Spillovers from United States Monetary Policy on Emerging Markets: Different This Time?

Author/Editor: Jiaqian Chen ; Tommaso Mancini Griffoli ; Ratna Sahay  

Publication Date: December 24, 2014

Summary: The impact of monetary policy in large advanced countries on emerging market economies—dubbed spillovers—is hotly debated in global and national policy circles. When the U.S. resorted to unconventional monetary policy, spillovers on asset prices and capital flows were significant, though remained smaller in countries with better fundamentals. This was not because monetary policy shocks changed (in size, sign or impact on stance). In fact, the traditional signaling channel of monetary policy continued to play the leading role in transmitting shocks, relative to other channels, affecting longer-term bond yields. Instead, we find that larger spillovers stem more from structural factors, such as the use of new instruments (asset purchases). We obtain these results by developing a new methodology to extract, separate, and interpret U.S. monetary policy shocks.


miércoles, diciembre 31, 2014



Gold and Silver Prices in 2015

Precious metals haven't grabbed dramatic headlines like oil and gas have.
But their story is no less exiting. And the metals remain a fundamentally critical part of the global economic and strategic landscape.
Indeed, gold and silver took roller coaster-like rides throughout the year, both screeching towards their respective price lows before bouncing, albeit cautiously, ahead.
With the benefit of hindsight and the value of foresight, it's time to look at how gold and silver acted in 2014, and what we can do to profit in 2015.
Let's start with the yellow metal…

Gold Will Bounce Back Quickly

gold and silver prices

As you follow along with the graph, note that gold started out with a bang, bottoming around $1,195 December 19, 2013, then surging upward 12% to $1,390 by mid-March. It then headed back to the $1,300 level, and meandered sideways between $1,250 and $1,350 until mid-year.

The U.S. dollar began a strong climb from July onwards, likely in anticipation of the Fed ending its asset purchase program in October, as it ultimately did.

By November the SPDR Gold Trust ETF (NYSE Arca: GLD), the largest gold ETF, saw its gold holdings at six-year lows. Gold had become almost universally hated, which may well have marked the bottom.

And then it embarked on a new rise…

One of the biggest positives is how gold held up over the recent months: as oil prices plunged 27% from early November into mid-December, gold climbed by 7%.

Not even news of the defeat of the Swiss Gold referendum held it back.

Then India, battling for top gold consumer spot with China, relaxed some of its import restrictions on gold, making it more attractive during the traditional wedding season, and helping to push its price higher.

Chinese gold demand remains robust as well, and is expected to grow substantially again in 2015.

Will 2014 eventually prove to define the bottom in gold?

The odds of that are improving. Even if the U.S. dollar continues to show relative strength, I believe the fundamentals are in place for gold to reach back into the $1,400 to $1,500 range by this time next year.

Silver Will Take Longer – but It Will Be Worth the Wait

Silver's had it rougher than gold which, thanks to its nature, is to be expected.

While gold is off about 1% so far this year, silver's given up about 12% – way more than it typically would.

But not everyone is selling…

China's Zombie Factories Provide Illusion of Work and Prosperity; Rebalancing Chinese Style

 By: Mike Shedlock
Monday, December 29, 2014

China has zombie malls and even zombie cities, so zombie factories can hardly be a surprise.

And as the malinvestments pile up, so do unrealized shadow bank losses.

The Financial Times reports China Zombie Factories Kept Open to Give Illusion of Prosperity.
In the shadow of a group of enormous smokestacks and abandoned foundries, a peeling sign welcomes visitors to the Wenxi Steel Industrial Park. 
Highsee stopped paying its 10,000 employees six months ago. Local officials estimate the plant supported indirectly the livelihood of about a quarter of Wenxi county's population of 400,000. Highsee was the biggest privately owned steel mill in Shanxi, accounting for 60 per cent of Wenxi's tax revenues. For those reasons, the local government was reluctant to allow the company to go out of business, even though it had been in serious financial difficulties for several years. 
"By 2011 Highsee was already like a dead centipede that hadn't yet frozen stiff with rigor mortis," says one official who asks not to be named because he was not authorised to speak to foreign reporters. "More than half the plant shut down, but it was still producing steel even though its suppliers wouldn't deliver anything without cash up front and it was drowning in debt." 
In the past month alone Chinese media have reported on at least nine large steel mills that appeared to be suspended in limbo after halting production but which are forbidden from going formally bankrupt. 
"There are large numbers of companies across China that should go bankrupt but haven't done so," says Han Chuanhua, a bankruptcy lawyer at Zhongzi Law Office, a Beijing legal practice. "The government doesn't want to see bankruptcy because as soon as companies go bust, unemployment spikes and tax revenues disappear. By stopping companies from going bankrupt, officials are able to maintain the illusion of local prosperity, economic growth and stable taxes." 
The outstanding volume of non-performing loans in the Chinese banking sector has increased 50 per cent since the beginning of 2013, according to estimates from ANZ, the Australian bank, but the sector-wide NPL ratio remains extremely low, at just over 1.2 per cent. 
In private, however, senior Chinese financial officials admit the real ratio is almost certainly much higher, obscured by local governments trying to prop up companies.
Rebalancing Chinese Style

As part of China's rebalancing effort, growth must slow (or an even bigger crash will come later), and shadow banking losses recognized. So far, all we see is the slowdown in growth.

Even then, China recently cut interest rates hoping to keep the illusion alive (as some might see it), or smooth the transition (as others might see it).

Regardless how one sees it, these closures are at the back end of a collapse in commodity prices as China moves from an investment (malinvestment) driven pattern of growth, to a consumer-driven pattern of growth.

The transition will not be easy. The SOEs (state-owned-enterprises), the regional governments, and all those who got wealthy from the prior boom will not let go easily.
Nor it seems will the central government. Failure to recognize absurdly high deposit rates are proof enough.

December 29, 2014 12:39 pm

Petrobras finds itself in deep water

Joe Leahy in Brasília and Samantha Pearson in São Paulo

The Petroleo Brasileiro SA P-26 offshore oil platform off the coast of Brazil©Bloomberg
There are not many executives who have asked their boss three times whether they should be fired and survived. Maria das Graças Foster, chief executive of Petrobras, Brazil’s crisis-stricken state-owned oil company, says she’s one.
She has offered her resignation to Dilma Rousseff, Brazil’s president, on multiple occasions in recent weeks but her close friend of more than a decade has stuck by her — so far.

“The president thought I should stay,” Ms Graças Foster told reporters this week.
Petrobras, the pride of Brazil in 2007 after it announced the world’s largest offshore oil discoveries in decades, is today in danger of becoming a pariah among investors and a national shame for Brazilians.
The company has been thrown into disarray by an investigation by Brazilian police and prosecutors alleging that former senior executives, construction companies and politicians of Ms Rousseff`s Workers’ party-led ruling coalition creamed billions of dollars off Petrobras’ contracts.
This allegedly took place under the noses of Ms Rousseff, who was the company’s chairman until she took office in 2010, and Ms Graças Foster, who has led Petrobras since 2012.

Although neither are accused of direct involvement, the scandal has sparked an investigation by the US Securities and Exchange Commission and led the dual-listed company’s auditor, PwC, to refuse to sign off on its accounts until Petrobras has conducted its own inquiry. 
If Petrobras is unable to satisfy PwC’s concerns and release audited financial results by April 30, the company, one of Brazil’s biggest corporate borrowers with debt estimated by Moody’s credit rating agency at $170bn, could trigger a technical default. 
It is all part of a perfect storm facing the company after what critics say are years of misuse of Petrobras by the government as an instrument of industrial and monetary policy at the expense of minority shareholders.

