Goldman Sachs created a stir earlier this week when it forecasted that gold would fall to $1,000 an ounce by the end of 2014, as the firm expected the Federal Reserve to reduce its bond buying program. Goldman also suggested that gold miners might want to hedge their output, locking in 2013 prices.
HSBC analysts have also been bearish on gold, although the firm admits that lower gold prices tend to draw out tremendous demand from emerging markets, especially China. Because of that demand, HSBC believes gold will end 2014 at around $1,435 an ounce, says MarketWatch.
Keep in mind that “Goldman Sachs does things that are good for Goldman, not you,” says Bryon King from Agora Financial. Things can change quickly in the gold market, as investors saw when, only days after Goldman’s assertion, the Federal Reserve surprised everyone by announcing it would continue purchasing $85 billion worth of bonds. Gold investors cheered as the precious metal shot up the most in 15 months.
Unlike many commodities, there are many shades to gold, such as the Love Trade’s buying gold for loved ones and the Fear Trade’s purchasing gold as a store of value. An additional “shade” investors need to be aware of is how the Fed interprets the recovery of the U.S. economy.
I had a few reasons to believe Ben Bernanke was going to pull the rug out from under the market’s feet. Last week before word came out, I told Canada’s Business News Network that the ending of quantitative easing was not going to be abrupt because it’s not a black and white issue.
Consider the lack of significant job growth in the U.S., as many of the jobs that have been created in recent history were part-time positions. Investor’s Business Daily (IBD) links this lackluster employment situation to President Barack Obama’s Affordable Care Act. According to the publication’s scorecard, “more than 300 employers have cut work hours or jobs, or otherwise shifted away from full-time staff, to limit liability under ObamaCare.” While providing affordable health care to Americans sounds honorable, the loss of full-time jobs seems to be an unintende d consequence from the onerous regulations placed upon a business.
Take a look at IBD’s chart, which shows the accommodations industry’s average weekly hours that nonsupervisors put in since 2000. During each recession, in 2001 and again in 2008 to 2009, the hours dropped. But since ObamaCare was signed into law, which mandated that employers would need to provide health care coverage for staff who work more than 30 hours a week, the average plummeted. As of July, the accommodations industry workweek hit 28.8 hours, “at a record low,” according to IBD.
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It’s not only about job growth. Housing is also not rebounding as strongly as some people think. I told Reuters that many people don’t realize that the real estate market boom has been narrowly focused. According to USA Today, almost half of the homes purchased in July were bought with cold hard cash. In places like Florida, “nearly two-thirds of home sales were completed without a mortgage loan,” says USA Today. In Nevada, about 65 percent of buyers paid with cash, followed by Maine, where nearly 60 percent of house sales were cash. Perhaps regulation in the banking in dustry has made the process of getting a mortgage too burdensome for families?
Housing is one of the biggest multipliers for jobs, where $1 spent in housing results in about $16 in related economic activity. When interest rates are low, more people apply for mortgages. They build houses, employ moving services and buy new furniture, which in turn employs more people in multiple industries.
But after interest rates rose quickly, the housing market came to a halt. People who once qualified for a mortgage to build a new home no longer qualify at the higher rates, meaning a potential inventory of new housing may quickly build.
At the same time, big banks are announcing layoffs in mortgage lending. Just today, Wells Fargo announced it was going to lay off 1,800 employees as refinancing activity continues to slow. The company had already told 2,300 workers to stop coming to work as rising interest rates curtail demand for new mortgages and refinancing.
So instead of the Fed quickly tapering its bond purchases and raising rates, this process will likely be very gradual. I believe the government will have to keep interest rates low to stimulate the economy.
And that’s positive for equity markets as well as for gold. If interest rates remain low, real rates could remain in negative territory. In my presentation on opportunities in resources and emerging markets, I told the crowd at the Toronto Resource Investment Conference that 2 percent has been the tipping point for gold. Historically, gold and silver performed well in a low or negative real interest rate environment.
