What has happened to gold?
(The views expressed in this column are the author’s own and do not represent those of Reuters)
Gold has disappointed, down 4 pct over the last 4 weeks, despite the risk-related Brent crude oil advancing 3 pct. Gold appears to have become the victim of a steadily improving global macro environment, where the pressing problems and risks of 2011 appear to be easing, if not being resolved. Slowly the market appears to be building a consensus that the growth outlook for 2012 looks more positive. Consequently gold’s ‘safe-haven attraction’ is starting to lose out to more growth oriented investments.
The biggest shift in gold’s fortunes has come from the U.S. After the gold price advanced 7 pct in February on the back of the U.S. Fed Chairman’s January 25 hint of another round of quantitative easing (QE), the March 13 FOMC statement appears to have triggered gold’s fall. While the statement did not contain an overt change in sentiment, it did acknowledge a better growth profile despite the continuing risks. Its ‘less wary’ tone suggested that QE possibilities were minimal.
The market appears to have gone further in its read of the FOMC statement and now appears to reflect the possibility of the U.S. Fed normalising its monetary policy earlier than the U.S. Fed’s reiteration that there will be no interest rate rise before late-2014. An ending of the ‘highly accommodative stance for monetary policy’ was considered not good for gold. UBS economists expect that the U.S. Fed will begin raising rates in mid-2013 and do not anticipate further quantitative easing.
The mood shifted has manifested itself in a rising U.S. dollar, now at an 11-month high against the Yen, and in rising bond yields. Strengthening U.S. employment and manufacturing data is building a ‘growth leveraging’ environment. Recent rises in leading indicators, such as the US Empire State Index (20.2 in Mar from 19.5 in Feb) and the Philadelphia Fed index (12.5 in March from 10.2 in Feb) and the continuing downtrend in jobless claims is augmenting the improving data flow. Job growth in the U.S. over the past six months has been the strongest since 2006 and UBS now expects that U.S. unemployment will drop to 7.7 pct by the end of this year.
In Europe, both the second tranche of LTRO and a successful restructuring of the Greek private sector debt that appears to have ring fenced the Greek debt crisis, have underpinned a more positive, less risky and hence less gold-friendly tone. While the euro area did fall into recession in Q411, recent lead indicators have brightened now suggesting that European economic weakness will not be as severe as we previously assumed. Meanwhile northern Europe, led by Germany, continues to provide upside surprises; the recent influential German ZEW index jump from 5.4 to 22.3, its highest level since June 2010.
China in the main has also added to more positive global outlook for growth. January-February data brought surprises with February CPI inflation falling from 4.5 pct in January to 3.2 pct, again undercutting gold’s role as a hedge against inflation. Fixed asset investment was stronger than expected and official steel production reported by the National Bureau of Statistics was 13 pct higher than CISA estimates for January-February. While the data and regional anecdotal evidence were confusing, the broad picture of a national soft landing, preparing the way for a cyclical rebound later in the year, appears to be confirming.
Further gold downside is likely if this ‘synchronous global growth’ story becomes more sustainable, and if U.S. yields and U.S. dollar continue to rise. Gold’s ability to rebound will hinge on doubts about global growth and the return of uncertainty about politics and debt, particularly for Asia and Europe. Market unfriendly French and Greek elections in coming months could be gold catalysts. In the meantime, gold is increasingly technically challenged. Having broken through its 200-day moving average at $1676, it now challenges the next key technical support level of $1625, the 62 pct retracement of the recovery since the December 29 low. A break below that target would bring into focus the $1605, the January 9 low, just ahead of the $1600 psychological level which has only been breached on two brief occasions in the last six months.
The risk for further downside also lies with the ETF holders of gold who have been net buyers of 2moz this year, taking total ETF holdings to over 80m ozs, close to a year’s mine supply. While it could be argued from the collapse in speculative positions that much of recent gold’s liquidation is complete there appears still room for further falls. Recent U.S. speculative data shows the largest weekly collapse in Comex net longs gold positions since 2004 to 21moz but that is still above the net longs of 17moz at the start of the year.
The extension and the speed of the recent selloff suggest a near-term upward correction is possible. What gold needs is stronger physical demand and opportune strategic buying. Unfortunately April to June is the weakest season for physical demand. India is still the biggest buyer of gold, twice as large a fast growing China. It had recently shown a stronger appetite to buy at current prices. However, the Indian government’s fiscal difficulties are undercutting the rupee exchange rate and negatively affecting import purchasing power. Furthermore the possibility of import tariffs on commodities, including gold, could compound the pressure on India’s key buying.
Central banks are also key to stabilising gold. Central Banks (CB) bought 440t of gold in 2011, the most in almost fifty years. Given continuing global liquidity and currency volatility, the market expects that CBs will continue to be a substantial and supportive factor in gold.
The other hope for gold, and some other commodities, is continuing tightness in mine supply. Global gold mining are struggle with costs, with both capital and operating costs rising on the basis of double-digit labour costs increases, rising power and equipment costs and increased tax take. Recent examples of rising political constraints on production include Impala Platinum conceding to Zimbabwe’s demand for 51 pct local ownership, Indonesia’s new law forcing foreign investors to reduce to 49 pct project equity within 10 years of the project’s life.
There are doubts now about the future of its huge Grasberg mine in Indonesia and the c$16bn investment needed to ensure copper and gold production continuity has grown. Mongolia, Peru and Brazil have also recently illustrated the rising uncertainty in the global mining investment context that ultimately limits global mining supply. The rising political risks appear to be also compressing equity valuations and the attractiveness of equities over commodities ETFs and may ultimately bring gold investors back.