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Gold Recovers While Crude Oil Falls
In the last week, gold has risen while oil has fallen. That is a rare combination, pointing toward overall commodity deflation, with gold regaining its unique status as a currency hedge and a crisis hedge.
So far this year, gold has performed comparatively well in the commodities universe. Oil’s performance, by contrast, has been dismal, with added North American capacity causing a glut of supply. After setting a new six-year low on August 12, crude oil was down 18.7% year-to-date in 2015. On the same day, the 19 commodities profiled in the Reuters-Jefferies CRB Index were down a composite 13.5% for the year, reaching a new 13-year low in that widely-watched commodity index. By contrast, gold was only down 5.1% year-to-date, so gold is down much less than either crude oil or the overall CRB commodities index.
Gold posted five straight daily increases while oil was falling to a six-year low of $42.23 per barrel.
What’s happening? First of all, Federal Reserve Vice Chairman Stanley Fischer implied last Monday that inflation is too low for the Fed to consider raising rates any time soon. Gold then got a second boost over the turmoil arising from China’s devaluation of the yuan. Both moves shocked the currency markets and the Fed Funds futures market – which is something like a real-money casino, where traders make bets on the likelihood of a Fed Funds rate increase. Early last Monday, the odds of a September rate increase were 54%. By Wednesday, after China announced it had devalued the yuan, those odds had declined to 39%.
What the Chinese Devaluation Means for Gold
Last Tuesday, the People’s Bank of China (PBOC) devalued the yuan – which had been loosely pegged to the U.S. dollar – resulting in a 2% drop to the dollar. This move helped to push gold up from a low of $1,080 on July 24 to an intra-day peak of $1123 on August 12. Gold then corrected to $1115 by Friday, but gold’s net gain for the week was a welcome sign for long-suffering U.S. dollar-based gold investors.
Gold jumped on the news of China’s devaluation since most traders assumed that this means that the U.S. Federal Reserve may not raise interest rates in September. This interest rate “overhang” has depressed gold for several months, since the trading community (falsely) assumes that gold will fall if the U.S. dollar earns a slight-bit (0.25%) more interest income than “dormant” gold. This is mob psychology, not based on historical fact. Gold rose the fastest from 1976 to 1980, when interest rates were rising into the stratosphere – up to a 21% Prime Rate and a 13% Fed funds rate. More recently, gold doubled from 2004 to 2006, when the Bernanke-led Fed was raising short-term U.S. interest rates from 1.0% to 5.25%. So there’s no reason why a single 0.25% “one and done” rate increase will somehow torpedo gold this time.
Gold also rose because China’s move is disinflationary – and perhaps deflationary – since it will reduce the costs to U.S. consumers of imports from China. This makes the dollar stronger, raising the question of why the Fed would want to raise rates and push the U.S. dollar even higher, hurting U.S. exporters.
Strangely, the world seems to be shocked by a 2% devaluation of the Chinese yuan. In the longer scheme of things, several of the world’s top currencies – including those from commodity-rich nations like Brazil, Canada, Australia and Mexico – have suffered currency devaluations of far greater scope so far this year.
China’s currency is actually one of the strongest competitors to the U.S. dollar, as this table indicates:
China’s 2.9% drop is a “drop in the bucket” compared to double-digit losses in many other currencies.
This table also implies that gold is rising in 2015 in terms of all of the currencies listed above, except the Chinese yuan and U.S. dollar. The world is in an uproar because China is the world’s “second largest economy,” but it is probably #3 if you count the European Union as one economy. By most accounts, the EU is still #1 as a unit, and the euro has fallen three times as fast as the Chinese yuan so far this year.
Gold’s rising price, especially in the face of an oil price collapse, reflects gold’s role as a crisis hedge. According to Ross Norman, CEO of Sharps Pixley (a London-based metals dealer), “The gold price is the sum of all fears, and we’re seeing a reflection of nervousness in the market following the yuan devaluation,” As a result, he added, “We’re now seeing good price strength with fresh longs coming in.”
China has also boosted gold’s fortunes by purchasing 600,000 Troy ounces (about 19 metric tons) of gold in July. In all, China has added over 600 metric tons of gold to its central bank in the last six years, a 57% increase in Beijing’s gold holdings, at a time when central banks in developed countries have not bought any more gold. (Russia and China have been buying the most central bank gold since 2009.)
