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Why these events are bullish for gold even with the fiat denominated gold price decline in 2013
Published: 31-12-2013 00:00
By: Vincent Tie
It is the last day of 2013 and it had been a tumultuous year for precious metals. After 12 consecutive bull market years, gold and silver is likely to end the year lower than when the year started. The mainstream media drums are already beating to announce that the bull market in precious metals have come to an end. Come January 2014, I have no doubt this news will be heralded even louder.
In this article, we review some of the major events that happened in 2013 to understand why they show that the fundamentals for gold demand is stronger than ever. You will see that the need to own physical gold and silver in your portfolio has never been greater. Keeping your eyes on these fundamentals will help you discern the pulse of the global economy and filter out the noise.
January: Germany moves to repatriate its gold from the US and France
2013 started with a watershed moment when Germany’s central bank, the Bundesbank, announced that they will repatriate a portion of their gold stored in the US and France. Of the 3,391 tons of gold owned by Germany, 69% of it is held outside of Germany. The Bundesbank plans bringing back to German soil 300 tons of gold from the US Federal Reserve and all of the 374 tons of gold stored with France.
Bypassing the speculation as to why they are repatriating gold, it is a fact that repatriating 674 tons of gold is a herculean task fraught with many risks. Imagine the complication if gold is lost in transit.
The Germans’ insistence to bring gold back to German soil despite the risks shows clearly the immense value and importance they accord to gold. This is no accounting trick to move gold from one account to another on paper or through the computer. It is the moving of physical gold back to German territory where they can touch and feel the yellow metal. In view that the Eurozone is still mired in recession with the occasional talk of Germany leaving the Euro and going back to the Deutschmark, it is no surprise that they are taking all their gold back from fellow-Eurozone neighbor – France. It is in line with the practice of backing currencies with real money – gold.
March: Cyprus depositors forced to take losses
In March, Cyprus came under the spotlight with its version of the Lehman-moment albeit a smaller one. Cyprus banks had invested their deposits in risky Greek government debt. When Greek bond holders were required to take a haircut in excess of 50%, the losses hit Cypriot banks like a sledgehammer. With the country’s credit rating already cut to junk status, the Cyprus government had no choice but to request for a bailout from the European Union.
As part of the bailout deal offered by the Troika (EC, ECB, IMF), Cypriot bank depositors who had up to EUR 100,000 would lose 6.7% on their deposits. Those who had more than EUR 100,000 would lose 9.9% of their deposits. Given the negative impact to depositors, the authorities closed Cypriot banks to prevent bank runs. Capital controls went into effect and limited the withdrawal of cash from ATMs. Due to public outcry and demonstrations on the streets, the bank deposit levy was rejected by the Cyprus government.
Four months after the bailout request, the government announced that depositors with savings exceeding EUR 100,000 with the Bank of Cyprus would lose 47.5% of their savings. The swift fall of Cyprus from a popular financial center and tax haven took depositors by surprise. By the time the crisis hit, it was too late to pull money from the banks. It illustrated the increasing risks with storing one’s wealth with financial institutions in the unstable economic environment today. Depositors had no clue where their bank had invested the deposits and the level of risks they took. Had they diversified some of their savings in physical precious metals held outside the banking system, they would have been better shielded from the deposit seizures and capital control measures. Their wealth will still be protected today.
April: Bank of Japan joins the money printing bandwagon
These were the actual words used in the mainstream media to describe the Japanese central bank plans to double their money supply by the end of 2014 by printing money. Through its actions, the Bank of Japan would pump a staggering $1.4 trillion dollars into the Japanese economy. This was its answer to jumpstart the economy which was nowhere near an original solution given that the US Federal Reserve and the European Central Bank have already put their printing presses into overdrive.
It would do one good to ponder over the words used to describe this latest round of money printing by the Bank of Japan. When will we realize that money printing is the only tool that major central banks have to make their economies competitive again. This screams inflation. For Japanese who save in the Yen, 2013 saw the Yen devalue to five-year lows against the US dollar, severely reducing their purchasing power. Gold has never been more important to preserve wealth in financial portfolios than now.
