G-khan
04-06-2003, 08:37 AM
Julian D. W. Phillips
Right now Gold shares are performing steadily, but the gold price still looks weak. Why? The lessons of 34 years of Technical experience tell us one solid fact - Gold Shares lead the gold price!
Yes, most markets players think that gold shares follow the Gold Price, because they are downstream in terms of cash flow from the price. Complaints are often heard that Gold Shares under perform the gold price.
If we ignore the fact that gold shares lead the gold price, we could follow the smart money into the market, some way behind it - the quick way to lose our own.
To get the right perspective on this approach, we have to ask these questions: -
What do we mean by performance?
Who are Speculators and what is Hedging and trading?
Who are Share Investors?
What are the results of these two approaches?
Summary and Conclusions
Performance is relative to the one defining what it should be, so to whom are gold shares performing badly?
Shares: - Because of the different objectives of the types of Players, shares lead the gold price. So, it follows that gold shares usually tell you what the metal is going to do. [This comes from 34 years of Technical experience].
Shares will be expected to yield greater earnings and dividends, than previously, as the fall in equity markets continues. This may, to some extent, diminish the vigour of the rise in gold share prices, [as better yields for risks are demanded] but at a rate extremely difficult to quantify, except with hindsight.
Gold Price Speculation: - Speculators on the gold price are capricious and momentary and have to be to succeed, but speculation is primarily attracted to, the 'cleaner', gold bullion and so will 'track' the gold price exactly. Speculators find the metal and its derivative instruments more rewarding, faster and more spectacular. The options and futures markets with their high risk and highly geared 'shapes' are tailored-made for this operator so give a far superior performance if tracking the gold price is what you want.
The Derivatives markets, in gold bullion contributes to gold price movements, far less than most people believe, attracting only the 'net' demand / supply of the derivative markets [the Delta]. There is a large and growing market in both Options on shares as well as Warrants on Gold Shares, but their impact on the Share market is much smaller than the volume of Warrants and Options would suggest, as only the net effect [the Delta] of this trading, requires hedging through the Share market itself.
The nature of the share investor in the majority, is more conservative and premeditated than the speculator, acting in a researched objective manner befitting the complexities of the shares and longer term considerations. than the short term, opportunistic, driving trader [who does well if he has a success rate of only 56% on his trades].
What do we mean by performance?
The market has two prime facets, the market players themselves and the instruments employed in the market. The capacities of the investing instruments attract different types of players for their own different, but chosen reasons. Hence the term under-perform is a difficult one to apply, as maximum performance is different things to different people.
If one means that shares do not reflect the volatility of the gold price, so they must be "under performing", then that is true, but only to the Speculator seeking near term capital gain, seeking the high rewards from the Derivatives, the direct way to deal in gold without touching the metal itself. He would like to see shares match that volatility to satisfy his aims, so they will under perform, when they don't track the shares closely. This man should switch out of shares and into the metal or a derivative emanating from Gold.
To the Investor seeking a long term Investment, paying for its keep, the Shares will outperform the Derivative with its unacceptably high risks [except where it is used to protect an underlying investment]. The investment he needs must have a capacity to earn its keep, reaping a yield from the cash flow of the company, from its Dividends, or through a Capital value increase [stemming from further investment intending to increase future Dividends]. Add the dividends over the life of the mine or company and the total return will show how a good long term decision is rewarded. In addition, hopefully, the mining company has a growing level of gold production and reserves, with the objective of giving an additional increase to his return on capital, not simply through the increasing gold price, but the growth inherent in the company whose shares he purchases. In the gold market, the assessment of these prospects is a complex process requiring great expertise and measurement. The expected gold price has a huge impact on these sums. Prime to this is the average gold price in the period in which the next dividend or earnings level is to be determined, not the current gold price. The shares Investor will therefore attempt to discount what they believe to be the future average gold price, based on, but not solely on, past dividends and dividend policy and price his shares accordingly. He will carefully analyse the expected gold price, which will translate into a price he is willing to pay. It is this share price level, that should describe his expectations of the near and medium price of gold.
