As global stock markets have soared in recent weeks, accelerating most recently after the dud of the G-20 meeting, gold has also rallied, strongly suggesting there is anything but confidence in this ramp.
So Gold Is Screaming, but as ConvergEx's Nick Colas asks, What Is It Saying?
Gold is up 19% so far in 2016, with prices making new one-year highs just in the past week. That shouldn’t be happening.
- First, gold has been stuck in a nasty (-44% peak to trough) bear market for +4 years.
- Second, global equity markets have begun to recover so risk-hedging assets like gold should be falling as stocks advance.
- Finally, isn’t technology supposed to be making all physical forms of wealth obsolete anyway?
Turns out there is a bull case for gold, and it is as simple as supply and demand. World Gold Council data for 2015 shows the slowest growth in mine production since 2009 and the weakest recycled supply since 2007. They expect production to actually fall in 2016. Meanwhile, demand is on the upswing from financial buyers like ETF investors and bullion coin investors. Looks like we can add another year to the +5,000 prior ones where gold has been a relevant asset class.
Investors in risk assets are breathing a sigh of relief as we begin the sprint to the end of the first quarter. Stocks in developed markets have stabilized after a rough start. Oil prices have shown some resilience. The CBOE VIX Index is 17, below its long run average of 10. Even the high yield corporate bond market is acting better.
And yet there is one asset that seems to still ring the alarm bell: gold. This oldest of all investments is up 19% in 2016 and hit a new one year high just last week. That’s significant, because the yellow metal is continuing its winning ways even as stocks and other financial assets seem back on more solid footing.
Many financial analysts and pundits claim that gold is unanalyzable since it has no cash flows. Its appeal, they claim, is based on historical precedent and nothing more. By this logic, gold has either zero value or infinite worth. The difference is simply whether you believe in modern financial systems based on central banks and asset markets or think Armageddon is just around the corner.
But look at gold as just another commodity, like oil or corn or sugar, and you get a different calculus. Price is where supply meets demand. No harsh value judgments about why the demand is there… It exists (and has since before humans knew how to write or use the wheel), which means we can value gold along these lines.
By that metric, the rise in gold prices is perfectly explainable. The World Gold Council keeps tabs on the global industry, and here are their statistics:
- From Q4 2012 to Q3 2015 gold production expanded from 2,900 tons (rolling 4 quarter data) to 3,200 tons. This expansion occurred in spite of the decline in spot prices from $1,800 in 2011 to barely $1,000 last year.
- In Q4 2015, global output slowed to 3,150 tons. The largest cuts came from Peru, the Dominican Republic, Mongolia and Argentina. No, I didn’t know there are gold mines in the DR either. Total growth in gold mine output slowed in 2015 to its slowest rate since 2009.
- Recycling also plays an important role in gold supply, but this reached multi-year lows in 2015 and total global gold supply last year was down 4% to 4,258 tons. That’s the lowest total production since 2009.
The volatility in financial markets earlier this year boosted gold demand just as supply had come off line. The two largest gold ETFs – GLD and IAU – have seen $7.1 billion in net new demand so far this year. The latter actually had to cut off new “Creates” last week since it had not registered new shares to issue. Embarrassing, but understandable since redemptions out of GLD and IAU totaled over $25 billion in the last 3 years.
And then there is demand from gold bullion investors. This is harder to track in real-time, but it seems to be expanding. A look at the APMEX precious metals dealer website (link at the end of this note) shows that premiums for fractional gold coins like the old Swiss and French 20 Franc pieces (0.1867 troy ounces) have gone from $9.99 to $11.99 over spot in the last week. Premiums on U.S. 1 ounce Eagles now run $52 over spot, up from $30-$40 last year.
This increase in demand seems to be, thus far, notable but relatively modest. Three brief points here:
Google searches in the U.S. for “Buy gold” were up 8% in January and 11% for February. At the same time, they are still off close to 50% from the peaks in August 2011.
The locations of these searches are concentrated in cities one associates with large retirement communities. Las Vegas tops the list, followed by Phoenix, Tampa, and Orlando.
Looking at a much longer time frame – back to 1800 – the mention of “Gold” in English language books and periodicals (courtesy of Google Ngram) seems to have bottomed out.
The peaks for usage of the word “Gold” were in 1896 and again in 1934. The trough, with less than half the number of uses as those dates, was in 1998. Since then, the use of the word has increased some 20%.
The other odd thing about gold’s recent move has been that silver hasn’t really played along. Yes, it is up 12% but that pales in comparison to the 19% advance for gold. During the last big move for precious metals (2009 to 2011), silver was up over 300% while gold only managed a 100% increase. That’s especially notable because the ratio of gold to silver, currently 81x, is appreciably higher than the average 56x ratio since 1970. If the run in gold continues, it would seem that silver should have some room to play catch up.
One final point of interest before we wrap up: Indian gold bonds. India imports a lot of gold, as it is a traditional store of value there as well as a customary gift at weddings. In order to curtail demand for physical gold (and help its trade deficit), the Indian government has begun to offer gold-backed bonds paying a 2.75% coupon. The bonds have an 8-year maturity but can be redeemed after 5 years or sold on a secondary market. Two auctions to date have raised about $154 million. At the same time, India imported $3.8 billion of gold in December 2015 alone, so it seems that Indians still prefer physical to paper holdings.
To sum up, gold prices may not be reflecting “Fear” as much as “greed”. The choppy start to the year for financial assets got the ball rolling, to be sure. That demand butted up against cuts in production caused by four years of declining prices. Prices responded as they do in any commodity: they went higher. Now, it is a matter of how much success begets future gains.
After a long and painful bear market, gold should get a bounce. If financial assets can really improve on recent gains, that will eventually pull money from all risk hedges, including gold. But if we do see more volatility in 2016 – and that is our base case scenario – then gold should prove resilient. Bottom line: we think gold does move higher from here in 2016.
via Zero Hedge http://ift.tt/21jP7pH Tyler Durden