Abundant Energy A Game Changer (And Gold Killer)

…you got to stick to your beliefs, that’s the other thing. I mean yes, I’ve taken some big down hits this year. But when I think of where we could go from here, and I’ve done it before, I’ve done it so many times I can’t even tell you…I might have been bullish and [everyone] thought we were in a bear market and it turns out to be a bull market. I’m going back over 40 to 50 years now. So that’s a lot of time. If you believe you’re right and the data says hold your ground, you hold your ground. Normally there’s a pretty big payday at the end.  - Eric Sprott, via mining.com  

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Holding one’s ground with an overlay of risk management and objective assessment of the facts makes sense to us. Losing more than half one’s money with a total misread of the macro — and a total refusal to adjust to obvious realities — does not. As we touched on in our here as to why.
 
The Best Case Scenario
 
Is there any plausible scenario that will make gold (and thus gold stocks) attractive again?
 
Yes — and it looks something like this:

As the US economic recovery accelerates, cost-push inflation picks up. Wages start to rise for the first time in years, even as corporations start increasing spending to increase age-old capital stock. Monetary velocity increases as banks willingly lend to businesses on an expansion and capex replacement track. Consumer borrowing, fueled by optimism and solidified balance sheets, picks up again too. The Federal Reserve observes all this pick-up and holds off on tightening for fear of nipping a young recovery in the bud. Inflationary pressures gain to the point of becoming serious. Still the Federal Reserve holds off. Gold and gold sticks rise in anticipation of inflation getting out of control.   

You know what though? Even the best case scenario for gold and gold stocks is still problematic and fraught with problems. If the economy is really improving, for example, there will be more attractive places to invest, and better plays on increased consumer and business spending. There will also be a mood of optimism that detracts from gold’s inherent value as a crisis play. And the cycle of progression from too-low inflation (what we have right now outside risk assets) to benign inflation to frighteningly high inflation is likely to take a long, long time to play out — we’re talking multi-year time horizon, i.e. much longer than the magical thinking “wake up and suddenly it’s inflationary” type assumptions current goldbugs desperately cling to.
 
…And the Worst Case Scenario
So the best case scenario for gold and gold stocks really isn’t that great. Note too that gold and gold stocks won’t really benefit from a return of macro-economic crisis, because gold has proven itself to be a speculative “risk on / risk off” asset just like any other. If risk assets across the board get whacked again, so too will the yellow metal. On a broad level gold and gold stocks are showing their true colors to be somewhat like those of the S&P 500 VIX Short-Term Futures ETN, (VXX) — a freaking horrible asset that is just better left alone in favor of other options in most circumstances.
 
The worst case scenario, on the other hand, is very, very ugly. It is not at all inconceivable gold prices could fall well back into triple-digits — below $1,000 per ounce — and maybe even as low as $700 per ounce on a mass-capitulation undershoot. Average production cost for gold miners is probably around a thousand bucks, and the more efficient miners are well below that. (Metals Focus analyst Oliver Heathman: “The bulk of mines are still profitable on a cash cost basis at $1,000 an ounce, but not on a prolonged basis.”) These mines have to keep producing to justify their costs, and as the US dollar strengthens and investment rationale softens, gold could simply outright collapse.
 
If you buy gold here, in other words, you aren’t buying at any kind of valuation floor. You are standing on a very thin crust of soil directly over a quicksand pit.
 
Drowning in North American oil
 
And then you have the oil factor…. consider the following:

The flood of North American crude oil is set to become a deluge as Mexico dismantles a 75-year-old barrier to foreign investment in its oil fields.
 
Plagued by almost a decade of slumping output that has degraded Mexico’s take from a $100-a-barrel oil market, President Enrique Pena Nieto is seeking an end to the state monopoly over one of the biggest crude resources in the Western Hemisphere. The doubling in Mexican oil output that Citigroup Inc. said may result from inviting international explorers to drill would be equivalent to adding another Nigeria to world supply, or about 2.5 million barrels a day.
 
Mexico’s landmark decision to open up its oil industry to foreign companies could be the nail in the coffin for gold bugs. What do Mexican oil and gold have to do with each other you ask? Mexico’s liberalization of its oil sector is part of a wider trend in new sources of oil supply, a trend that should put pressure on commodity prices and inflation. And there is nothing that gold hates more than low inflation.  - Bloomberg, North America to Drown in Oil as Mexico Ends Monopoly  

And this for good measure:

The U.S. is on track to reach records for crude-oil production by 2016, as hydraulic fracturing and horizontal drilling techniques continue to unlock oil in shale rock.
 
The renaissance in the oil sector feeds into the debate of whether the U.S. should allow crude oil to be exported freely. The U.S. has kept a lid on oil exports since 1973, when the Organization of the Petroleum Exporting Countries stopped selling crude to the U.S. in retaliation for its support of Israel in a war with Egypt and Syria.
 
The rising U.S. production “will weigh heavily on oil prices,” said Ed Morse, head of commodity research at Citigroup. He said he believes that in the second half of the decade the global benchmark price will be $15 a barrel below where it is now. - WSJ, US May Reach Records for Crude Oil Production by 2016

The Mexican oil rush is already on, with private firms banging on the doors. 
 
Jose Antonio Prado, a former Pemex official, said of the recent measures: “The Mexican state will be able to incorporate private participants in projects that are already in force as well as new opportunities. I can’t tell you the amount of banks and investment funds coming from the U.S. and Europe that have been talking to us and are trying to have an expectation of what’s going to happen with the energy reform. All those guys are going to be in Mexico next year in various forms trying to seek new opportunities.”
 
As for the United States outlook, the EIA (Energy Information Administration) expects the U.S. to become a net exporter of crude oil by 2018.

Even in the Middle East, where the “geopolitical premium” has been constant in recent years, Iran is starting to look like a more reliable source of oil. Stabilization on the US-Iran axis also increases the odds of stable flow from Iraq, a major oil source. The deal between the U.S. and Iran regarding its nuclear program could lead to another million barrels of oil a day reaching the market in the medium-term.
 
Oil is a Form of Goldilocks Stimulus
Think of oil as a form of goldilocks stimulus. The more oil that comes online, the better positioned the US becomes to deliver low-inflation economic growth. Cheaper oil means lower transport and production costs for US companies. Cheaper oil also acts as a stimulant to consumers via lower prices at the pump.
 
According to Deutsche Bank, a $10 fluctuation in oil prices translates to a 25 cent fluctuation in the retail price of gasoline. Each penny of increase or decrease in the price of gasoline equates to $1.4 billion in household energy consumption. A drop in oil prices to $90, or better yet to $80, would amount to a massive stimulus package for American consumers. Gasoline prices are already below where they were this time of year in 2011 and 2012.