In the last decade, 2015 was the toughest year for most of the leading commodities. While oil made the most headlines, other commodities such as copper, corn, and gold had a similar year. Gold fell by more than 10% during the year. This led to significant losses to the main gold producers such as Anglo-American Anglo-Gold. The selloff in gold was attributed to the weakening fundamentals in China and the broader global economic environment. I believe that gold will ultimately recover in 2016. In this article, I will explain the key reasons I hold to this belief.
China is the world’s second largest economy. It is also the world’s biggest consumer and consumer of all commodities. As a result, what happens in China has significant spill-over effects to the global economic environment. In 2016, China has started with the wrong footing. Early this week, China released its Purchasers Manufacturing Index (PMI) which showed weaknesses as was the case in 2015. Other key economic data from China have not been pleasing either. In addition, in the first week of the year, China depreciated their currency. This was done with the view of reducing the total cost of exports. However, investors were not happy with it. On the first day of trading, the China’s key stock market indices went down by more than 7% triggering the circuit breaker. The government pumped in more than $20 billion on Tuesday. On Thursday, the market was where it started again. The circuit breaker was triggered again. What all this tells us is that the Chinese government is implementing a massive financial engineering strategy with the intention of boosting investor confidence. For a short term, this can work. However, in the long term, the strategy is not sustainable. I therefore believe that the bubble in China will burst this year. When this happens, the biggest beneficiary will be gold.
I base this on a number of reasons. One, the fall in the Chinese markets will lead to capital flight. Investors will get out from equities to put their money in the safest haven. Gold is that haven. A good example is on what happened on Monday. When the circuit breaker was triggered, gold rallied making it one of the best performer this week.
In the previous year, gold has had one its worst years ever. The price has fallen from $1500 per ounce to the current $1090. This price is near the average cost of product and below the margin cost of production. As a result, this will lead to significant cuts in supply for gold. In fact, some gold miners have already started to close shop in South Africa. Since supply and demand are key in gold pricing, the price will rise as fewer miners are left to supply the commodity. Simply said, gold is now around the cost of incremental production.
Many people believe that the dollar will rise in 2015. However, this perception could be incorrect. This is because in 2015, many traders and investors anticipated that the fed would tighten the monetary policy. As a result, they priced the value of this tightening in their trades making the dollar to rise in in value. A divergence could arise in 2016 as a result of investors cashing in their trades. If this happens therefore, I expect the dollar to weaken. Since gold and the dollar have a negative correlation, investors will place their cash in the safe haven.