Gold: a response to more easing

Following my latest article on the Fed’s situation and a potential QE4 announcement next year if the situation deteriorates, I thought that a little article on gold could complete my overall view. As many other investors, I am trying to figure out where is the final bottom of the commodity. With all this currency debasement happening (and even more to come), I was wondering if agents will start to once again consider it as the ‘real money’ or – such as GS Jeffrey Currie calls it – the currency of the last resort.

The chart below shows the weekly prices of Gold since the late 90s; as you can see it, one ounce of Gold is now trading at 1,132 slightly above its 50% retracement (1,086.56) from a local low of 251.95 reached in August 1999 and a high of 1,921.17 reached in September 2011.


(Source: Bloomberg) 

Even though many Gold experts are still bearish on the commodity forecasts with a first target at $1,050 per ounce, I am wondering if $1,100 is a good level to start buying as a long term investment. I understand that investors have considerably starting to lose interest as soon as they realized we were entering in a disinflationary-then-deflation area and that it was more interesting to be exposed to US bonds as real interest rates were increasing. As you know, Gold doesn’t distribute dividends or coupons (and also lacks the full faith and credit of most governments) and is only subject to capital appreciation. Hence, a good factor that can explain the majority of changes in gold prices over the past few years is indeed the changes in real rates.

However, if we considered the 2016 scenario of QE4 as a response to the EM meltdown, in addition to an all-in desperate Abe and Europe’s Great Depression, gold could potentially attract more and more buyers in this sophisticated period.

Quick review of Gold inventories figures

According to two main sources – Kitco and World Gold Council – there is 170,000 metric tons of ‘above-ground’ Gold (i.e. Gold that have been mined in all human history), which corresponds to approximately USD 6.8 trillion based on a spot value of 1,130 USD per troy ounce. If we look at the growth of the top central banks’ balance sheets over the past twenty years (see chart below), we can see than we have reached an historical high of more or less USD 16 trillion. Therefore, based on that information, we can easily do the math and conclude that the gold-to-monetary-base ratio stands now close to zero.


(Source: Bloomberg)

As you can notice on the chart above, we have now entered in a Central-Bank-money-printing area since the Great Financial Crisis and we are struggling to get out of it. As I described in my latest article, I believe that the Fed’s response to the EM crisis will be a QE4. Based on a statistical analysis, it is clear that this one will be less efficient that the previous ones; efficiency of QEs has a sort of logarithmic function until a point where there is no effect to the economy or even a negative effect to it. Therefore, new money into the system could trigger Gold prices to the upside as investors’ faith on central banks will be clearly reviewed on the downside.

Even though global annual gold mine production has risen to 3,000 tonnes in recent years (reported by the World Gold Council) compared to a 10-year production average of 2,700 tonnes, I don’t think it will add further pressure on the commodity price in the medium/long term. Especially now that we have reached a sort of unlimited-printing strategy. In addition, geopolitical pressures and macro conditions in some of the main producers (Australia, South Africa, Russia. see gold main producers in the map below) will slow and perhaps revert that trend in the coming quarters.


(Source: World Gold Council)

To conclude, my view is that we could see a market’s response to gold as a sort of alternative currency to hold while we try to get out of this monetary debasement. The five-year chart clearly shows a negative trend, but I will try to add some gold in my portfolio at around 1,100 USD as a long term investment (and hedge).


(Source: Bloomberg)


The chart below shows a quick analysis of EURUSD and VIX Index over the past six months. As you can see, the 20-day correlation between the two underlying assets has switched from a negative 80 in Mid-March to a positive 80.6% today. If you are a global macro trader, I personally believe that it is important to notice those changes between different asset classes, so you can see how a particular currency will react in case of a volatile day.

During the ‘Black Monday’ session this year (August 24th), the VIX Index soared above 40 and one of the surprising assets rallying was the Euro. On that day, EURUSD surged above the 1.17 level, up 350 pips in a few hours. Sell-side research started to call it the New Safe-Haven Currency, therefore reviewing its 3-month and 6-month to the upside.

Keep a small long EURUSD in your book ahead of the FOMC

In my opinion, I think it could be good to keep a long position on EURUSD ahead of the FOMC meeting this evening in case we see a bit of volatility.