“At the end of the day, all of this is happening because the PT (Workers’ party) has fostered monopolies and, to a certain extent, cartels which generate inefficiencies and an atmosphere that is conducive to corruption,” says Adriano Pires, founder of the Brazilian Centre for Infrastructure and energy adviser to the opposition PSDB party.

With revenue of more than $140bn in the 12 months to end of June this year and 86,000 employees, Petrobras produced 2.3m barrels of oil equivalent per day (b/d) domestically last year. 

The company is also undertaking the world’s largest corporate capital expenditure programme, valued at up to $221bn over five years, to exploit its “pre-salt” discoveries, so-called because they lie under 2,000m of the compound up to seven kilometres beneath the waters of Brazil’s southeast coast.

Ever since Rio de Janeiro won the bid to host the 2016 Olympics five years ago, the game’s organising committee has faced growing scrutiny. Work has only just begun on the Deodoro Olympic Park, the site of the sailing events in Guanabara Bay and still dangerously polluted, and shoot-outs in the city’s favelas are as common as ever.

But since the discovery of the pre-salt, everything has gone wrong for Petrobras, critics say. To pay Brasília for the rights to the discoveries, it held the world’s largest share offering in 2010 amid controversy over valuation. 

The government also made it the sole operator of the pre-salt fields, overburdening its balance sheet and reducing competition. It was also forced to adopt an expensive local content programme and to subsidise domestic fuel prices to help the government control inflation.

The company has routinely missed forecasts and production has declined since 2011, due to delays in equipment delivery and other problems. “Petrobras has broken many promises in the past. Production targets were consistently missed,” said Credit Suisse in a report. 

The result of this and the corruption allegations is that Petrobras has lost 73 per cent for investors in the past four years, making it the worst-performing major oil stock, according to Bloomberg.
Domestic production is expected to turn around this year with forecasts it will rise to 2.5m b/d, the first step to doubling output by 2020. But now Petrobras must deal with the twin challenges of the corruption investigation, which is cutting off its access to capital markets, and the falling oil price, which threatens the viability of pre-salt. 

To avoid violating covenants associated with its $57bn in capital market debt, Petrobras must release independently audited financial results within 120 days of the end of this year. If it fails to do this, it has another 60 days — to June 30 — to “cure” the default.

Analysts say the company, which has begun an internal investigation, does not need to wait for the criminal procedures to conclude to produce audited accounts. It could instead provision for any likely losses by taking a writedown on its capital. This has been estimated by Morgan Stanley at up to R$21bn assuming that projects were overstated in value by 5 per cent.

“This is not going to be a cash item,” said Nymia Thamara Cortes de Almeida, credit analyst at Moody’s. That is important because Petrobras, with its huge capital expenditure programme, has lost direct access to capital markets while it is waiting to release its audited results, leaving it vulnerable to a cash crunch given its huge capital expenditure programme. 
Most analysts believe the company has enough cash and other resources to last until the middle of next year but it cannot afford to delay capital expenditure as this will slow its increase in production and undermine its ability to repay its enormous debt load.

“An average delay of 12 months or more in bringing new production units online could significantly weaken Petrobras’s standalone credit quality and result in negative rating actions,” said Fitch Ratings analyst Lucas Aristizabal.

The other concern for Petrobras is the 45 per cent fall in the oil price to about $60 per barrel in recent months. Although Brazil is a net oil importer, if the price falls any lower than $50-55 a barrel, the entire pre-salt project becomes unviable, analysts say.

“The problem is when you invest with the oil price at one level and have to sell with the price at another level,” says one analyst at a foreign bank in São Paulo who, like many of his colleagues, now refuses to be quoted on the company.

These challenges are fuelling expectations that the government will need to bring fresh blood into the management at Petrobras and replace Ms Gracas Foster.
Mr Pires says market-friendly candidates would include Murilo Ferreira, chief executive of Vale, the iron ore miner, and Henrique Meirelles, a former central bank president.

“They need to bring professionals from the market to be chief executive and chief financial officer, not Petrobras insiders,” he says.

Nicaragua’s canal

Digging for truth

Chinese construction is due to start—but of what?

Dec 20th 2014

ON DECEMBER 22nd an odd couple—Nicaragua’s left-wing government and a Chinese-born telecoms magnate—say they will begin the realisation of a dream that has captivated Nicaraguans for generations: the construction of an inter-oceanic canal to rival Panama’s.

According to Manuel Coronel, an octogenarian who runs the canal authority, their intentions are now beyond dispute. “When the bride and groom set a date, you know it’s serious,” he says.

But ask Mr Coronel just where construction will begin and who will pay for it, and he has no answers. Neither does HKND, the Hong Kong-based company run by Wang Jing, which is to build the $50 billion waterway. The project has been shrouded in secrecy since Nicaragua’s National Assembly awarded a 50-year concession to HKND in 2013. No feasibility study, environmental-impact report, business case or financing plan has yet been released. Instead come platitudes from the Sandinista government of Daniel Ortega about how it will bring a jobs bonanza and end poverty.

So far, it has brought as much fear as hope. Since Chinese-speaking surveyors, backed by Nicaraguan soldiers and police, began assessing land and houses along the canal’s proposed 278km (172-mile) route a few months ago (see map), peasants fearful of their land being expropriated have taken to the streets 16 times. On December 10th several thousand, shouting “We don’t want the Chinese”, protested in Managua, the capital, despite police efforts to keep them in their villages, activists say.

Boatmen in Punta Gorda on the Caribbean coast have refused to ferry heavy machinery to be used to begin construction, fearing their livelihoods will be harmed.

In November the Nicaraguan Academy of Science convened a panel of experts to demand clarification of the impact of dredging sediment along a 105km stretch of Lake Nicaragua. They said it could damage drinking water, irrigation systems, fishing and biodiversity in one of Latin America’s greatest tropical lakes. Engineers say the proposed canal, which is aimed at enticing bigger ships than those now able to cross between the Atlantic and Pacific, could run massively over budget and provoke further widening of the Panama Canal, which would ruin its business case.

Many still doubt it will ever be built. Carlos Fernando Chamorro, editor of an anti-Ortega publication, Confidencial, says the only groundbreaking on December 22nd will be for an access road to a proposed port near Brito, on the Pacific coast, at what is expected to be one entrance to the canal.

Some experts think the port, a proposed airport nearby and a free-trade zone may be as far as the canal gets.

But the case for a canal may not rest only on tolls and jobs. China may see it as a strategic route to the Atlantic, says Evan Ellis of the United States Army War College. If so, it might be built after all.

Greece comes back to haunt eurozone as anti-Troika rebels scent power

Greece's finance minister warns ECB could “strangle the Greek economy in a split second” if it cuts off life-support for banks.

By Ambrose Evans-Pritchard, International Business Editor

7:11PM GMT 29 Dec 2014

Greece comes back to haunt eurozone as anti-Troika rebels scent power

Eurozone’s long-simmering crisis has returned with a vengeance as snap elections in Greece open the way for an anti-austerity
The eurozone’s long-simmering crisis has returned with a vengeance as snap elections in Greece open the way for an anti-austerity government and a cathartic showdown over the terms of euro membership. 
Yields on 3-year Greek debt surged 185 basis points to 11.9pc on Monday amid default fears after premier Antonis Samaras failed to win the extra votes in parliament needed to avert a general election on January 25, despite dire warnings that such an outcome risked “bankruptcy and exit from the euro.”
The upset opens the door for the hard-Left Syriza movement, which has vowed to tear up Greece’s hated ‘Memorandum’ with EU-IMF Troika creditors “on its first day in office”, and threatened to default on up to €245bn of rescue loans unless the EU grants debt relief. 
Syriza is leading by 29.9pc to 23.4pc in the latest Palmos Analysis poll, though other surveys are closer. It is likely to become the first truly radical group to take power in any EMU state since the creation of monetary union. A quirk in Greece’s electoral law gives the winning party an extra fifty seats in parliament.
Alexis Tsipras, the bloc's firebrand leader, vowed to overthrow of the austerity regime and launch new era of social salvation, claiming the government’s campaign of “blackmail and terror” had failed. “There will be an end to austerity. The future has started,” he said.

