Not-So-Precious Metals

Precious metals of all types are trading terribly. I’ve written several times in the recent past about the virtues of having exposure to the precious metals sector, in particular platinum and palladium given their industrial usage in the auto catalyst industry. As we pointed out in previous postings, the undervalued platinum – palladium story was supported by the underlying industry fundamentals – i.e. demand outpacing supply. We also know that the fall in Chinese equities placed a crimp in auto demand in the fastest growing auto sales segment and that is hurting demand. Primary mines continue to increase production and weakened scrap and base metal prices have actually boosted secondary recycled “production” in my opinion. So the supply – demand dynamic that supported higher prices has started to weaken. We are still of the opinion that the metals at these levels will produce positive returns for those wishing to speculate in the space.

Auto Demand

Let’s start with some good news. European auto demand seems to be picking up with the help of extraordinary monetary policy procedures.  According to Business Insider, “European car sales are rising at the fastest pace in 5 and a half years, since the back end of 2009. Sales rose by 14.6% in the year to June, the most rapid increase since before the onset of the euro crisis. That's according to the European Automobile Manufacturers Association.”

 

 

 

 

Bloomberg News states, “Registrations rose 15 percent to 1.41 million autos from 1.23 million a year earlier, the Brussels-based European Automobile Manufacturers’ Association, or ACEA, said Thursday in a statement. The jump was the biggest since a 16 percent surge in December 2009, when governments in the region offered incentives on trade-ins of older cars to help the industry recover from the global recession.”

This sliver of good news although doesn’t offset the auto sales troubles in China.

Toyota is holding off building the Lexus brand in China because of the country's stalled auto market – Reuters (Via Business Insider): “Toyota Motor Corp will likely delay building its premium Lexus brand in China for at least a few years, as growth in China's auto market slows to a crawl and a weak yen makes it cheaper to keep making cars in Japan.”

China Headlines: Car price war launched as sales slow – Global Post: “Chinese car dealers have launched a price war as their inventories climb amid downward economic pressure. The auto sector, which experienced years of explosive growth, saw sales up by a mere 1.4 percent year on year in the first half of 2015, when about 12 million vehicles were sold, according to the China Association of Automobile Manufacturers. Sales in June fell by 5.3 percent month on month to 1.8 million, down by 2.3 percent compared with the same period last year. Industry insiders predict this year's growth to be a tepid 3 percent instead of the expected 7 percent.”

China's economic turmoil is starting to hit US automakers – Business Insider: “Shockwaves from a drop in Chinese car demand are reverberating in Wolfsburg, Germany and Detroit, Michigan, where VW and General Motors are feeling the effects of a slowdown in a market that has been their big profit engine. Both Volkswagen and GM are heavily exposed to China, which remains a growth market, but last week cut its 2015 forecast for vehicle sales. The two car makers depend on the country for large parts of their profits and cash flow, and neither has a convincing story to tell about how to offset a slowdown in growth in the world's largest car market with other parts of their business.”

China New Car Sales Drop in June—Update – Nasdaq.com: “The global auto industry's biggest market has slipped into the slow lane, with China new-car sales registering a rare monthly decline that indicates top car companies have another headache to handle in emerging markets. Although growth has been slowing in China, most auto executives had earlier in the year been forecasting 2015 sales to grow at a high single-digit percentage pace, but that now looks optimistic. Over the first half of the year, sales rose a disappointing 4.8% to 10 million vehicles, but that growth rate was far below the gains enjoyed for several years. The China Association of Automobile Manufactures said Friday that June sales fell 3.4%, just the third monthly decline since September 2012. Unlike the past two monthly declines, which were fueled by a weeklong holiday in 2013 or political events, this skid comes as the economy slows, stock markets decline and an increasing number of analysts say the Chinese auto industry is overheated.”

Audi Said to Revise China Target as Stock Rout Saps Demand – Bloomberg News: “Audi AG has abandoned a target to sell 600,000 cars this year in China, its biggest sales region, as the country’s stock market rout sapped demand for luxury vehicles, two people familiar with the company’s plans said. The German carmaker will provide an update on the market situation when it announces first-half results on July 30, said the people, who asked not to be named because the information isn’t public. Audi’s Chinese sales rose 1.9 percent to 273,853 cars in the first half.”

