With gold prices down over $130 from its most recent high in March 2014 and only a little over $60 above the lows of June and December 2013 one has to wonder if there is another major bear drop to come. Gold remains down over $600 from its all-time (nominal) high of $1,911 seen in September 2011. This has played out against the backdrop of the US stock markets making ongoing moves to new all-time (nominal) highs. Gold as a result has become a “bad word” with some predicting that gold has much further to fall even as those committed to the “yellow metal” continue to believe holding gold is the right strategy.

So who is right? Despite the fall in gold’s price since September 2011, the fundamentals have not changed.

(Click on images to enlarge)

Despite the fall in gold’s price since September 2011, the fundamentals have not changed. Despite what many say, gold is not a hedge against inflation or deflation. It could perform well under either scenario. If gold is a hedge it is a hedge against bad government and currency depreciation.

Gold is an alternate currency and is currently the only alternate currency to fiat currencies. It is traded either beside or on the currency desks of major financial institutions. Gold has acted as a safe haven during times of financial stress. In countries that have experienced currency collapses, those who held gold were able to maintain their wealth and purchasing power. They could also have maintained their wealth through the holding of US$ as well. The US$ as the world’s reserve currency is still viewed as safe haven despite being a fiat currency.

Fiat currencies have no value other than what a government says they are worth. At one time, the world’s monetary system was backed by gold. That was scraped in August 1971 under former US President Richard Nixon. Since then money and debt have exploded. Today the world’s leading industrial countries are burdened with debt. Since the financial crisis of 2008, the debt burden has increased sharply for all countries particularly for the G7. The table below outlines various forms of debt to GDP ratio of the G7 countries that represent 63% of the world’s GDP.

• Public Debt is the total amount of debt owed by government to creditors whether domestic or external.

• External debt is the total of public debt plus private debt owed to non-residents repayable in internationally acceptable currencies, goods or services. External debt can be lower than total public debt. External debt is considered more important than public debt.

• All debt is the total of government public debt plus household debt, financial institutions debt and non-financial institutions debt.

• NA – Not available or not applicable

• Gold to GDP Ratio is the value of all of the available gold in the world at US$1,260 as percentage of total world GDP. Gold is estimated to make up less that 3% of all financial assets (stocks, bonds).

A public debt to GDP ratio of 100% or higher is a cause for concern. It is estimated that a public debt to GDP ratio above 100% could shave upwards of 1% off GDP. Since the financial crisis of 2008, debt is growing faster than GDP ensuring that the debt to GDP ratio should continue to move higher.

More debt usually means higher interest rates. However, the G7 countries have been using interest rate suppression in order to keep interest rates down. Interest rates in the G7 countries are for the most part below the rate of inflation. Negative interest rates are considered to be positive for gold. The ECB announced that they would be imposing negative interest rates on deposits in order to cajole banks into lending. The Euro fell in response to the move by the ECB. Negative interest rates could lead banks to also impose negative interest rates on their deposits.

World trade has been shrinking or at least slowing. According to the WTO world trade grew at a rate of 5.5% in 2011 but slipped to only 2.5% growth in 2012. World trade has been slowing further since then. This has been causing trade tensions between countries. Trade tensions can lead to competitive currency devaluations as each country seeks to gain an advantage for their exports. Trade wars in the 1930’s exacerbated the Great Depression. There was no WTO back in the 1930’s so it is hoped that with the WTO today it can lead to trade solutions before they become a problem. Global trade tensions are positive for gold because of the risk of currency devaluations.

Because of the cost of the global financial crisis of 2008 to taxpayers, governments are moving from bailouts to bail-ins as a means of bailing out banks in future financial crisis. What this means is that instead of taxpayer funds being at risk instead it will be depositors funds that are at risk. It is not expected to impact depositors who are covered by government deposit insurance. This is another factor that should be positive for gold. However, in order to avoid potential confiscation by governments as was seen in the US in 1933 gold should be held “off the grid” outside the banking system.