Markets were caught off-guard. Flight to safety drove yields on German 10-year Bunds to an historic low of 0.54pc, while the Athens bourse crashed 10pc before partly recovering in late trading.
German finance minister Wolfgang Schauble warned Greeks not to play with fire by pressing impossible demands. “Fresh elections won’t change Greece’s debt. Each new government must fulfil the contractual obligations of its predecessors. If Greece chooses another way, it’s going to be tough,” he said.
JP Morgan said any Syriza-led coalition is likely to soften its line once in office. It is certain to ditch many of the extreme measures unveiled at a disastrous roadshow in London last month, deemed “Communist” by one hedge fund.
Yet it will be hard to settle the core dispute over debt relief, likely to be centred on calls for “Bisque bonds” where payment is linked to GDP growth. The IMF said Greece faces “no immediate financing needs” yet the issue will turn serious once Greece runs out of Troika money in February. “We could have a problem at the beginning of March,” said finance minister Gikas Hardouvelis.
It will be even more serious in July and August when Greece must repay €6.7bn to the European Central Bank. Capital markets are effectively closed.
The Greek banking system remains on life-support, kept afloat by $40bn of ECB liquidity. Frankfurt has a duty to safeguard the money of other eurozone members and cannot lightly prop up lenders in a country that is at the same time threatening to default on EU debt.
Mr Hardouvelis warned that the ECB could “strangle the Greek economy in a split second” if it switched off funding. Holger Schmieding from Berenberg Bank said there is now a 30pc risk that Greece could stumble into a rolling crisis and a potential euro exit. “That is a big risk,” he said.
Sources close to Mr Tsipras say he is braced for a showdown with the ECB at any time and knows that loss of bank support would force Greece’s ejection from EMU in short order. Yet they say he intends to call the bluff of EU leaders, calculating that they have invested too much political capital in Greek bailouts to let the crisis spin out of control.
The party’s Marxist Aristeri Platforma is the biggest bloc in the loose coalition, with 30pc of the votes on the central committee. It says Greece must “be ready to implement its progressive programme outside the eurozone” if needed, rather than submit to threats of Armageddon.
Joschka Fischer,the former German foreign minister, said northern Europe cannot give ground to Syriza without causing EMU discipline to break down. “Any renegotiation would unleash a political avalanche in the southern EU that would sweep away austerity and reignite the eurozone crisis,” he said.
While Greece’s economy has stabilized after contracting by 25.7pc in a six-year depression, the damage has been enormous and caused pervasive cynicism over EU claims. Investment has fallen by 63.5pc. Unemployment is still 25.9pc. Troika loans have left the country with a public debt 177pc of GDP, even after two “haircuts” for private creditors.
Elena Komileva from G+Economics said the unfolding drama is a reminder that “policy deadlock” between creditors and debtors remains as bitter as ever and continues to bedevil monetary union.

While credit risk may have abated, the deeper legacy of austerity is coming back to haunt.
She warned that the return of “Grexit risk” is particularly threatening at a time when deflationary forces are causing debt ratios to ratchet higher across southern Europe, and populist parties are gaining ground everywhere.
Contagion has been limited so far. Michael Hüther, head of the German Institute for Economics (IW), said spill-over effects no longer pose the same danger now that backstop machinery is in place. “Monetary union can handle a Greek exit,” he said.
Yields on Italian and Spanish debt spiked on Monday but remain blow levels earlier this month before the latest spasm of the Greek crisis began. “Athens is no longer the tail that can wag the Spanish and Italian dogs,” said sovereign bond strategist Nicholas Spiro.
“Everything hinges on the ECB. There will be no contagion long as the markets believe that the ECB will come out with all guns blazing and launch quantitative easing on a meaningful scale, but they are deluding themselves because this is not going to happen and that is when the trouble will start,” he said.
Mr Fischer said the spat over Greece is just a foretaste of much bigger fights approaching in 2015. “The conflict over austerity is politically explosive because it is becoming a conflict between Germany and Italy, and worse, between Germany and France,” he said.

December 28, 2014 12:17 pm

Emerging states must make their own mark

Alan Beattie

A boom based on borrowing cheaply is easier than to take on vested interests, writes Alan Beattie

Matt Kenyon illustration - emerging markets©Matt Kenyon
Nothing irritates specialist investors in emerging markets more than seeing all middle-income countries lumped into a single category: a special hatred is reserved for the “Brics” label slapped across the five wildly contrasting economies of Brazil, Russia, India, China and South Africa.
Yet despite manifest differences in economic structure and quality of policy making, emerging markets have suffered together this year from fears about rising interest rates and sliding commodity prices.

Given the disparate paths and policies among middle-income economies, it is implausible that the emerging market boom dating back to the early 2000s reflected only cheap borrowing and expensive commodities. But with a supportive external environment dissipating, even stable economies may find growth harder to achieve in the future.

In January fears of the US Federal Reserve tapering off its quantitative easing programme caused a general sell-off of emerging markets currencies and assets. In the past two months falling global oil prices and turmoil in Russia have triggered another widespread correction.

A fall in commodity prices always hurts raw materials exporters. But some have compounded bad luck with seriously poor policies, overextending government spending and borrowing on the back of expected revenue. Zambia, a copper producer, and Ghana, a newly minted oil exporter, called in the International Monetary Fund after shortfalls in export earnings exposed underlying fiscal and current account deficits.
Others have compounded economic mistakes with geopolitical follies. Russia was in theory better placed than some other oil exporters to ride out a fall in crude prices and even a slide in its currency.

With substantial foreign ex­change reserves and little dollar-denominated public debt, the impact of a fall in the rouble should have been to protect the value of the government’s rouble-denominated tax revenue. In­stead, it sparked all-round panic and surging outflows of capital, requiring an emergency rise in interest rates.

Though comparisons between the current emerging market volatility and the Asian and Russian financial crises of 1997-98 can be overdone, one parallel is the similarity of capital flight from Indonesia in 1997 and Russia this year, which turned a currency slide into a rout.

In 1997 Indonesia’s Chinese business community, fearing economic chaos and ethnic violence, reacted to market volatility by taking their money and themselves out of the country, causing the rupiah to go into freefall. Similarly, wealthy Russians have been sending their money abroad in the past few months, driving the rouble far lower than is justified by the falling price of oil.

As the costs of Vladimir Putin’s Ukraine misadventure become more obvious, Russia’s future seems dimmer — and the risk of erratic and possibly confiscatory behaviour on the part of the government increases. The Russian economic crisis underlines the uncertainty intrinsic to a one-man, one-commodity country where the former is almost as unpredictable as the latter.
While the pain inflicted on commodity exporters is to be expected, the lower oil price has also accompanied depreciation in net importers such as Turkey and India. In Turkey and other countries with big current account short­falls, the benefit from cheaper oil is likely to be outweighed by tightening credit conditions and a general aversion to risk. Deficits may be smaller, but it will be harder to borrow to cover them.

