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Van Eck notes gold’s use as a hedge in volatile markets

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Joe Foster, Gold Strategist with Van Eck Global, has commented on what has proved to be a very eventful start to 2016. 

From the outset, on January 4, the first trading day of 2016, the Chinese equity market fell drastically, with the Shanghai Composite Stock Index down 6.9 per cent during the session.
 
Foster details the rest of the sorry tale. “The equity slide continued, repeatedly triggering the recently instituted circuit breakers, which have subsequently been suspended. The Shanghai Composite Stock Index ended the month of January down 22.6 per cent. The Chinese selloff spread to global equity markets with the S&P 500 Index having one of its worse starts to any year, falling almost 9 per cent three weeks into January. By month end, however, the Index had recouped some losses to end January down 5 per cent." 
 
However, the situation spread with the MSCI All-Country World Index, which includes both emerging and developed world equity markets, falling 8 per cent during the month.
 
“Commodities also took a hit, with oil and copper down 9 per cent and 3 per cent, respectively. Even the Japanese yen ended the month weaker, down 0.8 per cent relative to the US dollar, after the Bank of Japan (BOJ) surprisingly announced on January 29 its adoption of negative interest rates, which drove the yen
down 2 per cent that day.”
 
In terms of gold, Foster reports that The World Gold Council published its latest World Official Gold Reserves for 2015.  The figures rank China (1,762 tonnes, representing 1.7 per cent of total foreign reserves) and Russia (1,393 tonnes, 13 per cent), respectively,
as the sixth and seventh largest holders of gold reserves in the world, behind the U.S., Germany, the International Monetary Fund (IMF), Italy, and France. 
 
Foster writes that the central banks of China and Russia were both significant buyers of gold in 2015. “After announcing its updated gold holdings in June 2015, the People’s Bank of China (PBOC) purchased an additional 104 tonnes of gold in the six months from July to December. This equates to an annualised rate of purchase exceeding 200 tonnes of gold, which is double the average annual rate estimated from the PBOC’s June 2015 update.”
 
Foster believes that this suggests China may be stepping up its gold reserves purchases. “Russia’s net purchases were estimated at about 185 tonnes of gold in 2015 (not including data for December), representing an increase of about 15 per cent from 2014.”
 
In its latest report Thomson Reuters GFMS Gold Survey estimates that in Q4 2015 total gold physical demand increased by 2.2 per cent year over year, driven primarily by strong growth (23.2 per cent) in official sector net purchases (dominated by Russia and China as explained above) and a 7.0 per cent increase in retail investment in gold bars (driven by strong demand from China and India.)
 
“While jewellery demand in China dropped by 4 per cent, demand out of India continued to recover, increasing 3 per cent in Q4.  The world’s total supply of gold dropped by 7.3 per cent with mine production declining 3.8 per cent.”
 
Not surprisingly, given this dramatic background, Foster reports that the performance of gold stocks was mixed in January. The NYSE Arca Gold Miners Index (GDMNTR) gained 3.35 per cent, while Market Vectors Junior Gold Miners Index (MVGDXJTR) dropped 0.79 per cent.
 
“While the underperformance of gold stocks relative to gold is atypical when the price of gold is on the rise, the end-of-year performance of gold stocks was also somewhat out of character.  In December, while gold fell to a new cycle low, gold stocks did not follow to new long-term lows, and in fact, the GDMNTR Index and the MVGDXJTR Index advanced 0.9 per cent and 2.8 per cent, respectively.”
 
Foster feels that perhaps the reversal of that uncharacteristic December outperformance helps explains some of the underperformance in January, along with general weakness in the broader equity market that can also drag down gold equities.
 
“Additional factors affected gold stocks and likely contributed to negative sentiment towards equities during the month. Some companies reported preliminary operating results for 2015 and provided guidance for 2016. While 2015 results were broadly in-line and costs continued to trend down, 2016 production guidance seems slightly below current expectations.  Furthermore, base metals and silver underperformed gold
in January, affecting valuations of companies with exposure to those metals. Finally, there was company-specific news that had significant negative impact on share prices, which we didn’t always deem as justified.”
 
Foster reports that the performance gap between gold bullion and gold equities was
widest on January 19.  Since then the stocks have materially outperformed, closing the gap. As of February 1, the GDMNTR Index and gold were both up 6.3 per cent year-to-date.
 
Foster concludes that financial markets in January helped to remind investors around the globe why perhaps every portfolio should have an allocation to gold.
 
“It is our opinion that gold should be used mainly as a portfolio diversifier and as a hedge against tail risk; a form of portfolio insurance that attempts to preserve value when tail risk becomes a reality.”

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