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Regardless of where analysts think the gold price will be a year from now, we believe gold and gold stocks can be an excellent portfolio diversifier. We’d rather hold quality gold companies that are experiencing a growth in resource base, growth in production and growth in cash flow instead of trying to time the market. Our in-depth analysis enables our team to seek the best returns for our shareholders.
In-depth analysis is why we’re headed to the Denver Gold Forum next week. Portfolio managers Ralph Aldis and Brian Hicks as well as one of our analysts, Sam Palaez, will be attending, meeting with some of the new CEOs about the state of the gold mining industry. I look forward to sharing with you updates from the conference.
Index Summary
- Major market indices finished higher this week. The Dow Jones Industrial Average rose 0.49 percent. The S&P 500 Stock Index gained 1.30 percent, while the Nasdaq Composite appreciated 1.41 percent. The Russell 2000 small capitalization index rose 1.79 percent this week.
- The Hang Seng Composite rose 2.37 percent; Taiwan gained 0.50 percent while the KOSPI appreciated 0.56 percent.
- The 10-year Treasury bond yield fell 15 basis points this week to 2.73 percent.
Domestic Equity Market
The S&P 500 posted another solid performance this week, rising by 1.30 percent. The market was braced for a reduction in the Federal Reserve’s quantitative easing (QE) program, which it had been communicating to the market since May, but the Fed surprised virtually everyone by not changing its QE program. With the Fed still on the monetary accelerator, the markets surged higher with many interest rate-sensitive groups leading the way as bond yields dropped sharply.
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Strengths
- The industrials sector was the best performer for the second week in a row as the sector experienced broad-based gains. FedEx led the way, rising 8.94 percent as quarterly earnings were well received.
- The utilities sector was not far behind industrials as interest rate-sensitive stocks rallied significantly on the Fed decision.
- Safeway was the best performer in the S&P 500 this week, rising 11.35 percent. The company announced that it had adopted a one-year “poison pill” plan to discourage a hostile takeover.
Weaknesses
- Every sector was positive for the week, but the telecommunication sector just barely eked out positive results. Frontier Communications was the worst performer, falling by more than 3 percent on concerns of dividend sustainability.
- Energy was among the laggards again this week as the refiners were down again.
- WellPoint was the worst performer in the S&P 500 for the week, falling 7.59 percent. The company would be negatively affected if CMS delays the October 1 start of open enrollment in the new healthcare exchanges.
Opportunity
- The current macro environment remains positive as economic data remains robust enough to give investors confidence in an economic recovery but not too strong as to force the Fed to change course in the near term.
- Money flows are likely to find their way into domestic U.S. equities and out of bonds and emerging markets.
- An improving macro backdrop out of Europe and China could be the next catalyst for the market to move higher.
Threat
- A market consolidation could occur in the near term after such a strong year.
- Higher interest rates are a threat for the whole economy. The Fed must walk a fine line and the potential for policy error is potentially large.
The Economy and Bond Market
Treasury yields rallied sharply this week as the Fed surprised the market by not adjusting its QE program. The Fed had been communicating this tapering message to the market since May. By not following through, the Fed truly surprised just about everyone, possibly hurting its credibility and adding uncertainty, which the market dislikes, potentially leading to more volatility.
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Strengths
- The Fed took a data-dependent approach and decided not to taper its QE program, igniting a significant bond rally.
- Industrial production rose 0.4 percent in August as auto production rebounded 5.2 percent.
- Leading indicators rose 0.7 percent in August, with broad-based strength indicated, which bodes well for economic growth over the next few months.
Weaknesses
- India unexpectedly raised interest rates by 25 basis points as inflation remains a problem in some emerging markets.
- The economy has been weaker than the Fed expected, thus not allowing it to taper as expected.
- According to Business Roundtable, large company CEOs are less optimistic about economic prospects over the next six months.
Opportunity
- Despite recent conflicting commentary, the Fed continues to remain committed to an overall accommodative policy and is unlikely to raise interest rates in 2013 or 2014.
- Key global central bankers remain in easing mode, such as the European Central Bank, Bank of England and the Bank of Japan.
- The bond market rally over the past two weeks has been impressive and may still have some running room.
Threat
- Inflation in some corners of the globe is getting the attention of policymakers and may be an early indicator for the rest of the world.
