Given we are now half way through the first quarter of 2014, it may seem a little desperate to continue write articles on what went on in 2013. However the World Gold Council has just released a review of the last year along with the outlook for 2014.
As we all know by now, the gold price had its first annual loss in 12 years, falling by nearly 28%.
We know all the depressing facts, even the record demand seen in both China and India wasn’t enough to counter the 900 tonnes of ETF outflows or the equivalent 481 tonnes equivalent fall in non-commercial long futures positions in COMEX.
The fall in the gold price, the first 15% drop that took place on Friday 12th April, has been blamed on many factors, from manipulation to the ‘increasingly bearish’ sentiment of market participants which culminated in the ECB suggesting Cyprus could sell its gold.
We cannot blame the fall in the gold price entirely on events seen in April and June. It is only fair to point out that the gold price had observed ‘range bound prices for more than a year previous to the price drop.’ But what will happen now and how will 2014 pan out?
In this report the WGC look at previous price corrections, how gold has responded afterwards and the major factors that will affect the gold price in 2014.
Learning from history
You would have thought, judging by the gold bear’s reaction that this recent drop was the first one. In fact, it isn’t, which might sound disconcerting but it’s quite the opposite.
The WGC explains that since 1971 ‘the gold price has had 12 periods with pullbacks of 20% or more.’ This may make the yellow metal sound like a volatile asset, but no more so than alternatives, say corporate bonds or even sovereign debt bonds.
This pullback is, according to the WGC’s research, in line with the last 12 periods of pullbacks when ‘the gold price has fallen on average by 36% over 18 months.’ Since the September 2011 high of $1,920/oz gold has lost around 37%.
Good news for gold investors however is that ‘in the average period of 18 months from the trough the gold price retraced 70% of its losses. A similar, if not better, performance to those of corporate bonds which ‘typically recover no more than 50% – 70% of their face value. Even sovereign debt bonds tend to recover 60% or less of their value.’ A fair response when gold bears argue that there is little point in investing in a yield-less asset.
Watch for dollar strength
It will come as no surprise to anyone reading this that historical pullbacks in gold have ‘generally coincided with a strengthening of the US dollar.’
The WGC believes that the gold/US dollar relationship will be something to look out for in 2014. ‘We believe that fluctuations in the US dollar will continue to be a guide for investor positioning.’
And, related to the US dollar, how will Fed tapering affect the gold price? The WGC believes that whilst the general consensus appears to be that the Fed will continue to taper during the year, the gold price already reflects these expectations. Further to this, it is likely that the US recovery will be weaker this year and monetary policies amended to reflect this, a positive for gold.
And interest rates? As we have discussed before (using the WGC’s research) the belief that high interest rates cause gold prices to fall is a bit of a myth. Whilst gold returns do tend to be lower when interest rates are between 0% and 4% than when rates are negative, its not as though gold trends lower.
Inflation in the US is also not expected to be a major problem, according to the WGC as ‘other factors such as the US dollar and emerging market demand’ will have a greater role in the financial and gold environment.
China bull
Both this year and last, we have been chatting all about China and what a significant role it is , and will continue to, play in the physical gold market.
The WGC comment on the contrasting views over the strength of the Chinese economy. For some asset bubbles have formed and are ripe for bursting, for others the pro-market shift in economic policies will stand the economy in good stead.
The WGC appear cautious to expect Chinese demand to match or top last year’s, particularly as such strong buying came during a major phase pf pullbacks. Yet, we would exercise some caution over this belief. The numbers quoted by the WGC, throughout 2013, repeatedly fell short of those reported by the SGE via Koos Jansen.
It is worth noting that savings have grown by 46% in the last year and that the Chinese government continue to encourage gold investment as well as the opening up of the gold market. Just today the CGSE announced plans to open up a physical exchange on the mainland, as well as a 1,700 tonne storage facility. Moves such as these do not suggest a slowdown in buying.
Will India pull through?
For many gold bears, the move by the Indian government to restrict gold imports was the final nail in gold’s bull-run. However, as the WGC point out ‘despite increased taxation, import restrictions and a weaker rupees in 2013, India demand during the first three quarters was not only higher in the same periods in 2012, but also above the corresponding 3, 5 and 10 year average.’
Whilst there have been calls for import gold controls to be relaxed, they have so far fallen on deaf ears. The WGC reminds us that general elections will take place this year and therefore any developments in policies surrounding gold will be affected by this, ‘as many consider the gold restrictions to be unsustainable over the long term.’
Can we afford to mine gold?
Since the first price drop in April there has been much chatter surrounding mining costs and how sustainable it is to mine gold at a sub $1,200/oz. According to Thomson Reuters GFMS, all-in-costs of production are around $1,200 and therefore a gold price below this could impair production.
We would remind readers that we rarely comment on gold mining and the costs incurred. However the individuals we spoke to over this matter don’t believe supply will be restricted too much as the majority of the costs involved in mining gold have already been incurred.
It is, however, worth considering what restricted supply will do to the price. This will become more prominent as recycled gold supply continues to fall.
Europe – good or bad for gold?
Data this week (and a general lack of headlines) suggests the Eurozone is not struggling right now. Previously gold has been positively correlated with the Euro. Having said this, the WGC do not expect the ‘Europe to be a major force in determining gold’s performance unless one of two things happen’ And those are:
- ‘A flight-to-quality environment’ is created due to a negative economic environment, driving investors to gold.
- Or a very strong recovery and strong euro against the dollar ‘could lead investors to turn more bullish on gold.’
Japanese gold demand
Japan continues to be the poster-child for loose economic policy and as a result has driven investors and pension funds towards gold. The WGC expects ‘pension funds will likely continue to look for alternative high-quality liquid assets to Japanese government bonds, with gold being a natural alternative…’
Unsurprisingly the WGC expect Abenomics to be supportive of gold.
Diversify with gold
Earlier this week I wrote about the permanent portfolio and how gold could be used as a key asset. The WGC conclude their report with a recommendation that gold be used as part of diversified and long-term portfolio, particularly in 2014.
This is something we agree with given the substantial correction the gold price has gone through since 2011 and the increasing frequency and magnitude of tail risks.
We, as do the WGC, believe 2014 will be an interesting year for gold following a serious shake-out and a new opportunity for investors to invest in the precious metal.
