2013 was an “annus horribilis” for gold. Here’s a look at the main factors behind the precious metal’s demise and whether next year offers any hope of a recovery.
This article was originally published on Gold Investing News on December 19, 2013.
2013 will go down as the annus horribilis for gold, to quote a famous monarch who coined the term as a pithy description for a series of misadventures that befell the British royal family in 1992.
Similarly, gold, as an investment class, was hit by a number of factors this year that saw the precious metal tumble from its perch as a safe, reliable asset that for the past several years has been an attractive alternative to depreciating fiat currencies, a hedge against inflation, and a store of wealth — the latter a sort of insurance policy taken out against future economic calamity.
At the time of this writing, gold had suffered another significant drop in a year that has seen it plummet more than 25 percent in value; or 37 percent lower than gold’s record high of $1,923.70 an ounce reached in September 2011.
On the day after the U.S. Federal Reserve’s announcement that it will scale back quantitative easing, or QE, by $10 billion a month starting in January, gold slipped below the $1,200 an ounce mark for the first time in 6 months, with the spot price trading around $1,196 in New York.
The Fed for months has been musing about when to scale back its quantitative easing program, the $85 billion a month stimulus package that since 2008 has pumped some $4 trillion into the U.S. economy in order to keep interest rates low and prevent the country from falling back into recession. But an improved economic picture in the United States, particularly on the jobs front, has lessened the need for stimulus and increased pressure on the central bank to taper its monthly bond purchases, which due to the program’s inflationary nature, has been exceedingly bullish for gold. Since the program started in 2008, the bullion price has more than doubled, and only in the past 12 months has it significantly slipped.
Indeed, there will be no Santa Claus rally for gold this year, and the metal’s 12-year bull run has almost certainly come to an end. Or has it? In this 2014 outlook, Gold Investing News takes a look at the main factors that led to gold’s demise in 2013 and then offers up some predictions, with some help from the experts, on what 2014 has in store for the precious metal.
Major trends in 2013
There wasn’t one thing that popped gold’s balloon this year. A number of factors conspired to pull the metal down. Here are eight to consider and reflect upon as we close out the year:
1. U.S. Federal Reserve: To taper or not to taper?
Hastened by the financial crisis of 2007-08, the U.S. Federal Reserve has pursued a loose monetary policy designed to keep interest rates low, the theory being that as long as inflation is kept at a manageable level, rock-bottom interest rates would inspire companies and individual to borrow money, thus stimulating the economy and cause it to grow again. Staged over three programs, Q1, Q2 and Q3 all benefitted gold and gold equities. But in May of this year, the U.S. Federal Reserve began hinting that the stimulus might no longer be necessary due to an improving economy. According to Bloomberg, economic factors that played into the Fed’s decision on December 18 to cut $10 billion a month out of the stimulus program included: a jobless rate that fell to 7 percent in November to a five-year low; retail sales climbing the most in five months in November; a boost in industrial production; and a 13.3 percent jump in housing prices, combined with a five-year high in home construction.
2. Improved U.S. economy: Jobs, jobs, jobs
Economics 101 teaches that the unemployed are a drain on the economy. People out of work do not pay payroll taxes, and are in no position to make large discretionary purchases that are a key factor in driving economic growth. According to the latest numbers from the US Bureau of Labor Statistics, in November the unemployment rate declined from 7.3 to 7 percent in November, with total nonfarm payroll employment rising by 203,000. Jobs were created in transportation and warehousing, health care and manufacturing, according to the U.S. Labor Department.
All is not sweetness and light on the economic front, however. Ben Bernanke, the out-going U.S. Federal Reserve chair, has admitted that economic growth has lagged previous recoveries — with the economy expanding at just 2.3 percent a quarter for the past 17 quarters, compared to a 3.2 percent average rise after the last two recessions. If growth doesn’t improve with the further removal of stimulus in 2014, will the Fed rethink its decision to withdraw bond purchases?
3. U.S. equities: The stock markets are on fire
Part of the reason for gold’s decline in 2013 had to do with the alternatives for investors. When interest rates are low, fixed income instruments like bonds net a low return, yet equity markets may offer too much risk for conservative investors. But in 2013, the stock markets in the United States caught fire, and everyone seemed to be jumping into equities. That, to a significant extent, came at the expense of gold, which offers no dividend payments and can be illiquid if bought in physical form versus on paper as an exchange-traded fund (ETF). For months the stock markets have been jittery over a withdrawal of stimulus due to the likely knock-on effect of a rise in interest rates, but actually the opposite occurred on December 18. With the Fed promising to hold interest rates near zero, both the S&P 500 and the Dow Jones Industrial Average rallied to new highs that day. The S&P has surged 27 percent this year and is on track for its biggest gain since 1997, while three rounds of QE have driven stocks up 168 percent from a 12-year low in 2009, according to Bloomberg.
