Gold & Precious Metals
Gold Miners are Dirt cheap, not only compared to other sectors. Relative to Gold they are at the lowest level since 1942. The Gold Bugs Index is valued at a mere USD 55 billion. Compared to the S&P 500, this market capitalization is tiny, amounting to 0.3% of the index.
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Strengths
- Although gold was down for the week it was the best performing precious metal. Perhaps gold was underpinned by the news that China added the most to its central bank gold reserves in five months, according to Bloomberg. Gold prices saw the biggest drop in more than two years, plunging 6.8 percent in November. Data from the People’s Bank of China (PBOC) this week shows the value of gold assets at $59.52 billion at the end of last month.
- Shanghai Gold Exchange withdrawals could be heading for a record year, says Lawrie Williams. Total withdrawals so far this year have amounted to a little under 2,405 tonnes, and with four more weeks of withdrawals still to come, Williams notes that this year’s total could be heading for the high 2,500s. This would be nearly 400 tonnes more than in the previous record year.
- South Africa’s President Jacob Zuma fired his finance minister this week, and replaced him with a little-known lawmaker, according to Bloomberg. The South African rand plunged against the dollar on this news, causing South African gold miners to surge in reaction due to the margin expansion from a falling rand.
Weaknesses
- Platinum was the worst performing precious metal this week. Johnson Matthey noted that platinum remains more expensive than gold jewelry at the retail level in China and that could be hurting its demand.
- According to The Statesman out of Mumbai, the Sri Siddhivinayak temple in India is the first religious trust/institution in the country to respond to the government’s call to invest in Prime Minister Modi’s Gold Monetization Scheme. The institution had an initial investment of 40kg of gold from its chest. It’s clear that there is a continued political push to support the scheme. The Statesman article notes that the famous Mumbai temple has 165kg gold in its vault.
- Barnabas Gan, an economist at Oversea-Chinese Banking Corp., believes that gold bullion will drop each quarter to $950 an ounce by the end of 2016. Gan’s prediction puts gold at the end of 2016 about 12 percent below prices now, according to a Bloomberg article.
Opportunities
- Pessimism by hedge funds came at the wrong time last week, with money managers boosting their gold net-short position to the highest ever just prior to the precious metal’s biggest rally since September, according to Bloomberg. George Zivic, a New York-based portfolio manager at Oppenheimer Funds, thinks Yellen spoke a bit more dovish than people expected. “I think less people are now willing to take the long-dollar, short gold trade,” Zivic said. “It was a very crowded trade.”
- What will happen after the Federal Reserve hikes interest rates? According to Macro Risk Advisors’ (MRA’s) Daily Note, one chart that has been making the rounds, and shows average performance of the U.S. dollar after the Fed hikes, explains a lot. MRA explains that for the past six rate hike cycles, the U.S. dollar has traded lower on average after the Fed starts hiking.
- According to American-German researcher, historian, and strategic risk consultant F. William Engdahl, a gold-backed ruble and a gold-backed yuan could start a “snowball exit” from the U.S. dollar. Engdahl explains that if this happens it would “diminish America’s ability to use the reserve dollar role to finance overseas wars.” He adds that the irony here is the central banks of China, Russia, Brazil and others (that are opposed to U.S. foreign policy course), are forced to stockpile dollars in the form of “safe” U.S. treasury debt. More recent trade deals between China and Russia have specified that either the yuan or ruble would be used to settle balances and not the dollar.
Threats
- Bank of America’s metal analyst Michael Widmer says gold prices could end up falling below $1,000 an ounce in the first quarter of the year. Despite the painful forecast for the precious metal, BofA expects rising inflation in the second half of the year to be “supportive of the beleaguered market,” and says gold could jump to $1,250 an ounce in the fourth quarter.
