The Gold Report: This year has been difficult for gold investors. The price went from a high of almost $1,800/ounce ($1,800/oz) to where it is now, in the mid-$1,200/oz range. You have written extensively about the supply and demand forces of precious metals. What is behind the drop in the gold price?
Jeffrey Christian: The single most important factor has been a massive decline in the investment demand for gold. In 2013 investors have bought about 30 million ounces (30 Moz) gold on a net basis globally. That's down from about 39 Moz in 2012 and 31 Moz in 2011, but it is still at a very high level compared to historic investment demand. The net purchases are down 24% because some investors are selling gold.
TGR: Are they putting their money into other investment vehicles or are they sitting on their cash?
JC: There are people who buy gold and hold gold. One person recently told me, "I'm not a gold investor; I'm a gold stacker." They buy gold as a long-term portfolio diversifier, a safe haven, a hedge against financial calamity and also an investment for other reasons. Those people have stepped back a little bit because they want to see how low the price goes before they buy and buy heavily again. That is also true among central bankers this year.
"The single most important factor in the gold price has been a massive decline in the investment demand for gold."
But other investors who were big buyers in the period 2007–2011 have, in fact, left. They are momentum traders who were watching the price of gold rise, so they were buying. Now that the gold price has been falling for two years, they've either sold or they've gotten out of the market. There also are disenchanted investors. They were buying gold because they thought all of this monetary accommodation globally had to lead to hyperinflation. Or they thought that the euro, the European Central Bank, the dollar or the U.S. Treasury would collapse. None of that has happened and they are starting to doubt the thesis on which they were investing in gold, so they are going someplace else.
And then there are the general investors who probably represent 90% of the gold investment community, people who invest across assets and gold is just one asset in a diversified portfolio. Those people are refocusing on real estate in the U.S. to some extent and the stock market, which has been very strong.
TGR: You mentioned the theory that quantitative easing (QE) would impact the gold price, either by deflating the dollar or creating hyperinflation. Does QE impact gold? Would the end of QE impact it negatively?
JC: Yes, monetary accommodations can affect gold in several ways. What we saw in 2009–2011 was that investors assumed it would be inflationary and bought gold in anticipation of that. The inflationary consequences of all that monetary accommodation have not yet arrived and, frankly, may not arrive. Investors bought gold in anticipation of that inflation, based on false assumptions about the relationship between monetary policy and inflation that were not grounded in fact or good economic theories. Now they are selling, or at least not buying, in reaction to the lack of inflationary reactions to the increased money supply.
In addition, QE or monetary accommodation can have a direct effect on gold by being inflationary. If the money that the Federal Reserve is pumping into the banking system was being lent by the banks and being spent by the corporations and individual consumers borrowing that money, it would have a much more positive effect on the real economy. It also would have inflationary pressures. A combination of those factors would drive gold prices higher. That hasn't been happening because the monetary accommodation we've seen the last five years has been going to shore up bank balance sheets. It hasn't been lent and it hasn't been spent. Therefore, it hasn't had that inflationary consequence, and it hasn't pushed gold prices up.
"Algorithmic trading is causing bunches of trades both on the upside and on the downside across markets."
Go back to late 1982–1983, the depth of the previous deepest recession in the post-war period, when Brazil, Mexico and Argentina were about to default. The gold price had fallen from $850/oz in January 1980 to $290/oz by mid-1982. It had given up three-quarters of its value over two years. Then-Federal Reserve Board Chairman Paul Volcker and the world central bankers opened the monetary sluices. The money was lent into the economy. The price of gold went from $290/oz to $500/oz in six months because investors saw all that monetary accommodation and assumed it had to be hyperinflationary. By Q1/83, we were out of the recession because that money was lent and spent.
Volcker started selling bonds, sopping up that excess liquidity, and we never had the inflationary consequence. Gold went from $500/oz in January 1983 back down to $285/oz by 1985 as a result. The reality is that monetary accommodation doesn't have to be inflationary. A lot of people, I think, misunderstood that over the past few years. What you're seeing now is a desire to understand the relationship between money supply, inflation and gold prices because it hasn't been as simplistic as a lot of people believe.
