LAWRIE WILLIAMS: 2015. Precious metals in retrospect
After a promising start of the year for precious metals investors, 2015 has largely been a year of disappointments as the complex has faced numerous headwinds. If we look at gold in particular – given the other precious metals tend to follow it in one respect or another – even if this is not entirely logical for those like platinum and palladium where demand is primarily industrial, various external developments have tended to militate against it, while other events, which at a different time might have acted positively have, in the event, had little or no impact.
London-based precious metals consultancy, Metals Focus, has come up with its own review and we note some of their points – and add others – all of which have come together to depress the precious metals complex, although we may have been seeing some slightly more positive elements as the year draws to a close. Bur whether these can be sustained into 2016 remains to be seen.
The gold price has been dominated by expectations of a U.S. Fed rate increase (finally realised this month). Each successive FOMC meeting, where the decision to start to raise rates was deferred and deferred saw gold rise in the aftermath, and then come back as analysts tried to interpret the vague statements which materialised, while those with a seeming agenda to keep the gold price down would then kick in at take it back down even more sharply – often a case of one step forward then two back.
One other result of the expectation of a U.S. rate rise has been to keep the dollar strong, although when the rate rise decision finally materialised at the eleventh hour, the dollar dropped back a little, but over the full 12 months it has strengthened quite materially against many of the world’s currencies, including against those of many of the world’s major producing nations. This has meant that in those producer nations like Australia (No. 2 in the world), Russia (No. 3), Peru (No.5), South Africa (No.6) and Canada (No.7) the fall in the local currency, in which most mining costs are incurred, and the rise in the U.S. dollar in which revenues are received has meant the gold mining industry has not suffered nearly so much as the fall in the dollar gold price might suggest, which has enabled them to carry on mining as margins remain positive. Many analysts had predicted the falling gold price would lead to global production turning down, but so far this just has not happened and 2015 global new mined gold output will probably come out marginally higher than in 2014. It is plateauing, but is not yet turning down.
The fall in oil prices has also contributed to gold’s weakness. As Metals Focus points out – firstly, investor demand for gold and, to a lesser extent, silver as an inflationary hedge (including expectations of future price rises) has all but disappeared. Secondly – the impact of weak oil prices has been on sentiment towards the global economy, which had already been undermined by the equities correction in China, itself the result of growing fears of a hard landing there.
We would add a third point in that the lower oil prices have also helped marginal gold producers reduce costs levels further than anticipated which is another contributing factor to global production holding up so well despite the dollar gold price fall.
Gold has had something of a see-saw ride in 2015. It started the year in positive fashion, but over the full year gold prices declined for a third consecutive year, averaging $1,163/oz over the full year – a decline of around 8% year on year, and by the time of writing was languishing only a little above the $1,050/oz level. It hit an annual high of $1,308 on 22nd January. Metals Focus reckons the catalyst for the rally was a focus on geopolitical events in Europe, with tensions between Russia and Ukraine, and the Grexit saga taking centre stage. This helped lift ETF demand, which increased by some 2.7 million ounces from 14th January to 24th February.
But, as the risk of a Grexit dissipated and the conflict between Russia and Ukraine moved out of the headlines, the focus moved back towards macroeconomic themes. In Europe, EU president Draghi continued with his commitment to do “whatever it takes” to save the euro and boost the flagging economy. The ECB cut interest rates over the year and signalled that it will extend easing to March 2017, and further out if needed. Growth from emerging markets also slowed, and the equity price correction in China dampened sentiment towards the state of the economy there. This, twinned with the prospects of the first Fed rate rise in nearly a decade, helped the US dollar strengthen, and in turn this proved to be a major headwind for commodity prices in general. Against the euro, Metals Focus calculates that the dollar so far has strengthened by 15% over 2015.
Physical markets have remained reasonably strong though despite an apparent turndown in Chinese jewellery sales – although this has been belied to an extent to record gold withdrawals from the Shanghai Gold Exchange which are likely to be well over 400 tonnes higher than the previous 2013 record of 2,181 tonnes. Indian demand has been quite robust too, with nine months jewellery consumption rising by 5%, helped by strong demand ahead of the festive and marriage season.
To counter this though, Metals Focus calculates that total holdings in gold ETFs declined by 4.5 million ounces to 46.9 million ounces. This was however a somewhat lower withdrawal rate than the 5.2 million ounces in 2014. With the biggest gold ETF being GLD in the U.S. this impacts on the price perhaps rather more strongly since the gold price overall is still largely being set by gold futures activity on COMEX.