There has also been talk of seizing pension funds. No, they do not actually seize the funds. Instead, what happens is that pension funds particularly social security funds are obligated to invest only in government debt. This is currently occurring in Greece where pension funds will accept only Greek government bonds as an investment.

Global geopolitical tensions are rising. There is growing geopolitical tension between the West and Russia over Ukraine and growing geopolitical tension between the West and China over China’s actions in the South China and East China Sea. Numerous countries are facing social unrest and in Europe and even in North America there has been a significant rise in more extremist right wing parties and some left wing parties. It is the most significant rise of extremist parties since the 1930’s. Anti-European Union parties gained a number of seats in recent Euro zone elections. Growing global geopolitical tensions should be positive for gold as a safe haven.

Despite the positive fundamentals for gold, fundamentals that have grown stronger since the financial crisis of 2008, gold has not responded in a positive manner. Gold is down 35% from its 2011 top while the US stock markets are up 66% as measured by the S&P 500 in the same period. During this same period the US government debt has expanded by about 16%, the US monetary base is up 47% while GDP has grown only about 8%. US credit market debt for all participants has expanded roughly 8% while consumer liability debt has expanded 12%.

The stock markets have been driven higher on monetary expansion and low interest rates, which led to outflow of funds from bonds into the stock market. As well numerous companies rather than invest their excess cash reserves in plants and equipment that could result in job growth they have instead embarked on stock buyback programs contributing further to the rise in the stock market. But the rise in the stock market is not reflecting the reality of the economy. Economic growth in the G7 countries has at best been sluggish and at worst in an ongoing recession. The US reported that Q1 GDP contracted 1%. While many quickly blamed it on the weather, the reality is that after five years of quantitative easing (QE) the US economy is contracting not growing. The stock market appears to have started to churn a sign that institutional money is fleeing the stock market and moving back into bonds. While the S&P 500 has moved higher, broader stock market indices such as the Russell 2000 are down on the year.

In April 2013, a number of banks including Goldman Sachs, JP Morgan Chase and Morgan Stanley forecasted that gold was going to fall to $1,000. Over April 12 and 15, 2013 someone offered upwards of 500 tonnes of gold in the futures markets at the open resulting in a panic in the gold market as it fell $200. Gold has not recovered since. The perpetrators of the sell-off have never been identified. While there have been many theories about who it might have been there has been no definitive identification. Because of the size (estimated to be $23 billion at the time), there are few market participants that could carry out an operation of that size.

There have been numerous arguments presented as to who may have been behind the sell-off. Many have claimed that the sell-off was manipulation. The most identified players who may have been behind the sell-off are the Federal Reserve, China, or the large financial institutions that have been active in the gold market and may have been spooked by requests from central banks for the return of their leased gold.

For the longest time it was denied that manipulation occurred in the gold market. This denial persisted despite a number of large financial institutions being investigated and ultimately paying billions of dollars in fines for manipulation of LIBOR, currency fixing, energy price fixing and some commodity price fixing. Ultimately, price fixing was under investigation in the gold market particularly surrounding the daily London fix of gold and silver. The result of the investigation determined that there was price fixing occurring on the London gold and silver fix and fines have been imposed.

Not only have fines been imposed against at least one large financial institution, the 100 year old London silver fix is coming to an end in August and one bank, Deutsche Bank of Germany dropped out of the London fix process and closed its commodity trading desk and was in the process of selling its seat on the LME. In some of the financial institutions, traders were let go. This has ended speculation as to whether there is price fixing and manipulation in the gold market. As with the LIBOR market, the currency market and the energy market the large financial institutions have paid fines. The fines were paid with no admission as to guilt. Manipulation in markets is temporary phenomenon that while it works for a period the markets eventually revert to the mean.

During the 1990’s central banks leased their gold out to financial institutions. The financial institutions subsequently most likely sold the gold in the market thus creating what became known as the gold carry trade. It is estimated that this may have created a short position in gold of at least 14 thousand tonnes and possibly higher. This position would need to be covered if the central banks were to ask for their leased gold back. In August 2011, Venezuela asked for their gold back and in January 2013, Germany asked for its gold that was stored with the NY Fed back. Germany was told it could take upwards of five years to get its gold back.

