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Gold Shines as a Safe Haven in January

Gold Shines as a Safe Haven in JanuaryGold Shines as a Safe Haven in January

Van Eck Global’s gold specialist Joe Foster shares his monthly perspective on the gold market, this one is named Gold Shines as a Safe Haven in January

» Open Gold Market Commentary

Gold Shines as a Safe Haven in January

Gold Market Commentary

By: Joe Foster, Gold Strategist

Market Review

Please note that the information herein represents the opinion of the author and these opinions may change at any time and from time to time.

It has been a very eventful start to the year. On January 4, the first trading day of 2016, the Chinese equity market fell drastically, with the Shanghai Composite Stock Index2 down 6.9% during the session. The equity slide continued, repeatedly triggering the recently instituted circuit breakers, which have subsequently been suspended. The Shanghai Composite Stock Index ended the month of January down 22.6%. The Chinese selloff spread to global equity markets with the S&P 500® Index3 having one of its worse starts to any year, falling almost 9% three weeks into January. By month end, however, the Index had recouped some losses to end January down 5%. The MSCI All-Country World Index4, which includes both emerging and developed world equity markets, fell 8% during the month. Commodities also took a hit, with oil and copper down 9% and 3%, respectively. Even the Japanese yen ended the month weaker, down 0.8% relative to the U.S. dollar, after the Bank of Japan (BOJ) surprisingly announced on January 29 its adoption of negative interest rates, which drove the yen down 2% that day.

Except for a stronger than expected employment report, most major U.S. economic data released during the month was disappointing, including the Empire State Manufacturing Index5, retail sales ex-autos, industrial output growth, capacity utilization, durable goods orders, pending December home sales, and Q4 2015 real GDP growth. It was no surprise that the Federal Reserve (Fed) left rates unchanged on January 27, but revised messaging in the Fed’s statement raised many questions in the market. The Fed softened its assessment of its growth and inflation outlooks, and indicated that it is “closely monitoring” global economic and financial developments, signaling that it is uncertain about their potential impact on the U.S. economy. Consequently market expectations for the Fed’s next rate hike have been delayed to November, with less than one full 25 bps hike priced in for 2016. We have been saying that, in our opinion, there is a good possibility that the Fed will not be as aggressive as previous guidance suggests, and that the U.S. economy is vulnerable, making rising rates a significant impediment in 2016. It appears that the market and even the Fed are increasingly adopting a similar view for 2016.

The U.S. dollar held up during January, with the U.S. Dollar Index6 (DXY) down slightly before the BOJ’s announcement on January 29, but rising later in the day to finish the month with a 1% gain. Gold bullion was, however, the true winner in January The gold price not only managed to gain in a month when the U.S. dollar also finished higher, but it outperformed significantly, benefiting from its safe haven7 status to close at $1,118.17 per ounce, a gain of $56.75 per ounce or 5.35%. Notably, holdings of global gold bullion exchange-traded products (ETPs) rose by 1.8 million ounces or 3.8% during January.

The World Gold Council published its latest World Official Gold Reserves for 2015. The figures rank China (1,762 tonnes, representing 1.7% of total foreign reserves) and Russia (1,393 tonnes, 13%), respectively, as the sixth and seventh largest holders of gold reserves in the world, behind the U.S., Germany, the International Monetary Fund (IMF), Italy, and France. The central banks of China and Russia were both significant buyers of gold in 2015. After announcing its updated gold holdings in June 2015, the People’s Bank of China (PBOC) purchased an additional 104 tonnes of gold in the six months from July to December. This equates to an annualized rate of purchase exceeding 200 tonnes of gold, which is double the average annual rate estimated from the PBOC’s June 2015 update. This suggests China may be stepping up its gold reserves purchases. Russia’s net purchases were estimated at about 185 tonnes of gold in 2015 (not including data for December), representing an increase of about 15% from 2014.

In its latest report Thomson Reuters GFMS Gold Survey estimates that in Q4 2015 total gold physical demand increased by 2.2% year over year, driven primarily by strong growth (23.2%) in official sector net purchases (dominated by Russia and China as explained above) and a 7.0% increase in retail investment in gold bars (driven by strong demand from China and India.) While jewelry demand in China dropped by 4%, demand out of India continued to recover, increasing 3% in Q4. The world’s total supply of gold dropped by 7.3% with mine production declining 3.8%.