Who are Speculators
Defined as short term, opportunistic buyers and sellers of Gold, they have been the dominant force on the day to day price of gold of late. They deal directly in gold bullion, as well as impact on the market through the grantors of options and dealers in gold futures who go to the market, having netted out their positions and defined their "Deltas" and bought and sold gold accordingly.
The Derivatives markets have siphoned off the bulk of the Speculators from the gold bullion market and into paper positions, which when matched throw up a relatively small 'net' position [compared to the total volume dealt], which only then impacts on the price. Likewise their activity in share Options or Warrants is huge, but via the issuers, their impact on the market itself is relatively small [the Delta].
Speculators hold sway in the market place, as the quantities they utilise in a tight illiquid market, are at sufficient levels to turn a relatively balanced market into a volatile one. They were largely responsible for the bulk of the $60 + of "War Premium" seen in the price at $390.
Not necessarily driven by fundamentals, but by the short term plus the latest reports from CNN, et al, they turn the swells in the sea [Conservative market action] into "surf" and command the most dramatic focus of attention in the market place. Although both the "surf" and the preceding "swells" are originally dominated by the tide of fundamentals, the seashore represents final wave striking the beach of the gold price. It is extraordinary that this capricious and volatile section of the market should sit on top of so vital a market. Occasionally non-plussed, as of late, they sit on the sidelines leaving the waves of the gold price gently lapping on the shores of a quiet market.
What is "Hedging & Trading"
The principle of Hedging was originally simple and prudent. Imagine if you are a Jeweller [who cannot borrow gold until he sells it then pays for the gold at that time] and you know precisely how much gold you will require for your business at any time in the future. Or conversely you are a Gold Producer who can accurately estimated when and how much gold you will have to sell at any period of time in the future. During that period the gold price may drop to a point that would be considered as the low point. You would want to buy all your present and future requirements at that price. You would then buy forward in line with the different dates you would need to take delivery. Or [as a producer] sell at a point you deemed to be a high point, the entire amount you wanted to dispose of at the different dates the Gold came into you hands. Hence the concept of "Hedging" came in and took the risk out of knowing what the final price paid for the product would be at the time you commenced production.
But nothing is that easy. By buying or selling "forward" you removed from yourself the ability to pay a lower price, or receiving a higher one and were left with a neat financial exercise with the risks removed. But as a Seller of gold, your Shareholders become upset with you if it becomes patently obvious that you could have got a better price and your customers, as a jeweller, refused to pay your prices because they could by the same jewellery at a lower price from another jeweller who paid less than you did for his gold. The consolation of a neatly tied up financial exercise becomes poor consolation.
But nothing is ever so neat in the end, in this moving market, because a falling price turns on the buyer, as well as a rising price on the seller of gold.
Two cope with this problem of price movement trading came into play. What a relief, you could keep improving the prices paid and received by trading, and with a conservative approach: -
- As a Producer of gold who had sold future production forward you could trade your forward sale, if the price had fallen significantly since your sale by buying it back and building in a profit. This left you with an open position, with the gold you were producing. You then waited for the price to rise again, hopefully to a point you thought was unsustainable, then sold what you original stock again. For a Jeweller the converse was true.
- As the exercise is repeated so your trading profits increased.
- The joy of this method was you only need have one exposure to risk at any time, as you had anyway, with your stock requirements. It could be that you ended up with 51 transactions or more in the same basic transaction.
Then the Option removed even the risks from futures trading down to a level you knew your maximum loss Day 1.
So much for theory! My trading friends tell me it is their experience that a really good trader succeeds in around 56% of his trades. A successful crowd will earn about 40+ % on his money per annum. Losses are part of the game of trading!
This cannot be acceptable to a Producer or a Jeweller, after all what is his business! Certainly not speculation on the gold price!
This risk separated the traditional "Hedger", the Producer and the "Trade" from the Speculator, who accepted such risks and 'played' the market for the short term gain. Our Speculator can include the conservative Investor who sets aside a portion of capital dedicated to acceptance of these risks on top of an essentially conservative position. Hence, the Speculator is a short term, opportunistic buyer and seller of Gold.
Share Markets
Gold Shares, encompass entirely different investment criteria to the metal for the Investor. As such they should attract an entirely different type of owner.
