By Sumit Roy
David Jollie is a veteran strategic analyst at Mitsui Precious Metals in London and covers all the precious metals globally for the company. His focus is not short-term price movements but more long term, and some medium trends as well as supply-and-demand issues. HAI’s Sumit Roy recently spoke with Jollie and tapped his insight for a look into the gold market.
HAI: After surging in anticipation of the Fed’s QE3, gold prices haven't done much. Some expected better performance from the metal. Is this merely a temporary pause or have prices topped out?
David Jollie: First of all, you have to think about what the impact of QE is, and there are a whole range of different ways QE works. It makes people worry about inflation in the future, it makes more money available to invest, and it does a whole range of other things as well.
The different phases of QE work different ways. If you're looking at an efficient-market hypothesis, the fact that some of these things are going to happen means that just the anticipation of QE is quite bullish for prices, and particularly for gold prices.
Therefore, it’s not a surprise that while QE was being rumored, you saw prices appreciate. The question is how much money is then really released to get extra leverage to invest wherever that might be, whether it’s gold or somewhere else. So people get very excited leading up to the announcement, but then the increased availability of money doesn’t come as quickly as people think. It’s still bullish for the metals, but it takes time for the second part of it — this extra availability of money — to take impact.
Thus, it’s not completely unexpected that the rise in prices might slow down, though it’s somewhat surprising that we didn’t make it to $1800 and that we fell back from there. That technical failure also took a little bit of the energy out of the market as well.
HAI: In the U.S., the dreaded “fiscal cliff” at the end of the year is fast approaching. How do you see that situation playing out and how will it impact gold?
Jollie: The fiscal cliff is a complex concept because there are so many different aspects that have got to be fixed in time to avoid it. It’s entirely possible the U.S. government will avoid some of the issues of the fiscal cliff, but not all of them. But that still leaves confidence low leading up to the end of the year, and potentially the start of next year, and that’s going to lead to a reduction in GDP growth. Even if the fiscal cliff is solved in time, it’s going to lead to some reduction in economic activity compared to what we would have seen otherwise.
What does that mean for gold? Clearly, it’s a risk event. In some ways it’s similar to the debt-ceiling debate from last year, which was very positive for gold. These types of events suggest that perhaps politicians are less able to solve intractable problems than we thought. And that generally would seem pro-inflation in the longer term, and positive for gold.
It also makes a lot of other things less attractive, in terms of investment — particularly equities. Relatively speaking, it might just make gold more attractive as an investment. Moreover, because the fiscal cliff is a negative for the U.S. economy, in theory, it ought to mean that you have a weaker U.S. dollar. Granted, there is a slight problem with that assumption, in that we know that the dollar is also a safe-haven asset. If markets are really worried about economic risks, then it’s possible the dollar might strengthen. The direction of the dollar is a little bit harder to read.
But generally, this sort of political risk is pro-gold and is negative for a range of other assets. Whether we hit the fiscal cliff, and to what extent, still is not really clear. But you would have to view it as positive for gold prices in the near term, in the three-month time period.
HAI: Speaking of the U.S. dollar, even though we’ve seen it fall ever since we got the rumors about QE3, we saw it fall much more when the Fed announced QE2 in 2010. Why is that? And what’s the relationship between the dollar and gold?
Jollie: The outlook for the dollar depends on which currency you're looking against. The most common relationship that people are concerned about is dollar-euro. Generally, you would say a strong dollar should mean — in the absence of anything else — a weak gold price. And a weak dollar should mean a strong gold price. There are logical reasons for that, because, of course, not every buyer is buying gold with dollars. There are huge amounts of buying in Chinese renminbi and in Indian rupees and other currencies.
If you look at the dollar-euro relationship, you’ve really got two different things. You’ve got fear of inflation in the U.S. in the longer term, derived out of QE. And we haven't seen that inflation yet, but people still have great concerns about that. In terms of the euro, there is some concern that the best way out of sovereign debt is to drive inflation in the economy. Then there’s the bigger issue of confidence about whether the euro will even exist or not in the future. A lot of people have taken a short euro position on the basis that growth will be low and that there is a risk that the euro may not continue as a viable currency.
