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Week Commencing June 23, 2014

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This week we look at the following topics:* Gold glitters again, this time for good?Gold saw a large price spike last week, is this the real thing?* Another look at ETFs for global exposureWe revisit exchange traded funds for investors looking at offshore diversification* Vision Eye Institute a stock we keep watching The share price has finally moved out of a long slumber and better days are ahead.

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Gold glitters again, this time for good?

Last week’s gold price spike caught many by surprise. Thursday’s move was the largest in nine months while silver also moved higher to a 3 week high as the Federal Reserve reasserted its view that interest rates will remain low. This drove the dollar down and boosted demand for metals.

We also wrote last week about the situation in Iraq and impact on energy prices as an ongoing theme which we have been pushing now for many months. We’ve included an update on our view below. We will continue to update our view as the Brent crude price keeps moving higher, but our focus this week is on gold and how to trade the gold price in light of what is occurring in energy markets.

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We think the move in gold is not only Fed driven by also a function of rising geopolitical uncertainty. It’s worth noting that gold added 70% from December 2008 to June 2011 as the Federal Reserve initiated quantitative easing and held borrowing costs near zero percent, where they still sit. Gold’s glory run unravelled though last year when it plunged 28% from its high, ever since then many traders have been asking themselves where it will go.

Invast published a Gold forecast guide last month and held a webinar with Vito Henjoto who remained bearish at the time given the short term technical indicators in place. Our long term fundamental view though was a positive one, we spoke about the supply challenges in the market and the impact of high oil prices on the marginal cost of producing an ounce of gold. We reaffirm this point this week – the gold price cannot continue to fall if oil prices are rising. Gold mining and processing is a very energy intensive process and if energy prices rise, mining and producing gold becomes more expensive. This is extremely important!

South Africa’s Department of Minerals and Energy (DME) estimates that the mining industry uses 6% of all the energy consumed in South Africa. In Brazil, the largest single energy consumer is mining giant Vale, which accounts for around 4% of all energy used in the country. In the US State of Colorado, mining has been estimated to account for 18% of total industrial sector energy use, while overall in the US it is calculated that the mining industry uses 3% of industry energy. Energy costs are estimated to represent more than 15% of the total cost of production in the mining industry in the US.

Australia’s miners are obliged to comply with the Equipment Energy Efficiency (E3) programme for energy efficiency. In South Africa, the DME set a target in 2007 for the mining industry to reduce energy demand by 15% by 2015: 32 South African mining and industrial companies have now signed up to an energy efficiency accord with the DME, on a voluntary basis. The pressure on energy costs to mining and the community are not to be ignored.

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With that in mind we continue to see upward pressure on energy prices to be a major boost for the gold price. The gold to oil ratio is a very popular trade among veteran traders to see the relationship reverting back to the mean average somewhere near 15x. The ratio calculates how many barrels of oil an ounce of gold can purchase. We can take the relationship back more than 60 years through the following chart to see the peaks and troughs brought about by wars and other geopolitical events which caused a shock to the relationship.

Image: Gold to oil ratio since WW2 via www.macrotrends.net

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At 15x the current Brent crude price, gold implies a price at US$1,710 per ounce. Using West Texas crude as the base measure, gold implies a price of US$1,590 per ounce. The 15x multiple isn’t an exact or precise measure but it is merely a level which the chart above suggests is the post-war average. The impact of higher oil prices has a huge flow on effect on global inflation and this is what gold bugs thrive on. The correlation between both is uncanny.

Because of this, we think gold can continue to rise with the recent break through US$1300 a potential catalyst to see it move higher. The gold to oil ratio can be traded through Invast’s MT4 platform, it means you don’t necessarily need to get the gold price movement correct or the price of oil correct, rather the ability of gold to increase relative to oil (which has moved higher in recent months) in order for the ratio to come back towards the average range of around 15x. Timing here is important, as with many other fundamental trading strategies.

On the Iraq issue, we continue to monitor energy markets very closely. One of the most interesting things we read this week was a piece by Stratfor which spelled out the geopolitical impact from the current violence and how it will impact countries like Saudi Arabia. The link to the article is here, definitely worth a read. It confirms our overall view expressed last week – always good to know our thoughts are broadly on the right page when it comes to such complicated matters.

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Another look at ETFs for global exposure

We cast our eye over exchange trade funds listed on the Australian market last year and we update their performance and wrote a piece on these in our Invast Insights report published on 28 January 2014. We continue to see ETFs as convenient way in which many share investors can add sophistication, diversity and exposure to various asset classes without having to complicate the whole investment process.

We have provided an updated list below of the ETF products listed on the Australian market and issued by iShares which is part of the Blackrock group. We note that the management cost for these funds is falling as their pool of funds under management grow to become more in line with other global counterparts. It’s worth noting that Australia is still a long way away from having the type of ETF listed exposure that investors in the United States enjoy, but the gap is closing quickly.

