Mining Research Articles
Central Bankers’ Wisdom Faulted as Gold Holdings Surge 25%
Ranjeetha Pakiam , Bloomberg
May 16, 2016 — 12:35 PM CSTUpdated on May 16, 2016 — 4:32 PM CST
- ETPs have expanded to the highest level since December 2013
- IG Asia’s Aw sees structural shift in gold investment demand
The great gold rush of 2016 is gathering pace. Holdings in exchange-traded funds have now surged by a quarter, with investors taking advantage of lower prices over the past two weeks to enlarge stakes on rising concern about central bank policy making worldwide.
The holdings have increased to 1,822.3 metric tons, the most since December 2013, according to data compiled by Bloomberg, after bottoming at a seven-year low in January. In the past two weeks, as prices lost 1.6 percent, ETFs swelled 63.2 tons, rising every day.
Gold is the best-performing major metal this year after silver amid rising concern over negative rates in Europe and Japan and whether the Federal Reserve will be able to tighten further. Demand jumped to the second-highest level ever in the first quarter, according to the World Gold Council, and billionaire hedge fund manager Paul Singer has said gold’s rally may just be beginning. Investors are being driven to gold on a structural shift in investment demand, according to Bernard Aw, a strategist at IG Asia Pte.
“Firstly, the negative interest rate environment and quantitative-easing policies are reducing the pool of suitable investment options, and making gold less costly to hold,” Aw said by e-mail on Monday, adding that while there may be more U.S. rate hikes in the pipeline, prevailing rates remain very low. “Second, lingering fears of competitive currency devaluations and potentially fresh bouts of market volatility encourage safe-haven demand.”
Rates Outlook
After the Fed raised rates in December, investors have been scaling back expectations of further increases amid concern about the strength of the global recovery. The chances of a hike at next month’s policy meet are just 4 percent, down from 75 percent at the start of the year, according to Bloomberg data. Higher U.S. borrowing costs typically hurt gold prices while boosting the dollar.
Bullion for immediate delivery has rallied 21 percent this year, gaining to $1,303.82 an ounce on May 2, the highest price since January 2015. The metal traded 0.7 percent higher at $1,282.40 an ounce at 4:30 p.m. in Singapore, according to Bloomberg generic pricing.
Singer — whose firm Elliott Management Corp. oversees about about $28 billion — told clients last month that if investors’ confidence in central bankers’ “judgment continues to weaken, the effect on gold could be very powerful.” Stan Druckenmiller, the billionaire investor, said this month while the bull market in stocks is exhausted, gold is his largest currency allocation.
Bankers Buying
While central bank policies may have contributed to gold’s gains this year, some countries’ banks — notably in China, Russia and Kazakhstan — have also been substantial and consistent buyers. The World Gold Council estimates that nations are expected to buy 400 to 600 tons this year, compared with 566.3 tons in 2015, according to Alistair Hewitt, head of market intelligence.
Even some the of leading bullion bears have had to backpedal this year as prices advanced and expectations for U.S. rates shifted. Goldman Sachs Group Inc. and Singapore-based Oversea-Chinese Banking Corp. beefed up their price forecasts last week, though both said they maintained their bearish views.
UBS Group AG, which expects gold to drop over 12 months, has increased its short-term forecast, citing uncertainty surrounding the pace of Fed increases as well as next month’s U.K. referendum on its membership in the European Union. The upper end of its range was increased to $1,350 from $1,310, analysts at the wealth-management unit including Wayne Gordon wrote in a report dated May 14.
Fear and Loathing in the Marketplace (with apologies to HST).
In a previous column I wrote about living in interesting times, well things continue to stay interesting, or are getting even more exciting!
Background reading I did for an interview on my view of gold has generally not left me in a very optimistic mood (taking into account my generally half-glass empty view of things), although there are a few bright points out there (and more of this later).
However, to start with, it is amazing to me the different views and opinions that can be gleaned from the same information that are there for investors to lap up and act upon. For example, with gold, some are saying the entire fiat currency system is about to collapse, and gold will go through the roof; others are seeing we could see 20-30% falls this year, with opinions on all points in between.
So who is right? We honestly don’t know, and only time will tell. (If I really knew I would have acted upon it and not be sitting here now!) Also, how many of the commentators’ opinions are based on vested interests, e.g. do many of the larger gold bears carry significant short positions and therefore it is in their interest to spook the markets to drop the price? This though brings up the whole conspiracy theory of market manipulation, which given the size of the gold market would require a coordinated effort by numerous parties to achieve “desired results”. There have been many column inches written on this subject.
So a brief look at the markets and world economy overall.
