Kitco's Peter Hug: Gold Bottom Already In

April 22, 2013

Nothing fundamental has really changed in gold markets, so don't expect selling to continue, Kitco's Hug says.


Peter Hug, director of Kitco's Precious Metals division, isn’t buying that the 12-year-old gold rally is over. In fact, he told Correspondent Cinthia Murphy that with all the currency debasing going on around the world, gold looks poised to go even higher.

So what has happened in the past several weeks? It began with the Cyprus spook in March, and with the help of computer trading and the growing presence of highly liquid gold ETFs, emotions have been pulled out of the market. I wanted to get your perspective on what’s been going on with gold. Why do you think gold fell so quickly recently?

Hug: Quite frankly, as a trader, I’ve been very cautious about gold for a while now. In fact, I’ve been relatively bearish on this market since about the $1,680 level, and suggested for a few months that gold looked like it was setting itself up for a test of the 2012 low around $1,527. I think what you have happening here is a perception issue because I don’t think, fundamentally, anything has changed in the market that would have caused gold to rally from, say, the $900-level in 2008 up to the high of $1,925 we saw recently. In retrospect, I think the market was just way ahead of itself.

But what happened when it broke through $1,527 was sort of the perfect storm. Some speculation first emerged that Cyprus would have to sell its gold reserves to meet its financial obligations to the EU, and everybody reacted to that. But it wasn’t a Cyprus story necessarily, because Cyprus has only 10 metric tons of gold and that’s nothing—10 metric tons of gold trade roughly every 20 minutes on the New York Futures Exchange. What it was, was the psychology of why they were selling the gold—there was a suggestion that the EU was putting pressure on Cyprus to sell its gold reserves to meet its financial commitments.

Now, under the EU charter, they have no legal authority to force the central bank to sell its gold reserves, but the fact that Draghi was suggesting that fueled the idea that this might be a prudent thing for Cyprus to consider. Psychologically, from a trader’s perspective, if they’re going to force Cyprus to do this, why wouldn’t they also force countries like Portugal, Spain, Italy, Greece to do the same? And these countries combined have massive gold reserves. So it was a change in the market’s sentiment more than a technical move?

Hug: Well, the psychology was that it was looking like central banks may be pulling back on their buying and may be forced to sell, but once gold prices broke through that triple bottom from 2012, after that it was all just computer selling. When I traded this market in the ’70s and ’80s, everything was a phone call. And there was a lot of emotion in the market, so people weren’t able to do what they’re able to do today. Today there’s no emotion—they just put their numbers into the computer. If it breaks $1,527, it’s “get me out,” and the computer just executes it. It was just a cascading effect all the way down. Do you think gold ETFs have added volatility to this market?

Hug: Absolutely. ETF outflows have been on the rise for the past three months. And I hate to say this, but the small investor is always on the wrong side of the trade. Everybody, every talking head on CNBC, CNN is calling for the stock market to go to 18,000. These guys are looking at their 401(k)s and saying “OK, well, where have I got some money that I can deploy into this equity market?”

The people that have the money to deploy on a small investor perspective are the people that are in the precious metal ETFs where they still have some profit. So, they liquidated that profit and moved into the stock market—in my opinion at the wrong time. They sold their metal load at the bottom, and I think they’re buying stocks near the top.

As the people get out of the ETFs, the fund managers have no choice because of the redemptions to sell the underlying metals positions to meet the redemption demand that they have to pay out in cash. So, you have more supply coming onto a market that is already oversupplied from a perspective of psychology. And it just feeds on itself. Then it goes lower; then you get margin calls. Now they’re forced to sell again.

So, it’s a cyclical thing, but at these levels, I’d be buying this market. I’m not discounting the fact that gold can’t break down through $1,300, but this is going to look like a bargain two or three years from now. How low do you think gold can go? How will an investor know when it’s time to buy?

