Joe Foster, Gold Strategist with Van Eck Global, reflects that after falling to its cycle lows in July, the gold price had advanced nicely. “Last month we wondered whether the positive trend was sustainable. The short answer is: No, it wasn’t."
"In November, the gold price fell to new 5.5-year lows at USD1,052 per ounce, as the US Dollar Index approached long-term highs. Gold ended the month at USD1,064.77 per ounce for a loss of USD77.39 (6.8 per cent)."
The early November reports that Federal Reserve (the “Fed”) Chair Janet Yellen said an improving economy would set the stage for a December interest rate increase if economic reports continue to assure policymakers that inflation will accelerate over time, set the tone for both gold and the US dollar, which fell and rose, respectively,
for the remainder of the month. A strong jobs report on November 6, followed by generally positive economic releases throughout the month enabled market consensus to gain momentum for a rate increase at the December 16 Federal Open Market Committee (FOMC) meeting.
November saw gold bullion exchange-traded products (ETPs) experience 1.59 million ounces (49.3 tonnes) of redemptions which drove gold ETPs’ combined holdings to a new cycle low of 47.92 million ounces (1,490.3 tonnes), Foster says. “During November gold equity indices fell with the gold price and nearly met the lows set in July. The NYSE Arca Gold Miners Index declined 8.5 per cent, while the Market Vectors Junior Gold Miners Index fell 8.6 per cent. Low gold prices caused investors to largely ignore
the robust results of the third quarter earnings season. BMO Capital Markets reported free cash flow of USD978 million from the North American senior miners, far surpassing expectations of USD94 million.”
Scotiabank’s universe of senior and larger mid-caps had production that was 3 per cent above expectations and all-in mining costs that were 8 per cent lower than expected, Foster writes.
“The favourable results stemmed from operating efficiency, bear market pricing for materials and services, low local currency values, and low fuel prices. Many companies have indicated that there is still room to cut costs further. We now expect positive production results and cost-savings to continue in 2016.”
Physical demand for gold bars, coins, and jewellery improved in the third quarter. The World Gold Council (WGC) reported that Q3 gold demand increased by 8 per cent over Q2 and by 14 per cent over last year. Year-to-date demand is up 3 per cent versus the same period in 2014.
Foster writes that the WGC reckons that there was a gold market deficit of 56.0 tonnes in Q3. The largest drivers of this strong demand were India and China, where demand increased 13 per cent in each country which equates to a 58.0 tonne increase over Q2.
Chinese demand continues as physical deliveries from the Shanghai Gold Exchange through November have now surpassed the record set in 2013. Investors might wonder how gold can make new lows in July and again in November while the market has been in a deficit, which means demand is presumably outstripping supply.
Foster writes that the gold market is unique among commodities and indeed unique in the financial world. “Most gold is hoarded as a financial asset, like currencies, stocks, and bonds. It is not consumed like oil, copper, or soybeans. All of the gold ever produced
is sitting in a vault, safe, jewellery box, place of worship, or museum, or is adorning a person’s body. This gold represents a huge reservoir of potential supply, some of which is available at a price. This is why the supply/demand drivers that apply to most commodities may not apply to gold.”
Beyond that, the gold market is not sufficiently transparent to account for all of the transactions that occur globally. “All of the gold that the WGC can account for amounted to a 56.0 tonne deficit in Q3, however, there is gold the WGC cannot count that may make this deficit larger or perhaps nonexistent altogether. For commodities other than gold, strong physical demand drives prices higher – prices follow demand. With gold, the current price drives physical demand – demand follows prices. Lower prices entice buyers in India and China. They also bring strong retail demand from the US and Europe. This physical demand increases when prices drop, helping to stabilise prices.”
However, physical demand usually diminishes when prices increase. Investment demand generates price strength in the gold market and a lack of investment demand characterises bear markets. “The motives that drive both physical and investment demand are the same – to utilise gold as a store of wealth and a hedge against currency weakness, tail risk, or financial stress. However, investment demand manifests itself mainly in the futures market in New York and the over-the-counter market in London. These markets exert the largest influence on gold prices and they are driven more by macroeconomic, financial, and geopolitical events than by prices and supply/demand equations” Foster says.
Gold ETPs, on the other hand, are relatively transparent vehicles and Foster says that his firm uses them as a proxy for broad investment demand. “In Q3 global bullion ETPs had 63.0 tonnes of redemptions. This is probably a good indicator of weak investment demand in New York and London. It also lends better insight into price action than physical demand from China or elsewhere.”
Foster believes that physical demand should play a larger role in price discovery, and maybe it eventually will as the Asian gold market grows and matures. He writes: “In the meantime, the Chinese seem happy to accumulate all the gold the West cares to provide at low gold prices. Regardless of what we believe should happen, we make investment decisions based on what actually drives the market. This means investing in companies that can survive intact or gain an advantage if a lack of investment demand drives prices lower than expected.”
Looking forward, Foster finds that the markets are essentially convinced that the Fed will raise rates at the next FOMC meeting. “Based on recent Fed comments, economic releases, and the level of expectations, we will be shocked if the Fed doesn’t raise rates. Rate rising cycles introduce risks to the economy and financial system and they often end badly. According to Gluskin Sheff, a bull market in the S&P 500 Index has never ended after an initial rate hike. It is a different story if the rate hikes keep coming.The stock market crashed in October 1987 after three rate hikes over five months. NASDAQ crashed in April 2000 after six rate hikes over 11 months. Rate increases are often a prelude to recessions, which become increasingly likely as the yield curve flattens or inverts (when short-term rates exceed long-term rates).”
