Sunday, April 26, 2020

Gold Investment— All Things Considered

Video 1.  Crescat Macro Outlook (YouTube link)


At an Hedgeye interview, Jurrien Timmer—Director of Global Macro at Fidelity Investments—stated that:
Gold has become a bond proxy. We've all seen the chart of the negative yielding debt overlaid against the price of gold. They're perfectly correlated. Gold is a play on real rates, probably more than anything else. If you look at the TIPs yield it’s a very strong inverse correlation over the last 10 years or so.
I'm convinced that over the next 10 years as this demographic tsunami sweeps around the most of the world I think yields will stay low. When you combine demographics with debt, that’s the two headed monster.
We're at $15 trillion in negative yielding debt. Warren Buffett always liked to dis gold because it doesn’t have a yield. In a negative yielding world, a zero yield is a high yielding asset all of a sudden. So yes, I like gold from that perspective.

10 Influencers


As a matter of fact, the driving forces of gold price are complicated and intertwined. For example, here are at least 10 "C's" influencing the price of gold:
  • Commodity price levels
  • Consumption patterns
  • Currency changes and trends
  • Continental changes in economic growth patterns
  • Current account trade deficits
  • Central Bank holding and hedging loans
  • Conflict and crises (economic and political)
  • Consumer inflation
  • Contrarian nature of gold
  • Constraints on owning and trading gold

3 Major Drivers


To simplify the discussion, we'll focus on three major drivers of gold price as Seeking Alpha author Arkadiusz SieroĊ„ suggested:[1]
  1. Real interest rates
  2. U.S. dollar
  3. Risk aversion

Real Interest Rates


The real rate is the return after inflation—generally regarded as the 10-year Treasury minus the CPI. Why do the real interest rates matter for gold?  Here are the reasons:[1]
  • Holding cost
    • Includes storage and insurance of gold
  • Opportunity cost
    • Instead of holding gold, investors could be lending it (or the cash spent) out. The higher the real interest rates, the larger are the opportunity costs of investing in gold.
    • And the lower real interest rates, the smaller are the opportunity costs, so people are more eager to hold more gold. 
In particular, the negative real interest rates are gold's real friends (the 1970s or the post-Lehman era are the best examples).

Video 2.  The Global Solvency Crisis | The Big Conversation | Refinitiv (YouTube link)

US Dollars


Most commodities including gold are quoted in U.S. dollar.  Some currencies (e.g., Swiss franc and South African rand) are also gold associated.  According to the statistics, gold price behaves like:
  • Negative Relationship Between Gold and the U.S. Dollar[9]
    • The long-term correlation (since 1973) between the U.S. dollar index and the gold prices is -0.6. So the link is strong, but a bit weaker than in the case of the real interest rates.
  • Gold behaves more like a currency, not a commodity
    • When investors sell the greenback, it depreciates against other currencies, such as the Japanese yen, the euro, and gold. This is why we often see a positive correlation between the euro or the yen's strength and the price of gold.
    • Although the gold standard was finally abandoned in 1971, the historical association of gold as the ultimate money is still deeply rooted in the minds of investors. 
      • But there is something more. Gold is not merely one of many currencies: it is a bet against the U.S. dollar. 
Volatility of Currency and Commodities 

Commodity prices are multidimensional. The dollar, weather, political events, and overall economic conditions contribute to their price paths.

A small move in the dollar magnifies moves in commodity markets given the historical inverse relationship between the asset classes.

Currencies are less volatile than other assets.  For example, the daily historical volatility or variance:
  • Dollar index: 7.5%
  • Gold: 13.72%
    • Both a currency and a commodity
  • Silver: 17.06%
  • NYMEX crude oil 30.52%
  • Natural gas: 45.28%
  • Sugar: 43.48%
  

Risk Aversion


The function of a hedge against the current financial and monetary system is related to gold being a safe-haven asset, i.e., an asset that is uncorrelated or even negatively correlated with another asset or portfolio in times of market stress. This feature explains why gold is used as insurance against tail risks, or as portfolio diversifier. 

