June 30, 2014
Geopolitical unease and inflation set gold on the starting blocks
The rising geopolitical risks and recent inflation figures highlight the positive fundamentals
on precious metals. A return of the bull market?
Oil and Silver Prices (June 2014)
Key Points:
- Geopolitical risks support the rise of gold and
silver in June.
- The likely rise in oil prices will affect price indices
(CPI and PPI).
- Strong correlation between inflation, gold and oil.
- Low inflation expectations.
- High chances of a surprise effect.
- Rates are rising in the United States.
- First two quarter rebound since 2011 for gold and
since 2010 for silver.
- Rebound of speculative positions and return of
investors on the paper gold market.
- Physical ETF positions remain unchanged.
- Most likely resumption of gold’s upward trend.
- Outperformance of silver.
The increasing geopolitical risks lift gold and
silver prices in June
Since the beginning of the acceleration of the Iraqi
crisis in early June, and the lightning advance of
the ISIS, gold and silver rose by +6.2% and +12.4%
respectively.
The advance of the ISIS (see Weekly Analysis of
June 18th, June 20th) in recent weeks was marked
by the announcement, on June 29th, of the
establishment of a caliphate - referred to as
The Islamic State (IS) -, spanning the border
between Syria and Iraq.
The IS conquests and the proximity of the fighting
to Baghdad is a serious threat to the internal
stability of Iraq, but it also represents a major risk
of spreading the conflict between Shiite and Sunni
communities to other oil producing countries in the
Middle East.
Sources: Bloomberg, BBGI Group SA
Neighboring Iran is not indifferent to events in Iraq, and
has declared that it is ready to intervene in the country to
safeguard the Shiite holy shrines and, hence, increasing
the possibility of a regionalization of the conflict. The
Iraqi government troops are currently trying to regain
control of the lost territories and cities, and in the case of
a success, this could rapidly lower the risks. On the
political side, the result of new attempts to form a more
representative government that could bring Iraq’s
estranged communities together, could also have a
positive effect, but there are also many obstacles to this
goal.
Meanwhile, the risk of a civil war in Iraq is high and the
partition of the country into three separate zones, each
controlled by the Kurds, Sunnis and Shiites is by no
means excluded. For now, the inner conflict has not had
any major impact on oil prices, as conflict areas are mostly
in the northern and central portion of the country, and do
not concern the oil production area. We must recall that
the country is currently OPEC's second-biggest crude
producer, with about 3.4 million barrels per day, and
increasing tensions could destabilize its ability to export
and strain the world's oil supply. But, it is also the
spreading of the religious conflict between Sunnis and
Shiites to other oil producing countries in the Middle
Weekly Analysis – Geopolitical unease and inflation set gold on the starting blocks
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East, which could further harm Middle Eastern oil
exports.
For the short-term, gold and silver prices have
steadily matched higher with a +6.2% and +12.4%
surge. Geopolitical risks in the Middle East have
undoubtedly had a stronger impact on precious
metals compared to the political turmoil and
violence in the Ukraine.
The crisis in Iraq should, in our view, reach no clear
long-time solution for the time being. It might affect
investments and slow the expected oil production
capacity level, thus affecting the ability of Iraq to
produce and supply the global oil market, as demand
will increase beginning 2015.
The risks of an increase in energy prices are
currently underestimated.
A rise in oil prices could affect inflation (CPI)
and gold
The oil price volatility index does not suggest any major
change to the appreciation of investors’ risks; however,
the historically low level suggests a likely future large
change of crude oil prices in the coming months. This
change could be the consequence of a deterioration of
the geopolitical context and a recovery in the global
economic activity.
Between 2011 and 2012, when crude prices surged from
$80 to $110, inflation rose from 1% to 4%. However, the
upward trend since 2012 on the price of crude from
$80 to $108 is just beginning to have an effect on inflation
in 2014. Price stability was replaced by a new upward
trend, which shows an annual increase of the CPI from
1% to 2.1%, above the Fed’s target level. In May, the
consumer price index displayed its strongest growth in
over one year (+0.4%).
Negative forecasts for real interest rates are
favorable to gold rise
Despite news of a contraction of U.S. economic growth
for the 1st quarter 2014, we still expect US economy to
grow by around 2% in 2014. The increase in industrial
production by +0.6% in May and a rate of capacity
utilization closer to 80% are paving the way for a rebound
in the second half. In what can be considered a « soft »
economic environment, inflation is rising in the
United States, while long-term interest rates remain
unchanged.
Inflation is currently at its highest level since 2012
and it could further increase to 3.5% - 4% in the
coming quarters and return to 2011 levels.
Consumer Price Index (US CPI)
WTI Crude Oil Price and Inflation (CPI)
Sources: Bloomberg, BBGI Group SA
Sources: Bloomberg, BBGI Group SA
The International Energy Agency (IEA) has recently
said that OPEC should probably boost its output by
some 900,000 barrels per day to meet a likely rising
global demand in the last quarter of 2014.