Gold Producers are responsible to their Shareholders twice yearly, for dividend payouts, plus hopefully, growth of dividends. This is determined from the "Average Price" of gold over the period in which they earn revenue from sales of gold. The price of the shares will therefore move on shareholders expectations of the earnings performance and dividend hopes and reflect these in the share price. The work that must go into understanding, evaluating correctly, and investing in a gold share professionally, is enormous. The usual, main body of Investors in shares is therefore professional. In the main, the Investors into gold shares are professional and Institutional Investors, who 'do their homework' and carefully. Whilst this is no guarantee of getting it right, it does improve the chances of doing so.
When the formula for success in the Share markets demands an understanding of the ground being mined, the mine itself, mine management, the currency and government under which the company lives, the market for the metal, the influences affecting that market and the long term prospects of the gold price, you have a depth of risk and work that demands a thorough professional assessment.
One would therefore, expect an in-depth understanding of what is driving the gold price, far in excess of the influence of the progress of the U.S. soldiers in Baghdad.
Being long sighted in approach, it should not surprise us that the projections of the gold price by the professionals and Institutions are far removed from the myopic objectives of the speculator, who by nature, exits from the market, when no immediate drama and consequent opportunity is apparent.
The result of the two approaches
We would postulate that share prices should lead the metal price, because of the competence of the analysis [including gold price projections] preceding such investments and the longer term objectives of Share Investors.
Yes, we agree that gold shares need to see a rising average gold price, before being convinced that cash flow will result, so confirming value, but, effective Investors will move into their Investments, well before, the market reflects their expected increase in value.
Speculators score the most, if they move in, just in time, for a short term gain.
So, structurally shares should lead the metal price.
After peaking in January 2003 gold stocks have been sliding for the last few weeks. Now they are holding a firmer line and appear to be recovering. The gold price has not yet done that and could show some more short term weakness.
The TSX Gold and Precious Metals Index was down almost 30% at its lows. The Philadelphia Gold and Silver Index (XAU) fell 25% and the Gold Bugs Index (HUI) fell 26% to recent lows. Gold fell roughly 13% from its highs near $390 but has not yet bottomed, or is it doing so now?
Right now are we again seeing Gold Share prices leading the Gold price? If it is, then it is repeating a pattern made for more than the last three decades.
Thus, shares have followed the gold price from in front!
However, the average gold price, more accurately reflects the true picture of supply and demand. It is the long term impact of the average gold price, that should be the leading factor in determining the share prices. So we add to our position this statement; that the Gold share prices will attempt to follow, the future average gold price.
Loss of confidence in Paper assets?
With the fall in paper investments in general some would howl that people are losing trust in paper overall and so gold shares will under perform because of the loss of trust in those representing the paper? But like the tiny child running away from home, only to return after an hour or so, where else do you go?
We would express it this way - partially softening the performance of the Share prices is the structural weakening of equity prices, which rose to overblown levels, in the last decade, rising to levels far away and above the realities of cash flow.
The euphoria of the markets in the last two decades has attracted the speculator as well as the naïve. Unfortunately many of these should have known better than to play in the 'surf' of overly priced paper. The catastrophic fall in equity markets and their reality realignment will bring shares as Investor instruments, more closely into 'synch' with performance realities.
Gold shares have to do the same, even though gold mine performances will improve with the gold price. This should be reflected in rising Dividends, a feature we fully expect to grow in the best gold mine companies. This may stunt the impact of rising gold prices on the performance of shares but only a little, and only until the increasing return achieved in paper assets is completed, [and favour higher dividend payers whilst this process is underway].
Conclusion
Standing back from the price and looking at the market, we see that shares have not 'tracked' the gold price, but that shares LEAD the gold price.
Gold shares do not 'track' the gold shares, nor should they. Hence they do not UNDER PERFORM the gold price, they attempt to HARNESS the gold price to the maximum.
Those who expect the Gold Shares to follow the gold price, should not own shares, they should stay in the Derivative market.
