March 2013

For the quarter, spot gold closed at $1,598.75, down $76.60 per ounce, or 4.57 percent.  Gold stocks, as measured by the NYSE Arca Gold Miners Index, slid 18.47 percent. The U.S. Trade-Weighted Dollar Index gained 4.02 percent for the quarter. Also for the first quarter, the Philadelphia Gold & Silver Index (XAU) lost 18.02 percent, the S&P/TSX Global Gold Index was lower by 15.91 percent and the FTSE/JSE African Gold Mining Index lost 18.37 percent.

Strengths

• Total assets of the Federal Reserve’s balance sheet broke through $3.2 trillion at the end of March, hitting new highs. Commentators noted money printing is in full swing and has started to have material impact on bank reserves, and dramatically expanding the monetary base. Over the past three months, the Fed’s balance sheet has surged almost $300 billion after remaining flat for the last 18 months. Gold price changes have exhibited a strong correlation with the Fed’s balance sheet expansion over the last decade. However, the price of gold has headed south with surging stock prices, yet the monetary base continues to rise, thus creating a very bullish scenario for gold in the coming months.
• Despite reports of lower-than-expected shopping over the Chinese New Year, the government reported sales of gold bars for investment purposes rose twofold, as compared to last year. Monitored establishments reported sales of gold, silver and jewelry pieces were up 38.1 percent during this year’s holiday season. Even fears of China slowing down could not dwindle Chinese craving for gold. Elsewhere in Asia, the South Korean Central Bank added 20 metric tons of gold to its international reserves in the month of February arguing a need to diversify its holdings. The transaction value of just over $1 billion is not massive by global standards; however, it symbolizes a 24 percent increase in the country’s gold reserves. Furthermore, including this recent transaction, gold reserves account for only 1.5 percent of the country’s total reserves, leaving plenty room for further reserve “diversification” purchases.

• Fed Chairman Ben Bernanke gave a speech on March 1 in which he reiterated his commitment to the third round of quantitative easing (QE), and added that the program’s main purpose is to “prompt a return to the productive risk-taking” essential for economic growth. David Rosenberg of Gluskin Sheff noted in his March 7  “Breakfast with Dave” newsletter that the Fed chairman is clearly telling investors that being in cash is a money-losing strategy, and that he has the power to maintain this “financial repression” for a long time. “Financial repression” means a sustained period of negative interest rates even with inflation expectations on the rebound. The U.S. Consumer Price Index for the month of February rose 0.7 percent month-over-month, surpassing analysts’ forecast of a 0.5 percent increase; in such a scenario it is difficult not to make a case for gold as the most effective inflation hedge.

Weaknesses

• With Chinese markets closed for the second week of February for New Year celebrations, gold prices were on slippery footing. The weakness in gold was further exacerbated on February 15, when filings for Soros Fund Management and Moore Capital showed that both players had sold a significant amount of their U.S.-held ETF gold investments in the fourth quarter. However, with Soros being an astute investor in the currency markets, it is not inconceivable that he swapped his U.S. dollar-based gold holding into gold-denominated in yen. Over the last six months, gold is flat in dollar terms but in yen terms is up almost 19 percent, with the price breakaway starting in the fourth quarter.
• In the first quarter of the year not a single company in the mining sector went through the laborious process of listing on the TSX Venture Exchange. The last record of one full quarter without any mining initial public offerings dates back 10 years. Most recently, financing has almost fully dried up for junior mining explorers leaving many of them struggling to stay liquid. Also in the first quarter, investors redeemed a record $9.16 billion from gold exchange-traded funds, according to Dow Jones. As negative as this is for gold mining stocks, record-setting money outflows traditionally coincide with a market bottom.

• Fred Hickey, editor of The High-Tech Strategist, noted in his February issue “Up It Goes, Until It Blows – Round 3” that the Dow Jones Industrial Average had its biggest January gain in 19 years. Investor bullishness is approaching levels seen in 2007 and the CBOE Volatility Index is near multiyear lows. Hickey eloquently captured the enthusiasm of the market towards an investment in bullion at this point in the cycle, saying, “Gold? We don’t need no stinkin’ gold. You only need that when there’s fear.”