- Trade and/or currency “wars” cannot be ruled out which may cause unintended consequences and volatility in the financial markets.
- The recent bond market selloff may be a “shot across the bow” as the markets reassess the changing macro dynamics.
Gold Market
For the week, spot gold closed essentially flat at $1,326.05, down $0.34 per ounce, or -0.04 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, gained 0.10 percent. The U.S. Trade-Weighted Dollar Index lost 1.25 percent for the week.
Strengths
- The Federal Reserve unexpectedly refrained from reducing the $85 billion pace of monthly bond buying, saying it needs to see more signs of lasting improvement in the economy. In Wednesday’s press conference, chairman Ben Bernanke said “conditions in the job market today are still far from what all of us would like to see.” He orchestrated the most aggressive easing in the Fed’s 100-year history, pumping up the balance sheet from $869 billion in August 2007 and holding the main interest rate close to zero since December 2008. Bernanke added in his press conference that the first interest rate increase may not come until the jobless rate is “considerably below” 6.5 percent. Gold closed at $1,364.02 on Wednesday, gaining 4.07 percent or $53.38.
- Attendance at next week’s Denver Gold Forum will match or exceed last year’s record even though gold is down, said Tim Wood, executive director of the Denver Gold Group. Investors account for 73 percent of non-industry registration so far, up from 69 percent last year, while so-called sell-side delegates have declined to 22 percent, from 27 percent a year earlier. The event has received increasing interest from value investors who traditionally haven’t had exposure to gold equities. The Denver Gold Forum will be attended by 166 mining and exploration companies, representing about 88 percent of global gold production.
- SEMAFO outlined new gold reserves at its Mana mine in Burkina Faso that are set to raise mineable grades considerably. Haywood Securities analyst, Kerry Smith, noted the new reserves boost overall reserves to 2.4 million ounces of gold at Mana and the grade increases to 2.77 grams per ton from 2.31. SEMAFO gained 22.4 percent this week.
Weaknesses
- IAMGOLD and its joint venture partners, AngloGold Ashanti and the government of Mali, have decided to suspend mining activities at the Yatela Mine, effective September 30, 2013. AngloGold Ashanti is the operator of the gold mine, which has been in operation since 2001. The initial closure of the mine was planned for 2007. The decision to close the mine reflects a combination of factors, including miner safety in the pit, the drop in the spot price of gold, and the reduction of profit margin.
- Mining group Anglo American has pulled out of the Pebble copper project in Alaska, one of the largest undeveloped copper deposits in the world, but also an environmentally challenging operation that has been studied for almost three decades. Anglo has vowed to halve a $17 billion project pipeline and bring down the cost of keeping options like Pebble open.
- Gold demand in India is poised to decline during the main festival season as the weakest economic growth in a decade curbs spending and volatile prices spur investor selling. Sales of jewelry, coins and bars between August and November are expected to be lower than a year earlier because of the slowdown along with a bullion shortage caused by central bank curbs on imports.
- Papua New Guinea’s government has taken 100 percent ownership of the controversial Ok Tedi gold and copper mine following a lingering dispute with a development fund. Also, a 12-year old immunity deal with the mine’s former owner, BHP Billiton, for environmental damage in the country’s Western Province, was removed. Former Prime Minister Mekere Morauta has criticized the government’s actions, accusing it of theft and signaling a likely court challenge.
Opportunities
- Leon Esterhuizen of CIBC suggests that South Africa’s gold space may be a very good short-term trade. His chart below shows the year-on-year change in the gold price in both rand and U.S. dollar terms against the same year-on-year change in the South Africa Gold Equity Index. “The key to the usual sharp run that tends to follow the current situation (seen only three times in the past 15 years) seems to be a slight increase or turnaround in the year-on-year U.S. dollar gold price,” he explains. A sharp sell-off in South African gold equities on the back of current labor strikes should be seen as a proper opportunity to get invested in advance of the very sharp turn in profitability that the rather high rand gold price appears set to deliver in early 2014.