More recently, the same financial institutions that were predicting a collapse in gold prices prior to April 12 and 15, 2013 have been once again predicting gold could fall to $900. Is that possible? The simple answer is yes. The weekly chart of gold shown at the outset shows both the consolidation following the September 2011 high and the current consolidation. Note the six-point reversal pattern. On the seventh wave, gold broke support at $1,525 resulting in the crash of April 12 and 15, 2013. The pattern has appeared as a possible descending triangle. A descending triangle usually has a generally flat bottom with a series of declining highs. The pattern was more prevalent on silver that did not break out to what appeared at the time new highs in September 2012. The breakout to new highs in September 2012 for gold turned out to be a false breakout but at the time, it was viewed as quite bullish.

Since the breakdown in April 2013, gold has formed what appears to be another descending triangle. The relatively flat bottom is seen with the lows of June and December 2013 near $1,180. So far using the same wave count as the earlier pattern gold appears to have completed four waves and the current decline may be the fifth wave. If the pattern holds, gold should not breakdown on this move. If it falls to the bottom of the range, a low near $1,190 may be seen. This zone is also where some other trendlines come in as well as the 400-week exponential moving average (currently at $1,205).

Assuming $1,190 holds on any pullback the key is how high will the sixth wave go? Resistance is currently near $1,350. A breakout over $1,380 and the 200-week exponential moving average would be positive and possibly break the pattern. If the market were to fail under $1,350 and return to the lows, the risk rises for a breakdown and close under $1,180/$1,190. If that were the case, the potential objective for the possible descending triangle is down to about $875.

On an encouraging note, the rally that took place following the December 2013 low was a strong one. The stochastic indicator during that rally went higher than it did during the July/August 2013 rally even though the price of gold did not go as high. That is a potentially positive divergence.

Two other charts are shown below that also offer some encouragement. The first chart is the Dow Gold Ratio. The Dow Gold Ratio has been rallying since bottoming in September 2011. Currently the Dow Gold Ratio is under its recent high of 13.7 but just. The pullback in the ratio seen in January/February saw the stochastic indicator go lower than it did in August 2013 even though the Dow Gold Ratio did not make new lows. This is a potential positive divergence in favour of gold. The Dow Gold Ratio may also be forming an ascending wedge triangle, which is normally bullish once it breaks under 12.25 (and back under the 400 week exponential moving average currently at 12.39).

Charts created using Omega TradeStation 2000i. Chart data supplied by Dial Data

The second chart is the Market Vectors Gold Miners (GDX-NYSE). Here too the GDX made higher highs on the stochastic indicator during the January/February rally than it did during the July/August 2013 rally even though the GDX did not make new price highs. Again, this is a potentially positive divergence. The significance of these divergences on gold, the Dow Gold Ratio and the GDX suggests the next low for gold could prove to be important.

harts created using Omega TradeStation 2000i. Chart data supplied by Dial Data

The fundamentals for gold remain positive. The positive fundamentals are being offset, however, by potentially bearish technicals. This is a condition that appears to have existed prior to the April 2013 meltdown. There are some positive signs but gold needs to take out key areas to the upside. The important points to take out are at $1,350, $1,380 and especially above $1,430 the high of August 2013. The danger is that Goldman, JP Morgan and Morgan Stanley’s bearish forecasts prove correct and gold does breakdown and close below $1,190 on a weekly or monthly basis. If that were to happen it would most likely set up gold’s final low. The next few months could prove to be important for gold’s future direction.