The growth in Turkey’s economy over the past decade has been real and substantial, but the country has become far too reliant on cheap borrowing. Last year it ran a current account deficit of about 8 per cent, and despite a lower oil import bill is likely to record a gap of almost 6 per cent this year.

With the government publicly bullying the central bank into keeping monetary policy loose, short-term interest rates have been kept too low, inflation has risen out of control and long-term borrowing costs are high. The Turkish lira has lost more than a quarter of its value against the dollar since the start of 2013.

More surprising is that better-performing countries such as India have also been caught up in the general malaise. India has done much more than Turkey to shrink its current ac­count deficit and the Reserve Bank of India, under its governor Rag­hu­ram Rajan, moved quickly to head off inflationary pressure. Nonetheless, though faring better than the Turkish lira, the rupee is also sharply lower than last year.
Quite simply, investors are discrimin­ating less between countries than their diverging economic fundamentals would suggest. The jittery state of financial markets worldwide means emerging markets still suffer collectively from a flight to safety at moments of stress.

There is not much policy makers can do about this but focus on the fundamentals of their economies and wait for calm to return. Unfortunately, far too few have been doing that over the past decade.

With one or two exceptions, productivity-enhancing structural reform has been notably absent from emerging markets. It turns out to be far easier and more rewarding to ride a boom based on cheap external borrowing and commodity export revenue than to take on vested interests to increase long-run growth.

Infuriating though it may be to many involved, investors’ discrimination bet­ween emerging markets is still a work in progress. That makes it ever more important, now that the supporting pillars of the commodity boom and cheap lending are being kicked away, that countries build their own reputations rather than relying on the brand of the emerging market bloc. The days of easy living for emerging markets are ending and hard work lies ahead.

Financial speculation

The baseball-card bubble

How a children’s hobby turned into a classic financial mania

Dec 20th 2014

FOR evidence that the inclination to barter and truck is in our genes, one need venture no farther than the nearest schoolyard. Lurking within school walls is a thriving economy, which begins with swaps of one lunch item for another and progresses to the flogging of assorted sweets picked up on a weekend run down the candy aisle. Yet the informal economic education goes beyond the mechanics of supply and demand. Often enough it runs to finance: it is on the playground that many children get their first real taste of the temptation of speculation.

Every now and then a particular craze sweeps across the swingsets. The allowance money chasing the suddenly hot trinkets grows. If the frenzy builds for long enough it can attract much bigger fish: adults, yes, but also Wall Street itself. There is no better illustration of how the seductive power of the fast buck stretches from the schoolyard to high finance than the madness that swept the world of baseball cards in the 1980s and 1990s.

Your correspondent fell under the spell of the mania, shelling out what meagre allowance money was available for prized “rookie cards” (those issued for a player’s first professional season), encasing the treasure in hard plastic and then mentally spending the riches that were certain to result. While comparing collections the young punters would swap apocryphal tales of forgotten hoards found in attics or cellars that fetched unimaginable sums at auction—or similarly valuable collections thrown away by oblivious parents during an overzealous round of spring cleaning. We all made it clear to mothers and fathers that under no circumstances were our boxes full of treasure to be tossed away.

And we would wait anxiously for the arrival of the bible of our trade: Beckett Baseball Card Monthly. We paid little mind to the articles clogging up the front of the magazine and turned straight to the pages upon pages of price listings, ready to mark our collections to market and watch our paper profits grow. Collecting baseball cards was better than playing the stockmarket. The cards were real, physical, beautiful items you could flip through and admire. And card values only went up.

A baseball card is a rectangular piece of cardboard paper, about the size of a small smartphone, with the picture of a baseball player on one side and his biographical details and statistics on the other. Its origins lie in the mid-19th century, writes Dave Jamieson in “Mint Condition”, his history of the phenomenon. Early ball clubs created “trade cards” of some of their players, a popular advertising strategy at the time. Tobacco companies soon hit on the idea of putting cards inside their cigarette packages: each part of a numbered series, intended to bring the buyer back until he had collected the whole set. The pictures proved most popular with children, however, who would besiege smokers on the street asking for the picture that came in the pack.

In the 1920s the baseball card began appearing in more child-friendly form when the market for chewing gum began to expand. Gum producers snagged children’s pennies during the Depression years thanks to the lure of the collectables, and the market rebounded strongly after wartime when the Topps Chewing Gum Company released, in 1952, the first set of recognisably modern baseball cards—big and glossy—to be sold in its packages. The card industry grew alongside the popularity of baseball, then America’s undisputed national pastime.

Through the 1970s cards appealed mostly to kids interested in finding pictures of their heroes, or in completing a collection. Yet a subtle change was under way. Older aficionados, many of whom had been building their collections for decades, began swapping cards and hunting for especially rare and valuable specimens. One such cardhound, a professor of statistics named James Beckett, began polling traders on the prices they had seen or paid for particular cards.

In 1979 he put together the first edition of what would become a regular price guide. In late 1984 the Beckett guide went monthly, the better to capitalise on soaring interest. Not long after that your correspondent took up collecting cards, just as that interest was turning into a speculative fervour.

Mr Beckett may not deserve sole credit for the baseball-card bonanza, but it is hard to imagine the mania having erupted without him. In the 1970s only aficionados knew that unique cards were fetching higher prices at trade shows and auctions. Beckett Baseball Card Monthly helped create a much larger market for the cards. Readers everywhere could see how prices were moving around the country, and decide to sell old memorabilia—or fill their attics with cards in anticipation of future price rises.

Economists have wrestled with the question of whether markets are “efficient” or not for more than half a century. Eugene Fama was awarded a Nobel prize in 2013 for pioneering work demonstrating that markets quickly incorporate new information and cannot systematically be beaten. Yet others reckon markets often go haywire. Robert Shiller, for instance, showed that market returns could in fact be predicted at longer time horizons. He also reckoned people are prone to certain behavioural tics, misjudgments that depart from rationality and which can drive markets to heights of “irrational exuberance”. He was also awarded the Nobel prize, jointly with Mr Fama. Other economists have investigated ways in which markets can overshoot in one direction or another. “There are idiots,” Larry Summers once wrote in a paper on the subject. “Look around.”

Yet Mr Shiller, who warned of both the stockmarket bubble of the late 1990s and the housing bubble of the 2000s, has pointed out that it is often not just the fools piling into speculative frenzies but the experts themselves. The bankers putting together dodgy mortgage-backed securities at the height of the housing bubble were not simply corrupt or stupid: they believed that they had discovered new ways of capturing high returns at low risk—which is why they retained so much dangerous stuff on their balance-sheets. Neither did big institutional investors pile out of equities before the crash of 2000-01. The potency of a bubble is in its plausibility, to laypeople and experts alike, right up until the moment the game is over.

Bubble-spotters tend to identify a few key contributors to financial mania. There is often an initial spark of enthusiasm rooted in real value: the promise of new technology in some cases, the recognition of the worth of a scarce commodity in others. Then there is the entry of many new market participants, to add fuel to the flame. A deepening market naturally places upward pressure on supply-limited goods. But new participants also add liquidity to the market, and thus the confidence that you will be able to find a willing buyer when you wish to sell and a willing seller when you wish to buy. For local dealers, buying cards at trade shows or from the factory became less risky as the stream of eager youngsters through the shop doors grew.

Perhaps most important, speculative fervour thrives on expectations of rapidly rising prices—rising rapidly enough that buyers find it rational to make bets they could not normally afford.