TGR: A lot of the experts we talk to at The Gold Report say it's really just a matter of time before the banks feel confident enough to start lending and that's when the hyperinflation will become apparent. Do you disagree?
JC: Not necessarily. Some of those people have been saying this for 30 years. I know a guy who started writing a newsletter in 1981, and his first newsletter said all of this monetary accommodation is going to bring hyperinflation and the bond market is going to collapse. Someday he probably will be right, but in the last 32 years, he hasn't been right.
If money starts getting lent and spent, that would strengthen the economy. Then we could start seeing inflationary pressures. But the Fed has this tremendous capacity to sell bonds to sop up that inflationary excess liquidity. It has $3 trillion in bonds sitting on its portfolio, and it can always go to the Treasury the way Volcker did in 1983 and ask the Treasury to print more bonds. Even when that money starts becoming mobilized, it may not have an inflationary consequence. We've seen it repeatedly, in 1982, 1987, 1991, 1997 and 2001. Money going into the economy may not have the inflationary effects that people who look at it in a less dynamic analysis are saying that it will have. It's not necessarily going to happen that way.
TGR: Based on your description of the investment demand for gold right now, how do you explain the periods of heavy buying and selling in 2013 that led to gold prices declining as much as $40/oz in a short period of time?
JC: What you are seeing is algorithmic trading. We saw this on April 12. We saw a tremendous amount of selling coming into the over-the-counter forward market, the spot market and the COMEX within a very short period and that led to prices falling sharply. If we disaggregate that, what we see is it was actually more than 1,000 independent entities all trading on technical price chart points, many of them using computerized trading programs that all came in selling at the same time.
"Our expectation is that mining stocks probably are close to a cyclical low."
We saw a similar situation in early October, when about 2.4 Moz of gold futures were sold in a 10-minute period on Oct. 1. The price, in fact, fell $24/oz in that 10-minute period, and it fell about $40/oz over the course of that day. A lot of people looked at it and said, OK, this is some large entity doing that selling. And some of the people, because they're conspiracy theorists, said this is someone trying to suppress the gold price. Neither set of conclusions was right, however.
If we take several steps back and do a good analysis, we find several things. Over the course of October, there were seven 10-minute periods with abnormally high volumes of COMEX gold trading. Of those seven periods, four were buying events based on the expectation that prices were going to rise. And, in fact, prices rose. That proves this is not about trying to push the price of gold down.
It is also not a single entity. In each instance hundreds of entities are buying and selling. Most of them are algorithmic traders. A lot of them have computerized trading programs, so it's not even an individual saying sell; it's the computer just triggering sell orders. And they all are using the same or similar programs, and they're all looking at the same price point as a buy or a sell signal.
It is also not isolated to gold. Gold people tend to be auro-centric. They look at the world through gold-tinted glasses. If we look at the overall commodities market, we see that this kind of algorithmic trading and this kind of concentrated sales and purchases at trigger points is occurring across commodities. It's actually a bigger volatility issue in the grain markets than it is in gold and silver.
Then if we take another step back, we find out it's not even limited to commodities. It's happening in currencies, fixed incomes, bonds and stocks. Algorithmic trading is causing bunches of trades both on the upside and on the downside across markets. So it's clearly not a single entity. It's clearly not aimed at a one-way trade—let's push the price of gold down. And it's clearly not even related to gold. It is a number of people trying to make money by trading on a short-term basis across financial assets.
TGR: If algorithmic trading is magnifying the swings in an already volatile market, does it need to be regulated?
JC: That's a tough philosophical and regulatory issue. I think that we should have a free market and it should be regulated. There may be some way that we can put brakes in there. We have had brakes in other markets. But who is going to be the arbiter to say, OK, you're allowed to trade and this guy isn't allowed to trade, or only limited size trades are allowed. As we speak, India is struggling with these definitions about what constitutes illegal speculation compared to legal investing. Ironically, many of the people who are demanding controls on algorithmic trading are the same people who don't trust government officials, so the decisions about who will intervene, who will make the rules, who will be allowed to trade and who will be excluded are much more complex than whether or not algo trading should be banned.
