Gold and Silver: 2016 in Review

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2016 started with a big bang in the foreign exchange and gold markets with the depegging of the Swiss franc from the euro, after being denied during the Swiss gold referendum by the Swiss National Bank just two months earlier in November 2015. Despite strong assurance to the contrary, the Swiss National Bank depegged the Swiss franc from the euro, shocking the foreign exchange markets shortly after the Swiss people rejected the increase in official gold reserves. The Swiss people, roughly 78 percent, voted against expanding central bank gold reserves to 20 percent of central bank assets from the current 7 percent. Currency wars started just after the 2008 financial crisis but intensified in 2016 after the Swiss franc depegging.

In January, we also learned that Canada sold its last remaining 3 tonnes of gold from its official gold reserves making it today the only G7 country without any gold reserves. It corresponded also, in my opinion, with the bottom of this gold bear correction that started in 2013.

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Events in 2016 strengthen my conviction that what will make gold and silver move substantially higher will be a collapse and reset of the international monetary system. Both gold and silver reacted to the currency wars. Since the 2008 financial crisis their demand has been dominated by the monetary side and not the commodity one. Gold remained in the shadow of the international monetary system even after the collapse of the gold exchange system in 1971. Silver, even if no more part of official international reserves, follows gold very closely confirming its role as poor man’s gold. High correlation between gold and silver continued after silver’s demonetisation. Looking at a long-term chart it is evident that the two monetary metals have a very high correlation and it increases even more during monetary crisis. I do believe that in this monetary reset gold will lead and silver will follow on steroids.

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Gold finished the year 2016 up 7.1 percent after peaking at mid year around 26 percent. Silver followed gold and finished 16 percent up outperforming gold. Silver hit at mid year approximately 48 percent, holding to its gold on steroids reputation. The gold/silver ratio dropped from a high around 84 in March to 65 by mid year. I do believe that in this monetary crisis environment the ratio has a better probability to reach 100 before retracing to a 20 to 30 level.

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Gold is a hard currency and without counter party risk. Gold is not only the anti dollar but anti all fiat currencies. From the chart bellow we can see that gold outperformed both the US dollar and the euro. You must be careful when using the US Dollar Index because since the introduction of the euro it has become a proxy for it. Observe the close correlation of the US Dollar Index with the euro. This is because European currencies dominate the index with a very low weighting for the Canadian dollar and the Japanese yen. All European currencies closely follow or are pegged to the euro. In 2016 gold was up 7 percent and silver was up 16 percent measured in US dollars while the euro and the inverse US Dollar Index were down 3 percent.

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A better indicator of gold price versus world fiat currencies is to use the Global Top 20 GDP Currency Index. It doesn’t matter if you use the GDP weighted index or not since the difference is small. What is important is the trend and divergence with gold priced in US dollars. Gold was up in both cases in 2016. Gold was up 7 percent in US dollars and 11 percent in a basket of major currencies in 2016. Silver was up 16 percent in US dollars and 20 percent in a basket of major currencies in 2016.

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If we take a longer view, we can observe that the correction started in 2013 ended in 2016 but the break out to the upside is being tested. Still, while in US dollar the trend of the correction was down, in a basket of major countries’ currencies the correction was horizontal with a slightly upward bias. Is the US dollar price of gold a leading indicator or is the currency basket? The global debt is the cause of the collapse of fiat currencies and the US is no exception. US debt is at the core of the global debt problem. I strongly believe it is the price of gold in dollars that will catch up with the global basket of currencies and not the other way around.

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A simpler proxy for the global currency index is the price of gold in SDRs (Special Drawing Rights) which is composed of the US dollar, EU euro, British pound, Japanese yen and since Sept. 30, 2016 the Chinese yuan.

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The election of Donald Trump has reversed public sentiment in the US towards the economy and the stock market. The stock markets were already up, after initially dropping in first quarter of 2016, ending the year up 15 percent for the Dow Industrial Average and 11 percent for the S&P 500 Index versus 7 percent for gold. I expected the gold price to go up after the election irrespective of who wins but faster if Trump wins. Originally gold did go up after the results were announced but the Republican victory of both senate and house of representatives gave investors and especially large hedge funds the impression that Trump will be able to get pass his economic, tax and geopolitical agenda easily in congress. What they are ignoring is that in the US the party line is rarely followed. The US also comes out of the election deeply divided with the least hated candidate as a winner. I expect this Trump euphoria and bubble to burst by April 2017 and gold break to the upside above $1,400.

