A Sign of Things to Come: Gold Outlook 2014
2014 has already proven much more difficult for stocks than last year.
Stocks are falling and bonds are calling.
Over the past two years, I have provided evidence that funds would eventually shift their bond allocations and fuel them into the equity markets in order to make a return. This was one of the primary reasons why I suggested being in stocks.
From my letter in March 2012, The Biggest Holders of US Debt:
“As stocks make new highs, naturally bond funds will see outflows and stock funds will see inflows. This fresh money coming into the stock market could help push the market up to higher highs.
…Keep an eye on bond outflows – the more this sell off continues, the greater chance the volumes in the equities market will increase on the buy side.”
The opposite, however, can occur when funds decide to increase their exposure to bonds.
We witnessed it this week as investors pulled a historic amount out of equity funds while at the same time putting a historic amount into bond funds.
According to Citi analysts Markus Rosgen and Yue Hin Pong:
“U.S. funds had record-high inflow into bonds and outflow from equities: In the week ended 2/5/2014, there was a $14.8 billion inflow into bond funds and a $28.3 billion outflow from equity funds, representing record highs in both cases. The inflow into bonds was driven by U.S. bond funds, which saw $13 billion of inflow. On the flip side, U.S. equity funds were hit by a $24 billion outflow. More than 95% of these flows were attributed to ETFs.”
We have witnessed outflows from bonds and inflows to stocks over the past two years, which has fueled the momentum of the stock market.
But the tide appears to be turning.
Keep an eye on bond inflows – greater inflows will lead to instability of the stock market, leading to decreased buy-side momentum for stocks.
Did Mike Dueker Know Something…?
Last week, I talked about the mysterious chain of deaths within the financial community.
In particular, I talked about the death of Mike Dueker over at Russell Investments, who (apparently) committed suicide and was “having trouble at work.”
None of the articles regarding his death or “trouble at work” mentioned that the sale of Russell Investments was being explored by its owner, Northwestern Mutual Life Insurance.
I went on to discuss what would happen to the index funds at Russell if things go south, and gave potential insight as to why Dueker would’ve commit suicide based on work related troubles (if, in fact, the reason for his death was suicide).
We witnessed a record outflow of equities, primarily from ETFs this week – just one short week after Dueker’s death.
How much has the outflow of equities affected the Russell index funds? What about other funds, such as emerging markets?
According to EPFR Global, outflows from emerging market equity funds since the start of this year now exceed those for all of 2013.
From a macro perspective, the outflows are not good and will weigh on currencies, credit extension, ability to consume, and therefore, global GDP.
While the market has once again shown us some life toward the end of the week, the reversal in fund flows – from equities to bonds – is a warning sign of fear.
With fear comes volatility and flight to safety investing.
Could 2014 be the Year for Gold Stocks?
The problem with gold stocks is that there are far too many Canadian investment resources that focus specifically on gold and silver alone. That creates a problem because those resources will always tell you to buy; they have to because that’s what pays their bills.
I stayed away from gold stocks last year because they were far too leveraged to the price of gold; a small drop in gold would lead to a big drop in gold stocks, while a small rise in gold did very little for gold stocks.
And since there were many reasons why gold wasn’t climbing last year, I decided to stay away.
But this year could be different.
Over the past few months, I have seen gold stocks leading ahead of gold – a very good sign.
As I mentioned at the beginning of this year, its time to start thinking about gold stocks.
Last week, I talked about gold’s relation to the fear index over the last decade.
Here’s the chart again:
Since stocks will likely fall if equity outflows continue, the VIX will likely spike. This occurrence would make a strong case to get back into gold.
Back to the Basics
Many (myself included) speculate that gold’s price has been manipulated. However, since we can’t prove it (despite a lot of coincidental evidence), let’s look at gold from a simple perspective: Supply and Demand.
While demand was strong in the Eastern Hemisphere, Western investors dumped much of their gold in 2013. This was seen last from year from the mass exodus of gold from the GLD and other American vaults. When any large holder of gold dumps their holdings in the market, prices drop.
Here’s a chart from my Letter, The Biggest Buyer of Gold:
Gold investment demand amounted for a very large portion of gold’s price move in the last five years. In less than 6 months, gold-backed ETFs had net outflows of 119t in Q3 2013 and a whopping 402t in Q2 2013. This outflow – manipulated or not – sent gold prices down very sharply:
It now appears that the majority of gold dumps from the West have taken place, allowing gold to find lots of support above $1200 – the break-even price for many gold mines.
Gold is not a consumable resource, but it still has supply and demand fundamentals. If there is demand, supply is required.
Goldman Sachs believes 20% of existing mines can’t make money at current price levels. And they’re right because many mines are being put on care and maintenance.
Its a simple concept: If the price of coffee beans is too low that farmers can’t make money, they’ll simply raise prices. Gold is no different and supply and demand fundamentals will catch up.
