Gold’s bull market called into question by bank analysts

January 22, 2013 04:22 AM
In the Lead: “Sachs and the Citi”

Spot precious metals trading resumed in New York this morning following yesterday’s MLK holiday-related hiatus. Albeit the U.S. dollar was trading 0.13% lower on the trade-weighted index (at 79.92) there was mild selling pressure on tap in gold and silver. Platinum moved higher and palladium was unchanged. The latest spot indications on the bid-side showed gold trading at $1,690 and silver quoted at $31.83 (down 19 cents).

Platinum was indicated at $1,678 (up $4) and palladium at $717 (up $1) the troy ounce. Rhodium remained static at $1,200 per ounce. Background markets showed crude oil falling by a nickel to $95.52 per barrel and copper moving 1% higher while stock index futures remained steady but cautious ahead of the release of U.S. home sales and regional manufacturing data.

Last week’s CFTC market positioning report (COT) noted that net longs in gold made a bit of a comeback with the addition of 24 tonnes of the metal. Standard Bank (SA) analysts opined that such a favorable nod to gold was in part a side-effect of the market’s strong fascination with platinum. More than 287,000 ounces were added to net-long positions in the noble metal in the wake of a recapture of its price parity (then premium) vis a vis gold and after miner Amplats informed markets of its operational review (in which the closure of two mines was outlined). As regards the mining world, well, not much is new there (unless of course you happened to read the latest from the Globe and Mail about the sad state of affair in that niche).

Standard Bank’s analytical team also noted a hefty increase in interest in palladium with the addition of nearly 143,000 ounces to net-long spec positions. Silver specs appear to be less than convinced that the uptrend in the white metal is sustainable for much longer. This kind of sentiment was reflected by the addition of 117 tonnes to the net-short position in the marketplace — a development that seriously countervailed the addition of 233-plus tonnes to net-long market positions.

Gold prices edged higher in holiday-thinned electronic trading on Monday and spot bids ended just above the $1,690 per ounce level. According to the latest EW market technical analysis, gold prices have stalled near their previous fourth-wave high at $1,695 and while a stab at $1,705 is possible this week, such a move would complete a 61.8% Fibonacci retracement of the decline that commenced at gold’s October 2012 high. Should gold prices breach $1,653 per ounce on the downside, gold could once again begin to exhibit greater bearish potential.

The situation is fairly similar in silver. The white metal has the potential to touch its own 62% retracement target at $32.43 per ounce after having rallied to $32.15 on Friday. However, after five consecutive rising sessions, some profit-taking fatigue may set in. If silver falls through the $30.15 Jan. 11 low, the picture might change in that metal’s trend as well.

Gold bullion prices inched up as speculation arose that the Bank of Japan might be preparing to unleash a fresh round of monetary easing. Japan’s central bank has been aggressively attempting to reflate in recent years but without too much success. Foreign exchange experts we spoke to over the weekend are split on the potential effects of such a move. One camp envisions easing as being gold-friendly (at least to would-be Japanese investors) while another sees the yen’s losses coming to bolster its principal rival currency — the U.S. dollar (and that development is not seen as being potentially gold-friendly, to be sure).

This morning, the BoJ announced a 2% inflation target, open-ended asset purchases, and…that was pretty much “it” for the watershed moves it was going to put into motion. The yen actually eked out a gain in the aftermath of the central bank announcement and the currency and equity markets were otherwise quite disappointed with the news release. The BoJ plans to begin its open-ended asset buying program only one year from now and, thus, there is a feeling among market observers that this was nowhere near as “aggressive” a monetary easing move as was originally inferred.

However, the BoJ has good reason to be so persistent in its efforts to bring about “desirable levels of inflation” — something that was talked about a decade ago already. We all know about and are familiar with the effects of noted historical deflationary spirals. Cash is king, consumers hoard it, prices fall, etc. However, go ask the average Japanese consumer (or business) and you might just learn that the dreaded “D” word is…not only not dreaded, but it is…liked. Really, as in: “Hey, that’s not so bad as one might have feared; in fact, it’s pretty okay.”

Bloomberg’s “The Market Now” found that, for example, Japan’s elderly denizens have been benefiting from increased savings and from pensions that buy more as a legacy of such conditions. In addition, falling price spirals such as Japan has witnessed, do not always engender riots, or soup lines — Japan’s unemployment is at a low “we wish we could have that” 4.1% level. The last notable “spike” in Japanese inflation occurred in 2008 when prices “heated up” by 2% only to be followed one year later by a 2% drop in same.

The Land of the Rising Sun has otherwise been “stuck” at near the 0% inflation level since 2003. Also of note is the fact that Japanese investors have been the stand-out sellers of gold on a global basis throughout the past several years. Cash (the “fiat” paper kind that is) is, indeed, king in some places. As for the “D” word, perhaps the Fed might take a page from the Japanese lesson and not fear it as much as it still appears to.

