5 Questions for Hard Assets Investor Managing Editor, Brad Zigler

February 08, 2009 | By: Hard Assets Investor

Brad Zigler (Zigler): Crowded? Define "crowded."

If by "crowded" you mean traders trying to squeeze through the doorway to get into or out of the market, then no, it's not crowded. Crowded was the summer of '07 when speculators elbowed their way into gold and even more crowded at the exits a year later.

Speculative interest in gold has built up since November, but certainly not at the vertical trajectory we saw in the last bull wave. Not yet, anyway. Speculative momentum has been building on the long side since November. That's the key. It's not been the headlong rush that characterized the '07 run-up. That's not to say that a rush can't or won't develop. It may, under the ministrations of those who DO crowd the market with extravagant claims about gold's upside.

Investors' complaints center around the shortage of physical gold now, mostly in the form of coins. U.S.-minted gold coinage is subject to tight restrictions on the origin and quality of the bullion content, so the shortage is more a manufacturing bottleneck than anything else.

HAI: How do you reconcile gold's rising price with the TIPS market's low demand for inflation?

Zigler: We've established a disconnect between inflation and the price of gold in past HAI articles (last year's Desktop series culminating with "A Picture's Worth A Thousand Words," for example). Gold's not a perfect inflation hedge. Since much of the world's economic health is keyed to oil prices, crude may be a better inflation hedge than gold.

Oil isn't money, however. Gold is. When the stuff hits the fan monetarily, people turn to gold as a safe haven. Monetary inflation – not to be confused with the price inflation measured by the Consumer Price Index – downtrended in 2008 along with gold's price.

TIPS yields are keyed off CPI, which didn't start disinflating until much later in the year. Keep in mind that CPI is a monthly lagging indicator. Gold, and the sentiments about monetary inflation reflected in its price, is repriced daily.

Our monthly Breakfast Index columns track the pass-through of wholesale price inflation to the consumer level. Take our last look, for example, "It's 2001 Again, Inflationwise" and "CPI: 'C' Is For 'Cocoa.'" If you look at the charts, you can trace the arc of food price inflation from the farm to the wholesale manufacturer and ultimately to the retail customer. Inflation, or disinflation, takes a while to work itself into the CPI figures.

Monetary disinflation is leveling now. That's reflected in gold's recent price action. It'll take a while for consumer price (dis)inflation to turn around.

HAI: Fourth-quarter GDP numbers were just released. Were they better, worse or the same as you expected?

Zigler: Nobody should be surprised by the fourth-quarter numbers. Business investment and consumer spending performed a vanishing act. We're not done, either. As inventories get worked off, the rate of decline may, in fact, accelerate.

HAI: Let’s turn to oil. When, oh when, will that front-month contango come in?

Zigler: Like contango's a BAD thing? For most storable commodities, contango is the natural state of affairs, though. Oil has historically liked living in a state of mild backwardation because the supply is below ground (or sea) and is subject to political and economic gamesmanship.

Contango represents carrying charges – the costs of storing a commodity for future delivery. The existence of a contango implies that there's supply to carry forward. Ordinarily that would be a good thing for consumers, so it isn't bad in itself. Producers may take a different view, as would investors in long-only commodity index products. The negative roll yield in a contango knocks the hell out of long-only index returns. Short oil index investors, however, have been loving the contango. They get a positive roll yield, which has augmented the commodity investment return.

When will contango dissipate? Well, if you're talking about oil, you shouldn't hold your breath. Oil's last excursion into contango lasted 32 months. The current contango developed in June '08. We're only seven months into this edition.

HAI: Exxon set a record for annual profits for a corporation in 2008. Are Energy stocks cheap, even given the pullback in energy prices?

Zigler: If one's looking for a short-term price play, the current environment favors pure refiners like Valero Energy Corp. (NYSE: VLO) or Tesoro Corp. (NYSE: TSO) over an integrated outfit such as ExxonMobil (NYSE: XOM). Ownership of downstream sources is a hedge against high refinery input costs, but it can be a drag on bottom-line results in today's market.

XOM can certainly take its cash and shop for cheap assets among lesser lights. That may be a more efficient way to acquire reserves compared to exploration and development.

For equity-minded investors, more immediate returns can be obtained from refiners taking advantage of better crack spreads (see "Lots Of Crude, Products Not So Much").

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