The Gold Grab - Short-Lived Or A New Beginning?

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Includes: GLD, IAU, PHYS
by: Brent Lyons

Summary

Looking at notable supply and demand changes, if any.

Comparing the current geopolitical environment with the world environment during previous gold runs.

Observations about changes and impact of world central bank acquisitions.

Looking for answers about the gold grab in the context of the recent stock selloff.

The recent run up in gold has stirred some euphoria, particularly from the gold crowd. And for good reason. Gold lovers have been silenced for the past four years and have needed a meaningful catalyst to prime the throttle to drive the price higher. We haven't seen a meaningful spike in the price of gold in some time as we have in the past few months.

In about 100 days from the November 2015 lows when gold was as low as $1,054/oz, the spot price climbed a remarkable 21% to its recent high on March 9. Valuations since then have been in hover mode. The big question is where does the price go from here. Possibly onward and upward? Maybe back down to previous levels?

In recent history (since the high of August 2011), we haven't before experienced such a significant run as we did in those 100 days. The only move that came close was during the summer of 2012 when gold prices moved from $1,553 to $1,781, representing an almost 15% increase. So a 21% move has generated some attention. As a point of reference, the historic all-time high was in January 1980 when the price reached $2,066/oz.

But in the context of where the gold market is now, what has been the driving force that has energized this move upward? And will this force or others drive price momentum significantly higher? Or is it all going to fizzle in a not-so-spectacular run and done?

I want to look at some possible answers to these questions and maybe get some clarity about where gold goes from here.

The magic of gold as a trading commodity is the constant nature of its supply. The amount of gold produced worldwide from year to year is relatively limited and that amount doesn't fluctuate much from year to year. According to SNL Metals and Mining, as of the end of 2015, the lowest level in the past fifteen years occurred in 2008. The USGA reported that year netted 2,260 metric tonnes. The highest was in 2015 when that number reached 3,000 metric tonnes.

Charles Jeannes, CEO of Goldcorp (NYSE:GG), was quoted by the Wall Street Journal back in September 2014 that the highest peak of gold production would be reached in either 2014 or 2015. We now know that gold mined in 2015 barely surpassed 2014 levels so we are led to believe that the peak of gold production is behind us. Mr. Jeannes believes we will never see the gold production reach these levels again due to the fact that there are just not that many new mines being found and developed.

So supply being fairly constant, what is happening with the demand side? The World Gold Council gives us the breakdown, with the jewelry market historically accounting for over half of the gold produced. Central bank purchases and investment demand account for over a third produced. And technology, industry, dentistry, and other sectors consume the rest. The consumption levels from all those areas hasn't changed much and a dramatic change isn't anticipated.

The biggest proportional increase of activity has come from world central bank purchases. While most central banks maintain a fairly constant level of reserve bullion, a few countries have been actively adding to their reserves with some degree of significance.

According to the World Gold Council, in 2010, central banks accounted for 2% of gold purchases, but since then that percentage has been increasing until 2014 when central banks accounted for 14%. Through Q3 of 2015, however, that buying was reduced a bit vs. 2014. The WGC reports that Russia and China are among the nations during that span actively ramping up bullion buying. The main reason for the purchases is for diversification of reserve assets, hedging economic and geopolitical uncertainty.

Another news grabber has been the repatriating of central bank gold by Germany's Bundesbank. According to the World Gold Council, to date, Germany's central bank ranks second to the United States in gold holdings with 3,381 metric tonnes. In 2015, all their reserves held in Paris were repatriated to Frankfurt as well as a small amount from the U.S. Currently, Germany's reserves are physically held in Deutsche Bundesbank in Frankfort, a relatively small amount at the Bank of England in London, and the rest is held 80 feet below street level at the Federal Reserve Bank in New York City. Germany is in a multi-year process of repatriating their gold. And many are wondering what is behind the move.

Worry about the dollar is also a cause for concern. The escalation of federal interest payments as a percentage of tax receipts is believed by many to be getting not just out of control, but beyond the point of containment. The U.S. sovereign debt level is now over the dreadful 100% mark as a percentage of GDP.

In addition, with an election looming, the sound bites from the current batch of Presidential candidates relating to their plan, or lack of plan to address the debt and spending crisis is certainly cause for serious concern.

And then there's the welcome-to-2016 equity selloff. Are we in a bear market? With little or no returns in 2015, and the slide during the 1st quarter of 2016, investors are definitely open to shifting their asset allocations.

And just for fun, let's take a brief look back to the context of the era of the 2011 gold run. As gold was making big gains, what events were populating the headlines?

During those months, there was endless news of a looming deadline when the federal government was going to run out of money. Pressure was mounting to raise the federal debt ceiling, and some in congress dug in their heels wanting a meaningful debt reduction plan before sanguinely signing off on more debt. Rating agencies were threatening to lower the sacred AAA rating of U.S. Treasuries. The Middle East was a hotbed of conflict with Assad's troops in Syria bombing civilian targets in Hama. Rebel forces in Libya were advancing in their civil war to overthrow Qaddafi's government. Tensions between Israel and Egypt were violent with air strikes and bombings. The Afghan war experienced its deadliest 24 hours to date with the downing of a Chinook helicopter and 30 deaths, including 22 Navy Seals. After a police attack in Great Britain, violent protests led to riots in London with fires and extensive property damage.

So in the midst of all this global noise, gold prices were marching higher. The headlines were packed with somber events that had gold buyers believing bad times were definitely here.

Not that we currently live is easy times, but in contrast, it feels to me like the recent gold grab might need more fuel. Certainly the federal deficit is alarming and deplorable. But with intelligent and responsible leadership and a better economy, it's not out of the question that the federal deficit could become manageable.

The volatility in oil and equities and little to nothing anticipated in bonds has surely prompted investors to buy some gold exposure. And better yet for gold investors if equities truly are in an entrenched bear market. But if this selloff is like most, the tide will shift and markets will start to churn toward higher levels. If oil stabilizes and the tight correlation between oil and stocks normalizes, equities may see some respectable returns in 2016. And that may be all it takes to end this run up in gold prices.

Longer term, however, one thing to keep an eye on that could certainly push gold prices higher and possibly a lot higher is what happens to the dollar and the deficit. If the next president and appointments are perceived as treating the nation's fiscal position with apathetic approach, or worse yet if there's perceived reckless spending, the gold grab will have a lot more life.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The fast price swings in commodities and currencies will result in significant volatility in an investor's holdings. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into. Any forecasts set forth in the material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.