Gold equities were essentially unchanged for the month, with a 0.4% gain in the NYSE Arca Gold Miners Index (GDM) while junior goldstocks suffered year-end selling pressure, falling 5.1% for the month (Market Vectors Junior Gold Miners Index, MVGDXJ).
Other than a sluggish housing market, US economic reports issued in December showed the economy firing on all cylinders; payrolls, manufacturing, auto sales, retail sales, and consumer sentimentall came in above expectations. While the Federal Reserve reported that household debt (as a percentage of disposable income) was at levels last seen in 2003, and third quarter GDP was revised higher to 5.0%.
With US interest rates among the highest of developed countries and the Fed poised to raise them, there is a good chance that much of the USD 1.3 trillion of QE forecast (by Credit Suisse) to flow into the financial system from the top four central banks in 2015 will windup in US assets. The parabolic rise the dollar has experienced since September looks set to continue as inflation is absent and the stockmarket is strong. It is hard to argue with anything but a rosy outlook for the US economy.
This is not a positive macroeconomic environment for gold. In order to see lasting strength in the gold price, typically investors must sense problems with the US economy or fundamental cracks in the US financial system. But without this, are there any opportunities for gold investors?
First, gold should be used primarily as a portfolio diversifier and hedge against tail risk. It has little correlation with other financial assets. When other parts of a portfolio are doing well, expect gold toperform poorly. Conversely, when mainstream investments struggle, gold may perform well. We think of gold as a form of portfolioinsurance and, as turns in the gold market are notoriously difficult to time, many investors maintain a permanent allocation.
Second, the currently rosy outlook for the US is not new. Indeed, elements of it were a factor when gold first collapsed in April 2013 and now form a part of the broader market consensus. Accordingly, much of this outlook is already reflected in the gold price and maybe the reason gold is proving so resilient around the USD 1200 level; where it has hovered for the past 18 months.
Finally, it is possible that the outlook will become even rosier through 2015 if the global economy responds positively to QE and joins the US in synchronised global growth, providing further difficulties for gold. Despite the good intentions of policy makers, however, there are a number of risks that might keep the rosier outlook at bay. The most immediate of which is the Greek election set for late January, which may produce a government that is hostile towards European Union austerity and may seek to default on sovereign debt. Looking further out, Russia has proven itself unpredictable and willing to engage in aggression that goes against Western norms. Low oilprices could weaken the Russian economy to some sort of breakingpoint where leadership becomes increasingly irrational and disruptive to the global economy.
Lower oil prices may not last. While the marginal cost of producing the unconventional US oil that created the current glut is around USD 70 per barrel, WTI crude ended the year at USD 53.71. Cuts in rig count and a demand response could cause crude to rebound. Additionally, the government could work to stifle this energy boom. Indeed, fracking was banned in the state of New York and the Obama administration announced plans to impose new regulations on the oiland gas industry in December.
In our view, however, the biggest current risk to financial stability is the radical ongoing monetary policy which, in 2015, will amount to the equivalent of over a trillion US dollars destined for sovereign bond and other financial asset purchases. The Swiss National Bank has introduced negative interest rates aimed at devaluing the Swiss Franc. The intended benefits to local economies, however, may not materialise. In the US, QE was effective at pumping up asset prices, but was not so good at stimulating the real economy from the bottom-up.
While consensus calls for Fed rate increases in 2015, since the credit crisis the Fed has always found a reason to postpone any increase. There are interesting parallels between the current globaleconomy and that of the 1997/98 Asian financial crisis. Both periods shared weak economies in Asia and Russia, falling commodities prices, and a robust US economy. The late nineties saw the techrevolution, while today we are experiencing an energy revolution through unconventional drilling technology. Despite the strong US economy and benefits of technology, the Fed chose to cut rates in late 1998 in response to the weak global economy and a sharp drop in US stocks. This helped propel a bubble in tech stocks that collapsed catastrophically less than two years later. It will be interesting to see whether international events again influence the Fed to pursue accommodative policies in 2015, as it did in 1998.
Joe Foster, Portfolio Manager, LOF World Gold Expertise