TGR: Separate from the algorithmic traders, what about the role of gold exchange-traded products? Why was there a big selloff in those this year?
JC: From our analysis, we believe that gold exchange-traded funds (ETFs) attracted investors who were new to gold, which is a good thing. But these new gold buyers may not buy and hold the way traditional gold investors have done. And because there is a daily reckoning in the ETF market, people will take it as a mirror of the gold investment market sentiment even though they don't necessarily represent the majority of gold investors. We've seen about a 25% reduction in gold holdings in the ETFs this year. So about a quarter of those investors have taken their chips and they've gone back to the stock market or wherever else they came from. I think that's what you're seeing in the ETF market.
TGR: So you think the dramatic selloff was caused by individuals new to the market who got scared?
JC: I don't know that they got scared. In some cases, they just decided to take whatever profits they had left. In some cases, you clearly had people who were buying ETFs at a much higher level, and they were taking their losses and moving on to something else. But I don't think that there was any particularly large participant. There were some hedge funds, and there were some companies that were using ETFs to hedge their short exposure to gold prices that had been liquidating those positions for a variety of reasons. But it was not any single entity that was liquidating 25 Moz gold. It was a lot of individuals who basically had said, OK, the gold bull market is over, at least on a cyclical basis.
TGR: So it wasn't the John Paulsons of the world changing their mind about gold and in the process pushing down the price?
JC: We did see some large hedge funds that were using those positions. John Paulson's position on the ETFs actually was not his core gold position. It was a hedge of Paulson & Co.'s exposure to gold prices from those investors in the Paulson hedge funds that had chosen to denominate their investments in those funds in gold. Paulson's gold investments are apart from those ETF investments. Over the years, gold prices have risen sharply and then they came off. Paulson's funds have done well and they've done poorly. The value of his position has fallen down in some of his funds. A lot of people have withdrawn money.
Paulson's selling of gold ETFs has nothing to do with that company's views about the gold market. It has to do with the fact that people either are withdrawing funds or they don't want to index their positions in the fund in gold anymore because the dollar is doing well and gold is doing poorly. So those sales by those ETFs holders do not necessarily represent a vote pro or con of gold; it's a hedge of his position with his investors, and as his investors make a choice, he's just unwinding his hedge.
TGR: But it does impact the market.
JC: It definitely affects the market, but you have to understand, it's not that there's somebody out there saying, oh my God, I do not believe in gold anymore. At least it's not Paulson & Co. saying that. It's investors saying, we've had a very good run in 2010 and 2011 by denominating our investment in Paulson funds in gold because during that time, Paulson's funds did very well and the gold price did very well. So we got a double whammy on the positive side. Now, Paulson's funds haven't done so well, and the gold price has plunged. So it makes sense to either take my money out or at least re-index it so it's based on the dollar or some other currency.
TGR: You mentioned the role of central banks buying gold. What impacts have international central banks had on the gold price?
JC: Central banks shifted to being net buyers around 2008. They had been net sellers for several decades, basically since around 1967. In 2010–2012, central banks were buying about 9.5–11 Moz/year of gold. This year, they're probably buying about 3.5–5 Moz of gold. It's just a handful of central banks that have been significant gold buyers in the last few years—Venezuela, the Philippines, Kazakhstan, Russia, and China in 2009, which was a special case. Those central banks remain interested in buying gold, with the probable exception of the People's Bank of China, but just like investors, they are price sensitive. They are waiting to see how low the price goes before they resume purchasing gold in significant volumes. We think the volumes will start rising again next year, once the gold price stops falling and starts stabilizing. We expect the gold price to rise over the next 10 years, so we expect those central banks to continue to buy gold over the next 10 years.
TGR: There is a lot of controversy around both supply and demand statistics from China and India. What statistics do you use for both investment and fabrication uses? What trends are you seeing in those numbers?
JC: CPM Group is in the business of developing its own estimates of supply and demand in commodities, including gold, silver and platinum group metals. We have been developing and maintaining our own supply and demand data since the 1970s, longer than anyone else in the market. We use our data.