- There seems to be a peculiar divergence emerging between the High Yield Index and the S&P 500 Index, which have previously followed one another closely. As of late, the High Yield Index has plunged but the S&P 500 has largely held up. While the energy sector has dominantly been the source of the stress, this discontent could easily spill over into the banks which lent the energy companies the money to drill. While the broad market has been flirting with all-time highs and gold prices already down significantly, the threat of a market correction could be buffered by rebalancing towards a higher precious metals exposure which is out of favor right now.
- On Friday, prices on junk-bond securities sank to levels not seen in six years, according to Bloomberg. Adding to the shocking news (which comes a day after a well-known Wall Street firm froze withdrawals from a credit mutual fund), billionaire investor Carl Ichan wrote the following on his Twitter account: “The meltdown in High Yield is just beginning.” Gluskin Sheff noted that the corporate bond default rate has jumped to 2.6 percent, the highest in six years, and is poised to rise further to 4.6 percent next year.
Like a rock tumbling down hill, oil prices have broken 40 dollars per barrel and sustained their downward momentum. Bearish reports ranging from the outcome of the OPEC meeting in Vienna over a week ago to supply outlooks from the International Energy Agency continue to weigh on the global crude market and have further dampening effects on global financial markets. Particularly equity markets look troubled with the notion of a diminishing global growth picture, and the prospects of a global recession come 2016. Not just limited to the aforementioned reasons, but markets remain on a jittery footing heading into the Fed meeting this week. It is remarkable how much can change in one short week as market participants exhibit signs of discontent with what’s in the pipe for the year ahead.
The greater probability though is not so much a fear for how North American markets will react to Fed actions next week, but instead what will result in the world’s emerging markets. South Africa reminded us this week that there are greater fears for emerging market (EM) investors than simply the price of the US dollar and commodity markets. Simply put, the commodity markets slump has put downward pressure on some of the world’s EM’s as returns are depleted and pressure mounts on government revenues. A strong US dollar also inflates the burden of US dollar denominated debt many of the countries and residing corporations have issued to finance themselves. But with the pressure of inflated interest payments and depleted revenues comes political risk.
With South Africa as the example, the Treasury and the Central Bank have long been viewed as stable and independent institutions. The benefit of an independent treasury is that it is an added pressure to government to restrain their finances and keep government debt in check. This all changed for the Republic of South Africa this week when the President Jacob Zuma fired his finance minister and replaced him with an unknown party insider. The Economist Magazine actually cited a spike in Google searches of the man’s name as people were unfamiliar with who would be taking the helm of the country’s finances. As the fear is this was a politically motivated decision, the rand, South Africa’s currency, in a swift reaction sold off 5 per cent against the US dollar despite sitting on multi year lows.
This is a critical time for emerging market economies. Also, given the demand from EM’s for precious metals, it has direct implications for the gold market. At the beginning of December Fitch Rating Agency downgraded South Africa’s debt to one notch above junk status. This is as Debt-to-GDP rose from 2009 until present time from under 30 per cent to just above 45 per cent. Political risks, whether from South Africa or any other nation, become more prevalent for investors and can change the dynamic of global markets.
This will likely reinforce a theme for the beginning of 2016 that the dollar, if not for investment opportunity in US markets, will be attractive for its safe haven and even more so liquidity status. It’s a challenge for commodity markets to counter trend a strong US dollar and as long as the outlook for EM’s is bleak, a strong dollar may persist. The global economy will be challenged in 2016, and objectively, remains one of the bearish factors weighing on the gold market.
Stage 4 bear markets are what create massive opportunities. Despite widespread pessimism, apathy, and derision towards the sector, gold and gold stocks present an extremely rare opportunity. Gold stocks are on track to record 5 years of losses starting in 2011 with the $HUI gold bugs index plunging 84% percent from 2011 to 2015. Gold is on pace to put in a 3+ year bear market with 3 years of losses. But the utter destruction in this sector is what has created an awesome opportunity. The only question is the timing of when this can be capitalized on
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