Gold Stocks hit lowest levels since 2013
Gold stocks creating scarcity sensation
Gold stocks have reached inventory levels at the COMEX exchange that have not been so low since 2013. Inventory on the exchange is now at less than 7 million ounces, a decrease of 30% from its previous peak, in mid-2014, at close to 10 million ounces.
This has created some concern by market participants on the capability of the exchange to honour its Futures contracts. The Gold held on inventory is ultimately what is readily available if a Long position in Futures desires delivery of the commodity.
This leads to the view that stocks are low and therefore the market must bid up to obtain higher levels of supply, which will cause the price of the shiny metal to rise. This theory certainly has no flaws but the cause of a possible near term rise in price given current Stock levels may be slightly different. Looking at the COMEX inventory chart we can see that the steady increase in Stocks from mid 2007 to 2011 was also accompanied by a steady rise in Gold price. While Gold Stocks during this period went from below 7 million to around 11.75 million Gold Price went from $649.25 in June 2007 to its peak at $1920.78 in September 2011.
If investors are buying into Gold heavily then there will be increasingly larger proportions of positions that are actually taking physical delivery of the commodity. Therefore it would seem logical that as prices are pushed upwards so too are inventories, as more Longs convert their Futures positions into physical positions.
Recent correlation between Stock and Price
Looking at more recent changes in inventory levels, we can see there is a surge in Stock towards the end of 2013 from its previous low which peaks out towards the end of 2014. At the same time price also stabilized after having fallen sharply for all of 2013 going from $1697.00 to its low for the year at $1182.27 in December. The first three months of 2014 saw Gold price rally to $1392.00 before eventually reaching new lows towards the end of 2014. There does seem to be positive correlation between Stock and Price levels. The last times Stock levels reached the current low of around 7 million ounces Price rallied over the following months, in the case of 2007 it turned out to last 4 years. In general price seems to have settled over the past 2 years creating the basis for a new support level.
Factors looking forward
The Macro-Economic scenario is about to change and should bring a different picture to the one we have been seeing for the past 7 years. The Fed has repeatedly said that interest rates are going to be on the rise. This of course is dependant on a sufficiently expansive economy that will be able to accommodate higher interest rates. Let's suppose the Fed is right, the economy begins expanding at a considerable rate. This will lead to increased inflation where the new target is seen as 2% while some analysts see the main Fed interest rate at 2.75% by 2020. Gold has had a long term positive correlation to US inflation, the chart below shows how that correlation turned negative during the 2008 crisis. This was actually spurred by temporary forces coming into play created by the crisis itself, as can be seen the correlation is once again positive.
Having said that the initial reaction for Gold price to interest rate increase will be to fall, as investors will prefer moving the cash into higher paying bonds. However Gold price has been falling for the past 8 months mostly on the back of an anticipation of higher interest rates as the Fed has released many warnings so as not to surprise the markets. This could mean that the current price of Gold is already discounting the first hikes in interest rates.
Economy headed into untreaded path
What is still not clear is where the past seven years of very cheap cash, increasing Money Supply and National Debt may lead us.
Money supply and national debt have increased to levels probably unthought of in 2007. The constitution needed amending in 2012, the debt ceiling had to be raised to accommodate for a higher maximum level of national debt given the circumstances after the 2008 crisis. Money supply has nearly doubled since 2006 as can be seen in the chart below.
Money Supply measures the amount of money in circulation, M2 supply includes physical money as well as bank deposits and other vehicles used for savings. It is has historically been a precursor to timing increases in inflation as an increase in Money Supply would have usually lead to an increase in inflation. This hasn't happened since 2008, where inflation reached negative levels during 2009. So there is a big question as to what the consequences will be of continued sustained Money supply and increasing National Debt.
Another strong positive correlation Gold has had historically has been with National Debt. Looking at the chart below we can see that since 2003 Gold price has followed the increase in National Debt very closely, this relationship broke down in 2013. However the fundamental reasoning behind this correlation remains unchanged. There is nothing else that can keep its value if all else were to fail. The higher the National Debt is then the higher those chances may be.
So why the change from positive to negative correlation? The cause was the massive increase in supply that happened due to the surge in price to $1900. This supply has remained steady but things like inflation and industrial demand that started to fall put a lot of pressure on the downside. Correlations that have a fundamental basis are bound to return if they have strayed off course. It would be logical to assume that this correlation should again resume, which could mean Gold has a lot of catching up in price to do.