What's the Game Changer for Gold?
By Frank Holmes
CEO and Chief Investment Officer
U.S. Global Investors
With the games in Sochi underway, people around the world are tuned in to watch the competition heat up in their favorite cold-weather sports, including cross-country skiing, snowboarding and hockey.
Back in Washington, we watched Ben Bernanke officially “pass the puck” to Janet Yellen, who became the new chairman of the Federal Reserve’s Board of Governors this week.
Imagine if the puck were the Fed’s assets—that would mean the disk is five times bigger today than when Bernanke became chairman in 2006. At the beginning of his reign, the Fed’s assets were $834.6 billion. Now, the balance sheet has grown to $4.1 trillion, a previously inconceivable size.
Until last year destroyed gold’s multi-year bull reign, the expansion of the U.S. balance sheet and the price of gold over the past decade moved in near lockstep. From 1999 through 2012, the correlation coefficient of the rising price of gold to the Fed’s climbing assets was 0.95.
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Even with the tapering of the bond purchases that began in late 2013, the Fed’s balance sheet remains on an upward trajectory and much higher than the price of gold. This suggests we should see much higher prices.
What will break gold of its losing streak? Will inflation, which is a lagging indicator, be stronger than expected? In one of my most popular posts last year, I said that based on the jobs market, the limited housing recovery and regulations slowing down the flow of money, the Fed would have no choice but to start tapering and raising rates very gradually to keep stimulating the economy.
In CLSA’s Greed & Fear, Christopher Wood points out the forward-looking U.S. data, pending home sales index, is “clearly suggesting stalling momentum.” Pending home sales have been declining for seven months in a row, “plunging by 8.7 percent month-over-month in December to the lowest level since October 2011.”
There’s also a weaker demand in mortgages in the past quarter. According to a survey of banks, nearly 30 percent reported weaker demand for prime mortgages, which is the “worst data since April 2011,” says CLSA. About 46 percent of banks are seeing weaker demand for non-traditional residential mortgages, the worst since January 2009.
The ISM manufacturing new orders index is also off. In January, new orders fell from 64.4 in December to 51.2 in January, which was the largest monthly decline since December 1980.
So even if investors shrugged off the disappointing jobs report today, we’re pretty certain the incoming chairman is paying close attention to the scoreboard.
- Major market indices finished higher this week. The Dow Jones Industrial Average rose 0.61 percent. The S&P 500 Stock Index gained 0.81 percent, while the Nasdaq Composite advanced 0.54 percent. The Russell 2000 small capitalization index dropped by 1.27 percent this week.
- The Hang Seng Composite fell 1.43 percent; Taiwan dropped 0.89 percent while the KOSPI declined 0.96 percent. The 10-year Treasury bond yield rose 4 basis points this week at 2.69 percent.
Domestic Equity Market
The S&P 500 Index bounced back this week, gaining 0.81 percent, and finishing strong with back-to-back gains of more than 1 percent. Cyclical areas of the market experienced the biggest lift this week with consumer discretion and materials leading the way.
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- The consumer discretion sector experienced broad-based strength this week. The auto-related retailers were strong, with Autozone and O’Reilly Automotive among the leaders, on the back of strong quarterly results. Michael Kors Holdings led the way this week, rising 17.88 percent on very strong quarterly results.
- The materials sector also outperformed this week. Construction materials were strong as Vulcan Materials reported better-than-expected results, coming on the back of merger activity in the industry last week. The fertilizer-chemical space also was strong with solid performance by Mosaic, Monsanto and CF Industries.
- Akamai Technologies was the best performer in the S&P 500 this week, rising 18.79 percent. The company released quarterly earnings results, which were ahead of expectations, and forecasted first-quarter earnings and revenues ahead of analysts’ estimates.
- The telecommunication services sector was the worst performer this week with Verizon Communications and AT&T each falling 2.5 to 3 percent. AT&T announced a new family pricing plan as the pricing wars escalate within the industry.
- The utilities sector was also weak, in what appears to be some sector rotation as the utilities sector remains the best year-to-date performer.
- Dun & Bradstreet was the worst performer in the S&P 500 this week, falling 11.13 percent. The company announced quarterly results that slightly disappointed, but the new CEO laid out his strategic vision for the company which will require additional investments and execution risks.
- The current macro environment remains positive as economic data is robust enough to give investors confidence in an economic recovery, but not too strong as to force the Federal Reserve to aggressively 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.
- The improving economic situation could possibly drive equity prices well into 2014.
- A short-term market consolidation period after such strong performance over the past six months cannot be ruled out.
