Getting 'Constructive' on Gold
Wednesday, 7/26/2017 09:01
Boom in ETP risk-asset investing masks growing debt risks...
SINCE the start of the year, the five-year Treasury yield, adjusted for inflation, has risen about 150%,
writes Frank Holmes at US Global Investors.
Normally this would put remarkable pressure on the price of gold – higher yields raise the opportunity cost of buying gold – but over the same period, the US Dollar has steadily weakened and is now officially in a bear market. Because gold is priced in Dollars, this has been supportive for prices. Year-to-date, the yellow metal is up more than 8%.
As I said, the greenback's been on the decline for most of the year so far, but it slumped to a 13-month low against the Euro last week following European Central Bank (ECB) president Mario Draghi's remark that "monetary accommodation" would continue in the European Union (EU) until at least the end of the year.
"We need to be persistent and patient and prudent, because we're not there yet," Draghi said, referring to the fact that EU inflation and wage growth have been disappointingly slow, despite the bloc's economic recovery since the financial crisis. (Indeed, the June purchasing manager's indexes for emerging European markets were all above the key 50 mark for the first time in recent memory.)
That gold is still holding at its current level – despite rising rates, despite a stock market that continues to rally – is "encouraging". That's one of the key takeaways from a UBS note last week, in which the Swiss financial services firm maintains its constructive view of the yellow metal. Investor demand this year has been slower than expected, but UBS analyst Joni Teves makes the case that expectations of a good monsoon season in India this summer could help push consumption in the world's second-largest importer of gold to a new record high by the end of the year.
With India having imported a phenomenal 525 metric tons in the first half of 2017 alone, Teves writes that "we expect gold demand in India this year to be around historic averages," which would be very supportive for prices.
Like gold in India, exchange-traded products (ETPs) also had a knockout first half. As Deutsche Bank reports, ETPs offering investors a simple way to access a broad range of assets attracted a record $245 billion in the first six months of 2017, in what has historically been the weaker half of the year.
To put into perspective just how impressive this figure is, $245 billion would be the second-largest full-year record amount following 2016's $283 billion. We could see ETP inflows climb as high as $500 billion by the end of this year, Deutsche estimates.
Of course, runaway demand for stockmarket ETPs and other risk assets has contributed to muted interest in gold.
Having said that, though, BullionVault – the world's number one online precious metals market – reported recently that private gold holdings among its users leaped to a record 38 metric tons, as of the beginning of July.
That's enough gold to make more than 10 million 18-carat wedding rings, BullionVault says, or to supply the microchips for 1.5 billion iPhones. The site points out that investor demand has lately been driven by lower prices, following three months of "light liquidation".
All of what I've said so far pertains to the near-term. Gold's medium- to long-term investment case, I believe, looks even brighter. Many unsettling risks loom on the horizon – not least of which is a record amount of global debt – that could potentially spell trouble for the investor who hasn't adequately prepared with some allocation in a "safe haven."
According to the highly-respected Institute of International Finance (IIF), global debt levels reached an astronomical $217 trillion in the first quarter of 2017 – that's 327% of world gross domestic product (GDP). Notice that before the financial crisis, global debt was "only" around $150 trillion, meaning we've added close to $120 trillion in as little as a decade. Much of the leveraging occurred in emerging markets, specifically China, which is spending big on international infrastructure projects.
It goes without saying that this is a huge risk. Some are calling this mountain of debt "the mother of all bubbles," and we all remember how the last two bubbles ended, in 2000 (the tech or dotcom bubble) and 2007 (the housing bubble).
Paying down this debt will not be easy. As Scotiabank mentioned in a note last week: "Higher interest rates are going to make the burden of refinancing the debt considerably heavier, and as more money goes into servicing the debt, it means less money is available to spend on other things, which could lead to less infrastructure spending and increased austerity."
Add to this the fact that global pension levels are also sharply on the rise, with people living longer and population growth – and therefore workforce growth – slowing in many advanced economies. In May, the World Economic Forum (WEF) estimated that by 2050, the size of the retirement savings gap – unfunded pensions, in other words – could be as much as $400 trillion, an unimaginably large number.
The US alone adds about $3 trillion every year to the pension deficit. I shared with you earlier in the month that the State of Illinois's unfunded pensions could be as high as $250 billion, putting each Illinoisan on the hook for $56,000.
Central banks' efforts to promote economic growth through monetary easing haven't exactly been a raging success, nor can they continue forever. Plus, near-zero interest rates are precisely what encouraged such inflated levels of borrowing in the first place.
You can probably tell where I'm headed with all of this. Another crisis could be in the works. Savvy investors and savers might very well see this as a sign to allocate a part of their portfolios in "safe haven" assets that have historically held their value in times of economic contraction.
Gold is one such asset that's been a good store of value in such times, and gold stocks have tended to outperform the yellow metal as production costs have fallen, according to Seabridge Gold. I always recommend a 10% weighting in gold – 5% in bars and coins; 5% in gold stocks, mutual funds or ETFs.
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