The performance of gold stocks was mixed in January. The NYSE Arca Gold Miners Index (GDMNTR) gained 3.35%, while Market Vectors Junior Gold Miners Index8 (MVGDXJTR) dropped 0.79%. While the underperformance of gold stocks relative to gold is atypical when the price of gold is on the rise, the end-of-year performance of gold stocks was also somewhat out of character. In December, while gold fell to a new cycle low, gold stocks did not follow to new long-term lows, and in fact, the GDMNTR Index and the MVGDXJTR Index advanced 0.9% and 2.8%, respectively. Perhaps the reversal of that uncharacteristic December outperformance helps explains some of the underperformance in January, along with general weakness in the broader equity market that can also drag down gold equities.

Additional factors affected gold stocks and likely contributed to negative sentiment towards equities during the month. Some companies reported preliminary operating results for 2015 and provided guidance for 2016. While 2015 results were broadly in-line and costs continued to trend down, 2016 production guidance seems slightly below current expectations. Furthermore, base metals and silver underperformed gold in January, affecting valuations of companies with exposure to those metals. Finally, there was company-specific news that had significant negative impact on share prices, which we didn’t always deem as justified. This news included: Eldorado’s planned suspension of its projects in Greece; a material mineral resource revision of Rubicon’s Phoenix project and its impact on Royal Gold’s stream on that project; and the potential fundraising B2Gold may require, given current gold prices, to finance its Fekola project.

The performance gap between gold bullion and gold equities was widest on January 19. Since then the stocks have materially outperformed, closing the gap. As of February 1, the GDMNTR Index and gold were both up 6.3% year-to-date.

Market Outlook

Financial markets in January helped to remind investors around the globe why perhaps every portfolio should have an allocation to gold. It is our opinion that gold should be used mainly as a portfolio diversifier and as a hedge against tail risk9; a form of portfolio insurance that attempts to preserve value when tail risk becomes a reality. Gold has little correlation to other financial assets (Figure 1 below).

(Click to enlarge)

Figure 1: Correlation of Gold to other asset classes during expan¬sions and contractions since 1987*

*As of December 2015. Expansion and contraction as per the National Bureau of Economic Research (NBER). Source: Bloomberg, NBER, World Gold Council. Historical information is not indicative of future results; current data may differ from data quoted.

When most other investments are performing poorly, gold is expected to do well, and vice versa. Worsening financial conditions, escalating geopolitical turmoil in the Middle East, recurring issues with European sovereign debt, currency issues and slow growth in China, Russian aggression, and failure of Japan and the U.S. to reach their economic potential are all risks that threaten growth and economic development globally. Gold can act as a financial hedge against these risks.

Many investors use gold stocks to gain leveraged exposure to gold, however, we just finished a one-month period during which the expected outperformance of gold stocks relative to gold did not materialize. We do not expect this trend to continue.

As we mentioned, a day after month-end, on February 1, the year-to-date gap between the GDMNTR Index and gold had already closed, and we expect stocks to continue to outperform if the gold price continues to rise. In fact, gold shares should offer their highest leverage to gold when the gold price is close to the cost of production, as is now the case. The leverage comes from earnings leverage; as the gold price increases, the change in a company’s profitability significantly outpaces the change in the gold price. For example, say a gold producer realizes a $200 per ounce margin at current gold prices. At $1,100 gold, a $100 increase in the gold price would increase the producer’s margin by 50%, while representing only about a 9% increase in the gold price. The higher the cost of production, the smaller the margin, and the more leverage companies have to increasing gold prices.

It therefore makes sense that equities should outperform gold during rising gold prices, and underperform if gold falls, unless of course costs are increasing at the same time the gold price is increasing and margins are flat or shrinking. This was the main reason why gold equities underperformed gold in 2011 and 2012, two years during which the gold price increased. Since then positive changes have taken place in the gold mining industry, returning profitability to the sector.