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The most interesting ETF’s providing international exposure at the moment to us seem to be the iShares Europe ETF and (perhaps rather surprisingly to some) iShares China Large-Cap ETF. On the later first, we feel that sentiment in the Chinese market and Chinese stocks at the moment is near all-time lows, the Chinese market has been a major under performer because of economic growth fears.

But Chinese officials remain very confident of their ability to meet a 7.5% growth rate for the year and we feel that investors will eventually start to re-asses their deep bearishness to China as the data starts to flow through in the coming months. Europe continues to benefit from money printing and a central bank which will do anything to ensure the economy recovers, which is why we think the European ETF might be attractive in portfolios also.

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The table below shows the composition of the European ETF. The index has some decent exposure to Financial and Health Care companies, both of which are leveraged to a turnaround in the global economy and benefit largely from low interest rates which makes M&A opportunities greatest.

Image: IEU ETF composition via iShares website

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Vision Eye Institute a stock we keep watching

We have written about Vision Eye Institute (VEI) several times in Invast Insights over the past year.

It’s a stock that was recently featured in our emerging opportunities special stock report. The company is Australia's largest provider of ophthalmic care in Australia comprising 18 dedicated ophthalmic consulting facilities, eight day surgeries and seven refractive and laser eye surgery centres along the Eastern seaboard of Australia (Vic, NSW and QLD).

Vision’s ophthalmology network of high quality doctors and other health care professionals (35 doctors and 450 staff) offers a broad sub-speciality service mix. Services include specialist care in the areas of cataract, refractive, glaucoma, cornea, medical and surgical retina and oculoplastics.

Doctor partners as a group, own approximately 10% of the company’s shares and key operational decisions are made only after input from them. Management works with our doctors and staff to maintain a local level of control and direction of our practices. This is supported by company standardisation in areas such as risk management, quality activities, and accounting practices.

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We think Vision is very well placed to benefit from an ageing population and growth in ophthalmic procedures are more and more eyeballs are glued to electronic screens (computers, tablets, smart phones) in coming generations. The business is also a real estate play – its day hospitals could potentially be used to start cross selling other medical procedures, like IVF for example. It’s a long shot but definitely a possibility. We note that Primary Healthcare (PRY) is the major shareholder, owning around 20% of the company. It’s unclear what Primary will do with its holding, it could be a good time to take over the remaining 80% of the stock but we’re unsure about this and just speculating.

Either way Vision is currently interesting because on our numbers it is trading on an EBITDA multiple of around 5x. For those of you who don’t know what this means, the total firm value including debt values the business at 5 times its operating earnings. In the medical space, comparable businesses (although not ophthalmic) are trading at more than twice this multiple. Others might have greater

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short term growth prospects – we grant that, in the short term only though – so the discount is just too large for us to ignore. The stock saw a moderate rise in its share price from the low 60 cent range to the mid-70s before receiving a speeding ticket from the ASX where it said it didn’t know the reason for the share price rise. As expected, the shares have fallen back towards more appropriate levels. Keep the stock on your watch list and watch the Substantial Shareholder Notices very closely!

Image: Vision’s revenue composition by vision, data from last interim report for 2014 financial year

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Webinar reminder – Aussie dollar outlook

Australia’s Terms of Trade are under threat from lower commodity prices. The fiscal stance is tightening and the RBA has no other choice but to keep interest rates where they are. What does this mean for the Australian dollar? CLICK HERE to register as spaces are filling fast.

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Join Invast Insights editor Peter Esho on Tuesday 24 June at 7PM as he uncovers 1) the key drivers for the Aussie Dollar and supporting currencies; how savvy traders are positioning themselves for what is in store over the next few months and; what are the fundamental and technical drivers and how you can maintain your edge in this potentially turbulent time ahead. If you’re trading currencies and in particular the Aussie Dollar, this is a must attend event. If you haven’t already registered you can click here directly to the registration page.

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Go to www.invast.com.au/insights to get a complimentary 4 week trial and receive the latest insights as they are published to our live clients.

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DisclaimerPlease note that you are receiving this report complimentary from Invast Financial Services Pty Ltd (AFSL 438 283). Invast staff members may from time to time purchase securities which are included in this or future reports. The authors of this report may or may not be holding a position in the securities mentioned. Please note that the information contained in this report and Invast's website is of a general nature only, and does not take into account your personal circumstances, financial situation or needs. You are strongly recommended to seek professional advice before opening an account with us.

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Risk Warning: It's important for you to read and consider the relevant Product Disclosure Statement, and any other relevant Invast Financial Services Pty Ltd documents before you decide whether or not to acquire any financial products listed in this email. Our Financial Services Guide contains details of our fees and charges. All these documents are available here on our website, or you can call us on +612 8036 7555. CFDs and Foreign Exchange are leveraged products and carry a high level of risk and you can lose more than your initial deposit so you should ensure CFD and Foreign Exchange trading meets your personal circumstances.

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