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- The U.S. House of Representatives passed H.R. 761, the National Strategic and Critical Minerals Production Act, which streamlines mining permitting processes and allows the United States to more efficiently and responsibly develop mining resources. The Republican-led U.S. House of Representatives approved it, but the question remains as to whether the proposed act will again die in the U.S. Senate, which is controlled by Democrats.
- “Barrick Gold shares are no higher than they stood in 2003 when gold was around $400 an ounce,” Andrew Bary wrote in a Barron’s article that made the case for the world’s largest gold miner. The ill-advised Equinox purchase, a 75 percent dividend cut, and a lack of cash flow put the company in the penalty box. Barrick is expected to produce around 7.2 million ounces of gold this year, and is one of the more highly levered names in the space. However, this “probably means more upside if gold rebounds.” Barrick gained 5 percent this week.
Threats
- Looking forward, while tapering uncertainty may return for the October Fed meeting, Deutsche Bank economists believe the likelihood of an October taper is reduced. The first move is now forecasted to be in December. Deutsche’s commodity team expects “the bounce in gold likely to be short-lived as long term interest rates, the equity risk premium, and the U.S. dollar will eventually conspire against a sustained rally in gold.”
- At the beginning of this week, Goldman Sachs’ senior commodity analyst Jeff Currie warned that gold could fall to $1,000 an ounce or lower. Goldman’s “sell gold short” call in April this year was immediately followed by a huge decline in the price of gold. The market will undoubtedly take notice of this latest report.
- David Franklin, market strategist at Sprott Asset Management, asks “given the manipulation we know has occurred in the oil and LIBOR markets, could gold and silver be any different?” The London Bullion Market Association website states that the gold price is “fixed” by telephone twice each London business day at 10:30 a.m. and 3:30 p.m. Last week, a new study emerged that suggests that the pricing mechanism may not be so transparent and that some market participants could be profiting from information leaked during the fixing process. Andrew Caminschi and Richard Heaney published their analysis of the fixing process in “The Journal of Futures Markets.” They found statistically significant return advantages for informed traders in the four minutes following the start of the fixing. While the study does not analyze or comment on the process by which the gold price is determined, it does provide evidence that information during th e process is being leaked somehow to the advantage of some market participants.
Energy and Natural Resources Market
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Strengths
- Commodities and related stocks jumped strongly after the Federal Reserve announced mid-week that it would leave bond purchases steady in an attempt to reverse the recent tightening in financial conditions.
- The U.S. dollar fell to the lowest level since February, which should create a positive tailwind for commodity prices.
- The North Dakota Industrial Commission Department of Mineral Resources reported that oil production in the state for July increased to a new record of 847,681 barrels per day (bpd), compared to 821,809 bpd in June. There were 9,019 producing wells in July, which is the first time this number has exceeded 9,000. The volume of oil per well hit a new record of 3,006 oil barrels (bbls) per well, the first time this measure has exceeded 3,000 bbls per well. The daily production rate increased 29.3 percent since July 2012.
- August data from Japan’s Federation of Electric Power Companies (FEPC) continues towards strong consumption of thermal coal by Japan’s 10 regional power utilities. Consumption was 5.7 million tons of coal, up 20.6 percent year-on-year.
Weaknesses
- With delays in North Sea loadings, production in the U.K. has dropped below seasonal-average lows and has fallen to the lowest point in 23 years, according to Bloomberg Industries.
- The aluminum markets remain challenged as United Company RUSAL plans to reduce its production for a second year in 2014 amid cutbacks across the industry, Bloomberg reports. Output will fall below 3.8 million tons, from 3.8 million to 3.9 million tons this year, deputy CEO Oleg Mukhamedshin said. RUSAL produced about 4.2 million tons in 2012. First deputy CEO Vladislav Soloviev added that the company already shut at least three Russian smelters and expects to make more cuts.
Opportunities
- Reuters reported on Sunday that China's state media said the country will increase its investment into oil and gas exploration to 80 billion yuan (roughly $13 billion) in order to help the country reduce its dependence on imported energy.