We now see the industry in the best shape it has been in for a long time. Unfortunately, this positive transformation of the sector coincided with, and to some extent was intensified by, a period of falling gold prices. As Figure 2 below indicates, however, equities have consistently demonstrated their effectiveness as leverage plays on rising gold during these past years.

(Click to enlarge)

Source: Bloomberg. Past performance is no guarantee of future results; current performance may be lower or higher than the performance data quoted. Gold equities are represented by NYSE Arca Gold Miners Index (GDMNTR).

by Joe Foster, Portfolio Manager/Strategist

With more than 30 years of gold industry experience, Foster began his gold career as a boots on the ground geologist, evaluating mining exploration and development projects. Foster offers a unique perspective on gold and the precious metals asset class.

Important Information For Foreign Investors

This document does not constitute an offering or invitation to invest or acquire financial instruments. The use of this material is for general information purposes.

Please note that Van Eck Securities Corporation offers actively managed and passively managed investment products that invest in the asset class(es) included in this material. Gold investments can be significantly affected by international economic, monetary and political developments. Gold equities may decline in value due to developments specific to the gold industry, and are subject to interest rate risk and market risk. Investments in foreign securities involve risks related to adverse political and economic developments unique to a country or a region, currency fluctuations or controls, and the possibility of arbitrary action by foreign governments, including the takeover of property without adequate compensation or imposition of prohibitive taxation.

Please note that Joe Foster is the Portfolio Manager of an actively managed gold strategy.

Any indices listed are unmanaged indices and include the reinvestment of all dividends, but do not reflect the payment of transaction costs, advisory fees or expenses that are associated with an investment in the Fund. An index’s performance is not illustrative of the Fund’s performance. Indices are not securities in which investments can be made.

1NYSE Arca Gold Miners Index (GDMNTR) is a modified market capitalization-weighted index comprised of publicly traded companies involved primarily in the mining for gold. 2Market Vectors Junior Gold Miners Index (MVGDXJTR) is a rules-based, modified market capitalization-weighted, float-adjusted index comprised of a global universe of publicly traded small- and medium-capitalization companies that generate at least 50% of their revenues from gold and/or silver mining, hold real property that has the potential to produce at least 50% of the company’s revenue from gold or silver mining when developed, or primarily invest in gold or silver. 3Tail risk is the risk of an asset or portfolio of assets moving more than three standard deviations from its current price. 4S&P 500® Index (S&P 500) consists of 500 widely held common stocks covering industrial, utility, financial, and transportation sectors. 5Dot-com bubble grew out of a combination of the presence of speculative or fad-based investing, the abundance of venture capital funding for startups and the failure of dotcoms to turn a profit. Investors poured money into internet startups during the 1990s in the hope that those companies would one day become profitable, and many investors and venture capitalists abandoned a cautious approach for fear of not being able to cash in on the growing use of the internet. 6Source: Bloomberg.

Please note that the information herein represents the opinion of the author and these opinions may change at any time and from time to time. Not intended to be a forecast of future events, a guarantee of future results or investment advice. Historical performance is not indicative of future results; current data may differ from data quoted. Current market conditions may not continue. Non-Van Eck Global proprietary information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of Van Eck Global. ©2015 Van Eck Global.

Gold Markets Tormented by Rate Hike Intrigue in 2015

Gold Markets Tormented by Rate Hike Intrigue in 2015

Van Eck Global’s gold specialist Joe Foster shares his monthly perspective on the gold market, this one is named Gold Markets Tormented by Rate Hike Intrigue in 2015

» Open Gold Market Commentary

Gold Markets Tormented by Rate Hike Intrigue in 2015

Gold Market Commentary

By: Joe Foster, Gold Strategist

Market Review

During November gold came under pressure and the U.S. dollar strengthened as the market gained conviction for a December Federal Reserve (Fed) rate increase. This selling pressure continued into the early days of December and gold fell to a new cycle low of $1,046 per ounce on December 3. At that point, it appeared that the gold market had already priced in this anticipated rate hike. On December 4, gold gained $24 per ounce despite a strong U.S. payroll report that earlier in the year would have spelled trouble for gold. Gold gained $11 on December 16, the day the Fed announced its a 25 basis point increase in the targeted federal funds rate, the first rate increase in over nine years. Time will tell if this change in direction by the Fed also marks a turning point for gold, but it looks as if there are some prominent investors that might hold this view. As evidence, on December 18 gold bullion exchange traded products (ETPs) booked 18.7 tonnes ($641 million) of inflows, the largest one day increase in four years. Overall for the month, gold was little changed, finishing December down $3.35 at $1,061.42 per ounce.