By the late 1980s these ingredients were firmly in place in the market for baseball cards. The initial spark seemed to be a wave of sales of rare, vintage cards at eyebrow-raising prices. Early in the decade the 1952 rookie card of one of baseball’s all-time greats, New York Yankees star Mickey Mantle, sold for $3,000: a remarkable sum for a small piece of cardboard. There were more headlines for the repeated sales of the most valuable of all baseball cards: the 1909 Honus Wagner. The vintage tobacco card was made particularly scarce by its limited production run (due, according to rumour, to Wagner’s objection to the use of his image to sell cigarettes). Only three of the cards that survive are in decent condition. One changed hands for a shocking $25,000 in 1985. It subsequently fetched $110,000 in a 1987 sale, then $451,000 in a 1991 auction (won by the ice-hockey star Wayne Gretzky).

Such prices were the result of very limited supply meeting new demand, in the form of nostalgia-driven consumption. The baby-boom generation that had grown up in a golden age of baseball entered its prime earning years in the 1980s. Some of its members used their new-found purchasing power to recapture the stuff of their childhood memories. Their demand pushed up prices, and higher prices attracted attention.
Author and speculator

Your correspondent came to the hobby around the time the Wagner card was selling for six figures.

You could still walk into a drugstore and find packages of cards sitting by the cash register, complete with a piece of gum which had by then become an afterthought, thrown away more often than not.

Kids discovering the hobby would nag a parent or spend their allowance money on a package or two and add the cards to their hoard, often as not stored in a shoebox. The most prized cards would go in the bookbag, to be paraded before peers on the playground, or swapped to fill gaps in the collection.

The exuberance building within the community of hobbyists quickly made its way to the core market.

One schoolmate or another inevitably brought in a binder, with cards neatly ordered inside and sheathed in protective plastic. From there it was a relatively short journey to purchases of box sets: complete collections produced by card companies containing all the cards produced each year. They would sit untouched, often enough, gathering dust but remaining pristine on a closet shelf, the better to fetch a good price years down the road. I can recall the anxiety I experienced before shelling out for one of the hot new properties of the era: the Ken Griffey Jr rookie card.

Mr Griffey, who made his debut in 1989, was a near-instant superstar: a number one draft pick by the Seattle Mariners who walloped a double in his first plate appearance. He went on to enjoy a stellar career, retiring at sixth on the league table for career home runs. Yet back then he was more than a hero-in-waiting; he was a hot stock—a must-have for any baseball-card portfolio. I bought the card, sealed within a lucite case, from a dealer located in a strip mall not far from my house. And there it sat, untouched, rising in value.

In 1979, when Mr Beckett published his first official price guide, the 1963 rookie card for Pete Rose (the all-time Major League Baseball hits leader) was valued at $5, while the 1973 rookie card for Mike Schmidt, a Hall of Fame third baseman, went for 12 cents. Just five years later, when Mr Beckett’s guide went monthly, those values had risen to $350 and $65 respectively. In 1994, at the top of the market, the cards purportedly fetched $1,100 and $425. Among high-value cards the rise in prices in the decade to 1994 was on a par with equity-price increases in the ten years to 2000 and home-price gains in the decade to 2006.

Cards went for outrageous sums; and, as always happens in bubbles, people who had shared only a passing interest in the hobby found themselves buying with aplomb, for fear of looking like suckers later for having missed the obvious route to wealth. For a few strange years, children—like your correspondent and his similarly crazed brothers—piled up boxes full of cardboard, confident that their contents would only grow in value, never quite asking themselves who would buy their hoards, but never doubting that someone would.

As the boom neared its apex interest in the phenomenon spread well beyond the world of collectables, eventually garnering the interest of those more accustomed to trading stocks and bonds. Even the Wall Street Journal touted cards as an investment worth investigating, as Mr Jamieson notes in his book. “[T]he key player isn’t really Rose or [Dwight] Gooden or even Honus Wagner, but rather Paul Volcker, the rangy Federal Reserve Board Chairman. His nifty squeeze play against high inflation has made card-collecting a whole new ballgame.” In an amusing reversal of the old legend of Joseph Kennedy, the financier and political patriarch who famously sold out of the market just before the crash of 1929 after receiving a trading tip from a bell boy, the youngsters might have known something was amiss in their little hobbying world when Wall Street got involved.

How the madness took hold
In a 2013 paper Edward Glaeser, an economist at Harvard University, examined America’s long history of property booms and busts. In each case, there is an underlying logic to the speculative mania that inflates a boom. Yet across the episodes there is a clear pattern. The busts are typically triggered by some decisive change in sentiment or credit conditions. And the biggest failure of investor rationality through boom and bust is the tendency to underestimate the extent to which supply eventually responds to demand.

The baseball-card world responded in dramatic fashion to the insatiable desire for the hot items. The older, more valuable cards had never been produced in particularly massive runs, and many were lost to carelessness or the rubbish bin in the intervening decades, when there was little reason to suspect the little cardboard headshots would ever be worth a thing. Once the world began to cotton on to the possibilities in baseball cards, however, the supply dynamic changed. Less sentimental adults ransacked basements and attics for long-lost supplies, adding marginally to the number of relative rarities in circulation. But such efforts were dwarfed by the mobilisation of the card industry itself, which kicked production into high gear, producing hundreds of millions of new cards each year. New entrants appeared, like Upper Deck, which debuted a slick, upmarket set of baseball cards in 1989 to attract those buying as an investment.

In 1991, reckons Mr Jamieson, Upper Deck sold around 4 billion cards, earning $250 million in the process.

The boom continued as long as it did only because of the relatively limited interest in cashing in; cards, many collectors understood, were something one held for a time, and so many of the boxes full of newly produced sets headed directly for storage. Yet interest in collecting could only maintain momentum while published values were rising. The values published in Mr Beckett’s monthly could only wander so far from the reality in card shops and trade shows around the country. And in 1994 conditions in those markets turned decisively for the worse.

The Federal Reserve was perhaps to blame. In 1994, then under the control of Mr Volcker’s successor, Alan Greenspan, it began a series of interest-rate increases that squeezed an economy that had not fully recovered from the previous recession. But the effect of monetary tightening was overshadowed by a crisis in the sport of baseball itself. Several years of caustic negotiations between team owners and the players’ union culminated in a work stoppage in 1994 and the cancellation of the World Series for the first time since 1904. The strike cost Major League Baseball dearly—attendance and revenues fell sharply when play finally resumed—and spelled doom for the card traders and dealers whose success depended on unbroken good fortune.

Card prices fell dramatically in subsequent years and in relation to their scarcity. Cards produced during the boom years of the 1980s and 1990s frequently lost half their value or more. Few have come anywhere close to regaining their bubble highs, even after adjusting for inflation. Older cards proved more resilient. The 1963 Pete Rose had dropped in value from $1,100 in 1994 to a reported $800 ten years later, but has since rebounded to an even $1,000, according to current Beckett valuations. The true gems sailed through the crash without a scratch. The Honus Wagner card that went for just under half a million dollars in 1991 sold for $1.3m in 2000 and $2.8m in 2007.

The great boom permanently transformed the collectables industry and led, as bubbles often do, to innovation. Seeking to entice new generations of buyers, card manufacturers have experimented with new formats, including cards with pieces of game jerseys and scraps of used bat embedded: gimmicks, true, but tempting ones to those with a desire to commune with actual heroes of the diamond.

Meanwhile, a generation is still holding on to boxes upon boxes of baseball cards: children’s toys, essentially, that somehow became transmuted into something quite different. Mr Jamieson recalls his own experience attempting to unload his hoard in 2006, boggling at the rock-bottom prices they commanded on eBay, an auction site. “One guy wanted $1,500 for his ten thousand cards. He didn’t understand: we all still had our ten thousand cards.”

