Buying gold?

“Gold right now may well represent a once in a life time opportunity for Australian investors,” said Jordan Eliseo, the Chief Economist, ABC Bullion.

“The recent fall in gold price offers an opportunity for investors to get in at a discount price, with a range of bullish factors likely to push prices substantially higher over the next five years,” he said.

Eliseo was speaking at the ‘International Precious Metals & Commodities Show’ in Munich about Australia’s opportunity to take advantage of buying gold.

The ‘International Precious Metals & Commodities Show’ is an international conference dedicated to investments in precious metals and commodities that has taken place annually in Munich since 1985.

“Right now sentiment towards precious metals is at record lows – which typically means we’re getting close to a bottom,” Eliseo said.

“Gold is the only asset that has not only endured, but prospered throughout every period of economic turmoil the past five millennia have thrown at humanity,” he said. “It’s pretty bold to think this time will be any different.”

Eliso said that gold was undervalued as an asset despite its importance to Australian economy. “Australia is the second largest gold producer in the world, and while it has consistently outperformed most traditional assets for a decade, it is not represented at all in mainstream portfolios.”

“The biggest demand for physical gold is the Asian market, in particular the Chinese, and we would do well to treat gold, not just another commodity export but as a key plank in furthering our banking and wealth management relationships with our neighbours to the north.

Eliseo said that gold also provides a strong hedge against the falling A$ as well as offering a balance to overall portfolio volatility through low correlations.

“With the currency likely to be under pressure in the coming years, gold is perhaps the smartest way of getting non-$A exposure into a trustees portfolio, as it will also balance out equity market risk,” said Eliseo.

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Gold undervalued: Van Eck Global

Gold stocks are likely to rise over the next year from their current undervalued levels. Additionally merger and acquisition activity could heat up with any rise in the gold price towards US$1400 an ounce, according to Joe Foster, Portfolio Manager of Van Eck Global’s gold strategies.

Mr Foster said in a recent outlook on the gold market that while the gold price and gold stocks are off their 2013 lows, further gains in price are likely given the extent of last year’s sell-off.

“Gold stocks have done very poorly over the last several years as they have been out of favour. It’s going to take a lot to make up the lost value that has been destroyed over the last several years.  We’re in the process of recovering that value,” said Mr Foster.

“Even though gold stocks are up from 2013 levels, with some stocks up some 30% or so this year, we think they’ve got a long way to go to reach fair value. Valuations still look very attractive to us now.”

Mr Foster said several factors could help support the gold price over the coming year, which has formed a solid base around US$1200 per ounce.

“Gold continues to trade in the US$1200 per ounce to US$1400 per ounce range and we maintain our view that the price has established an important base. Fundamentally, Chinese demand is expected to increase, and lower costs of production, heightened geopolitical risk and an absence of persistent bullion exchange-traded product (ETP) selling are helping to support the gold price at current levels,” he said.

“People are worried about events in Iraq, Gaza and stability in the Middle East generally. Ukraine remains unstable. We expect these uncertainties and conflicts to continue to underpin the gold price throughout this year and next,” he said.

“In the US, financial-market and monetary policy risk remain. In the current low-growth recovery the US Government has piled up trillions of dollars of debt that looks like it is here to stay. We like to think of gold as a hedge against irresponsible policies from Washington, D.C. and possible asset bubbles or inflationary pressures, particularly,” Mr Foster said.

According to Mr Foster, M&A activity will likely rebound with any further gains in the price to US$1400 per ounce, which could positively impact Australian gold miners.

“I think M&A will continue at relatively low levels, as long as the gold price remains at current levels. If we get a move through US$1400 an ounce and we see a more positive trend in the gold market, I would expect to see M&A activity start to heat up as valuations rise and higher takeover offers are made for gold miners,” he said.

“In the first quarter, we saw a hostile takeover attempt.  This underscores  my point that the takeover target, Canadian miner Osisko, wasn’t willing to be purchased at current valuations.  The acquirer, Goldcorp, had to go hostile.

“Osisko, in the end, was taken over by a combination of two companies, Yamana and Agnico. Again, takeover activity has been at low levels because companies aren’t willing to be taken over at these low valuations as this struggle indicated,” Mr Foster said.

“We haven’t seen much on the mega-merger front in recent times because a lot of that activity has already occurred; these companies are already at a very large size. In fact, there was recent news about changes in top management at Barrick. Barrick is the largest gold company in the world and we think that they realise that this mega gold company model might not be the best way to run a gold company.