By contrast, although gold stocks also felt the downward pressure leading up to the Fed’s rate decision, they did not make new lows in December. The low point of this cycle for the NYSE Arca Gold Miners Index (GDMNTR)1 was on September 11. This was the first time since the bear market began in 2011 that the GDMNTR has not followed gold bullion to new long-term lows. For the month, the GDMNTR advanced 0.9%, while the Market Vectors Junior Gold Miners Index (MVGDXJTR)2 gained 2.8%.

Gold funds had a difficult year – tormented by the Fed’s seemingly endless machinations around the timing of a rate increase. For the year 2015 the gold price declined $123 per ounce (10.4%). Gold miners exhibited their leverage to gold with a decline of 24.8% in the GDMNTR and a drop of 19.2% for the MVGDXJTR. The overall downward price trend was interrupted twice by concerns over financial risks. The first came in January when the Swiss broke the franc’s peg to the euro, the European Central Bank (ECB) started a massive quantitative easing (QE)3 program, and radical leadership came to power in Greece. Gold rose to its high for the year at $1,307 on January 22. The second risk driver started in August when China’s stock market collapse panicked markets globally. While these events each created $100 moves in the gold price and substantial increases across gold stocks, in the longer term they were not enough to overcome the negative sentiment brought on by persistent anticipation of rising rates in the U.S. This enabled the U.S. Dollar Index (DXY)4 to make new long-term highs in March and again in December, while bullion ETPs experienced heavy redemptions in July and November. Gold was also pressured by the bear market in the broader commodities complex, shown by the 32% decline in WTI crude and 25% fall in copper for 2015.

Market Outlook

As the positive moves in the gold price in January and again in August – October have shown, gold responds to heightened levels of financial stress. Gold is commonly used as a portfolio diversifier and a hedge against onerous levels of inflation or deflation, currency turmoil, insolvencies brought on by poor debt and/or risk management by governments and financial institutions, and difficulties caused by overall economic weakness, to name a few. For our investors and clients, we endeavor to identify the systemic risks that might drive the gold price. With the start of the New Year, we make several observations that may offer clues as to where the gold price might trend in 2016.

To begin, it is instructive to look at where the market has been. For gold fund managers, it has been the worst of times. When it seems the market can’t go lower, it finds new lows. In our view, gold and gold stocks are unloved and oversold. We have felt this sentiment before, in the crash of 2008, the grueling bear market from 1996 to 2001, and the epic collapse from 1980 to 1985. The current period of 2011 to 2015 ranks historically among the worst bear markets for gold and gold stocks, as measured by peak-to-trough performance in percentage terms. Given the depth and duration of this bear market, using past markets as guides suggests this market should begin to improve in 2016.

In order for the market to improve, there must be a fundamental driver or drivers. Because of radical monetary policies and unsustainable debt levels globally, the financial system remains quite vulnerable to another crisis event or crash like the tech bust or subprime crisis. However, 2016 may not be the year for such a calamity. Think of German economist Rudi Dornbusch’s famous quote: “The crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought

We see 2016 as a year when many of the headwinds to the gold price begin to ease. Such headwinds have included:

■ Fed tightening
■ Strong U.S. dollar
■ Weak commodities
■ Rising real rates
■ Rising gold production
■ Market positioning

Here is a brief look at each:
The Fed has guided towards roughly another one percent in rate increases in 2016, which would probably amount to four 25 basis point increases. Given the extreme caution the Fed has exhibited in getting to this point in the rate cycle, it is hard to imagine it being more aggressive. In fact, we believe there is a good possibility that the Fed will not be as aggressive as its current guidance suggests. In our view, the U.S. economy is no longer capable of generating more than 2% annual growth due to policy uncertainty, the debt burden, and a byzantine tax and regulatory structure that has reached economically stifling proportions. A low-growth economy is vulnerable to impediments and rising rates could become a significant impediment in 2016.

