2008 Comparisons Give Gold Big Boost

By Frank Holmes – CEO and Chief Investment Officer, U.S. Global Investors

Plunging oil prices, rising market volatility, surging global debt—it’s all beginning to remind some investors of 2008. Earlier this month, billionaire former hedge fund manager George Soros warned of an impending financial crisis similar to the last major one, which sent shockwaves throughout global markets.

The comparisons to 2008 have triggered gold’s Fear Trade, with many investors scrambling into safe haven assets. Jeffrey Gundlach, the legendary “bond king,” recently made a call that amid further market turmoil, the metal could spike as much as 30 percent, to $1,400 an ounce.

Are we headed for another 2008? George Soros thinks so.

Making such predictions is often a fool’s game, but there’s no denying that gold demand is on the rise, both in the U.S. and abroad. For the one-month period ended January 20, gold (and silver) outperformed, comfortably beating domestic equities as well as a basket of other commodities.

Precious Metals on Top in 2016
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I’ve already shared with you the fact that gold has historically had a low correlation with equities. This point is worth reiterating: When equities have zigged, gold has zagged. And with volatility high in global markets right now, many investors are choosing to rotate a portion of their portfolios into the precious metal.

Marc Faber suggests that it might be a good time to get back into gold.

This was the advice of my friend Marc Faber, who recently warned investors in his influential “Gloom, Boom & Doom Report” newsletter that global stocks could fall an additional 40 percent on mounting liquidity and debt problems. In the event such a crisis occurs, Marc says, investing in gold—which, again, has been shown to be inversely correlated with stocks—might be one way to protect one’s wealth.

I’ve always recommended a 10 percent weighting in gold: 5 percent in physical bullion, the other 5 percent in gold stocks or mutual funds. This applies in all market conditions, good or bad.

Something else I want to draw attention to in the chart above is the extreme divergence in performance between gold and oil, which is trading at levels we haven’t seen in a long while. Declines in oil have traditionally invited enormous selloffs in other commodities, making gold’s resilience at this time all the more impressive.

China Consumed Nearly All of Global Gold Output in 2015

Investors in China appear to recognize the importance of gold in times of market uncertainty. Since June 2015, the Shanghai Composite Index has dropped close to 45 percent, prompting scores of retail investors to pivot into safe haven assets such as gold. As you can see below, 2015 was a blowout year for the Shanghai Gold Exchange (SGE), which in the past has served as a good measure of wholesale demand in China.

Physical Gold Delivered from Shanghai Gold Exchange (SGE) vs. World Mining Output
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Not only did gold deliveries climb to a record number of tonnes in 2015, they also represented more than 90 percent of the total global output of the yellow metal for the year.

The SGE has made it incredibly easy for Chinese citizens to participate in gold investing. Recently it rolled out a smartphone app, making it more convenient than ever before to open an account and begin trading.

Gold Miners Are Winners of the Currency Wars

Gold priced in the strong U.S. dollar might have netted a loss in 2015, but in many other parts of the world, prices were either stable or even made gains. For buyers of gold in non-dollar economies, it’s the local price that matters most, not the dollar. In Russia, the third-largest producer, the metal rose 12 percent—and came close to an all-time high. In South Africa, the sixth-largest, it was well above the all-time high. Investors there saw returns of greater than 20 percent in 2015.

Gold Was Positive in Non-Dollar Currencies
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This has been beneficial to many mining companies based outside the U.S. Operations are paid for in local currencies—most of which have weakened in the last year—but companies sell their production in U.S. dollars. This has helped offset the decline in gold prices since they peaked in 2011.

Canadian-based companies such as Claude Resources, Richmont and Agnico Eagle Mines are performing well, even in the gold bear market and amid high volatility.

Canadian Gold Stock Performance
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For the last three years, gold miners all over the globe have been thoroughly beaten up. Today, they’re heavily discounted, and there are signs that conditions are stabilizing.

Managing Expectations

With the Fear Trade heating up, it’s important that we manage our expectations. The length and extent of the current bear market, which began in September 2011, might seem unprecedented to many investors. In actuality, it doesn’t veer very far from what we’ve seen in the past, according to data presented by the World Gold Council (WGC).

