June 15, 2012

Eric Sprott on the Recent Volatility in Gold

As we know gold has been performing weak in the last months and as you know many hedge funds still hold it. That is why we believe it is good to update you and provide the views of one of the most outspoken silver and gold promoters and advocate: Eric Sprott, the man behind Sprott Asset Management.

Lets not forget that gold is a top position in the holdings of Dan Loeb, the manager of Third Point. Not only him but also David Einhorn of Greenlight Capital also owns a lot physical gold. John Burbank has also been buying gold in April and probably continues.

 SO if you wonder what investors are doing now regarding gold? Eric Sprott and Shree Kargutkar shared and interesting comments on gold on June 8th 2012:

Eric Sprott on Gold

"There have been key devel­op­ments in the phys­i­cal gold mar­ket over the last few weeks which we feel are worth highlighting:

1) The Chi­nese gold imports from Hong Kong in April, 2012 surged almost 1300% on a Y-o-Y basis. Total gross imports for the month of April were 103.6 tons and the net imports were 66.3 tonnes1. It is not the data for April alone which has caught our eye. There has been a stun­ning increase of gold imports through Hong Kong for export into China over the past 2 years. Between May 2010 and April 2011, China imported a net 66 tons of phys­i­cal gold through Hong Kong. Between May 2011 and April 2012, that num­ber jumped to 489 tons. This rep­re­sents an increase of 640%.

2) Cen­tral banks from around the world bought over 70 tons of gold in April, 2012. Data from the IMF showed devel­op­ing coun­tries such as the Philip­pines, Turkey, Mex­ico and Sri Lanka were sig­nif­i­cant buy­ers of gold as prices dipped.

3) Iran pur­chased $1.2B worth of gold in April, 2012 through Turkey. As the devel­oped nations con­tinue devalu­ing their cur­rency at the expense of devel­op­ing nations, coun­tries such as Iran, China and Mex­ico are forced to look at alter­na­tive stores of value.

4) After twenty years of lack­lus­ter returns and stag­nant bond yields, Japan­ese pen­sion funds have finally dis­cov­ered the value of invest­ing in gold. The $500M Okayama Metal and Machin­ery pen­sion fund placed 1.5% of its assets into gold bullion-backed ETFs in April in order to "escape sov­er­eign risk"4.

5) Bill Gross writes, "Soar­ing debt/GDP ratios in pre­vi­ously sacro­sanct AAA coun­tries have made low cost fund­ing increas­ingly a func­tion of cen­tral banks as opposed to pri­vate mar­ket investors. Both the lower qual­ity and lower yields of pre­vi­ously sacro­sanct debt there­fore rep­re­sent a poten­tial break­ing point in our now 40-year-old global mon­e­tary sys­tem. […] As they (investors) ques­tion the value of much of the $200 tril­lion which com­prises our cur­rent sys­tem, they move mar­gin­ally else­where — to real assets such as land, gold and tan­gi­ble things, or to cash and a fig­u­ra­tive mat­tress where at least their money is read­ily acces­si­ble". Is the bond king rec­om­mend­ing gold? YES, YES YES!

6) The Gold Min­ing ETF, GDX, has seen strong inflows in the past 3 months. The num­ber of units out­stand­ing has increased from 162.5M to roughly 187M between March 1, 2012 and May 31, 2012. This rep­re­sents an increase in assets of almost $1.2B in a span of 3 months. It is worth point­ing out that for a major­ity of this three months period, GDX, and by exten­sion the gold min­ing com­pa­nies were expe­ri­enc­ing sig­nif­i­cant declines in their mar­ket values.

We believe there has been a mate­r­ial change in the gold invest­ing land­scape. The HUI, which is the Gold Bugs Index, is now up over 20% from its lows since May 16th, 2012. The slide in gold equi­ties seems to be sub­sid­ing as a foun­da­tion for a strong move upwards is set. New buy­ers, rep­re­sented by the Chi­nese, cen­tral banks, Japan­ese pen­sion funds and the Ira­ni­ans, bought almost 140 tons of gold in April alone. To put this into per­spec­tive, the annual gold pro­duc­tion is approx­i­mately 2600 tons. China and Rus­sia pro­duce around 500 tons of gold annu­ally, which never makes it to the open mar­ket. This leaves about 2100 tons of gold pro­duc­tion annu­ally for the rest of the world.

