This article is based on an interview Ronald Stoeferle. He is one of the top precious metals analysts and author of the well known reports “In Gold We Trust” (see last edition of the report). He explains in detail why lower gold price forecasts lack insights in the physical gold fundamentals.
The new year brings traditionally forecasts. Those are interesting data as they reveal the market sentiment. In general, analysts are revising their outlook for gold downward. Goldman Sachs lowered considerably their outlook in the light of an expected economic recovery. Deutsche Bank and HSBC reduced their gold price outlook, although they still expect a slightly higher price.
A quote from one of the reports: “Global investment demand for gold has moderated considerably over the past 18 months, largely a function of the apparent success of central bankers in mitigating the risks associated with excessive financial leverage within the Western economic system,” […]”The strength in other more conventional assets, U.S. equities for example, as economic conditions appear to normalize has also resulted in less urgency for investors to buy unorthodox investment instruments such as gold.”
We asked Ronald Stoeferle for his view on the lowered outlook. Stoeferle is a top precious metals analyst and author of the comprehensive series of gold reports “In Gold We Trust”. His high level view: “Gold analysts remain bearish, which is a reliable contrary indicator. I honestly would interpret that as a positive sign. Most of the major investment banks were bullish on gold a while ago. As a contrarian, that made me cautious. The fact that a lot of banks are turning bearish now is a good sign. The bottom must be in soon.”
Stoeferle comes to the same conclusion by looking at other gold indicators, including the put/call ratio, COT reports, sentiment indicators and gold stocks. He points to the 2012 edition of his report, quoting the following:
The market opinion held by the analyst community is not exactly over-the-top. Normally, the consensus at the end of a trend should have substantially higher price targets; in the case of gold, however, no such irrational exuberance can be seen. The 24 gold analysts covered by Bloomberg show little signs of excessive optimism: the consensus estimate expects a falling gold price from 2014 onwards. The median price targets are USD 1,720 (in 2012), USD 1,835 (in 2013), USD 1,600 (in 2014) und USD 1,400 (in 2015). This is in stark contrast to the forward price, which signals a gold price of USD 1,650 for 2015. (page 106, July 2012)
The earnings revisions of the Gold Bugs index remain extremely negative. This means that at the moment more analysts revise their earnings estimates downwards than upwards. It highlights the primary analysts’ profound pessimism. 2008 was the last year we saw similarly sharp adjustments of earnings forecasts. By relating earnings revisions to the price development of the Gold Bugs index, we find that the timing of the greatest pessimism tends to provide investors with reliable signals to engage.” (page 94, July 2012)
Contrarian behavior has proven to be successful in the financial markets. As an example in the stock market, Nomura Research Institute has analyzed forecasts at the beginning of each year for the German DAX index, for the last five years. They measured the bullish vs bearish expectations of analysts on selected German stocks. Interestingly, the most bearish forecasts resulted in the best performances.
However, a contrarian approach is only part of the answer. The gold market fundamentals reveal a much larger truth, which remains largely underexposed in Stoeferle’s view.
Driving fundamental forces: Asian physical gold demand
What the previous forecasts fail to see, is the exploding physical gold demand in Asia and the emerging markets, driven by solid economic fundamentals in those countries. The increasing welfare and the gradually rising propensity to save, i.e. the savings ratio, are the crucial factors. Recent statistics confirm this.
The Federation of Indian Exporters Organisations has said India exported gold jewellery to the tune of $12.12 billion in the first nine months of this fiscal, which was just 30.68% of the value of imported gold. Between April to December 2012, gold imports jumped 40.23% over $28.16 billion imported during the corresponding period of April to December 2011. [Mineweb]
Indians save roughly 30% of their income, as opposed Americans, who save 5%. Plus, Indians are getting richer all the time. Once a very poor country, the rich and middle classes now outnumber the poor in this nation of 1.2 billion. The country has the sixth-largest economy in the world. [LFB]
The net gold flow from Hong Kong to mainland China in November hit its second-highest level in 2012 after April. Hong Kong exported 90.763 tonnes of gold to mainland China in November, an increase of 91 percent on the month. Its gold imports from China rose 23 percent to 27.681 tonnes. The total net gold flow in the first eleven months of the year, at 462.75 tonnes, already exceeded last year’s total of 379.573 tonnes, Reuters calculations showed. [Mineweb]
The Iraqi dinar exchange rate is based on the amount of cash reserves, which include not only money but gold as well. Iraq’s gold holdings quadrupled to 31 tons, the first time something like this has happened in years. [BullionStreet]
Turkish gold exports rose to $12.7 billion in the first eleven months of 2012 compared to the $1.47 billion exported in the whole of the previous year, Economy Minister Zafer Caglayan told a briefing in Istanbul. Around half of the exports – $6.5 billion worth – went to Iran, while $4.2 billion went to the United Arab Emirates. Turkey exported just $54 million worth of gold to Iran in 2011. [Reuters]
To put things into perspective, the following chart compares demand for physical gold out of Asia and emerging markets with other large purchasers. The strength in the gold market by physical demand out of Asia is unrightfully underexposed or even ignored by most commentators and analysts.
Dynamics in the Asian gold market are simply too strong
Let’s take the above facts and trends one step further by looking at the dynamics within the Asian gold market. All signs point to a continuation of the current trend. What makes Ronald Stoeferle convinced of this expectations, is the strength in the drivers in their economies.
(1) Physical demand is set continue its rise because gold is NOT expensive. China and India as the biggest (gold) markets experienced the same percentage increase in nominal GDP, wages and their currencies’ gold price. Locally, the gold prices did not change when expressed in terms of purchasing power, which is fundamentally different to the West. China has been the trendsetter in their reaction to financial repression (started in 2000). The Chinese population has chosen consciously and hugely for physical gold investments as a way to escape from financial repression.
