Markets have started 2016 with a healthy dose of turmoil with global stock markets in the red right out of the starting gate. Gold and Silver meanwhile have started the year strongly in the green. Forecasting today’s volatile, leveraged and paper-dominated markets is challenging, as a great many precious metals investors will attest. To complicate matters, an obsession with central bank policies (US Fed policy in particular) continues to dominate all markets.
Nevertheless, beneath all of the external influences and all of the leveraged paper, the gears of the physical market for gold and silver still turn. We can be sure prices will reflect actual supply and demand for physical metals at some point, even if we do not know when. With that in mind, here is a look ahead to 2016…
Silver production looks to have peaked in 2014, while the expectation is that gold production is likely to have peaked in 2015. Falling prices made an increasing number of mining projects uneconomic and thus shut down. Whilst lower fuel costs are helping [fuel can amount to 30% of the cost], the average all-in cost of production for silver is estimated at around $17/oz and for gold at around $1,150/oz.
Today precious metals sell for well below their all-in production costs. At time of writing, Silver is at $13.98/oz and Gold is $1,078.30/oz. Primary producers of gold and silver will likely deliver even less to market in 2016 given that a great many miners currently take a loss on every ounce they sell.
But there is another factor likely to decimate supply in 2016. Base metal prices, including for copper, fell dramatically last year, and the outlook is not too bright for the year ahead. The Chinese economy, the world’s largest market for commodities, is slowing. Brazil is in real trouble and economists are worrying more about the possibility of recession around the world.
Slumping demand for base metals will impact supply of gold and silver because huge quantities of these precious metals are produced as a by-product of mining for base metals such as copper and zinc. The reorganization of Anglo-American PLC, one of the world’s largest mining conglomerates, earlier this month highlights just how difficult the current environment is for producers – regardless of which metal they are mining.
Gold and silver prices have been in decline since 2011, but it is only during the past year that average prices will finish well below even the most conservative estimates of production costs. The recent carnage in base metals will add significantly to constraints on precious metals supply in the months ahead.
Physical Demand Rising
Investment demand for physical bullion is perhaps the biggest story in precious metals for 2015. Mints and refiners spent much of the 2nd half of the year unable to keep up. Investors had to contend with higher premiums and delivery delays all the way into the year's end.
Only time will tell if 2016 can top last year’s record. We look set start this year in much the same way we entered 2015 – with steady, but far from overwhelming buying activity for fabricated coins, rounds, and bars. Investors loaded up in recent months and now await the next catalyst.
It may be price action. Lower spot prices over the past 4 years have been a big driver of demand. And prices moving consistently higher will also inspire demand from newcomers (as we saw during the last bull cycle between 2009 – 2011). Only flat or range-bound prices typically lead to investor apathy.
As always, geopolitical events will play a big part in whether or not metals benefit from safe-haven buying. In 2016, investors will be watching the ongoing saga surrounding Greece and other hopelessly indebted European nations. The U.S. is at odds with Russia in the Middle East and in Ukraine. Further, the recent tensions between Saudi Arabia and Iran have alarmed markets worldwide
And recent tremors in high-yield debt markets may be advance warning that extraordinary leverage is about to rock financial markets once again. These stories, and others no one can predict, have potential to generate a flight to safety in the coming year.
Industrial demand for gold and silver may turn out to be tepid for 2016. This is less of a factor in gold markets than for silver, where manufacturers consume a good portion of what is produced annually. As mentioned above, some economists worry about the possibility of recession in the coming year. Any slump will weigh on demand for items such as jewellery and other goods. However, a lot of industrial demand comes from high-growth sectors which have proven resilient during past recessions. Electronic, solar, and healthcare related applications for silver are a few that spring to mind.
A 2016 Wildcard
Delivery defaults are possible in the futures markets. The explosion of leverage in Comex gold futures bears watching in 2016. The number of registered bars available for delivery in exchange vaults relative to the number of paper ounces being traded shrunk dramatically to record lows in recent weeks. It’s a trend that simply cannot go on very much longer – not at the current pace of decline.
Exchange participants may store more gold as 'registered' in Comex vaults. That’s possible, though there is good reason to wonder how much physical metal the holders want to part with at current prices, and would go against the trend of continuous withdrawals that has been going on for the last few years. The precipitous drop in registered stocks may well be signalling they are more than a little reluctant to part with it.
If holders of silver and gold futures contracts start standing for physical delivery of more metal than the COMEX has available to deliver, or should traders even begin to seriously entertain that possibility, we’ll see some fireworks.
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