Easy Fed policies have supported growth in residential and commercial real estate as well as booming auto sales. Fed tightening usually increases rates on everything from mortgages and car loans, to the cost of financing fiscal deficits. It looks like the recent decline in the size of U.S. federal deficits will end as Congress has approved a rash of tax breaks and credits that are expected to add more than $800 billion to the debt load over the coming decade. While federal debt is now a staggering 100% of GDP, interest on that debt is at multi-decade lows of around 11% of GDP. Debt service would double if rates returned to the levels of 2007, which suggests that increasing rates could become unpopular politically.

The U.S. dollar had a tremendous run from July 2014 through March 2015 during which the DXY advanced 25% to new long-term highs. It has maintained those gains through December. A strengthening U.S. economy, weak global growth, and anticipation of rising rates drove the dollar’s rise. These drivers are currently already priced in, in our view, which limits the scope for further gains in the dollar.
Commodities prices have been hurt mainly by slack demand from China. China is transitioning from a commodities intensive industrial revolution to an economy led by consumerism and services. This transition is in full swing and as overproduction of commodities is being addressed by producers, we believe much of the bad news is already reflected in prices. While it is difficult to see a turnaround in things like oil, iron ore, or copper, we believe that downward price pressure is likely to ease in 2016.

Negative real (inflation-adjusted) rates are a common characteristic of gold bull markets. In the 2001 to 2011 bull market, real one-year treasury rates bottomed at -3.75% in 2011, around the same time gold reached its all-time high. Since then, real rates have trended upwards, reaching a high of 0.40% in September. The increase in real rates was achieved through a combination of disinflation in the global economy, deflation in commodities, and tightening in Fed policies through QE tapering and guiding market expectations towards higher rates. We believe real rates could fall somewhat in 2016 if inflation picks up as commodities prices stabilize and if tighter U.S. labor markets put pressure on wages. In addition, economic weakness may cause the Fed to reduce its rate outlook.

Gold production has been on the rise since 2009. We expect mine production to begin a slow, permanent decline in 2016, a trend that would increase should the gold price fall further. Credit Suisse calculates that 15% of production in its coverage universe is free cash flow negative at $1,100 gold. These marginal mines are no doubt doing all they can to cut costs further, but at lower gold prices, some would likely be forced to shut down. While gold production is not a strong price driver due to large above-ground stocks, we believe evidence of a production decline would nonetheless have a positive influence on prices.

Gold positioning indicates that bearish bets are at extreme levels that are typical of turning points in the market. Net speculative long positions on Comex5 are now lower than what occurred following the 2013 gold price collapse and are currently at levels last seen in 2002. Gross speculative shorts reached an all-time high in July, and remain at high levels. This points to the heavy exposure hedge funds, commodities traders, and other speculators already have to falling gold prices. Gold held in bullion ETPs is down to levels last seen in early 2009. This suggests that most of the extraordinary gold buying that occurred in ETPs after the financial crisis has been unwound.

We acknowledge that the gold market is on shaky ground and that there is little positive sentiment as the year begins. However, having been through a number of bear markets in our 47 years as gold fund managers, we also know historically that these markets always come to an end and that gold shares offer their highest leverage to gold when the price is close to the cost of production. Perhaps this leverage will be on display in 2016.

by Joe Foster, Portfolio Manager/Strategist

With more than 30 years of gold industry experience, Foster began his gold career as a boots on the ground geologist, evaluating mining exploration and development projects. Foster offers a unique perspective on gold and the precious metals asset class.

Important Information For Foreign Investors

This document does not constitute an offering or invitation to invest or acquire financial instruments. The use of this material is for general information purposes.

Please note that Van Eck Securities Corporation offers actively managed and passively managed investment products that invest in the asset class(es) included in this material. Gold investments can be significantly affected by international economic, monetary and political developments. Gold equities may decline in value due to developments specific to the gold industry, and are subject to interest rate risk and market risk. Investments in foreign securities involve risks related to adverse political and economic developments unique to a country or a region, currency fluctuations or controls, and the possibility of arbitrary action by foreign governments, including the takeover of property without adequate compensation or imposition of prohibitive taxation.

