Gold. Listless Amid Calmer Macro Environment JULY Mark Allen Nondini Chakrabarti

Transcription

1 JULY 2014 Gold Listless Amid Calmer Macro Environment A special report by the Portfolio Advisory Group RBC Dominion Securities Inc. Mark Allen mark.d.allen@rbc.com Nondini Chakrabarti nondini.chakrabarti@rbc.com For Important Disclosures, see page 5. Priced as of market close, July 18, 2014 (unless otherwise stated).

2 While the price of gold has multiple drivers, we believe at its core the price of gold is in many ways driven by investor whimsy. For the decade leading up to 2012, the price of gold increased at a CAGR of 17%, with double-digit growth in seven of those 10 years. Then, in 2013, the price of gold plunged 28%. If we look back at the two most favourable periods for gold the 1970s and the 2000s while traditional factors such as supply and demand likely played a role, the larger driver was an investment climate punctuated by rising fear of systemic risks. Now, we believe that these systemic risks have begun to take a backseat over the past 18 months, which has coincided with a weakening gold price. Combined with a backdrop of rising mine supply, our outlook for gold is muted. Scarcity of Value and Supply Throughout history gold has played a role as a store of value because of its scarcity. Not only are existing stocks of gold rare, but also finding new sources has proven increasingly difficult. Across existing mines, grades have fallen steadily over the last decade with major North American producers seeing mined grades drop from nearly 2.0 grams per tonne (g/t) 10 years ago to about 1.3 g/t today. Furthermore, despite a surge in exploration spending, the pace of discovery for economic ore bodies has fallen. These long-term supply trends have been supportive of gold s steady price ascent for most of the past decade. However, a buoyant price environment in the years following the global financial crisis has encouraged a period of substantial mine expansion. After a long period of global gold production remaining broadly in the range of million ounces per year, production rose in , reaching 96 million ounces per year by 2013 and peaked in Q at an annualized rate of 103 million ounces per year. With capital spending (capex) budgets coming down last year in the face of lower gold prices, mined supply may decline going forward. Global Gold Production Annualized Global Production (MMoz) Source - World Gold Council, Veritas, RBC Wealth Management PORTFOLIO ADVISORY GROUP SPECIAL REPORT JULY 23,

3 Long-Term Demand Trends 5,000 Jewellery Coin & Bar ETF Technology Central Banks 4,000 Global Demand (tonnes) 3,000 2,000 1, ,000-2, Source - World Gold Council, RBC Wealth Management Demand Shift in Long-term Demand Trends A decade ago, jewellery was the dominant driver of gold demand, comprising almost 95% of total tonnes purchased. While jewellery remains the single largest component of demand, the total tonnage of gold used for jewellery is lower than it was 10 years ago. The most significant upturn in demand has been from coin and bar, which has climbed more than fivefold from about 300 tonnes in 2003 to nearly 1,600 tonnes in The second major change has been central bank activity. Central banks were previously net suppliers to the market for the two decades leading up to the global financial crisis. Since then, central banks have become in aggregate significant buyers of gold. The swing from net seller to net buyer represents about 1,000 tonnes of demand (when comparing 2013 net purchases to 2003 net sales). Current Demand Trends ETF Activity More Stable ETF activity played a key role in the market sell-off last year. Gold has historically held an inverse relationship with real interest rates, and an expected wind-up of the Fed s quantitative easing program led many ETF investors to liquidate. ETF selling pressure was substantial throughout 2013, but stabilized in early 2014, influenced by political uncertainty in Ukraine. Global Gold ETF Holdings Global ETF Gold Holdings (MMoz) Oct-03 Oct-04 Oct-05 Oct-06 Oct-07 Oct-08 Source - Bloomberg, RBC Wealth Management Oct-09 Oct-10 Oct-11 Oct-12 Oct-13 PORTFOLIO ADVISORY GROUP SPECIAL REPORT JULY 23,