“We could see changes at Barrick that reflect what we’re talking about, the fact that some of these companies have gotten too big for their own good,” Mr Foster said.

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Gold looking to improve price

Several factors could support further increases in the gold price for the second half of 2014, according to Joe Foster, Portfolio Manager of Van Eck Global’s gold strategies.

Speaking on the outlook for gold recently, Foster said geopolitical risks, and lingering concerns about developed economies could favour the gold price over the coming months.

“Geopolitical risks in emerging markets have probably been the main driver of gold this year. Investors’ concern of political unrest and a possible contraction in Thailand, Venezuela, Ukraine, and Turkey has led to an outflow of capital. With no resolution in sight for many of these countries, we think these geopolitical risks will continue to underpin the gold price throughout the year.

“Economic growth in China and its banking system is also a concern for investors. After clocking double-digit growth rates over the last three decades, China’s economy has slowed as the government repositions activity to rely more on domestic demand. Despite those efforts, China’s first-quarter annualised growth rate of 7.4% was the lowest level in 18 months. Any further signs of a slowdown in China could create financial risks that drive investors to gold,” Mr Foster said.

According to Foster, changes in gold demand in India and China could also generate further gains in the gold price.

“In the second half of 2013, gold demand out of India dropped off significantly because of exchange controls and import restrictions that were placed on the Indian gold market. There are talks this year about India reversing or relaxing many of those controls. If so, that could be another catalyst that could move gold prices higher later in the year.

“As for gold demand in China, in a recent report the World Gold Council predicts that its will remain flat in 2014. While some analysts have put a negative spin on this, we see it as positive for gold. Last year saw unprecedented demand as the Chinese stepped in to take advantage of the collapse in gold prices. Demand that approaches similar levels this year would still be very supportive of gold. The Gold Council further reckons that Chinese demand will rise about 25% in the next four years, which would likely be another significant factor supporting its price,” Mr Foster said.

“The current US recovery is now longer than the average for post-World War II recoveries, yet growth has been half the average and unemployment has never been higher at this stage in past recoveries. The withdrawal of US Fed stimulus may have unintended consequences, putting further pressure on a weak US economy. Gold could respond favourably if the Fed finds it needs to reverse its tapering initiative.

“On a more positive note, we believe valuations on gold stocks are very attractive. Mergers and acquisition activity is on the radar for gold miners around the globe, including those in Australia. Assets are the cheapest they have been in years and bigger gold miners will be considering their options,” Mr Foster said.

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It seems all it takes is a little volatility to get the bulls running for the hills. Gold has been especially volatile this year.

After rising as much as seven-fold from 2000 to 2012, the yellow metal is down 17% this year to date. It’s been a disheartening year for investors in precious metals, and a recent survey by the American Association of Individual Investors (AAII) recorded bullish sentiment dropping from 49% to 29%, in two weeks.

Click here to view the full commentary.

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Gold fundamentals remain strong

Investors questioning the portfolio implications of the recent volatility in gold and gold-related assets have been reassured by Evy Hambro, Chief Investment Officer of the BlackRock Natural Resources team.
 
Gold prices dropped approximately 12% (from US$1565/ oz to US$1377/ oz) between 11 April and 16 April 2013.
 
In a conference call with investors Mr Evy Hambro, Chief Investment Officer of the BlackRock Natural Resources team, said: “In essence what we have seen here is the outflow of the ‘hot money’ that was in the market.
 
“The recent series of trades is the main reason for the move in the price.
 
“However in terms of the overall role of gold in the portfolio as a long-term play, the fundamental drivers have not changed. People taking longer, more traditional positions are not likely to sell.”
 
In considering the value of gold stocks, Mr Hambro said: “Recent events will give greater traction to gold managers who are moving to a more shareholder friendly way of doing business, keeping costs down, not dropping cutoff grades and not using high prices to calculate worth.
 
“As far as BlackRock is concerned, these are the companies we have invested in and as a consequence have outperformed materially in the recent gold selloff, during which we trimmed our holding considerably.
 
“We would not be looking to, or expecting to see, much forward selling because we’re now close to the spot price. In fact, we put some cash to work yesterday to take advantage of the low price.” 
 
