One has to love the market’s propensity to crush the crowd at points of extreme pessimism or optimism. Gold is an example. Apart for the gold perma-bulls, nobody wanted to own the precious metal heading into 2014, amid expectations of a strengthening global recovery.
Who would want a “safe-haven” asset when the US and Japanese economies were strengthening, Europe was slowly recovering, and China, if not booming, was maintaining high growth? Few signs of inflation strengthened the case to sell gold and buy growth assets.
The market might be right on a three-year outlook for gold. But the precious metal’s short-term prospects are rapidly improving – partly because it was horribly oversold by the end of 2013. After peaking at US$1900 an ounce in 2011, it tumbled to US$1187 late last year.
Gold has since raced to US$1336, after jumping 8.3 per cent in February – the biggest monthly gain in two years. It now trades at a near 17-week high on speculation that the US economic recovery is sputtering and that the risk of a financial “shock” from emerging markets is building.
I was cautiously optimistic on gold’s prospects in 2014, but underestimated recent gains. In January, I wrote for The Bull: “This unrelenting negative sentiment (in gold) should interest contrarian investors … It’s far too soon to get excited about gold, but there are enough signs to suggest negative sentiment is moderating, and that the recent rally in gold can extend in 2014. If gold can hold above US$1200 an ounce, and head towards US$1350, it would be a much better year for gold bugs.”
Although gains will slow from here, gold has decent prospects in 2014. To my thinking, the wild card is a bigger shock from emerging markets (EMs) as the US Federal Reserve tapers its monetary stimulus program and investors withdraw funds for higher-yielding developing economies.
The problems in EM economies are far from over, and the rout in January will be repeated at some stage this year, prompting investors to own perceived safe-haven assets such as gold. EM currencies in January had their biggest sell-off since 2009, and the FTSE Emerging Markets index shed 9.9 per cent in the three months to January 31, 2014.
Risks for EM economies include: uncertainty about the speed of withdrawal of the Fed’s quantitative easing program, the sustainability of Chinese economic growth, slowing economic growth in key EMs, worsening current account deficits, and elections in several key nations this year. None of these problems will be resolved anytime soon.
EMs are already facing new strains. Russia’s deputy finance minister said Ukraine faces a “high” chance of defaulting on its sovereign debt, and violent political protests this month in Thailand, sadly, could be a sign of things to come in some other EM economies if conditions deteriorate. If civil unrest spreads to other developing nations, demand for gold will increase.
At the same time, the US economic recovery has had a few blips this year, with consumer confidence falling more than forecast, and home price gains slowing in the 12 months to December 2013. I’m still bullish on the US economy, but its recovery will have twists and turns. The bigger concern is whether China lowers its annual economic growth expectations and if its regional debt issues worsen.
So the backdrop for gold, at least in the short term, is reasonably positive. Although it may give back some recent gains, given the speed of this year’s rise, gold looks to have a good chance of breaking though the next level of solid resistance at US$1360.
Normally, I prefer exchange-traded funds (ETFs) over gold to buying gold equities. These ETFs provide pure exposure to the metal and eliminate company and equity market risk. Too many gold stocks have underperformed the gold price and destroyed shareholder wealth.
But as I wrote in January, gold equities look much more interesting after being smashed in recent years. The All Ordinaries Gold index has average annualised loss of 11.5 per cent over five years to January 2014, compared with the 15.2 per cent annual gain in the S&P ASX 200 index. Over one year, the All Ords Gold index, heavily influenced by Newcrest Mining, has slumped 42 per cent.
In January, I nominated Newcrest and Silver Lake Resources as two standout gold equity ideas. Newcrest has rallied from $8 to $11.50 this year and Silver Lake has risen from 55 cents to 68 cents. Both stocks, in particular Newcrest, have further to run this year if the gold price maintains current levels.
Northern Star Resources is another interesting gold stock. It is now ASX’s fifth-largest gold producer after acquiring a 51 per cent interest in the Plutonic, Kanowna Belle and East Kundana Joint Venture gold projects from Barrick Gold.
Although it has rallied this year, Northern Star is well placed to benefit from current gold prices – and possibly higher ones in 2014 – given its low-cost operations and solid long-term growth prospects.
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– Tony Featherstone is a former managing editor of BRW and Shares magazines. He is not a licensed financial adviser. Readers should do further research of their own or talk to their adviser before acting on themes in this article. This article implies no recommendations. All prices and analysis at Feb 26, 2014.