Market stress to boost safe haven demand for gold

Cape Town - Rising stress in credit markets and the growing likelihood of a major “credit event” should boost the safe haven demand for gold, says Overberg Asset Management (OAM) in its weekly overview of the SA economic landscape.

"Gold has been one of the world’s best performing assets since the start of the year. The gold price has risen around 17% and broken above key technical barriers indicating further upside ahead.

"As central banks run out of options to stimulate monetary policy there is a growing tendency towards currency devaluation and ultimately debt monetisation, which could potentially herald significant interest in gold as the ultimate store of wealth," OAM says.

Yet sentiment towards gold remains depressed.

"Even after the recent sharp rally sentiment towards gold is around -35% below its peak in September 2011. Negative sentiment tends to be a reliable contrarian indicator and precursor to positive price movement.

"While we would not advocate gold as a long-term investment portfolio holding, it has its merits as a short-term safe haven and insurance policy against further financial market stress," says OAM.

South Africa economic review

• Manufacturing production increased in December by 1.8% month-on-month and on a year-on-year basis by 0.4% beating the -1.5% consensus forecast contraction. The data is a considerable improvement on the -1.8% and -1.3% month-on-month contractions in October and November.

Despite the positive reading manufacturing production for the fourth quarter (Q4) as a whole declined -2.1% quarter-on-quarter annualized placing a headwind on Q4 GDP growth. Unfortunately December’s manufacturing data is unlikely to mark a sustainable change in trend. The latest purchasing managers' index, which is a forward-looking indicator, remains in deep recessionary territory.

• Mining production increased in December by 2.1% month-on-month and on a year-on-year basis by -0.3% beating the -0.9% consensus forecast. The performance builds on solid month-on-month growth of 1.5% in October and 2.1% in November. However, there are doubts whether the solid trend can be maintained.

December’s improvement was not broad-based, while coal production increased 1.9% on the month the production of gold, iron ore and platinum group metals all fell by -1.4%, -2.1% and -1.7% respectively. Nonetheless mining output increased in the fourth quarter by 1.3% quarter-on-quarter annualised and for 2015 as a whole by 3.2%.

SA political review

• The 2016 State of the Nation speech by President Zuma was characterised by unusually little emphasis on the current government’s traditional populist policies. The speech provided only a cursory mention of politically expedient programmes such as National Health Insurance, the National Minimum Wage, land reform, and the nuclear procurement programme.

By contrast there was an acknowledgement of the dire state of the economy and the need to act decisively in order to avoid a sovereign debt downgrade to “junk status”. The speech broke with the President’s usual pattern of denialism reflecting a renewed approach to tackling the country’s economic challenges. Zuma concluded by saying that: “We cannot change the global economic conditions, but we can do a lot to change the local conditions.”

Encouragingly Zuma acknowledged the relationship between growth and job creation, and the expansion of social benefits. Emphasis was given to the need to cut costs across government and to streamline state-owned enterprises (SOEs). While falling short of mentioning privatisation Zuma said that (SOE) “interventions are essential for growth and also for the reduction of debt levels.”

One can infer that state assets would have to be sold in order to reduce debt. Overall the speech was encouraging from the perspective of economic growth and provides Finance Minister Pravin Gordhan with the political support he needs to make meaningful concessions in his Budget Speech on 24th February.

• After facing numerous delays the full report on the Presidential Review on State-Owned Enterprises (SOEs), which had been commissioned in 2010, was finally released on Friday 12th February. The report recommends the partial listing of some SOEs and the privatisation of others.

Without identifying specific SOEs the report said the government “should consider possibilities of listing select SOEs on the JSE, while astutely preserving government control and maximising investor participation.”

The adoption of these recommendations would make a significant contribution towards SA maintaining its current investment grade credit rating. An inter-ministerial team headed by Deputy President Cyril Ramaphosa is reviewing the fate of the country’s 700 SOEs but said the recommendations were far from complete.

The week ahead

• Consumer price inflation (CPI): Due Wednesday 17th February. According to consensus forecast headline CPI, which includes the volatile food and energy components, is expected to accelerate from 5.2% year-on-year in December to 6.0% in January, touching the upper limit of the SA Reserve Bank’s (Sarb) 3-6% target range.

The sharp inflationary increase is attributed to the base effect of comparatively low energy prices a year ago and the impact of the drought on food prices. Food price inflation has been compounded by the weaker rand and the need to import food as a result of the drought. At its last policy meeting the Sarb lifted its CPI forecasts for 2016 and 2017 from a previous average of 6% and 5.8% to 6.8% and 7% respectively.

• Retail sales: Due Wednesday 17th February. According to consensus forecast retail sales growth is expected to slow from an elevated 3.9% year-on-year in November to 3.3% in December due to constraints on household disposable income from rising inflation, higher interest rates and weakening employment growth. These pressures are likely to be a constant theme during 2016 lowering retail sales growth to around 1% from the 3% real growth rate achieved in 2015.  

Technical analysis

• The rand remains below successive support levels suggesting a continuation in the rand’s depreciation. Although the rate of the rand’s depreciation is accelerating there is little sign so far of panic selling or capitulation. This stage needs to be reached before a reversal in the rand’s move can occur.