Please note that Joe Foster is the Portfolio Manager of an actively managed gold strategy.

Any indices listed are unmanaged indices and include the reinvestment of all dividends, but do not reflect the payment of transaction costs, advisory fees or expenses that are associated with an investment in the Fund. An index’s performance is not illustrative of the Fund’s performance. Indices are not securities in which investments can be made.

1NYSE Arca Gold Miners Index (GDMNTR) is a modified market capitalization-weighted index comprised of publicly traded companies involved primarily in the mining for gold. 2Market Vectors Junior Gold Miners Index (MVGDXJTR) is a rules-based, modified market capitalization-weighted, float-adjusted index comprised of a global universe of publicly traded small- and medium-capitalization companies that generate at least 50% of their revenues from gold and/or silver mining, hold real property that has the potential to produce at least 50% of the company’s revenue from gold or silver mining when developed, or primarily invest in gold or silver. 3Tail risk is the risk of an asset or portfolio of assets moving more than three standard deviations from its current price. 4S&P 500® Index (S&P 500) consists of 500 widely held common stocks covering industrial, utility, financial, and transportation sectors. 5Dot-com bubble grew out of a combination of the presence of speculative or fad-based investing, the abundance of venture capital funding for startups and the failure of dotcoms to turn a profit. Investors poured money into internet startups during the 1990s in the hope that those companies would one day become profitable, and many investors and venture capitalists abandoned a cautious approach for fear of not being able to cash in on the growing use of the internet. 6Source: Bloomberg.

Please note that the information herein represents the opinion of the author and these opinions may change at any time and from time to time. Not intended to be a forecast of future events, a guarantee of future results or investment advice. Historical performance is not indicative of future results; current data may differ from data quoted. Current market conditions may not continue. Non-Van Eck Global proprietary information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of Van Eck Global. ©2015 Van Eck Global.

Gold Price and U.S. Dollar Head in Opposite Directions

Gold Price and U.S. Dollar Head in Opposite Directions

Gold Price and U.S. Dollar Head in Opposite Directions Van Eck Global’s gold specialist Joe Foster shares his monthly perspective on the gold market.

» Open Gold Market Commentary

Gold Price and U.S. Dollar Head in Opposite Directions

Gold Market Commentary

By: Joe Foster, Gold Strategist

Market Review

After falling to its cycle lows in July, the gold price had advanced nicely and last month we wondered whether the positive trend was sustainable. The short answer is: No, it wasn’t. In November, the gold price fell to new 5.5-year lows at $1,052 per ounce, as the U.S. Dollar Index1 (DXY) approached long-term highs. Gold ended the month at $1,064.77 per ounce for a loss of $77.39 (6.8%).

On November 4, Bloomberg News reported that Federal Reserve (the “Fed”) Chair Janet Yellen said an improving economy would set the stage for a December interest rate increase if economic reports continue to assure policymakers that inflation will accelerate over time. This set the tone for both gold and the U.S. dollar, which fell and rose, respectively, for the remainder of the month. A strong jobs report on November 6, followed by generally positive economic releases throughout the month enabled market consensus to gain momentum for a rate increase at the December 16 Federal Open Market Committee (FOMC) meeting. Gold bullion exchange-traded products (ETPs) saw 1.59 million ounces (49.3 tonnes) of redemptions in November which drove gold ETPs’ combined holdings to a new cycle low of 47.92 million ounces (1,490.3 tonnes).

During November gold equity indices fell with the gold price and nearly met the lows set in July. The NYSE Arca Gold Miners Index2 (GDMNTR) declined 8.5%, while the Market Vectors Junior Gold Miners Index3 (MVGDXJTR) fell 8.6%. Low gold prices caused investors to largely ignore the robust results of the third quarter earnings season. BMO Capital Markets reported free cash flow of $978 million from the North American senior miners, far surpassing expectations of $94 million. Scotiabank’s universe of senior and larger mid-caps had production that was 3% above expectations and all-in mining costs that were 8% lower than expected. The favorable results stemmed from operating efficiency, bear market pricing for materials and services, low local currency values, and low fuel prices. Many companies have indicated that there is still room to cut costs further. We now expect positive production results and cost-savings to continue in 2016.

