US election years, QE and a few "oh oh" moments for gold
GEOFF CANDY: Welcome to this week's edition of Mineweb.com's Gold Weekly podcast. Joining me on the line is Sharps Pixley CEO Ross Norman. You wrote a very interesting piece on gold and quantitative easing yesterday, one's that currently on Mineweb.com and in it you talk among other things about the fact that 2012 is an election year in the US and that this does have an impact on the gold price. Why does it have an impact on the gold price?
ROSS NORMAN: It's interesting - gold's had a run rate, in other words an annual increase of 17% every year ever since the beginning of this bull run, but 2004 and 2008 and 2012 have all been lack lustre years within that period of time and when I say lack lustre that is just single digit growth and the gold market has come to expect a bull run of a double digit every year. So those years - 2004, 2008 and 2012 - all coincide with elections in the US and with that we tend to see relative dollar strength and therefore the corollary to that is gold weakness or comparative weakness. This year gold was up only 4% until recently - until the announcement of QE3 or as some call it QE infinity, that are up 11% on the year to date, so, below the run rate but still reasonably good gains.
GEOFF CANDY: I want to get into the impact of QE in just a second but in terms of the US election does it really make much of a difference or is it likely to make of a difference to gold prices who wins this election?
ROSS NORMAN: I don't think so particularly. You can take your own view on whether the Republicans will be able to push through, for example on the gold standard. I think many believe that it probably won't happen. It's probably posturing and what they are fundamentally saying in that regard, on the Republican side is they would like to see more fiscal discipline not spending their way out of the economic crisis. So the truth is that Europe has taken one route out of its crisis - austerity cuts and tax increases. America has taken a different route and neither route has been more successful than the other. So, in short, in the microcosm of the US economy, whether they go the European route or they continue the US route, I don't think makes a massive degree of difference. I think there is still a great desire to avoid a debt deflation spiral but the route you take is probably not going to be one route better than the other, so in short probably not a lot of difference to gold.
GEOFF CANDY: Just one final point on this matter, would there be pressure brought by a Romney government perhaps to end QE infinity perhaps sooner than the Obama administration would like it or is it completely separated?
ROSS NORMAN: I don't know. I think probably what we are seeing, probably across the globe, whether it's in the US or in Europe, you can't have one without the other. You cannot have austerity cuts and expect growth. You do need to have some mechanisms, some stimulus in place to stimulate growth in certain key sectors. You can no more get growth for example in Greece through austerity cuts than you can drive a car well with one foot on the brake and one on the accelerator. In America they've got the focus is very much on jobs and to that extent and also housing, to that extent they are buying mortgage bank securities and trying to do what they can to stimulate growth in the job sector. Those are the two key areas that they are focusing on. I think it's a way out of this mess that is probably the right answer. If you want confidence to return you need stable housing markets and you need the confidence that there are jobs there. Once you have that the economy will pull itself out of the mire. I think the Americans are probably getting it right but it will take some years to come before they are back to a surplus again certainly.
GEOFF CANDY: And I think that's in some respects one of the points that you made is that it is going to take a number of years and indeed that is going to have an impact longer term on the gold price because clearly this bull run has a large fundamental backing from things like QE that are going to be in place for a while.
ROSS NORMAN: That's absolutely right. In very simplistic terms look at the run rate, extend it for the number of years you feel that the crisis will remain in place and you end up with a figure and that figure is roughly double where we are today. You can use other connectors if you like to see whether that is sensible. Look at the Dow Jones:gold ratio. What should that return to in order to close out that trade? In other words if you look over the last 60 years there's been a ratio, a slow glacial movement between equities and gold and back. You would expect that trade to close out at two, in other words, you would expect either the Dow Jones to remain where it is and gold to go to $6000 an ounce, which we don't think will happen or indeed the equity market to fall by 75% which would be dire for the economy which we don't see either. Something in the middle - we would expect the Dow to fall to probably 10 000 and gold to rise between $3500 and $4000 an ounce. We would expect that to occur over the next four to six years and that's consistent with interest rate cycles, it's consistent with what we are hearing about the amount of time it's going to take the economies to repair themselves. So, certainly, we think there is four to six years of growth and just simply applying the run rate of 17% year-on-year that we've seen since the beginning of the bull run, takes again to that same figure. So there's a number of different pointers all indicating that gold should peak somewhere around the $4000 level as things stand and assuming, very much I have to emphasise this a benign outcome to the economy. Should things turn nasty, it could be double that but it's difficult to forecast anything under those conditions.
GEOFF CANDY: Late last week Natixis Bank put out a note where they said interesting that, or pointed out really that some of the largest gains by gold have come around issues around the debt ceiling and debt concerns in the US as opposed to QE which have seen rises but a lot of that being priced in ahead of those announcements, there is much talk about the fiscal cliff in the US. Would you go along with that that is perhaps the next catalyst for an up-leg in the gold price?