When buy­ers rep­re­sent­ing 140 tons of new demand enter a mar­ket which only has 175 tons of monthly sup­ply, we are left won­der­ing about two things:

1) In a bal­anced mar­ket, where is the source of sup­ply to the new buy­ers going to come from?

2) How can a new buyer of size get into the gold mar­ket, which is already bal­anced, with­out sig­nif­i­cantly impact­ing the price of gold? The answer is fairly obvi­ous. When demand out­strips sup­ply, prices move higher. These sig­nif­i­cant macro changes in the supply demand dynamic of the gold mar­ket should pro­pel the price of gold to new highs."

It seems that Eric Sprott continues to like gold and believes that now is even a better buy as the market is strangely situated and points to a higher prices.

Eric Sprott is a Canadian hedge fund manager and founder of Sprott Asset Management. He became a billionaire on paper with the initial public offering of Sprott Inc., the parent of his Sprott Asset Management firm.

June 01, 2012

ERIC SPROTT: THE REAL BANKING CRISIS, PART II

The Real Banking Crisis, Part II

Here we go again. Back in July 2011 we wrote an article entitled "The Real Banking Crisis" where we discussed the increasing instability of the Eurozone banks suffering from depositor bank runs. Since that time (and two LTRO infusions and numerous bailouts later), Eurozone banks, as represented by the Euro Stoxx Banks Index, have fallen more than 50% from their July 2011 levels and are now in the midst of yet another breakdown led by the abysmal situation currently unfolding in Greece and Spain.

EURO STOXX BANKS INDEX


Source: Bloomberg 

On Wednesday, May 16th, it was reported that Greek depositors withdrew as much as €1.2 billion from their local Greek banks on the preceding Monday and Tuesday alone, representing 0.75% of total deposits.1 Reports suggest that as much as €700 million was withdrawn the week before. Greek depositors have now withdrawn €3 billion from their banking system since the country's elections on May 6th, seemingly emptying what was left of the liquidity remaining within the Greek banking system.2 According to Reuters, the Greek banks had already collectively borrowed €73.4 billion from the ECB and €54 billion from the Bank of Greece as of the end of January 2012 - which is equivalent to approximately 77% of the Greek banking system's €165 billion in household and business deposits held at the end of March.3The recent escalation in withdrawals has forced the Greek banks to draw on an €18 billion emergency fund (released on May 28th), which if depleted, will leave the country with a cushion of a mere €3 billion.4 It's now down to the wire. Greece is essentially €21 billion away from a complete banking collapse, or alternatively, another large-scale bailout from the European Central Bank (ECB).

The way this is unfolding probably doesn't surprise anyone, but the time it has taken for the remaining Greek depositors to withdraw their money is certainly perplexing to us. Official records suggest that the Greek banks only lost a third of their deposits between January 2010 and March 2012, which begs the question of why the Greek banks have had to borrow so much capital from the ECB in the meantime.5Nonetheless, we are finally past the tipping point where Greek depositors have had enough, and the past two weeks have perfectly illustrated how quickly a determined bank run can propel a country back into crisis mode. The numbers above suggest there really isn't much of a banking system left in Greece at all, and at this point no sane person or corporation would willingly continue to hold deposits within a Greek bank unless they had no other choice.

The fact remains that here we are, in May 2012, and Greece is right back in the exact same predicament it was in before its March 2012 bailout. Before the bailout, Greece had approximately €368 billion of debt outstanding, and its government bond yields were trading above 35%.6 On March 9th, the authorities arranged for private investors to forgive more than €100 billion of that debt, and launched a €130 billion rescue package that prompted Nicolas Sarkozy to exclaim that the Greek debt crisis had finally been solved.7 Today, a mere two months later, Greece is back up to almost €400 billion in total debt outstanding (more than it had pre-bailout), and its sovereign bond yields are back above 29%. It's as if the March bailout never happened… and if you remember, that lauded Greek bailout back in March represented the largest sovereign restructuring in history. It is now safe to assume that that record will be surpassed in short order. It's either that, or Greece is out of the Eurozone and back on the drachma - hence the renewed bank run among Greek depositors.