And so we do. Yet it is such a strange thing to have lived through and forgotten. Just a few years after the bitter collapse of the baseball-card boom, many of the same kids were intoxicated again, swapping tech stocks across fancy new online trading platforms from dorm rooms and group houses.

And then, older but no wiser, they were at it once more, borrowing recklessly for a first home and a ticket to future wealth. Three strikes, as it were.

Is Putin Winning The Oil War?

by: Shareholders Unite            

  • Admiration for Putin's decisiveness has largely subsided in the West, but not totally. There are still people arguing Russia will come out the other end reinforced.
  • While low oil prices will also produce problems in the US shale sector, it's strange to close one's eyes to the problems these cause in Russia's energy sector.
  • The fall in the ruble could, long-time provide a boost to non-energy production and exports from Russia, but not without serious reforms.
  • And Russia first has to survive a rather acute crisis.
  • Only if oil recovers and Russia embarks on reforms would it be a good place to invest.
Putin was, until recently, regarded by some as an excellent chess player, running rings around the West. That view was rather at odds with the reality even at the time, and one would argue that Russia is in a spot of bother:
  • Oil prices have nearly halved in less than a year
  • The ruble has nearly halved in a year
  • The economy is stagnating
  • Capital is fleeing the country
  • Foreign direct investment is drying up
  • Interest rates have been hiked to 17%
  • Inflation is high and rising above 10%
  • Russian companies have $700B+ in foreign debt
  • These companies have little, if any access to foreign capital, as a result of the sanctions
  • The Russian budget breaks even at $100 oil and half of the budget comes from energy
While it's one thing to assume that Putin will roll-over and withdraw from the Ukraine (or, even more improbable, Crimea), it's another thing altogether to assume that he's actually winning the battle with the West. Yet there are people who actually argue just that:
Not really says Marin Katusa, author of "The Colder War," and chief energy investment strategist at Casey Research. Katusa believes that falling oil prices will eventually give Russia the upper hand and deeply injure the U.S. energy industry. The falling ruble makes Russian oil less expensive and more desirable to other countries-Russia also produces oil quite cheaply while the American shale industry has a larger cost of operation. Russia is more than able to weather the current storm, Katusa says. "They have a $200 billion a year trade surplus. They have over $400 billion in reserve currency. They've increased their gold reserve. They have much lower debt to their GDP than America. So yes there's pain in the economy… [but] it's far from terminal."
This is an odd comment. Yes, the low oil prices might very well dent, or even damage US shale prospects. Opinions are really divided on how much though. For instance, Citygroup argues:
"Production is going to continue to grow. Could we see another million barrels a day of growth next year over this year? We happen to think so," said Edward Morse, global head of commodities research at Citigroup. Morse expects an average Brent crude price of $80 per barrel next year, but if it's lower, he says U.S. oil production could still add 800,000 barrels per day.
But a more pessimistic assessment comes from Bank of America:
The bank said in its year-end report that at least 15% of US shale producers are losing money at current prices, and more than half will be under water if US crude falls below $55 (€44.4, £35.1). The high-cost producers in the Permian basin will be the first to "feel the pain" and they would have to cut back on production soon.
Many players are hedged against falling oil, providing something of a cushion. On the other hand, much of the expansion is based on leveraged finance and with cash flows rapidly decreasing, quite a few players might go under. In the greater scheme of things that won't matter all that much, as their licenses and assets will quickly move to more capitalized companies.

There are odder parts in the comment from Marin Katusa. Oil is priced in dollars, nobody from abroad is buying in rubles, so for export purposes, Russian oil isn't cheaper. The $200B trade surplus is also rapidly disappearing and is testifying to that.
According to US Energy Information Administration (NYSEMKT:EIA) figures, oil and gas shipments accounted for 68pc of Russia's total $527bn of gross exports in 2013, when Brent crude - comparable to Russian Urals - traded at an average of $108 per barrel. Should the current price of Brent, at around $60 per barrel, be sustained over the next 12 months, that would result in Russia's export income from crude dropping to $95bn, from $174bn in 2013. However, these losses will be amplified by the total loss of revenue accrued from lower prices for refined petroleum products and domestic sales of crude, which totalled $122bn in 2013, according to the EIA. [Andrew Critchlaw]
Yes, we realize that over time, China might buy more oil and gas from Russia and payments might be partly settled with currency swaps enabling Russia to pay its imports from China bypassing hard currencies altogether. But this is a slow movement, and Russia and China aren't exactly buddies.
The Kremlin is counting on acquiescence from the BRICS quintet as it confronts the West, and counting on capital from China to offset the loss of Western money. This is a pipedream. China's Xi Jinping drove a brutal bargain in May on a future Gazprom pipeline, securing a price near $350 per 1,000 cubic metres that is barely above Russia's production costs. [The Telegraph]
But to suggest that the fall in oil will in time be a blessing in disguise is, well:
Every $10 fall in the price of oil cuts export revenues by 2pc of GDP. The "financing gap" will soon be 10pc of GDP.
Let's see how they get out at the other end of this first. We're also not convinced (to put it mildly) that Russia's energy sector is thriving without Western capital and technology. According to the International Energy Agency, it needs $100B investment a year for two decades to stop its oil and gas output from declining.
Russia's reserves of cheap crude in West Siberian fields are declining, yet the Western know-how and vast investment needed to crack new regions have been blocked. Exxon Mobil has been ordered to suspend a joint venture in the Arctic. Fracking in the Bazhenov Basin is not viable without the latest 3D seismic imaging and computer technology from the US. China cannot plug the gap. Andrey Kuzyaev, head of Lukoil Overseas, said it costs $3.5m to drill a 1.5 km horizontal well-bore in the US, and $15m or even $20m to drill the same length in Russia. "We're lagging by 10 years. Our traditional reserves are being exhausted. This is the reality for our country," he said. Lukoil warns that Russia could ultimately lose a quarter of its oil output if the sanctions drag for another two or three years. [The Telegraph]
Then there are serious problems in the banking system:
the combination of economic contraction, a liquidity crunch and the falling exchange rate is likely to lead to the failure of a number of banks. Russia has more than 800 banks, many them with low capitalisation, weak finances and weak corporate oversight. As of December, the RCB had withdrawn licenses from more than 80 banks in 2014 alone. While the sector is in need of consolidation, however, the disorderly failure of a large number of banks could cause significant economic disruption, deepening the recession and further undermining public confidence in the financial sector. [The Economist]
What would be the way forward for Russia? Well, they should embark on something they've promised for years, reform their economy:
Russia ranks 136 for road quality, 133 for property rights, 126 for the ability of firms to absorb technology, 124 for availability of the latest technology, 120 for the burden of government regulation, 119 for judicial independence, 113 for the quality of management schools, 107 for prevalence of HIV, 105 for product sophistication, 101 for life expectancy and 56 for quality of maths and science education. This is the profile of decline. [The Telegraph]
And they should diversify their economy away from energy and commodities, which are cyclical, highly capital intensive sectors that lock the economy in a boom-bust cycle generating little employment. Now they have to make that transition largely without the help of the West. It could have been so much easier after the end of the Cold War.

We have already argued that Russian stocks, no matter how cheap, are a dubious bet at the minimum. We haven't seen much to change our minds. Only an oil recovery would do the trick.

But bigger tasks remain, getting Russia of the energy and commodity trap would be one.

But there is a simple gauge to assess which way Russia will turn, the oil price. Should the price of oil recover the next year, then things might turn out less dire. Some (but only some) comfort can be taken from the fact that Saudi Arabia itself seems to predict $80 next year.

