The gold price has been a surprisingly boring story for the last few months. After shooting the lights out in the immediate wake of the 2007/8 financial crisis, the yellow metal has taken a real backseat in the last twelve months, as the process of monetary and fiscal tightening has begun in earnest, albeit haltingly.
Historically, higher interest rates and a growing global economy have been bad for the gold price. Gold is a safe haven, a place to retreat too when all other asset classes become risky and uncertain. In today’s economy, it’s not really clear where we are. Are we in a state of pre-recession, or are better days around the corner? Will the Fed tighten too fast and risk deflation, or will it tighten too slowly and spark inflation? Will emerging markets deliver on growth, or will developed markets be the place to be invested? With so much uncertainty, the gold price has struggled to find any clear direction, and according to metals expert Paul Walker, this state is likely to continue for some time. – FD
GUGULETHU MFUPHI: Welcome back to Power Lunch. Gold has steadied today, but it’s still trading at its lowest levels in four months, while the platinum sector strike is still ongoing. Paul Walker, Chief Executive of Isondo Precious Metals, joins us now for more. Paul, thank you so much for joining us. Perhaps, looking at that gold price, are we still concerned at the fact that it’s trading at those levels, which is well below $1300.00 per ounce?
PAUL WALKER: It’s too be expected because the gold price has been in a state of suspended animation now for quite a long period of time. It’s waiting for a kind of macroeconomic shift so that it can fundamentally determine the direction of gold over the next ten years. It’s been able to avoid any real pressure to date because the interest rate environment stays where it has been for much of the last seven or eight years. The direction of interest rates is still uncertain. The turning point is uncertain, so gold has been able to hold its own to a degree, but I think the signs are now starting to emerge that the U.S. is coming back more strongly. The trajectory of interest rates in the U.K. – they were talking about putting interest rates up yesterday in the U.K. – I think this is really why gold is starting to come under pressure and as that momentum gathers gold will come under increasing pressure. It’s one of those usual stories in gold. The precise turning point is going to be difficult to determine. It’s going to be an interest rate story when it does turn.
ALEC HOGG: Paul, we were at a very interesting conference in Omaha last month, and at that conference Arnold van den Berg of Century Management was explaining the endgame for quantitative easing, and I’d love to get your insights into this. He used the 1970’s situation, where it took eight years for inflation to take off in the U.S. and when it did, of course it went crazy, from two percent to 12 percent in a period of 18 months. He says that with QE, it’s going to need to be finessed. The money has to be pulled out at some point in time. If Janet Yellen pulls it out too quickly, you’d get a deflation situation, so that’s unlikely to happen. However, if she pulls it out too slowly, you could have inflation running away again. Do you think that he’s smoking something or might he have a point?
PAUL WALKER: I’ve always been deeply sceptical about the inflation story. I’ve always asked people to explain how the inflationary mechanism works in their minds. The balance sheet of the Central Banks around the world; the Feds have gone to over $3tr. Every major Central Bank around the world has had an expanding balance sheet and inflation hasn’t come about. Now, a lot of the commentary in 2008/2009 as this experiment was entered into…the story was, inflation inevitably has to go up. In fact, if anything we’ve seen deflationary pressure. I think the whole unravelling of the balance sheet of the Fed and the other Central Banks of the world is key to this story. I suspect it’s going to be a very gradual process. Bernanke has already been on the record with his two-hundred-and-fifty-thousand Dollar talk show fee. He’s been saying it will be processed…it will extend through his lifetime, and I think that’s probably likely.
However, what will undoubtedly happen progressively during this unravelling process is that interest rates are going to go up. That is given. Interest rates will move and the unfortunate consequence for gold is gold will come under pressure as that process gathers momentum. I think the chances of inflation are relatively small. The mandates of the Central Banks are pretty clear on inflation, so they will have to step in at the juncture where inflation starts to raise its head and increase interest rates. The outlook here is if we do start to see inflationary pressures, gold typically doesn’t actually do very well under inflationary scenarios. I think you’ll see a prolonged unravelling of this, with interest rates moving quite slowly on the upside. Certainly, the longer dated part of the curve will continue to be managed by the Fed and others.