Physical demand for gold bars, coins, and jewelry improved in the third quarter. The World Gold Council (WGC) reported that Q3 gold demand increased by 8% over Q2 and by 14% over last year. Year-to-date demand is up 3% versus the same period in 2014. The WGC reckons that there was a gold market deficit of 56.0 tonnes in Q3. The largest drivers of this strong demand were India and China, where demand increased 13% in each country which equates to a 58.0 tonne increase over Q2. Chinese demand continues as physical deliveries from the Shanghai Gold Exchange through November have now surpassed the record set in 2013.

Investors might wonder how gold can make new lows in July and again in November while the market has been in a deficit, which means demand is presumably outstripping supply. The gold market is unique among commodities and indeed unique in the financial world. Most gold is hoarded as a financial asset, like currencies, stocks, and bonds. It is not consumed like oil, copper, or soybeans. All of the gold ever produced is sitting in a vault, safe, jewelry box, place of worship, or museum, or is adorning a person’s body. This gold represents a huge reservoir of potential supply, some of which is available at a price. This is why the supply/demand drivers that apply to most commodities may not apply to gold. In addition, the gold market is not sufficiently transparent to account for all of the transactions that occur globally. All of the gold that the WGC can account for amounted to a 56.0 tonne deficit in Q3, however, there is gold the WGC cannot count that may make this deficit larger or perhaps nonexistent altogether.

For commodities other than gold, strong physical demand drives prices higher – prices follow demand. With gold, the current price drives physical demand – demand follows prices. Lower prices entice buyers in India and China. They also bring strong retail demand from the U.S. and Europe. This physical demand increases when prices drop, helping to stabilize prices. However, physical demand usually diminishes when prices increase.

Investment demand generates price strength in the gold market and a lack of investment demand characterizes bear markets. The motives that drive both physical and investment demand are the same – to utilize gold as a store of wealth and a hedge against currency weakness, tail risk4, or financial stress. However, investment demand manifests itself mainly in the futures market in New York and the over-the-counter market in London. These markets exert the largest influence on gold prices and they are driven more by macroeconomic, financial, and geopolitical events than by prices and supply/demand equations.
Gold ETPs are relatively transparent vehicles that we use as a proxy for broad investment demand. In Q3 global bullion ETPs had 63.0 tonnes of redemptions. This is probably a good indicator of weak investment demand in New York and London. It also lends better insight into price action than physical demand from China or elsewhere.

We believe that physical demand should play a larger role in price discovery, and maybe it eventually will as the Asian gold market grows and matures. In the meantime, the Chinese seem happy to accumulate all the gold the West cares to provide at low gold prices. Regardless of what we believe should happen, we make investment decisions based on what actually drives the market. This means investing in companies that can survive intact or gain an advantage if a lack of investment demand drives prices lower than expected.

Market Outlook

Once again the markets are essentially convinced that the Fed will raise rates at the next FOMC meeting. Based on recent Fed comments, economic releases, and the level of expectations, we will be shocked if the Fed doesn’t raise rates. Rate rising cycles introduce risks to the economy and financial system and they often end badly. According to Gluskin Sheff5, a bull market in the S&P 500 Index6 has never ended after an initial rate hike. It is a different story if the rate hikes keep coming. The stock market crashed in October 1987 after three rate hikes over five months. NASDAQ crashed in April 2000 after six rate hikes over 11 months. Rate increases are often a prelude to recessions, which become increasingly likely as the yield curve flattens or inverts (when short-term rates exceed long-term rates).

The Fed has never waited as long as five years into a bull market to begin to raise rates. A few reasons the Fed has been reluctant to pull the trigger:

■ In the last four decades, the Fed has never raised rates when the Institute of Supply Management (ISM) Manufacturing Index7 was below 50, which signifies a manufacturing recession. The ISM Index is currently 48.6.
■ How long can Fed policies diverge from the rest of the world where the central banks of Europe, China, Australia, and Japan are all easing to combat economic weakness?
■ Every country that started a rate-hiking course after the Great Recession that ended in 2009 was ultimately forced to reverse course.

