Gold Trade Is Not Overcrowded Says UBS – The Holmes SWOT

By Frank Holmes, CEO and Chief Investment Officer, US Global Investors

Strengths

  • The best performing precious metal for the week was gold, down slightly by 1.47 percent. Current market conditions make it the perfect time to invest in gold, according to Heather Ferguson, an analyst at Hargreaves Landsown. “There is a fixed amount of this precious metal in the world so central banks are not able to manipulate the gold market like they can with bonds and cash,” Ferguson explains. “In the current environment of quantitative easing and increasingly extreme monetary policy, gold is highly sought after.”
  • UBS says the gold trade is not overcrowded, according to a note this week.  The group believes that Federal Reserve policy decisions relative to the metal are not as straightforward in this environment where global yields are under pressure ahead of a rate hike.
  • Citigroup is also positive on the metal, raising its forecast for the second half of the year. The group cites elevated levels of U.S. election uncertainty and stickiness of ETF and hedge fund flows into gold products, reports Bloomberg.

Weaknesses

  • The worst performing precious metal for the week was platinum with a loss of 3.77 percent. Platinum sold off when precious metals were bear raided on Wednesday, but did not get much of a bounce following Yellen’s speech on Friday.
  • “The past 48 hours have been an interesting period for gold…” writes Steven Knight of Blackwell Global. “As the metal has again seemingly fallen sharply following the liquidation of a $1.5 billion futures position over the course of 60 seconds.” According to Knight, given the amount of gold derivatives floating around, the fairness of the COMEX exchange likely needs an additional level of scrutiny. In addition, the timing of this “flash crash” could potentially be revealing.

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  • Goldcorp fell the most in six months, reports Bloomberg, on the back of retreating gold prices and the discovery of a leak at the company’s mine in Mexico. Less-than-stellar news was also reported from Kinross Gold Corp this week, as it suspended operations at a mine in Chile ahead of schedule due to a dispute involving water use (causing 300 workers at the Maricunga mine to be laid off as a result). Lastly, Orezone Gold Corp told investors on Monday that it will likely slash the gold resources at its Bombore project by a staggering 30 percent, reports the National Post.

Opportunities

  • When viewed against the aggregate balance sheet of the “big four” global central banks (Fed, ECB, BoJ and PBOC), the argument can be made if we view gold as a currency, that the metal is worth closer to $1,700 an ounce (versus the spot price of $1,326 an ounce USD), says Deutsche Bank. Over the same period that the aggregate central bank balance sheet expanded 300 percent, the bank continues, global above ground stocks grew by 19 percent in tonnage terms.
  • More than 500 million people are living in a climate of negative central-bank interest rates, according to a study by Standard & Poor’s cited by HSBC this week. This represents around 25 percent of global GDP and is a clear sign of “economic and policy desperation,” – a bullish factor for gold. Francisco Blanch of Bank of America agrees, stating that central banks “are very scared of hiking rates and that is a very good story for gold.”
  • “Although we have seen a significant rally in gold, I think investors should still consider an allocation to the precious metal,” Nick Peters, multi-asset investor at Fidelity, said. He continues by explaining that gold can function as a safe haven during times of market volatility and provide strong countervailing returns to equities.

Threats

  • The Reserve Bank announced today that sovereign gold bonds issued in February and March can be traded on stock exchanges starting Monday. Four tranches of the bonds have already been issued, with a fifth likely to be issued next month. Sovereign gold bonds provide an alternative to actual gold investing, offering investors a choice to buy bonds worth 2 grams of gold going up to a maximum of 500 grams.  The bonds are denominated in gold and pay 2.75 percent interest in physical gold.
  • Are the positive changes in the gold industry sustainable? This was the point of question from Gold Fields CEO Nick Holland during a keynote presentation on Monday, reports Mineweb.com. Holland points out that not only are companies cutting “fat,” but “muscle” as well. Stay-in-business capital (as a percent of operating expenditure) decreased from 46 percent in 2012 on a per ounce basis, to 26 percent in 2015. How can companies do this? “I believe that they have merely deferred capital that is going to come back, because if you want to sustain the business into the future, you need to spend the money,” Holland said. “That for me is a little bit of a concern.”  The Industry is going to play catch up, which could yield poor capital allocation decisions, particularly if the industry errors on the side of growing production ounces versus growing profitability.
  • In a note from BMO Private Bank this week, Jack Ablin points out that historically, options investors have been able to generate reasonable income by selling options to other investors looking for downside protection and upside opportunity. However, struggling yields have created an “outsized supply of yield-seeking options sellers who collectively outstrip buyers.”  The result is that implied volatility has declined. But just because yields are low, doesn’t mean that actual risk has gone away, the note continues.
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