InnOvation Capital & Management, LLC
IntelDigest
LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR
SEPTEMBER 20 , 2017
Contact Richard Power with comments or questions. IntelDigest is intended for the use of our clients and colleagues. Material may not be reproduced, forwarded or shared without express permission.
Last week, we discussed the current trends in the Gold market. In this issue of IntelDigest, we’ll talk about longer-term issues in Gold investing.
Political Considerations
As we stated in the February 22 issue of IntelDigest:
Inflation in the economy and a weakening of the U.S. Dollar are primary stimulants of the price of Gold. There is a looming battle between the Trump Administration and The Federal Reserve over Inflation …
The Fed wants to keep Inflation in check; typically, The Fed will opt to raise interest rates fast enough to moderate Inflation, which adds strength to the U.S. Dollar. The Trump Administration, on the other hand, wants a weaker dollar to help U.S. exports and create U.S. export-related jobs. Donald Trump has railed against several of our trading partners … China, Germany, Japan … assailing them for using cheap currencies to hurt U.S. workers. He is determined to fight back with a weaker U.S. Dollar.
A weaker Dollar will translate to Higher Gold Prices. Gold is both a Hard Asset and a form of money, like the Dollar, Yen, Euro, Chinese Yuan. When the Dollar is weak, the price of Gold (as measured in Dollars) rises.
How will Trump “trump” The Federal Reserve? He will be in a position this year to appoint up to four of the seven members of the Federal Reserve Open Market Committee. It is a sure bet that the “reconstituted” Open Market Committee will side with the President.
The resulting weakening of the Dollar will be good for Gold investments.
Fundamentals
We have addressed the fundamentals of Gold investment in prior issues. The basic arguments are:
1. Ultra-low … even negative … interest rates around the world, and enormous amounts of public and private Debt, all propel investments in Gold.
2. Gold is a traditional safe haven in times of insecurity; it can provide insurance against cyber and political risks.
3. Demand for Gold is growing in the marketplace, from Russia and China to western markets, while supply has been dormant because new mining projects were delayed or closed down over the last few years, when the gold price was receding from its 2011 highs.
4. Only a strong U.S. Dollar has kept the value of Gold and Silver from rocketing higher in the last two years.
5. Historically, Gold has done well when “real” interest rates have fallen. “Real” interest rates refers to the return one can receive when inflation is factored in. For example, in the 1970s and 2000s, inflation was high, essentially wiping out any return from normal interest rates on fixed income investments, as well as yields on equities. Gold performed very well then, because the return from normal investments dropped to zero or went negative.
There are also a number of International Factors which affect the Gold market.
The “Gold Season”
We are now at the time of year which leads to important holidays in several cultures, characterized by giving gifts of jewelry, most made of Gold and Silver.
Two countries which generate 50% of global Gold demand … India and China … celebrate major holidays in the fall and winter. In October and November, India celebrates Diwali, the Festival of Lights, followed by India’s wedding season, when it is auspicious to give Gold to the bride.
Then comes Christmas in the West, followed by the Chinese New Year and Valentine’s Day.
Seasonal jewelry demand makes August to February the best time of the year for Gold and Silver.
Shanghai Gold Exchange
China is the top consumer, importer, and producer of Gold in the world. China probably has the largest Gold reserves of any country, as it has acquired massive amounts of Gold in the last decade, much of it secretly. But, government actions are opaque, so outsiders can only make estimates of the reserves.
China is set on dominating the Gold market. It established the Shanghai Gold Exchange in 2002, and would now like to make it the center of Gold trading and pricing for the world. China has proposed that the Shanghai market would set the price on the basis of ACTUAL PHYSICAL GOLD, not on paper futures contracts.
Increased activity in the Shanghai Gold Exchange would be a significant factor in propelling growth in the Gold market.
Islamic Law Changes
Another development is a change in Islamic law which would allow massive investments in Gold by Muslims around the world, who number 1.6 Billion.
Some interpretations of Islamic law prevent Muslims from investing in trades considered “immoral,” such as alcohol and tobacco; this ban has included investment in Gold bullion as a tradeable commodity for the last few decades. As a result, approximately 23% of the population of the world has stayed out of the Gold market.
