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Gold Gains 10% in the First 10% (36 Days) of 2016
“Gold doesn’t build new factories or things like that, new software. What it is, is insurance that if things really go wrong you’ve got something that will balance your portfolio. So whether it’s five percent, ten percent, it shouldn’t be dominating your portfolio… Not that you’re going to make quick money on it, but it’s like an insurance policy. You hope it doesn’t have to be used, but if it does you’ve got it.”
In the first five weeks of 2016, unlike the previous four years, investors made “quick money” on gold. On Friday, February 5, 2016, gold closed at $1174 per ounce, up over 10% during the first 10% (36 days) of 2016. That doesn’t mean this rapid price increase will continue unabated for the rest of the year, but gold’s recent performance is a welcome relief after four declining years.
What makes gold’s recovery all the sweeter is that investors suddenly seem afraid of the stock market, so gold is up 10% while the S&P 500 is down 8% and NASDAQ is down almost 13%.
At the same time, global interest rates are falling sharply. After the Federal Reserve raised short-term interest rates by 0.25% in mid-December, most investors assumed that interest rates would start rising again. Instead, Japan shocked the world by reducing its key short-term rate from +0.1% to -0.1%. In all, five major central banks (Japan, the European Central Bank, Switzerland, Denmark and Sweden) are now punishing their short-term investors with negative interest rates.
This decline in short-term interest rates gives gold an advantage when it comes to short-term returns. The rap on gold is that it offers “no interest income,” but zero is better than -0.1%!
Longer-term interest rates also declined sharply during January. Here are a few examples:
With this surprise decline in long-term and short-term interest rates in 2016, it’s almost certain that the Federal Reserve will forego an immediate increase in short-term interest rates at the next meeting of the Federal Open Market Committee (FOMC) in March. The slow economic growth statistics (0.7% annual GDP growth in the last quarter of 2015), the sharp decline in stock prices and the surprising decrease in rates paints the Fed into a corner of “no further action” in March.
More Demand & Less New Supply = Higher Prices
Gold and stocks tend to have a negative correlation. A lot of the money flowing into gold comes from stock sales. We know this because “paper gold’ investors are piling back into gold exchange-traded funds (ETFs) more than physical metals. Since the beginning of the year, gold ETF holdings have increased by 67.5 tons. In the first three weeks of 2016, the biggest gold ETF, the SPDR Gold Trust, made up for about one-third of its 2015 losses, but it still has a long way to go before matching the peak of gold ETF holdings in 2012 – or the peak price of gold in 2011.
Traders Magazine Online News has said that stock-based exchange-traded funds (i.e., backed by equities) were net sellers of $16 billion in January, while precious metals ETFs attracted $1.2 billion during the same month. Other commodities have not done as well, so this is mainly a gold move, unlinked to the dollar or to commodities. This surge appears to be a classic “fear” trade.
One of the major factor supporting gold’s price increase in 2016 is the fact that new mine supply likely peaked in 2015 at 3,177 metric tons (a metric ton equals one million grams, or 32,150 Troy ounces, our 2,205 pounds). New global mine supply is likely to decline by 95 tons (-3%) in 2016 and by a total of 366 tons (-11.5%) by 2018. This puts gold’s supply/demand fundamentals into deficit in the next three years, as this projection from Credit Suisse and Richardson GMP shows:
As usual, the major investment banks are trend-followers, not trend-setters. They usually miss the first 10% move before getting on the gold bandwagon. This time around, Bank of America Merrill Lynch said that “this will be a transitional year, with gold ultimately breaking out of the bear market.” HSBC says that “growing risk aversion” is “supplying the oxygen for gold’s rally. The decline in risk appetite is exemplified by the drop in yields,” while Macquarie’s Bank says “one positive lesson we can learn from [last] month is that gold does still have a safe-haven role.”
Private investors don’t have to wait for the Wall Street crowd to join the party. We have been advising the accumulation of gold all along, and gold remains undervalued now. We are likely just in the beginning of the next bull market surge in gold now. But even if gold takes another year or two to gain momentum, the more gold you accumulate at low prices rewards you later on.