Mr Hambro also made the following points:

• It is thought the equivalent of 100 tons of gold futures were sold last week, followed a few hours later by a trade of some 300 tons, likely due to programmed trades kicking in following price drops. While still positive in long positions, the shorter term market became bearish from that point. At the same time the market saw a sharp rise in the physical gold premium, including in demand from traditional markets in Shanghai and India as well as some less traditional pockets in the developed world – although there has been no visible central banking activity on this front.
• Profits have been taken in the past two months, prior to the most recent sell-off, as evidenced in redemptions from hedge funds.
• Current prices leave gold trading close to the marginal cost of new supply, putting it more in line with the pricing structures prevailing for other commodities such as aluminium, zinc and so on.
• The gold companies that have responded positively to investor demands to improve practices, including acceptable leverage and realistic valuation levels (closer to US$1000/ oz), are unlikely to be severely affected by the current situation and in fact will be well positioned to maximise the benefits of a recovery.

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Gold could lose its shine

Ric Spooner from CMC suggests that  platinum may  recover ground against gold in 2013.

2013 should see platinum recover ground after falling to a 16 year low against its golden counterpart according to CMC Markets’ Chief Market Analyst, Ric Spooner’s annual outlook on the commodities market.

According to Mr Spooner, the combined news of a reduction in annual production of platinum, and a forecast of the greater demand for platinum at this stage in the industrial cycle could see prices surge in 2013.

In mid-January Anglo American Platinum announced that it will cut annual production by 400,000 tonnes, an amount that equates to 7% of the world’s production, creating a substantial supply deficit. With an upturn expected in the industrial cycle, and therefore greater requirements for platinum, Mr Spooner believes that platinum will surge, particularly against its gold counterpart.

Mr Spooner also highlights the potential for industrial disputes such as that which occurred in South Africa as a potential threat for production which could also drive prices higher.  “Ageing mines in South Africa which are subject to considerable political risk are a major supply source for platinum. This came into play in recent months when strikes disrupted mine production,” said Mr Spooner.

Production levels
As a scarce metal, current mining production has a much greater impact on the demand supply balance for platinum than it does for gold according to Mr Spooner. Annual mine production is only a small proportion of total stocks in the gold market.

The industrial cycle
Demand for platinum centres much more on industrial uses and much less on investment than in the gold markets, with its main industrial uses being auto exhaust systems, electronic switching and glass manufacture. 

Figures from the World Gold Council and Johnson Matthey show that the proportion of platinum used for industrial purposes is six times greater than gold. This, according to Mr Spooner, means that platinum is more sensitive to the industrial cycle than gold, falling more heavily when industrial production declines as it did in 2008 and 2011 but rising more when the economy recovers.

Monetary policy
Financial commentary often assumes that the end of quantitative easing and higher interest rates will be bearish for commodities. 

Spooner expands, “While there is typically a short term negative reaction to the Fed withdrawing stimulus, the fact is that monetary tightening cycles are very often associated with bullish cycles in commodity markets.  This is because the Fed begins to tighten when economies start to improve. 

In the earlier stages of tightening cycles, improving industrial demand outweighs the negative impact of lower commodity investment demand and possible strengthening in the US Dollar. Indeed during the last two Fed tightening cycles in 1999/2000 and 2004/2006 we saw broad increases in the S&P GSCI Commodity Index.”

Trading prices
Today an ounce of platinum buys approximately an ounce of gold according to Mr Spooner, only slightly higher than the low of .86 in August.  The recent mine strikes and more optimistic economic outlook have seen the ratio climb off this low but not enough to break through lower resistance levels, according to Mr Spooner.  

He added “It may only take the markets to become a bit more optimistic about industrial production and motor vehicle sales for platinum to recover ground against the gold price.  I expect that confirmation of reduced mining production could fuel this recovery.”

Implications for traders
Mr Spooner suggests that it could be a long while before markets return to a situation where an ounce of platinum buys 2.36 ounces of gold as it did in May 2008, however it expects traders to increasingly look to a ‘buy platinum; sell gold’  trade, known as a pairs trade.   In such trades the trader does not have an exposure to the overall precious market but will profit if platinum outperforms either by rising more than gold in a bull market or by falling less in a bear market.

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Greece has only 2% of Eurozone GDP and 3% of its debt, but its significance is as a member of a group of economic laggards known ironically, and perhaps appropriately, as “PIIGS” (Portugal, Italy, Ireland, Greece and Spain). These omnivores all suffer, in varying degrees, from overconsumption and sovereign debt indigestion! 

Germany and France have both affirmed Greece’s place in the Eurozone, making clear their commitment for a bail out program to calm fears of a contagion. For its part, Greece committed to abide by conditional austerity measures, whilst Italy, the largest of the PIIGS, faces a decisive vote on budget cutting measures of its own. 