###

David Chapman
email: david@davidchapman.com
website: www.davidchapman.com

David Chapman: Disclosure

Copyright 2014 All rights reserved David Chapman

Barry Ritholtz is out with another article spelling more doom for the precious metals sector and the gold bugs. The self proclaimed “Gold Agnostic” penned a 2500 word missive in January which followed a blog post amid the spring 2013 collapse titled “What are Gold’s Fundamentals.” For the record, Ritholtz’s calls on the markets and Gold have been very good. He was bullish during most of the 2001-2011 advance and sold out prior to the 2013 breakdown. Give credit where credit is due. Yet, while the anti-gold and anti-gold bug mainstream eat up his Gold analysis like a lap dog we have to mention some errors and a startling omission of Gold’s key driving force.

Despite having spilled tons of ink on the subject, Ritholtz has continually failed to mention the major driver of Gold which is the direction of real interest rates. Ironically, Ritholtz often writes about following the data and avoiding narratives, yet he ignores this when discussing the yellow metal. Gold rises when real interest rates are negative or declining sharply. Its simple to understand. If investors and fund managers can earn a real rate of return on a money market fund, CD, or bond then there is no need for an alternative currency. If you can’t earn a real rate of return safely then you’ll seek alternative currencies such as Gold and Silver. The following chart from Nick Laird shows real rates and Gold over the last 80 years.

The venerable Ned Davis Research, as reported in Barrons yesterday noted that real interest rates recently have turned favorable for Gold. That is probably why they concluded that the bull is alive but wounded. Capital Economics, as reported by Frank Els also notes in a report that the real yields have declined. I happen to agree with NDR’s view that the short-term technical situation is not conducive to speculative positions. Last week we wrote that Gold could fall to $1080 before the bear ends. A weekly close below $1200 would likely trigger that final washout.

Ritholtz’s arguments for the end of Gold’s secular bull are surprisingly weak. Of course none revolve around the end to negative real rates. He cites a chart and some commentary which regards the dollar rebound as potentially an epic squeeze. This Business Insider style observation bears no reality. The US Dollar index is up less than 2 points in the last month and the commitment of traders report does not show a huge speculative short interest conducive to a short squeeze. Ironically, the epic squeeze is likely to come in Silver and on a lesser scale Gold. Gross short positions in Silver reached a new all time high last week. Further weakness in both metals could setup a large short squeeze in the coming months.

By now you know that Ritholtz’s conclusion (the bullish factors from 2001-2011 are gone) is incomplete and irrelevant. His five points help explain the bear market in Gold but none of them reveal anything about an end to negative real rates, which is the key driving force. If one wants to make a case that the secular bull is over then they need to make the case that real rates have bottomed and will rise indefinitely. This is what happened following 1951 (commodity peak with gold price fixed) and 1980. With the latest uptick in inflation and decline in yields, real rates are again negative and trending favorably for Gold.

Statistically speaking inflation has almost no downside and has in fact started to trend higher. Core inflation in the OECD countries is at an 18 month high while inflation in Canada is at a two year high. The CPI and PCE in the US have started to tick up. MIT’s Billion Prices Project which has led the CPI at key turning points since 2009 has accelerated higher since December 2013. This implies the CPI has further upside. With regard to rates, we know that each 1% rise in rates equates to an additional ~$180 Billion in interest costs. That is over 6% of FY 2013 federal revenue. Policy makers want but more importantly need inflation to get the debt burden under control. Real rates were strongly negative for much of 1942 to 1949. Inflation surged while real growth stagnated but we got the debt burden under control. It led to a tremendous uninterrupted equity advance from 1949 to 1956. However, that was after a rip roaring advance in hard assets.

Hopefully this missive cut through both the bull and bear BS on Gold. Gold bugs will shamelessly promote anything as bullish while gold bears will mention anything but the only fundamental that matters, negative real interest rates. The historical bear analogs, sentiment and negative real rates argue that the precious metals complex is nearing the conclusion to a cyclical bear market within a secular bull. If you’ve followed my work you will know that I have been bearish since the hard reversal in March. Patience and discipline will be the name of the game over the coming weeks. Discipline is required to exit hedges at the right time while patience is required to buy as low as possible. I am looking at JNUG (3x long GDXJ) as well as several juniors I believe have exceedingly strong upside potential over the coming quarters and years. If you’d like to know which stocks we believe are poised to outperform after the coming low, then we invite you to learn more about our service.