Current Gold Bear Market Not Far off the Mean
January 1970 – January 2016
Current Gold Bear Market Not Far off the Mean BULL MARKET Current Gold Bear Market Not Far off the Mean BEAR MARKET
Dates Length (months) Cumulative Return Dates Length (months) Cumulative Return
Jan 1970 –
Jan 1975
61 451.4% Jan 1975 –
Sep 1976
20 -46.4%
Oct 1976 –
Feb 1980
41 721.3% Feb 1980 –
Mar 1985
61 -55.9%
Mar 1985 –
Dec 1987
33 75.8% Dec 1987 –
Mar 1993
63 -34.7%
Apr 1993 –
Feb 1996
35 27.2% Feb 1996 –
Sep 1999
43 -39.1%
Oct 1999 –
Sep 2011
144 649.6% Sep 2011 –
Present
52 -44.1%
Average 63 385.1% Average 47 -44.0%
Median 41 451.4% Median 52 -42.7%
Source: World Gold Council, U.S. Global Investors

Reaching back to 1970, the WGC identified five bull and bear markets, with bull markets defined as periods when gold prices rose for longer than two consecutive years, bear markets as the subsequent periods when they fell for a sustained length of time. Although these lengths vary, the cumulative loss in each bear market is relatively uniform, with median returns at negative 42.7 percent.

The present bear market, at negative 44.1 percent, falls easily within the realm of normalcy.

Further, the table suggests that a turnaround in gold prices is overdue.

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Gold price could end 2015 up on the year

Will Gold Finish 2015 with a Gain?

By Frank Holmes – CEO and Chief Investment Officer, U.S. Global Investors

Gold-Ready-For-His-Closeup

After its stellar performance last week, gold might do something it hasn’t done since 2012—that is, end the year in positive territory. You can see past returns for yourself in our perennially popular Periodic Table of Commodities Return.

Responding to a weaker U.S. dollar, continued contraction in global growth and wide speculation that interest rates will stay near-zero for the remainder of the year, the yellow metal broke above its 200-day moving average and is close to erasing its 2015 losses.

gold-breaks-above-its-200-day-moving-average
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This could be the price reversal many gold bulls have been expecting.

Back in August I shared with you that legendary hedge fund manager Stanley Druckenmiller, who’s made some mythic calls over his long career, invested $323 million of his own money in gold, now the largest position in his family funds. Although such a large weighting isn’t appropriate for all investors—I’ve always recommended 10 percent in gold: 5 percent in gold stocks, 5 percent in bullion—it looks as if Druckenmiller made another good call.

The big news last week was that Walmart took a massive hit after the retail giant said it expected a profit slump in 2016. Walmart investors lost a whopping $24 billion—$21 billion on Wednesday alone. While this news dominated the headlines, it’s important to recognize that the total amount of net assets in the SPDR Gold Trust, the world’s largest gold-backed ETF, is just slightly more than Walmart’s one-week loss.

in-one-week-walmart-shares-lose-nearly-as-much-as-GLD-total-net-assets

“Death” of the Dollar?

It’s no mere coincidence that gold’s breakout coincides with the weakening of the U.S. dollar last week. The greenback signaled what’s known as a “death cross,” just in time for Halloween. Widely recognized as the start of a bearish trend, a death cross occurs when the 50-day moving average crosses below the 200-day.

This hasn’t happened since September 2013.

US-dollar-experiences-a-death-cross
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As ominous as this sounds, it’s good news for gold and other metals and commodities, not to mention emerging markets and American exports. For the past year, the strong dollar has crushed these assets, something I write and speak about frequently. If the death cross does indeed indicate the start of a downward trend, gold might have the breathing room it needs to reach the important $1,200 resistance level.

Our China Region Fund (USCOX) and Emerging Europe Fund (EUROX) have responded well to the dollar’s drop, both of them crossing above their 50-day moving averages.

China-Region-Fund-USCOX-Crossed-above-50-Day-Moving-Average
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Emerging-Europe-Fund-EUROX-Crossed-above-50-Day-Moving-Average
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When we factor in the Love Trade, gold has even further upside potential. In India, the world’s largest consumer of the precious metal, the annual wedding and fall festival season has officially begun, which has historically triggered a spike in demand. This period is followed by Christmas and the Chinese New Year in February, when gold prices have surged, based on the shorter-term, five-year pattern.

