Did 2015 Fly By? Read This and You Will Be Up-to-date Again

January 21 2016

Gold has ended the year with a small loss of 0.7%. This followed a larger loss of 31.2% in 2013, and the 2014 recovery when the gold price ended with a plus of 12.1%. Silver however continued its losing streak with a decline of 2%, after it also declined 9% last year, and 38.5% the year before.

2015: The Year of the Black Gold

The past year was marked by the black gold: oil. It was a great year for fuel users, but it certainly wasn’t for oil investors, given that the oil price crashed down to below 2008’s lowest point. This week, the oil price even dropped down below 30$ per barrel. As a reminder, oil previously cost more than $100 per barrel! Oil ended the year with a loss of 30%, and Brent oil even topped this with 35%.

You’ll mostly hear the press raving about (an alleged) excess supply. This contains a grain of truth, given that production exceeds consumption at this moment. Despite this state of affairs, the oil cartel OPEC, the US and Russia continue unabatedly with their supply of oil to the market. Simultaneously, oil production has increased.

But while production has increased, so did the demand for oil. Yet, that’s not what is most important. Rather, the expectations of investors are regarding the future demand for oil are of crucial importance. And those expectations are highly pessimistic. The reason is clear: our previously held expectation (the growth of the world economy is disappointing) is becoming widely accepted.

A lot of the figures we have discussed in the past year point to a slowdown of economic growth. Corporate profits in both US and China have declined for the first time in years, while the GDP growth forecasts of the Federal Reserve of Atlanta came crashing down to zero. The amount of goods transported over sea and rail have reached recession-like levels, and interest rates continue to decline in the US (while every economist had told us, for two years now, that the rates would increase!).

This constitutes a period of economic weakness. And as speculators look forward, this will be factored into oil prices. The result: an oil price which is far below its 2008 low.

But even that is not the full story.

There Is Little Leeway in Oil Production, Potential Outbreak This Year

For investors, oil may offer the chance of a lifetime right now; a huge opportunity.  

After all, we have to ask ourselves the following question: if demand suddenly grows, will oil producers be able to keep up and expand their production in the short term? If the answer is 'yes,' then we should steer clear of oil. If the answer is 'no,' then oil may very well be a highly interesting investment. 

The global demand for oil has reached a new peak: 96 million barrels each day. However, the potential production capacity of oil producers to sell more oil has never been this limited: there’s leeway for, approximately, an additional 1.5 million barrels per day (which is slightly higher than 1.5% of oil demand).

Excess supply currently equates to about 600,000 to 700,000 barrels. U.S. oil production added one million barrels to the daily overall supply for five years in a row. U.S. shale oil producers will be marginal producers in the oil market. And rather than producing a million extra barrels, they will probably produce one million barrels less in 2016.

In short, this could be the year in which we go from excess supply to a shortage. And the world isn’t prepared for a shortage of oil. The oil price could rise as fast as it crashed earlier. 2016 will turn out to be a very volatile year for the oil price. But that means we should invest now, change our investment portfolios accordingly, and allocate part of our wealth in oil production for the coming three to five years. Only then, will we be able to profit from our observation. An observation which a lot of press and many investors do not seem to make. If you do not make your decisions in the first quarter, then you could be too late.

The balance in the oil market is delicate, very delicate. A recipe for a volatile year.

Investing in Oil Is Easier Said than Done

Some investors make a crucial mistake though. They buy an oil ETF (e.g. the US Oil Fund, USO), with the presumption that it tracks the oil price (an ETF is also commonly known as a tracker). This is a wrong assumption.

The reason is simple: these funds do not buy oil to subsequently store, but rather buy futures. The problem? Oil futures have moved into 'contango'; which means that short-term futures contracts are much cheaper than long-term ones. A futures contract is a promise to deliver oil, in the future, for a fixed price agreed upon beforehand.

The oil contract with the shortest time horizon is below $30 per barrel. This is called the oil price in newspapers. The earlier mentioned ETFs usually buy these contracts, and then roll them over to the next month. However, as long-term futures contracts are currently more expensive, the fund makes a loss while rolling over their contract each month. The result? As a buyer of an oil ETF you are the biggest loser: after paying a management fee (1%), the fund makes a loss on their positions each month, in a desperate attempt to replicate the oil price.

These ETFs will never do a good job at tracking the oil price. You have been warned.