Good Luck!

Jordan Roy-Byrne, CMT

Jordan@TheDailyGold.com

Gold jumps 1 pct after ECB rate cut, easing measures 

Dealers who had bet against gold in the run-up to the announcement rushed to cover positions as the metal held above $1,240 an ounce, traders said.- Reuters

Even investors who typically eschew precious metals have been hard-pressed to ignore the platinum industry this year. The longest strike in South African history paired with surging Asian demand is set to push the metal back into a physical deficit in 2014 – and could have repercussions for years to come. While gold remains the most conservative choice for saving, the “industrial precious metal” platinum is a compelling investment for those, like me, who are bullish on global net economic growth.

China in the Driver’s Seat

As with gold and silver, examining platinum demand takes us to the Eastern hemisphere and China’s rapidly expanding economy. In particular, the growing Chinese middle class is generating massive demand for new automobiles, which in turn is consuming plenty of platinum.

For the last ten years, autocatalysts have composed 40-50% of total global platinum demand. Autocatalysts use platinum to clean the emissions of motor vehicles, and 95% of the world’s new passenger cars come equipped with them. Both auto production and emissions standards are steadily increasing around the world, especially in the huge emerging market of China.

Global auto production grew 4% in 2013 to almost 89 million units. According to IHS, Inc., world auto sales will continue to grow to more than 100 million units by 2018 – that’s 12% growth in the next five years. And you can bet that growth won’t be coming from the US.

China’s share of global vehicle production has exploded from under 4% in 2000 to an astounding 25% last year. I expect this demand to keep expanding as more Chinese citizens grow wealthier and are able to enter the auto market.

Chinese vehicle production grew almost 15% in 2013 and should grow another 10% in 2014. New emissions standards that went into effect last year are already forcing Chinese auto manufacturers to use more platinum. Indeed, platinum use in Chinese autocatalysts increased 33% in 2013.

I believe this trend will continue as the Chinese government tries to tackle the country’s critical pollution crisis. Just last week, the PRC announced that it would be removing 6 million vehicles from China’s roads by the end of the year because they no longer meet emissions standards.

Platinum as an Investment

Though industrial applications have the largest impact on its price, platinum remains a sought-after precious metal with growing demand from the investment and jewelry sectors. Jewelry accounts for well over 25% of platinum demand, and that figure has been steadily increasing. Once again, we look east for the most compelling numbers.

Chinese platinum jewelry demand represents about 65% of the world’s total and is expected to expand 5% this year. But India is the real bright point – high import tariffs imposed on gold by the Indian government in 2013 have created shortages and very high premiums on the yellow metal, driving consumers to replace gold with platinum. India’s platinum jewelry market has seen 30-50% growth every year so far this decade. 2014 should continue that trend with a 35% projected growth in platinum jewelry sales.

While Eastern investors buy physical platinum in the form of jewelry, Westerners are piling into relatively young exchange-traded funds (ETFs) backed by the metal. Platinum ETFs did not exist until 2007, and the first South African-based platinum ETF began just last year. 2013 saw a 55% increase in the amount of physical platinum held by ETFs, totaling 2.5 million ounces.

As short-term traders wake up to the same supply/demand issues summarized in this commentary, the trend of increasing retail investment may well absorb a greater share of the limited supply.

Just as with gold and silver, I believe platinum ETFs are inferior to physical bullion for long-term investment. However, many investors prefer the liquidity they offer, and as a fundamental data point, they should not be ignored.

Supply Goes from Shaky to Shocked

With promising new sources of demand, platinum supplies have been under pressure. To put into perspective how little platinum is available, simply compare it to gold and silver. Over the past decade, about 13.5 times more gold and 100 times more silver have been mined than platinum. The vast majority of the meager platinum supply comes from just two countries – South Africa and Russia. Troubles in both of these countries are pushing supply constraints into a market shock.

