Gold prices have further to fall
When people talk about “the perfect storm,” they’re almost never talking about the weather any more. Instead, high and low pressure points, downdrafts, forecasts and the collision of hot and cold air have become the language of global financial markets rather than meteorologists.
Currently, the direst terms apply to gold and its relentless battering. The only things about the precious metal that glitters these days are the tears in the eyes of mining company executives and disappointed gold bugs.
But it’s also particularly bad news for Canadian markets which are extremely leveraged to energy and mining stocks – both of which are under intense downward pressure.
That’s why Canada has the worst-performing stock market of all G-7 countries – including Greece and Spain – so far this year. The TSX is down about three per cent in the first six months of 2013, compared with an almost 15 per cent rise in U.S. stock prices. Gold stocks are down 46 per cent over the past six months.
Given the stubbornly strong preference that Canadian investors display for keeping their money invested at home, that’s a big potential problem for everyone – especially for those who depend on income from investment or pension funds.
In the second quarter of 2013, gold spot prices fell by almost 23 per cent, the biggest quarterly loss since 1968. Below $1,200 an ounce, it’s now at its lowest price since August 2010.
And chances are pretty good that it’s got some distance left to tumble.
By way of context, while it’s about 30 per cent off its 2011 peak, gold is still well above the pre-recession trading range of $400 to $600 an ounce.
Furthermore, the conditions that made it such a popular “safe haven” investment for the past several years have by no means dissipated.
Destabilizing factors like the sovereign debt crisis, fragile economic growth, nascent inflation, and currency devaluation caused by longer-than-expected quantitative easing are still dark clouds.
The issue is that several traditional sources of price support have been subdued, while more sophisticated gold-levered financial products such as exchange-traded funds have provided new sources of downward pressure. (ETFs have ditched 550 tons of gold since mid-February, which is the equivalent of adding over 10 per cent to the amount already being produced by miners.)
Historically, consumers in India and China represent half the world market for physical gold and step in to buy it when prices fall. That happened in April, but since then things have changed.
In India, the world’s single-largest bullion consumer, soaring gold import levels and a 40 per cent decline in the value of the rupee against the U.S. dollar has pretty effectively quenched demand.
The Indian government recently raised the import duty to eight per cent to get a better grip on a surging current account deficit and the central bank has banned the use of gold jewelry and coins as collateral for loans.
In China, the second-largest consumer market for gold, an economic slowdown and fears of a possible credit crunch have also weakened demand.
Evidence that the U.S. economy is on the road to recovery has been one of the single greatest sources of pressure on gold prices. That was further exacerbated by the latest economic data.
There have been strong gains in U.S. orders for durable goods and consumer spending in May exceeded expectations. Year-over-year spending was up 1.8 per cent and personal income rose 1.1 per cent.
That sort of data has had a ripple effect: it has given equity markets a boost and created the sense that it’s no longer necessary to cower in the safety of gold holdings. (Despite the fact that annualized growth forecasts have been significantly revised to 1.8 per cent from 2.4 per cent.)
The Federal Reserve Board’s indication that its stimulus program for the U.S. economy may begin to gradually wind down, has re-affirmed the belief that the U.S. economy is on track to recover and the time has come to look for investment opportunities to leverage that.
There is also – at least so far – a sense that inflation is well in hand, even as the U.S. economic engine stars to rev.
Further down the road when interest rates rise and liquidity is tightened, returns on fixed income products will increase as well. Gold loses out there as well because it doesn’t pay an income stream.
All of this is deeply threatening for gold producers – and for those who own their shares. Most of them have already alluded to measures ranging from restructuring and cutting back their operations to reviving the hedging strategies most of them ditched when gold prices began to soar.
Most analysts consider a commodity price of about $1,200 an ounce to be the trigger point for project delays, capital spending cuts and layoffs. They note that profit margins are already razor thin for many gold producers.
The thing about perfect storms, of course, is that the storm clouds alone cause panic. And the prospect of renewed hedging and spending cuts is driving gold stocks – and the TSX - even lower.
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