Opportunities

• Russian President Vladimir Putin continues to turn his black gold into bullion. After turning Russia into the world’s largest oil producer, Putin has turned the country into the biggest gold buyer. His claims that the U.S. is endangering the world economy by abusing its dollar monopoly have led Russia to seek safety in gold. The country added 570 metric tons of gold in the last decade, beating runner-up China by almost 150 metric tons. Gold has risen almost 400 percent since Putin’s first purchases. Building into sovereign purchases of bullion, Christopher Wood of CLSA noted in his latest article that central banks bought a net 145 tons of gold in the fourth quarter of  2012. Furthermore, central banks across the world purchased a whopping 535 tons of gold in 2012, making it the year with the greatest official demand for the metal since 1964.
• Rick Rule, Chairman and Founder of Sprott Global Resource Investments, gave his comments on the current state of the economy and what is coming for commodity prices. He argues the debasement of the U.S. dollar is the most likely outcome of the current situation, which he describes as follows: The U.S. Federal debt exceeds $16 trillion, off-balance sheet liabilities exceed $60 trillion, annual deficit is close to $3.6 billion. This means the country is attempting to service $76 trillion in debt with $2.5 trillion in revenue, while spending $3.6 trillion annually. He insists that no matter how many dollars we “counterfeit” by printing, the math simply does not add up. A U.S. dollar debasement will increase commodity prices around the world, making the outcome of the “unnerving” commodity markets quite predictable, even though the timing is not predictable.
• As if the Cyprus debate had not given savers enough to fear, Eurogroup’s Jeroen Dijsselbloem sent markets into a downward spiral when he stated the Cyprus bank restructuring plan should be seen as a template for the rest of the eurozone. The harsh rebuttals forced him to retract his statement, but the damage had been done. Investors around the world now know that the next EU bailout will likely take a similar form as the Cyrpus one; after all, politicians in countries like Germany and the Netherlands (Dijsselbloem’s home country) are finding it harder to justify bailouts to their electorates. We interpret Dijsselbloem’s statement as an open invitation to withdraw  without delay any savings from the bank and invest them in hard assets, especially gold.

Threats

• Gold’s bull market is over, according to Rene Hochreiter, Allan Hochreiter’s CEO, the top forecaster in the London Bullion Market Association’s 2012 poll. The fading of so-called fear trades is set to diminish the appeal for gold, said Tom Kendall, Credit Suisse’s head of precious-metals research, and the most accurate precious-metals forecaster in the past eight quarters tracked by Bloomberg.
• Yi Gang, a deputy Chinese central bank governor, said a 2 percent ratio of gold holdings to China’s total foreign exchange reserves is likely to be the limit. The People’s Bank of China (PBOC) last released data on its gold reserves in 2009, when it announced that it held 1,054 tons. There have been no revisions since then and it is speculated the PBOC has continued to accumulate gold reserves by purchasing domestic production. Yi Gang was quoted stating, “we can only invest about 1-2 percent of the foreign exchange reserves into gold because the market is too small.” His assertion serves to reinforce the theory that it is only a matter of time for the unprecedented monetary expansion and high debt-to-GDP ratios around the world to drive up prices of hard assets such as gold.

Past performance does not guarantee future results.

The Hang Seng Composite Index is a market capitalization-weighted index that comprises the top 200 companies listed on Stock Exchange of Hong Kong, based on average market cap for the 12 months. The Purchasing Manager's Index is an indicator of the economic health of the manufacturing sector. The PMI index is based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment. The Consumer Price Index (CPI) is one of the most widely recognized price measures for tracking the price of a market basket of goods and services purchased by individuals. The weights of components are based on consumer spending patterns.

The NYSE Arca Gold Miners Index is a modified market capitalization weighted index comprised of publicly traded companies involved primarily in the mining for gold and silver. The index benchmark value was 500.0 at the close of trading on December 20, 2002. The U.S. Trade Weighted Dollar Index provides a general indication of the international value of the U.S. dollar. The Philadelphia Stock Exchange Gold and Silver Index (XAU) is a capitalization-weighted index that includes the leading companies involved in the mining of gold and silver. The S&P/TSX Global Gold Index is an international benchmark tracking the world's leading gold companies with the intent to provide an investable representative index of publicly-traded international gold companies. The FTSE/JSE African Gold Mining Index is a market capitalization weighted index. (Returns are quoted as price return in the home currencies of each index. For example, the S&P/TSX Canadian Global Gold Index is calculated using Canadian Dollars.)

The Consumer Price Index (CPI) is one of the most widely recognized price measures for tracking the price of a market basket of goods and services purchased by individuals. The weights of components are based on consumer spending patterns. The Dow Jones Industrial Average is a price-weighted average of 30 blue chip stocks that are generally leaders in their industry. Chicago Board Options Exchange (CBOE) Volatility Index (VIX) shows the market's expectation of 30-day volatility.