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Van Eck’s gold specialist fears stagflation

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Joe Foster, portfolio manager and gold specialist with Van Eck Global writes that gold reached a new high for the year of USD1,285 per ounce on March 11 when the European Central Bank (ECB) announced their upcoming plans which include reducing rates on overnight bank deposits by 10 basis points to -0.4 per cent, expanding quantitative easing to include corporate bonds in addition to sovereign bonds, and adding a new
series of bank loans.
 

Safe haven gold saw gains that reflect investors’ worries over the financial risk and currency debasement that may come with negative rates, more printing of money, and easy credit. Bloomberg reports that in February sovereign bonds issued primarily in Japan and Europe worth more than USD7 trillion in US dollars had negative yields, Foster writes.
  
Gluskin Sheff calculates the average yield on USD23 trillion of global sovereign bonds outstanding has dropped below 0.7 per cent for the first time in history, Foster writes.

“Some of the potential risks of negative rates include: 1) the fundamental framework of the financial system is simply not designed to operate with negative rates; 2) providers of long-term services, like pension funds and insurance companies, have trouble meeting goals and expectations; 3) currency relationships and valuations become impaired; and 4) investors may disengage from the financial system.
 
“Comments from central bank officials seem oblivious to the dangers that gold investors see in the radical policies that are being promulgated.”
 
Foster comments that overall for the month, gold trended lower from its March highs, ending the month at USD1,232.71 per ounce for a small loss of USD6.03 (0.5 per cent).
 
Gold shares reached their highs for the year on March 17 and the NYSE Arca Gold Miners Index gained 4.0 per cent for the month.  Foster writes that the junior gold stocks had been trailing the benchmark, however, but the Market Vectors Junior Gold Miners Index caught up with the GDMNTR for the year by outperforming in March with an 8.6 per cent gain.
 
Looking forward, Foster notes that the 300 tonne flow of gold into bullion exchange-traded products (ETPs) in the first quarter was the largest quarterly inflow since 2009, a period of heightened demand due to the credit crisis.
 
“Despite these record ETP flows, other demand drivers have been lacking. Jewellers in India were on strike for three weeks in March to protest a tax increase. Bloomberg reports Chinese purchases of gold for the first two months of 2016 were down 56 per cent from a year ago. The People’s Bank of China (PBOC) raised its gold reserves by 10 tonnes in February, its smallest monthly increase since it began reporting gold holdings last year. Producer hedging, which involves selling, increased as we count seven companies that announced new hedge  positions in the first quarter. This was entirely short-term tactical hedging to lock in profits for new start-ups, high-cost short-life mines, or mines in weak currency countries. The weak physical demand from Asia and increased hedging suggest that overwhelming investment  demand, mainly from the West, has been the primary driver of the strong gold market this year.”
This was the best quarter for gold performance since 1986 and gold stock gains were of a similar magnitude. In the first quarter, gold advanced 16.1 per cent, while the GDMNTR was up 46.3 per cent and the MVGDXJTR climbed 45.4 per cent. “These are the types of early gains we expected to see in a sector that has been radically oversold. Since gold crashed in 2013, short sellers have dominated the market with many banks calling for lower prices, making the bear market one of the worst ever. Now it looks like we will see how vulnerable the new market is. Inflows to bullion ETPs have slowed and Comex net speculative long positions are the highest since 2012.”
 
Foster notes that as of April 5, gold has declined USD56 per ounce from its March 11 high and looks to be into its first significant consolidation of the year. “Holding above USD1,200 per ounce would be a very bullish sign. However, a more plausible expectation based on trends in the early stage of past bull markets would be a correction to around the USD1,150 per ounce level. A fall below USD1,100 per ounce would suggest the bears have regained the upper hand, although we see this as the least likely outcome.”
 
Consumer price inflation now merits watching, Foster says. “The era of disinflation that was punctuated by the deflation of the great recession may be coming to a close. Normally we prefer to include food and energy when evaluating inflation trends. However, because of the recent crash in oil prices, we believe it is important to strip out energy volatility to see what is happening with underlying core inflation.”
 
Foster believes that for some reason the Fed and other central banks are trying extremely hard to escalate inflation. “They do not appear worried by the asset price inflation that easy money policies has brought to stocks, bonds, and real estate. In past cycles the Fed remained too easy for too long. This is looking like a cycle in which the central banks remain way too easy for way too long, in our opinion. Perhaps this cycle will be different from the ones that brought about the tech bust and subprime crash. In addition to the usual asset bubbles that inevitably burst, we might be adding an
inflationary cycle in goods and services. There is a distantly familiar name for that in a low-growth world: stagflation.”

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