A new gold bull market

A higher gold price largely correlates to investors’ increasing unease about a weakening global financial system. Investors are realising that central bank policies are no longer effective and have run their course without accomplishing their intended results. There is a growing belief that central banks are running out of options to stimulate economies and even though 2016 has already been among the most volatile on stock markets since the GFC, fear remains of more economic surprises ahead including uncertainty around the US election.

Following the June 23 Brexit shock, gold rallied to two-year highs reaching US$1,375 per ounce on 6th July. Then in the US, surprisingly strong economic results in manufacturing, retail sales and housing created US dollar strength which resulted in gold declining to US$1,310 per ounce on 21st July. However, as was the case throughout the post-crisis expansion, good economic news doesn’t last long and July ended with disappointing durable goods and pending home sales reports, along with second quarter GDP growth of just 1.2%.

This type of disappointing data continues to fuel investor’s uncertainty and support demand for gold as a safe haven asset. As gold mining stocks provide leverage to the gold price, it is no surprise that they have also enjoyed another surge higher in July with the VanEck Vectors Gold Miners ETF (ASX code: GDX) gaining 7.95%. 

Such strong gold equity gains are typical in the early stages of a gold bull market. For example, the S&P/ASX All Ordinaries Gold Index gained 49.51% and 45.76% in 2001 and 2002, the first years of the 2001 to 2011 gold bull market. Similar returns were experienced globally and while there were no subsequent years that matched those returns, there were many years during that Bull Run in which gold miners experienced double digit returns that outpaced gold’s performance over the same timeframe.

Outlook

The outlook for a strong gold price is supported by the ineffective monetary policies of central banks.  Policy makers seem to be focused on solutions to previous problems without realising that excesses are going to create additional issues. For example, an odd thing happened after Brexit - stocks ignored the risks Brexit posed to the global economy and stock markets such as the S&P 500 advanced to all-time highs. Markets rallied in the belief that more central bank stimulus would be forthcoming. Bonds also moved to all-time highs. The traditional negative correlation between bonds and risk assets, including stocks, no longer applies thanks to meddling by central banks that have caused asset price inflation (or bubbles) in both these asset classes.

Negative yielding sovereign debt in Japan and Europe totals over US$13 trillion now, according to a recent Bank of America Merrill Lynch analysis. We believe US rates may not be far behind with cash deposits there barely yielding 0.05%. Negative yields lock in a capital loss if held to maturity. The only way to come out ahead is when negative yields are accompanied by deflation in excess of the yield rate. However, deflation comes with its own drawbacks, namely, bank failures, job loss and depression. Without deflation, there is a limit to how much further yields can fall and for how long they stay in place before savers abandon the banking system to hold cash, despite the inconvenience that option brings. Or perhaps as an alternative, they look to hold gold since it exists outside of financial authority, cannot be a target of financial repression and carries virtually no counterparty risk.

As central banks buy up more bonds and more bonds move into negative yields, investors search among a smaller pool of substitutes and trades get crowded for higher risk alternatives. According to the Wall Street Journal, higher prices for stocks, bonds and real estate have caused net wealth to swell to over 500% of national income in the US. This has happened only twice historically - just before the tech and housing busts.

By definition, black swan events are nearly impossible to predict however with the imbalances and extremes present in the markets today, we must assume that the odds are increasing for a calamity. The further bond prices rise (and rates fall) the greater the risk is to bond values from even moderate increases in inflation and interest rates. One possible crisis scenario might involve higher than expected consumer price inflation that crushes negative yielding bonds, causing liquidity to dry up as investors rush for the exits and sell assets to cover losses.

Mervyn King, Governor of the Bank of England from 2003 to 2013, was interviewed in the World Gold Council’s June 2016 edition of Gold Investor and said, “The risk is that we just muddle through with a prolonged period of very low growth. The longer that goes on, the more output we will have lost in the interim. And in the long run, it makes another crisis more likely because, if everyone is relying on monetary policy and it isn’t the answer, we won’t get back to a new equilibrium. We do need to make that jump at some point so the question is do we get there as a result of active, conscious policy decisions and cooperation between countries or will it only happen as the side-effect of another crisis.”

There was heavy investment demand for gold following the 2008 financial crisis. We are seeing a similar level of investment demand in 2016, as many are preparing their portfolios for the next possible crisis. Gold bullion and gold shares declined with other markets in the massive sell off in 2008. However, both gold and gold equities bottomed in October 2008 and then made a strong recovery. The action in the current gold markets indicates that investors have become more proactive, buying gold as a hedge against future turmoil. This suggests that gold is now more broadly recognised as a hedge against financial stress. With this recognition, if there is another crash, perhaps gold will not see the same selling pressure as the broader markets.

Australian investors can hedge their portfolios too by investing in VanEck’s Gold Miners ETF.  Available on ASX, GDX is the world’s largest gold miners ETF and gives investors instant access to a diversified portfolio of 49 global gold mining companies in a single trade on ASX.

With nearly 50 years of experience managing gold equities, VanEck has the longest tenure among global asset managers in the gold sector.

If you would like more information on GDX please contact our ETF specialists on 02 8038 3300 or email us at info@vaneck.com.au

IMPORTANT NOTICE: Issued by VanEck Investments Limited ABN 22 146 596 116 AFSL 416755 (‘VanEck’). VanEck is a wholly owned subsidiary of Van Eck Associates Corporation based in New York, United States. VanEck Vectors ETF Trust ARBN 604 339 808 (the ‘Trust’) is the issuer of shares in the VanEck Vectors Gold Miners ETF (‘US Fund’). The Trust and the US Fund are regulated by US laws which differ from Australian laws. Trading in the US Fund’s shares on ASX will be settled by CHESS Depositary Interests (‘CDIs’) which are also issued by the Trust. The Trust is organised in the State of Delaware, US. Liability of investors is limited. Van Eck Associates serves as the investment adviser to the US Fund. VanEck, on behalf of the Trust, is the authorised intermediary for the offering of CDIs over the US Fund’s shares and issuer in respect of the CDIs and corresponding Fund’s shares traded on ASX.

This is general information only and not financial advice. It does not take into account any person’s individual objectives, financial situation or needs. Investing in international markets has specific risks that are in addition to the typical risks associated with investing in the Australian market. These include currency/foreign exchange fluctuations, ASX trading time differences and changes in foreign regulatory and tax regulations.  Before making an investment decision in relation to the US Fund you should read the PDS and with the assistance of a financial adviser consider if it is appropriate for your circumstances. The PDS is available at www.vaneck.com.au or by calling 1300 68 38 37.

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