Time to Take Profits in Gold Mining Stocks? Jim Rickards Says Not Yet

Suddenly, gold miner shareholders have the problem everyone wants: They’ve made fairly serious recent money and now must decide whether to convert some of their paper profits to cash. Anyone who’s been round-tripped in a big position understands how serious this question is.

Jim Rickards, author of a series of best-selling investment books, just weighed in with the observation that for gold — and by implication the miners — the risks and potential rewards aren’t well-balanced. Here’s an excerpt:

The Asymmetric Gold Trade

(Jim Rickards) - One reason for gold’s surge is the role of central banks. Retail and institutional investors may not be that interested in gold, but central banks definitely are.

In recent years, central bank holdings of gold have surged from 33,000 metric tonnes to over 36,000 metric tonnes, a 9.0% gain measured by weight.

This increase has been heavily concentrated in two countries – Russia and China. Russian gold reserves have risen from 600 metric tonnes in 2008 to 2,335 metric tonnes today, a gain of 1,735 metric tonnes or nearly 300% from the 2008 base.

China also had about 600 metric tonnes in 2008 and today has 2,280 metric tonnes, a 275% gain. (There is good reason to conclude that China has undisclosed gold reserves which would make those total and percentage gains ever higher).

Why the large gold holdings and why the rapid additions to gold reserves if gold is not a monetary asset? The question answers itself. Gold is a monetary asset.

Central bank net buying is equivalent to about 20% of annual gold mining output. That does not indicate a gold shortage, but it does put a firm floor under the dollar price of gold.

That creates what we call an asymmetric trade. On the upside, the sky’s the limit, but on the downside, the central banks have your back to some extent because they will definitely buy the dips to increase their gold hoards. That’s the best type of trade to be in.

So, the stage is set. The simple maths of easier constant dollar gains is the dynamic that can set off a buying frenzy and lead to super-spikes in the dollar price of gold.

All that is needed to set off the super-spike is an unexpected development that is not already priced in.

True to form, we may have it. Trump announced his tariff plans for Canada, Mexico and China. Tariffs on the EU are not far behind. These tariffs would come on top of existing ones, which are quite high in the case of China.

Enter the BRICS Countries

The BRICS are a multilateral economic organisation including Brazil, Russia, India, China, South Africa, Iran, the UAE and several other nations. At least twenty other countries, including some large economies such as Malaysia and Turkey, have applied for membership.

Collectively the BRICS represents about half the population of the planet and about 30% of global GDP (or over 50% of global GDP if the purchasing power parity method of calculation is used). The BRICS are not some polyglot collections of developing economies. They represent a large proportion of the entire global economy.

The truth is the BRICS nations already have a common currency but no one in Washington understands what it is. That common currency is gold.

Today, if BRICS want to avoid the US dollar, they have to trade in their local currencies. China can pay for Russian energy exports using yuan. Russia can pay for Brazilian aircraft using rubles. India can pay for manufactured goods from China using rupees. And so on.

That method works fine. The payments can move between local banks without relying on the SWIFT payment message system in Belgium. (Russia and Iran are both banned from SWIFT).

Central banks in each BRICS country can pay local buyers and sellers in their home currency (or offer dollars through separate channels if needed to buy inputs from other countries). Those central banks then maintain a ledger showing the gross amount of other BRICS currencies they hold in their reserves.

Difficulties arise when one country runs a continual surplus with another and accumulates more of that trading partner’s currency than the surplus country can put to good use. Reserve positions in trading partner currencies also pose liquidity risks and foreign exchange risks to the holder.

A simple solution is to settle the balance in gold. This can be done on a net basis, which requires far less gold than gross settlements. It can also be done periodically (say quarterly or twice per year) which is also far easier than real-time settlement.

The gold itself can easily be transported by plane or kept in an agreed vault location with a digital ledger identifying how much gold was in each country’s account and reflecting transfers of ownership as needed.

This arrangement is not a gold standard. None of the BRICS members are offering to freely exchange gold for any currency. None of the members is offering to buy or sell gold at a fixed exchange rate.

The purpose of gold is simply to provide an agreed medium of exchange and store of value for settling trade surpluses and deficits among willing members. This is a solution for the BRICS, but there’s no reason why participation in such an arrangement must be limited to the BRICS. Any trading country could in principle join the arrangement.

And that’s good news for gold investors because the BRICS and other nations will have to acquire gold themselves (which they are already doing) in order to participate. Other investors who buy gold are along for the ride and it’s a ride that should lead to even higher dollar prices for gold.

Read the full article here.

To Sum Up

If a currency goes to zero, gold goes to infinity when measured in that currency. Its upside is thus unlimited. Meanwhile, central banks are buying gold in anticipation of a future currency crisis, and they’re not price-sensitive. They presumably have a quota to meet and are required by their governments to pay whatever it takes.

As a result, gold’s potential gains outweigh its risks even at today’s record price, and the best-run miners should continue to generate plenty of cash flow with which to reward shareholders.

Trade Notice: I sold some NASDAQ and SPY put options last week at a (suddenly) decent profit but continue to hold shorts as insurance against even more near-term chaos.