ROSS NORMAN: Almost certainly. As we say 2012 was always going to be a modest year. We think next year will be a cracker and the thing that will kick it off will be concerns around the fiscal cliff early in the New Year, early in 2013 and will the US extend yet again the debt ceiling and how will they roll all of these tax breaks that they currently have in place etc. So, certainly, yes this will focus the mind very much on the US dollar. Gold prices are not a random walk they have to obey, they do obey relationships with certain other asset classes, whether it's oil, food, the dollar, technical indicators, so we could well see in the New Year the dollar coming under significant pressure again, perhaps back towards a 72 level again as the US dollar index and that will certainly give gold a leg up towards fresh all-time highs. Is that likely to happen? We think it's likely to happen next year. We think gold will be seeing fresh all-time highs next year and I think that probably the thing that will kick the market off will be issues surrounding the US dollar and in particular the fiscal cliff you alluded to.
GEOFF CANDY: One would assume then that we'd have a fairly or perhaps a less volatile period between then and now.
ROSS NORMAN: I think so. In fact I wouldn't be surprised to see gold coming off in the interim. For the last two weeks we have seen US dollar strength. Gold has actually tracked sideways, probably on the basis of other news. So, actually, for the last couple of weeks gold hasn't obeyed its relationship entirely with the US dollar. We'd expect it to track - even a good chance of some former retracement - perhaps back to $1670 on the charts would indicate that. We've had a good bull run. We wouldn't be surprised to see some profit taking before strength in the fourth quarter of this year. These things don't move in straight lines. The dollar has strengthened, gold has flat-lined, so we think some form of retracement of gold is likely for gold over the next short few weeks which will provide a fantastic buying opportunity for those who want to come in for the next leg next year.
GEOFF CANDY: A lot of the scenarios that you have been painting presume a fairly dominant role for the investment side of the gold market. There has been some concern that given the high prices we've seen, perhaps slightly less or perhaps slightly more lack lustre buying from the traditional jewellery sectors of the world. Is that a concern at all, has there been a structural shift do you think or is this something we should be concerned about.
ROSS NORMAN: As you point out, with the higher prices we have demand destruction on the jewellery side but we've had a burgeoning investment market. It's grown from $3bn to $80bn in a short few years. You are right in saying, certainly for this year, physical flows in Europe have been lack lustre, physical flows in India have been lack lustre for different reasons. Gold in rupee terms are at all-time highs and the government out there are hell bent on diminishing the role of gold within the economy. It's harder to explain why gold sales in Europe have been as poor as they have - 2008 and 2010 were fantastic years for physical sales. This year it has been very quiet and it's a case of people sitting on their hands, but notwithstanding that we think that investment demand is beginning to return supported to a very significant level by central bank buying that we are seeing. Of course central banks have been net sellers of about 400 tons a year, moving to net buyers of 400 tons a year. That 800 tons swing on a 2500 ton market is proving quite central. So the growth in the investment market, yes certainly although it has been lack lustre in Europe and India and on-going central bank buying is continuing to support the market and taking it to new highs.
GEOFF CANDY: One final question, one of the other perhaps pillars of the lower gold prices was the hedging of the gold producers. Given the rate at which costs are rising, do you think we will see perhaps a return to some kind of hedging as prices go higher or is that now not really a factor in this market anymore?
ROSS NORMAN: I don't think we are likely to. I don't see it coming in, in the immediate future. Certainly in the low interest rate environment as we have today and are likely to have for some time to come, the Contango or the premium you can get for selling forward is very modest so what it comes down to then is a view of what you think gold prices are likely to go from here. I think with the rise in costs that we are seeing I think that very much provides a new floor, a rising floor to the gold price and I think that's very supportive of prices. The only reason you would see miners coming in [and hedging] is that if the bankers insisted on it, required it. In other words to support their balance sheet as part of a hedging portfolios but at the moment I think the miners and the bankers alike believe that gold has scope to run higher. To that extent they are prepared to run free with the gold price and I think what they have been doing for the last five years, de-hedging and remaining unhedged is likely to remain the case, particularly if they want to attract investors. Investors want to have a play in the gold market. Heavily hedged miners are no longer a play on the gold price; they are a play on the quality of the asset and the management of the company, which is often not what they want. So I suspect they will remain unhedged because they will see scope to go higher from here.
GEOFF CANDY: Is there any view or any scenario where you can see gold prices falling significantly from where we are?
ROSS NORMAN: Yes I can. Gold was born - this Bull Run was born with a series of oh-oh moments. Back in 1999 contrarians have pointed to the Bank of England's gold sales, in 2000, the removal of the AT across investment gold, across the whole of Europe - 9/11, the birth of the Shanghai Gold Exchange and the liberalisation of that market. It wasn't one thing that shifted the psychology. I think the gold will end the same way that it was born, by a series of oh-oh moments. I think we've had one already which is India's indication, it's minister of finance certainly falling out of love with the gold, it sees it as a misallocation of resources. It's a small oh-oh moment but it's one and the same. We need to have five of those and we'll start to see some decline in sentiment. There have been some suggestions about a tax on hedge funds that hold gold funds offshore, that they should now be taxed. That could be a second oh-oh moment, we will wait to see on that. So yes, we're not perma-bullse and expect this to continue forever. We are watchfully waiting for other signs, oh-oh moments that would indicate the beginning of the end. At the moment we don't see it happening certainly for another five years to come or so.
GEOFF CANDY: Well we're going to be watching for those with a hawk eye...