Supply side is tight, looking positive for price of metal
My first gold-related article for the Financial Mail (“Return of a golden age”) was published in August 2001 and my most recent contribution about it was 11 years ago, so I guess the time has now come to resurrect the subject.
The first article was inspired by my belief that the 21-year bear market in gold had ended, primarily as a result of the signing of the Washington Agreement, which restricted the 15 central bank signatories to total annual sales to 400 t. It effectively put 85% of official gold holdings out of play.
The bullion market had been fighting the head winds of hedge fund short-selling and forward gold sales by producers, but these activities became less attractive as the yield on US treasuries had shrunk from 6% to below 4%. Diminishing yields made short-selling less profitable and more dangerous (smaller margins of error) and forward sales less compelling, the one-month forward rate having fallen from 5,8% to 1,6% during the course of 2001. Exchange traded funds (ETFs) had yet to be invented, but the market had absorbed the unravelling of a large speculative long position in the gold futures market, and this was ending.
A major obstacle masking gold’s charm as a store of value was the inexorable rise of the US dollar, which, on a trade-weighted value, had climbed 25% between 1995 and 2000 and added a further 11%, to reach a 15-year high, by mid-2001. Does this pattern not seem familiar today?
The euro recently hit 1,08 to the dollar, a 12-year low, and the yen has fallen from 76 to 120 to the dollar in the past 3½ years. These days mines generally don’t sell forward — it upsets their shareholders — and hedge funds have lost too much of their bravado to short gold seriously. As for central bankers, the shocking exchange in 1999 by Gordon Brown (the then-UK Chancellor of the Exchequer) of over half of the Bank of England’s gold reserves for US dollars, has made disinvestment a rather unfashionable activity. The pretext proffered for this move was that gold had been a bad investment. The price was $280/oz at the time. In fact, central banks have been net buyers of gold for the past five years and have added a total of 1 430 t to their reserves in the past three years. I just wonder how long it will take the public to cotton on to this change in trend, or are they perhaps better informed than bankers?
The assumption that central banks prefer gold to the fiat money of other countries may, in part, lie in the thought that it takes less than an hour to print the cost of a ton of gold ($38,4m) — in $100 notes — less time than it takes some underground miners to reach the stope face.
The principal arguments put forward by the current pack of gold disbelievers are: the strong US dollar, the probability of higher US interest rates and the absence of inflation in America. These are beliefs that held water 30 years ago.
At present the US accounts for just 10% of physical gold demand while emerging markets absorb 70% of this market.
In the latest news letter from the much respected World Gold Council, it is highlighted that the gold market is moving steadily from West to East and the importance of the dollar price of gold is diminishing.
They also note that global reserves of US dollars have fallen from 66% in 2000 to 55% in 2015 and that this trend is likely to continue as the world adopts a more multicurrency model. Interest rates are going to stay low longer in the eurozone and Japan than in the US, where inflation is still benign. The same cannot be said of many of the emerging markets.
Gold production is flat at present, but is due to decrease given that the average all-in cost of production is presently estimated by GFMS to be $1 208/oz. Above-ground sources from central banks, ETFs and recycling are drying up. ETF holdings are 1 759 t, down 34% from their peak, and gold recycling is at a seven-year low. Thus the future supply-side of the equation looks increasingly tight and positive for the gold price.
Demand also looks looking healthier. Jewellery and technology now account for 60% of total demand. Emerging markets devoured 70% of last year’s gold supply, India and China together absorbing 47% of this. Since emerging countries’ consumer markets are the fastest growing, the future for gold demand seems in good hands.
Global stock markets and the US dollar are both looking expensive: should either falter, gold’s reputation as a store of value would surely be enhanced. Finally, lest we forget, the world is not getting any safer.
The last major bear market (January 1 1980-April 1 2001) contained three bear phases, each lasting just over five years. Since the current bear run on gold is of less than 3½ years duration, my thoughts of a reversal may be premature but things do tend to move faster these days.
Jewellery and technology now account for 60% of total demand