- Higher interest rates are a threat for the whole economy. The Fed must walk a fine line and the potential for policy error is large.
- A lot of good news may be priced into the market and the economy will need to deliver to maintain the positive momentum in the market.
The Economy and Bond Market
Treasury bond yields were mixed this week. We saw the long end of the yield curve rising, but saw a modest decline in yields in the short end of the curve. Economic data was also mixed this week with the two, most-widely watched numbers disappointing. The ISM Manufacturing Index fell in January to 51.3 from 57, which is a dramatic decline. Bad weather was cited, and although it may be reversed in upcoming months, the index should still be watched closely. The other big data point of the week was the weak nonfarm payroll report, which indicated only 113,000 jobs were created in January. Once again, weather likely played a factor, but the data was still disappointing.
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- The J.P. Morgan/Markit Global Manufacturing & Services PMI rose 0.1 in January, making this the sixteenth straight monthly increase.
- Retail sales for January rose 3.3 percent, beating expectations despite poor weather in many parts of the country.
- Mortgage applications rose 0.4 percent last week as mortgage rates fell five basis points to 4.47 percent.
- Disappointing payroll growth for the past two months is pointing to a continued slow economic recovery.
- The ISM Manufacturing Index fell dramatically in January. Weather likely had an impact, but after similar disappointing numbers out of China, the report should not be dismissed.
- Auto sales declined in January and were generally worse than expected.
- Janet Yellen was officially sworn in as head of the Federal Reserve. She brings credibility and consistency to the position, making the transition relatively seamless.
- Key global central bankers remain in easing mode such as the European Central Bank (ECB), Bank of England and the Bank of Japan. ECB president Mario Draghi vowed to take “decisive action” if needed to combat deflation. Speculation is building that the ECB may take action in March.
- There are many moving parts to the taper decision, and while the Fed began the process, it is very possible that tapering could be delayed if the economy stumbles.
- Several emerging market countries are raising interest rates at an aggressive pace to either deal with inflation or a weak currency. It could be the beginning of a new global interest rate cycle for higher rates.
- Trade and/or currency “wars” cannot be ruled out which may cause unintended consequences and volatility in the financial markets.
- Puerto Rico was downgraded to “junk” status this week, highlighting the fact that even six years past the financial crisis, the fallout continues.
For the week, spot gold closed at $1,267.21, up $22.66 per ounce, or 1.82 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, rose 1.97 percent. The U.S. Trade-Weighted Dollar Index lost 0.78 percent for the week.
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- Australia’s Perth Mint, which refines most of the bullion from the world’s second-largest producer, joined the U.S. in reporting that gold demand climbed in January. A Bloomberg story reports sales of coins and minted bars increased 10 percent to 64,818 ounces in January. Sales of gold coins by the U.S. Mint climbed 63 percent in January.
- On the back of last week’s three bought deals, the activity kept up this week as Luna Gold announced a C$20 million bought deal and Gold Standard Ventures announced a C$10 million marketed private placement. In addition, on the M&A front, Silver Standard Resources agreed to purchase the Marigold Mine from Barrick and Goldcorp for $275 million in cash.
- Comstock Mining announced that it secured over 300 acres of private lands adjacent to the American Flat processing area, providing valuable expansion opportunities for its leaching, processing and refining solutions. In addition, the company received notice of the Lyon County Board of Commissioners unanimous approval of zoning law changes expected to increase the company’s reserves dramatically as its Marble, Alhambra and Kossuth mining claims reside in the area.
- Harmony Gold Mining, the South African miner, announced that a number of its workers died as a rock fall accident triggered a blaze more than one mile underground at its Doorknop site. Search and rescue efforts were deployed, but the efforts were hampered by smog and falling rock. This is South Africa’s worst gold mining accident in at least five-and-a-half years.
- New Gold released its full-year 2013 operating results together with its guidance for 2014. Gold production for 2014 disappointed investors’ expectations at 380 to 420,000 ounces, roughly flat relative to 2013. The analysts at Paradigm Capital were “baffled” as to why the company made no mention of significant reserve grade decreases in the New Afton mine, which represents more than half of the company’s valuation. The team at Desjardins estimates reserve grades across the company decreased 2.9 percent, with New Afton’s grades decreasing nearly 14 percent. As a result, gold contained in the resource statement decreased over 10 percent (ex-Blackwater).
- A Mineweb article suggests that gold ETFs appear to have fallen out of favor in India. The exchange traded funds had their first yearly decline in assets under management (AUM) since their introduction in 2007. In 2013, the local gold ETFs slid 26 percent, losing approximately $479 million in AUM.