Gold-seasonality
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Russian Air Strikes Ignite the Fear Trade

Gold has also likely benefited in the short term by the Fear Trade, specifically global geopolitical events such as Russia’s involvement in Syria. We should never welcome war, but the truth is that political turmoil very often has had a positive effect on commodity prices and currencies. Both the Russian ruble and Brent oil are currently above their 50-day moving averages.

the-russian-ruble-and-brent-oil-are-above-their-50-day-moving-averages
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In a recent piece titled “The New Cold War Battlefield… and How It Will Affect Oil Prices,” Dr. Kent Moors, global energy strategist for “Oil & Energy Investor,” writes that what happens in the Middle East has “always had a rather direct impact on energy prices and the prospects for investing in the sector.”

Syrian-president-Basher-al-Assad-shaking-hands-with-Russian-president-Vladimir-Putin

The difference today, Moors says, is that Syria “is a rising power vacuum right smack in the middle of the largest concentration of global crude production.”

This is a theme that’s explored in even further detail in my friend Marin Katusa’s bestselling book, “The Colder War: How the Global Energy Trade Slipped from America’s Gasp.”

Speaking of Marin, his Katusa Research and Cambridge House International will be co-producing the Silver Summit and Resource Expo in San Francisco November 23 and 24. I’ll be giving the opening keynote address. If you’d like to attend the conference as my guest, send me an email for a complimentary registration.

Real Interest Rates, Real Impact on Gold

The Fear Trade also includes monetary and fiscal policies such as money supply and real interest rates. As opposed to geopolitical events, which might have an immediate effect on gold, these drivers can have a long-term influence.

As a reminder, real interest rates are what you get when you deduct the rate of inflation from the 10-year Treasury yield. For example, if Treasury yields were at 2 percent and inflation was also at 2 percent, you wouldn’t really be earning anything. But if inflation was at 3 percent, you’d be experiencing a negative real rate.

When gold hit its all-time high of $1,900 per ounce in August 2011, real interest rates were sitting at -3 percent. In other words, if you bought the 10-year, you essentially lost 3 percent a year on your “safe” Treasury investment. Since gold doesn’t cost anything to hold, it became more attractive and the metal’s price soared.

Today, the U.S. has virtually no inflation, so real interest rates are at 2 percent, a swing of 500 basis points since August 2011. This has lately had a negative effect on gold, which means it’s even more remarkable that the precious metal has broken above its 200-day moving average.

Our office was visited last week by Barry Bannister, CFA, the chief equity strategist for investment firm Stifel, who gave us buckets of useful macroeconomic research, much of which validated what we’ve been saying for a long time regarding the relationship between the price of gold and real interest rates.

Barry made the case that real interest rates are even higher than we realize. He argued that the reason the Federal Reserve hasn’t allowed rates to lift off yet is because—you might want to sit down for this—it already has, in an “invisible” interest rate hike of 4 percent. Quantitative easing (QE), Barry said, was “negative” interest rates, and that “economic recovery and time ‘raised’ rates to 0 percent, a de factorate hike.”

Gold’s rally last week occurred in spite of this “invisible” rate hike.

Active Management on Top

Even with gold prices off around 38 percent since the August 2011 high, our Gold and Precious Metals Fund (USERX) has done well, outperforming the Market Vectors Gold Miners ETF (GDX) and PowerShares Global Gold & Precious Metals ETF (PSAU).

active-management-on-top-USERX-vs-gold-ETF-peers
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Speaking to Investor’s Business Daily, portfolio manager Ralph Aldis pointed out that one of the reasons why our fund has outperformed is because we’re able to apply our tacit knowledge of company executives and management teams, as well as anticipate and act on political risks in countries we invest in. This is a skill (and benefit) that only active management can provide.

Both the GDX and the PSAU are strictly market capitalization-weighted, so they might miss out on unexpected “success stories.”

“They end up owning the biggest companies, which because of their size have difficulty growing,” Ralph told IBD.

Klondex Mines is one such success story. It’s the fund’s top weighting, at 17 percent—and yet because of its market-cap, it isn’t included at all in the two ETFs.

As Ralph told The Gold Report last week, “I want to own companies where management can increase the value proposition,” regardless of gold prices.

Gold Holds Its Own While Media Darlings crash

By Frank Holmes
CEO and Chief Investment Officer
U.S. Global Investors

There’s no other way to put it: Commodities took it on the chin last month.

July was the seventh worst performing month for the S&P Goldman Sachs Commodities Index, going back to January 1970. Crude oil saw its steepest monthly loss since October 2008. Both copper and aluminum touched their lowest levels in six years. And on July 19, possibly as a result of deliberate price manipulation, gold experienced a mini flash crash, sending it down to five-year lows.

