Contributing editor Gavin Graham is back this week with a look at what's happening to the gold market. Gavin has had a long and successful career in money management and is a specialist in international securities. He has held senior positions in financial organizations in London, Hong Kong, and Toronto. He currently is chief strategy officer at Integris Pension Management, a provider of personal pension plans for incorporated individuals. He divides his time between Toronto and the U.K. Here is his report.
Gavin Graham writes:
The price of gold peaked at $1,850 per ounce (U.S. dollars) in September 2011. At that point, it entered a bear market that lasted three years and saw its price fall 40% to $1,100 an ounce last November. After a sharp rally through year-end 2014 that saw the price gain almost 15% to touch $1,250 at the end of January, it subsequently slipped again to revisit its November lows, hitting $1,150 an ounce at time of writing (March 11). Over one year gold is down 13.7%, and almost 40% over three years. However, gold was little changed over the course of 2014, after a 28% decline in 2013. Year-to-date it is only off 1.9%, only 4% behind the S&P/TSX Composite's performance for the year.
The reasons for gold's lacklustre performance have been discussed extensively, including in the pages of IWB. As the bull market in stocks has continued, now in its seventh year, the fear factor that kept many western investors holding some gold as a form of disaster insurance diminished. Last year, it is estimated that almost $7 billion was withdrawn from gold-based exchange traded funds (ETFs), such as the SPDR Gold ETF (GLD, Financial), the largest and best known of such vehicles, which now has $28 billion in assets.
As a non-income producing asset, gold has always been at a disadvantage against other perceived "safe haven" investments, such as U.S. Treasury and Government of Canada bonds. However, with bond yields in these countries below 2% before tax, the loss of income argument has become much less important in recent years. In fact, in a number of European countries, such as Switzerland, Denmark, Germany, and the Netherlands, the desire to buy "safe" investments has become so great that government bonds and short-term cash now have negative yields out to five years. In other words, you have to pay the government or the bank for the privilege of having them hold your money!
Finally, the desire to buy physical gold in many Asian countries has not diminished. In fact, China has looked at setting up an international gold exchange in Shanghai to complement the domestic Shanghai Gold Exchange (SGE), which traded approximately 17,000 tonnes in 2014, up from 11,600 in the previous year. While the daily total of 656,000 oz. traded on the SGE in October 2014 was a small fraction of the 17.4 million oz. traded in London, China passed India as the world's largest gold consumer in 2013, and it is estimated that a large percentage of the gold redeemed from ETFs found its way to Asia.
This was despite the Chinese government's clampdown on excessive consumption, which saw gold demand slump 37% to 182.7 tonnes in the quarter ended September 2014, according to the World Gold Council.
India's gold consumption, which accounted for 25% of world demand, had been badly hit by the imposition of higher gold import duties by the previous Congress government in late 2012, which were increased three times to reach 10% in 2013. This caused gold imports to plummet from $6 billion a quarter at the end of 2012 to less than $1 billion in the same period a year later. Not coincidentally, this was the year the price of gold fell by 28%.
A lot has changed since the election of Narendra Modi and the BJP government in May last year. In November the requirement that 20% of gold imported had to be re-exported as jewelry, which had merely led to an increase in smuggling, was removed. As a result, imports have rebounded to over $4 billion a quarter. The halving of the oil price has eased worries that the Modi government might impose further controls due to the negative effect on India's current account deficit. That enormously benefited India, which is a major importer.
With import restrictions eased in India, and the Chinese government aiming to stimulate its economy, which is forecast to grow only 7% this year, the lowest for over a decade, it seems likely that demand for gold from the Asian consumer will continue to rebound from the slowdown seen over the last two years.
The more interesting question for investors in Europe and North America is whether the gold miners have already seen their lows and are now poised to benefit from a stable gold price. This is because gold mining stocks have done much worse than the metal itself as, unlike physical gold, there are no Indian and Chinese buyers. Likewise, central banks, which bought an estimated 500 tonnes of gold last year, with Russia alone buying over 100 tonnes, do not buy mining shares, only physical gold.
Thus, while GLD is down by 12.6% per year since the bear market began three years ago, the Market Vectors Gold Mining ETF (NYSE: GDX) is off 30.9% annually. The Canadian iShares Global Gold Mining ETF (TSX: XGD) has performed a little better due to the weak Canadian dollar, off 25.1% per year.
Individual gold miners have also fallen by similar percentages, with Detour (TSX: DGC), Barrick (TSX, NYSE: ABX), Kinross (TSX: K) (NYSE: KGC), and Yamana (TSX: YRI, NYSE: AUY) off between 30% and 37% per year. Some of this underperformance reflects expensive acquisitions at the top of the market, but mining stocks are essentially leveraged plays on the commodity they produce. It costs the same to mine one ounce of gold whether the price is $1,850 an ounce or $1,150, but the profit made is obviously much smaller when the price is down. Thus miners tend to outperform on the upside and fall further when there's a bullion bear market.
Some of the concerns that investors had over gold miners are fading as the fall in the price of oil helps their costs (diesel for generators for milling and running dump trucks is a major expense). Also companies have cut back head count, reduced drilling programs, and avoided making dilutive acquisitions.
While it's probably little consolation, my recommendations to IWB readers have done better than the average mining stock, with Goldcorp (TSX: G) (NYSE: GG), now the largest gold miner by market capitalization, down 21.2% per annum over the last three years. Agnico-Eagle (TSX, NYSE: AEM) is down only 1.6% per annum while gold royalty company Franco-Nevada (TSX, NYSE: FNV) is actually up 10.7% per year.
All of these companies pay dividends, with yields of 1.2% for Agnico-Eagle, 1.7% for Franco-Nevada, and 3.3% for Goldcorp. Following are operational updates for each as well as for base metal and coal royalty play Anglo Pacific (TSX: APY).
