PROPRIETARY RESEARCH REPORTING ANALYST: Radhika Kamath March 07, 2011

Transcription

1 PROPRIETARY RESEARCH REPORTING ANALYST: Radhika Kamath March 07, 2011 GOLD: A COMMODITY PLAY OR A SAFE HAVEN? ANALYZING GOLD S PERFORMANCE VERSUS OTHER METALS AND GOLD EQUITIES Gold prices have cooled-off since their historical highs in late 2010; however, most of the key macroeconomic price drivers point to continued momentum for bullion. Continuing weakness in the dollar, low to negative real interest rates, and rising global inflation expectations are likely to help extend gold s rally. Additionally, TED spreads (a key gauge of market fear) have fallen significantly from their 2008 peak, and are currently below their long-term trend line, suggesting that gold s recent rally is increasingly driven by inflation worries. Although gold has been on a relentless bull run since the start of the last decade, its performance lags in comparison to other precious and nonprecious metals. Silver and copper, for example, have outperformed gold over the last decade, and may therefore offer better high-beta commodity exposure. For those seeking an exposure to pure gold mining equities, our user-created Global Large Gold Miners Price Index may point to attractive opportunities over the longer term. The index has outperformed bullion over the last decade, as well as in the recent leg of the rally, proving the dominance of gold stocks over the underlying asset. Investors looking at the rapidly developing economies (RDE) space may want to consider adding Thomson Reuters BRIC Precious Metals & Minerals Index to their portfolio. The index has outperformed the Thomson Reuters Global Emerging Markets Precious Metals & Minerals Index and our user-created Global Large Miners Index since its base date (July 2006). Recent data from the Commitment of Traders (COT) report reveal that gold producers have been hedging faster than gold users, possibly suggesting a near-term neutral to bearish outlook for gold. However, money managers have added more long positions since early February, and their actions may be pointing to a bullish outlook. BACKGROUND Gold prices, after hitting historic highs in December 2010, witnessed some decline at the start of the year, with prices coming off by about 6%. However, the last few weeks have seen gold prices again edging higher, and they are currently just about 0.6% lower than their historic highs. With oil and other major commodities also continuing their ascent, what does that mean for gold? A November 2010 Thomson Reuters Proprietary Research study pointed to strong momentum for gold over the medium term, identifying strong global liquidity and low interest rates as support for a continued rally. Since that report, gold prices have risen by about 4%. In this new study, we revisit the gold rush theme: a) examining and comparing the performance of gold mining stocks at a regional/country level, b) shedding light on gold s key macroeconomic price drivers and its performance versus other metals, and c) gauging the short-term outlook based on the Commitment of Traders report. Product Insights provide our customers with a detailed look at how they can extract more value from Thomson Reuters products, often in the context of current market events. View all Thomson Reuters Proprietary Research subscription channels. All data sourced from Thomson Reuters Datastream, the world s market leading time series. It is available through a range of delivery platforms (via a desktop interface and Excel add-in or a dedicated data-download FTP site), and offers easy-to-use, focused and flexible tools to analyze, manipulate and display the data. Datastream includes more than 140 million time series, more than 10,000 data types and more than 3.5 million instruments/indicators. Learn more about Datastream and request a free trial Thomson Reuters. All marks herein are used under license.