World equity markets have generally performed poorly in recent times – the Dow is off 10% since its May 2015 high, and in my view looks to be heading into bear territory. The whole US situation has not been helped by generally negative comments by the Fed, with a number of commentators now fearing that the US will go into recession, although the US economy is showing some mixed signals. This was after cautious optimism late last year when rates were raised 25 basis points (is 25 points really a rise??), with an expectation of three or four rises in 2016. This looks to now have gone out the door.
We also have a possibility of more damage coming from the fall in oil prices, especially in the US. US oil and gas companies are set for reserve restatements over coming months. Given the falls in prices these restatements will generally be negative, and will affect the amount of debt that companies can carry. This may well send more highly geared companies under.
We also now have China, the world’s largest economy slowing down, and also with severe stock market ructions. This has led in a large part to the severe and continuing downturn in commodities since 2011. And as I have previous written other global markets are not in good health either.
With the two largest economies (and others) encountering headwinds, what hope is there for the next year or so, and where is there life?
The headline grabber over the last month has been gold, with the price increasing some 15%, which has put a sparkle in many a broker’s eye! My view is that this sustainable, and I foresee prices remaining at least at current levels over the coming year, given the uncertainty in the global economy and other assets overall. Gold is still a safe haven commodity.
Australia (and other gold producing countries with currencies depreciating against the US Dollar) are enjoying strong performances from gold stocks – gold prices are at historical highs in Canadian Dollars and Brazilian Reals, and near historical highs in Australian Dollars. Performances have also been helped by lower costs – anecdotally contractors’ costs have come back >20% since the end of the boom, and the recent decreases in energy costs have also helped considerably. Higher prices + lower costs = much higher margins….
On the ASX we have also seen graphite and lithium stocks performing well, however some of this will be due to speculation with these commodities being the current hot things (or they were until gold came back). This is not to say there are no quality stocks in both of these commodities – there most definitely are some excellent opportunities in the battery space.
It is generally all doom and gloom on the base metal front; however there still are companies that are advancing quality projects. Some of these may not be viable at current prices, but when prices and capital markets improve they will be in a position to go quickly into production. This requires patience from investors; however there are some excellent buying opportunities out there.
As I have written ad-nauseam before, with the right due diligence there is still value our there even in these troubled times.
Oh, and another area performing at high levels is the volatility index. We however would prefer this not to perform as such.
Until next time…
Thermal Coal’s Future Threatened by Falling Emerging World Demand
“The interval between the decay of the old and the formation and establishment of the new constitutes a period of transition which must always necessarily be one of uncertainty, confusion, error, and wild and fierce fanaticism.” John C. Calhoun
We’ve previously discussed the clouded prospects for thermal coal. On the one hand, changing environmental attitudes, combined with the implementation of stricter environmental legislation worldwide, is leading to further damage of coal’s image as an appropriate 21st Century energy source.
On the other hand, there is an argument that thermal coal will realistically remain an essential component in the energy mix of many countries, particularly emerging ones.
And there’s a certain amount of logic to support both arguments. However, recent independent market evidence suggests that coal’s future might be more problematic than rosy.
Let’s firstly examine the situation as it related to the world’s biggest thermal coal consumer, China. Over recent weeks it has been reported that China plans to reduce coal production capacity as part of government efforts to firstly cut industrial overcapacity as well as utilise cleaner energy sources.
As Bloomberg reported, “The world’s largest coal consumer aims to eliminate as much as 500 million metric tons of annual output in three to five years, the State Council said in a statement Friday. The country also plans to consolidate an additional 500 million tons a year of capacity among fewer miners, ramp up financial support for some coal companies and encourage mergers, according to the guidelines. All coal companies should be able to produce least 3 million tons a year, it said.”
To put things into perspective, the 500 million-ton target could erase almost 9% of China’s thermal coal capacity. Including projects under development, the country can produce 5.7 billion tons, however only 3.9 billion tons of that is currently in operation, according to independent estimates.
The aggressive targets highlight the determination of the central government to ease oversupply, although there will likely still be a degree of tug-of-war between the central and local governments on when and how those targets can be achieved.
Just as significantly, a statement from the State Council (the country’s highest administrative body) says China will also suspend approvals of new coal mines for the next three years. As part of this strategy the government plans to set up a fund to help coal miners and steelmakers eliminate workers and dispose of bad assets.
The industry theme in China is already ominous, with the nation’s coal imports falling by their biggest margin on record last year, amid weak domestic demand.
And they mirror similar initiatives within China’s steel sector, with the world’s biggest producer set to close between 100 million and 150 million metric tons of annual crude steel capacity by 2020. These amount to around 13% of current capacity and in reality larger cuts are likely to be required in order to bring markets back into balance.
Now let’s turn our attention to India, which has been optimistically promoted as one of the largest growth markets for thermal coal for the next few decades. A Reuters article recently highlighted that contrary to general opinion, a decline in thermal power projects and a rapid up-scaling of renewable-energy projects indicates that India’s appetite for coal is actually dwindling.