Now, however, the Accounting and Auditing Organization for Islamic Financial Institutions is working with the World Gold Council to set a standard allowing Gold trading by Muslims. If the pent-up demand by this group of investors is unleashed, Trillions of Dollars could soon pile into the Gold market.
Peak Gold
Peak Gold is the theory that the production of new Gold is shrinking around the world. Declines in new Gold discoveries have coincided with a surge in the costs of mining exploration. This has resulted in a reduction in mining operations and a steady decrease in Gold production.
Goldman Sachs has warned that there are “only 20 years of known mineable gold reserves.” Blackrock, the largest asset manager in the world, has also warned about “Peak Gold,” and asserts that Gold production is likely to decline by 20% per year for the foreseeable future.
There is no way to predict if Peak Gold is a concept which will last for years, or if new technologies or discoveries will change the dynamic. But, for now, the production of Gold is decreasing at the same time that Gold demand is expected to soar.
Global Insecurity
As we stated in the July 26, 2016 issue of IntelDigest:
Gold is a traditional safe haven in times of insecurity; it can provide insurance against cyber and political risks. And, there are good, old-fashioned fundamentals at work …. demand for gold is growing in the marketplace, from Russia and China to western markets, while supply has been dormant because new mining projects were delayed or closed down over the last few years, when the gold price was receding from its 2011 highs.
Deflation
Despite deflationary forces in the world economy over the last eight years … which would adversely affect the price of Gold … we have always been confident that governments will succeed in forcing Inflation, primarily because they have no choice. Deflation makes the real value of debt go up. Deflation destroys tax collections … when prices and wages go down in deflation, governments collect less tax. If the value of debt goes up and tax collections go down, then economies collapse.
Governments can’t allow that. So, they will do whatever they can to produce inflation. Some economists posit a theory that governments will be forced to go to an extreme to produce inflation, and do so by setting the price of gold at $5,000 per ounce, or even higher. The Gold market has been manipulated for several years to keep the price of Gold down; it would be easy to change direction and manipulate the price up.
Effects of Interest Rates
Traditionally, gold prices have tended to go down when interest rates go up, mainly due to carrying costs. Gold pays no interest, so it has a negative carry. Compared to bonds, money market funds, and dividend-paying stocks … which have traditionally paid out a return of 4-5% or more … Gold was at a disadvantage.
However, we are in an environment where bond and money market yields are close to Zero. Many government bonds around the world now trade at Negative interest rates; taking inflation into account, Cash has a negative interest rate as well.
For the first time in history, Gold has a positive carry compared to cash and government bonds. Central banks, investment banks, and large money managers have bought significant amounts of Gold over the last few years, pushing up the prices of Gold, gold funds, and mining companies.
Even if The Fed raises short-term rates, we expect that Gold will rise even faster! Any hike of U.S. interest rates will attract hundreds of billions of Dollars from foreign investors seeking yield; this money will likely flood into U.S. bonds.
As the U.S. bonds are bid up, their yields will come right back down again. And, as these yields go lower, the positive carry of Gold will become more pronounced, likely leading to a rally in Gold.
Gold Market Manipulation
Other than the strong US Dollar of recent years, the price of Gold has been held back by suspected market manipulation. Investors have been frustrated as Gold fundamentals continue to improve, but the market price of Gold is repeatedly knocked back by manipulation in the paper Gold market, specifically Comex gold futures contracts.
The Comex Gold and Silver markets have been described as “absurdly leveraged paper-trading cesspools, where deep-pocketed players … routinely drive prices down for profit.”
Whenever Gold displays some upward price momentum, hedge funds with short positions can sell tons of “Gold” (really, just paper contracts) in the futures market. This forces many Gold traders to sell their leveraged long positions. Momentum trades follow on the automated Globex trading system.
The short traders can then close out their positions with a nice profit, while holders of physical Gold are left to shake their heads. Many suspect that the short traders often work at the behest of a government or international financial organization to hold down the price of Gold. The bottom line is that the price of Gold is repeatedly held back.
This manipulation of the futures market has motivated million of investors to take refuge in various forms of physical Gold, and the opening of numerous physical gold exchanges and physical gold vaults.