4. The Cyprus gold bailout
Casting our minds back to the antecedents of the gold price fall in April, gold investors will recall the hand wringing that occurred over Cyprus, the small Mediterranean island that holds significant stores of gold. At the beginning of that month, Cyprus shocked the world, and the gold market, by announcing it would sell its gold to finance a 400-million-euro bailout, and wind down underperforming banks — even signalling the government would go after the deposits of ordinary citizens. The impact on gold was drastic, with the precious metal falling below $1,500 for the first time in more than 18 months, as investors fretted over the prospect of other heavily indebted European nations doing the same.
5. Manipulation: The great short
The Cyprus moment, though, was just a taste of what would turn out to be the crucial turning point for gold this year. On April 15, in what is now being recalled as a very black day for the yellow metal, gold futures fell $140, a drop of 9.4 percent, to a two-year low of $1,360.60 — the biggest one-day drop in 30 years. While analysts initially attributed the fall to events in Cyprus, along with growing signs of a U.S. economic recovery, a more sinister reason began to reveal itself, as it became clear that leading bullion bank Goldman Sachs (NYSE:GS) had earlier slashed its outlook for gold and suggested that investors short the precious metal. Around the same time that Sachs gave its sell recommendation, JP Morgan & Chase was reportedly selling gold bullion on the paper (ETF) market. According to Yahoo Small Business Advisor, from January to April, JP Morgan had a net short position of 14,749 100-ounce gold contracts on the COMEX, equating to 1.47 million ounces of gold. “I’ll be the first to admit it: the gold bullion price takedown that started in April sure looks and smells fishy,” wrote Yahoo columnist Michael Lombardi.
6. ETF outflows: That giant sucking sound
One of the first victims of the April gold crash were gold exchange-traded funds. Four days after the meltdown, more than a billion dollars flowed out of the world’s largest gold ETF, the SPDR Gold Trust (NYSE:GLD), the third-largest withdrawal on record, reported The Wall Street Journal. Investors continued to dump gold ETFs in the second and third quarters, with gold demand falling 21 percent in Q3 driven primarily by continued outflows from ETFs according to The World Gold Council. The news for gold ETFs got even worse in December, when Barclays Capital released data showing the value of precious metals assets under management fell by $78 billion compared to last year; worst hit was GLD, whose holdings dropped 26 tonnes this month, to their lowest levels since January 2009, reported MINING.com.
7. Gold flows West to East
But while the reduction in gold ETF holdings is certainly bad news for gold demand, and has been a key factor in holding down the price, there is one positive related trend, and that is the flow of gold “from West to East,” as consumers in Asia — particularly China and India — continue to buy the metal in the form of jewelry, gold coins and bars. In its latest Gold Demand Trends report, the World Gold Council’s managing director, Marcus Grubb, noted that “Consistent with the first two quarters of 2013, the global gold market remains resilient, underpinned by the continued shift in demand from West to East, strong demand in consumer categories and solid central bank and technology sectors”. As an example, global consumer demand for gold in Q3 was 26 percent higher than the same period in 2012.
8. Indian import restrictions: The price of success
The gold price would likely have performed better this year if it wasn’t for the actions of the Indian government. As Western investors sold their gold ETFs and moved into equities and other asset classes, Indian citizens began lining up to buy cheap gold. The Economic Times reported that Indian citizens bought over 15 tonnes in just three days. The rise in gold imports to meet the demand affected India’s current account deficit, and on May 3, the Reserve Bank of India imposed restrictions on imported gold. Two months later, the RBI introduced an 80:20 scheme, whereby 20 percent of imported bullion had to be exported back. Gold trading was also banned in special economic zones. The measures resulted in total gold consumption in India dropping by 50 percent, from 310 tonnes in the second quarter to 148t in Q3, according to the World Gold Council.
Where do we go from here?
Will gold’s annus horribilis turn into an annus mirabilis (wonderful year?) in 2014? The indications aren’t promising, considering the number of negative factors pushing against it, as outlined above.