2 METHODOLOGY Using Datastream s User-Created Index (UCI) functionality, we created a Global Large Gold Miners Price Index of the top 25 companies (based on market cap) at each year-end, for 2001 through Van Eyck's Falcon Fund (a global gold-focused mutual fund) holdings helped us identify all publicly traded gold mining companies extant each year, helping to ameliorate survivorship bias. We cross-referenced this list with the Thomson Reuters Global Precious Metals & Minerals Industry Price Index, to get historical market-cap data for for each constituent. Using the Thomson Reuters Global Precious Metals Index also ensures that each constituent has been filtered for free-float and liquidity. OBSERVATIONS Exhibit 1 shows the historical performance of gold bullion versus our user-created index of equities of large pure global gold mining companies. Over the last ten years (January 2001 December 2010), the movement in our Global Large Gold Miners Price Index has closely tracked gold price trends, with the two series showing a 90% correlation (Appendix: Exhibit 1). However, from a relative performance perspective, our Global Large Gold Miners index has outperformed the bullion, turning in a gain of 438% during the stated period, against gold s 419%. Exhibit 1. Historical Trends in Gold vs. Gold Mining Stocks Gold prices and index are rebased on January 01, Gold prices, after bottoming in October 2008, have rallied sharply, with prices nearly doubling since then. During the same period, large gold mining companies stocks (as represented by our UCI) have risen by 187% again proving their dominance over physical gold. However, the fact that the bullion has kept pace with the UCI, since mid-2008, may reflect an increased global risk premium on the back of the Eurozone debt crisis and fears of a double-dip recession, possibly leading to higher demand for the metal. The Picture by Region. We next turn our attention to relative performance of gold mining stocks across the major gold-producing countries. Exhibit 2 shows historical trends in the Global Large Gold Miners index (UCI) versus Thomson Reuters Precious Metals & Minerals indices for some of the large gold-producing countries Thomson Reuters. All marks herein are used under license. TRPR_51203_41 2

3 Exhibit 2. Historical Trends in Thomson Reuters Precious Metals Equity Indices of Major Gold-Producing Countries Indexes in the upper pane are rebased on January 01, 2001 and those in lower pane are rebased on July 03, Exhibit 2 s upper pane shows the outperformance of TR Precious Metals & Minerals indices for Canada, South Africa, US, and Australia versus our UCI over the last decade. The large-cap bias in the UCI may explain the relative underperformance against the TR indices, which have a multi-cap orientation. The TR US and Canada indices have significantly outperformed, gaining 1130% and 710%, respectively, from , versus 438% for our Global Large Miners Index, and 578% and 535% for the TR Australia and South Africa indices, respectively. While these four countries boast strong gold mining and exploration prowess, US-based miners have earned the reputation of being very substantial players, well funded and armed with strong acquisition competencies of regional markets. Further, they also enjoy higher production efficiencies due to their high investment in technology over the years. The fact that the TR US and Canada indices have historically had a larger weighting of pure gold mining companies (84% and 79%, respectively, as against roughly 60% and 48% for Australia and South Africa, respectively) may also have influenced the higher price returns of these indices. The TR US and Canada Precious Metals indices may therefore offer a good proxy for investors looking to play the gold mining equity space with North American exposure. However, over the last 12 months, the Australian and Canadian indices have outperformed their global peers (Exhibit 3), possibly reflective of the buyout premium, as gold miners increased their consolidation drive in these regions and as China upped its ante for prolific acquisitions. Kinross Gold s buyout of Redback Mining (Canada), and Lihir Gold s takeover by Newcrest Mining (Australia) in 2010, both underscore this. Exhibit 3. One-Year Performance Statistics Index 1-Year Price Return TR Australia Precious Metals & Minerals index 46% TR Canada Precious Metals & Minerals index 34% TR US Precious Metals & Minerals index 32% Global Large Gold Miners index 25% TR South Africa Precious Metals & Minerals index 17% 2011 Thomson Reuters. All marks herein are used under license. TRPR_51203_41 3

