Global Investment Strategy Global Real Assets Strategy Report February 11, 2016 John LaForge Head of Real Asset Strategy Analysis and outlook for the real assets market» Gold has had an impressive 2016 rally, but we are skeptical that it will last. We expect that the upside is likely to be capped by the ongoing commodity bear super-cycle.» Gold continues to lose ground, long-term, vs. other major assets. What it may mean for investors» We would not add to gold holdings at this time. Not the Time to Buy More Gold At $1,250 per ounce, the price of gold is off nearly $640 per ounce from its 2011 peak of $1,888 per ounce. The $640 per ounce discount, plus 2016 s positive action, has some investors wondering if it is time to buy more gold. We don t believe so. Today, we will review the two main reasons why we don t believe that this is the time to buy more gold. As a counter point, we will also discuss a factor that has the potential to change our minds China. Reason 1 Bear Commodity Super-Cycle Still Holding Sway Over Gold Gold is a commodity, first and foremost, which makes it susceptible to the direction of the overall commodity super-cycle. As we have mentioned in past publications, commodities historically have moved together over long multi-year super-cycles. Since 1800, the average commodity bull market has lasted 16 years; the average bear market lasted nearly 20 years. In 2016, commodities are knee-deep in a bear market gold included. In fact, it was gold that kicked off the new commodity super-cycle bear in 2011. Chart 1 highlights the price of gold from 2001 to today and reflects the different price action since the 2011 gold price peak. Gold is no longer following the long green dashed line, which represented its bull market. For the past five years, gold has been setting lower lows, which is a classic characteristic of commodity bear markets. Until this downward price pattern changes (designated by yellow channel bars), shifting to an upward-facing pattern, we would not be adding more gold to portfolios. Chart 2 provides us a better view of the shorter-term action in gold. The yellow bars highlight the downward price channel that gold has been stuck in, thanks to the bear super-cycle. Should the downward channel continue to be followed, as we suspect it will, gold appears to have limited upside from here. While there is always the chance that gold breaks above the down channel for a short period, we are skeptical that the break turns into a new long-term bull market for gold. The history of commodity bear super-cycles suggests that it is much too early for that. 2016 Wells Fargo Investment Institute. All rights reserved. Page 1 of 6
Chart 1. Gold in U.S. Dollars (2001-2016) 2000 2000 1750 1500 1250 1000 1000 875 750 625 500 500 437.5 375 Gold (Spot) 312.5 250 250 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Source: Bloomberg, Wells Fargo Investment Institute. 2/8/16. Data is daily, 1/1/2001-2/5/2016. Prices in log scale. Chart 2. Gold in U.S. Dollars (2009-2016) 2000 1750 1500 Gold (Spot) 1500 1250 1000 875 750 2009 2010 2011 2012 2013 2014 2015 2016 750 Source: Bloomberg, Wells Fargo Investment Institute. 2/8/16. Data is daily, 1/1/2009-2/5/2016. Prices in log scale. Past performance is not a guarantee of future results. Reason 2 Gold Still Losing Ground to Other Major Assets Gold is a major investment asset and should be treated as such. From our perspective, most investors should own some gold in a diversified portfolio. The precise amount to hold depends on the individual investor, of course. Because we do see gold as an asset to be consistently owned, part of our role is to guide investors on how gold looks vs. other major assets. After all, adding to gold means pulling money from another asset. Chart 3 shows the ratio of gold vs. U.S. Treasury 10+Year bonds (first clip), gold vs. large cap stocks (second clip) and gold vs. home prices (third clip). Gold continues to lose ground relative to other major assets, which keeps us in the underweight gold camp. With these long-term downtrends still intact, we do not believe that buying more gold now is prudent. 2016 Wells Fargo Investment Institute. All rights reserved. Page 2 of 6
Chart 3. Gold vs. Stocks, Bonds, and Home Prices 9 8 7 6 5 4 3 2 1 0 Gold Spot Prices/Barclays US Treasury 10+ Year Index Total Return 1.2 1 0.8 Gold Spot Prices/S&P 500 Index Total Return 0.6 0.4 0.2 0 10 9 8 7 6 5 4 3 2 1 Gold Spot Prices/Mean Existing Home Prices 0 1999 2001 2003 2005 2007 2009 2011 2013 2015 Source: Bloomberg, Morningstar Direct, Wells Fargo Investment Institute, 2/8/16. Data is daily, 1/31/1999-2/5/2016. Past performance is not a guarantee of future results. Gold Spot Prices are represented by New York Gold Spot Price. Clip 1 is the ratio of Gold Spot Price vs Barclays U.S. Treasury 10+Year Total Return Index value, Clip 2 is the ratio of Gold Spot Price vs S&P 500 Total Return Index value, Clip 3 is the ratio of Gold Spot Price vs. Mean Home Prices (in thousands) 2016 Wells Fargo Investment Institute. All rights reserved. Page 3 of 6
China Is a Potential Game Changer A wild card for the future of gold prices could be China. Chinese citizens have the purchasing power, and possibly the motive, to alter gold s price trajectory in the coming years. Let us explain. China s impact on commodity prices in recent decades, especially industrial metals, has been well documented. As an example, in 1980 China accounted for less than five percent of the world s copper consumption; by 2014 that number had morphed to 45 percent! Over the same period, however, gold was largely exempt from Chinese influence. The reason was that private citizens were not allowed to own or trade bullion from 1950 to 2004. Now that gold can be bought, we are beginning to see the impact in the consumption data and it is big. Chart 4 tracks physical gold exports from Hong Kong to mainland China. We want you to focus on the blue bars in the top clip, which represent gross gold exports, in tons, over the past twelve months. As of the end of 2015, approximately 1,000 tons were exported into mainland China through Hong Kong. For perspective on just how large 1,000 tons of Chinese imports is; roughly 3,000 tons were extracted from world mines in 2015, according to the U.S. Geological Survey (USGS). Approximately 500 tons of the 3,000 tons were mined inside China, and that gold largely stayed inside China. What this means is that roughly 2,500 tons (3,000 minus 500) of 2015 s global mine supply was available to be exported into mainland China. Chart 4 highlights that mainland China consumed roughly 1,000 tons of the available 2,500. In five short years (2011-2015), China has evolved from being a non-existent global gold buyer to importing the equivalent of 40 percent of the gold unearthed last year. Chart 4. Chinese Gold Imports Copyright 2016 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All rights reserved. Past performance is not a guarantee of future results. 2016 Wells Fargo Investment Institute. All rights reserved. Page 4 of 6