Hug: Again, since I’ve been in this business since ’74, I’ve had that question asked of me I can’t tell you how many times, and I can’t answer that question without asking a question first: “Are you buying gold as a trade, as you would a stock?”

My answer to that individual is different than my answer to an individual that says, “No, I believe that I should be holding 3, 5, 10 percent of my assets in an inflation-protected basket,” be it metals, oil, or real estate; in other words, investors buying an insurance policy against the rest of their portfolios in case the world ends. To that investor, what they tend to get as an answer, is “Yes, you should buy whatever, 3,5, 10 percent of your portfolio in gold.”

But that’s not the end of the answer. The end of the answer is, “But you need to recalibrate that.” So, if you believe that you should hold 10 percent of your assets in gold, you need to look at that at least every quarter, if not at minimum semiannually, and then look at what that allocation represents as a percentage of your portfolio.

Had you done that and bought gold at $800 or $1,000 an ounce three or four years ago, you would have noticed that at $1,900 an ounce, where gold hit its high, your 10 percent allocation was probably worth 17-18 percent of your portfolio. At that point, you need to sell 8 percent of your portfolio to get back down to 10 percent.



Hug (cont’d.): Vice versa, when you get a drop like this, you need to calibrate your portfolio. And just because you may think everything is great, you don’t cancel your life insurance policy or your health policy because one day you feel particularly healthy. It’s an insurance policy.

So when the market drops to $1,300, you recalibrate your portfolio. And if you wanted 10 percent of your assets in metals, and now that ratio is at 6 percent because the metals have dropped, you need to buy 4 percent more.

That will allow you to add positions in corrective markets, in weak markets and sell into strengthening markets, at the same time maintaining your core holding. And that’s the long-term view, right?

Hug: It’s a view that could be long or short. You may in three years from now—for whatever reason … now again it will depend on age or risk profile what you need. You may look at this and say, “When I look at the world today it just feels better; it looks better. Everything I’m seeing is better. So what I want to do now is maybe drop my allocation from 10 to 5 percent.” But in that scenario, in that environment, your other 90 percent should have done extremely well. So you recalibrate your insurance position.

But I don’t see anything fundamentally that has changed in this market that would make you change your percentage allocation at this point. If you were comfortable at 10 percent three months ago, there is no fundamental reason not to be less comfortable at 10 percent today—again, with a recalibration. Because when you look at the globe, nothing has changed. In fact, everything is getting worse, in my opinion, not better. And now you’ve got Bank of Japan that’s got a stimulus program that on a GDP basis is twice, if not 2 1/2 times the size of the U.S. spending program. Nothing is getting better out there.

When you look at the weak sisters of the EU—the Spanish, the Greeks, the Portuguese—they have youth unemployment, some of them approaching 60 percent. These kids are going to hit the streets in the spring and summer, and they’re going to be protesting. I think you would not be wise, to not have a precious metals component in your portfolio. What’s puzzling to me is that given this fundamental picture, why has so much confidence been lost in gold? You think it’s mostly a tactical event?

Hug: I don’t think it’s an issue of confidence on the investor’s part that’s buying this from an insurance position. I think what this is, is just the big players out there—everything happens now on a push of a button, and it just gets overdone. Whether it’s on the upside or on the downside, it gets overdone. The valuation here of gold at $1,300 is low. The mining industry has finally been taken to task, and after telling investors for a long time that they have a $300 production cost on gold—which is absolutely garbage—they are now admitting the production costs are probably closer to $900, $1,000 an ounce.



Hug (cont’d.): And now the SEC and some of the fund managers are making these mining companies own up to the fact that their production costs are not $300. And gold production is declining while the cost of gold production is rising. We’re almost at a point where eventually mines will just stop producing; it won’t be profitable for them.