My feeling is that the euro will continue. Given that we’ve seen a lot of dollar strength this year, it seems unlikely that dollar strength will be repeated next year. The outlook is more positive for gold just on a dollar-euro basis next year because we don’t expect to see this continuation of a strong dollar as we saw this year. That should give gold a little bit more room to breathe and a little bit more room to the upside.
HAI: Looking toward 2013 and beyond, what do you see as the biggest drivers of gold?
Jollie: You have to view the developed world and developing world separately. There is a perception that the re-election of President Obama makes quantitative easing more likely in the U.S., and may make reducing the deficit in the U.S. more difficult, therefore making inflation more likely. That is dollar-negative and gold-positive.
Then you have to add to that what’s happening in the physical market where gold has been bought as insurance by people. We still see gold having an immense cultural position in China and in India. If you see a rebound in Indian growth, and no change in the tax regime for gold buying, and if you see a recovery or soft landing in the Chinese economy, then you would expect those things to reinforce demand in Asia. And that would be positive for gold as well.
We’re expecting high prices. But there are certainly more question marks about the market than there were last year.
HAI: Do you have a price target?
Jollie: My average forecast for 2013 is $1920.
HAI: What do you see as the biggest risk to the 12-year gold bull market?
Jollie: The biggest risk is that we’ve developed an innate sense of bullishness. Up until the middle of last year, gold rose fairly steadily. On a day-to-day and month-to-month basis, there are big changes and the picture looks much lumpier. But the fact is that gold has risen throughout most of the last several years fairly steadily.
The major challenge will be how the mindset changes if and when gold stops rising. We could be beginning to see the start of that. Looking back over the last year, gold prices have been fairly steady. It certainly hasn’t declined in most currencies. But it hasn’t shown wildly exciting moves upwards, either. In that sense, the bullishness is still there, but it’s decreased a little.
The biggest challenge will be if we lose that sense of bullishness, the sense that the price is guaranteed to go up. Once that happens, you have to rely on the innate value of gold — whether that’s an inflation hedge or as insurance against political risk or just as a cultural object.
That would be quite a different market from where we are now. That doesn’t mean the market would suddenly become bearish. But certainly, if that happened, you would see a less bullish sense to the market and you would see fewer buyers out there than you have now.
HAI: It seems as if eurozone sovereign debt concerns have retreated ever since the ECB announced its bond-buying program in September. Is this just a lull before another shoe drops? Or have policymakers finally gotten the crisis under control?
Jollie: The impression that we are getting is that policymakers at least are beginning to get a sense of the seriousness of the sovereign debt issues. They now understand they have to do something and are slowly getting to grips with that. We have been seeing the austerity programs for some time. But the problem is that the austerity programs have the potential to be self-defeating, in that extreme austerity leads to GDP decreases. And falling GDP makes it much harder to repay debts.
But now we have a maturing policy situation, where the politicians are aware that austerity is needed, but that austerity has to be tempered somewhat. In my view, they are approaching it in a more constructive way than they have been. But it’s too early to say that this is under control. Rather, this might be the beginning of starting to get this under control.
Certainly, bond yield spreads have dropped and that suggests the market is a lot less worried. But the expectation continues to be that Spain and Italy will have to get external help to address their debt issues. No one knows when that will happen or the scale of what will be asked or how it will work.
HAI: And finally, China reported that its economy grew only 7.4 percent in the third quarter, the slowest rate since 2009. Is China’s slowdown material to the gold market?
Jollie: If you look at the physical gold market, China and India are by far the biggest two purchasers of physical gold. And gold plays interesting roles in China: as jewelry, as investment and as cash.
In the last quarter, the World Gold Council has shown a slowdown in gold buying in China. And our recent visits confirmed that a weak economic pattern has reduced the amount of money available for some people. Therefore, gold’s role as cash has been less important. Gold jewelry demand is still reasonably strong, and should rebound if the GDP growth rates go up, but there's no doubt that the physical market has been weaker.
Gold is a hybrid between a Western-investor asset and a developing-market, cultural asset. If you look at the weakness in the Indian market since the tax regime was changed earlier this year, and if you then add in a weak Chinese market, that’s a concern for investors.