Gold Investors Weekly Review – October 25th

In his weekly market review, Frank Holmes of the USFunds.com nicely summarizes for gold investors this week’s strengths, weaknesses, opportunities and threats in the gold market. The price of the yellow metal recovered from past week’s losses. Gold closed the week at $1,350.80 which is $34.55 per ounce higher (2.6%). The NYSE Arca Gold Miners Index went 7.94% higher.

Gold Market Strengths

India’s third-largest gold fund has reopened to investors after disallowing buy-ins three months ago. Reliance Gold Savings Fund, which manages about $300 million, originally closed to support government efforts to curb bullion demand and control a rising trade deficit. “The economic conditions are getting better and the dollar has come down…,” said Sundeep Sikka, CEO of Reliance Capital Asset Management, justifying the re-launch. The rupee has appreciated 11 percent from its August lows, which could revive investment interest for physical gold and put pressure on supplies.

According to the most recent data from the Indian market, current premiums for physical delivery are running at around 18 percent over the spot price of gold. The chart below shows that the premium has been steadily rising over the last two years, but it has accelerated since April of this year. According to Hebba Investments, a Seeking Alpha contributor, high premiums usually signify bottlenecks in the supply chain or a general shortage in the physical market; a shortage being extremely bullish for the gold market. In addition, Asian press is starting to pick up on this story and dealers are complaining that physical gold is in short supply. This is evident by people not willing to sell their old jewelry at these prices, according to a wholesaler in Kolkata.

Indian-gold-premiums-2012_2013

Gold Market Weaknesses

Mineweb contributor Lawrence Williams reported on this month’s unusual gold trades on the futures markets, which are now occurring almost daily. The chart below, by Reuters’ Frank Tang, shows the number of contracts traded daily and the corresponding movement in the gold price. What are visible are massive trading volumes every day of over 5,000 contracts, all around the same time. On the first of October, as well as on October 10, there were massive trades of over 20,000 contracts. This amount represents well over 2 million ounces, or around $2.6 billion. It’s safe to say nobody has that amount of physical gold, apart from the big central banks, so these trades are being done by entities trading gold they do not have in a manner designed primarily to trigger stop loss orders. However, someone with enormously deep pockets does have to be there in order to support these massive trades; the risks could be huge if the market turns against them. Obviously the “big bad banks” haven’t learned anything in regards to the risk of failure due to this speculation. It’s no wonder these trades took place while the regulators were on paid vacation, drawing unemployment benefits to boot!

GOLD_price_unusual_trades_October_2013

Macquarie, in its U.S. Strategy research this week, stated that the most important insight coming out of the September payroll report was the continued deceleration in private sector labor demand. The reading came in at a soft 126,000 new jobs, while the three month average retreated back to pre-quantitative easing levels, and is more than 100,000 below the early 2013 levels that prompted the initial tapering signals from the Federal Reserve governors. The deceleration likely continued into October thanks to the government shutdown, making it difficult for the Federal Open Markets Committee (FOMC) to justify that there has been a substantial improvement in the labor market.

Gold Market Opportunities

Gold is probably at a cyclical bottom, according to CPM Group. Bloomberg reports that CPM Group targets the gold price at $1,240 to $1,380 per ounce for the next few months. However, gold may trade in the $1,240 to $1,500 per ounce range for the “next couple of years,” before prices rise sharply in the 2016 to 2023 period, says CPM Group. Inflation expectations are likely to be vindicated by this time as the Federal Reserve will remain on an accommodative policy stance longer than previously anticipated.

Eric Sprott, Chairman and CEO of Sprott Asset Management, is under the opinion that the gold supply and demand statistics published regularly by the World Gold Council (WGC) are flawed, despite the fact these numbers are considered to be industry standards around the globe. Mineweb reports that Sprott has written an “open letter” to the WGC, putting forward his company’s position in the gold supply and demand equation, drawing the conclusion that global gold demand exceeds available new supply by a substantial margin. Sprott argues that global demand totals 5,184 tons for this year, leaving gold supply short a massive 3,044 tons. Only a portion of this shortfall can be met through scrap sales and sales out of gold ETFs. It is no surprise to Sprott that the imbalance between supply and demand is not reflected in prices because available statistics misrepresent reality, mostly regarding demand from Asia.

world_gold_production_2013

Gold Market Threats

Jayant Bhandari, a former consultant to U.S. Global Investors who is knowledgeable on matters in India, wrote to us recently saying that he thinks gold will likely stay as the preferred way for Indians to save. However, with Indian currency falling about 12 percent this year, gold has become unaffordable for a portion of buyers. Going forward, the Indian rupee is likely to weaken up to 50 percent more as it is truly expensive for an economy at India’s stage of development, and the fact there is little hope for the economic growth rate to increase. Bhandari’s comments coincide with recent reports by India’s finance ministry, claiming there have been significant improvements to the nation’s current account deficit. Nevertheless, this number fails to consider the growing unofficial imports of gold and the diversion of remittances escaping the tighter money flow conditions introduced recently. Therefore the projection of a lower current account deficit is a mere window-dressing exercise, highlighting that the government has not acted prudently to address economic headwinds, but instead has taken the easy way out of singling gold imports as a threat to the Indian economy. This year imports of silver into India have surged, perhaps as a substitute to buying the higher-priced gold bullion.

Earlier this month, the Mexican Congress modified the tax reform proposal prepared by the Mexican Executive Branch, including a special mining fee of 7.5 percent of operating profits and an additional fee of 0.5 percent of gross earnings for gold, silver and platinum. In addition, Congress has proposed the elimination of accelerated depreciation for fixed assets and immediate deduction of pre-operative expenses. According to Macquarie analyst Michael Gray, the implications in the current lower-metal price environment are likely to further compress the profitability ratios of higher cash cost producers. Meanwhile, the elimination of the accelerated depreciation will limit the tax benefits upfront, which acts as a strong disincentive for exploration and mine development activities, but also sets a much higher feasibility threshold for assets, likely deterring M&A activity.

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