July: Negative gold GOFO rates
On July 8, the Gold Forward Offered Rate (GOFO) went negative. To appreciate the impact of this occurrence, the GOFO rate has gone negative only 4 times in the last 14 years. In 2013 alone, the GOFO has gone negative 5 times. Moreover, previous occurrences were only 1 to 2 day events. This year the occurrences stayed negative for as much as 38 trading days consecutively.
Usually, the GOFO rate is positive. What it means is that a party having gold is willing to put the gold up as a collateral to borrow dollars and pay the lender an interest. When GOFO is negative, the opposite is true – a party is willing to put up dollars as a collateral to borrow gold and pay the owner of the gold an interest. It shows that the market is placing a higher value on gold in hand versus dollar in hand. It also points to a shortage of physical gold.
September: Taper QE sideshow
After months of keeping the markets in suspense as to whether there will be tapering of the Quantitative Easing Program, the US Federal Reserve announced that there will not be a reduction in their $85 billion a month bond purchase. The Fed will continue to conjure up currencies to monetize the debt of the US government. Given that the Fed needs to keep interest rates down, it is more likely for the monthly bond purchases to increase. This is inflationary and is positive for gold.
In December, the Fed announced that they will taper QE by $10 billion a month. This is a miniscule amount because the Fed would still be creating $900 billion a year. Moreover, they are now committed to keep interest rates artificially low even if the US unemployment rate falls below 6.5%. This is evident that the US economy is severely reliant on low interest rates to allow the government to borrow money cheaply. Higher interest rates would be the death knell as it makes interest payments on future ballooning debt unserviceable. The Fed's main viable tool to keep interest rates low is QE. It is therefore hard to see how they can eventually stop the QE program without interest rates skyrocketing.
October: US debt limit fiasco
In October, the political struggle between the Democrats and the Republicans pushed the United States to the edge of default. If the country’s debt limit was not raised, the United States would not have enough money to meet its debt obligations. This episode described in the media as potentially catastrophic reminded the world of how abysmal the fiscal state of the United States really is. The issuer of the world reserve currency is essentially insolvent and is prevented from declaring bankruptcy only because she could continue to borrow to fund her spending addiction.
Against this backdrop, it is bewildering that international trade is still conducted largely using the US dollar. However, there are already calls for a more de-Americanised world. When the US dollar is dethroned from its reserve currency status, the world will need to lean on the time-tested stability of gold to find its footing again for the next trusted medium of exchange. It is no wonder that China is leading the scramble to import gold along with many other Asian central banks.
November: Increasing physical gold demand
In a year where there was a large decline in the price of gold and silver, we are seeing soaring physical demand. China is almost certain to eclipse India as the largest importer of gold this year. Chinese gold imports through Hong Kong alone are likely to exceed an already staggering amount of 1,000 metric tons. And we have yet to factor the numbers from China’s domestic gold output and gold obtained through overseas mine acquisitions.
December: More gold mines shutter
Unlike printing paper money, gold requires years of productive effort to bring it to the market. Mining gold is also notoriously fraught with risks such as the lack of economically viable gold deposits, high overheads, mine collapse, outcry from unions and environmentalists and political instability of governments. With plummeting gold prices, major gold producers have shuttered many mines deemed unprofitable to survive this period of lower revenue. Inflation has also led to unions demanding wages of miners to be increased. Such factors are contributing to gold producers deciding to shutter mines to survive by lowering overheads.
The closure of mines will have a knock-on effect in reducing future gold supply. At a time when money printing is in overdrive, it is unimaginable for the gold price to remain at such low levels. Such a situation is an open invitation for currency abundant parties to buy up the annual global gold supply. When this happens, the law of demand and supply will ‘rectify’ the price of gold to balance market demand.
While many may see 2013 as the year the gold bull market ends, to those who see the above bullish signs for gold, the fall in gold prices this year is godsend for physical gold buyers. The data that is coming out is pointing to an increasingly inflationary future that warrants a higher gold price.
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