Outlook as good as gold

Last year was a very encouraging period for the resources sector around the world with five key developments occurring and combining to mark a major sea change for the next decade. By Barry Dawes*
Outlook as good as gold Outlook as good as gold Outlook as good as gold Outlook as good as gold Outlook as good as gold

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The five developments were:

• Resumption in the powerful bull market for gold

• Equity indices making new all-time highs for many important markets

• Peaking in the global bond markets after a 35-year bull run

• Industrial metals enjoying a price resurgence

• A recovery in the iron ore price

The fundamental driving force was Asia with China, of course, leading but with ASEAN and India not too far behind. Rising personal incomes there is, from my perspective, the underlying feature driving raw materials demand so that in comparison the US, Europe and Japan have just been economic sideshows for resources.

Asia showed relentless absorption of gold from all sources and despite interference from the new Indian Government in the key Indian jewellery market the demand simply kept growing. Gold moving from weaker hands in the West to strong hands in the East can’t continue for much longer without some fireworks of sharply higher prices.

I refer to gold being in a powerful bull market with signs of the strength being shown in this West-to-East transfer, premiums being paid for coins in the West and concerns over the accessibility of gold held by investors with major banks. This is just supply and demand. And also the 16.5%pa growth rate in the US$ gold price from 2000 to 2012 (bottom low to correction low) in the first up-leg was simply powerful.

What is also happening is the changing structural platform of gold trading and price discovery. Dubai, as a proxy for India, and Shanghai are combining their platforms with cash backed market contracts that will exclude ‘paper’ transactions and provide true price discovery. The recent acceptance of gold as a Sharia-acceptable investment can only add to Asian and Middle East demand.

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Gold moving from weaker hands in the West to strong hands in the East can’t continue for much longer without some fireworks of sharply higher prices

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The debt-laden West has created a very large volume of money that is now likely to emerge as inflationary forces sometime soon. The rises in US Fed fund rates is not at all negative but rather is forcing  US banks to better use their improved balance sheets and lend into the economy again. A new US president has already significantly boosted business confidence there. The 11% outperformance of the Dow Jones US Banks Index over the S&P 500 since January 1, 2016, after 14 years underperformance, bears testament to the improving economic outlook, rising bank sector earnings and confirmation that a US banking collapse is just not happening right now.

Key equity indices hit all-time highs with the FTSE and US markets following the earlier all-time highs by the German DAX and the Indian Nifty 50. Rallies in so many other countries produced new all-time or multi-year highs.

Technology is so important in this bull market for equities particularly in basic industries where adoption of new technologies to increase earnings is helping the likes of Boeing and Caterpillar and the oil giants Exxon and Chevron, but we really must also consider the ubiquitous Microsoft and the amazing Amazon as basic industries now. These companies can provide rising earnings that boosts market caps and gives equity indices a move along. Investors locked into defensive sectors and who can’t imagine higher indices levels will be taken by surprise by these cyclicals and technology groups.

The underlying global market strength running through 2015 and 2016 was making itself known quite some time ago so the recent whirlwind of new president Donald Trump is late to this party but is just the icing on a very tasty and wholesome cake. The underlying forces are globally strong.

The peaking in the global bond market was also a key feature. This peak recognised that bond coupon interest rates were far too low given the current state of the global economy, a certain bull market high `hysteria’ prevailed and common sense strongly suggested that the quality of many debt encumbered sovereign issuers was not wonderful.

However, the most important feature would be the marking of the reduced attractiveness of bonds against equities and the reluctance of many investors to roll over bonds at maturity into new issues. Higher yields are needed but capital is now likely to flow to more attractive sectors like equities and commodities.

Thirty-five years of bull market would have lulled many into comfortable positions but comfort in markets always means complacency and danger.

Industrial metals and their products have been in good demand with almost all LME metals experiencing record consumption levels in 2015 and 2016.

Zinc and lead have been price leaders but aluminium, copper and tin have also done well. The market place is suggesting copper may be having a nice price surge this March quarter.

Capacity utilisation rates are high in mine production in the West and with very low (read just about nil for all except nickel) LME inventories. Minor and technology metals like cobalt and lithium are also strong.

Crude steel in production in China was 1.2% higher in 2016, at 802 million tonnes, with the December quarter finishing  4.1% higher than 2015. Iron ore imports were 1.02 billion tonnes, up 7.5% on 2015, reflecting the strong steel production and lower domestic ore supply.

Iron ore prices responded to rebuilding of stocks at steel mills after a substantial run down in 2015.

Bull's Eye is anticipating further rises in iron ore prices in 2017 and with the confidence from the US$80/t forecast given from mid last year.

The One Belt One Road action is already well under way with the first freight train service arriving in the UK after its 18-day trip from Yiwu in central Zhejiang province in east China, just south of Shanghai. The weekly service is similar to that for Germany and Spain and is the latest in 15 European destinations.

The project is likely to invest hundreds of USD billions over the next few years with a multiplier impact on local infrastructure and commerce to be literally far reaching.

President Trump is undertaking his own revolution in the US but infrastructure renewal is high on the agenda. Infrastructure spending is a key big ticket item and it usually needs lots of steel. The US is only producing 79Mtpa of crude steel at 70% capacity utilisation and has imports at 33-38Mtpa. Steel demand in the US is likely to rise but reopening mothballed local capacity might need much higher prices so imports are likely to rise sooner.

Steel imports have around 26% US market share and are mostly finished products rather than slab or billet and come from South Korea, Turkey, Japan and Germany in order of size. China is only a few percent of all imports.

Should the infrastructure spending and the Mexican Wall require more than 20Mtpa then it is hard to see where the steel will come from other than China.

800Mtpa versus 80Mtpa.

Should the US need Chinese steel then China has capacity spare so seaborne iron ore demand and prices will be much higher.

All this is confirming the rolling on of the global economic boom and for gold prices. Aim high!

A positive outlook indeed. However, the mining industry should not be complacent on costs because energy prices such as oil and diesel might not be down for much longer. 

*Barry Dawes, BSc FAusImm MSAA, has had more 35 years’ experience in the resources financial markets in key roles as a fund manager, commodities and equities research analyst and corporate financier. He worked at BT Australia, was head of resources research at Deutsche Bank and also at Macquarie Bank prior to setting up and running Martin Place Securities for almost 17 years. He is currently executive chairman and head of resources.