platinum and palladium markets are so much smaller than other precious metals markets. So an announcement like this has the potential to dramatically drive prices.

Jessica Cross: It certainly does. I think once investors pick up on this it will create a knee-jerk reaction, because of South Africa's dominance as a producer of PGMs, but also as you said, the markets are that much smaller, and people know that the PGMs are very instrumental in the control of exhaust emissions.

HAI: Speaking of which, how do you see power disruptions affecting the auto industry, especially with the current recovery in automobile demand?

Jessica Cross: Well, it's interesting that they're happening at the same time. You could have a double whammy. You've got very strong car registrations in China, and a recovery in Europe, a recovery in the U.S. It's all primarily gasoline-driven cars, too, so you're not seeing many electric cars coming in that don't use platinum or PGMs at all. The market penetration isn't there, and we don't see that happening for the foreseeable future.

So we're still very much relying both on diesel and gasoline catalysts, both of which require PGMs in different ratios. The procurers of these metals for the car manufacturers are left in a difficult situation, because they're obliged to procure metals for long-term plans and production lines, but they have to do that not only amid rising prices, but also volatile prices. That's very difficult.

HAI: There's another factor, too, here, and that's the platinum and palladium ETFs. Europe has had physically backed PGM ETFs for awhile, but in the United States, PPLT and PALL just launched, and they're very popular. How do you see ETF investment affecting demand in this sector moving forward?

Jessica Cross: All the precious metals ETFs are doing particularly well. They're the right products at the right time in the right place. They're allowing investors to participate in this commodities cycle in a way that they couldn't do before.

Clearly, if you have a sharply rising PGM price because of the Eskom factor in South Africa, you're going to see more interest in these ETFs. People who got in early are obviously going to do very well with their investments. So I think the Eskom factor could raise the volatility of the ETFs, raise the turnover and it will lead to more investors coming in as a consequence.

HAI: Do you see the ETFs having a disproportionately large effect on the platinum and palladium markets, compared to something like GLD and gold?

Jessica Cross: I think you're getting a slightly different sort of investment coming in, but it's a very savvy investment. I think, yes, the ETFs are a very significant bottom line in your demand/supply balance, and this will instill volatility. So not only could there be upward pressure on PGM prices, but you'll see a roller coaster of very sharp up and down movements, as this thing continues to play out.

That in itself gives investors a fantastic opportunity to trade. There's nothing more boring for an investor than a very stable price that moves a tiny percent over a certain period of time – it's like watching paint dry. Of course, you could lose your shirt very quickly, too! So I'd say PGM ETFs are not for the faint of heart, and they're not for the inexperienced. But there are enormous opportunities coming in this industry.

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China’s Impact on Gold Prices

Gold Prices are now critically linked to China and its booming middle class...

CHINA IS KEY when it comes to the shape of gold demand according to Eily Ong, author of the World Gold Council's recent study, Gold in the Year of the Tiger, writes Lara Crigger at Hard Assets Investor.

China's growing middle class with disposable income and a penchant for saving, says Ong, could drive gold consumption in the country to double over the next decade – which should help boost Gold Prices.

Ong has been with the World Gold Council since November 2009. Previously, she was a metals and mining equities analyst for Credit Suisse, in London. Currently, she is an investment research manager for WGC, where her role is to research and promote the use of gold as a long-term portfolio asset.

Recently we sat down with Ong to learn more about the supply and demand factors underpinning Chinese gold consumption, including why jewelry plays such a big role, how China could affect gold's price seasonality, and whether the current growth is sustainable.

Crigger: We've seen incredible growth in Chinese gold demand over the past few years. What's driving the push?

Ong: Chinese gold consumption has been driven mainly by several factors: the rising average income per head; a surplus of investable income, given the high savings rate amongst the Chinese people; the underlying strength of the Chinese gold culture; and the improving standards of living in China itself.

