Friday, December 4, 2009

Raymond James on gold

According to the Casey's Daily Dispatch, Raymond James had the following in their report on gold:

Central Banks Banking on Gold

The major paradigm shift we have seen evolve recently is the transition of central banks from net sellers of gold to net buyers. Given the inelasticity of mine supply, this shift has significant implications for gold’s supply/demand equation over the medium term. Furthermore, the symbolic implications of central banks buying gold (i.e., indicating a lack of confidence in the U.S. dollar) should underpin healthy retail investment demand as well. We believe this lack of confidence may not be restored for several years given the extent money supply has increased in the U.S. and the extravagant levels of U.S. public debt that will be further encumbered by the building burden of an aging population and health care inflation.

We continue to believe the equities are roughly 30% undervalued versus the gold price, and as a result we recommend investors add to their precious metal equities positions. We also suggest, based on historic valuation metrics, that the Junior/Mid‐tier producers offer better upside at current levels.


Since the end of the third quarter gold and silver prices are up 16% and 9%, respectively. In absolute terms gold is up $163/oz, an impressive result; however, we would argue this is just the beginning of a longer‐term period of strong precious metal prices based on:

1. Investment demand continues to be extraordinarily strong (and we see no reason for this to change) given the loss of confidence in both the financial system and policy makers and as investors prioritize capital preservation over capital appreciation, increasing portfolio allocation to more creditworthy or “safe haven” investments, i.e., precious metals. Regaining this loss of confidence in the financial system and policy makers, in our view, will take a considerable amount of time, earning precious metals a permanent place in any prudent portfolio and underpinning prices over the longer term.

2. The specter of future inflation is building. Recall it is the fear of inflation that tends to drive the metal prices higher.

3. Declining supply – central banks have moved from net sellers to net buyers. This is a significant structural change in the gold market as central banks have been net sellers for two decades. Central banks looking to diversify their reserves in light of the rampant currency debasement have very few options available, and we would argue gold is the most attractive. It is also important to note new mine supply has essentially just been replacing aging mines. Given the long lead time between finding a deposit and actually moving it through to production is on average around 10 years, new mine supply remains largely inelastic. Adding further pressure on the supply side of the equation is the dearth of new discoveries and the increasingly challenging mine development environment.

4. All‐in costs remain high – aging mines are experiencing declining grades, and new projects tend to be of lower quality, requiring higher and higher metal prices in economic studies, which are still returning IRRs in the mid to high teens.

5. Very low/negative real rates – lowers the opportunity cost of holding hard assets. Most major countries (including the U.S.) continue to support a low interest rate environment; we suspect this will be the case for some time to come as increasing rates may derail recoveries.

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