- The Wall Street Journal reported that Spanish oil company Repsol is looking for oil-weighted exposure to increase investments in politically stable countries, and to gain exposure to the U.S. energy boom. The cited size range was $5 to $10 billion for Canadian or U.S. targets, with a commodity preference for "much more" oil than natural gas. Repsol agreed to sell more than $4 billion of LNG assets to Royal Dutch Shell by year-end, and the proceeds could be used to fund a North American purchase.
Threats
- The New York Times reported this week that the ailing American coal industry, which has pinned its hopes on exports to counter a declining market at home, is scaling back its ambitions as demand from abroad starts to ebb as well. U.S. coal exports this year are expected to decline by roughly 5 percent from last year’s record export of 125 million tons, and many experts predict the decline will quicken next year. At the beginning of 2012, the coal industry had plans to expand port capacity by an additional 185 million tons. But those hopes have faded this year. “Global coal prices right now are not supportive of large-scale U.S. coal exports,” said Anthony Yuen, a Citigroup energy analyst.
Emerging Markets
Strengths
- Passenger vehicle sales in China went up 14 percent in the first two weeks of September. As the overall auto sector steps into the seasonal boom, Bank of America Merrill Lynch expects auto stocks to rally in the short term. This forecast comes on a wave of positive news flow and catalysts. The firm also forecasts growth between 16 and 15 percent year-over-year for 2014 and 2015, respectively.
- Reportedly, the China Security Regulatory Commission is studying a bank preferred share trial, claiming to support issues by banks to expand financing channels.
- Technical forecaster Tom DeMark commented that the Shanghai stock market will extend its gains as the Chinese economy strengthens. Earlier this year he predicted a market rally at the end of June for Shanghai.
- The China Security Regulatory Commission approved the Dalian Commodity Exchange to begin trading iron ore futures.
- Zhoushan City in Zhejiang province has eased purchase restrictions in the property market by permitting all households to buy a new home this year. Separately, China may allow real estate investment trusts, or REITs, as part of loosening its property financing policy, the China Securities Journal reports.
- Malaysia’s headline inflation eased slightly to 1.9 percent year-over-year in August versus 2.0 percent in July, with 2 percent as the consensus.
Weaknesses
- China’s August foreign direct investment grew 0.6 percent to $8.38 billion. This was below the market expectation of a 12.5 percent gain.
- Two private banks in China, Suning Bank and Huarui Bank, were launched under a policy reform encouraging private capital. The launch was done in order to get into industries previously licensed solely to state-owned enterprises (SOEs). The reform will be extremely positive for the economy, but it is negative to the incumbent banks since competition will squeeze profit margins through rising deposit rates and falling lending rates.
- Singapore’s non-oil domestic exports (NODX) declined in August by 6.2 percent year-over-year versus the consensus of 2.4 percent growth, extending the decline in July by 1.9 percent.
Opportunities
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- As shown in the charts above, China’s power generation and consumption have been increasing since June. Particularly, the increase in industrial power consumption has coincided with industrial production growth in August. August power generation went up 14 percent and power consumption 13.5 percent, which may indicate a short-term growth recovery in China.
- Despite a slight deterioration in June’s unemployment data, labor participation in Turkey is at an all-time high in a counter trend to OECD economies, boding well for domestic consumer demand.
- According to Russia’s Finance Minister Anton Siluanov, the Russian government has approved a budget plan that includes Russian state companies paying out 35 percent of International Financial Reporting Standards (IFRS) earnings in 2016 (on 2015 earnings). Nothing has been mentioned yet about 2013 and 2014 earnings, though it makes sense that 25 percent on 2014 earnings would mean 35 percent on 2015 earnings.
Threats
- Recent acceleration in the growth of housing prices, along with the potential for local government tightening, may defer a price recovery for developer stocks. There is news that developers are paying record-high land prices, making them vulnerable on tightening as well as on a sector slow down.
- The European financial transaction tax is designed to discourage speculative trading and raise tax revenues, but the tax could actually kill off the repo market which the banks rely upon for funding.
- The recent bailout of two of the Slovenian banks at the taxpayers’ expense was in violation of the European Union’s resolution mechanism applied to Cyprus, perpetuating the seemingly haphazard approach to crisis management.
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