In recent years, we have seen demand across all sectors grow for the expanding Chinese middle class, especially in the 18-karat jewelry market and the industrial sector (particularly for mobile phones). However, our report and our outlook are based on the Chinese population as a whole, not just the middle class.

Crigger: What about the investment side? Are we seeing growth among the Chinese middle class there?

Ong: We do see strong evidence from both the jewelry and investment side; they are expected to be the chief drivers of Chinese gold demand going forward.

By far, jewelry is the most dominant area of gold demand in China; it absorbs almost 80 percent of all gold usage! We found that if gold was consumed in China at the same per capita rate as it was in India, Hong Kong or Saudi Arabia, then the annual Chinese demand could increase by at least 100 tonnes, to as much as 4,000 tonnes, in the jewelry sector alone.

But in terms of investment demand, this sector has been growing in line with the country's GDP and population. The IMF and World Bank have forecast Chinese GDP to grow by 10 percent and 9.5 percent, respectively, in 2010. So we'll also see that investment demand grow. The Chinese are high savers, and the World Gold Council expects consumers to look at gold as an asset class as they continue to build (or, in some cases, rebuild) wealth, while minimizing the variability of their returns.

Crigger: Would such a high growth be sustainable over the long term?

Ong: Gold demand has grown in China at an average rate of 13 percent per annum. During the past decade, the Chinese gold mining producers stepped up production by 84 percent. So Chinese demand growth has continued to outpace domestic production capacity, and we've seen this since 1992.

But China is still ranked No. 2 behind India in terms of demand. And although we see the acceleration in the demand growth, the country still has one of the lowest gold consumption intensity rates, if you compare it to Western economies, or even countries with similar gold cultures, like Taiwan or South Korea.

Crigger: Why is that?

Ong: Well, we had this deregulation in the Chinese gold market; I think people aren't really aware that the regulations were only lifted less than a decade ago. So, yes, we've seen the per capita consumption level growing: From 2002, the per capita consumption was at 0.17 grams, and this has almost doubled to 0.33 grams in 2009. But it's still one of the lowest in the world. So they are catching up in terms of their Western counterparts.

Crigger: Won't this growing consumption eventually put the squeeze on global gold supply?

Ong: We did some analysis in the report on recently published '09 figures from the United States Geological Survey; they estimate that China's known gold reserves account for just 4 percent of the total global gold reserves. That's really small. So our estimates suggest that China may exhaust its known gold reserves in just six years from now. And it could be less, if the Chinese demand continues to accelerate.

So if our suggested analysis comes to fruition, then it seems that indubitably, there would be some implication for the gold market, as China is the world's largest gold producer since 2007.

Chinese companies have already started acquiring gold mining production and businesses outside China, as the country tries to secure sources of gold supply to meet its growing domestic demand. We do see that domestic supply growth could be challenging structurally in China, unless there's more funding directed toward exploration. Chinese gold mining resources are still relatively undiscovered, and we believe this could create new investment opportunity.

Crigger: As China continues to increase in importance in the gold market, do you think we'll start to see gold's seasonality follow the Chinese calendar more closely? Will we see a bigger bump from the Chinese New Year, for example?

Ong: There are many factors driving commodity prices, of course, and seasonality is just one of them. If you look at it in terms of Dollars, we showed in the report that January, September and November have been the strongest months for gold in the past five-10 years.

In terms of Chinese holiday seasons, we do typically see investors restock during the Chinese New Year, Christmas and the world New Year. Yes, they do have a positive impact on the world Gold Prices, historically. But there's no perfect rule of thumb to seasonality, in terms of forecasting.

India is still a key gold market; it has been the world's largest gold market, in terms of volume. Certainly, China's outlook will have implications for the gold global market, but in many respects, China shares a similar gold culture or heritage to India. So in long terms, we do see both India and China to be very important gold markets, regardless of which is going to be the main driver.