For instance, while the U.S. government recently passed the Volcker rule designed to curb banks’ participation in high-risk strategies such as investing in hedge funds and trading gold and silver, the banks are already “seeking exemptions, loopholes and new ways to interpret the rule” instead of figuring out how to comply with it, according to a recent Forbes articles quoted by Silver Investing News. That means gold investors will likely continue to see gold and silver prices manipulated next year as they rise and fall with each mention of another pullback, or continuation, of QE.
On a more positive note, the Economic Times reported that gold buyers in India may soon have reason to cheer, considering that the government may ease import restrictions “following a dramatic improvement in the [current account deficit] and an unintended consequence of the curbs — a rise in smuggling”. A reduction in gold import duties from the current 10 percent could spur increased physical gold demand in India next year which could bid up the price.
An interesting trend that hasn’t been covered in the mainstream financial press is one identified by Jeff Clark, senior precious metals analyst at Casey Research. While the World Gold Council noted that total gold supply — mined and recycled — fell three percent in the third quarter compared with the same period a year ago, Clark is predicting a more serious supply crunch in 2014. That would bode well for the gold price, even if demand factors continue to flounder. According to Clark, the four factors that could chip away at the gold supply are: lower production, delayed mine development, and cuts to exploration budgets; “high-grading” deposits; governments putting a stop to big mining projects; and the implosion in South Africa’s gold mining industry. As the old adage goes, “the cure for low prices is low prices”, and if all or even some of Clark’s four factors come into play next year, the gold price could see an upward move.
Let’s take a look at what some of the experts are saying could happen to gold in 2014.
The day after the Fed’s decision to curb QE, the Financial Post quoted Canaccord Genuity’s Martin Roberge as pointing to the fact that this year is the first year since 1997 that gold will finish with a double-digit drop. Roberge noted that in other years where gold fell at least 10 percent, gold was flat the following year. “Very importantly, negative momentum should carry through the first half,” Roberge said in a note mentioned by FP.
UBS Investment Research
UBS Investment Resarch said earlier this month that with few positive catalysts moving forward, “gold is unlikely to regain its former appeal”. Accordingly, the firm cut its 2014 average gold price from $1,325 an ounce to $1,200. “As 2013 comes to a close, the New Year will likely tempt investors to further move out of safe havens — and especially out of gold — into other assets. Gold has become old news, and investors are likely to be eagerly searching for new places to put their cash to work,” said the UBS analysts.
Bank of America
The Bank of America was a little kinder to gold, predicting on December 15 that gold in 2014 will average $1,294 an ounce, rising from $1,250 in the first quarter to $1,350 in the fourth. The bank, however, warned that further slides could occur if the U.S. central bank tightens monetary policy by raising interest rates — a factor that could push gold down to $1,100.
Morgan Stanley in October predicted that gold will extend losses in 2014 amid expectations of a further paring of U.S. stimulus — a prediction that proved prescient considering the $10 billion cut to QE announced on December 18. The investment bank said bullion will average $1,313 an ounce next year, compared to its 2013 forecast of $1,420, Morgan said in its quarterly metals report quoted by Bloomberg.
Following bearish gold calls in October, Goldman Sachs said today, December 19, that gold’s declines aren’t over. “Gold is now likely to grind lower throughout 2014,” Jeffrey Currie, Goldman’s head of commodities research in New York, told Bloomberg. “Much of the expected price decline has been priced in as opposed to a more gentle process as the Fed backs away from QE. When the gold market sees these events, it usually tries to price it in immediately.”
The most bearish of the bunch, the investment bank said on November 20 that gold will drop to $1,050 by the end of next year.
Ending on a more upbeat note, Australian Mining wrote in a December article that even though gold company revenues are predicted to shrink next year by 10.2 percent, due to the combination of a lower gold price and higher production costs, the future for gold in the short term is positive.
The publication quoted Owen Hegarty, a former Rio Tinto (NYSE:RIO,ASX:RIO,LSE:RIO) executive, as saying that Chinese demand for gold is “unstoppable” and that “Australia will be playing catch up to deal with a supply problem for years to come, as big miners continue to shelve projects.”
“Supply is going to continue to be the issue, we are going to be playing catch up football on the supply side,” Hegarty told the recent Gold Symposium forum in Sydney.
Securities Disclosure: I, Andrew Topf, hold no investment interest in any of the companies mentioned.
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