The World Gold Council projects that central banks will buy 400 to 500 metric tons of gold in 2015. The People’s Bank of China (PBOC) says it holds over 1675 metric tons of gold, #5 in the world, virtually tied with Russia, which has more than tripled its gold hoard since 2005. The third most active gold buyer is Kazakhstan, which has added to its central bank gold holdings every month since October of 2012.
New York Traders Stage a Sudden “About Face” on Gold
Commodity traders switched allegiance on gold in a “New York minute” last week. Before last week, some major investment houses were unusually bearish, publishing widespread predictions that gold would fall below $1,000 per ounce before rising. Despite the fact that July physical sales of gold coins and bars doubled at the U.S. Mint and on the Shanghai Gold Exchange (SGE), the traders in paper gold derivatives (mainly gold ETFs and futures contracts, often bought on leverage) were mostly bearish on gold’s future.
For example, the August 3 issue of Barron’s (Commodities Corner) asked, “Will Gold Fall Below $1,000?” Their survey of analysts mostly answered in the affirmative. For instance, “Jeffrey Currie, head of commodities at Goldman Sachs, said gold would drop below $1,000 by the end of the year. Analysts at Merrill Lynch are also calling for a drop below $1,000, as rising interest rates and a lack of inflation create ‘the most bearish cocktail for gold in the past 43 years.’” (Oddly, Merrill Lynch was pointing back to 1972, when gold was very cheap. Gold’s price then multiplied more than 20-fold from 1972 to 1980!)
Analysts surveyed by Bloomberg were equally bearish, predicting that gold will drop to $984 (an average of their survey participants). Many predicted a “prolonged bear market” for gold. Morgan Stanley said that gold investment buying would shrink through at least 2018! Natixis, a French investment bank said that “it is more likely than not that gold prices will drop below $1,000 in the period after the Fed announces its first rate hike.” Barrick Gold, the world’s largest gold mining company, said it has laid out contingency plans for $900 gold, so the whole of the gold world was in a blue funk going into August.
Due to this depressed outlook for gold, miners have been closing their marginal operations and battening down the hatches to ride out a long bearish run for gold. As a result of this bunker mentality, global mine supply fell 4% last quarter (vs. the second quarter of 2014), according to the World Gold Council’s just-released “Q2 2015 Gold Demand Trends” report. Also, a recent PricewaterhouseCoopers survey of gold mining executives showed that 87% expected gold to fall further or stay the same for the rest of this year.
However, the tide may have turned in the first week of August. The latest Commitment of Traders (COT) data for the week ending August 4, released by the Commodity Futures Trading Commission (CFTC), said that large speculators added 5,435 net bullish contracts for the week, the first net rise in six weeks.
If gold continues to rise, you can bet that the momentum traders will change their long-term views on gold. We at Navellier Gold continue to advise accumulation of a meaningful position in gold at these prices. By doing so, you can beat the momentum players to the punch by buying near the cyclical low.
August 16 – a Golden Day in U.S. History
On August 16, 1896, George Carmack discovered one of the largest gold strikes in history on Rabbit Creek in Canada’s Yukon Territory, just across the border from Alaska. The Klondike Gold rush was on.
On August 16, 1924, Charlie Chaplin’s silent film classic, The Gold Rush, opened in New York theaters.
On Monday, August 16, 1971, the day after President Nixon announced the “closing of the gold window,” the devaluation of the dollar, a wage and price freeze, increased tariffs and a tax surcharge – all pretty scary stuff, it would seem – the U.S. stock market soared, rising 32.93 Dow points (+3.8%) in a day. The reason was that all these programs were politically popular, with 75% approval rates, but this was the beginning of a decade long decline of the dollar, punctuated by gold’s rise from $35 to $850.
For the week ending Friday, August 16, 1974, the Dow fell by 45.76 points (down 6%). It was the week after President Nixon’s resignation. In the middle of that week, on August 14, 1974, the U.S. Congress authorized U.S. citizens to finally be able own gold (for the first time in 41 years) by year-end 1974.
On Tuesday, August 16, 2011, gold gained $43.50 to close at $1782.50, its largest one-day rise in its meteoric ascent from $1483 on July 1 to its record high of $1895 on September 5. Gold’s sharp two-month rise came in the midst of S&P downgrading U.S. government credit amid a stock market decline.
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