In India, we are seeing a small increase in investment demand. The government has severely limited imports of gold except for manufacturing into jewelry that gets re-exported. It has raised taxes to try to discourage some of the investment demand in gold. But investors in India are still buying gold. The country has been a major gold investment market for centuries. In fact, for the last decade it was the largest market for gold, but China surpassed India last year as the largest market both for jewelry fabrication and electronics, as well as for investment products. We're seeing an acceleration of that this year.
Our current estimate is that total demand for gold in China is about 35 Moz this year. A lot of that occurred in January, February and then April and May. Since that time, we've seen Chinese investors become more price sensitive along with everybody else, waiting for lower prices before they buy more.
Our estimate is in line with the estimates used by the China Gold Association, CPM Group's strategic partner in China and the major Chinese gold industry organization. It also is in line with estimates from Chinese dealers and bullion banks that are moving gold into, around and out of China. There have been some outrageously unsupportable statements that gold demand in China is three times that, or more, but these numbers are totally unsupportable based on statistics and evidence that is available in the market, and are being pushed by gold marketing people desperate to convince Western investors that they should keep buying gold, and buy it from them.
TGR: Can you give me an example of some of the ways you figure out how much gold China is buying and mining?
JC: We collect import and export data. But that misses a lot of information. So we develop independent sources of information with major smelters, refineries, industrial users, investment wholesale and retail outlets, central banks, exchanges—around the world. For each major market, we create what we call a national metal account for each metal—gold, silver, platinum, palladium, rhodium, vanadium, aluminum, copper, all of the metals. We put it into a model, and that gives us a rough idea of what the size of the market is.
TGR: We've talked about a lot of things that could impact the gold price—the supply and demand in emerging markets, central bank buying, ETFs. Have the larger economic trends overshadowed traditional seasonal fluctuations in demand and price? There are the summer doldrums and the love trade buying season that Frank Holmes talks about, but the gold price doesn't seem to be following the usual patterns anymore. Is that just being overshadowed?
JC: The seasonality patterns are averages. Like the weather report on television where they talk about how the normal temperature on a given day should be 50 degrees, it's not the normal temperature; it is the average temperature over a period. The normal range in temperature that the average reflects might be 35 to 75 degrees. So seasonality is an average of a wide range of occurrences.
Seasonality is always trumped by macroeconomic and fundamental trends. If something is happening in the market, it regularly blows away the seasonal patterns. That is what we are seeing this year. Fundamental and macroeconomic factors are weighing gold prices down during a period where congestion usually drives the price temporarily higher.
TGR: In June, you issued a qualified Buy recommendation on gold as an intermediate- to long-term Buy. What trends are you anticipating for 2014, both in the developed and the emerging markets?
JC: As background, we issued a Sell recommendation on Jan. 2, 2012, for gold and silver. Gold was trading around $1,800/oz, and we said that we thought it would fall to $1,300/oz to $1,400/oz on an annual averaged basis in 2013–2015 before rising again. What we said in June of this year was that we are kind of there in terms of our downside price targets. There is some more weakness in the market, but long-term investors might want to buy gold if it spikes down to $1,200/oz.
Our expectation now is that the gold price will be relatively weak for the next two or three quarters, into Q2/14 or Q3/14. We think that this period of bearishness about gold still has a ways to go. We're not convinced that we'll see prices fall further on an intra-day basis, and that the $1,180/oz low that we saw in late June may well prove to be the low. It was tested earlier this month and we bounced off of it, at least for now. Arguably, that may well hold, but there is a tremendous amount of bearishness about gold, and there is a tremendous amount of bullishness about the global economy and the U.S. economy.
In that environment, gold could be relatively weak. Investors right now are turned off to gold and are refocused on stocks and bonds. We think that by H2/14 investors may start refocusing on the structural financial and economic problems facing the U.S., Europe, Japan, China and the world as a whole. That could lead to a downdraft in U.S. stock prices. Combined with nasty, uncooperative Washington politicians, and a nasty, uncooperative election, H2/14 could lead investors to start buying gold again in higher quantities.
TGR: The silver market is smaller and often more volatile than gold. Do you see the same fundamentals at work there? What are you expecting for 2014?