On November 2 as we watched Fed Chair Yellen address the Economic Club of Washington D.C., the U.S. Dollar Index approached a 12.5-year high while gold made a new 5.5-year low at $1,052 per ounce. With the U.S. dollar and gold at extreme levels, it seems the market has already priced in forthcoming rate hikes. Credit Suisse reported in October that historically when the U.S. has raised rates the dollar has stopped appreciating. In some cases the dollar fell into a bear market and in others the dollar eventually recovered.
Gold has a similarly inconsistent reaction to rate increases, as shown in this excerpt from our March gold market update, written when the market was obsessed with the Fed’s rate decision, as it unfortunately still is:

Scotiabank has analyzed the last six tightening cycles since 1982 when a suitable gold index became available. They found that gold prices advanced in the year following the first rate increase in half of the cycles, whereas gold declined in the other half. Scotia points out that the only other point at which the Fed raised rates in a low-inflation environment was in 1986, when rates were increased in order to help defend a sharply depreciating U.S. dollar. It was also one of the rate-rising periods when gold performed well. The Scotia analysis leads to an uncertain outlook; it tells us that sometimes gold advances when rates rise and sometimes it does not. However, the economic and financial backdrop to the next rate cycle is unlike any other in history. The imbalances in asset markets, sovereign debt levels, and central bank finances create risks that may become overwhelming under the stress of rising rates. Perhaps the first rate increase will mark the beginning of the end of the gold bear market.

by Joe Foster, Portfolio Manager/Strategist

With more than 30 years of gold industry experience, Foster began his gold career as a boots on the ground geologist, evaluating mining exploration and development projects. Foster offers a unique perspective on gold and the precious metals asset class.

Important Information For Foreign Investors

This document does not constitute an offering or invitation to invest or acquire financial instruments. The use of this material is for general information purposes.

Please note that Van Eck Securities Corporation offers actively managed and passively managed investment products that invest in the asset class(es) included in this material. Gold investments can be significantly affected by international economic, monetary and political developments. Gold equities may decline in value due to developments specific to the gold industry, and are subject to interest rate risk and market risk. Investments in foreign securities involve risks related to adverse political and economic developments unique to a country or a region, currency fluctuations or controls, and the possibility of arbitrary action by foreign governments, including the takeover of property without adequate compensation or imposition of prohibitive taxation.

Please note that Joe Foster is the Portfolio Manager of an actively managed gold strategy.

Any indices listed are unmanaged indices and include the reinvestment of all dividends, but do not reflect the payment of transaction costs, advisory fees or expenses that are associated with an investment in the Fund. An index’s performance is not illustrative of the Fund’s performance. Indices are not securities in which investments can be made.

1NYSE Arca Gold Miners Index (GDMNTR) is a modified market capitalization-weighted index comprised of publicly traded companies involved primarily in the mining for gold. 2Market Vectors Junior Gold Miners Index (MVGDXJTR) is a rules-based, modified market capitalization-weighted, float-adjusted index comprised of a global universe of publicly traded small- and medium-capitalization companies that generate at least 50% of their revenues from gold and/or silver mining, hold real property that has the potential to produce at least 50% of the company’s revenue from gold or silver mining when developed, or primarily invest in gold or silver. 3Tail risk is the risk of an asset or portfolio of assets moving more than three standard deviations from its current price. 4S&P 500® Index (S&P 500) consists of 500 widely held common stocks covering industrial, utility, financial, and transportation sectors. 5Dot-com bubble grew out of a combination of the presence of speculative or fad-based investing, the abundance of venture capital funding for startups and the failure of dotcoms to turn a profit. Investors poured money into internet startups during the 1990s in the hope that those companies would one day become profitable, and many investors and venture capitalists abandoned a cautious approach for fear of not being able to cash in on the growing use of the internet. 6Source: Bloomberg.

Please note that the information herein represents the opinion of the author and these opinions may change at any time and from time to time. Not intended to be a forecast of future events, a guarantee of future results or investment advice. Historical performance is not indicative of future results; current data may differ from data quoted. Current market conditions may not continue. Non-Van Eck Global proprietary information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of Van Eck Global. ©2015 Van Eck Global.