During the interview, Ronald Stoeferle quotes from its 2012 report (page 55): “In view of the fact that Asia already accounts for the majority of gold demand, the US data is of limited significance. Therefore the development of household income in China and India is a crucial factor for physical gold demand. In terms of the Indian rupee, the gold price has posted an average increase of 18% p.a. since 2001, while in Chinese yuan the growth rate was only slightly lower at 16%. Nominal income has been going up at the same rate and pace, which means that the gold price is basically unchanged in real terms for the Chinese and Indian population since 2000. The following chart illustrates the rapid development of Chinese (left scale) and Indian (right scale) GDP per capita.”
The officially reported inflation in Asia is often a rather vague depiction of reality. Therefore the gold price in terms of disposable income provides more insights. The next chart shows how the gold price in terms of purchasing power in China and India is currently 80% lower than in 1980. Gold is amazingly cheap for them.
(2) Governments stimulate people owning gold. The Indian gold mania has resulted in a decrease of the current account deficit (source) which was a reason for their government to attempt to increase duties on gold trades. The Indians succeeded in changing their policy makers from that idea, after several protests and strikes. Apart from that case, most Asian governments stimulate their citizens to own gold for their protection. It shows the trust from the Indian people to hold gold. China, which accounts for one sixth of world population, is a perfect example. The Turkish government is in the process of creating incentives for the population to deposit their private holdings with the banking system. As the global “run to debase” currencies becomes increasingly apparent, the Asian and emerging markets will undoubtedly continue to stimulate their citizens to hold gold.
(3) Alternative currency. Oil producing countries start dealing their oil with huge purchasers (think Russia, China, Brazil) in alternative currencies, resulting in a lower demand for dollars. A potential rush to the exit is coming from central banks that do not need US dollars anymore, which would lower the value of the dollar, make inflation and interest rates explode. We saw the first proof of this in 2012, where several Asian and BRIC countries began trading oil for gold.
Looking through the noise of the paper market
In addition to all the fundamental forces in Asia, Ronald Stoeferle looks to the day-to-day confusion primarily created in the paper futures market. That’s indeed where the short term price is set, but it’s nothing more than the short term price. “We are witnessing a huge disconnect between the short term price set in the paper market and the long term fundamentals primarily driven by Asian and emerging markets.” This is a concept that most people fail to understand, at least the fundamental impact on it on the gold market.
“Recently this became very blatant to the point I am considering this ridiculous” says Stoeferle. The Tokyo gold futures hit record high in the past days as the Yen slides on monetary easing announcements (source). That is normal market behaviour. Compare this with the five week waterfall decline in dollar gold after the QE4 announcement on December 12th, the most bullish event possible. Unusual large selling orders were placed in very thin trading (overnight) and suppressed the metals prices significantly and counter intuitively. The paper market behavior can be very misleading to the point that these short term anomalies could be thought of being normal.
The Dow Theory says that the primary trend cannot be ignored. In the case of gold and silver, the long term fundamentals are so strong that manipulation is only possible on a short term basis. So take the opportunity to accumulate on every price dip.
The West fails to understand that gold follows prosperous economies
On the most essential level, people need to understand what gold really stands for. Ronald Stoeferle refers to his report where he wrote on page 52 that gold has always abandoned regions of stagnating wealth, heading for prospering economies and rising savings volumes. In 1980 Europe and the US accounted for 70% of gold demand, since then this share has plummeted to below 20%. Chart courtesy Sharelynx.
“Gold goes where the money is; it came to the United States between World Wars I and II, and it was transferred to Europe in the post-war period. It then went to Japan and to the Middle East in the 1970s and 1980s and currently it is going to China and also to India” (quote from James Steel, page 52 in the report).
Conclusion: Gold is often called the investment of doomsayers and chronic pessimists. However, this point of view fails to acknowledge the fact that China and India are the driving factors on the demand side. Real interest rates remain negative in both countries. On top of this the market is clearly underdeveloped with respect to its investment universe. Basically local investors are very limited when it comes to the use of their savings. Gold has been a time-tested store of value for centuries. The traditionally high affinity for gold and the rising net worth will support demand in the long run. Whoever expects incomes in China and India to continue rising and real interest rates to remain negative or low, will by default recognise gold as the beneficiary of these developments.
Impact of a Chinese recession
In closing, we talked about the impact of a Chinese recession on the gold fundamentals discussed in this article. Ronald Stoeferle believes that the fears for a hard landing did not play as some expected. In contrast, most indicators are picking up momentum currently. In his last oil report to premium subscribers he wrote the following:
In our view, the increasingly expansive Chinese monetary policy will cause Chinese oil consumption to regain its momentum in the short term. However, over the long term we continue to believe that an extensive market shakeout will take place. The earlier China allows the necessary break to happen, the less painful it will be. Chinese leadership is facing a difficult task. Due to the exceptionally high capital intensity of the Chinese economy (gross capital expenditures stand at 40% of GDP), future growth will be dependent on the propensity to consume of the Chinese people. To lift China’s domestic demand, the level of real wages would have to increase. However, the low current level of wages in China is the country’s most important competitive advantage which permitted the economy to grow at enormous rates over the past decade. Thus, it is evident that the Chinese government finds itself in a dilemma.
As opposed to the now generally accepted belief in the Chinese economic miracle, we take a more skeptical stance. Merely extrapolating the past into the future can eventually be disastrous. To this point the exorbitant stimuli have been sufficient to prevent an economic collapse. Substantial existing overcapacities have increased further. The governments share in the overall economic performance is gradually rising, state-funded infrastructure projects are responsible for the majority of this growth. In the long run, China will not be able to overturn the fundamental laws of economics and business activity.