December 28, 2014 3:49 pm

Clever wrapping disguises Europe’s worn-out policies

Wolfgang Münchau

A delayed but well-aimed monetary stimulus blast is better than a premature sputter from cannons

 Maybe it is the seasonal spirit. I feel like someone who got almost everything I ever wished for.

When the eurozone crisis erupted, I asked for an emergency backstop from the European Central Bank. Then I demanded a banking union, and then a large investment programme.

Each time, Europe’s policy makers said yes. I wanted quantitative easing, the purchase of sovereign bonds by the ECB, which has not happened yet but probably will next month. The eurobond was the only thing I did not get.
The score is four of five. So why am I still not happy? The answer is that I feel robbed. It was only an illusion. I did not get a single thing.

The banking “union” will be one in which each country is responsible for its own banking system. The most important structural innovations are joint banking supervision and a tiny fund to cover losses when a banker runs away with the till. When I asked for a co-ordinated approach to dealing with failed banks, this is not what I meant.

It looks as though the same is going to happen with QE. I am sure the financial markets will celebrate the decision. The euro will fall — until somebody reads the small print. The compromise under discussion allows creditor countries to wash their hands of any risk. The idea is that each national central bank buys the sovereign bonds of its own country — and if this results in losses, the national government in question makes the central bank whole. Think about that for a second. Italy’s government borrows money, the Bank of Italy buys the debt and the government promises to compensate the bank if its bonds fall in value (for instance because markets stop believing the government’s promises). The circularity is preposterous.
If the ECB goes down this route, it will be the end of a single monetary policy. Yet the eurozone is supposed to be a monetary union, not a fixed exchange-rate system where everybody happens to use the same notes and coins.

The mooted compromise would also limit the size of any QE programme. There is only so much risk that the cash-strapped governments of the eurozone’s periphery can absorb. They are unlikely to be able to do enough to anchor inflation expectations at the ECB’s target of just under 2 per cent.
I understand that this compromise is still being discussed. No decision has been taken, and not everybody agrees. It is not clear to me why central bankers in favour of QE would accept it.

They might, I suppose, reason that an inadequate QE programme is better than none at all. If so, they are wrong. The habit of accepting half-baked solutions is the reason why the eurozone is in its present mess. Governments accepted permanent austerity in return for emergency cash in the crisis years, but that policy only ended up enlarging the burden of government debt. A flawed QE programme would likewise be, not a small step towards a solution, but a big step away from one.
It is important to be clear about the reasons why QE is needed. There are two possible rationales.

One would be to monetise debt — turning it into a bond that pays zero interest and is destined never to be repaid. This would work, and it would bring economic benefits. It would also be totally illegal, under both the Maastricht treaty and German domestic law.

The other reason for conducting QE — and the only one that is legally acceptable — is to help the ECB achieve its price stability target.

One can have a long discussion about what that means. But a QE programme would have to be open-ended if it were to have any chance of producing this effect. You can either say: “Whatever it takes.”

Or you can say: “No more than such and such billion euros.” But you cannot say both at the same time, and expect people to believe you.

If an incoherent compromise is the only option available, it should be rejected. The eurozone cannot afford another botched policy measure with dubious benefits and considerable side-effects.

If they decide to do nothing, central bankers will at least keep this barrel of powder dry. A delayed but well-aimed blast of monetary stimulus is far better than a premature sputter from the ECB’s cannons. I fear, however, that accommodating Germany will be the overriding priority.

The resulting policy might be wrapped up in language that makes it look like what I asked for.

But the resemblance is superficial. That is the trouble with trying to please everyone. It forces you to take decisions that are pragmatic and realistic — even if they are wrong.

Complete Third-Quarter Gold All-In Costs Show That Gold Investors Should Be Very Comfortable With Their Investment

  • Our analysis of gold costs includes more than 25% of total world gold production and thus we're confident it can be extrapolated very accurately.
  • Gold miners on a core cost basis are producing gold at a higher cost than the previous two quarters due to an increase in taxes.
  • Gold miners on a core non-tax cost basis saw their costs drop sequentially, but are relatively flat on the year.
  • Despite heavy cost cutting, most gold is produced at prices higher than the current gold price, and that is bullish for the gold price.
Over the last quarter, we have analyzed and posted the costs of almost all the publicly traded gold miners, which includes over 6 million ounces of mined production for the third quarter of 2014. This represents 25% of total estimated world production - which is a very large portion of the total worldwide production of gold, and we believe our numbers represent a large enough portion of mined production to extrapolate as a general figure across the industry.

We're looking to add companies to the list that we cover and use them in our total FY2014 analysis, so if you are interested in receiving it and keeping up-to-date, consider following me (clicking the "Follow" button next to my name).

Why These Costs Are Important

For gold ETF investors (SPDR Gold Trust ETF (NYSEARCA:GLD), ETFS Physical Swiss Gold Trust ETF (NYSEARCA:SGOL), Central Fund of Canada (NYSEMKT:CEF), and Sprott Physical Gold Trust (NYSEARCA:PHYS)), this metric is very important because it allows an inside understanding of the true costs associated with producing each new ounce of gold. This is arguably the most important metric in analyzing any commodity because it shows the price where production of that commodity becomes uneconomic. If it costs more to mine a commodity than the market is willing to pay for it, eventually producers will stop producing the commodity and close up shop.

These are the type of environments that savvy commodity investors dream of because it allows them to purchase assets that cost more to produce than to buy, which is an environment that cannot last for very long because eventually supply will be cut, cause scarcity, and then the price will increase.

There are some people that erroneously believe that newly mined gold supply is irrelevant to the gold price. Unfortunately, this causes investors to completely ignore the fundamentals of global gold mine supply and leaves a large hole in their understanding of the gold market. This article isn't the place to go into why they are wrong, but I've addressed this issue thoroughly in a previous article with quotes.
But to make a long story short, the two main reasons why newly mined gold supply is very important to the gold price are the following:
  1. Newly mined gold supply makes up a large portion of annual gold supply (it provides two-thirds of annual physical demand, according to the World Gold Council's numbers).
  2. It is held in the weakest hands (the gold miners) who sell that gold at the prevailing market price.
Again, please refer to that article for a more detailed description of these reasons.

Explanation of Our Metrics

For a detailed explanation of the metrics and each metric's strengths and weaknesses please check out our previous full quarterly all-in costs gold report where we discuss them in detail. The last two metrics (core costs and core non-tax costs) are the most important ones in our opinion, but we provide all four for investors to use.

All Costs per Gold-Equivalent Ounce - These are the total costs incurred for every payable gold-equivalent ounce, which includes everything. This is the broadest measure of costs, and since it includes write-downs, it is essentially the "accounting cost" of producing gold-equivalent ounces.

Costs Per Gold-Equivalent Ounce Excluding Write-downs and S&R - This is the cost to produce each gold-equivalent ounce when subtracting write-downs and smelting and refining costs, but including everything else.

Costs Per Gold-Equivalent Ounce Excluding Write-downs (Our "Core Costs" Metric) - This is similar to the above-mentioned "Costs per Gold-Equivalent Ounce Excluding Write-downs and S&R" but includes smelting and refining costs. That makes this measure one of the best ways to estimate the true costs to produce each ounce of gold, since it has everything (including taxes) except for write-downs.

Costs per Gold-Equivalent Ounce Excluding Write-downs & Taxes (Our "Core Non-Tax Costs" Metric) - This measure includes all costs related to gold-equivalent production, excluding all write-downs and taxes. Essentially, this is the bottom dollar costs of production with an artificial 0% tax rate (obviously unsustainable) which works well because it removes any estimates of taxation due to write-downs or seasonal fluctuations in tax rates, which can be significant. The negative to this particular measure is that since it does not include taxes, it will underestimate the true costs of production.