Clearly slowing auto demand in China is a serious headwind for a sustainable move higher for platinum and palladium. Staying on the subject of PGM demand, I had a conversation with the folks at CPM Group a while back and while they agreed with my general thesis that PGM offered value buying opportunities they pointed out that investment demand could soon start to wane. They mentioned one investor that claimed platinum was a very small holding in his overall portfolio but it’s the one asset that keeps him up at night. Indeed if this gets to the point where investors just throw up their hands and call it quits, that can also increase the downward pressure currently weighing on PGM prices.

When looking at platinum and palladium holdings for all the known ETF’s, there are 2.7 million ounces of platinum and just under 3.0 million ounces of palladium held. There have been some minor declines in PGM holding in these funds but given the rout in PGM prices, I’m actually surprised at how well they held up. Major withdrawals within these funds will impact prices and increase the risk of “flash crashes” in the asset.

 

 

 

 

 

Flash Crash

Gold crashed – 7/19/15 – Business Insider: “The price of gold, courtesy of stop-loss selling and thin market conditions, endured a wild ride Monday. At 9:25 p.m. EDT, the spot price crashed 3.8%, or $43, to $1,087 an ounce in just a matter of seconds.”

 

 

There has been concern by many that the next crisis will be sparked by a liquidity trap in widely held assets. We wrote a piece a while ago entitled The Looming Crisis that highlighted the concerns. The crash in gold prices goes to show that if there was indeed a mass bout of selling, investors will have a hard time exiting the position. That is certainly enough to spark panic in the markets. The folks at Business Insider opined on the dilemma writing, “Broadly speaking, liquidity measures how easily traders and investors can buy and sell an asset in the market without seeing big price dislocations. When liquidity is low, selling can cause prices to plummet. "I think of this as one of the most underappreciated risk factors facing most investors today," Allianz's Mohamed El-Erian said in May.”

“This whole discussion about liquidity risk by the market experts wasn't about gold. Rather it was about the bond markets. Specifically, there are concerns about what might happen should the tide turn in the bond markets when 30 years of falling interest rates reverses at a time when the Federal Reserve is preparing to tighten monetary policy by forcing rates higher. "Current concerns in the financial markets center around the absence of liquidity and the effect it might have on future market prices," Janus' Bill Gross said in June. "In 2008/2009, markets experienced not only a Minsky moment but a liquidity implosion, as levered investors were forced to delever. Ultimately the purge threatened even the safest and most liquid of investments."”

China’s Gold Reserves

From Mining.com, “China shocked the bullion market by unveiling Friday its official gold holdings for the first time since 2009, putting an end to years of speculation and rumours of Beijing quietly buying gold since prices began declining According to data from the country’s central bank, China’s gold reserves stood at 1,658 tonnes (53.31m fine troy ounces) at the end of June. In April 2009, its gold holdings were 1,054 tonnes. This 57% jump in reserves means that China now surpasses Russia in the list of countries with the largest stash of the yellow metal, placing it in the sixth position, after the US, Germany, the International Monetary Fund, Italy and France, according to the World Gold Council.”

 

 

 

This announcement has left many underwhelmed as the figures were much lower than anticipated. So much so that there is speculation that China purposely low-balled the figure for public release.

Where Is China's Missing 1,850 Tons Of Gold? – Forbes: “The assumption that China still has not disclosed all its gold has led Lundin, like many others, to wonder “why they would feel compelled to understate the total now.”The thinking of Chinese officials about their stockpile remains a mystery, but there are various theories. The most benign comes from GoldCore’s Mark O’Byrne, who said China may have been “lowballing” the size of its holdings to maintain confidence in the dollar. The dollar, however, does not need confidence boosters at the moment, so that explanation is probably wide of the mark. Others speculate that Beijing’s announcement on Friday was intended to reassure panicky domestic stock investors. But if so, why didn’t the central bank come out with a bigger number? Surely no one would have questioned a figure double or triple the one released on Friday. Another theory is that Beijing will announce further purchases in coming months as part of its campaign to persuade the IMF in November to include the renminbi in the Special Drawing Rights basket of currencies. Call it “momentum building.” The stretching out of disclosures—false reporting—is not impossible. After all, the PBOC has no problem releasing inaccurate information on its gold reserves. The bank’s records show, for instance, no net addition to its holdings from May 2009 to this May. Incredibly, the bank officially maintains that its gold reserves increased by 19.43 million ounces within one month, this June. Given what is known about transactions in gold markets last month, that could not have occurred.”