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Gold at $1400, Oil at $100

Subpar economic growth doesn't mean flat-to-falling gold or Silver prices...

PHILIP SILVERMAN, managing partner of Wall Street's Kingsview Management – a registered commodity trading advisor (CTA) and member of the National Futures Association – speaks here with Hard Assets Investor about the outlook for Gold Prices and the broader commodities market.

HAI: What is your outlook for the economy and commodities? The year's off to somewhat of a flat start...

Philip Silverman: Well, our outlook is for subtrend growth. You know, we've had a bounce off the bottom in economic growth, as well as the markets. But we don't think that that has very much legs. Not in any way calling for a collapse, but not growth rates that we would have been accustomed to in the last couple of decades.

HAI: So that 5.7% growth rate at the end of 2009 – that won't be sustained?

Philip Silverman: We do not believe that will be sustained. You know, there was a lot of bounce-back from the crisis, a lot of inventory rebuilding. But to think that coming out of this crisis we'll be able to sustain even a normal trend growth is a very optimistic outlook and one that I don't think we can necessarily bet our money on.

HAI: Now, a 2% growth rate; how does that work out for equities, for commodities? Is it supportive?

Philip Silverman: I think certainly a general sideways price action is something we're expecting. In stocks, it's going to be a stock-picker's market. Those companies that are able to thrive, have good products, manage their balance sheets very well and compete effectively in the marketplace are going to do well; value stocks will be able to do well.

But as a whole, I wouldn't bet on very large advances any time in the near future. You know, we've made a large bounce off the bottom. A lot of money was reallocated into equities. And it's going to be a tough time to see the market go up significantly. Like I said, I'm not looking for the bottom to fall out here, but we think you're going to see a lot of sideways action.

HAI: How does the Fed play into the outlook? Recently we saw the Fed bump up the discount rate by 25 basis points...

Philip Silverman: Well, that is something you have to keep an eye on, because if they move too soon, they could choke off their recovery. But if they don't get ahold of the stimulus, we're going to see inflation coming down the road. Now, it's tough because I wouldn't expect to see any signs of inflation in 2010. We may not even start to see it towards the end of 2011. But typically, historically, when you've injected so much stimulus into the market, you will see inflationary pressures coming, tending to be three to five years out from where all of it began.

HAI: So, next year, basically, if it started in '08?

Philip Silverman: I would say we would be looking for it to really start to show up between '11 and '13. And it's going to be very challenging for the Fed to get itself out of it without...in a smooth way. And I think to bet that they're going to be able to do it is a pretty tough bet to make. I mean, they've not been able to get out of the way of inflation in the past. So we certainly think you need to have some assets in your portfolio that are going to be a benefit in this sort of a situation, whether it's TIPS – inflation-protected securities – or the gold and Silver hard assets. And most likely we're going to be seeing that, we believe.

The inflation trade is not dead. You can take your time to get there, but it's coming. Gold and silver are the two that we like – silver because there's a lot of industrial uses, technology-wise, and even in the medical field. So that it's something that's not as popular with investors, but offers essentially the same sort of price movement.

HAI: What if the Fed reacts, starts to raise interest rates? Is this not going to be negative for gold and Silver?

Philip Silverman: I don't believe so. I think people will move to gold as a safety asset and a hedge against inflation. And at the same point, gold also is a little bit of a currency alternative. The currency markets are a very difficult place these days. The Dollar has rebounded significantly. A lot of that has been the "best house in a bad neighborhood". The EU is having a lot of problems. So that's a currency that's being moved away from. But the US has got a lot of problems with the fiscal deficit...

HAI: But so does Europe.

Philip Silverman: Well, absolutely. Europe is much worse than us. And that's going to continue to put pressure on the Euro, which can mitigate the inflation outlook for the US if the Dollar continues to go up. But, the point is, unless we can get control of all of our financial house, there will not be a strong push to the Dollar. And the more it goes up, we will just see it getting more overvalued and an inability to have a lower-risk play on being short against the Dollar.

