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CPM Group MD, Jeff Christian, takes a look at some of the reasons behind gold's recent sell off and looks at some of the factors that could impact on the price going forward
GEOFF CANDY: Hello and welcome to this week's edition of Mineweb.com's Gold Weekly podcast, joining me on the line is Jeff Christian, he is the MD of the CPM Group and he is actually in Johannesburg South Africa today but, he has just come back from China. And, Jeff I want to get your views on what we are seeing globally and how people are reacting to what we have been seeing over the last few days because gold did take a knock toward the end of last week, although perhaps not as much as other commodities and stocks. What do you make of this, was it a much needed correction, is it the start of something bigger, how do you place this?
JEFF CHRISTIAN: I think it is a little too early to tell. We have been saying since August when the gold price was going up that the gold price could trade between $1,600 and $2,100 between August and the end of the year, that we are looking at this incredibly volatile situation. And, we have seen the downside play out, I am not sure we won't see the price go back up between now and December because it is being driven by investment demand and investor fears of a catastrophic failure of the global financial system and the volatility has also been driven a lot by the delta hedging of call options that investors bought earlier by the banks that sold those options. Neither of those two events have gone away so the volatility could continue, its going to be interesting to see how investors re-engage with gold on the upside having seen a $300 decline in the gold price.
GEOFF CANDY: What kind of investors are on the fence at this stage, I saw an interesting report about ETF investors about the fact that they have been more sticky than we have seen on the edges, on the speculative side. What is the mindset of the generalist investor that has perhaps come into gold when it was quite a lot higher than it was a few years ago.
JEFF CHRISTIAN: One of the really positive things you have seen in the gold price and one of the things that makes us think that you could see prices rise again are the ETF investors, who are the new kids on the block, they are institutional investors, they have not liquidated over the last week and, in fact, ETF investments are up over the last few days so ETF investors have taken the sell-off as a buying opportunity, which is what we are telling our clients it is - so that is positive. Where you've seen most of the liquidation has been in the futures and options markets and those are shorter term people; we were talking prior to the last couple of weeks that you have had a lot of nervous longs. Gold was $1,482 on July 1st, so even if you waited till July 1st to buy gold, if you had gone long at $1,480 and the price was $1,900, you had a lot of very nervous long investors and you saw a lot of those guys bail out. But, you haven't seen necessarily the longer term investors, it's really the shorter term people who were sitting on the fence who are saying, wait, what if the world doesn't collapse? And I think that is where you saw the liquidation.
GEOFF CANDY: And, indeed, we have historical precedents of the world not collapsing when we have seen significant problems in the macro financial world and gold reacting on the back of that as well.
JEFF CHRISTIAN: It's funny, talking to the institutional investors in South Africa, I find that the gold bugs think I am a bear because I think that the gold price could stabilise above $1,200, $1,300 over the next decade and not go away and because I don't think the world is going to collapse and I don't think the dollar and the euro are going to collapse. But, I happen to think I am more bullish than they are. What I see is not a catastrophic failure of the financial system, as you said, the global financial market tends to have spasms and it tends to recover from the spasms and this one, as bad as it is, is probably recoverable too. So, we might not see gold, spike to $3,000 or $7,000 and then blow off but, what we may see is that investors migrate from the view that everything is going to collapse, whatever that means, I can't even figure it out and when you ask them they can't really give you a lot of details as to what a collapse would look like. But, I think you are going to see investors migrating from the view that I have to buy gold at any price because the system is going to collapse, to a view that, ok the system is not going to collapse, we have major problems that are going to take decades to resolve and in that environment I want to buy and hold gold for the foreseeable future, for the next 10, 20,30 years but, I can be a little bit price sensitive. If I see the crazy guys driving the price up to $1,800, $1,900, $2,000, $2,100 gold, I don't have to jump in, I can wait until it comes down to $1,600. So, I think you are going to see a maturation, a sophistication in investor views in the next 6 to 12 months, assuming that the European and US politicians don't destroy the world economy which may be a panglossian assumption. But, I think you will see investors migrate from this, "buy gold at any price because the world is about to end" view to a more mature one of: "I need to have gold in my portfolio because these problems are not going to be resolved anytime soon. We aren't going to have a Greek default, we are going to have a Greek rescheduling and I need gold in my portfolio to diversify it for the long run, not to buy bread tomorrow.
GEOFF CANDY: What is the best case scenario here on in given what we have been seeing from the politicians in both the US and Europe. Clearly there will have to be some longer term effects of Operation Twist, of QE2 and the amount of money that has been pumped into the system already.
JEFF CHRISTIAN: The best case scenario for the global economy is that we actually pump up the economy right now. In the 1980s, we had a debt crisis when Brazil, Mexico and Argentina were about to default and it looked like it was going to bring the house down and the US Treasury stepped in and created these things called Brady Bonds, basically standing behind the Latin American government debt and saying, everyone is going to take a shave, which is one of the things that the Europeans aren't doing this time. If you are a bond holder and you bought bonds in these countries and you thought they were risk free you were wrong and you are going to take a loss on it but, if you are willing to hold them and be able to be made whole and if you don't like it you can trade them in for a Brady bond to someone who is willing to take that risk. And, quite frankly, the people who bought the Brady Bonds made a fortune because they were wise enough and bold enough to buy them. And, you need some sort of resolution like that in Europe. And, the US actually, there are some interesting nuances in the August second debt ceiling agreement that have been overlooked by the market that suggest that the US government fiscal situation may also have turned the corner. But, what you really need in an ideal world is 10, 20, 30 years of sub-par growth in the US, Europe and Japan during which time, those governments get out of their structural, fiscal deficit problems, because their debt problems are only secondary to their deficit problems. You can't solve the debt problems because you have these structural deficits that have to be dealt with and that is going to be very painful and is going to take years or decades to deal with but, it has to be dealt with. At the same time you probably want to move to a multi-polar currency system. So you slowly but surely create, as you are already seeing the Chinese government doing by allowing Dim Sum bonds which are basically Yuan-denominated bonds issued outside China, by outside China-entities to outside China entities. You need to create a euro-bond market, if you will, that is not denominated in either dollars or euros so that you have more liquidity. And, probably the solution to the currency situation is to try and move to this multi-polar currency regime so that you have any number of currencies that are liquid enough and attractive enough so that people say I will hold some dollar, I will hold some euros but I can also hold some yuan and some rupees and some rand. And, that is going to take a long, long time to create the kind of liquidity that you need. So, the ideal solution is that you take three decades and you create a better world for everyone and you try to hold everything together from the periodic spasms that you would expect to occur over that 30-year period.