Have Commoditeis Hit a Bottom?
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Regardless, several commodities are beating the exchange-traded funds that track them for the one-year period, according to the Wall Street Journal. Our Gold and Precious Metals Fund (USERX) is over 1,900 basis points ahead of the Market Vectors Gold Miners ETF (GDX) year-to-date.

But that hasn’t stopped many gold bears from using this as an opportunity to disparage the yellow metal. A recent Bloomberg article points out that the gold rout has cost China and Russia $5.4 billion, an amount that would sound colossal were it not for the fact that U.S. media companies such as Disney and Viacom collectively lost over $60 billion for shareholders in as little as two days last week.

Below are the weekly losses for just a handful of those companies. Compared to many other asset classes, gold has held up well, even after factoring in its price decline.

Media Stocks Collapse, Gold Holds Its Own
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And isn’t it funny that the Federal Reserve doesn’t keep other countries’ currencies, but it continues to hold gold—and in larger amounts than any other central bank? China and Russia have two of the biggest gold reserves in the world—and have added to them recently—but they don’t come close to the Fed’s holdings, even when combined. What’s more, the U.S. Treasury’s Office of the Comptroller of the Currency just classified gold as money by placing gold futures in the foreign exchange derivatives classification.

Countries with largest gold holdings

Indeed, central banks all over the world continue to add to their gold reserves. If the metal were as valueless as a pet rock, as one Wall Street Journal op-ed recently claimed, why would they bother to do this? A few weeks ago, China disclosed the amount of gold its central bank holds for the first time in six years. Global markets reacted negatively that the country increased its reserves “only” 57 percent. But the World Gold Council (WGC) saw this as positive news:

We believe the People’s Bank of China’s confirmation of its revised gold holdings is supportive for the gold market. It reiterates how China, along with other central banks, views gold as a key resource asset as it continues to seek diversification away from the U.S. dollar.

As I’ve said before, China is the 800-pound commodities gorilla. This has largely been the case since 2000.

Half a Trillion Dollars a Year in Commodities

Between 2002 and 2012, China was growing fast at an average annual pace of around 10 percent. The country was responsible for nearly all of the net increase in global metals consumption between 2000 and 2014, according to the World Bank. Over the same time period, its share of metals consumption tripled, eventually reaching an astounding 47 percent.

China's Share of Metal Consumption Reached 47 Percent in 2014
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The year 2014 was a standout for Chinese commodity imports. Compelled by low prices, the country, which accounted for 12 percent of worldwide imports, brought in record volumes of crude oil, iron ore, copper and other raw materials.

Because China is a trading partner with practically every other country, and because it imports over $500 billion a year in commodities, its importance in global trade cannot be stressed enough. BBVA Research writes that “any reduction in its level of [purchasing] activity places significant downward pressure on the prices of [commodities], such as oil or copper.”

And yet we’re seeing that reduction now. For the past five months, China’s purchasing managers’ index (PMI) has remained below the neutral 50 mark, indicating that its manufacturing sector has been in contraction mode for the better part of this year so far.

China's Manufacturing PMI Falls to a Two-Year Low in July
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It’s important to keep in mind that China is still the number one importer of many key materials, including coal, iron ore and crude oil. The country’s import growth of these commodities continues to rise, but at a slower pace than in years past.

This isn’t necessarily the case with gold, however.

Demand Still Higher Than the Five-Year Average

According to the WGC, the decline in Chinese gold demand has been overstated.

Although China’s jewelry demand in the first quarter of 2015 was down from the record level the previous year, it was 27 percent higher than its five-year average. And consumer demand—jewelry plus bar and coins—in the first quarter was the fourth best on record, surpassed only by the surge in demand triggered by the price fall in 2013.

The WGC also points out that gold has a low correlation with and different demand drivers than commodities. Whereas commodities, as expressed by the Bloomberg Commodities Index, have returned to 2001 levels, gold is still up significantly for the period shown in the chart below.

Gold has Outperformed the Commodities Complex
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As many of you know, I call gold’s drivers the Fear Trade and the Love Trade. I recently had the pleasure to describe these drivers to Mike Gleason of Money Metals Exchange.

The Fear Trade, dominant in the psyche of North America, involves money supply growth and real interest rates. Whenever the U.S. has negative real interest rates, gold starts to rise in dollar terms, and whenever we have positive real rates of return, it starts to decline. If you go back to 2011, we had negative real interest rates off 3 percent on a 10-year government bond, and the average gold price that year was around $1,500 per ounce. But now that rates are positive 2 percent, the metal’s been depressed.

