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Gold: Will the Rally Continue?

29 January 2016

It’s been another positive week for precious metal investors, with the gold price comfortably pushing through USD $1100 an ounce, whilst silver has also strengthened, currently trading near USD $14.50 an ounce, up a further 2% for the week.

If the metals can hold onto their gains for the entire week, it will cap a very strong January 2016 for the sector, with both gold and silver up 4-5% for the month, a performance that is even stronger on a relative basis, when one considers the substantial decline we’ve seen in equity markets, and the broader commodity complex so far this year. 

In Australian dollar terms, it’s been an even better start, with a decline currency pushing gold in Australian dollars toward the $1580-$1590 an ounce level, up some 8% for the first month of the year. 

With the ASX again floundering below 5,000 points, it is no wonder we’ve seen a noticeable pick up in interest amongst new bullion buyers in the last three weeks, as well as topping up from long-standing clients who have held core allocations in the metals for some time.

That buying interest is clearly being seen across the world, with strong demand at the retail level for gold and silver coins, a pick up in gold ETF buying (which we covered last week), and renewed interest from institutions and self-directed retirees, who are rediscovering their appetite for bullion.

Trading in Asia has been steady, though could well slow down in the run up to the Lunar new year holiday, which takes place in early February this year. Price sensitive in the extreme, buyers in India and China may also be holding back due to the rally of late in metals prices, hoping to pick up metal on any pullback, were one to eventuate, with the Shanghai premium over loco London heading towards $2.50. 

In this week’s market update, we’ll again take a look at the precious metal complex from a technical perspective, to see if this rally is likely to peter out soon, or can continue pushing higher.

We’ll also take a look at some of the latest developments in the gold market, looking at an update on German gold repatriation, Chinese gold demand, an interesting read on gold, Bitcoin and financial technology from the Alchemist, the LBMA’s regular publication on all things precious metals. We also share a report into the Financial economics of gold, which has a host of interesting charts and data in it. 

Before that though, we’ll share a couple of quick charts and thoughts on the global economy, and developments that have caught the eye this week. 

Economic Update

The main market focus this week was obviously the Fed, who surprised no-one by keeping interest rates steady at the latest FOMC meeting. Clearly rattled by the extreme financial volatility we’ve seen in the first 4 weeks of 2016, the market is now openly questioning the suggestion that we’ll see a further 4 interest rate hikes in 2016. The Fed itself did note that “economic growth slowed late last year”, which does make one wonder why they hiked at all in December 2015, especially with official inflation so low and commodities crashing.

Skepticism regarding the ability of the Fed to hike rates again this year will only have strengthened overnight with what can only be described as a horrendous durable goods result out of the United States.

The market was expecting a decline of 0.6%, but the actual result was far worse, with durable goods orders for December falling 5.1%. The less volatile, and more closely watched durable goods ex transports number also fell, coming in at -1.2% for the month, a terrible result when the market was expecting this number to more or less come in flat.

Expressed visually (thanks to Zerohedge), we can see that durable goods orders have seen a slower rate of growth for the past year or so, and that indeed there has been a weakening trend dating back to late 2010. 

Chart1

Some recovery – and it’s no wonder Caterpillar sales continue to plumb new lows, with the company seeing a decline in year on year sales for 37 months now, which is double the period they saw year on year sales declines during the GFC.

We also read with interest an article in Bloomberg this week, which looked at the $29 Trillion debt binge corporates have been partaking in, which has left many companies more indebted than ever, and which exposes the folly of those who argue corporates have never been in better health due to the level of cash on their balance sheets. Most interesting, and alarming, is rising corporate leverage, which company debt to earnings ratios now at a 12 year high, as you can see in the chart below.

Chart2

This is not getting as much attention as the recent sell off in commodities and equity markets, but there is a growing risk in this area as well, with the spread between yields for highly rated debt vs. government bonds hitting its highest point in 3 years, according to Bank of America Merrill Lynch.

Corporate debt, and leverage ratios can be added to the list of things that have worsened since the onset of the GFC, and the emergency measures enacted by policymakers across the globe. 

Technical Update

with John Feeney

Volatility in stock markets around the world continues, though we expect a temporary bounce in US stocks purely from being short-term oversold on a technical basis.

We have seen some of this since last Friday, but the ASX is still below 5000 and the S&P 500 is still below 1900, and despite some sort of bounce expected, it should be met with a lot of selling. 

I think the overall sentiment towards US equities has completely flipped from ‘buy-the-dip’ to ‘sell-the-rally’, even with the more cautious Fed tone, so it will be interesting to see if this is indeed the start of the next sustained bear market in US stocks.

We’ll take a look at the daily USD gold chart below and the rally has continued since last week. We saw USD gold reach as high as $1,127 an ounce, but we are approaching what has been a level of strong resistance in the past few years which is the 200 day moving average. You can see that as the green line on the chart below, titled MA (200).

The next test for gold therefore will be to see if we can comfortably clear the 200 day moving average and stay above it for some time.

If this can occur it will give more confidence to those looking for gold to put in a meaningful bottom, as opposed to a short-term bounce, and would be a very positive development. It would also scare a lot of remaining speculators out of their short positions, which in and of itself will give another boost to prices. 