• The US dollar index is testing a major 30-year resistance line, which if broken will pave the way for further strong gains in the currency.

• The long-term JPMorgan global bond index bull trend remains intact, with the yield targeting a new low during the fifth and final wave.

• The US 10-year Treasury yield has broken below key resistance levels of 1.9% and 1.7%. There is unlikely to be a major bear trend in US bonds as the deleveraging phase is still in its early stages.

• The benchmark R186 SA Gilt yield broke out of its long-term bull trend as a result of “Nenegate”. The new bear trend for the R186 is underpinned by resistance at 9.0% with a risk of further upside to 10.50%. While SA bond yields may fall in line with global bonds they are unlikely to return to the bull trend.

• The MSCI World Equity index has broken downward from a rising wedge formation which has been intact since the 2008/09 global financial crisis. Given the magnitude and duration of the 2009-2015 bull market the overall correction is likely to reach a downside target for the MSCI World Equity index of 1 400.

• Since the 1950s the Dow Jones and S&P 500 have displayed 7-year up-cycles and the top of the current US equity cycle is likely to have just occurred. The next major wave down will complete the 16-17 year secular bear market that started in 2000. The secular bottom should occur around June 2016.

• The S&P 500 index has broken downward from a rising wedge pattern, which is traditionally a trend-changing pattern. The downward trend is likely to remain intact unless the index decisively regains the 2070 level. A break below 1800 should pave the way for a steep decline to 1600. The Dow Jones Transport Index, traditionally a lead indicator for the broader market, is leading the broader market lower on the downside.

• Brent crude’s break below the key $30 support level suggests a continuation of the weakening long-term trend to a downside target of $25. Copper is regarded a reliable lead indicator for industrial commodity prices and barometer of global economic growth. It has broken below the key $4 500 support level suggesting further downside ahead.  

• Gold has broken its recent downtrend by rising decisively above the $1 100 resistance level. An extended break above $1 250 is needed to confirm the end of gold’s bear market.

• The JSE All Share index remains below the 24-month moving average at 50 600. The recent consolidation pattern between 47 000 and 49 000 is likely to be resolved with a break to the downside to an initial target of 45 000 and an ultimate target of 43 000.

Bottom line

• Gold has been one of the world’s best performing assets since the start of the year. The gold price has risen around 17% and broken above key technical barriers indicating further upside ahead. The gold price has broken above the downward resistance line (bear trend line) which has been in place since 2015, and more recently the 2013 bear trend line. These key technical moves signal further upward momentum.

• Gold fundamentals are improving. The physical gold market ended 2015 with a deficit as total gold demand increased by 2.3% and total gold supply shrank by -7.3%. Mined supplies experienced their first quarterly decline in the fourth quarter last year, and for 2015 as a whole the slowest annual growth in production since 2008 rising year-on-year by just 0.2%. By contrast central bank demand increased by 23.4% in 2015 led by strong gold reserve accumulation in China and Russia.

• The World Gold Council reported an increase in global gold demand over the past six months for gold jewelry, bars and coins. In 2015 gold demand in India increased by 6% year-on-year. China’s demand has slowed ever since peaking in 2013 but the slowdown has decelerated substantially from -40% in 2014 to -9% in 2015. With gold prices at their lowest level in five years, demand could pick-up further.

• While gold fundamentals are improving the current state of global financial markets has significantly brightened the outlook for gold over the short- to medium-term. As central banks run out of options to stimulate monetary policy there is a growing tendency towards currency devaluation and ultimately debt monetisation, which could potentially herald significant interest in gold as the ultimate store of wealth.

• The adoption of negative interest rates by major developed market central banks and most recently by the Bank of Japan is rapidly eliminating the carrying cost of gold investment, which historically has been one of the greatest impediments to investment inflows into bullion.

• China's authorities are clamping down on capital outflows, which are averaging around $100bn per month. Faced with restrictions on cross-border capital outflows China-based investors will turn increasingly towards gold as a means of hedging against the inevitable devaluation of the yuan.

• Rising stress in credit markets and the growing likelihood of a major “credit event” should boost the safe haven demand for gold.

• Sentiment towards gold remains depressed. Even after the recent sharp rally sentiment towards gold is around -35% below its peak in September 2011. Negative sentiment tends to be a reliable contrarian indicator and precursor to positive price movement.

• While we would not advocate gold as a long-term investment portfolio holding, it has its merits as a short-term safe haven and insurance policy against further financial market stress.

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* Overberg Asset Management (OAM) is an Authorised Financial Services Provider No. 783. Overberg specialises in the private management of local and global discretionary portfolios as well as pension products.

Disclaimer: Information and opinions presented in this report were obtained or derived from public sources that Overberg Asset Management believes are reliable but makes no representations as to their accuracy or completeness. Any opinions, forecasts or estimates herein constitute a judgement as at the date of this Report and should not be relied upon. There can be no assurance that future results or events will be consistent with any such opinions, forecasts or estimates. Furthermore, Overberg Asset Management accepts no responsibility or liability for any loss arising from the use of or reliance placed upon the material presented in this report.