It’s really what’s going to happen at the short end of the curve and how quickly they’re going to allow a rise in nominal interest rates. That I think is starting to increasingly come onto the horizon, and this is why gold’s under pressure at the moment.
GUGULETHU MFUPHI: Well, gold’s still under pressure, but what about platinum, Paul?
PAUL WALKER: Well, there’s an interesting one. I think the platinum industry in some senses, has a bigger crisis than gold. You have the South African production story playing out against the backdrop of these intransigent strikers and I guess, probably intransigent management to some extent, too. The problem with platinum is that it needs a demand side kicker. The supply side story as it’s unfolding…yes, South African production may come under pressure, but there’s a real compensation for this on the secondary side. Autocat Recycling is growing. The pool of available stocks is still there for this to come back to the market under any price scenario. I think the crisis as I see it, facing the platinum industry at the moment is where do we find the next kicker for demand? There is – dare I say it – a somewhat delusional view in certain quarters that auto demand is going to ride to the rescue, that we’re really going to repeat the late 80’s and the 90’s.
I don’t think that’s going to happen for the very simple fact that we’re seeing massive rates of substitution and thrifting, and probably, the profile of demand for automobiles going forward if anything is going to be a palladium/rhodium story. The industry here is therefore being pressured from virtually every single quarter. Production: their levels of production will go down. They may have a short-term fill-up of slightly higher platinum prices, but my concern here is where is the long-term vision, and I think the industry needs a long-term visionary player here. Obviously, the South African producers – in my view – should be the visionary players here and I think there are things they can do, but I’m not sure they’re happening at the right pace and with the right level of intensity. Hopefully, that will change. Certainly, for the sake of the South African industry.
ALEC HOGG: Well, you’re full of lots of ‘joys of spring’ for us today, Paul. I’m looking at the platinum index.
PAUL WALKER: I’ve always been an optimist, Alec. You know that.
ALEC HOGG: I thought coming back home would make you more optimistic into the future – or living in Cape Town. If you look at the platinum index (talking about the shares, themselves), they’re discounting some kind of increase in the platinum price after the strike has ended. The gold index of course, is the other way around. That’s down by half over the past couple of years. Are investors in platinum and investors in gold bullion – just taking the ETF’s – are they thinking very differently to the way that you are? It appears that way to me.
PAUL WALKER: Well, I think these markets have always responded to short-term informational flows. What’s happening with the South African industry at the moment – the strikes – there’s no doubt that there’s a broad expectation that this is going to lead to higher platinum prices over the next few years. That ‘short-term’ view always impacts on the equities. In terms of gold, I think that the investors in gold are still holding on to their metal because interest rates haven’t moved. Broadly speaking, I think most people in the gold industry are starting to ponder whether there is any real upside potential left in gold. Are we going to see $2000.00? I think the market is speaking with a collective sense of ‘no, it’s not going to happen’. In the case of platinum, I think the likelihood of sustained higher prices is only going to be achieved if South African production were to fall substantially and stay substantially lower under current circumstances.
What’s needed, as I said earlier, to change the long-term fundamentals of this market is to find a demand side kicker, and that’s still not there. You’ll remember the last time I was on your show I declared an interest. I’m very interested in the area of fuel cells, and I still believe that those are the kind of technological innovations and market development measures that the industry should get involved in. I also should declare an interest. I’ve been looking at the investment market for platinum. I think this is a relatively neglected area where you can shift the demand curve for platinum quite profoundly as the ETF for gold did, as the drive for a world gold council did in the 2000’s, encouraging investments into gold completely changed the 10/15-year view for gold. I think you can do similar things in platinum, but I don’t see those in place at the moment.
ALEC HOGG: Yes, but you need the vision as you say, Paul. Thanks Paul, for as always, your contribution. That was Paul Walker, Chief Executive of Isondo Precious Metals, which Gugu tells me means ‘tired’. He doesn’t look too tired, though.
GUGULETHU MFUPHI:Â No, not at all.
ALEC HOGG: He looks as though he’s rolling on.