4 Central Banks Buying Again Central bank buying softened in 2013 with full-year demand down by about one-third from the 2012 level. This trend reversed course in Q as central bank buying returned to the levels seen in the first quarters of recent years. Jewellery Adds Some Lustre Despite the long-term trend shifting to modest declines in demand from jewellery, it has provided a source of strength over the last four quarters as lower prices have encouraged consumption. Bar and Coin a Mixed Bag Demand for bars and coins has moderated in the last three quarters, led by India. In 2013, India introduced gold import rules aimed at restoring its current account balance to health. The first rule imposed a 10% import duty, and the second, known as the 80:20 rule requires 20% of imports to be reexported before further imports are permitted. Since implementing these rules, India s current account balance has markedly improved. It was hoped that new Indian Prime Minister Narendra Modi might loosen these import rules, but no action was taken in his administration s first budget. Coin and bar purchases in China remain robust, at levels similar to those observed in Gold remains an important tool for savings in China, which has grown substantially since it opened its domestic retail market for gold in With rising individual wealth, physical demand from China has expanded to become a large and potentially rising long-term component of global demand. Gold Price Outlook: The Fear and Risk Conundrum The biggest challenge in forecasting the outlook for gold is that it does not tend to track the same supply/demand drivers as other commodities. Rather, the price of gold is often driven by factors that are in some ways more difficult to measure. These factors usually revolve around issues of fear and systemic risk in the financial system. When these are front and centre in investors minds, the gold price tends to enjoy a strong tailwind, as was the case in the 1970s and 2000s. However, when fear and systemic risk are on the wane as may be the case over the past two years the price of gold tends to lose momentum. Forecasting fear and systemic risk on a go-forward basis is challenging to say the least. But we believe that global policymakers seem much more attuned to the problems facing the financial system than they were a few years ago, and this should continue to lessen systemic risks in the financial system. Given global debt levels and the still-tenuous nature of the recoveries in Europe, Japan, and to a lesser extent the U.S., we do not expect this systemic risk quotient to dip sharply anytime soon; however, a gradual diminution may be the base case over the next 5 10 years, in our view. Against this backdrop, we believe other factors will play a role: Inflation: For the near term, inflation appears in check with Europe just emerging from recession and wage pressure in the U.S. unlikely, given under-employment in its labour force. Real interest rates: Interest rates appear to be on a slow path to normalization, albeit with a pause in recent months. Demand trends: Demand trends are mixed with ETF activity more stable, jewellery demand up, central bank buying gyrating, and India an unknown. Mine supply: Capex budgets have been reined in; however, many major projects continue to move forward. While supply may fall away, we would expect this to take time. With the likely gradual decline in systemic risk, a mixed set of macro drivers, and levelling supply/demand trends, our outlook for the price of gold is muted. We continue to like gold as a hedge against unforeseen global events. But this enthusiasm is tempered by our belief that there will be a gradual normalization of the U.S. and global economies. PORTFOLIO ADVISORY GROUP SPECIAL REPORT JULY 23,

5 AUTHORS Nondini Chakrabarti, Generalist RBC Dominion Securities Inc. Mark Allen, Portfolio Advisor RBC Dominion Securities Inc. DISCLOSURES AND DISCLAIMER Important Disclosures Explanation of RBC Capital Markets, LLC Equity Rating System An analyst s sector is the universe of companies for which the analyst provides research coverage. Accordingly, the rating assigned to a particular stock represents solely the analyst s view of how that stock will perform over the next 12 months relative to the analyst s sector average. Although RBC Capital Markets, LLC ratings of Top Pick (TP)/Outperform (O), Sector Perform (SP), and Underperform (U) most closely correspond to Buy, Hold/Neutral and Sell, respectively, the meanings are not the same because our ratings are determined on a relative basis (as described below). Ratings: Top Pick (TP): Represents analyst s best idea in the sector; expected to provide significant absolute total return over 12 months with a favorable risk-reward ratio. 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