A more solvent group of nations with their own acronym – the “BRICs” (Brazil, Russia, India and China) meet next week in Washington to discuss what role they might play. 

The Greek Drama will continue to play out over the next several weeks. Is there enough political will to rescue Greece from default or let it fail? More importantly, can European and world leaders steer the region towards solvency? 

Recent days have been signs of that leadership emerging with quieter markets. Any positive moves should send strong signals to restore lost confidence. What does this mean for our resource-based fund? 

The gold “disconnect” is a result of this uncertain environment. Investors have preferred physical gold, the traditional safe haven and currency hedge, to gold-based equities. Indeed, the price of gold has almost doubled since early 2008 while HUI index, measuring unhedged equities, rose by just 22%. Proven reserves of gold have been available for c. US$500/oz – a quarter of the physical price! 

This pattern now seems to be reversing. For example, on August 10th, the DOW dropped 4% with gold stocks rallying 3% and on September 7th gold lost over 3% while gold stocks actually rose by 0.33%. We expect this pattern to strengthen, with a number of funds and institutions beginning to transfer from bullion into equities, with the best potential gains with the smaller cap “junior” stocks. 

The gold commodity/equity disconnect is nothing new and historically the subsequent reversion tends to be swift and dramatic.

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Why the historical fascination with gold
Gold has long been a source of fascination for mankind. The interest in gold dates back thousands of years to when advances in farming led to surplus food, and eventually the growth of prosperous civilisations. Around this time gold became valued as a medium of exchange, as a store of value, and as a display of power and status.

Over the centuries it has acquired a status beyond its industrial use (which is now trivial) because it is attractive, malleable, ductile, resistant to corrosion, a conductor of heat and electricity, fungible, scarce and dense. This range of properties has helped drive demand for it as jewellery, as a medium of exchange or money and as a store of value. Today some see it as the only truly safe way to store wealth as it is highly liquid, portable, accepted globally and lacks any credit or counterparty risk. Further, some see the decision to break the link between gold and paper currencies as being the undoing of the global economic system, By contrast it’s seen by others as a barbarous relic with no real value beyond its beauty and use in jewellery.

A long term perspective
Until the early 1970s, the US dollar was fixed against gold. This was subject to periodic devaluations, such as in 1934. From the early 1970s to 1980 gold was in a secular upswing as investors turned to gold for protection against inflation. However, from 1980 to 1999 gold was in a secular downtrend as inflation was brought under control. This decade has seen gold enter another secular upswing in line with other commodities.

What’s driving the gold price higher?
Gold has benefited from the general rise in commodity prices over the last decade, driven by rapid emerging world industrialisation, constrained commodity supply and a fall in the $US (which benefits commodities as they are mostly priced in US dollars). However, a range of specific factors have also been at play in the case of gold:

• First, some have been buying gold as a hedge against inflation on the basis that quantitative easing in the US and elsewhere (which involves using printed money to buy financial assets – notably government bonds) will generate higher consumer price inflation.
• Second, gold is seen as a good alternative to major currencies which are at risk thanks to high public debt levels and quantitative easing. While the focus has been on the US dollar, where the supply of dollars is increasing thanks to quantitative easing, the outlook for other major currencies is not much better. Europe’s economy looks worse than the US and its debt problems are threatening to tear it apart. The Bank of England looks likely to also engage in another round of quantitative easing. The Bank of Japan is likely to intervene further to stop the Yen rising. Switzerland is already doing the same. The Chinese Renminbi is not really an option as it’s not convertible and China is limiting its rate of appreciation. This leaves the commodity currencies such as the $A (which is a separate story) and gold as potential safe havens.
• Third, central banks in emerging countries are buyers of gold as part of a strategy to diversify their foreign exchange reserves away from the $US.
• Fourth, fears of another financial meltdown on the back of European debt problems have increased, and some see gold as a hedge against this risk.
• Finally, the opportunity cost of holding gold versus cash or government bonds as an alternative store of value is continuing to collapse. The Fed has signalled US interest rates will stay near zero into 2013, no increase is on the horizon in the UK and the ECB will likely cut its short term interest rates to near zero. Government bond yields in developed countries are averaging around 2% or less. So with cash and bond yields so low the missed income from holding a non-income producing asset like gold is very low.