Something else that perhaps we ought not to fear as much as some of us do is the U.S. debt. You know, the fatal, country-destroying debt that will spell the “end of America” as we know it. Well, if you happened to watch CBS’ “Sunday Morning” you would have seen a very relaxed (about the debt) Warren Buffett make certain comments that would have the prophets of American Doom swooning in disbelief and seething with anger. This would not be the first time that Mr. Buffett has irritated the extreme gold bugs with his “unorthodox” take on certain matters.

Mr. Buffett said on that TV show, and we quote: “The debt itself is not a problem. The nation’s debt is [at] a lower percentage of GDP than it was when we came out of WWII. You’ve got to think of it [the debt] in relation to GDP. What is right with America just totally dwarfs what’s wrong with Washington. 535 people are not going to mess up 315 million over time. I know it.” Hey, when it comes to what Mr. Buffett may “know” we would not dispute it. He is, after all, also known as the “Oracle of Omaha.”

Picking up right where we left off last week, we now bring you a little more Bundes Bull myth-busting content, courtesy of a…German banker. Commerzbank’s Carsten Fritsch addressed the (non-) issue of the Bundesbank moving some of its gold reserves back onto German soil and made some noteworthy observations on Deutsche Welle. First, Fritsch noted that — sizeable as they might be at 3,400 tonnes — the country’s gold reserves represent little more than “symbolic” value, especially when seen in the light of Germany’s five trillion euro-large sovereign debt. As well, the gold tonnage is not especially large, considering that individual Germans are estimated to own as much as 7,500 tonnes of the metal.

More importantly, Fritsch launched a broadside on the conspiracy theorists’ fatally flawed arguments that the move was somehow indicative of a huge amount of missing bullion and/or of a terminal distrust of the Fed or fear of U.S. collapse. It was in fact, partially the Bundesbank’s own fault that such wild fairytales were born, to begin with. The central bank did not conduct recurring audits of its golden stash. As for the Zero Hedge style reality-challenged claptrap that implies that Germany was somehow “denied access to its gold because it isn’t there to begin with because it has all been lent out,” The Bundesbank’s Carl-Ludwig Thiele (a board member) remarked in a Frankfurt press conference that Everywhere we were welcomed with open arms. We were shown the inventory lists and inspected individual gold bars, which were then crosschecked with those lists.” Sounds like an open and shut case to us, folks.

In other government-and-gold-related news, on Monday, the Indian government, unsurprisingly, enacted a 50% hike on the duty being levied on imported gold. Effective immediately, the tariff on imported bullion was raised to 6% and it will be “reviewed” on the condition that there is a decline in overall inflows of the yellow metal into the country. Indian officials had indicated for several weeks now that they intended to address the issue of swelling current account deficits with an appetite-curbing measure aimed at the country’s second-largest import item (after oil).

It is too early to conclude whether the measure will prove effective or whether it might give rise to higher levels of clandestine inflows of gold. The bottom line however is that the country’s economic stewards appear to be resolute as to the necessity of doing something about the identifiable causes of the current account gap. According to Bloomberg News, “about 80% of India’s current-account deficit, the broadest measure of trade, tracking goods, services and investment income, is due to gold imports, according to the Reserve Bank of India.”

In March of last year India also doubled the tax on the purchase of gold coins and bars but was not able to put too much of a dent into the demand that arose during the third quarter. Nevertheless, overall Indian gold demand fell by 28% in the one-year period ending in September 2012. As for the current tariff hike and its impact, “consumption and imports will fall definitely,” Bachhraj Bamalwa, Chairman of the All India Gems & Jewellery Trade Federation, said yesterday. It remains to be seen the extent of the measures on the final 2013 Indian gold import tonnage tally will be — we have many months left to go before that figure becomes known.

Also on Monday, bankers at Citigroup scaled back their 2013 gold forecast by 4.2% to $1,675 per ounce (gold was seen by Citi at an average price of $1,653 per ounce in 2014). Among the reasons given for the bearish turn in their forecast, Citi analysts cited gold’s recent struggle to sustain itself beyond the $1,800 technical resistance level despite seemingly conducive conditions such as record low interest rates and fiscal uncertainty has cast doubt onto the bullish case for gold among the investor community.”

Citi’s market observers also made note of the fact that, of late, “Investors appear to be losing faith in the bull story for gold, if net managed money positions on Comex provide a reasonable guide. Net-long managed money positions on Comex have dropped by 50% since the start of October 2012. Positive flows for exchange traded fund investing — an important gauge of investor sentiment — has also stalled since that month, with 17 metric tons of redemptions seen so far in 2013.”