Hence, when uncertainty increases, investors become more risk averse and demand higher risk premium (as it is seen in widening credit spreads). And they shift some funds into safe-haven investments, such as gold. Similarly, when economic confidence increases, gold struggles.

Seasonality


Gold performance "normally" follow the seasonality, for example:
  • Gold performs much better in the second half of the year than the first.
  • March is historically a weak month for gold
  • Summer Doldrums
    • Gold and silver tend to perform well through May and then pull back during the summer. 
      • This is the title given to the traditionally quiet period in the gold market from May until the end of August in the gold market.
      • It came about because this is the time period in the year when Indian gold imports virtually cease.
  • Indian Wedding
    • Early part of the year 
  • Jewelry Trade
    • From the summer lows until the mid-late autumn highs.

Note that junior gold and silver shares are different:
  • Tend to mirror gold’s price movement early in the year and into the summer. However, they normally languish during the summer months and may not perform well even if gold moves higher at times.
  • When gold consolidates in price, the juniors tend to drift lower.

Figure 1.  GDX:SPX Ratio (Courtesy of stockcharts.com)

When to Trade?


You may decide when to trade based on some useful indicators:
  • GDX:GOLD ratio
    • When GDX is going up faster then gold then this ratio will be rising and is a bullish sign for both Gold stocks and gold and vice versa.
  • GDX:SPY Ratio
    • The GDX:SPY ratio measures precious metal stocks out-performance vs. the general stock market. 
    • Looking at gold’s price relative to stocks might be more appropriate for long-term tendencies than a look at the gold price itself, simply because the major shift in investor’s sentiment happens when investors prefer gold to the most popular investment class – stocks.
    • It is a useful tool for estimating when a top or bottom is in for PM stocks as this ratio usually tops out along with PMs and PM stocks.
  • $GOLD:UDN Ratio
    • Gives the non-USD point of view
    • RSI based on the $GOLD:UDN ratio works not only as a bottom indicator for the ratio, but also for gold itself.
  • $BPGDM (Bullish Percent index for the Gold Miners index)
    • If $BPGDM cross its 7 day moving average bearishly and it appears to be turning down, it gives a bearish short term signal and will imply a pull back in this index.
  • $PLAT:$GOLD Ratio
    • Gold is treated as a safe haven with very little use in industry. 
    • Generally, when platinum is at a discount to gold, it points to concerns about the economic outlook, given that 60% of demand for platinum comes from the automotive industry. But when platinum moves above gold, it tends to indicate that investors expect the economy to pick up.
    • Platinum extraction is more difficult and therefore more expensive to produce than gold.
    • Compared to gold, platinum is a much more volatile metal.
  • Oil Price ($GOLD:$WTIC Ratio)
    • Companies that do very well when oil prices go down — airlines and gold miners
    • Oil comprises 25% of the cost of mining and industrial metals prices can be a proxy for industrial costs.
  • $GOLD:$CDW Ratio
    • Gold in CAD$
    • Most gold companies are Canadian. Their costs are in Canadian Dollars. So the Canadian Gold price is more relevant to them.
  • $GOLD:GYX Ratio
    • Gold/Industrial Metals
  • $HUI:$GOLD Ratio
    • As Gold continues to outperform Oil and Industrial Metals, the future margins for gold producers will expand and thus, so to will the HUI/Gold ratio. 
  • $GOLD:$SILVER Ratio
    • A hike in the gold/silver ratio would indicate the metals' fear premium is strengthening—a likely consequence of continuing dismay over economic prospects. 
    • Down ticks in the ratio would indicate more enthusiasm for silver and its industrial applications in an improving economy.
    • If you own stocks and commodities, you would prefer to see silver win the battle relative to gold. Strength in silver relative to gold tends to occur during economic expansions and periods when the ‘risk on trade’ is in favor.
    • Bob Hoye notes that whenever the RSI of the silver-gold ratio approaches the 90 level, one must begin to exercise caution and watch for a potential reversal in the ratio