Interestingly, even as domestic coal production has risen, growth in new thermal power projects is showing a decline for the first time in the last three years. According to data sourced from government departments, growth in newly-installed thermal power capacity was recorded at 8.78% in 2015, down from 8.99% in 2014 and 12.48% in 2012.
In sharp contrast, growth in new capacity in the renewable-energy sector rose to the highest level ever at 18% during 2015. A senior official with the country’s largest power producer, NTPC Limited, said that the “pipeline of new thermal projects has completely dried up” and “no new plant are scheduled to come on stream in 2016”.
At the earliest in 2018/19, 10,000 MW of new thermal capacity could come on stream in the form of ongoing projects – delayed by varied reasons such as conclusion of fuel supply agreements, environmental clearances and/or scrimping of funding options by project promoters. Ultra mega power projects (UMPPs), planned by the government were also turning out to be “pipe dreams” according to the official, with no such new projects put up for bidding since 2014.
Ominously, even UMPPPs put up for bidding in 2014 had all fallen through, with all successful bidders subsequently withdrawing from the projects. In sharp contrast, in the renewable space the country is poised to commission 2,000 MW of solar power between January and March 2016, equal to the total generation capacity added in the full year of 2015.
While the impact of these trends in the power generation sector on medium- and long-term coal demand consumption patterns was not readily available from government departments, current empirical data indicate that the ‘coal rush’ in consuming industries had eased, giving way to stockpiles at both the producer and consumer ends.
Coal India Limited currently maintain unsold pithead stocks of 40-million tonnes, while thermal power plants across the country were carrying a combined stock of 32-million tonnes of coal as of January 2016, up from 12-million tonnes during the same month a year earlier.
So the evidence in both China and India, two of the industry’s biggest consumers, indicates that thermal coal consumption growth is actually falling. This is enormously significant, because whilst industry watchers are acutely aware of a changing energy balance in Western nations, it has generally been accepted that emerging economies with their burgeoning populations and related growth in energy requirements, would continue to drive coal demand growth – perhaps for the next three to four decades.
Instead, government action in the world’s two most populous nations related to reducing emissions and prompting initiatives in the renewable sector, looks likely to significantly reduce the time period until we reach peak thermal coal demand.
Gold Price Strength Shouldn’t Be a Major Surprise
The recent decision by the Federal Reserve to raise interest rates in the face of a rapidly weakening global economy has given a new lease of life to gold.
A year ago, oil and other commodities signaled that potential turmoil was coming to the global economy. Now the signal is starting to come from gold.
We’ve commented consistently that we expected gold to firm in the wake of the US rate rise – not fall – contrary to what so many other market-watchers had predicted. In formulating our views we’d looked at the underlying health of the US economy, along with actual evidence from previous rate-rising cycles over the past 50 years.
At the end of the day it’s about negative real interest rates, where the rate of inflation is still well above the underlying rate of interest.
As we’ve previously written, “The Dow Jones at record levels does not necessarily reflect a robust economy – it’s in many respects a reflection of an equity market that’s been pumped full of Fed-administered hot air.”
The Federal Reserve made a big mistake when it raised interest rates in December. It wasn’t the mixed economic data that caused the change in policy, it was a desire to ‘normalise’ monetary policy. The data makes it seem like the US economy is on a roll, when it clearly is not.
Firstly, the US labour force participation rate is averaging 4% less than it did a decade ago, prior to the Great Recession. This means 10 million unemployed people are categorized as having given up looking for work and not in the labor force. They are therefore unemployed – and if properly accounted for – the unemployment rate would be reported as being a little over 10%.
Secondly, the unemployment rate is determined by a survey of 60,000 people each month. It’s like a giant poll. If a person says they have started a business they are counted as employed. If they lost their job and can’t find one, but start up an E-bay business selling stuff from home, they are counted as fully employed – no matter how little their business makes.
Many people who can’t find work try to pick up what they can by starting some sort of small service business. This little known fact makes a mockery out of the headline numbers.
Other data also paints a less than glowing picture of the US economy, as recently released US 2015 fourth quarter GDP was just 0.7%. To demonstrate how worried the markets are, the Japanese 10-year government bond fell to negative interest rates last week.
The rate has never been negative before and this movement is not confined to Japan. Rates on debt instruments perceived as safe are falling everywhere. It is possible the yield on the German 10-year bond may also fall below zero.
10-year Japanese Bonds, Source Bloomberg
Markets’ Loss of Fed Confidence
Markets are expressing a loss of confidence in the global economy and a loss of confidence in the Federal Reserve, as Chairman Yellen commented this week that the Fed may pause on expected additional rate rises this year based on outcomes in the economy.