Meanwhile, in Spain, bank depositors have been pulling money out of the recently nationalized Bankia bank, which is the fourth largest bank in the country. Depositors reportedly withdrew €1 billion during the week of May 7th alone, prompting shares of Bankia to fall 29% in one day.8 The Bankia run coincided with Moody's issuance of a sweeping downgrade of 16 Spanish banks, a move that was prompted over concerns related to the Spanish banks' €300+ billion exposure to domestic real estate loans, half of which are believed to be delinquent.9The Spanish authorities were quick to deny the Bankia run, with Fernando JimĂ©nez Latorre, secretary of state for the economy stating, "It is not true that there has been an exit of deposits at this time from Bankia… there is no concern about a possible flight of deposits, as there is no reason for it."10 Funny then that the Spanish government had to promptly launch a €9 billion bailout for Bankia the following Wednesday, May 24th, an amount which has since increased to a total of €19 billion to fund the ailing bank.11 Deny, deny some more… panic, inject capital - this is the typical government approach to bank runs, but the bailouts are happening faster now, and the numbers are getting larger.

The recent bank runs in Greece and Spain are part of a broader trend that has been building for months now. Foreign depositors in the peripheral EU countries are understandably nervous and have been steadily lowering their exposure to Eurozone sovereign debt. According to JPMorgan analysts, approximately €200 billion of Italian government bonds and €80 billion of Spanish bonds have been sold by foreign investors over the past nine months, representing more than 10% of each market.12 The same can be said for foreign deposits in those countries. Citi's credit strategist Matt King recently reported that, "in Greece, Ireland, and Portugal, foreign deposits have fallen by an average of 52%, and foreign government bond holdings by an average of 33%, from their peaks."13 Spain and Italy are not immune either, with Spain having suffered €100 billion in outflows since the middle of last year (certainly more now), and Italy having lost €230 billion, representing roughly 15% of its GDP.14

As we've stated before, no matter what happens in the Eurozone, the absolute worst case scenario for the authorities is a bank run. It terrifies all involved, because they can spiral out of control faster than governments can react to stop them, save for the most Draconian measures. They also prompt banks to liquidate whatever assets they can, revealing the truth about what their "assets" are actually worth. In this environment, no one wants to find out what the market will really pay for them. We're seeing this now in Spain, where according to Bloomberg, "Many Spanish banks are avoiding property sales so they don't have to "mark to market" valuations. Instead, they're giving developers new loans to pay debt coming due to prevent defaults."15 Sound familiar? We're now at the point where a bank run in one Eurozone country could quickly seize up the entire system - not just in Greece or Spain, but throughout the entire Eurozone and beyond. Greek and Spanish banks are just like all the others; they operate with leverage ratios averaging 25x their equity capital. They are all so overleveraged that it takes very little in deposit withdrawals to cause instantaneous liquidity issues. This is why we'll likely see another ECB-induced printing program announced (with a new abbreviation, hopefully) before a broader bank run can take root. The Eurozone authorities simply cannot risk the consequences of bank runs in countries like Spain, Portugal or Italy, which are far too big to bailout for the over-stretched ECB. It's not about Greece staying or leaving the European Union anymore, it's about the bailout ability of European banking system to survive the impact of massive money transfers.

Nothing is really being solved here, and everyone knows it. We're essentially in the same place we were when the crisis erupted back in 2010, only now there's more total debt outstanding. Bank of Canada Governor Mark Carney remarked in a December 2011 speech that "the global Minsky moment has arrived", and it's now plain for all to see.16 The "Minsky moment" refers to the work of Hyman Minsky, a deceased American economist who developed theories on how debt accumulation eventually leads to financial crises. You don't have to be an economist to understand the crux of Minsky's theories. As an economy grows it takes on increasing amounts of debt. The point eventually comes when the cost of servicing that debt can no longer be met by that economy's productive capacity - that's the Minsky Moment, and we're watching it play out all over the world today. When Greek bond yields spiked back in February 2012, bond investors looking at the country's €368 billion of debt outstanding, its population of 11 million people, and its nominal GDP of $312 billion realized that it couldn't possibly work. There was no way Greece could pay the interest on its debt load. There was no way the bond market could keep pretending everything was ok, like it currently does with the UK, US and Japan… for now.

