Investors’ interest in gold peaked in September 2011, when it was generally agreed upon that the endless rounds of quantitative easing policies by the world’s central banks will result in rising inflationary pressures, while concerns over a potential Euro Zone break-up ran rampant, as government finances in countries such as Spain and Portugal became stretched as a result of various bank bailouts. All of these occurred while the U.S. government was running unprecedentedly high fiscal deficits, with little sight of budget tightening to come. Debt reduction through inflation was the mantra, and investors bid up gold prices to $1,900 an ounce as they bought in this narrative of rising inflation and monetary instability.
In retrospect, September 2011 marked the peak of the last gold bull market. Weighed down by its speculative (long) bets on the euro zone’s peripheral bonds as yields of Spanish, Italian, and Portuguese sovereign bonds rose, MF Global filed for bankruptcy the next month, but gold prices—and eventually, stock prices—took it in stride. 2012 came along; the euro zone and its monetary union stayed intact as the European Central Bank Chairman, Mario Draghi, vowed to do “whatever it takes to preserve the euro” that summer.
I subsequently became bearish on gold in January 2013 (see my January 25, 2013 global macroeconomic commentary), when gold traded at $1,660 an ounce. To recap, my reasons for turning bearish on gold prices were as follows: 1) the immediate danger of a euro zone breakup—which investors were genuinely worried about at the time—was passing, as Spain, Portugal, and Greece had just been bailed out by their richer euro zone peers, 2) U.S. economic growth was re-accelerating, and 3) gold prices were highly vulnerable to a major decline coming after a 12-year bull market. My 12- to 18-month price target for gold at the time was $1,100-$1,300 an ounce, a target which was reached just 5 months later.
Over the course of 2013 and 2014, I stayed bearish on gold prices. When gold hit $1,200 an ounce in February 2015, however, I became mildly bullish on the precious metal, when I wrote an article here discussing three reasons why gold prices will bottom in 2015; when gold prices declined below $1,100 an ounce in August 2015, I became even more bullish on gold and asserted here that it was “one of the best times to own gold.” My three main reasons for buying gold during nearly all of last year remain valid today, if not more so. I now want to discuss and expand on my three reasons for owning gold at today’s prices and why gold is now in a new bull market.
- Global gold mining production has plateaued despite the recent bounce in gold prices
According to the World Gold Council’s Q1 2016 Gold Demand Trends report, global mine supply totaled 774.0 tonnes during the 1st quarter of this year. This is up 8% on a year-over-year basis (mainly due to an uptick in producer hedging), but is nearly 14% below the peak of 897.0 tonnes achieved during the 4th quarter of 2014. Moreover, global mining executives have continued to focus on cost reduction and balance sheet deleveraging, as opposed to exploration & development. A recent PricewaterhouseCoopers survey shows that global gold mining executives remain bearish on gold prices, as evident by another drop in their average long-term price for planning purposes (from $1,284 to $1,231 an ounce on a year-over-year basis). Gold miners who are bearish on gold tend not to invest in new exploration & development, thus constraining future supply.
Furthermore, production growth during the first quarter of this year was driven by a handful of major miners, e.g. increases in Barrick’s Goldstrike (+3.3 tonnes) and Cortez (+6.8 tonnes), as well as Newmont’s Batu Hijau (+2.6 tonnes). This increase is expected to be temporary. Barrick is still in deleveraging mode, and expects to reduce its debt by $2 billion this year to $8 billion, with a goal of less than $5 billion in the next several years. Barrick produced 6.12 million ounces of gold in 2015; this is expected to decline to 5.0-5.5 million ounces in 2016, and to 4.6-5.1 million ounces in 2018. On the other hand, Newmont’s production is expected to increase from 5.0 million ounces in 2015 to 5.3 million ounces in 2017, but its production is expected to dip below 5.0 million ounces in the ensuing years as its Yanacocha mine nears the end of its life. Global mining gold production is expected to decline over the next several years even as prices increase, as miners have become much more disciplined since the peak of the last cycle.
- Both the Global Monetary and Fiscal Policy Outlooks Remain Highly Expansionary
After President Nixon severed the U.S. dollar link with gold in mid-1971, the global economy entered an environment where the world’s major currencies were no longer tied to the price of gold. Gold prices subsequently entered a nine-year bull market—rising from $35 an ounce to $850 an ounce at the peak in January 1980—as inflation ravaged most of the world’s currencies. The structural rise in inflation in the 1970s was fueled by spending on the Vietnam War, the rise in social welfare, and the fact that the Federal Reserve did not recognize the dangers of inflation until much later.
Today, over one-third ($10 trillion) of the world’s sovereign debt is yielding negative interest rates. There is increasing evidence that investors and global reserve currency managers are flocking to gold as a means to preserve capital. E.g. global gold investment demand during the 1st quarter of this year soared to a seven-year high, and is the second-highest quarterly of investment demand on record. European investment stayed strong given the prevalent negative interest rate environment as well as increasing fears (which have since been realized) over a “Brexit” scenario. There is increasing anecdotal evidence of a surge in physical gold demand in Europe, e.g. Germans opening safety deposit boxes to store gold to hedge against further interest rate cuts and quantitative easing policies. With Japan now rumored to implement a $US100 billion fiscal stimulus policy this fall (essentially a “helicopter money” policy as a significant part of this package will likely be “coupon vouchers” forcing Japanese households to spend the funds by a pre-determined time frame, likely in six months), the likelihood of an ongoing surge into gold is very high. Finally, fed funds futures are no longer projecting a Fed rate hike either this year or in 2017; this will support gold inflows for the foreseeable future as U.S. rates stay low.
- Chinese and Indian demand for gold will continue to rise
According to the World Gold Council, both Chinese and Indian demand for the 1st quarter of this year was tepid. For Chinese consumers, the recent uptick in gold prices lowered jewelry demand, while Indian demand unexpectedly dropped due to a jeweler’s strike as a protest against a proposed government excise duty. I see these recent drops as temporary in nature. By far the most important drivers in gold demand in India and China are income levels and urbanization, as gold jewelry is regarded as a luxury consumer item in both countries. Chinese real wages continue to rise at over 10% year-over-year, Indian wages are rising at similar rates (10 million Indian civil servants just received a 23% pay raise). From a structural standpoint, both Indian and Chinese gold demand should rise over the next several years as income levels and urbanization continue to rise.
I thus believe gold remains a solid, long-term investment and the time to buy gold is now. I anticipated a gold price of $2,000 an ounce by 2020. Such a purchase could be made either through an ETF, e.g. SPDR Gold Trust (GLD) or physical gold.
By Henry To