GEOFF CANDY: I suppose one of the problems you have is that there are a lot of 24-hour news cycles in a 30-year period. Jeff, if we look at gold's role in that and, particularly, the restructuring of how people view currencies, do you see a longer-term role for gold?
JEFF CHRISTIAN: I see gold as gaining stature as a financial asset in the private sector. I see gold gaining stature as a monetary reserve asset for central banks. I don't see gold playing a role as a basis or collateralisation for currency systems. The gold market is not liquid enough and it doesn't make sense. The guys that are talking their own book when they talk of a return to a gold standard, they always say currency systems that weren't backed by gold all fail and that is true. But, the fact of the matter is that the only currency system that hasn't failed is the current one. Through 5000 years of history you have seen currency regimes fail one after the other and almost all of them were backed by gold. The important thing to understand is that currency regime systems fail and having them backed by gold doesn't help. And, in the current situation, where we have gone so far beyond gold in terms of international financial markets and financial market deregulations and private issuances of corporate bonds and stuff, gold doesn't necessarily make sense. And, I think most central bankers that I talk to and read don't see gold playing an integral role in a future international currency regime. And, if I may put a plug in for someone else, there is a book that came out earlier this year by Barry Eichengreen who is a fabulous economist, called Exorbitant Privilege and it has a history of the last 100 years of currency regimes and currency markets. It has an excellent description of where we are today and why we are where we are and it has two scenarios, one is a much more catastrophic scenario and one is this ideal scenario along the line of what I talked about earlier. That is a must read book because Barry Eichengreen knows what all of those people like Jim Rickards, who keep talking about a return to the gold standard don't know and don't seem to be able to understand, it is an excellent book and should be on everyone's must read list.
GEOFF CANDY:I will definitely have to get a copy of that. Jeff, just to close off with, there was a lot of talk of gold getting to $2,000, breaking through $2,000 an ounce before year end, that seems less likely now, what is your view of the gold price over the next 12 months?
JEFF CHRISTIAN: It seems less likely but, as I tried to point out at the very beginning, I don't know that it is not going to happen. We have said it could spike down as low as $1,600 but it could rise back as high as $2,000 or $2,100 between now and December. There are several events that are going to occur in the US government and the European governments that could cause investors to buy a lot of gold. If you look at the open interest on the calls in the major gold options for December expiry, there is still something like 2.4m ounces of $2,00 calls for December expiration and another 1.7m ounces at $1,800. And, I think that the existence of those calls could easily help catapult the price back up to $1,800, $1,900, $2,000 even, $2,100 between now and late November, but then that may be the time to sell if you are a short term investor. If you are a long term investor, that would be the time to buy puts to cover your long term position.
GEOFF CANDY: What particularly are you going to be looking at over the next couple of months. What events are you going to be focusing on?
JEFF CHRISTIAN: In the US, the big thing is the first round of budget cuts. People missed nuances. Again, the crazies were talking about this trans-constitutional creation of a super committee to take over the powers of congress, which is total BS. What happened was that you had a joint committee of the two houses of congress created, which is very common in the history of the US government. And they are going to come together and they have to, between now and the end of November, come up with $1.5 trillion of budget cuts, but Congress has to vote on that yes or no, they can make no amendments. So, they are taking some of the politics out of fiscal reform in the US government, which is a good thing and, I think, that has been overlooked. If Congress votes yes, then the budget cuts go into effect and the debt ceiling can be raised to the next level that is needed. If they vote no, then the President can unilaterally raise the debt ceiling, which he actually could all along but he didn't want to because of politics. And there is a great deal of anger on my part as well as other people because he didn't do that. He didn't do the government thing, he did the political thing in June, July, August. And now they have taken that out and they have put it into this thing where it has been taken out of the political maelstrom. And, over the course of October, November as this joint committee does this and Congress votes on it, I think people are going to realise that there was something good that came out of the August 2nd agreement. On the bad side, and that will be good for gold, in the US you have politics and both sides are going to be incredibly fear-mongering, focusing on economic problems. And, they are going to try and use economic fears to get people support their side. On the European side, it is harder to see what is going to happen because the European governments have been so incredibly irresponsible in their approach to the Greek debt and the broader European sovereign debt. But, it is our expectation that over the course of October into November, the Europeans will actually step up to the plate and say something in the order of a Brady Bond type of resolution. And, you will probably see people realising that Greece isn't going to default, Greece is going to reschedule. The German and the French banks that have been applying the political pressure that they cannot take a loss on those bonds, they have to step down and take some of the pain that everyone else is feeling. And, I think that will lead to this transition that I was talking about earlier from this catastrophic failure fear to the realisation that, ok, it is not a Greek default, it is a Greek rescheduling, it is a problem, people are going to lose money by having bought Greek bonds stupidly in the past, but it is not going to be a catastrophic failure, it is going to be a long slow burn.
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