3 Drivers, 2 Months, 1 Gold
Rally?
By Frank Holmes
CEO and Chief Investment Officer
U.S. Global Investors
Posted Nov 10, 2011
Federal Reserve Chairman Ben Bernanke announced last week that
the Federal funds rate will stay near zero for now. He reasoned
that the “low rates of resource utilization and a subdued
outlook for inflation over the medium run” would likely
“warrant exceptionally low levels for the federal funds
rate at least through mid-2013.”
This will likely translate to the real interest rate (which
is the rate of interest an investor can receive on a U.S. Treasury
bill after allowing for inflation) remaining negative for at
least another year and a half.
For gold investors, a low-to-negative interest rate has been
associated with a powerful historical trend. Going back four
decades, gold has experienced positive higher year-over-year
returns whenever the real interest rate tipped below 2 percent.
And the lower the rates drop, the stronger gold tends to perform.
Marc Faber, editor of the Gloom Boom
& Doom Report, believes the Fed will keep rates near zero
even longer than 2013. In his November commentary, he points
to the opinion of Chicago Federal Reserve Bank President Charles
Evans, who wants the Fed to “commit itself to keep short-term
rates at zero until the unemployment rate falls below 7 percent
or the outlook for inflation over the medium term goes above
3 percent.” If Evans has his way, Dr. Faber extrapolates
that rates could “stay at zero for five or even 10 years
(and negative in real terms).” Based on Dr. Doom’s
prediction, one could infer that gold could continue its bull
run for several years to come.
This rate-cutting trend is not only an American phenomenon, as
other countries have been slashing their interest rates. In surprise
moves, the central banks of Europe, Brazil, Indonesia and Turkey
have all recently cut rates. This week, the European Central
Bank surprised markets when it cut its key interest rate by 0.25
percent. Brazil has cut rates twice over the past two months,
and Turkey cut its benchmark interest rate a few months back
as part of an unorthodox move to keep its economy from overheating.
Many investors follow the Fed’s decisions, but to see countries’
rate changes in action over the years, The Wall Street Journal
put together an interesting interactive showing how countries
around the world have increased or decreased their interest rates
over the past several years. Check
it out now.
The other strong action central banks have been taking is loading
up on gold. In Perfect
Storm Creates Tidal Wave of Gold Demand, we discussed how
the trend of gold buying by central banks in the East has been
increasing while the Western central banks have ceased selling
their gold. Now Turkey’s central bank is trying to manage
liquidity in the banking system by allowing banks to keep up
to 10 percent of their required reserves against lira liabilities
in gold.
Bloomberg News reported that if Turkish banks fully allocate
that 10 percent, it will free up $3.1 billion in liquidity.
This has followed a similar move by Turkey’s central bank
to allow private banks to hold an increased percentage of their
reserves against foreign-currency liabilities. Since that change,
21.6 tons of gold were added. According to Bloomberg News, another
55 tons of gold could be added after the new adjustment goes
into effect on November 11. This would bring the total gold reserves
in the Turkish central bank to a value of $10 billion.
‘Tis the Season for Gold
Combine the central bank purchases of gold with the fact
that we are now entering the strongest months of the year for
gold. The chart from Bank of America Merrill Lynch (BofA) below
shows how gold and gold equities have performed on an average
monthly basis over the past 10 years. While the spot gold price
has differed from the S&P/TSX Composite Index of gold equities
during the first 10 months of the year, their historical pattern
is very similar during the last two months. November has historically
been the strongest month of the year for gold equities, with
mining stocks increasing 8.1 percent.
Combined with equity valuations at historically
low levels, BofA believes, “gold equities could follow
the historical pattern in late 2011.”
The argument for a rally in gold and gold equities this time
of year is strengthened when we compare the seasonal patterns
over different time frames. I often show gold’s historical
patterns when I present my Goldwatcher Presentation to emphasize
how strong these last months of the year have been over every
time period.
The 5-year pattern has strayed from the longer-term historical
patterns, particularly before the October timeframe. For the
past five years, the gold price has started the year weak, and
then moved considerably higher than its 15- and 30-year historical
average from February through September.
However, over the 5-, 15- and 30-year patterns, the trends in
November and December have mimicked each other.
BofA says a key driver of this late-year
gold trend has been increased jewelry demand for the Christmas
buying season. We agree wholeheartedly, as the gift giving season
around Christmas drives many consumers to purchase gold jewelry
for their loved ones. And despite consumer sentiment remaining
near a record low, the National Retail Federation anticipates
holiday sales rising a modest 2.8 percent this November and December.
In India and China, people are especially amorous of the metal
and buy gold out of love. It is customary in most developing
countries to give gold as a gift to friends and relatives for
birthdays, weddings and to celebrate religious holidays. And
this time of year, gift giving in the form of gold is especially
strong in India. Indians recently celebrated Diwali, which spurs
gold buying during a five-day celebration of good over evil,
light over darkness, and knowledge over ignorance (Read the Frank
Talk post on Diwali). Diwali is followed by the main Indian wedding
season where many Indians will be buying golden gifts for the
bride and the groom. In China, 2012 is the “Year of the
Dragon” and retailers expect to sell gifts in the form
of gold dragon jewelry, pendants, statues and coins.
Gold investors should remember that volatility swings both ways.
If you look at 10 years of data, gold bullion has had 10 percent
price swings about 7 percent of the time. These ten percent swings
are more common for gold equities, as the NYSE Arca Gold BUGS
Index has had 10 percent swings over 20 trading days about a
third of the time.
With three drivers - 1) negative real interest rates propelling
investors to seek gold for it’s perceived “safe haven”
qualities, 2) the Love Trade in full bloom, and 3) central banks
increasing their holdings in the yellow metal - happening over
the next two months, gold is one commodity that could benefit.
 Frank Holmes
###
U.S. Global
Investors, Inc. is an investment management firm specializing
in gold, natural resources, emerging markets and global infrastructure
opportunities around the world. The company, headquartered in
San Antonio, Texas, manages 13 no-load mutual funds in the U.S.
Global Investors fund family, as well as funds for international
clients.
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Past performance
is no guarantee of future results.
The NYSE Arca
Gold BUGS (Basket of Unhedged Gold Stocks) Index (HUI) is a modified
equal dollar weighted index of companies involved in gold mining.
The HUI Index was designed to provide significant exposure to
near term movements in gold prices by including companies that
do not hedge their gold production beyond 1.5 years. The S&P/TSX
Composite Index is a capitalization-weighted index designed to
measure market activity of stocks listed on the TSX.
All opinions
expressed and data provided are subject to change without notice.
Some of these opinions may not be appropriate to every investor.
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