- There have been commentaries circulating that suggest billions of dollars worth of private capital is currently waiting to be deployed in the mining sector. Yet, according to Mark Tyler, senior investment banker at Nedbank Capital, there is a “wall of funding” waiting. According to Tyler, there is evidence suggesting $8 billion of private capital, and a similar amount of money in public funds, are currently stuck as fund managers are engaging in more comprehensive due diligence processes. The main argument for the increase is the fact that good deposits have been ruined by poor management in the past, and it takes longer to perform due diligence on management.
- Mexican pension funds have shown fresh interest in gold after certain investment regulations were lifted, says the World Gold Council. The Council has been in contact with fund managers representing nearly $160 billion in assets, who have demonstrated interest in gold investments now that Mexican legislation allows pension funds to invest in gold and commodities.
- West Kirkland Mining, a Nevada gold exploration company, is in the process of acquiring the Hasbrouck asset from Allied Nevada. Tyron Breytenbach at Cormark Securities published a very interesting report in which he remodeled the Hasbrouck project as a smaller, higher grade, heap leach project which West Kirkland could develop with only $55 million in capital expenditure. The resulting production should come at all-in prices below $800 per ounce, which highlights the potential for this project.
- National Bank Financial is of the opinion that 2014 gold mining production guidance is likely “to carry a mixed negative bias as the move to ‘profitable ounces’ may not materialize as quickly as investors hope.” This next step of cost-cutting may fall short of expectations, both with respect to magnitude and timing, since the flexibility of mining operations is constrained, according to the bank’s analysts.
- The Bureau of Land Management and the U.S. Forest Service are being accused of inappropriately seeking to list the Sage-grouse as an endangered species, which under current U.S. Mining Law would withdraw an estimated 17 million acres from mining-eligible land. The model has been used in the past: in 1980 the U.S. Fish and Wildlife Service declared the spotted owl as threatened, which resulted in an estimated 5.3 million acres being named conservation areas. As a result, more than 200 mills in the Northwest were forced to close.
- A new Environmental Protection Agency (EPA) report states that nearly 40 percent of total toxic chemical releases came from metals mining in 2012. According to the agency, the extraction and beneficiation of metals generates large amounts of waste, which are not especially amenable to reduction. Tim Crowley, President of the Nevada Mining Association, came out in defense of the sector stating that more than 99 percent of the state’s toxic releases are secured and monitored in engineering facilities and protected from exposure to the surrounding environment, a fact that was not found in the EPA report.
Energy and Natural Resources Market
- The price of coffee futures rallied to an eight-month high on Monday as unusually dry weather in Brazil sparked worries about possible crop damage for the world's biggest coffee producer. Coffee prices hit seven-year lows of nearly $1 a pound in early November. Recently the prices on ICE Futures U.S. were around $1.34 a pound, up 7 percent on the day and 21 percent so far in 2014.
- Spot crude from Alberta strengthened against the U.S. oil benchmark West Texas Intermediate (WTI). This happened as California, the third-largest oil refining state in the U.S., takes a record volume of oil (709,000) from Canada by rail.
- WTI crude oil rose to $100 a barrel this week for the first time since December 30, due in part to colder-than-normal weather across much of the nation.
- The Baker Hughes International Rig Count for January fell by 10 rigs to 1,325, while the U.S. rig count declined by 2 rigs to 1,769. Both measures, though, are up comfortably year-over-year.
- Australia’s iron ore exports to China from Port Headland, which is 20 percent of the global seaborne iron ore market, fell 3.5 percent in January to 23.3 million metric tonnes. This came on weaker Chinese demand and a three-day closure of ports because of a cyclone threat.
- The benchmark hot rolled coil (HRC) price declined for a fourth consecutive week. The CRU Weekly Price assessment shows U.S. HRC at $670 per short tonne for the week ending February 5, following a decline of $3 a short tonne the week prior.
- The world’s mining assets may be the target of mergers and acquisitions (M&As) as an $8 billion pool of private-equity money, that has lain dormant, is stirred this year by attractive valuations and predictions of resilient demand for raw materials.
- According to Citigroup Research, a mid-$5 natural gas price should be the long-term U.S. gas price range. This price is above marginal production costs and stands at 20 to 25 percent above current forward prices to 2020, as demand surges between now and then. Short-term production costs should set a soft price floor at roughly $4; power generation/exports economics put a soft price ceiling at roughly $6 to $7.