JC: Silver is pretty much in the same situation. We're a little less optimistic about silver. Broadly speaking, we expect it to be the same, but because silver is a schizophrenic metal that acts as an investment product and an industrial commodity and both are negative at the moment. The silver price could bounce around $18–22/oz for the next three quarters. Then it could be a little weaker than gold in 2015. Depending on what happens in the global economy and whether investors remain keen to add to their silver holdings at these prices, silver could do well after 2015.
TGR: Do you think there is an ideal silver-gold ratio?
JC: No. In the history of free metal prices, since 1968, the ratio has ranged between 16:1 and 100:1. There are absolutely no physical or economic reasons why the ratio should be anything in particular. When people ask us where we think the ratio is going to go, we look at our 10-year projections for gold prices based on fundamentals in the gold market. We look at our 10-year projection in silver. We divide one by the other and come up with the ratio. There is no real reason for a ratio to be anything. There is very little substitutability except in the eyes of investors. Back in 1979 we said the ratio would go to 16:1 because Nelson Bunker Hunt thought the ratio should be 16:1. He was buying silver and selling gold accordingly. It did hit 16:1 the day he went bankrupt.
TGR: A lot of analysts are bullish on platinum and palladium because of country risk to supply and possible increases in demand as the global economy improves and people start buying cars with catalytic converters. Do you agree with that supply and demand picture?
JC: Yes. We have been more positive on platinum than on gold and silver, and we've been more positive on palladium than on platinum for a couple of years. We've been embarrassed to some extent because the prices haven't been quite as strong as we thought. There are supply concerns in South Africa, and those supply concerns probably will be heightened in 2014 from what they were in 2013. So that should apply upward pressure on platinum prices and palladium prices. We're actually already seeing relatively healthy markets for autos in China, India, the U.S. and Europe. We're also seeing an increase in the sales of large diesel trucks and buses. That's important because those vehicles use more platinum relative to palladium.
The problem with platinum and palladium is that there has been a buildup of millions of ounces in the hands of investors. Investors in gold, when they turn bearish on gold, tend not to sell gold. They tend to just stop buying as much because it's a financial asset and it's a quasi-currency in their minds. But platinum and palladium are industrial commodities. When investors turn bearish on them, they dump them.
One of the things we've seen since Q4/11 is that a lot of investors who had bought platinum and palladium earlier in the decade, in 2002 to 2008, were taking the opportunity of any rallies in the platinum and palladium markets in 2011 and 2012 to sell into the rallies. Now, in H2/13, they're not even waiting for rallies. They're just selling. There is a very positive balance between supply and fabrication demand, but a negative investor attitude. We think that will shift at some point over the course of 2014 and you'll probably see platinum prices move sharply higher at some point. You'll probably see palladium prices move steadily higher from early 2014.
TGR: What does all of this mean for the junior mining equities? They've been hit even harder than the commodities in a lot of cases.
JC: Mining equity values tend to be much more volatile than the metal prices. They are a less liquid market, so they have a high beta to gold prices. The juniors, in particular, are heavily exposed to that because of their small size and lack of cash and revenue stream to get through the bad times. They have been hit very hard over the last several years.
Investors have to be very careful and pick the good ones, but our expectation is that mining stocks probably are close to a cyclical low. They may go a little bit lower in H1/14 simply because investors are going to continue to be bearish on precious metals in general. There are some interesting opportunities to pick up stocks that were overvalued in 2009–2010. Then wait for that investor psychology to shift. We think it will happen over the course of 2014, but it may be the middle to late 2014.
TGR: Thank you for your time.
JC: Thank you.
Jeffrey M. Christian is managing partner of CPM Group. He has been a prominent analyst and advisor on precious metals and commodities markets since the 1970s, with work spanning precious metals, energy markets, base metals, agricultural markets and economic analysis in general. He is the author of "Commodities Rising: The Reality Behind the Hype and How to Really Profit in the Commodities Market," published in 2006.
Christian founded CPM Group in 1986, spinning off the Commodities Research Group from Goldman, Sachs & Co and its commodities trading arm, J. Aron & Company. He has advised many of the world's largest corporations and institutional investors on managing their commodities price and market exposures, as well as providing advisory services to the World Bank, United Nations, International Monetary Fund and numerous governments.
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