On the same day of the US election another major event happened in India. India’s prime minister Modi decided in secrecy to demonetise the 500 and 1000-rupee paper notes. The effect was to create a run-on gold but also to some extend into silver. It is a war on cash and it must be watched closely in 2017 because it will have an impact globally. Soon after the attack on paper cash, the Indian government went also after gold. The monetisation of gold started earlier in the year with attempt to monetise private and temple gold but without much success.

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This reversal in the gold and silver bullion market triggered also a bull market in gold and silver mining stock. As you can see in the chart bellow gold stocks indexes (XAU, HUI) were up 70 percent for XAU and 59 percent for HUI versus gold bullion up only 7 percent. The silver index (Silver 7 Index) was up 4.5 times by August but ended only 3 times higher versus silver bullion which was up only 16 percent.

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Speculators and investors, mostly North Americans, also bought bullion gold and silver through funds and ETFs as indicated by the charts bellow. However, investor flows into gold and silver reversed after the US election and cash went into stocks.

The gold Shariah standard was also adopted at the end of 2016 which will be bullish for gold and to a lesser extend silver. This standard doesn’t make physical gold bullion Shariah compliant as many believe since it has been already Shariah compliant for thousands of years. What it makes compliant is some paper gold instruments like gold bullion funds and ETFs. Muslims all over the world have been big hoarders of gold, as Indians are, as saving and store of wealth for thousands of years and this will not change. Switching from physical to paper gold will not, in my view, affect substantially the demand and therefore the price of gold.

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I can’t end without mentioning the accumulation of gold by sovereigns through different state agencies but mostly through central banks as official international reserves. Official international reserves are composed of fiat foreign exchange and gold. Central banks were sellers of gold since the peak reached in 1965 but more intensively since 1990 to manipulate the price of gold. Despite this selling and until they stopped during the 2008 financial crisis central banks only sold 22 percent of the high reached in 1965. Since the financial crisis of 2008 they bought back 62 percent of the gold sold.

Kenneth Rogoff, who served as an economist at the International Monetary Fund (IMF) and at the Fed, in a recent article in 2016 recommended that developing countries should increase their official gold reserves to at least 10 percent of international reserves and sell US Treasuries. He is also one of the most influential advocate for banning paper and metal cash.

Election of Donald Trump as US president, a “gold bug”, could also have a bullish impact on the price of gold. Trump at least is very strong in using gold as a symbol of power and wealth and as such shows himself frequently surrounded by gold. This doesn’t mean he will push for a monetary gold standard. It will, I think, bring gold in fashion in the jewelry industry just like UK’s prince Charles brought polo in fashion, which will have a marginal bullish effect on the price of gold.

trump1Donald Trump’s Gold 5th Avenue New York Apartment
trump2Donald Trump accepts gold bullion as lease payment rather than cash in one of his properties

However, the most bullish catalyst for the price of gold remains the collapse of the present de facto international monetary system based on the US dollar since the collapse in 1971 of the gold exchange system (Bretton Woods Agreement). As the governor of the Bank of England Mark Carney said in 2011, when he was governor of the Bank of Canada, the present international monetary system is close to its Minsky moment. Ben Bernanke, past chairman of the Fed, also said recently that the system is “incoherent”.

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Both China and Russia accumulated large amounts of gold since the 2008 financial crisis and will continue to do so. It is my believe that both target an amount around 9,000 Tonnes which will put them in the “club” between the US (8,333.5 Tonnes) and the Euro Area (10,786 Tonnes). Both China and Russia were major buyer of gold in 2015 and they remained in 2016 and I strongly believe they will continue to be again in 2017.

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There is no official demand for silver for international reserves but as I said, silver will follow gold very closely and even accelerate when the gold price takes off. Before and during a monetary crisis and reset, monetary and investment demand (both for gold and silver) dominate jewelry and industrial demand. We are in such a period now.

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