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Gold Market "Stronger Now Than 2011"

Fundamentally speaking, that is. Mine output will fall, consumer demand is growing...
 
MARCUS GRUBB is managing director of investment strategy at market development organization the World Gold Council.
 
Here, and following the release of the World Gold Council's latest quarterly Gold Demand Trends report, he speaks to Mike Norman at Hard Assets Investor about the latest data and the fundamental picture in the market...
 
Hard Assets Investor: We've seen a lot of negative sentiment recently build up toward gold, major firms like Goldman predicting maybe as low as $1000 or $800 an ounce. How, if at all, has that affected trends in physical demand?
 
Marcus Grubb: The fundamental picture in the gold market doesn't look too bad. This last quarter we had a 2% drop, with a 4% drop in jewelry. After what happened last year, that's looking a lot better. You saw a 1% rise in mine production, but the supply side's starting to come down because recycling fell 25%. Overall, supply dropped.
 
The demand side is looking pretty strong. China is down after last year, but it was a record in 2013. China is still looking pretty good when you take the whole year into account. It'll still be the second-best year ever for China. And India is coming good in the latter part of the year. It's very strong numbers in India in this quarter: 60% increase in jewelry. The import figures are looking very strong in India right now. I think the pressure on gold is not coming from the fundamental demand and supply, it's coming from the view about interest rates, the Dollar, and the financial side of it.
 
Hard Assets Investor: You're talking mainly about investor participation. How did that fluctuate in the third quarter?
 
Marcus Grubb: Well, I would say the investor side has been pretty slow this year for gold. We had huge redemptions in exchange-traded funds last year. It's not been as bad this year. We've seen somewhere around 140 tonnes out of ETFs so far this year. That's only about 10% of the figure last year. So it looks a lot better. But what you're not seeing is a return of the investor yet to gold. That is partly what we will need to see the gold market move a lot higher.
 
Hard Assets Investor: Are investors incentivized by higher prices? You tend to see that in the stock market. It catches media attention. People get involved. But now is the time when you should be buying gold...?
 
Marcus Grubb: Exactly. Gold is different from a pure financial asset: It's half a consumer good, and it's half a financial asset. So if you look at US jewelry right now, it's up six quarters in a row, and had a strong quarter this last quarter. Why? Because the price has come down.
 
Consumers think jewelry is now a good buy. Consumer confidence is improving in the US as well. On the other hand, on investment, you need a rising price to get investors back in the bars and coins, for example. Longer term, you need a floor under gold here. You need a rising price, longer term, to bring investors back in.
 
Hard Assets Investor: Let's talk a little bit about central banks, which had been very active – China and, in particular, Russia...a big buyer of gold recently. It almost looks like a fiscal operation there. Gold purchases by the Russian central bank put currency into the banking system at a time when they're running budget surpluses, which remove stimulus. Is that kind of what's going on there?
 
Marcus Grubb: To some degree it is. Since central banks became net buyers of gold about five years ago, Russia is the No.1 new buyer, other than China. The problem with China is we don't know how much it has bought. But the Russian central bank now holds well over 1,000 tonnes. And it's the biggest reported purchaser this year as well, in the latest figures out of Gold Demand Trends. In this quarter too, they're a major buyer of gold.
 
Hard Assets Investor: They're also a major producer, which is odd; that would be like General Motors buying its cars, right?
 
Marcus Grubb: In some ways. Other countries are similarly positioned. They're big consumers for demand; they're big miners; they produce it. Central banks own a lot of it. Russia's is another culture where gold is more embedded than in Western cultures, historically.
 
With Russia, I think it's more about diversification against the Dollar. Oil revenue's their biggest source of income, which is in Dollars. They're buying gold as a diversifier. There may be some geopolitical influences in those decisions.
 
Hard Assets Investor: As a former trader myself, I think it's totally normal to see the price pull back. In fact, the last bull market in gold peaked in 1980 up to $800 an ounce. There's no reason why we can't revisit that number, which would be like the new support level, wouldn't it?
 
Marcus Grubb: We wouldn't agree with that; I think a lot has changed since those days. The first thing is that the all-in sustaining cost of mining an ounce of gold is a lot higher than $800. In the past, it wasn't. So you have a supply-side problem.
 
Hard Assets Investor: What is the average cost of production?
 
Marcus Grubb: Now, it's probably, for the bulk of the industry, between $1200-$1300 per ounce. We're really below it. You have miners high-grading their mines. They're reducing capex, restructuring their operations to take account of the fall in the gold price. I think the problem anyone who's really bearish on gold from here, when we're down 40% from the all-time high already, is you'll reduce supply if you see gold go a lot lower than where we are now.
 
Hard Assets Investor: Which ultimately and fundamentally creates a long-term bullish environment...
 
Marcus Grubb: I think so. I think some of the last decade's gains was froth, pursuing the returns and the commodity bull market. But I think some of it was that some investors, especially in the US, were concerned about the financial system, about the Dollar five or six years ago. They bought gold as a hedge asset, as a credit hedge.
 
Now those investors are out. They're the 1,000 tonnes of gold that came out last year. Now you have investors who look at it more as a long-term strategic asset, a hedge against the Dollar, against future inflation, against tail risks and unforeseen events. Longer term, they believe in a more positive dynamic for gold, that you will have a deficit in supply and demand develop again. The central banks are still buying. Consumers in China and India are still buying.
 
Mine production will likely fall next year. Most of our big investment banks forecast falls in mine production next year. Recycling is down. You'll have to find another 2,000 tonnes of gold from somewhere in the next few years to meet the demand. It's only a 4,000 tonne market per year. I think that's the longer-term reason to be more positive about gold. It's in a very different position than a lot of the other metals, where there's been a big supply increase, and a big drop in Chinese demand. Gold is different.
 
Hard Assets Investor: Has the inflation outlook perception changed? A lot of people said quantitative easing asset purchases would lead to inflation, maybe hyperinflation, because of all the money printing. That didn't happen.
 
Marcus Grubb: But an inflation hedge is only one of gold's properties. I think right now, as you rightly say, the fear is back in the other direction. I think in the medium term, the fear everywhere, even in the US, is will the economy produce enough inflation to satisfy the central bankers and to satisfy the economic objectives of getting the debt burden down, rekindling earnings growth, rekindling corporate investment, and keeping growth high enough so the stock market can continue to rally?
 
I think that's going to be the challenge, it's actually not going to be inflation yet. I think, though, once the velocity of money increases again around the world...
 
Hard Assets Investor: It's like historically really low right now.
 
Marcus Grubb: It's extremely low. That is when inflation will become a problem again. But, as you say, right now it isn't. But I don't think that's as bad as people think for gold, because gold can do well, also, in a disinflationary environment. And I think that is the bigger fear right now. So who knows, maybe quantitative easing isn't over yet.
 
Hard Assets Investor: A major point – the fundamental backdrop is looking a lot better now than it did three years ago. Marcus, thank you so much.

Hardassetsinvestor.com is a research-oriented website devoted to sharing ideas about investing in the natural resources sector. Published by Van Eck Associates Corporation, the site offers an educational resource for both individual and institutional investors interested in learning more about commodity equities, commodity futures, and gold – the three major components of the hard assets marketplace.

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