Why the price of gold rose 20% in 2016
by Judy Baker, Argo Gold
Let’s start with discussing the bottom of the market and the backdrop. The Fall of 2015 was pretty grim in the resource sector. We were into long innings of oversupply of oil, (although the US was an economic bright spot) the world economy outside of the US continued to be in a state of malaise, and Goldman Sachs was calling for US$1000/oz. gold.
In December 2015 gold was trading around the US$1070/oz. level and there was fear it would even go lower but it actually held in around these levels. Even Goldman Sachs with their house short position and investor recommendation against gold couldn’t push it below US$1000/oz.
We were already into years of oversupply in the relatively small mineral commodity business. Glencore was the first to recognize this in February 2012 when they bid for the portion of Xstrata that they didn’t already own. Basically they were consolidating two large mineral commodity producers to reduce supply. A year later – April 2013 – was the biggest one day drop in the gold price in 26 years. US$1600/oz. gold bullion straight down to below US$1400/oz. As gold is the elephant in the tent in the relatively small mineral commodity business - a US$200 billion dollar market on an annual basis relative to the copper market which is more like a US$100 billion dollar market on an annual basis – the April 2013 downward move in gold price resulted in significant negative sentiment towards both gold and the already slowing mineral commodity business. Copper actually held in relatively well until the end of 2014 but it seems to be a managed destocking process in copper. By the beginning of 2015, the mineral commodity business was a “sunset industry” yet again and gold was a “sunset investment”. The Chinese economy was in decline and then the Chinese stock market declined in the summer of 2015 spreading uncertainty worldwide as the second biggest economy in the world. 2015 just kept getting grimmer.
In November 2015 there was a little article in the Economist showing Canada was one of only five countries that didn’t have negative real rates. Apparently this was a bright spot for Canada but the feeling on the ground - with the fallout of the oil price a year earlier – November 2014, ongoing low mineral commodity prices, no investment interest in gold and the country’s oil and gas export capacity hindered by the capability to build pipelines for export – the sentiment was relatively depressing even though Canada was one of five countries without negative real rates!
Certainly there have been years of concerns with the world’s largest economies seemingly running the printing presses fulltime and the low interest rate environment where government bank officials were calling this the “new norm” but then the “Negative Real Rates” theme started echoing from economists. Negative real rates – how is this sustainable?
With the new backdrop of “Negative Real Rates”, the money sloshing around the world and frothy valuations in many investment options; there was renewed investment interest in beaten up gold bullion. It is hard to see where the buying comes from in the bullion market but the investment in producing gold stocks appears seems to be very much a US driven investment based on my opinion that the gold producers with relatively large US investor bases moved first and foremost.
The moves in bullion and even more significant moves in gold stocks were fueled by short positions. The rumour on the street was that some of the financings done for producing gold companies early in the gold price rally were mainly subscribed to by funds that had short positions and essentially waved the white flag – they couldn’t take any more losses on their positions and they couldn’t cover them.
The dramatic move in gold and gold stocks also brought in institutional investors that needed to have exposure to the sector. The dramatic move in gold price also resulted in material retail investor buying of gold bullion and gold bullion funds. Banks that sell physical gold noted big interest from retail buyers for the first time in years.
It is interesting that the gold rally was fueled by the US; the healthiest economy in the world with its big economy, low employment, strong dollar, spectacular stock market performance, big wealth creation in venture/private equity and its world renowned market of money that is between debt and equity that like the venture/private equity contributes to its large self-generating economy.
Although people consider gold a safe haven and an investment for bad times - and look for items such as protection against inflation, a store of value, US dollar depreciation and geopolitical risks. I have always considered it an investment of cash flow of the wealthy in good economies. In my opinion, the wealth creation in China fueled gold prices in the last bull market in gold and the wealth creation in the US now is fueling another investment round in gold by the seemingly richest country and best economy in the world. I also suspect that the Chinese are also still significant buyers of gold bullion price as evidenced by the movement of investment money out of China.
So we have been through the worst of gold. We have seen gold bullion come back a solid twenty percent. It has come back very quickly and is back on the radar screen as an investment alternative. Where are we going from here?
Economists seem to be echoing China as the biggest risk to the world economy with other big concerns being the sluggish global economy and debt across the board. The world has yet to learn how the US – the biggest economy in the world – will be impacted by a sluggish world economy and whatever is going on in China with its economy.
Debt across the board seems very concerning but with low interest rates being the “new norm” perhaps debt is also new norm?