The fundamental long-term picture for the metals is extremely positive. If you add in some of the other arguments that aren’t yet prevalent, but I believe will become prevalent, such as the fact that you can’t just keep printing $85 billion a month, nor can the Japanese be doing $160 billion a month and debasing their currencies without the inevitable result being an inflationary surge—whether it comes next year, or two, three years from now, it’s in the system—that’s going to be price-positive for hard assets. Be it oil, be it real estate, it’s going to be price positive. And the last leg of a metals cycle is usually the inflationary cycle. And that hasn’t happened yet.

So, as a trader, would I buy at $1,392? Yes, I would, but I’d have a tight stop in there, hoping that it will get through $1,400 and scare the shorts out. As long-term investors, at any of these levels here, I’d recalibrate my portfolio. Do you have any sort of price range for gold, say, for the remainder of the year? I recently interviewed a trader who was telling me we would not see $1,600 gold any more.

Hug: I hate long ranges. But I think we may have seen the low in gold. I don’t know if there’s much more below $1,300; maybe $1,250. But we may have already seen the low. This may have been the opportunity to get in before the next leg up. The only context in which that $1,600 ceiling would be correct, in my opinion, would be is everything is rosy, and there is no need for a safe-haven asset. Does it make a difference what the dollar does going forward? All the monetary easing has not weakened the dollar, and a strong dollar is detrimental to gold prices, right?

Hug: It is. But it’s important to point out that many say a $1.32 euro indicates a strong dollar, and it does when you compare it to a $1.50 euro, but it doesn’t indicate a strong dollar when you equate it to the euro being at 90 cents way back a year or two years after it came out. So the dollar is right in the middle of its range; in fact, it’s closer to the bottom end of its range against the euro than the top end of its range.

An increasingly stronger dollar generally will be negative for the metals, but it depends what creates the strength in the dollar. If the European banking system—for the sake of a worst-case scenario—collapses and people move their assets out of the euro into the dollar, it will strengthen the dollar. But I can guarantee you that if that were the scenario that strengthened the dollar, gold would go up as well.



Hug (cont’d.): If the scenario for a stronger U.S. dollar is that the U.S. economy really starts to grab hold, and the Fed starts to raise interest rates, in that scenario, the dollar strengthening would be very detrimental for gold. And there I think the gold cycle will end. But I don’t see that ending until we get either an inflationary surge, or much, much more geopolitical or financial risks occurring over the next year. And in that scenario, I can easily see gold trading back to $1,600, or even $1,800. It really depends on how crazy it gets, and what causes it to start the acceleration.

So when somebody says a stronger dollar is negative for gold—yes. But it’s what created the stronger dollar that you have to analyze. Makes sense. As a final thought, do you have a preferred method of holding gold, as in bullion, coins, ETFs? Or does it even matter?

Hug: Again, it really depends on your psychology. And there’s a breakup of psychology specifically as it relates to the U.S. market. There’s a segment of the U.S. market that believes, right or wrong, that the government is, somewhere down the road, going to control gold ownership again, and they’re terrified that there’s going to be anarchy in the streets. Now, I know it sounds a little crazy, but there is a significant segment of the market in the U.S. that buys metals based on that theory.

The irony of it is that they buy it from a U.S. dealer, and they store it in the U.S. But it’s illogical. If you think the government is going to ban gold ownership, or is going to ban your financial capital movement freedom, it makes no sense to hold your metal in your country of residence. Because the first thing the government is going to do, if that scenario proves correct, is they’re going to go to the dealers. And they’re going to say to the dealers, “We want every single record of every ounce of gold you’ve ever sold to any American in this country.”

So if you’re in that camp owning physical metal, you should consider having it stored outside of the U.S. because it’s not a financial asset, it’s not a bank deposit. If you’re not worried about that type of “catastrophic” issue, but you want to hold metals as a percentage of your portfolio, it makes no sense to buy physical metals, because you’re paying very, very high premiums, fabrication costs, storage costs, insurance costs; you have risks associated with holding physical metal. Those people should consider either investing in a mutual fund that invests in baskets of commodities, metals included, or buying the ETFs directly as a stock. It all goes back to your psychology.



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