The other alternatives are not great either: buying stock of oil companies (is Royal Dutch Shell really undervalued? I have my doubts) seems imprudent, with the exception of a few individual stocks. And buying physical oil, and storing it, doesn’t seem feasible either. Bloomberg journalist Tracy Alloway found out how hard that can be (see That Time I Tried to Buy an Actual Barrel of Crude Oil ). Not an option either.

So, what’s the alternative?

Buying Gold as an Alternative for Buying Oil

The good news is that buying gold (physical), and storing it, is quite easy. It is even cheap compared to other investments in physical commodities. And the oil price and gold price are closely linked.

Yet, due to the strongly declining oil price, this linked has loosened a little over the past weeks. The gold price even strengthened a little (breaking though the $1,100 barrier). The gold/oil rate is currently 36, and has never been this high. That’s why we have to take a careful look the prospects of gold for the coming year.

It is highly likely that the gold price will continue to be under pressure in the first and second quarter, and will decline further.

Yet for investors in continental Europe, it’s important to note that the euro is equally likely to remain under pressure.

Which means that gold, priced in euros, will remain an interesting investment. So if you want to make use of the opportunity in oil we discussed above, then my advice for retail investors, who do not have a large expertise when it comes to oil, is to buy gold instead.

The Federal Reserve and the Omnipotence of Central Banks

2015 was also the year in which the Federal Reserve finally hiked interest rates. That did not go by unnoticed. Yields on junk bonds rose sharply. As a results, funds like Third Avenue and Stone Lion Capital went bankrupt. Memories resurfaced again: similar events happened in 2008, when BNP Paribas and Bear Stearns faced problems due to a flood of redemptions by investors.

The market has closely followed the Fed’s communications last year. But the power of the Federal Reserve is actually quite limited. And that will show, more and more, in the coming year(s).

It is ironic that Fed chairwoman Janet Yellen complains about economic inequality, while it is her policies that widen the divide. Large companies and investors, with easy access to cheap credit, have profited for years from the policies that Janet Yellen and co. have set forth.

The Stock Market Consolidates

It is overly clear that we are nearing the end of a stock market bubble. The market temporarily crashed in August, after which it recovered slowly. However, the US S&P 500 index hasn’t been able to reach new highs yet. After a small correction in August, new records remain absent. Actually, stock markets have crashed in the entire world. The Dow Jones lost a thousand points.

The Dutch AEX stock index is currently at 400 points, which is a strong decline from its highest point. Investors who were so smart to bring their money to the stock market in 2015, currently face hefty losses. In April last year, the AEX was still at 500 points. In short, investors who thought it was wise to buy stocks at their highest point, currently face a 20% loss.

Is this decline a buying opportunity? That is what many investors say. The Americans say 'buy the dips.' But that certainly isn’t the case. Stock prices are still very high. Some companies are valued on perfection, but we live in a world that isn’t perfect. Don’t be surprised when the AEX takes a dive below 300 points: it could be this year, or maybe later.

Incidentally, last year I spoke to an investor who quickly dismissed gold investments. His words: "Investors are stupid." "It was clear for everyone that, given QE, US markets would rise. Now the roles have reversed, the ECB has launched its QE, and the European markets should rise." I already warned him that it was too easy to think it would go like this. And now it seems like investing is not as simple as some hope it is. My advice? Never be too frivolous.

Investing is not easy. Certainly not now, at a time that central banks hold the markets in a tight grip. Fund manager Seth Klarman recently said "Investing, when it looks the easiest, is at its hardest." And that completely nails it. When everyone is making big bucks by investing in stocks, it becomes very hard to resist starting yourself as well. When a stock market continues its way up, despite worrisome fundamental factors — China, Japan, Europe and the US, things become very tricky for investors. This is currently exemplified best by the billion dollar valuations in a growing 'unicorn club'.

Smart investors avoid the European and US stock markets for the coming while, and certainly should avoid 'fantasy' stocks like Amazon, Netflix and Tesla.

While we expect that the gold price could decline in the short run, just like the euro, we are very optimistic about the prospects for the medium and long-term. The unusual level of speculative activity on the stock markets is something that, just as it did in 2008 and 2001, will come to an early end. By holding gold, we believe that investors will be well prepared for when the market will make a U-turn. Given the euro’s weakness, it is recommended that you do not delay a purchase of gold too long. The coming two quarters will probably be very good moments to allocate part of your financial wealth in gold, in order to yield great returns in the coming years.

We are thankful for your trust in us, and look forward to a series of successful years for gold in 2016 and onwards.

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