What are the Industry's Gold Costs?

We have compiled all the numbers for gold companies that we analyzed for 2014 and provided them in the table below. Investors should remember that these costs are displayed and sorted by core non-tax costs, as in costs BEFORE taxes and thus are lower than the real costs of production. To see the real costs of production investors can click on the detail of any of the companies listed below.

CompanyCore Non-tax CostsCore Costs
Randgold (NASDAQ:GOLD)Under $1000 per gold-equivalent ounceAround $1000 per gold-equivalent ounce
Eldorado Gold (NYSE:EGO)Under $1000 per gold-equivalent ounceOver $1100 per gold-equivalent ounce
Barrick Gold (NYSE:ABX)Around $1100 per gold-equivalent ounceUnder $1300 per gold-equivalent ounce
Yamana Gold (NYSE:AUY)Around $1100 per gold-equivalent ounceOver $2000 per gold-equivalent ounce*
Gold Fields (NYSE:GFI)Over $1100 per gold-equivalent ounceAround $1200 per gold-equivalent ounce
Richmont (NYSEMKT:RIC)Under $1200 per gold-equivalent ounceUnder $1200 per gold-equivalent ounce
Timmins Gold (NYSEMKT:TGD)Over $1200 per gold-equivalent ounceUnder $1200 per gold-equivalent ounce
Goldcorp (NYSE:GG)Under $1200 per gold-equivalent ounceUnder $1300 per gold-equivalent ounce
Newmont Mining (NYSE:NEM)Over $1200 per gold-equivalent ounceUnder $1200 per gold-equivalent ounce
SilverCrest Mines (NYSEMKT:SVLC)Over $1200 per gold-equivalent ounceOver $1200 per gold-equivalent ounce
Agnico-Eagle (NYSE:AEM)Over $1200 per gold-equivalent ounceUnder $1300 per gold-equivalent ounce
Kinross Gold (NYSE:KGC)Over $1200 per gold-equivalent ounceOver $1300 per gold-equivalent ounce
Iamgold (NYSE:IAG)Under $1400 per gold-equivalent ounceOver $1600 per gold-equivalent ounce
Alamos Gold (NYSE:AGI)Over $1400 per gold-equivalent ounceOver $1400 per gold-equivalent ounce
Allied Nevada (NYSEMKT:ANV)Over $1500 per gold-equivalent ounceOver $1500 per gold-equivalent ounce

Important Note: For our gold equivalent calculations, we have adjusted the numbers to reflect the second-quarter average LBMA price for all the metals and converted them into gold at these rates which results in a silver-to-gold ratio of approximately 65:1, copper-to-gold ratio of 404:1, lead-to-gold ratio of 1295:1, and a zinc-to-gold ratio of 1221:1.

Investors should remember that our conversions change with metal prices and this will influence the total equivalent ounces produced for past quarters - which will make current-to-past quarter comparisons much more relevant. This will also lead to minor differences in our previously published true all-in gold costs for the industry since each period has different conversion rates into gold - it will not make a big difference but there will be a difference.

(click to enlarge)

Important Note on Gold Table Above: The difference between "Top-line Gold Ounces" and "Attributed Gold Ounces" is that top-line ounces include ounces produced by miners that are not a portion of their true distribution of production. Attributable ounces are the true ounces that represent a miner's share of production.

To calculate costs, we remove all costs associated to top-line ounces and the top-line ounces themselves to make sure we have accurate cost figures.

Observations for Gold Investors

The first thing gold investors should notice is that in the third quarter we saw a rise in attributable gold production from 5.89 million ounces to 6.11 million ounces, which is around a 5% gain sequentially - with almost 200,000 ounces of this gain attributed to Barrick's additional production.

On a year-over-year basis, though, we saw attributable ounces drop slightly from the 6.20 million ounces we saw in Q3FY13. In general, it seems like gold production will end the year essentially flat - assuming we don't have an extremely good or bad fourth quarter.

Total gold-equivalent production rose by a slightly larger percentage, but we're not particularly surprised as during the quarter most base metals appreciated in terms of their conversion ratios with gold, which would lead to higher gold-equivalent production - though we did see an increase in base metal production by a few gold miners.

Cost Structure of the Miners

But we think the more important statistics here for investors are related to the cost structure of the companies because ultimately production will follow the margin of the miners. As margins rise, gold production will tend to increase, while if margins are falling (or negative), then production will eventually fall - pretty straight forward long-term economic law here.

In terms of core costs (costs including taxes), during the quarter we saw core costs rise on both a sequential and year-over-year basis to $1324 per gold-equivalent ounce. That was the highest for the year and significantly higher than previous quarters despite the increased production (which should have averaged down the cost per ounce).

When we take a look at core non-tax costs (costs excluding write-downs and taxes) we see that costs actually fell on a sequential basis to $1160 per gold-equivalent ounce. That's pretty much the mid-point of what we saw in previous quarters and it tells us that taxes were a significant contributor to the rise in core costs.

Conclusion for Investors

Let's now focus on the actual numbers and what they mean. The fact that core costs were $1324 per gold-equivalent ounce really means that miners, on average, are still well above the gold price when we include all their costs. Of course, this number is a quarterly number and can fluctuate quite a bit from quarter-to-quarter, but even if we look at the first quarter ($1222) and second quarter ($1225) numbers we see that the costs to produce gold are above the current spot price when all costs are taken into account.

When it comes to core non-tax costs, which may be a better indicator into the general trend of mining costs as it leaves out taxes and write-downs, we see that costs for the quarter ($1160 per gold-equivalent ounce) were down slightly from the previous quarter but up from the first quarter. While they aren't above the current spot price, these are costs before taxes and there is very little margin for miners to make any meaningful profits - a 2-3% margin on such a risky endeavor like mining a deposit will severely discourage future investment.

Additionally, these core non-tax costs completely ignore taxation, which in the natural resource business often includes royalties and revenue-based taxes. Thus, a portion of taxes will hit the miners regardless of their profits - thus this 2-3% on sub-$1200 gold quickly disappears.

The fact that core and core non-tax costs are not sustainable at the current gold price, may not have much of an effect on production this quarter - but it certainly will in future quarters and years. Investors need to remember that the seeds of gold production five and ten years from now are being sown today.

Miners still haven't cut costs enough to make a decent profit on a core costs basis, and this suggests that there is a structural problem with producing gold at the current gold price. This supports our belief (and the belief of many in the industry) that we've reached peak gold and soon we'll see production start dropping significantly as operations are closed and wind down.

For mining investors that means that you have to be very careful which miners to invest in if we don't see a higher gold price. But for investors that own the gold ETFs and physical gold, this is a very promising trend as the miners' pain is the gold investors' gain - more struggling miners means less future production.

The fact that miners still cannot get costs lower suggests to us that the gold price really isn't sustainable below $1200 per ounce on any intermediate to long period of time. So while some prognosticators calling for $1000 gold (Goldman we're looking at you) may be right on the short term, there really is no way in our minds how we can see that gold price for very long - most gold would cease to be produced.

So as long as investors can take a little volatility, we think that some time in the next few years gold will be much higher as supply is choked off by the current gold price. If gold demand actually increases during this time frame, then we could see some fireworks in the gold price as supply simply will not be ramped up enough to meet any increase in demand.

Gold is a much safer investment than the financial media seems to think, and gold investors should sleep well knowing that production costs are on their side.