After having a rather dismal year investing I haven't been interested in posting much. I don't expect there are any readers left, so when I post its going to be because of some information I want to organize and be able to reference. What you are going to read is completely out of the "gold community" mainstream because there is no expectation of a resumption of the "Global Financial Crisis" in 2014.
I'm still long gold and gold mining stocks. In this post, I'm going to go over why I'm still bullish. The argument is based entirely on simple supply/demand dynamics.
I consider the closing of the Magellan Lead mine in Australia to be the classic example of how sensitive commodity pricing can be to a shifts in supply or demand. In March 2007, the Magellan Lead mine, source of 3% of the world's lead supply, was closed down due to environmental violations. As you can see in the chart below, the price roughly doubled based on this 3% shift in supply vs demand.
So, with that in mind, let's look at what happened to the gold supply in 2013. There were several one-time changes in the demand/supply balance that seriously hurt the supply of gold in 2013.
800 to 1050 tonnes of extra supply due to ETF dishoarding. According to Adrian Ash's piece referenced above, in 2013, ETFs lost 800 tonnes of inventory rather than gaining their usual 250 tonnes of inventory. For 2014, I expect that this extra supply of 800 tonnes will wind down and, if the price of gold can starting rising, the 250 extra tonnes of demand can resume. Overall, that's a one-time shift of roughly 67 to 88 tonnes per month.
According to this piece and others, in 2012 India imported 1000 tonnes of gold and while its expected to import just 725 tonnes in 2013. That reduction of 275 tonnes begun in just the second half of this year, so you could say that the government restrictions reduced indian demand by roughly 46 tonnes a month. I expect that the BJP will win the general election and eliminate the government restrictions on gold imports initiated in 2013. So, this also is a one-time demand shift.
Now, hedge funds and institutional large speculators and small speculators reduced their COMEX futures long positions by quite a bit this year. This is a significant part of the "paper" supply of gold. It does not include over-the-counter gold derivatives. Eyeballing the chart below I see that large speculators have reduced their long position this year from 150,000 contracts to 50,000 contracts and small speculators from 40,000 contracts to 5,000 contracts. That's a paper supply of 135,000 contracts which is 420 tonnes per year or 35 tonnes per month. I expect that all of the momentum chasing speculators are done ditching their long contracts and so this shift in supply is also a 2013 one-time occurance.
Ok, so let's total this up. Annual gold mine production is around 2,700 tonnes or 225 tonnes per month. Totalling up the above arguably one-time shifts in increased gold supply (or reduced demand) for 2013 we get:
- 30% supply increase due to momentum investors leaving gold ETFs.
- 9% supply increase due to the lack of new ETF investors buying gold thru ETFs.
- 20% demand decrease due to Indian government import restrictions.
- 16% paper gold supply increase due to speculator selling.
Based on the Megellan Mine closure, any one of these shifts, if they are truly one-time are easily big enough to cause a doubling in the price of gold. Of course, there are significant differences between "lead" a base metal with limited inventories and gold (with its centuries of hoarding). Still, the Magellan 3% mine closure does show how any of the above shifts could have a quite significant impact on the price of gold. In my opinion, the Indian Government restrictions is the sole reason that gold is in the $1500 price range right now.
So, overall, in 2013 the gold market absorbed a 75% bearish potentially one-time shift in supply / demand fundamentals and the price fell only roughly 30%. I'm pretty confident that item 1 is a one-time situation that will not prevail thru 2014. I expect that item 4 is similar. I expect that item 2 will either be eliminated by a change in government or reduced sharply by increased smuggling. So, I expect a bullish shift in monthly demand / supply by roughly 56% of mine supply. That's enough, even if Chinese demand flattens out or decreases somewhat, to push the price of gold up pretty strongly in 2014.
That's the dominant reason I'm bullish for 2014. Notice that none of this depends on a resumption of the 2008 financial crisis. It just depends on what I consider to be one-time shifts to be, as I think, actually one-time.
Of course, 2013 could be like 1997 from a technical standpoint (see below) and the bottom may not be in. At the end of 1998, gold ended at roughly the same price as the low from 1997 (end of 1997), but did have a monthly close that was 4% below the 1997 low. That would target a price around $1160. This is most likely if 2014 is a continued boom for Western stock markets and Indian demand remains suppressed. It could be worse than that if something happens in China to suppress their demand. So, nothing its certain. I think that rising Indian and Chinese demand is secular and that is why I'm bullish on gold long-term.
On a more positive note, the drop from Jan 1975 thru Aug 1976 is a lot like the current situation where all of the momentum investors fled gold. The year that followed got the price half-way back to its previous all-time high (targeting roughly $1550 for end of 2014 if it follows that pattern). That was based entirely only Western sentiment-based trading fluctuations without the secular rise of gold demand in China and India. Just having Indian gold demand resume could change Western sentiment and we could see a much bigger rise in 2014.
I guess that overall my 2014 gold outlook is bullish with the key things to watch being Indian government import restrictions (follow BJP in the May 2014 elections) and the macro-economic situation in China and Chinese imports. 2014 could be a really strong year if Indian actual demand rises significantly and Chinese demand continues without government interference. The beginning of 2014 could be pretty dicey up until the gold-investing world (and Western institutional money-managers) wake up to the likelihood and significance of a BJP win in the May 2014 Indian elections.