Gold-Investment Related Topics

  • When to sell Gold
    •  I would be looking for one of three things:
      • I would expect to see a blow-off peak-- an irrational buying frenzy – where valuations get to ridiculous levels. 
      • Government is displaying some fiscal sanity. 
      • If they made the dollar convertible into gold, I would no longer need to own physical gold.
  • GOFO (Gold Forward Offered) 
    • GOFO rate has recently gone negative, as it was at the June low in the price of gold. It has only been negative 5 times in the past 15 years, and is generally linked to strain on the physical gold supply.
  • Deflation vs Inflation
    • Gold is a real-time monetary indicator and the peak in March 2008 correctly warned that deflation risks were escalating. Gold’s recovery in early 2009 (ahead of the bottom in equities) then accurately indicated that reflationary policies were finally gaining traction.
  • Kondratieff Season (Ian Gordon )
    • Simply, that during each Kondratieff season there is an investment  medium that performs very well. 
      • For example, in the spring 1949-1966 stocks and real estate performed well because the economy did well. In summer 1966-1982 inflation investments, such as art, commodities, gold and silver did very well, because it was the season of inflation. In autumn 1982- 2000 stocks, bonds and real estate did exceptionally well. 
    • Winter is signaled by the peak in stock prices following the huge bull market - 2000 to possibly 2020, so it's time to get defensive because the economy collapses into a deflationary depression brought about by the collapse of debt. Under the circumstances cash and gold do well. Remember the cycle is a lifetime cycle of approximately 60 years, each season is approximately one quarter of the entire cycle.
  • Commitment of Traders (COT) Report
    • COT report is issued every Friday. It details the long and the short positions of three categories of traders:
      • Commercials—They are dealers in the physical precious metals - for example,  gold miners.
      • Non-Commercials—They include hedge funds and large commercial banks like JP Morgan. Non-commercials are sometimes called "large speculators." 
      • Non-Reporting—The rest are the small traders since they are not required to identify themselves. 
    • The ones to watch are the large speculators (non-commercials), as they tend to move with the direction of the market. Individual entities could be long or short, but in combination the net position of the group is a key indicator.
  • Eligible Gold vs Registered Gold (COMEX)
    • Eligible gold is gold that meets exchange requirements but isn’t available for delivery, whilst registered gold is fully available to anybody who stands for delivery on the exchange
  • Gold Contract Delivery (Price Manipulation)
    • Prior to a delivery period or due date on the contracts, manipulation is used to drive the Comex price of gold as low as possible in order to induce enough selling to avoid a possible default on gold delivery.
      • Typically toward the end of a delivery month, these banks drive the price of gold lower  for the purpose of coercing holders of the contracts to sell. 
      • For example, the February gold contract is subject to delivery starting on January 31st. As of  January 29th, 2 days before the delivery period starts, there were 2,223,000 ounces of gold futures open against 375,000 ounces of gold available to be delivered.
  • Dividend-Providing Miners (based on historical data)
    • Newmont Mining (1.55 percent)
    • Buenaventura (1.82 percent),
    • Yamana Gold (1.59 percent),
    • Gold Fields (1.39 percent)
    • Barrick Gold (1.11 percent)

How to Invest in Precious Metals?


Silver vs. Gold

Silver was valued at about 1/12th of the price of gold for several hundred years—1/12th is the natural ratio (the ratio at which silver and gold appear in the earth's surface).