At the same time, the giant financial institution lifted its platinum price projections by 1.5% to $1,700 the ounce for the current year. Citi anticipates that a balanced supply/demand situation might not materialize in the noble metal until sometime between 2014 and 2017. As regards palladium, Citi analysts opine that the metal will tally a shortfall on the order of 336,000 ounces in the current year. Citi has now joined a growing list of pared-back institutional 2013 gold price forecasts.

One possible factor in Citi’s revised price outlook for gold is the overall performance that has been observed in the commodities’ niche since last fall. One market expert remarked that “The poor performance of commodity investments since the third tranche of quantitative easing in the U.S.… has undermined the claim that liquidity injections boost prices irrespective of fundamentals.  Ninety-seven percent of last year’s $20 billion of [commodity investment] inflows went solely into precious metals (mostly gold-backed ETPs).” As we have noted here before, that kind of overdependence on a sole source of demand does not a healthy bull market make.

The Citi forecast occurred even as Goldman Sachs reiterated its own gold price prediction calling for $1,825 per ounce within 90 days (largely on U.S. debt ceiling-related fireworks that might materialize). Recall that gold has fallen 5.5% in the final trimester of 2012 — its worst showing since 2008 — and that Goldman stands by a projection that gold prices will soften in the second half of this year on the back of a rebounding U.S. economy. Other market analysts do not see gold being able to post price prints too much higher than the low $1,700s before heading lower later in the year and in 2014.

Bloomberg News relays that “Gold’s bull market is over,” Allan Hochreiter Chief Executive Officer Rene Hochreiter, the top forecaster in the London Bullion Market Association’s 2012 poll, said this month. The metal’s appeal is set to diminish as so-called fear trades fade, according to Credit Suisse’s Tom Kendall, head of precious-metals research and the most accurate precious-metals forecaster in the past eight quarters tracked by Bloomberg.”

The same Goldman Sachs that was quoted above, BTW, envisions gold trading at or near $1,200 an ounce by 2018. The Business Insider informs that “In a note to clients, Goldman analysts Christian Lelong, Max Layton, Damien Courvalin, Jeffrey Currie, and Roger Yuan write, "Assuming a linear increase in U.S. real rates back to 2.0% by 2018, as proxied by the 10-year U.S. TIPS yield, we expect that gold prices will continue to trend lower over the coming five years and introduce our long-term gold price of $1,200/oz. from 2018 forward." The GS team’s 2% U.S. real interest rate target is actually quite conservative — some analysts have projected that interest rate normalization will result in a 4% real rate paradigm within five years.

Assuming that the $1,825 “peak gold target” does materialize this year, one can calculate a roughly 35% possible decline in the metal’s value over the next five years. Even if that translates into an average 7% easing in annual gold prices, the take-away is that unlike the past five years, when average annual increases on the order of 12%+ have been the ‘new normal’ for many, the period that lies ahead might offer a different “paradigm” — even if we do not label it as a “brutal collapse.”

Some folks will invariably question the value of a 2018 gold price forecast, especially since we might be on the verge of what the very same firm sees as a debt ceiling-driven potential 7.5% rally in the value of the yellow metal. Yes, but as you recall, almost everyone who has made a name for themselves in the gold analysis and forecasting arena over the past five years has depended nearly 99.99% on the argument that low and/or negative real interest rates have been, are, and will continue to be, the principal driver of gold prices. Some have even argued (successfully we might add) that gold is not linked to inflation(!). It is intrinsically and inexorably tied to low real interest rates and little else, in fact.

In that sense, the Goldman 2018 forecast is nothing less than pivotal in its importance. The aforementioned Goldman client note contains this passage: “Our framework for evaluating gold prices relates the real (inflation-adjusted) price of gold to real interest rates and the monetary demand for gold.” Evidently, GS envisions the path towards interest rate normalization (read: gradual increases) as being open in the wake of recent Fed posturing and certain statements.

The GS client “note” (and you just know that this means “advice” to the crème de la crème of high net-worth investors out there) went on to posit that “Even if higher inflation materializes, its impact on gold prices could be offset by: (1) U.S. real interest rates rising more quickly than we anticipate if the economic recovery is accelerating, or (2) an end to the Fed’s aggressive balance sheet expansion if inflation expectations become unhinged.” In other words, notes the Business Insider’s Matthew Boesler, “Goldman expects the effect from higher interest rates to weigh more heavily on gold than the boost the shiny yellow metal would get from continued monetary easing and inflation.”

Translation: The one asset that has benefited the most from the Fed’s campaign or easy money up to this point also stands to possibly be affected the most when such policies go into reverse. Whether or not such a battleship turn takes one year or five is not the issue; the important fact is that it will not occur without collateral “damage.” None of the above obviates the need to keep a core 10% gold allocation in one’s portfolio. It does however bring into question the wisdom of getting carried away with an “all-in” bet at a time when the “tide” might just be rolling out, ever so slowly.

Until next time.

About the Author

Jon Nadler is senior metals analyst with Kitco Metals Inc. in Montreal.