Along with the rest of the precious metals complex, silver has weakened significantly in 2015, falling by 9% on an intra-year basis, matching the losses in gold. However, the full year average has declined by 18%, posting the second highest drop in the precious metals complex behind platinum. Having underperformed gold in 2014, this year silver has largely tracked gold lower. This was reflected in the gold:silver ratio, followed strongly by some silver investors who are convinced the ratio will come back substantially, which spent much of 2015 between 70-75:1. A brief exception occurred over the northern summer during what was in effect a relatively short-lived equity market rout in China, which led to widespread liquidations across industrial commodities. Here silver’s role as an industrial, as opposed to a precious, metal emerged as a key price driver. This served to reinforce investor concerns about silver’s industrial credentials. First, uncertainty remains over the pace of the global economic recovery, not only in China, but also in Europe and the US (where manufacturing is seemingly in recession). Second, even though global silver industrial offtake is estimated to have risen by almost 3% in 2015, Metals Focus reckons that ongoing thrifting, in key areas such as photovoltaics, as well as substitution elsewhere, may threaten the outlook for 2016 and beyond.
Despite these uncertain prospects, and the perceived lack of price upside this conveyed, investors still viewed silver’s downside as being well protected. Metals Focus reckons that this helps explain the 10-year high gross long positions that at times have emerged this year. Retail investors also tended to agree, reflected in bargain hunting in the US and India, silver’s two largest physical investment markets. The former posted a record total this year, while Indian offtake remains close to 2014’s all-time high. Without the strength in these two countries, silver’s supply/demand fundamentals would have been far poorer this year.
However, those that foresee an improvement in gold in 2016 are still in there in silver on the grounds that when gold does turn around, history suggests that silver will turn around faster and stronger despite the fact that fundamentals suggest it should be treated more as an industrial metal. But it is very much the investment demand for silver coins in the U.S. and in the silver jewellery sector in India and elsewhere that has been preventing it falling further.
Platinum has been the worst performing precious metal this year, although here again it perhaps should not really be seen as such as the greater part of demand is as an industrial metal, particularly in the diesel exhaust cleaning catalyst department. Here the VW diesel emissions scandal has convinced the markets that the diesel market will decline (although there seems to be little evidence of this so far). There is a counter-argument that ever strengthening emission control legislation will actually increase demand over the next few years.
As Metals Focus points out, the overall fundamentals have actually been benign with the market being in overall deficit, as it has been ever since the South African five-month mine strike in 2014. However South African production was not quite as badly hit as some analysts were suggesting - and the recovery has been quicker than expected.
The South African currency’s 30% decline against the dollar has meant that some of the expected mine closures have just not happened and the vast majority of South African operations appeared set to continue producing for the foreseeable future.
From being the top performing precious metal of 2014 (+11% y-o-y) with arguably the best fundamentals, palladium has had a disastrous 2015, down 30% ytd. It was probably virtually every precious metals analyst’s pick as being the likely best performer in the complex, but in practice it has performed pretty disastrously seeing a 34% fall in 13 weeks from late May, to an intra-day low of $521 on 26th August. This marked the metal’s lowest price since September 2010.
Here again the American futures exchanges appear to have been the main culprits in the huge price decline seen mid-year. There was a huge spike in short positions on NYM EX – increasing by1.25 million ounces between 2nd June and 4th August; to their highest level on record at 2.02 Moz. As Metals Focus points out there was no particular economic data that prompted this sell-off. The consultancy sees it as reflecting growing bearish sentiment towards Chinese economic growth and industrial commodities and the big stock market falls which were seen as, in combination, contributing to dampened expectations for the country’s auto sales; China had contributed more than 40% of the growth in total palladium autocatalyst demand over 2011-14. In reality Chinese auto sales remain pretty well at record levels despite the various downturns and slowing growth – and here again future emission control standards may temporarily, at least, increase palladium loadings. The main concern has to be a move to electric and fuel cell vehicles, but this is still probably a few years away.
However,Metlas Focus notes, palladium enjoyed a strong rally, rising back above $700 by early-October, as firstly investors viewed the metal as oversold and then, as the VW scandal gave the metal a boost at platinum’s expense. As a result, the spread between the two PGMs closed to a 13-year low of $211 on 2nd October. However, this was short lived, and further concerns about the Chinese economy once again flared up, hitting the wider industrial commodities complex. What’s more, ETF outflows increased, particularly from South African funds. Where profit taking (with rand denominated palladium prices just 3% off their all-time high) led to some 350,000 ounces of combined outflows in a month. As a result, by mid-November prices had fallen back below $550.
One suspects analysts again may pick palladium as the likely best performer in the precious metals complex in 2016 – but as 2015 has shown even metals apparently showing the best fundamentals of all can hugely underperform when sentiment turns against them.