In general, here are some guideline for precious metals (PMs) trading:
  • If PMs trade very much in tune with the general stock market during both upswings and downswings and we don't have identical moves in the USD Index (as we will see in the main stock indices - but in the opposite direction), then PMs may be in trouble.
  • If, on the other hand, PMs stop declining or even rise modestly along with falling main stock indices, it will mean that even more declines should not cause serious damage to the PM market.
  • Additionally, if we see the USD Index move higher and PMs refuse to move lower, it will give us a "probably the bottom is in" signal.
  • If PMs prove to hold well despite weakness on the general stock market it will indicate that gold and silver are a strong buy at the moment.
Gold Investment

  • Multiple Jurisdictions
    • Services like BullionVault and Goldmoney let you hold gold internationally in multiple jurisdictions.
    • Switzerland is still a relatively good place to store things in Europe
      • Some ETFs like sgol hold their gold in Switzerland. 
    • In South America, Uruguay is the best, in Central America, Panama, and in the Orient, Singapore.
  • Larger Amounts of Gold
    • In addition to GoldMoney.com, theres Canadas Central Fund, the ETFs, and Perth Mint Certificates for handling larger amounts of gold without having to build your own Fort Knox.

Silver Investment
The rule of thumb of silver investment is that generally silver initially lags behind gold, but as gold gathers steam, speculators flock to silver and ignite the sharp moves higher for which this fidgety metal is so famous. We can also expect silver to drop faster than gold during a recession.

  • Silver ETFs
    • Proxy ($SILVER or $SLV)
    • Global X Silver Miners chart, an ETF (SIL) 

Alternative Views


In [5], a Bloomberg listed 5 gold myths and debunked all of them:
  • Myth 1: U.S. rates drive gold
    • The argument hasn’t rung true for a while now, in fact. There’s very little correlation between the metal and 10-year inflation-linked Treasuries, coming in at -0.2 on a rolling 120-day basis. And just look at what happens when the Fed raises rates.
    • Instead, the author Eddie van der Walt thought: "The key driver of gold, in fact, is the dollar."
  • Myth 2: The precious metal is the anti-Dow
    • The shiny metal offers no such inverse correlation to equities -- the metal’s co-movement to the Dow and Nasdaq was less than 0.03 in the past decade.
  • Myth 3: The physical market never matters
    • While physical buyers aren’t key in fueling rallies, real-economy demand has historically proved a faithful floor when prices have fallen.
  • Myth 4: ETFs don’t move the needle
    • Gold exchange-traded funds can have an outsize influence on the broader market -- much more than commonly assumed.
    • ETF vaults hold the equivalent of roughly two-thirds of the fresh supply mined in 2017, for example. And those tracked by Bloomberg contain more than 2,100 tons, worth about $80 billion.
  • Myth 5: Central banks sell gold to avert financing crunches
    • It rarely works out that way.  Big disposals risk spooking markets, and the divestiture mechanics are far from straight forward. 

References

  1. 3 Drivers Of Gold
  2. 3 Drivers Of Gold, Second Look
  3. Gold Outlook Brightens (Pimco)
  4. Gold to Soar Above $6,000
  5. Safe Havens, U.S. Rates and Physical Demand: Gold Myths Busted
  6. Gold's Initial Lackluster Response To Turkey Likely To Be A Red Herring
  7. Gold: Waiting For A Reflexivity Trigger
  8. Gold-Stock Red October
  9. The Negative Relationship Between Gold and the U.S. Dollar
  10. BullionVault
  11. Bullish / Bearish Gold ETFs
    • GLL (Ultrashort Gold ETF)
    •  NUGT (Gold miners Bull 3x)
  12. HoweStreet.com
  13. Global: Once we are out of this mess, the USD could be hammered
  14. Is the Global Economy facing a Kondratieff Winter in the midst of Summer?
    • The central thing of Kondratieff cycle theory is the next cycle of economic growth and prosperity cannot begin until the excessive debts, which has been built up in the previous cycle, have been removed.
  15. The Dollar Wrecking Ball (@Raoul Pal)
  16. Q1 2020 letter by Paul Singer on the economy and opportunities (pdf)
  17. Louis Gave: «Inflation Will Come Back With a Vengeance» (12/31/2020)
    • Buy value stocks, buy the commodities sector, and buy emerging markets. And for the antifragile part of your portfolio, buy RMB bonds and gold.
  18. Fidelity Funds - China RMB Bond Fund
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