Everyone got short the Dollar this past year. It was the most crowded trade out there, carrying...short the Dollar, long other assets, which is one of the things we believe helped spring gold back recently. It got ahead of itself trading-wise.

HAI: Where do you think it's going to go in 2010?

Philip Silverman: I think we could see a new high in gold, but I'm not calling for a huge move up to $2000. It needs to come at a more sustainable pace, nearer $1400 or $1500. What we saw before got a little parabolic at the end. And that scares a lot of traders out. And at the same time, with the Dollar bounce and the carry trade coming off, it pressured the Gold Price.

HAI: What do you see besides gold and Silver? What other commodities?

Philip Silverman: We actually have been watching oil very closely. It's been in a sideways market for quite some time. So we don't see any urgency to be getting in. But we do believe that the long-term outlook for crude, based on the idea that it is a limited resource, and there will be a continued demand for crude, out of Asia and South America that we believe that, if we start to resolve out of the range to the upside, it's going to be a place that you're going to want to be.

Getting back to the $150 that we saw is a little optimistic. We would be looking for oil...if we get above the low $80s – particularly the $85 level...to make its way up towards $100. If you start to get up towards $100, we're going to need to have a much stronger economy. Because at $100, it starts to really have some effects on the end-users. And even the producers are starting to get nervous too at $100 too.

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Position Limits in Gold Futures

Was US regulator the CFTC right this week to discuss position limits in Gold Futures and options...?

On THURSDAY this week, US regulator the Commodity Futures Trading Commission (CFTC) held a daylong hearing to discuss the possibility of enacting position limits in the gold, silver and copper markets, writes Lara Crigger at Hard Assets Investor.

That might sound a little strange, considering the general lack of evidence or even public outcry on the matter. Apart from Gold Futures manipulation theorists, such as the Gold Anti-Trust Action Committee (GATA) – which was represented by founder Bill Murphy at this week's meeting – few have even publicly raised the question of curbs on speculation in the metals markets.

That hasn't deterred the CFTC or Commissioner Bart Chilton, however. He recently called out a need for "professional-grade regulatory tools" in the base metals and Gold Futures markets. But CFTC-managed position limits would be a very bad idea, says precious metals expert Jeffrey Christian. Managing director and founder of the CPM Group, and a well-known authority on gold, silver and base metals, Christian has worked with the United Nations, World Bank, International Monetary Fund, as well as dozens of miners, industrial companies, investment banks and investors.

Here Jeffrey Christian speaks to Hard Assets Investor about position limits, bona fide hedgers, and why gold manipulation theorists shouldn't be so quick to call for more regulation...
 
HAI: Even though Bart Chilton was quoted as saying we need "professional-grade regulatory tools" in the metals markets, there really hasn't been much of an outcry in favor of position limits in the metals markets. What are your thoughts?

Jeffrey Christian: Well, the exchanges impose and manage them already; there are position limits in the metals markets now that the exchanges run. And the exchanges' position limits, generally speaking, tend to be more stringent than the ones that the CFTC might impose, were it to try and take the reins.

I think the idea of the CFTC as a federal regulator removed from the market, living in Washington and managing position limits is a bad idea. I think the idea of position limits on noncommercial positions is a good idea, but it is a good idea that is best effected by the exchanges, which are, by definition, closer to the market.

But I'm hesitant to predict the probability of the outcome of something that depends on the attitudes of politicians and political appointees in Washington. I hope we never see CFTC-managed position limits either in energy or metals, because I think it's a bad idea. I don't know what the probability is. I know that government regulators regularly crush my hopes.

HAI: Do you think the Nymex and the Comex do a good enough job regulating the metals markets already, then?