Chart3

German Gold Update 

Precious metal enthusiasts will be well aware that Germany, alongside other European nations like Austria, the Netherlands and Belgium, has decided to repatriate a decent portion of its national gold reserves back to Frankfurt, decreasing the amount of metal they store in the United States, France and England. 

This is a process that begun a couple of years ago, though the entire repatriation process is not due to be completed until 2020, at which time the Germans are expected to keep more than 50% of their reserves within their own borders.

Why the entire process is taking years at all is of course the subject of much controversy, which we will not delve into today, though it was worth briefly mentioning that as at the end of 2015, the Bundesbank was already the largest holder of German gold, as the following chart from Bloomberg shows. 

Chart4

Repatriation movements, where developed market sovereigns are attempting to minimise the amount of gold they have stored in other countries, has of course begged the question of whether Australia should do the same.

Some argue that the RBA should move the circa 80 tonnes of gold it owns back to Australia, rather than keep it stored overseas, with the Bank of England the current custodian of our national treasure.

Much as I see merit in this proposal, I’d much rather see the RBA increase its overall allocation to gold, which could be easily achieved within Australia itself, considering the volume of gold we produce and refine domestically.

If the RBA wanted to quadruple its gold exposure to say 320 tonnes, it would merely need to buy one whole year worth of domestic mining production, though of course that would not be the way to go about it, with it making sense to stagger purchases over a handful of years, as other central banks are doing at this very moment.

And whilst the idea of quadrupling our gold reserve might sound far-fetched, that kind of figure would still leave our national gold holdings at a lower level of net reserves compared to the percentage gold made up in the late 1990s, when the RBA decided to auction off the majority of our then gold holdings.

If the RBA were to do this, I’d be in full support, as would the Australian gold industry I’d imagine. It would also obviate, or at least largely reduce the need to repatriate existing gold holdings, not that that is a bad idea in anyway.

Of course, increasing our national gold holdings is not something that would appear to be on the agenda of the RBA, though we do think its only a matter of time before developed market sovereigns join their emerging market counterparts in the gold acquisition game.

We’d love to see Australia lead the charge. 

Chinese Gold Demand

Precious metal afficionados will be well aware of the work of Koos Jansen, who has become one of the world’s leading authorities on Chinese Gold Demand. He’s been at it again recently, publishing a great presentation which looks at the discrepancies between the World Gold Council figures for gold demand, and those that can be inferred by looking at withdrawals from the Shanghai Gold Exchange (SGE), as well as other sources.

One of the most interesting points raised is of course to do with whether or not the PBOC buys gold through the SGE, with Koos stating that they do not, and that the PBOC:

  • Prefer to buy gold with USD
  • Prefer the OTC market for privacy reasons
  • Are likely buying 400oz (12.5kg bars), which are rarely traded on the SGE

Statistics regarding net exports of gold from London over the past few years were also interesting, with nearly 3,000 tonnes of gold leaving UK vaults over that period, much of which has no doubt made its way into China, via refineries in Switzerland, and intermediaries in Hong Kong.

The presentation can be viewed in full here for those interested, with a handful of other fantastic charts and data contained within. 

The Alchemist

More of a trade publication for those working in the physical precious metals industry, the Alchemist always contains interesting articles re the mechanics of the precious metal market, and developments within the industry.

The latest edition, which you can access here, is no exception, with an interesting read on the Gold, Bitcoin and Financial Technology. I don’t agree with it all, and have written articles in the past warning on the dangers of Bitcoin (as an investment that is, I have huge faith in the power of Blockchain technology).

For those interested in something gold related, if not directly to relevant to gold prices, then I’d suggest you click here. You’ll find the article on page 14.

The Financial Economics of Gold

Long read of the week, and definitely the final share, can be found at the following link, which contains a 60 page PDF download on the Financial Economics of Gold. 

It contains a handful of great charts, plotting the rise of ETF investment in gold, the relative turnover in various gold markets (London OTC vs. COMEX and Shanghai), and some excellent information regarding research into the role gold can play in a portfolio.

This is something we’ve been working on internally in the last couple of months, with ABC Bullion set to publish some detailed research into the gold market (its physical characteristics, investment fundamentals and practical tips for investors) in H1 2016, though our findings will have a distinctly Australian feel to them.

One of the more interesting charts in the paper was the first one, which simply plotted how many gold related articles appeared in the Financial Times in any given year. I have included it below, and as you can see, gold as a topic would appear to have been as uninteresting a topic in 2014 as it was in 2004.

Chart5

Of course, those who bought boring old gold and silver back in 2004 have done quite well with their investment. I’m quietly confident that those who maintain, or add to their positions in 2016 will be just as happy, when we look back on market developments several years from now.   

Until next week

Warm Regards

Jordan Eliseo

Disclaimer

This publication is for educational purposes only and should not be considered either general or personal advice. It does not consider any particular person’s investment objectives, financial situation or needs. Accordingly, no recommendation (expressed or implied) or other information contained in this report should be acted upon without the appropriateness of that information having regard to those factors. You should assess whether or not the information contained herein is appropriate to your individual financial circumstances and goals before making an investment decision, or seek the help the of a licensed financial adviser. Performance is historical, performance may vary, and past performance is not necessarily indicative of future performance. Any prices, quotes, or statistics included have been obtained from sources deemed to be reliable, but we do not guarantee their accuracy or completeness. 

JE