What May Trigger More Chinese Buying A consumer-led economy could equal more gold buying. Chinese authorities have made no secret of the fact that they want gross domestic product (GDP) growth to transition away from mining, manufacturing, and heavy industry to consumer-driven services, and they are succeeding. A consumer-friendly government could equal more gold buying in the coming years. Chinese citizens could lose confidence in its paper money system. Since the start of 2014, the local currency, the yuan, has lost 20 percent to the U.S. dollar on a trade-weighted basis. And in August 2015, the People s Bank of China (PBoC) took steps to accelerate the yuan s devaluation vs. the greenback. If Chinese citizens feel that their paper currency cannot be trusted to keep its global purchasing power, they may turn to gold as a safe haven. Caveat Recent Chinese buying has yet to impact price. The big purchases shown in Chart 4 took place while the price of gold was sinking, alongside the rest of the commodity complex. Chinese buying was not enough to offset the start of the commodity bear super-cycle from 2011 to 2015. But it is now 2016, and if history is any guide, most commodities have seen the worst of their downside price action. While the commodity bear market should continue for many more years, keeping most commodity prices low and range-bound, this is the point in the cycle where a few lucky commodities could break away from the pack. Gold has that potential should Chinese buying accelerate. Risk Factors Buying gold allows for a source of diversification for those sophisticated persons who wish to add precious metals to their portfolios and who are prepared to assume the risks inherent in the bullion market. Any bullion or coin purchase represents a transaction in a non-income-producing commodity and is highly speculative. Therefore, precious metals should not represent a significant portion of an individual s portfolio. Investing in commodities is not suitable for all investors. Exposure to the commodities markets may subject an investment to greater share price volatility than an investment in traditional equity or debt securities. The prices of various commodities may fluctuate based on numerous factors including changes in supply and demand relationships, weather and acts of nature, agricultural conditions, international trade conditions, fiscal monetary and exchange control programs, domestic and foreign political and economic events and policies, and changes in interest rates or sectors affecting a particular industry or commodity. Products that invest in commodities may employ more complex strategies which may expose investors to additional risks, including futures roll yield risk. Definitions Barclays U.S. Treasury 10+Year Total Return Index measures the performance of U.S. Treasury securities that have a remaining maturity of at least 10 years including price appreciation and dividends/distributions. New York Gold Spot Price is the price of gold as indicated in the New York Gold Market. S&P 500 Total Return Index is a total return index that reflects both changes in the prices of stocks in the S&P 500 Index as well as the reinvestment of the dividend income from its underlying stocks. Disclaimers Global Investment Strategy ( GIS ) is a division of Wells Fargo Investment Institute, Inc. ( WFII ). WFII is a registered investment adviser and wholly-owned subsidiary of Wells Fargo & Company and provides investment advice to Wells Fargo Bank, N.A., Wells Fargo Advisors and other Wells Fargo affiliates. Wells Fargo Bank, N.A. is a bank affiliate of Wells Fargo & Company. The information in this report was prepared by the GIS division of WFII. Opinions represent GIS opinion as of the date of this report and are for general informational purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report. This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment 2016 Wells Fargo Investment Institute. All rights reserved. Page 5 of 6
decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including you existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. Additional information is available upon request. Past performance is not a guide to future performance. The material contained herein has been prepared from sources and data we believe to be reliable but we make no guarantee as to its accuracy or completeness. This material is published solely for informational purposes and is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or investment product. Opinions and estimates are as of a certain date and subject to change without notice. Wells Fargo Advisors is registered with the U.S. Securities Exchange Commission and the Financial Industry Regulatory Authority, but is not licensed or registered with any financial services regulatory authority outside of the U.S. Non-U.S. residents who maintain U.S.-based financial services account(s) with Wells Fargo Advisors may not be afforded certain protections conferred by legislation and regulations in their country of residence in respect of any investments, investment transactions or communications made with Wells Fargo Advisors. Brokerage products and services are offered through Wells Fargo Advisors. Wells Fargo Advisors is the trade name used by two separate registered broker-dealers: Wells Fargo Advisors, LLC and Wells Fargo Advisors Financial Network, LLC, Members SIPC, non-bank affiliates of Wells Fargo & Company. CAR 0216-02717 2016 Wells Fargo Investment Institute. All rights reserved. Page 6 of 6