Gold and Precious Metals

Gold takes off

Markets have had a wobbly 2016 so far. But as investor nerves have frayed one asset has shone. That’s gold, our favourite “lustrous lump”. At US$1,210 per troy ounce the price is up 14% so far this year. This is probably too far too fast. But it’s worth remembering what’s likely to drive the gold price in the long run.

Stock markets have been having a tough run this year. The very overpriced US market is down 8%, leaving it still very overpriced.

Japan is down 12%, and experiencing massive price volatility. Daily moves, up or down by 5% or more, have been a regular feature of recent weeks. This is a sign of nervousness. Japan is a bankrupt country that’s resorting to ever more desperate policy interventions. Our view is that it’s still best to stay away as far as investments go. (But it’s a great time to visit Japan. With the currency devaluation of recent years it’s probably the cheapest it’s been in decades.)

Ever beleaguered Greece has sunk to new lows. A few days ago the Global X FTSE Greece 20 ETF (NYSE:GREK) was down 29% year-to-date, although it’s bounced a bit since. In April last year I noted that the Greek stock market was down 95% since its 2007 peak, but that you should still stay away. Since then GREK is down another 40%.

Emerging markets also took a battering in January. The MSCI Emerging Markets index was down 12% by mid January, but has since rebounded to be down 6%. This means emerging markets have been among the better stock market performers so far this year, which makes a change.

As I’ve repeatedly pointed out, emerging market stocks are cheap and likely to be much better long term investments than overpriced markets like the US. The MSCI Emerging Markets index has a P/E ratio of 12.7. By comparison the S&P 500 has a P/E of 21.1. Ultimately the numbers will win out. The cheaper markets will outperform.

In such an uncertain environment it’s no surprise that US treasury bonds have enjoyed a bounce. The US Federal Reserve is considered less likely to hike interest rates as far or as fast, which makes bonds more attractive.

In any case, whenever there’s a whiff of trouble portfolio managers flock to the supposed safety of US government debt. The iShares 20+ Year Treasury Bond ETF (NASDAQ:TLT), which holds long dated bonds with average maturity of 26.4 years, is up 7% year-to-date.

But gold has outshone even long dated treasuries, being up twice as much as TLT. Last week there were reports of long queues in London to buy coins and bars (see here) as news swept around about a new wave of bank distress. Gold really seems to be seen as a safe haven, at least by a significant portion of the population.

Indeed on 12th February the gold price reached US$1,239 per troy ounce, which was up nearly 17% since the lows at the start of the year. Charlie Morris of Atlas Pulse reckons that when gold rallies more than 20% within a few weeks then it signals a new bull market trend. At least that’s been the historical pattern. So 2016 has certainly got close to that trigger, and could still hit it if gold keeps rallying in the coming days and weeks.

Most of the analysis of gold market fundamentals focuses on what’s going on in financial markets. There’s a great deal of commentary on the outlooks for US inflation and US dollar interest rates, or the difference between them (real rates). How many long (bullish) or short (bearish) positions there currently are in the COMEX derivatives market. The facial expression on Janet Yellen’s face. That kind of thing.

Indeed in the short term these factors are essential. And in the past they were probably big drivers of the medium to long term too. But things have changed massively in recent years.

The USA may still dominate the financial, paper gold markets (for now at least), but most physical demand for gold is found far from those shores.

The USA may still dominate the financial, paper gold markets (for now at least), but most physical demand for gold is found far from those shores. Total consumer demand – for jewellery, coins and small bars – in China and India alone was 1,900 tonnes in 2015, according to data from the World Gold Council. That’s about 10 times as much as the 193 tonnes of demand in the USA. Physical gold demand is dominated by emerging markets, especially the two Asian giants.

Gold demand has also grown over time. In 2006 total demand was 3,096 tonnes, whereas in 2015 it had swelled to 4,212 tonnes. That’s an overall increase of 36% over nine years. That’s perhaps surprising given that half of that period, since 2011, was during a bear market for the gold price. It’s also a 3.5% average annual growth rate (compound).

That means gold demand has been increasing much faster than population growth. In mid 2006 the world’s population was 6.59 billion. By mid 2015 it was 7.35 billion. In other words it was up 11.5%, or 1.2% a year. Gold demand has been growing 2.3% a year more than the population expands.

This is because so much of the population is becoming wealthier in developing countries, where most of the world’s people live. We tend to think of gold as a highly durable investment asset. And it is.

But it’s just as much a consumer good: in 2015 around 57% of production was turned into jewellery. People buy more jewellery as they become wealthier. Overall Chinese retail sales are growing at an 11% annual clip. Gold jewellery forms part of that.

As I’ve shown before, there is an apparently close link between economic growth and volumes of gold purchased. See the charts in my article “The Golden Inconstant” for evidence from the all important Chinese and Indian markets.

Gold has had a great run so far this year, but that doesn’t mean it has to continue. In fact it may well reverse in the short term.

As I recently showed, gold has underperformed US stocks over the long run (contrary to some claims) – see here and here. But that doesn’t mean you shouldn’t own it. The long term fundamentals of rising wealth, and hence demand, remain strong.

Given the still high prices of US stocks, gold may even outperform them over the next 10 or 20 years. And even if you think that’s unlikely then there’s always the insurance angle. The world continues to pile on debt. Eventually something has to give. Physical gold is no one’s liability. Everyone, including you, should have some.

Stay tuned OfWealthers,

Rob Marstrand

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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.