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Gold is enjoying a Very Good Year…Outside of the United States
The gold headlines in the U.S. financial press remain dismal. In October, gold hit a four-year low, in dollar terms, and November brought lower lows, 4-1/2 year lows. At one point, gold dropped to $1132.
The untold story is that gold is rising in terms of most other major currencies – including the euro, Swiss franc, British pound, Swedish krona, Russian ruble (all located in Europe), plus the Japanese yen, Canadian dollar and most Latin American currencies. In terms of the euro – the most important currency outside the dollar zone – gold is up over 7% as of mid-November. At the start of 2014, an ounce of gold sold for 870 euros ($1200 divided by a $1.38 euro). Gold is now 935 euro ($1160 gold divided by $1.24).
Using the benchmarks of $1200 gold on January 1 and $1160 on November 12, gold is down 3.3% in U.S. dollar terms. Using those same benchmarks, gold has risen in terms of most other currencies in 2014:
The Major Exceptions are
China and India
Combined, China and India account for 35% of the world’s population and more than 50% of the world’s gold demand. So far in 2014, demand has been sporadic in both nations, partly because their currencies have been strong. The Chinese yuan and Indian rupee have tracked the U.S. dollar fairly closely, year to date. Through November 12, the rupee is up 0.7% and the yuan is down 1.1%. Year-to-date, gold is down 2% in China and 4% in India. The Indian government has also taxed gold imports, in an attempt to solve their balance of payments deficit, thereby putting an added burden on gold dealers and customers.
However, we’re seeing a positive change in the fall months, as usually happens due to various festivals and the wedding season in India. Indian gold imports in October rose 16% over September, surpassing 24 tons. With the wedding season starting (in the third week of November), the All India Gems & Jewelry Trade Federation now predicts that fourth-quarter gold imports to India will rise 75% (vs. the third quarter), since gold traditionally adorns many bridal trousseaus and gold remains a popular wedding gift.
Gold demand in India is clearly recovering. According to the World Gold Council (WGC) gold imports to India rose nearly 60% in the third quarter, including a 450% rise in September (over September 2013). In addition, WCG estimates that about 200 tons of gold were smuggled into India’s “gray market” last year.
China’s economy may be “slowing” (to 7% GDP growth), but gold imports from Hong Kong were 61.7 metric tons in September, the highest import totals since last April. Also in September, the World Gold Council forecast a 20% rise in Chinese gold demand in the next three years. China is also the world’s #1 gold producer, so their gold exports often surpass their imports, temporarily pushing gold’s price down.
Statistics out of China are notoriously sporadic and unreliable, but one of the most reliable numbers is the weekly withdrawals from the Shanghai Gold Exchange. The latest week shows 54.19 metric tons going from Shanghai into the rest of China. The latest monthly withdrawal, October, totals 225 tons, an annual rate of 2700 tons, or roughly the amount of gold being mined in all global mining operations each year.
Russia is Also Loading up on Gold – Partly Due to a Falling Ruble
Last January, when Russia was seemingly docile, preparing for the Winter Olympics in Sochi, an ounce of gold cost 39,510 rubles. Now, gold is up 35% to 53,280 ruble. In September the Russian central bank bought 1.2 million ounces, their biggest one-month purchase ever. Russia’s purchases in the six months from April through September total 3.5 million ounces. Their total holdings now amount to 37 million ounces, doubling over the last five years. (This is another example of gold acting as a currency hedge.)
Low Gold Prices Will Lead to Gold Mine Closings …
and then Supply Shortages…and then Higher Prices
Gold, like most commodities, is universally priced in U.S. dollars, so gold miners have trouble wrestling a profit out of their ongoing operations, due to a declining price of gold in U.S. dollar terms. Analysts at Citigroup calculate that about 75% of gold mining companies lose money at any price below $1200 per ounce on an “all in” cost basis (including both mining and administrative costs). With gold mired below $1200, many gold mining operations will have to be closed down. If gold drops to $1100 for an extended time, even more mines will close. This will limit the new supply of gold. Many mining companies will disappear. Those that survive will likely have to reduce production. With demand staying the same or rising, the gold price will inevitably rise, so the ultimate solution to gold’s low price is…gold’s low price!
Even though gold bullion is down slightly in U.S. dollars this year, gold mining shares are at 13-year lows. Standard & Poor’s TSX Global Gold Sector Index (containing about 40 gold mining stocks) is at its lowest level since 2001. Gold is up four-fold since 2001, but gold mining stocks are at 13-year lows!
Gold has fallen 40% since its peak of $1,920+ in September 2011, but the gold mining stocks tend to act like gold bullion on leverage. For instance, if a mine’s all-in cost of production is $1200 per ounce, their profits can double if gold rises from $1400 to $1600, but those profits turn into losses when gold falls below $1200. This will necessitate closing operations. That’s why the gold mining ETF (GDX) is down 78%, twice the 40% drop in gold. One leading stock, Barrick Gold, has fallen back to its 1992 price. A more typical example is Iamgold, a leading Canadian miner, which announced last week that it would cut 40% of its management staff, reduce other outlays and “considerably reduce” its active mining operations.
WGC summarized this supply/demand crunch: “With recycling at a 7-year low and mine supply looking increasingly likely to be constrained in the future the outlook for physical gold demand remains strong.”
How low will gold go first? We don’t want to throw out any scary triple-digit numbers, but in a sense it doesn’t matter. Gold acts as portfolio insurance. While the bulk of your portfolio is rising, gold may fall a bit, but in bad times, your gold position will provide the gains not available in many other asset classes.
As Marc Faber, editor of the Gloom, Boom, and Doom Report, said to an audience in New Orleans last month: “Be your own central bank…buy gold as catastrophe insurance.” He said that gold could drop to $900 and a lot of miners could go out of business, but gold will not stay low for long. “If central banks continue printing money as they have been doing,” he said “gold could rise to $5,000, $10,000, or even $100,000,” but you might not enjoy living in the kind of world that pushes gold prices over $10,000.
In the meantime, you can take advantage of gold’s currently low prices (in U.S. dollars) to build up a meaningful position in gold (with smaller positions in silver and platinum) as your portfolio insurance.