Jeffrey Christian: You can always look at it in hindsight and say no, it could be better done. And frankly, I've seen a couple slip-ups in the 30 years I've been involved in the metals markets. But I think they do a fairly decent job. They could probably do better, but the CFTC could probably do a better job of working with the exchanges on these issues.

HAI: Would adding position limits in the metals markets reduce the liquidity available, and hurt the ability of producers using these futures to hedge their risk?

Jeffrey Christian: I think there's a risk there, but it would depend on how the CFTC executes the position limits. If they were to put position limits on commercials – and the CFTC seems to have a skewed idea of what a "commercial" entity is trading in the market – then what you have is that you start skewing the futures price relative to the physical price. All of a sudden, you have asymmetrical markets. People will say that the Nymex and the Comex no longer reflect the price, and they start migrating to unregulated or under-regulated and less transparent markets.

So you have a couple of issues. First, you have "regulatory arbitrage," where people bail out of the markets because there's regulation they don't like. And the second thing is, if the regulations skew the liquidity in the futures market, you have people saying, "The futures price no longer reflects the underlying commodity market, so I'm not going to use it to hedge my positions anymore."
 
HAI: A lot of gold and silver manipulation theorists – the ones who believe precious metals markets are being manipulated by large banks – are calling for position limits in these markets, and they're testifying at this hearing.

Jeffrey Christian: Well, the discussion is that bona fide hedgers would not have position limits against their bona fide hedges. And that's good. But what GATA doesn't seem to realize – and even some of the people on the CFTC can get confused – is that the major banks are bona fide hedgers, too.

Most producers and consumers don't trade futures. They trade over the counter forward and dealer options with a bank, and the bank turns around and hedges its forward market position with the futures. So if you're going to allow bona fide hedgers to hedge their positions on an unlimited basis, the position limits that would be imposed would do absolutely nothing to reduce the concentration of the major banks in the market. In fact, it would actually take other people – noncommercial speculative types – and prohibit them from having too large a position.

So if anything, the position limits that are being discussed – if they're applied intelligently – would actually have the potential to increase the concentration of trades by the major banks, which is exactly what GATA wouldn't want. So insofar as they say they want position limits, they're basically saying they don't understand the nature of the market. Only speculators, trading opposite of the bona fide hedgers, would be limited.

HAI: All right, a nonposition-limit-related question for you: What precious metals do you see performing the best over the next 12-24 months, and which do you see not doing so well?

Jeffrey Christian: I think all the precious metals will do well, at least by my modest standards. I'm most bullish on the minor gems like rhodium, rhenium and iridium. I'm slightly less bullish on palladium. I'm slightly less bullish than that on platinum, and I'm slightly less bullish than that on silver. Still, I think all of those metals stand to see rising prices over the next 12-24 months.

HAI: Why do you think the minor precious metals like rhodium are going to do so much better than the others?

Jeffrey Christian: I think all the platinum group metals – and silver, for that matter – are relatively tight on a fundamental basis. I think fabrication demand will stay strong for all the platinum group metals and silver, but when I look at the individual markets, I think the fabrication demand for palladium may be stronger than the fabrication demand for platinum. The same is true for rhodium.

Also, for rhodium, rhenium and iridium, not only do you have healthy fabrication demand, but you have some supply constraints. They're much tighter, much less liquid markets, because they're not exchange-traded, and they're not commonly seen as investments. They tend to respond to tighter supply more dramatically.

HAI: So what about gold?

Jeffrey Christian: Gold may actually be reaching a cyclical peak right now, and it may have reached its cyclical peak back in December, when it touched $1227 per ounce. I think it has the potential to go a little higher over the next month or two. But if the economy continues to improve, gold actually may reach a cyclical peak in the first part of this year, and then it may trade sideways.

I don't see it falling sharply, though, because there are a lot of long-term investors who will take any decrease in the price of gold as an opportunity to add to their positions. So I don't think the Gold Price is necessarily falling. But it may not rise as rapidly as the white metals.
 
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