Monday, September 7, 2009

The Untold Story Behind This Golden Breakout

. Monday, September 7, 2009

By Christopher Barker

It was surreal.

Throughout the financial media, commentators and analysts appeared at a loss for words Thursday to identify potential catalysts for the abrupt surge in gold and silver prices.

The equity markets felt calm, the dollar's value against foreign currencies was not tanking, and the bond markets offered nary a clue. Gold was the hot topic of the day, but insightful discussion remained remarkably absent.

I generally consider it a trap to ascribe daily market oscillations to specific causal factors, but when a clear technical breakout carries even large-cap mining shares like Newmont Mining (NYSE: NEM) to double-digit percentage gains, the discussion must dig deeper than the momentum-buying and short-covering explanations that dominated the airwaves.

Gold had indeed been primed for a technical breakout, as I pointed out in an article drafted before the move began. However, a long list of fundamental drivers supporting higher gold and silver prices leads this Fool to conclude that the move will have some legs.

In no particular order, here are some of the more recent fundamental catalysts I've identified:

In a move that Western media sources have failed to cover adequately, the agency responsible for oversight of China's state-owned enterprises (SOEs) recently warned foreign financial institutions that SOEs will be permitted to walk away unilaterally from failed OTC derivative hedge contracts.

China will purchase up to $50 billion in Special Drawing Rights (SDRs) from the International Monetary Fund. Fools will recall that China has explicitly called for replacing the U.S. dollar as the world's reserve currency in favor of these SDRs. Russia and India have likewise indicated an interest purchasing SDR-denominated IMF bonds.

China's ramped-up dealmaking activity for resource-related assets around the globe reflects an official policy directive. Recent loans or investments by Chinese entities relating to foreign resource assets are themselves nearing the $50 billion mark. China has indicated that foreign reserves will be deployed in support of this broader initiative, representing another clear diversification away from U.S. dollar exposure.

The Democratic Party of Japan emerged as the clear victor in last week's election, ending a 15-year reign of the Liberal Democratic Party. Fools will recall that the Democratic Party of Japan's finance chief advised his nation last May to cease purchasing U.S. Treasury bonds unless those bonds are denominated in yen.

China is considering a ban on rare-metal exports. More than 95% of the world's supply of rare-earth minerals comes from China, so the move places global manufacturers of everything from hybrid cars to cell phones in a difficult position. China is also the world's leading producer of gold, and this move raises this Fool's eyebrow as a precedent for China's restricting exports of key strategic resources.

China is actively encouraging its 1.3 billion citizens to invest in precious metals. I have viewed excerpts from state television touting the extraordinary relative value of silver to gold given the large deviation from the historical ratio between prices of the two metals. Because gold and silver are surprisingly small physical markets, even a minor uptick in investment demand could fuel sizeable price increases.

Hong Kong is repatriating its physical gold reserves from London to high-security vaults at home, and it is inviting the region's central banks to store their bullion there. Announced just this week, the move deals a significant blow to London's historical role as a global hub in the precious metals market, and it raises the specter of a potential price-settlement hub in Asia to rival the New York and London daily spot-price fixes. The Hong Kong Monetary Authority is also targeting a new gold bullion ETF using the new vault as a repository, which would remove yet more physical supply from the market. The SPDR Gold Shares (NYSE: GLD) reports holding 1,078 tonnes of gold, slightly more than China's last-reported gold reserves.

It's no coincidence that all of the above developments -- which can be considered potential near-term catalysts boosting the strength of this breakout in gold and silver -- hail from Asia. This Fool has observed China, which holds more dollar-denominated debt than any other nation, steadily ramping up both its rhetoric and its actions in a clear vote of no confidence in the greenback. I view an end to this 18-month correction in precious metals as imminent, and I concur with the likes of Jim Rogers that the dollar remains between a rock and a hard place.

Where to invest
If you lend credence to these and other fundamental factors supporting a continuation of the eight-year bull market in precious metals, then you'll want at least some investment exposure to gold or silver. With commercial production at the world-class Penasquito mine slated for early 2010, I consider Goldcorp (NYSE: GG) the best-positioned of the large-cap miners. I also find it interesting that shares of Yamana Gold (NYSE: AUY), which trade around $10.50 now, fetched $19 before the correction took hold in March 2008, as the company has only strengthened in the meantime. Golden Star Resources (AMEX: GSS) is just one of many promising junior miners that have broken out impressively this week.

For silver, I continue to highlight Silver Wheaton (NYSE: SLW) for its fixed, low-cost business model. Coeur d'Alene Mines (NYSE: CDE) is enjoying quite a resurgence as two huge mines rake in the cash flow.

Disclosure: stockOzone does not own any of the stocks discussed here.

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