At current prices, we’re going to see a major decline in gold production in 2015.
But that doesn’t mean demand will slow down.
A Rise in Demand
India, once the world’s largest gold consumer, was relatively out of the picture in 2013.
This was a result of the import restrictions placed on gold by the Indian government. India’s government attempted to tackle a widening trade deficit by reducing gold consumption by including a 10 percent import tax and a requirement that a fifth of all imports of the metal be shipped out.
Was the government’s plan successful?
While India’s actions put a temporary halt (on paper, anyway) on gold demand, its actions have not changed its citizens’ thirst for gold.
According to the All India Gems and Jewellery Trade Federation, which represents more than 300,000 jewellers, gold jewellery imports have surged nearly four times to 4-5 tonnes in January from 1.0-1.5 tonnes two months prior to that.
But those numbers alone don’t factor in what’s going on behind the scenes.
Gold smuggling is up sevenfold in the last six months and has essentially backfired on the Indian economy. Instead of reaping the benefits of gold taxation, smuggling is bypassing much of the potential taxation associated with its purchase.
Furthermore, the shortage of gold in India has only led to higher premiums of physical gold. This, in turn, has forced Indian jewelers to import gold in jewellery form to save money:
A 10-gram gold chain from Dubai costs 27,000 rupees ($430), about 10 percent lower than the cost in India, said Raman Solanki, owner of Mumbai-based Sangam Jewels and Gold, who now regularly imports from Dubai. The cheaper price is even after adding a 15 percent duty that finished jewellery imports attract.
Indian jewellers import finished jewellery either to sell directly or to melt to make customised designs.
“Since there is no gold available, we import jewellery as it fits well with our costing. We imported about 700-800 kg of jewellery from Dubai last month,” said Prithviraj Kothari, managing director of Mumbai-based Riddhisiddhi Bullions Ltd.
Dubai-based wholesaler Siroya Jewellers, which exports to India, has also seen a spurt in jewellery sales to India.
“There is demand for jewellery from India due to a shortage of gold there,” said Rajesh Jain, a partner at Siroya Jewellers.”
Surely India’s government cannot allow this to continue. The country is facing an election this spring, and Narendra Modi is the leading candidate for Prime Minister. He is pro-business and has stated many times that the Indian government is foolish for limiting citizens’ rights to purchase gold. He also suggested that a better solution would be to turn India into a net exporter of gold jewelry:
“Just like machine-made goods, hand-made jewellery also has a big demand in the world market. We have the skills. But does the government think about this?” – Narendra Modi
Narendra Modi, via One India News:
“If such jewellery is marketed in the world market, then all gold kept at home will find an automatic route to the world market. If the Indian government promotes special jewellery, the gold will see a value addition and also the rupee will get stronger.
“Buying gold is matter concerning the mind and not just the buying-capacity, a Reserve Bank report has said, someone told me,” Modi said. He said the thought that the buyers of gold will decrease if gold gets expensive is not right. “We must ensure that the gold’s value is enhanced before it goes to the world market. It will also get us foreign currency and our rupee will get stronger,” he said.
“People need security and value addition and hence buy gold. Because of lack of penetration of banks, rural people buy gold to invest. They don’t have to undergo long procedures at banks or real estates. The unstable share market also discourages them to invest and hence the gold is the only choice for them. The Indian government needs to assure the common people,” he said.”
I suspect that India will have to loosen its gold import restrictions this year; thus, a strong surge in gold demand from the once-biggest consumer of the yellow metal.
When Gold Dumping Stops
In the 1970’s, the US and the IMF sold large quantities of gold. When their selling subsided, gold prices shot up very quickly.
It appears that gold outflows out of the US have eased, while countries in the Eastern Hemisphere such as Russia, Saudi Arabia, and China, continue to be net buyers.
Central banks also continued their buying spree purchasing 93.4 tonnes of gold during the third quarter last year, taking year-to-date purchases to 296.9 tonnes (non-inclusive of Q4).
Could US investors continue to dump until there is absolutely no gold left in the vaults of the Comex or GLD? Perhaps. If this happens, gold prices will surely take a historical move downward, especially since the GLD vault still holds around 800 tonnes.
But the reality of this scenario is highly unlikely.
Furthermore, there are many clues that suggest America no longer has the gold it claims to have. Surely if this was the case, the nation will want to secure the outflows from the GLD or Comex vaults so it does not enter the Asian markets. Remember, America still has to deliver a lot of gold back to Germany – so far, it hasn’t been able to.
Since gold stocks are a much better leverage at current gold prices than gold itself, the opportunities in the market are very enticing.
Junior gold stocks appear to have finally bottomed and a new trend is slowly appearing. A small move in gold prices can result in large moves in gold stocks.
I am a buyer of gold stocks this year – especially if equity outflows continue.
The Equedia Letter