Julian D. W. Phillips
7 April 2003
www.authenticmoney.com
authenticmoney@iafrica.com
http://www.gold-eagle.com/editorials_03/phillips040703.html
Right now Gold shares are performing steadily, but the gold price still looks weak. Why? The lessons of 34 years of Technical experience tell us one solid fact - Gold Shares lead the gold price!
Yes, most markets players think that gold shares follow the Gold Price, because they are downstream in terms of cash flow from the price. Complaints are often heard that Gold Shares under perform the gold price.
If we ignore the fact that gold shares lead the gold price, we could follow the smart money into the market, some way behind it - the quick way to lose our own.
To get the right perspective on this approach, we have to ask these questions: -
What do we mean by performance?
Who are Speculators and what is Hedging and trading?
Who are Share Investors?
What are the results of these two approaches?
Summary and Conclusions
Performance is relative to the one defining what it should be, so to whom are gold shares performing badly?
Shares: - Because of the different objectives of the types of Players, shares lead the gold price. So, it follows that gold shares usually tell you what the metal is going to do. [This comes from 34 years of Technical experience].
Shares will be expected to yield greater earnings and dividends, than previously, as the fall in equity markets continues. This may, to some extent, diminish the vigour of the rise in gold share prices, [as better yields for risks are demanded] but at a rate extremely difficult to quantify, except with hindsight.
Gold Price Speculation: - Speculators on the gold price are capricious and momentary and have to be to succeed, but speculation is primarily attracted to, the 'cleaner', gold bullion and so will 'track' the gold price exactly. Speculators find the metal and its derivative instruments more rewarding, faster and more spectacular. The options and futures markets with their high risk and highly geared 'shapes' are tailored-made for this operator so give a far superior performance if tracking the gold price is what you want.
The Derivatives markets, in gold bullion contributes to gold price movements, far less than most people believe, attracting only the 'net' demand / supply of the derivative markets [the Delta]. There is a large and growing market in both Options on shares as well as Warrants on Gold Shares, but their impact on the Share market is much smaller than the volume of Warrants and Options would suggest, as only the net effect [the Delta] of this trading, requires hedging through the Share market itself.
The nature of the share investor in the majority, is more conservative and premeditated than the speculator, acting in a researched objective manner befitting the complexities of the shares and longer term considerations. than the short term, opportunistic, driving trader [who does well if he has a success rate of only 56% on his trades].
What do we mean by performance?
The market has two prime facets, the market players themselves and the instruments employed in the market. The capacities of the investing instruments attract different types of players for their own different, but chosen reasons. Hence the term under-perform is a difficult one to apply, as maximum performance is different things to different people.
If one means that shares do not reflect the volatility of the gold price, so they must be "under performing", then that is true, but only to the Speculator seeking near term capital gain, seeking the high rewards from the Derivatives, the direct way to deal in gold without touching the metal itself. He would like to see shares match that volatility to satisfy his aims, so they will under perform, when they don't track the shares closely. This man should switch out of shares and into the metal or a derivative emanating from Gold.
To the Investor seeking a long term Investment, paying for its keep, the Shares will outperform the Derivative with its unacceptably high risks [except where it is used to protect an underlying investment]. The investment he needs must have a capacity to earn its keep, reaping a yield from the cash flow of the company, from its Dividends, or through a Capital value increase [stemming from further investment intending to increase future Dividends]. Add the dividends over the life of the mine or company and the total return will show how a good long term decision is rewarded. In addition, hopefully, the mining company has a growing level of gold production and reserves, with the objective of giving an additional increase to his return on capital, not simply through the increasing gold price, but the growth inherent in the company whose shares he purchases. In the gold market, the assessment of these prospects is a complex process requiring great expertise and measurement. The expected gold price has a huge impact on these sums. Prime to this is the average gold price in the period in which the next dividend or earnings level is to be determined, not the current gold price. The shares Investor will therefore attempt to discount what they believe to be the future average gold price, based on, but not solely on, past dividends and dividend policy and price his shares accordingly. He will carefully analyse the expected gold price, which will translate into a price he is willing to pay. It is this share price level, that should describe his expectations of the near and medium price of gold.