The correlation between oil prices (WTI) and
inflation (CPI) in the United States is relatively
strong as illustrated in the graph above. A future
increase in crude oil prices should therefore
support the recent rising inflation trend.
Weekly Analysis – Geopolitical unease and inflation set gold on the starting blocks
The recent rise in inflation has still not worried investors,
according to the 2-year breakeven inflation indicator,
despite an increase of 1% in November 2013 to 1.8% to
date; there is still no relevant warning. The Fed Chairman
seems momentarily unconcerned by rising U.S. inflation,
which she defined as “noisy” recent data. Janet Yellen’s
tone while commenting data was reassuring, to avoid
adverse expectations on long-term interest rates. It is not
the first time that we suggest that the Federal Reserve will
take its time to move interest rates up, even if the CPI
level rose as we had forecasted. Janet Yellen’s insouciance
has already had a positive impact on gold prices, while
remaining without apparent effect on the observed
inflation expectations in the bond markets.
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In our view, such investors underestimate the risk
of rising inflation which nevertheless appears as a
new probable catalyst for higher gold price.
Expected Inflation and Gold Price (2013-2014)
Gold and silver have finally climbed above the
200-day moving average
The price corrections on the yellow metal (-38%) and
silver (-62%) between 2001 and 2014 were close to those
of 2008 (respectively -36% and -60%), before the
subsequent spike of +181% for gold and +460% for
silver. The price has successfully tested the $1,200 an
ounce level, and for the first time since 2011 has recorded
two positive consecutive quarters (+6.5% and +3.4%) in
2014.
The recent increase from $1,250 to $1,330 was mainly
caused by the rise of inflation in the United States, as it
brakes gold’s 200-day moving average and challenges the
downward trend initiated in October 2012.
Sources: Bloomberg, BBGI Group SA
Over the past eighteen months, gold price was linked to
short-term inflationary expectations. The two lows at
$1,200 per ounce were marked, while inflation
expectations rebounded from their lows in June and
December 2013.
More inflationary data will undoubtedly be required for
gold prices to break out of the 1200-1400 trading range.
But, in our opinion, physical gold’s market fundamentals
are particularly positive in the medium term. This will be
the subject of a separate weekly analysis.
Gold’s Price Corrections and Rebounds
An upward revision of inflation expectations will
most likely support gold’s next upward trend…and
that of nominal interest rates.
U.S. Government Bond Interest Rate (2, 5, 10 years)
Sources: Bloomberg, BBGI Group SA
For their part, real interest rates should once again
slip, due to the gradual rise of inflation.
Net-long futures (CFTC CMX Gold net non-commercial
future positions) positions have been strongly reduced
since 2011, which had reached 250,000 contracts when
gold was trading at $1,900 per ounce. They were then
reduced to a trickle in 2013, representing only 16,500
contracts in June, as prices settled at $1,200 per ounce.
These levels were close to the same speculative positions
of 2001, back at the beginning of the secular increase of
gold at $300 per ounce.
Actually, the bond market is just beginning to take more
seriously the risks of rising inflation since the beginning
of June.
In 2014, speculative positions increased from 32,000
to 120,000 contracts, thus, indicating an early return
of investors to the yellow metal.
The 2 and 5-year government bond rates are back to
their September 2013 and April 2014 highs, whereas,
long-term rates are still at 30 basis points from previous
highs.
The level remains low by historical standards, and
corresponds to when gold was trading between $ 400
and $600 per ounce in 2005-2006.
Effets d’une hausse du pétrole induite par un
choc géopolitique sur l’inflation
Sources: Bloomberg, BBGI Group SA
Weekly Analysis – Geopolitical unease and inflation set gold on the starting blocks
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Non-Commercial
Long Futures Positions CFTC
As for silver, its massive correction was followed by a
long stabilization period at the 2008 and 2010
historical levels. Given silver’s greater volatility, it
should benefit even more than gold from the
abovementioned factors.
Silver Price
Sources: Bloomberg, BBGI Group SA
The paper gold market has become very attractive for
hedge funds, while ETF physical gold investors remain
undeterred, for the time being, by the change which
appears to be taking place. The graph below shows
stabilization at 55 million ounces of total physical gold
positions held by ETFs worldwide. The sale of ETF
holding over the past eighteen months now amounts to
30 million ounces, or approximately 35% holdings in
2012. This represents about 930 tons of gold or more
than a third of annual gold production, which is
currently estimated at 2,600 tons.
Sources: Bloomberg, BBGI Group SA
Conclusion
There will be a return of inflation and geopolitical
tensions which will support the rebound in precious
metals in 2014.
The geopolitical situation and the rebound in
inflation are new elements which may boost
interest in a neglected, but still attractive market.
Hedge funds are already bullish as investors are still
not aware of the improving fundamentals for gold
and silver.
Total Global Gold-ETF (ETF)
There will be a likely return to a lasting upward
trend.
Sources: Bloomberg, BBGI Group SA
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Weekly Analysis – Geopolitical unease and inflation set gold on the starting blocks
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