- Mine closures are pointing to future inflection points for uranium prices, as Paladin has announced that it is putting on care and maintenance for one of its two operational uranium mines, Kayalekera in Malawi. The mine was responsible for 2.94Mlbs (million pounds) of U3O8 production in 2013, or around 2 percent of global mine supply.
- Global manufacturing confidence dropped in January, implying a softening short-term outlook for base metals demand growth, although there could be a seasonal pick-up in early March.
- Indonesia will be consistent in applying the ore export ban, per the Deputy of Energy and Mineral Resources Minister. The Minister adds that companies can, if they want to, go ahead with seeking arbitration or shutting down operations. Newmont Mining and Freeport McMoRan are in talks with the government as they claim that Contracts of Work protect them from the new export tax rules.
- Emerging market currencies rebounded strongly on Tuesday. Hedge funds and other speculative investors booked profits on recent bets against the currencies as they un-winded carry trades. The rebound originated when the Turkish central bank raised lending rates to banks to 10 percent. The spillover effect had 13 other emerging market currencies in our universe posting multi-sigma moves to the upside.
- Greece’s manufacturing sector expanded in January posting at 51.2, up from 49.6 in December, as measured by Markit’s Purchasing Managers’ Index (PMI). This was the first reading above 50 since August 2009, reflecting solid expansions in output levels and new orders, as production levels at Greek manufacturers rose for the third consecutive month. A slight rise in new export orders contributed to the improved performance, though data showed that it was the domestic market that provided the principal boost.
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- Indonesia’s GDP expanded faster than expected at 5.7 percent year-over-year in the fourth quarter, recovering from 5.6 percent in the third quarter, as a weaker Indonesian rupiah drove a positive contribution to growth from higher net exports. Trade balance returned to a surplus of $2.3 billion in the fourth quarter from a deficit of $3.1 billion in the third quarter.
- Hungary's industrial output growth slowed in December after accelerating for three consecutive months. Industrial output grew by 4.4 percent year-on-year in December, lower than the forecast of 6.2 percent. On a monthly basis, industrial output was down 1.9 percent.
- Despite a strong performance in 2013 from Czech and Hungarian exporters, the official trade numbers for the month of December were much less rosy. Hungary's trade surplus declined sharply to EUR 289.8 million (euro) in December from EUR 825 million in November, while the Czech Republic’s trade surplus declined sharply to EUR 9.6 billion in December from EUR 36.4 billion in November.
- Growth of Macau’s gross gaming revenue slowed to 7 percent year-over-year in January from 18.5 percent in December, reflecting a deceleration of casino traffic one week ahead of the Chinese New Year. Gaming stocks exhibited higher than normal volatility as a result.
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- A recent correction in Hong Kong-traded Chinese equities, induced by slowing manufacturing activities and trust product default fears, may have created an opportunity to accumulate innovation-driven, well-managed internet companies in China founded by inventive entrepreneurs. Privately owned companies as a whole have outperformed state-owned counterparts in China, post-global financial crisis, and may sustain outperformance given reform-oriented government policy incentivizing innovation.
- Eurozone business activity strengthened again, as the composite PMI rose to 52.9 in January from 52.1 in December, and the services print edged up to 51.6 from 51. In peripheral Europe, Spain's composite PMI hit a six-and-a-half year peak of 54.8, while Italy is also returning to growth and France's business sector is showing signs of stabilizing, according to Markit.
- Christopher Wood of CLSA offered an interesting perspective on this year’s “turmoil” in emerging markets. In his Greed & Fear report, Wood notes that the negative market action in emerging market debt and currencies is now much more concentrated in those countries which have high U.S. dollar indebtedness. He adds that blanket generalizations about “emerging markets” ignore the reality that some countries have decent fundamentals and some do not. It is more of a country-specific issue that an asset class issue.
- Dedicated emerging market funds have set a record of 15-straight weeks of outflows, with cumulative outflows of $33.3 billion, equivalent to 4.4 percent of assets under management. The previous record of 14-straight weeks of outflows occurred in 2002. This week’s outflow of $6.36 billion was large, similar to last week’s outflow of $6.33 billion. The outflows combined from these two weeks are the largest since January 2008.
- Greek banks are likely to need additional capital after results of a health check are finalized. According to the country's central bank, this could threaten government plans to reduce its own funding gap. Banks rallied this week however, as a review by Blackrock is expected to show that the funding shortfall will have a more limited impact to the institutions.
- Returning fears of emerging market currency turmoil from Latin America and Eastern Europe could trigger sell-offs in outperforming Asian equities in order to meet redemption needs of global emerging market fund managers.
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