Can it continue?
First, the negatives.  After rising 34% year to date to $US1900 an ounce, gold has become technically overbought and due for a pullback. Adding to the risk, investor interest in gold is very high – evident in net speculative positions in gold running at high levels, which is negative from a contrarian perspective. (Bear in mind speculative positions in gold have been high for two years and it hasn’t stopped the gold price rising to record highs.)

What’s more I do not believe inflation is about to take off – there is too much spare capacity in the US, Europe and Japan and too little pricing power. And while narrow money measures have surged in the US, until banks lend this out & spending returns to normal, inflation won’t be a problem.

What’s more, the gold price is trading well above its normal margin above its cash cost of production. A normal margin would imply a price of just below $US1000 an ounce.

Finally, there is also a risk that in the event of another global financial meltdown, the gold price could fall as investors are forced to sell their liquid assets to cover losses elsewhere –as occurred in second half 2008.

However, the medium term picture remains positive for gold. Global interest rates look set to either remain low or go even lower keeping the opportunity cost of holding gold down. The outlook for the $US and other major currencies remains bleak given the prospect of more quantitative easing and ongoing debt problems in Europe. And of course as long as monetary policy remains easy, demand for gold as an inflation hedge will likely persist. 

For some time we have seen gold as a prime bubble candidate, and this seems to be unfolding thanks to a loss of confidence in major paper currencies, the low opportunity cost of holding gold and the ease of access to investing in it thanks to gold exchange traded funds (vehicles listed on share markets that buy exposure to gold). This likely has further to go in the years ahead as major countries continue to debase their currencies. But if gold does go on to become a bubble, like all bubbles it will eventually burst.

Investing in gold
There are numerous ways to get exposure to gold, all with their pros and cons:

• Physical gold – gives pure exposure but costly to store.
• Gold futures – no storage problem and easy to leverage up but need to role futures contracts over as they expire.
• Gold exchange traded funds – these are highly liquid but do involve counterparty risk.
• Gold shares – these reflect the movement in gold prices but are also affected by the performance of the individual companies.
• Gold funds are offered by fund managers that provide an exposure to gold – these may reflect a combination of the above.

It’s worth stressing that gold is highly speculative. It’s not grounded by an income stream like most shares, property, bonds and cash. Virtually all the gold ever produced still exists and can potentially come back on to the market. At the same time, actual production and demand for jewellery and industrial use is trivial relative to the huge gold stock.

As a result, ‘animal spirits’ can play a huge role in the determination of the gold price. This can make for a volatile ride over time and history has shown that just as the gold price goes through long term upswings, it can also go through long downswings. So, overall we think there is a role for gold in investors’ portfolios as a hedge against major currency weakness and financial turmoil, but it should be limited to maybe no more than 5% (depending on an investors’ circumstances).

Concluding comments
Gold is vulnerable to a correction but the trend is likely to remain up as global interest rates remain low and scepticism about paper currencies remains high.

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For example, while spot gold prices surged 74% in the period December 2008 through end May 2011, unhedged spot gold returned only 14%. This is because a rise in the value of the Australian dollar eliminated much of the benefit of the rising value of gold (which is priced in US dollars).

Drew Corbett, Head of Investment Strategy & Distribution at BetaShares said that while gold demand is currently at unprecedented levels, many investors do not realise that a historical relationship exists between the price of gold bullion and the Australian dollar.

“By analysing the movements in the gold spot price and the AUD/USD exchange rate we have found that, generally speaking, over the last 3 decades, when the price of gold bullion has risen so too has the Australian dollar relative to the US dollar,” he said.

“Gold is widely regarded as a currency in its own right and thus, during times of US dollar weakness, gold often increases in value as many investors choose to own gold rather than US dollars. Similarly, the Australian dollar is also likely to strengthen during times of US dollar weakness. In addition, Australia’s role as a major producer of gold and other commodities means the Australian dollar is seen globally as a “commodity currency”. Accordingly, strengthening prices for commodities (including gold) have a tendency to push the local currency higher.”

“The tendency for gold and the Australian dollar to move together has negatively affected local investors with unhedged exposures to gold. At BetaShares, we recognised this relationship and listed the first currency hedged gold ETF on the market,” said Mr Corbett. “If the US spot price of gold rises 10%, investors in the BetaShares ETF can expect a 10% gain, too, before fees and expenses.”

“If an investor has a bullish view on gold, it is our view that investors should look for pure exposure to gold which necessarily involves hedging the currency” Mr Corbett concluded.

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