Blood in the Streets

For gold investors, these are the darkest days. There is blood in the streets. From Mining.com, “Last week large gold futures investors such as hedge funds, referred to as "managed money", slashed overall bullish positions by a whopping 64%. The week before speculators cut long positions by more than half. Bets that prices will rise only amounted to just 7,574 lots or 757,400 ounces in the week to July 7 according to the Commodity Futures Trading Commission's weekly Commitment of Traders data. The net long positioning is now the lowest since at least 2006 when gold was worth less than $600 an ounce. Speculators' short positions – bets that gold could be bought cheaper in the future – jumped to more than 10.8 million ounces (306 tonnes), a new record high for bearish bets placed on the New York gold futures market.”

Then there are those ultra-contrarians in the market that make a case for the purchase of gold and gold mining stocks at these levels.

Daily Reckoning: “It’s ironic that China’s underwhelming gold announcement may be the catalyst to send gold to its capitulation low. But the market works in mysterious ways. I say capitulation low because that is what it’s shaping up to be. Let me tell you why. In the future markets, ‘managed money’ (basically the hedge funds) are now short a record amount of gold. Being ‘short’ means they are betting on a price fall.

You can see this in the chart below:”

 

 

This is the largest short position by this group of traders in the report’s history. And chances are it’s going to get more extreme as downward momentum gathers pace. That means you could see more downside in the US dollar gold price. But such a drop just adds fuel to the fire of an eventual rebound. Consider the following commentary from trading legend Martin Armstrong:  ‘At the top, the majority is long and they become the fuel to make any market crash and burn. ‘At the bottom, the opposite unfolds for everyone will be short. They will pile on looking for $600 gold and will count their profits upon entering the trade. They become the fuel to send the market higher for it always begins with a short-cover rally; people continually try to sell each rally, looking for that new low, just as the people at the top remain convinced that a decline would follow with new highs.’ So as this US dollar gold bear market reaches its crescendo, and as the mainstream media puts the boot in about gold’s prospects, keep in mind we’re close to the bottom with an all-time record amount of punters betting on more falls.”

The Felder Report: “This prolonged pain has created an incredible degree of despair in these markets right now. Everyone hates gold today. Traders hate it. Speculators hate it. The media hates it. But only when something becomes so widely out of favor does an investor get the opportunity to buy it at such a wide discount. The more out of favor it is the greater the discount. The greater the discount, the greater the prospective return. Meb Faber recently showed us the terrific returns to be had by buying an asset class after a prolonged decline: “You doubled your returns in the year following three down years for both country stock markets and asset classes.”

 

 

Graphic via MebFaber.com

 

 

“Gold and the miners are now down nearly 4 years in a row. I can only imagine the sort of returns that degree of despair produces. And that’s just the sort of setup that piques my interest. All in all, I’m fairly certain that the gold mining stocks are now the most hated asset class in the markets. For that very reason, they may very likely be the most attractive opportunity an investor can find.”

Bottom Line: I am in agreement with the ultra-contrarian camp as it relates to PGM. While the supply – demand dynamic has deteriorated slightly over the past few months, we continue to believe this space offers an opportunity for outperformance from these levels in the months and years to come.

Joseph S. Kalinowski, CFA

 

Further Reading

Sell Gold To Buy Platinum When Uncertainty Is High – Seeking Alpha

Rhodium prices dip below $800/oz, but mid-week buying seen – Platts

Rhodium’s 29% rally in a week beats other stocks – Mineweb

Platinum drops below $1 000/oz – Reuters (Via) IOL Mobile

Mazda is beating everyone in China's competitive auto market – Business Insider

Asteroid passing by Earth may hold $5 trillion in precious metals – Market Watch

The gold bear keeps growling – Seeking Alpha

 

 

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