Who are Speculators
Defined as short term, opportunistic buyers and sellers of Gold, they have been the dominant force on the day to day price of gold of late. They deal directly in gold bullion, as well as impact on the market through the grantors of options and dealers in gold futures who go to the market, having netted out their positions and defined their "Deltas" and bought and sold gold accordingly.
The Derivatives markets have siphoned off the bulk of the Speculators from the gold bullion market and into paper positions, which when matched throw up a relatively small 'net' position [compared to the total volume dealt], which only then impacts on the price. Likewise their activity in share Options or Warrants is huge, but via the issuers, their impact on the market itself is relatively small [the Delta].
Speculators hold sway in the market place, as the quantities they utilise in a tight illiquid market, are at sufficient levels to turn a relatively balanced market into a volatile one. They were largely responsible for the bulk of the $60 + of "War Premium" seen in the price at $390.
Not necessarily driven by fundamentals, but by the short term plus the latest reports from CNN, et al, they turn the swells in the sea [Conservative market action] into "surf" and command the most dramatic focus of attention in the market place. Although both the "surf" and the preceding "swells" are originally dominated by the tide of fundamentals, the seashore represents final wave striking the beach of the gold price. It is extraordinary that this capricious and volatile section of the market should sit on top of so vital a market. Occasionally non-plussed, as of late, they sit on the sidelines leaving the waves of the gold price gently lapping on the shores of a quiet market.
What is "Hedging & Trading"
The principle of Hedging was originally simple and prudent. Imagine if you are a Jeweller [who cannot borrow gold until he sells it then pays for the gold at that time] and you know precisely how much gold you will require for your business at any time in the future. Or conversely you are a Gold Producer who can accurately estimated when and how much gold you will have to sell at any period of time in the future. During that period the gold price may drop to a point that would be considered as the low point. You would want to buy all your present and future requirements at that price. You would then buy forward in line with the different dates you would need to take delivery. Or [as a producer] sell at a point you deemed to be a high point, the entire amount you wanted to dispose of at the different dates the Gold came into you hands. Hence the concept of "Hedging" came in and took the risk out of knowing what the final price paid for the product would be at the time you commenced production.
But nothing is that easy. By buying or selling "forward" you removed from yourself the ability to pay a lower price, or receiving a higher one and were left with a neat financial exercise with the risks removed. But as a Seller of gold, your Shareholders become upset with you if it becomes patently obvious that you could have got a better price and your customers, as a jeweller, refused to pay your prices because they could by the same jewellery at a lower price from another jeweller who paid less than you did for his gold. The consolation of a neatly tied up financial exercise becomes poor consolation.
But nothing is ever so neat in the end, in this moving market, because a falling price turns on the buyer, as well as a rising price on the seller of gold.
Two cope with this problem of price movement trading came into play. What a relief, you could keep improving the prices paid and received by trading, and with a conservative approach: -
- As a Producer of gold who had sold future production forward you could trade your forward sale, if the price had fallen significantly since your sale by buying it back and building in a profit. This left you with an open position, with the gold you were producing. You then waited for the price to rise again, hopefully to a point you thought was unsustainable, then sold what you original stock again. For a Jeweller the converse was true.
- As the exercise is repeated so your trading profits increased.
- The joy of this method was you only need have one exposure to risk at any time, as you had anyway, with your stock requirements. It could be that you ended up with 51 transactions or more in the same basic transaction.
Then the Option removed even the risks from futures trading down to a level you knew your maximum loss Day 1.
So much for theory! My trading friends tell me it is their experience that a really good trader succeeds in around 56% of his trades. A successful crowd will earn about 40+ % on his money per annum. Losses are part of the game of trading!
This cannot be acceptable to a Producer or a Jeweller, after all what is his business! Certainly not speculation on the gold price!
This risk separated the traditional "Hedger", the Producer and the "Trade" from the Speculator, who accepted such risks and 'played' the market for the short term gain. Our Speculator can include the conservative Investor who sets aside a portion of capital dedicated to acceptance of these risks on top of an essentially conservative position. Hence, the Speculator is a short term, opportunistic buyer and seller of Gold.
Share Markets
Gold Shares, encompass entirely different investment criteria to the metal for the Investor. As such they should attract an entirely different type of owner.