What’s intriguing is that The Fed has consistently ‘talked tough’ with respect to interest rates, seemingly recognising the dangers of keeping rates too low for too long. It has also pointed to economic growth in the US as clear evidence that its ‘easy money’ policies have been working.
Yet it seems to now be admitting what we’ve been saying for some time – that all isn’t well. Something the Fed hasn’t previously been prepared to directly acknowledge for fear of spooking markets.
One lesson here is that the Fed’s great monetary experiment since the recession ended in 2009 looks increasingly like a failure. Recall the Fed’s theory that quantitative easing (bond buying) and near-zero interest rates would lift financial assets, which in turn would lift the real economy.
While stocks have soared, as have speculative assets like junk bonds and commercial real estate, the real economy hasn’t. The Wall Street Journal recently commented that “This remains the worst economic recovery by far since World War II, and we’ll be watching to see if financial assets now fall to match the slow real economy.”
The table above is courtesy of The Wall Street Journal and compares GDP growth projections by the Fed’s governors and regional bank presidents to actual results. What it highlights is how optimistic the Fed has been with its growth forecasts, with actual growth rates falling well short. Fed policy was also supposed to raise inflation to its target of 2% a year, but it has failed even that test.
The same monetary also lesson applies to the rest of the world. Bond buying and near-zero rates have been implemented worldwide, but the global economy has to this point failed to respond with faster growth. The European Central Bank’s bond has so far prevented a recession, but European growth remains sluggish.
Meanwhile, the emerging-market economies that benefited from capital inflows during the height of QE are now seeing those flows and economic growth recede. China is trying to clean up its stimulus excesses without going into recession.
However the far bigger concern lies in the fact that financial markets have become so dependent on QE and artificially-suppressed interest rates that it will be very difficult for the Fed to reverse these policies without major repercussions.
Markets of course have typically been comfortable with the ‘easy money’ scenario continuing, as it will help maintain the value of already-inflated share and property investments. For now the game of musical chairs continues, but the day of reckoning seems to be getting closer.
Good News for Gold
All of this of course is good news for gold, for which I am an unashamed bull – as it remains the ultimate ‘insurance policy’ for investors and which has stabilized and strengthened in the wake of the Fed announcement.
As I read in a recent article, “As bond yields have been dropping gold, has been rising. But bonds can only go so low. Once the rates are negative the bond buyer is the one paying interest. At some point it would be better to ask for cash and pay for a safe deposit box.”
Gold however has no real top – and with each bout of bad news, gold can keep its rally going. And the Fed is signaling they won’t step in for some time. Gold tripled in value during the Great Recession, has since fallen back by more than 40%, but just this year has rallied by 10% off its lows.
The latest statistics further reinforce this demand strength. Buying by central banks as well as Chinese investors seeking protection from a weakening currency have helped lift gold demand for Q4 2015 – and the trend looks set to continue.
The World Gold Council reported last week that China remained the world’s biggest consumer of gold, ahead of India – with economic headwinds influencing purchasing.
Chinese demand for gold coins surged by 25% during the fourth quarter compared to the same period a year earlier, as consumers sought to protect their wealth after Beijing devalued the yuan currency. But stock market turmoil and a slowing economy negatively impacted consumer, with Chinese demand for gold jewellery falling by 3% compared to the previous year. Indian jewellery demand reached its third-highest level on record in 2015 at 654.3 tonnes.
It’s clear that central banks have continued buying gold in order to diversify their reserves away from the US dollar, with purchases firming to 588.4 tonnes last year, second only to a record high of 625.5 tonnes during 2013. In particular, central bank buying accelerated sharply during the second half of last year and jumped by 25% during the fourth quarter.
Investment demand for gold is also improving and flows into exchange-traded funds (ETFs) turned positive this year. Barrons reported last week that gold ETFs are going global, and one strategist contends that wider ownership will fortify the precious metal from selling by fickle American investors.
“You can quibble about magnitude, but a flood of dollars into gold-tracking exchange-traded funds seems to be stoking a rise in price of gold itself. John Teves, a strategist at UBS, notes on that global ETF holdings have increased by 3.86 million ounces so far this year, and that fully two-thirds of this haul is from U.S.-listed funds such as the SPDR Gold Shares (GLD). This ETF has already taken in $2 billion in 2016, essentially recouping last year’s $2.2 billion full-year outflow, according to ETF.com.”
At the same time the global supply of gold fell by 4% last year to 4,258 tonnes, partly because of slower mine production. Mining companies have scaled back since 2013 in a bid to slash costs, with mine production shrinking during the fourth quarter of 2015 – the first quarterly contraction since 2008.
Accordingly, I maintain our optimistic price forecast on gold of between $1,100 and $1,300 during 2016.