Greece clearly needs another large-scale bailout, and we think they'll get one. Greece's exit from the Eurozone represents a Lehman-like scenario to the global banking system - why wait to see what carnage it will unleash? It's always easier to print money, and printing another couple €100 billion is nothing compared to the trillions that have been printed since last November. Where this will get tense, however, is when the market acknowledges the Minsky moment in a larger EU economy, like Spain or Italy. As we go to print, Spanish bond yields are now trading back above 6.5%, signaling the market's non-confidence in the country's ability to back-stop its own banking system. Spain has a population of 47 million, a GDP of roughly $1.3 trillion, national debt of roughly $1.1 trillion, debt owed to the ECB and various bailout funds totaling €643 billion, and now, a banking system that also appears close to collapsing.17 Their Minsky Moment has already arrived, and it's simply a matter now of how the market will react to it, and how long it takes the ECB to come to Spain's rescue.

Without a doubt, the most counterintuitive aspect of the Greece/Eurozone debacle has been its impact on the price of gold. Gold is now back below $1600 for the third time since August 2011; each time has coincided with severe banking stress within Greece and the broader Eurozone. Some pundits have suggested that various European banks are selling gold to raise liquidity, and this would make sense if the Eurozone banks had gold to sell, but we cannot find any evidence of large physical sellers out of Europe. Also, ever since the unlimited US-dollar SWAP agreement was launched in November 2011, USD liquidity has not been the key issue in Europe - rising sovereign bond yields and deposit withdrawals have. On the contrary, the selling pressure in gold once again appears to be expressed primarily through the futures markets, which are highly levered and rarely involve any physical transactions involving actual bullion. The futures market sell-off also appears to be waning now, since the European banking crisis has provided central banks with a politically-palatable excuse to take action if it deteriorates any further.

The recent gold price has been particularly frustrating given the continuation of bullish demand trends out of China. China posted another record Hong Kong gold import number in March of 62.9 tonnes. Gold imports into China have now totaled 135.5 metric tonnes between January and March 2012, representing a 600% increase over the same period last year.18 We don't have to connect the dots here - China is stockpiling the precious metal while investors in the West scratch their heads wondering why the spot price is so low.

CHINA HONG KONG GOLD IMPORTS AND GOLD SPOT PRICE


Source: UBS, Bloomberg

Non-G6 central banks have also continued to accumulate physical gold, with the latest reports revealing another 70 tonnes of gold purchases completed in March and April by the central banks of Philippines, Turkey, Mexico, Kazakhstan, Ukraine and Sri Lanka.19 We won't bore you with the exercise of annualizing those numbers and comparing them to the annual global mine supply, but suffice it to say that the fundamentals still remain firmly intact. It's now simply a matter of improving sentiment towards gold in the West, and if the current banking crisis in Europe gets any worse, or if we see another large-scale policy response, it will likely happen on its own accord.

Although the last eight months have not played out the way we would have expected for gold, they have played out the way we envisioned for the banks. The question now is how long this can go on for, and how long gold can remain under pressure in a banking crisis that has the potential to spread beyond Greece and Spain? So much now rests on the policy responses fashioned by the US Fed and ECB, and just as much also rests on what's left of European citizens' confidence in their local banking institutions. Neither of these things can be precisely measured or predicted, but we continue to firmly believe that depositors in Greece and Spain will choose gold over drachmas or pesetas if they have the foresight and are given the freedom to act accordingly. The number one reason we have always believed gold should be owned, and why we believe it will go higher, is people's growing distrust of the banking system - and we are now there. We will wait and see how the summer develops, and keep our attention firmly focused of the second phase of the bank run now spreading across southern Europe.

Eric Sprott is a Canadian hedge fund manager and founder of Sprott Asset Management. He became a billionaire on paper with the initial public offering of Sprott Inc., the parent of his Sprott Asset Management firm.