Gold Producers are responsible to their Shareholders twice yearly, for dividend payouts, plus hopefully, growth of dividends. This is determined from the "Average Price" of gold over the period in which they earn revenue from sales of gold. The price of the shares will therefore move on shareholders expectations of the earnings performance and dividend hopes and reflect these in the share price. The work that must go into understanding, evaluating correctly, and investing in a gold share professionally, is enormous. The usual, main body of Investors in shares is therefore professional. In the main, the Investors into gold shares are professional and Institutional Investors, who 'do their homework' and carefully. Whilst this is no guarantee of getting it right, it does improve the chances of doing so.
When the formula for success in the Share markets demands an understanding of the ground being mined, the mine itself, mine management, the currency and government under which the company lives, the market for the metal, the influences affecting that market and the long term prospects of the gold price, you have a depth of risk and work that demands a thorough professional assessment.
One would therefore, expect an in-depth understanding of what is driving the gold price, far in excess of the influence of the progress of the U.S. soldiers in Baghdad.
Being long sighted in approach, it should not surprise us that the projections of the gold price by the professionals and Institutions are far removed from the myopic objectives of the speculator, who by nature, exits from the market, when no immediate drama and consequent opportunity is apparent.
The result of the two approaches
We would postulate that share prices should lead the metal price, because of the competence of the analysis [including gold price projections] preceding such investments and the longer term objectives of Share Investors.
Yes, we agree that gold shares need to see a rising average gold price, before being convinced that cash flow will result, so confirming value, but, effective Investors will move into their Investments, well before, the market reflects their expected increase in value.
Speculators score the most, if they move in, just in time, for a short term gain.
So, structurally shares should lead the metal price.
After peaking in January 2003 gold stocks have been sliding for the last few weeks. Now they are holding a firmer line and appear to be recovering. The gold price has not yet done that and could show some more short term weakness.
The TSX Gold and Precious Metals Index was down almost 30% at its lows. The Philadelphia Gold and Silver Index (XAU) fell 25% and the Gold Bugs Index (HUI) fell 26% to recent lows. Gold fell roughly 13% from its highs near $390 but has not yet bottomed, or is it doing so now?
Right now are we again seeing Gold Share prices leading the Gold price? If it is, then it is repeating a pattern made for more than the last three decades.
Thus, shares have followed the gold price from in front!
However, the average gold price, more accurately reflects the true picture of supply and demand. It is the long term impact of the average gold price, that should be the leading factor in determining the share prices. So we add to our position this statement; that the Gold share prices will attempt to follow, the future average gold price.
Loss of confidence in Paper assets?
With the fall in paper investments in general some would howl that people are losing trust in paper overall and so gold shares will under perform because of the loss of trust in those representing the paper? But like the tiny child running away from home, only to return after an hour or so, where else do you go?
We would express it this way - partially softening the performance of the Share prices is the structural weakening of equity prices, which rose to overblown levels, in the last decade, rising to levels far away and above the realities of cash flow.
The euphoria of the markets in the last two decades has attracted the speculator as well as the naïve. Unfortunately many of these should have known better than to play in the 'surf' of overly priced paper. The catastrophic fall in equity markets and their reality realignment will bring shares as Investor instruments, more closely into 'synch' with performance realities.
Gold shares have to do the same, even though gold mine performances will improve with the gold price. This should be reflected in rising Dividends, a feature we fully expect to grow in the best gold mine companies. This may stunt the impact of rising gold prices on the performance of shares but only a little, and only until the increasing return achieved in paper assets is completed, [and favour higher dividend payers whilst this process is underway].
Conclusion
Standing back from the price and looking at the market, we see that shares have not 'tracked' the gold price, but that shares LEAD the gold price.
Gold shares do not 'track' the gold shares, nor should they. Hence they do not UNDER PERFORM the gold price, they attempt to HARNESS the gold price to the maximum.
Those who expect the Gold Shares to follow the gold price, should not own shares, they should stay in the Derivative market.
Julian D. W. Phillips
7 April 2003
www.authenticmoney.com
authenticmoney@iafrica.com
http://www.gold-eagle.com/editorials_03/phillips040703.html