The financial markets have begun 2013 in remarkably similar fashion to
how they began 2010, 2011 and 2012. In each of these preceding three years
the average market participant became optimistic about global economic growth
during the first quarter, leading to weakness in gold relative to the
industrial metals. Here we go again.
As illustrated by the following chart of the gold/GYX ratio (GYX being a
proxy for industrial metals such as copper, zinc, nickel, lead and aluminium), gold declined relative to the industrial
metals complex during the early part of each of the last three years. Up
until now, 2013 has followed the same pattern. The price action is prompting
many analysts to recommend increased exposure to the industrial metals
relative to gold, but note that the gold/GYX ratio made its low for the year
during February-April of 2010, 2011 and 2012. This suggests that economic
optimism was beginning to give way to economic realism by April in each of
these prior years.
We can't be sure that 2013 will keep following the pattern established during
2010-2012. It's possible, for example, that this time around the central
banks have injected enough hallucinogenic in the form of newly-created money
to prolong the false economic dawn by a few months, causing gold/GYX to
continue its slide into mid-year rather than reversing upward between now and
early-April. However, we are reticent to significantly increase our exposure
to the industrial metals at this time. Doing so could work for a while, but
from our perspective it relies too much on the tenuous assumption that there
will be a larger pool of irrational optimists a few months from now than
there is today.
On a related matter, the markets for gold and the industrial metals are very
different. They both benefit from low real interest rates, but in other
respects they are diametrically opposite. For example, whereas gold benefits
from declining economic confidence and increasing uncertainty, as often
indicated by widening credit spreads and a steepening yield curve, the
industrial metals benefit from rising economic confidence and greater
certainty, as often indicated by contracting credit spreads and a flattening
of the yield curve.
The major differences between the price drivers of the gold and the
industrial metals markets stem from the fact that gold is accumulated as a
store of value whereas the industrial metals are consumed. We acknowledge
that some gold gets consumed in commercial processes each year, but the
amount is far too small relative to the aboveground gold stock to affect the
price. The aboveground gold stock comprises most of the gold ever mined, the
bulk of which is held as either a form of savings by the private sector or a
monetary reserve by the public sector, whereas almost all of the iron, lead
and other industrial metals produced during a year have always been consumed
during that year. Hardly anyone saves for a rainy day by accumulating/holding
iron, lead or zinc, but hundreds of millions (perhaps even billions) of
people save by accumulating/holding gold.
The differences between gold and the industrial metals outlined above go part
of the way to explaining why China and its dramatic economic swings have had
a substantial effect on the prices of industrial metals over the past ten
years and will probably continue to do so over the next few years, and why
China has not had much effect on the gold price over the past ten years and
is unlikely to have much effect over the next few years. China's effect, or
lack thereof, on the gold market is a big enough topic to warrant a separate
discussion, so we'll deal with it in another commentary within the next two
weeks. Suffice to say right now that we've read many articles over the past
year citing China's gold demand as a major bullish influence on the gold
price and that every one of these articles has contained basic
misunderstandings about how the gold price is formed.
The above-mentioned differences between gold and the industrial metals also
explain why none of the purely industrial metals have been able to exceed the
inflation-adjusted price peaks that were in place by early-2008, whereas the
panic of 2008 and the economic malaise that followed did not alter the
long-term upward trend in gold's inflation-adjusted price.
The final point we'll make concerns silver, a metal that is part industrial
and part store-of-value. Silver, like gold, went on to make new highs in
inflation-adjusted terms after the major financial panic of 2008 and the
beginning of the bust phase of the bank (central and commercial)-caused
boom-bust cycle. This suggests that silver's store-of-value characteristic is
dominant and that it will be more in synch with gold than with the purely
industrial metals over the years ahead.
This article is excerpted from a commentary
originally posted at www.speculative-investor.com on
14th February 2013.