Beginning in January, more than 70,000 South African miners went on strike against the three largest platinum producers in the world – Anglo American Platinum, Impala Platinum, and Lonmin. This is the longest strike in South African history and is estimated to have already reduced global platinum production by 40%. About 1 million ounces of platinum will not be mined this year due to the strikes.

No matter when these wage disputes are resolved, they’re going to have a deep impact on the platinum industry. Wages are already one of the biggest expenses of mining, and the Association of Mineworkers and Construction Union (AMCU) is demanding a doubling of wages by 2017. They’ve already rejected an offer of a 10% increase.

This much seems clear: wages are going to go up and the industry will have to restructure its operations to handle the extra expense. The average global all-in cost of production (including capital expenditures and indirect overhead costs) is already at about $1,595 per ounce of platinum – 10% above the current market price.

As the cost of business rises, some industry analysts are forecasting that Lonmin and perhaps other companies will be forced to keep some of their mines closed after the strikes end. This could affect the platinum market for many years into the future. Large mining operations cannot be started and stopped at the drop of a hat, and it may take a significant increase in the price per ounce to justify reopening any shuttered mines.

Meanwhile, there’s the possibility that Russia’s annexation of Crimea could draw stricter economic sanctions from the United States and the European Union. How this would affect Russia’s giant mining industry is hard to tell, though it has already put a lot of upward pressure on the price of palladium, another important platinum group metal (PGM). Russia is the world’s largest producer of palladium and is widely suspected of having exhausted its official reserves of the metal. This rumor, combined with the news that Russia has been exporting abnormally large amounts of palladium to Switzerland in anticipation of economic sanctions, helped to drive the metal’s price to its highest since 2011 in May.

The rising price of palladium and its ever-deepening physical deficit might even spur more producers to pay the extra for platinum, which can be more efficient than palladium in some autocatalysts. Generally, any limitations on Russian mining are bullish for all PGMs, and I am waiting for platinum to follow palladium’s spike.

An Opportunity to Diversify

All told, Thomson Reuters GFMS is predicting at least a 700,000-ounce physical platinum deficit this year. It projects that platinum will pass $1,700 per ounce by the end of 2014, a 18% increase from today’s price. Johnson Matthey is even more pessimistic (or optimistic, from the point of view of a platinum investor), predicting a deficit of more than 1.2 million ounces – the largest since 1975.

Even precious metals bears cannot deny the robust fundamentals for platinum this year. Investors who have already formed a bedrock for their portfolio with gold should consider adding physical platinum to increase future returns.

Peter Schiff is Chairman of Euro Pacific Precious Metals, which sells high-quality physical platinum, gold, and silver coins and bars. 

Click here for a free subscription to Peter Schiff’s Gold Letter, a monthly newsletter featuring the latest gold and silver market analysis from Peter Schiff, Casey Research, and other leading experts. 

And now, investors can stay up-to-the-minute on precious metals news and Peter’s latest thoughts by visiting Peter Schiff’s Official Gold Blog.

Ecuador hands Goldman Sachs 466,000 ounces of gold worth roughly $580 million at today’s ruling price. Ecuador under its socialist President Rafael Correa is seeking sources of cash after they borrowed over $11 billion from China because they defaulted on $3.2 billion of foreign debt five years ago. This is the consequence of debt and in the hands of socialists-communists, the bonds ultimately are always defaulted upon.

Like Zimbabwe, who had to adopt foreign currency because people will not trust their own, Ecuador is the only country in South America that is using the US dollar as currency. Ecuador did not sell its gold, it effectively borrowed against it in exchange for more liquid assets. Ecuador expects to turn a profit of as much as $20 million on the transaction and it will get the gold back within three years and the central bank expects to turn a profit of as much as $20 million on the transaction without explaining how.

It appears that Goldman will most likely sell the gold forward helping to break the back of gold and will most likely look to replace it at the lows under $1,000.

…more from Martin Armstrong:

EU to Seize Greek Pension Funds

Will The Petrodollar Die?