4 For investors looking at the rapidly developing economies (RDE) space, TR BRIC Precious Metals & Minerals index may offer a better bet; the index has delivered a price return of 124% since its base date of July 2006, as against 53% for the TR Global Emerging Markets Precious Metals index and 38% for our Global Large Miners index. With Chinese companies also expected to increase their acquisition pace in 2011, as they seek to expand gold output, the TR BRIC Precious Metals & Minerals Index may continue to enjoy a higher premium, and may therefore provide greater high-beta exposure. Macroeconomics. However, performance of mining stocks depends largely on movement in gold prices; as such, any correction in the price of bullion is likely to bring mining stocks under pressure. But we believe that the major macroeconomic forces (e.g., the US dollar, real interest rates, and inflation) are likely to work in favor of the bullion, thereby helping to keep prices buoyant. The US dollar has been on a secular downtrend for many years now, while gold prices have seen a near-linear uptrend (Exhibit 4). The dollar and gold have an inverse relationship over longer time periods; as the dollar s exchange value falls, it takes more dollars to buy gold, so the price of gold in dollars rises. Conversely, when the dollar s exchange value rises, it takes fewer dollars to buy gold, so gold s dollar price falls. Exhibit 4. Historical Trends in US Dollar, Federal Budget Balance and Real Interest Rates Among other factors, rising deficits may have been working against the dollar, leading to a decline in its value against major currencies. Since 2001, the trade-weighted value of the dollar against major currencies has fallen by about 30%, while the US federal budget balance has swung from a surplus of 1.2% in 2001 to a deficit of 8.9% in 2010 (Exhibit 4). The US federal budget deficit reached a high of 10% in 2009, and while it is projected to fall over the next few years, any additional bond-buying programs by the Fed to prime the economy are likely to exert downward pressure on the dollar potentially extending gold s rally. One also needs to keep in mind the growing rhetoric surrounding reserves diversification by central banks across the globe, which is also likely to result in further erosion of the dollar, over the longer term. Real interest rates also have a significant bearing on gold prices. During low to negative real interest rate periods, holding dollars via Treasury bills or notes would yield a negative return, so investors turn to gold as a store of value, thereby driving up prices. Real rates (the difference between the one-year Treasury yield and the annual inflation rate) have remained negative in the US since late 2009, propelling gold to higher levels (Exhibit 4). Real interest rates based on the latest data (January 2011) stand at -1.4%, and should help support gold prices over the near to medium term. Rising inflation expectations also appear to be aiding gold s ascent. The expected global inflation rate over the next six months as measured by the IFO World Economic Survey has risen from 5.9% in Q to 6.6% now, which is above the linear trend line (Exhibit 5). With food inflation already hitting headlines in some of the Mideast and Asian markets, rising agri-commodity and energy prices, along with continued expansionary policies in the West, are likely to keep inflation expectations on the higher side again a positive for the bullion Thomson Reuters. All marks herein are used under license. TRPR_51203_41 4

5 Exhibit 5. Trends in the Global Expected Inflation Rate and TED Spreads Also, the fact that TED spreads 1 have fallen significantly since their 2008 peak, and are currently below the long term trend line (Exhibit 5), perhaps suggests that this recent leg in gold s rally is increasingly driven by inflation worries. This is different from 2007 s gold rally, which was driven largely by panicky market behavior reflected in the spike in TED spreads, as investors rushed to gold as a safe-haven investment. Commitment of Traders. Trends in the positions of various classes of gold futures traders can also help gauge market direction. The Commitment of Traders (COT) report from the Commodity Futures Trading Commission (CFTC) provides a snapshot of positions held by traders in various commodities. Exhibit 6 shows the last six months trends in net positions 2 of various classes of traders classified under CFTC s disaggregated 3 COT report. 1 TED spreads are calculated as the difference between 3-month interbank rate and the interest rate on 3-month US Treasury bills. 2 Net positions are calculated as the difference between total long and short positions. 3 The disaggregated COT report splits the broad commercial category from the legacy COT report, pulling out swap dealers to reveal true producers positions, adding granularity and transparency to true commercial hedgers activities. Noncommercial trading is disaggregated into professional money managers and a wide array of other reportable traders. Exhibit 6. Six-Month Look at Net Positions of Disaggregated COT Report s Trader Categories 2011 Thomson Reuters. All marks herein are used under license. TRPR_51203_41 5

