Trade secrets: The future of gold

by Katie Daniel | June 14, 2017 11:28 am

[1]By Dino Vannicola
Every day, people ask me, “What do you think of the price of gold? Is it going to go higher?” After spending decades running a trading desk, I always give the same answer: “Would I be working here if I knew the answer?”

The fact of the matter is we don’t really know where the price of gold is going on a daily basis. There are far too many variables in a trading day or week that can affect its price. Gold is simply another item in financial trading, which represents a global business pushing through trillions of dollars each day.

Gold as an investment
Precious metals represent a tiny fraction of daily trading activity. On an average day, about 250,000 contracts of gold trade on the Comex, which represents nearly 709 million g (25 million oz), a nominal value of $41 billion. A big number to be sure, but in relation to overall activity, it’s a minor player. Gold represents a special place in the realm of tangible goods, especially jewellery. An investment in a fine piece of jewellery is not only an esthetic purchase, but also a de facto investment in the precious metal. However, there are many more products competing in that space for those investment dollars. The proportion of jewellery sales as a gold investment has been declining steadily over recent years.

This author suspects this trend will continue for the simple reason the high-unit cost of gold makes it harder for the average person to buy a substantial piece without straining their finances. There has also been a steady rise in the number of silver goods to help offset higher gold prices. Silver jewellery is more accessible to a wider swath of buyers.

Keeping stock
The easiest strategy to protect yourself against an adverse price drop in gold and silver is to hedge your prices when purchasing inventory. If you have a commodity trading account with a brokerage company, you can sell a gold futures contract, or 2835 g (100 oz).

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Typically, you have a cost for the gold component of your inventory when you buy it from a supplier. When the price rises, you have nothing to worry about. Since the 2011 high of $1900, however, we have seen the price drop to a low of $1060.

In a falling market without any price hedges in place, substantial losses on inventory can happen. By hedging your gold price when you buy goods, you remove the risk of a drop in the intrinsic gold value of your inventory.

The purpose of a hedge is to maintain your profit margin regardless of the value of gold. If the price drops, your short contract makes money, which offsets the loss on the gold price of your inventory. If the price goes higher, your inventory rises in value, but your hedge loses. If you can manage your inventory by ordering in 2835-g (100-oz) increments, you can always lock in the effective price of the gold component in your inventory. The labour charge has no intrinsic hedge that can be offset with a financial product. This has to be incorporated into your business plan when pricing jewellery.

Gold dealers can help with excess inventory you may wish to scrap. Many jewellers have a certain level of physical inventory matching their specific size and operational needs.

However, when your inventory grows too large, or you wish to purchase new material, or you simply have to pay bills, selling inventory is an obvious way to mitigate your financial exposure and raise funds.

Most dealers will give you the opportunity to lock in a price and deliver material to be scrapped. The process is fairly straight forward. You deliver material, it gets melted and analyzed, and you are then paid for the gold content. If you are registered with the Canadian Revenue Agency (CRA), then you can also file a claim for a refund on the HST you initially paid when you bought the inventory.

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Future of gold
In this author’s opinion, the value of gold is not necessarily reflected in the current price. The problem with this piece of information is the market can remain unbalanced or illogical far longer than most of us can remain liquid. The current price of $1655 is roughly the average price of the last two years, although there have been big drops and rallies interspersed over that same time.

The two biggest factors going forward this year are: when and how many interest rate increases are we going to see from the U.S. Federal Reserve.

There is a general consensus two-rate increases are possible in the U.S. this year. If rates go up in the U.S., the dollar rises with downward pressure on the price of gold as a result. This trading environment has existed since the U.S. raised rates last year. The results are obvious: global money pours into the U.S. from abroad as foreign investors buy trillions of U.S. dollars. This money, generally, goes to the stock market.

It’s been all-time high after all-time high this year. Gold does not attract very much interest or investment in this type of environment except from central banks. The simple explanation for this is the possible in-stock returns are too great to ignore. Gold suffers from neglect and is easily ignored. When something is ignored in the investment world it doesn’t trade higher and may, in fact, be sold.

If U.S. rates do go higher this year, then a sharp rise in the dollar can be expected. Gold has been priced for at least one rise already.

The other factor is the geopolitical risks in the world today. There are numerous elections taking place in European countries such as France, Holland, Italy, and Germany. Any of these elections could have a material impact on the price of gold. All of the risks in elections present positive risk sentiment for gold. If the Brexit and U.S. elections are indicative of voter sentiment, then we shall see some interesting possibilities emerge—gold may continue to rise.

I believe we shall see gold prices rise in 2017, accelerating in the second half because of geopolitical risks. In Canadian terms, with a strong U.S. dollar, we will see Canadian trading back along the $1.38-$1.40 range as our own interest rate policy shall lag the U.S. Federal Reserve. Furthermore, I believe the Organization of the Petroleum Economic Countries (OPEC) agreement limiting oil production is at best a very long shot, and more realistically, has no chance of being maintained. This leads me to predict a test of $1800. A test of US$1364 would bring us back to the potential of a bull market in metals should that level be breached.

Lastly, as a reminder, the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC) has begun to audit dealers in precious metals and stones (DPMS) with more regularity. Make sure your anti-money laundering (AML) and anti- terrorist financing (ATF) regimes are up to date, and follow your industry association guidelines.

Dino Vannicola has been a chief trader of foreign exchange and precious metals for nearly 30 years. As a young man he discovered his love for trading after visiting the main vault at Guardian Trust in Old Montreal shortly after being hired, and has never looked back. Today, Vannicola is the president of Guardian Gold. He can be reached at dino@guardiangold.com.[4]

Source URL: https://www.jewellerybusiness.com/features/trade-secrets-the-future-of-gold/

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