Based on the macro situation in the US, a persistent moderate nominal growth and a poor core PCE deflator at 1% (Bloomberg PCE MBXYH Index), I think a no-hike scenario will make more sense. However, a 25bps is still in the game and wouldn’t have dramatic consequences for the market; but in that case, we could see a bit of equity sell-off, a higher VIX and therefore a higher EURUSD. An interesting level on the upside will be 1.1380; a break out could potentially bring EURUSD to 1.1450. On the downside, 1.1220 is the key level where I should potentially keep a safe stop.


(Source: Bloomberg)

Quick update on China ahead of the FOMC meeting…

Ahead of the FOMC meeting this week, I thought a quick update on China would be useful to review the major data on a global macro perspective.

Over the past few years, Chinese slowdown has massively impacted commodity prices, which are still ‘trying’ to find a bottom according to the late analysis I read. The chart below shows the historical moves of the Bloomberg Commodity Index (BCOM), a broadly diversified commodity price index (22 commodity futures in seven different sectors) that I like to watch quite a bit. As you can see it, the index has been trading below the 2009 lows since the beginning of the year and is now approaching the 2002 levels.


(Source: Financial Times)

If we look at Iron Ore monthly prices for instance (see chart below), we can see that the commodity has lost more than three times its value since its high in February 2011. It fell from 187.18 (US Dollars per Dry Metric Ton) at that time to 56.40 (for the September 2015 Futures contract). There has been a few topics on the table that could have describe this drop – US rising rates and Dollar strength, Grexit fear, Oversupply issues – however the decrease in Chinese growth and productivity are the most important factors to the commodity market in general.

Iron Ore

(Source: indexmundi website)

How fast is China slowing?

First of all, if we look at the country’s annual growth rate over the past five years, China GDP decreased from approximately 12% in early 2010 to 7% in the last Q2 update. And looking at the major’s institution forecasts (IMF, World Bank, see below), it is more than likely that we are going to see lower and lower figures in the next few years, and therefore constantly weigh on export-driven economies. Based on the forecasts below, we are looking at a 5.5%-6% annual growth rate in 3 to 5 years.


(Source: knoema website)

Salaries increase in China, a secular change?

For decades, China has mostly been competitive based on its cheap labour and low-cost raw materials, and has been profitable based on its export-driven economy combined with an ‘undervalued’ exchange rate. However, with wages and transportation costs on the rise, the country’s economic projection has changed and I don’t know if the rest of the World is yet prepared for it. According to some financial analyst experts, compare to the mid-2000 levels, China needs twice the amount of Capital or Debt to create a 1-percent growth today.

Based on the International Labour Organization’s 2014 Wage report for the Asia Pacific published at the end of the first quarter of this year, Asia annual growth in real wages has been outperforming the global average over the past decade (6.0% vs. 2.0% in 2013). And East Asia (driven by China) reported at 7.1% increase in 2013, therefore indicating a growing consumer spending power. And between 1998 and 2010, the average annual growth rate of real wages were approximately 13.8% (Carsten A Holtz, 2014). Since 2010, real wages have grown by 9%, outperforming productivity which has grown by 6-7%, therefore reflecting negative signs about the economy.

Availability of a large pool of labour combined with low production costs have been one of the major pros of China, however the constant increase in labour costs will narrow the difference in manufacturing costs between China and a developed economy (such as the US) to a degree that is almost negligible.

As a result, no hike in September…

My view goes for a neutral FOMC statement this week, but no hikes from the Fed based on the weak current market’s conditions. If we look at it, we have more and more EM countries facing a currency crisis (Brazil, Russia, Malaysia…), low oil prices affecting highly leveraged US Shale oil companies, US debt ceiling ‘threat’ at the end of the month, China selling its USD FX reserves, US equities showing a sign of fatigue… These are all negative elements that the US policymakers will take into account at the September meeting (16th / 17th of September). The upside for currencies such as the Euro, the Swiss or the Sterling pound will be quite limited until the release of the FOMC Statement, however we could see some Dollar weakness in case of a status quo.