6 Net positions of producers/users ( commercial hedgers ) have been increasing since their previous lows in November 2010, suggesting that gold users have been increasing hedging at a faster rate relative to gold producers. However, in the last three weeks, net positions have been declining, while gold has risen by about 3.5%, and may suggest increased hedging activity by sellers reflecting their strong need to lock in higher prices, and pointing to a neutral to bearish near-term outlook. Swap dealers have been adding more short positions in the last few weeks than long, and this may indicate that they are turning bearish. Money managers (the smart money ) have been reducing their net positions since their October 2010 highs, and this may be indicative of some profit-taking as gold prices made historic highs in December However, since early February, their net positions have increased 36%, as gold prices trended upward (about 6%) since their pullback in January. Money managers recent actions point to increased buying interest and may suggest a near-term bullish outlook. As far as the Other reportables category, it largely consists of small traders, and the activity of this group is often considered to be a contrary indicator as these traders tend to bet against the big boys (large speculators). Further, they are also known to be wrong at the market extremes; currently their net positions are the lowest in the last six months and may again be a bullish indicator. Comparison to Other Metals. Lastly, we look at gold s performance versus other precious and industrial metals, to help identify high-beta commodity plays. Exhibit 7 shows gold prices plotted against prices of other precious and nonprecious/industrial metals over the last decade. Exhibit 7. Historical Performance Trends Gold vs. Other Metals Prices are rebased on January 01, Shading indicates US recessionary periods. Silver has clearly been the leader in the pack, turning in a price return of about 570% from 2001 to 2010, followed by copper at 434%, as against gold s 419% gain. This may be supportive of the view that gold, not being a real store of value in an industrial sense, may provide less commodity value and therefore may not be the best high-beta commodity play. Conversely, gold s widely claimed status of being a safe haven, especially in tough economic environments, becomes evident when looking at gold s returns vis-à-vis other metals. The last decade witnessed two recessions the dotcom bubble burst from March November 2001, and the subprime/housing crisis from December June During both these recessions, gold delivered the highest (and positive) returns, while most other metals generated negative returns (Appendix: Exhibit 2). In the recent leg of the rally that began toward late 2008/early 2009, palladium has seen a sharp ascent, with prices rising about 330%. Copper and silver are next, with price gains of 221% and 202%, respectively. Gold takes the last place, with a return of 63%, behind the 68%, 99%, and 109% returns for aluminum, platinum, and zinc, respectively Thomson Reuters. All marks herein are used under license. TRPR_51203_41 6

7 CONCLUSION Though gold prices have come off by about 0.6% since their historical highs in December 2010, most of the key macroeconomic price drivers point to continued momentum for bullion. Ongoing dollar weakness on the back of higher budget deficits in the US, coupled with likely diversification of central banks reserves into non-us dollardenominated assets, is likely to help extend gold s secular bull-run. Further, negative real interest rates in the US and rising global inflation expectations are likely to lend buoyancy to gold prices over the near to medium term. While fear has been quite a strong factor influencing gold s rallies in the past, the recent leg of the rally appears to be driven more by inflation worries, at least according to TED spreads. Comparison of gold s historical performance with other precious and nonprecious metals, reveals that silver has been an outperformer, delivering a price return of 570% over the last decade, followed by copper s 434% gain, as against gold s 419% rise. This may imply that while gold is a store of value and a safe haven, especially in a tough economic climate, it may provide less commodity value and therefore may not be the best high-beta commodity play over the longer term. Other precious metals, such as silver, and nonprecious metals, such as copper, could be better bets for investors looking at high-beta commodity exposure. For those seeking exposure to pure gold mining equities, our user-created index (Global Large Gold Miners Price Index) may point to attractive long-term opportunities. The index has outperformed bullion over the last decade, as well as in the recent leg of the rally proving the dominance of gold stocks over the underlying asset. For investors looking at the rapidly developing economies (RDE) space, TR BRIC Precious Metals & Minerals index may offer a better bet; the index has outperformed the TR Global Emerging Markets Precious Metals index and our user-created Global Large Miners Index since its base date (July 2006). With Chinese companies expected to increase their acquisition pace this year, too, as they seek to expand gold output, the TR BRIC Precious Metals & Minerals index may continue to enjoy a higher premium, and may therefore provide greater high-beta exposure Thomson Reuters. All marks herein are used under license. TRPR_51203_41 7

8 APPENDIX Exhibit 1. Historical Correlation of Gold vs. Global Large Gold Miners Index Exhibit 2. Price Performance of Gold vs. Other Metals Price Returns (%) Recession (Mar - Nov 2001) Recession (Dec Jun 2009) Gold Silver Platinum Palladium Copper Aluminum Zinc Thomson Reuters. All marks herein are used under license. TRPR_51203_41 8

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