The Love Trade includes the purchase of the precious metal due to cultural affinity and rising GDP per capita in Asia and the Middle East. This includes gift giving of bullion and gold jewelry in anticipation of upcoming festivals such as Diwali, Christmas and the Chinese New Year. Historically, the Love Trade has begun to pick up around this time of the year.

Gold is a long-term investment with long-standing tradition. This remains true even now that prices have declined. As always, I recommend a 10 percent weighting: 5 percent in gold stocks, 5 percent in bullion or jewelry, then rebalance every year.

The Fed, the Fear Trade and Gold – Frank Holmes

Latest thoughts from Frank Holmes, CEO and chief investment officer of U.S. Global Investors – www.usfunds.com

Following the recent Federal Open Market Committee (FOMC) meeting, Federal Reserve Chair Janet Yellen made it clear (again) that interest rates would not be raised until inflation gains more steam. With current inflation rates negative for the first time since 2009, and with the U.S. dollar index at an 11-year high, we can probably expect near-record-low interest rates for some time longer.

With the Dollar index at an 11-yeah high, gold prices are under a lot of pressure

Image courtesy of http://www.welovecostarica.com/watching/ 

Along with major stock indices, gold prices immediately spiked at Yellen’s news, rising nearly 2 percent, from $1,151 to $1,172. That’s the largest one-day move we’ve seen from the yellow metal in at least two months.

It’s also a prime example of gold’s Fear Trade, which occurs when investors buy gold out of fear of war or concern over changes in government policy.

As I’ve frequently discussed, one of gold’s main drivers is the strength of the U.S. dollar. The two have an historical inverse relationship, as you can see below.

Strong Dollar Weighs on Gold

In September 2011, when gold hit its all-time high of $1,921, the dollar index was at a low, low 73. With the dollar having recently broken above 100, although since fallen back a little, the yellow metal sits under a lot of pressure. However, I’m pleased at how well it’s held up compared to the early 1980s, when gold plunged 65 percent from its peak of $850 per ounce as the U.S. currency began to strengthen.

We’re seeing the opposite effect in the eurozone as well as other regions around the world. In the last 11 months, the euro has slipped 24 percent. Many analysts, in fact, expect the euro to fall below the dollar for the first time.

When priced in this weakening currency, gold has climbed to a two-year high.

Gold Prices in Euro Terms Strengthens as the Currency Falls

Inflation consumes the returns on your five-year treasury bondAs I write in last year’s special gold report, “How Government Policies Affect Gold’s Fear Trade”:

One of the strongest drivers of the Fear Trade in gold is real interest rates. Whenever a country has negative-to-low real rates of return, which means the inflationary rate (CPI) is greater than the current interest rate, gold tends to rise in that country’s currency.

To illustrate this point, take a look at the current five-year Treasury yield and subtract from it the consumer price index (CPI), or the inflationary number. You get either a positive or negative real interest rate.

When that number is negative, gold has tended to be strong. And when it’s positive, gold has in the past been weak.

This month, real interest rates in the U.S. have turned massively positive, putting additional downward pressure on the yellow metal.

HOw real interest rates drive gold

When you look at the yield on a five-year Treasury bond in March 2013, you see that it was 0.88 percent. Take away 1.5 percent inflation, and investors were getting a negative real return of 0.6 percent. This made gold a much more attractive and competitive asset to invest in. March 2013, by the way, was the last time we saw gold above $1,600 per ounce.

Because inflation is in negative territory right now, returns on the five-year Treasury are higher than they’ve been in several quarters. Compared to many other government bonds worldwide, the U.S. five-year Treasury is actually one of the very few whose yields are positive, which tarnishes gold’s appeal somewhat as an investment.

The following oscillator for the five-year period gives you another way to look at the strong inverse relationship between the five-year Treasury bond and gold. As if locked in a synchronized dance, each asset class swings when the other one sways, and vice versa.

HOw real interest rates drive gold

This is why it’s so important to manage expectations.

As Ralph Aldis, portfolio manager of our two precious metals funds, said in our most recent Shareholder Report:

You need to use gold for what it’s best at: portfolio diversification… You have to be a bit of contrarian. Buy it when everybody hates it, sell it when everybody loves it. Our suggestion is to have 5 to 10 percent of your portfolio in gold or gold stocks and rebalance once a year. You might also get some additional benefits by rebalancing quarterly. That’s like playing chess with the market as opposed to rolling craps.