China is on the edge of a massive prize fight with global central banks. The prize is domination of the world’s gold supply. The fight has already begun.
This, coupled with investors taking on more risk again, and the biggest winner in 2012 could be a surprise … gold exploration stocks.
Gold exploration stocks can give you more ‘leverage’ to the gold price.
That is, if the gold price goes up 10%, gold stocks could go up 20%, 100%, or even more if you pick the right stock. So if you think gold is going to go up, investing in a gold explorer is one way you can increase your potential gains.
But last year it didn’t work this way at all. In fact – it was the other way around.
Gold stocks did worse than gold! Gold went up 10.2%. And the gold producers in the GDX index LOST 11.7%. The gold explorers in the GDXJ index scored bottom of the class, losing 32%.
What Went Wrong With Gold Stocks?
Well, you need more than a rising gold price to push the price of gold stocks up. And there were two essential ingredients MISSING from the market last year: an appetite for risk, and a firm belief in higher long-term gold prices.Without these critical ingredients, gold stocks could not, and will not, outperform gold as they should.
The market had the kitchen sink thrown at it in 2011. We had the Arab Spring, Fukushima, the US debt ceiling debate, and the escalation of the European debt crisis. Risk appetite evaporated.
This sky-high risk level sent the whole stock market crashing 20%, taking most gold stocks down with it. The market didn’t care that gold was up for the year.
And gold explorers have the highest risk level of all gold stocks. They won’t produce cash for many years. Their lifeblood is the regular cash top-ups from the market to keep the drill rigs turning. So when risk appetite evaporated, it got hard for explorers to raise capital and their share prices tanked.
The gold bull had gone just too hard in the first nine months of the year. After setting an all-time high around US$1900, the gold price fell roughly 19% between September and year’s end.
After 11 years of consecutive gains, investors began to doubt: could the gold bull REALLY keep running? This wave of doubt about gold’s future delivered the next blow to gold stocks.
If the bull-run was over, investors wondered who would want to invest in a gold explorer? A stock that only plans to profit from gold many years into the future…
So Why Will 2012 Be Different for Gold Exploration Stocks?
Quite suddenly, the market has a raging appetite for risk again, and the gold bull is back with a vengeance. Best of all, after getting smashed last year, gold stock prices are cheap.The fact is the gold bull never stopped running. Every few years gold has experienced a big correction, such as the 12.6% fall in 2010, the 28.9% fall in 2008, and the 21.6% drop in 2006. Each time, it sets the stage for the next leg up. Last year’s fall was no different.
Nothing has changed in the argument for gold’s record rally to continue … Actually that’s not true … the case for gold to keep rising just got STRONGER.
The value in gold exploration stocks lies in that they may produce and profit from gold in the future. So investors need a reason to believe that the long-term gold price outlook is good.
Even during last year’s correction, there was already a long list of good reasons to expect strong future gold prices. For one thing, gold production from mines is hardly increasing, even after a decade-long, multi-billion-dollar global exploration effort.
Only 2800 tonnes was mined worldwide last year. In 2001 it was 2646 tonnes, which is a tiny 6% rise in a decade.
Another 1689 tonnes also came from scrap gold last year – in other words, old melted-down gold jewellery. This source of gold has also flat-lined in the last 3 years, even though the gold price has doubled in the same time. The fact is there is only so much old jewellery people will sell. And short of raiding people’s homes, there is a limit to how quickly the industry can source it.
So between 1689 tonnes from this ‘scrap gold’, and 2800 tonnes from mine production, the total gold supply in 2011 was 4489 tonnes.
This total gold supply figure was up just 3% over the previous year.
China Vs the Central Banks in the Gold Rush of 2012
Meanwhile demand for gold is rising on all fronts, but SURGING demand from China and the world’s central banks has given us two BIG reasons to expect prices to rise much further. China is already the world’s biggest gold producer. It produced a record 361 tonnes of gold last year. ALL this gold stays within China’s borders, yet it’s still not nearly enough to meet China’s accelerating demand.
Chinese gold mines provided less than HALF of what Chinese buyers wanted last year. So China imported A LOT more gold to bridge the shortfall, with Chinese gold imports TRIPLING to a total of 428 tonnes in 2011.
So between domestic mine supply and imports, Chinese gold demand last year was a total of 789 tonnes.
To put that in context, it means a massive 28% of the gold produced worldwide last year is now in China.
As with many commodities, in the last 10 years China has come from the back of the field to become the biggest player in the market. This is happening for gold later than it did for industrial commodities like copper and iron ore, because the country had to make its wealth before it could buy so much gold.
In 2001, China bought just 4% of global production. This climbed slowly to 10% by 2006, before accelerating to 18% four years later in 2010. The jump to 28% by the following year was the biggest so far. Gold imports soared in the second half of 2011 and look set to continue in 2012.
But the Chinese know they are sending prices up. They have been very astute in their buying, and following the old mantra of ‘buy on the dips’. Every time the West panics and sells its gold, Chinese trading volumes spike. You can see this in data from the Shanghai Gold Exchange.
In fact Shanghai’s busiest days ever were at the end of last year when many large US hedge funds sold their gold holdings to sugar-coat their terrible end-of end-of-year results.
Source: ETF Securities
I think the Chinese demand story has much further to run, and that this will be a growing factor in maintaining gold’s 12-year bull-run.
It’s no coincidence that Chinese gold demand had its biggest ever jump in 2011 – the year the Chinese housing bubble started to strain.
As Chinese property prices teetered at unsustainable levels, Chinese investors started pouring their money into gold. Other than the stock market, there aren’t many other investing options open to them.
Besides, for Chinese retail investors, precious metals are the only internationally traded assets available to reduce the Chinese country-risk in their portfolios.
China isn’t the only big-swinger trying to dominate the gold market. The world’s central banks are the biggest holders, with around 31,000 tonnes of gold, or seven years’ worth of supply.
After selling for years, central banks have done a MAJOR U-turn in the last five years, and are now huge buyers.
Overall they bought 336 tonnes last year – in the first nine months alone. That accounted for 7.5% of annual total production.
Buying 7.5% of global supply in 9 months implies the total demand for the year will have been 10% of annual total production. That’s up from just over 1% the year before.
This means the combined share of Chinese and Central bank gold demand has doubled from 19% to 38% of the market in the space of a single year.
Any auctioneer will tell you that you only need two serious buyers to get a good result.
And China is now going head-to-head with the world’s central banks in a battle for global gold supply.
This fight has been brewing for years. And is not about to stop now.
Dr. Alex Cowie
Editor, Diggers & Drillers
Source @MondayMorning
