Gold (NYSEARCA:GLD) is unique among commodities in that the annual production is not consumed in the conventional sense, other than ~15% that is used in industry. Instead, gold is and has been used as jewelry, money, and to store wealth for thousands of years.
The following are the reasons that the price of gold will rise in the immediate future as demand increases and supplies diminish.
1. China loves gold now like they loved T-bills before 2008. China is on track to import 800 tonnes of gold in 2012. If China's domestic gold production merely remained the same as it was in 2011, China will have accumulated a total of 1,200 tonnes of gold in 2012, which is ~30% of worldwide production. This is part of China's plan to eventually provide the world's new reserve currency.
Prior to 2003, it was illegal to own gold in China (pdf page 11). Now China has swung the gold pendulum to the other extreme by encouraging and assisting its population to buy gold. This will continue to drive up demand since the Chinese population saves ~30% of their income and they prefer gold to stocks or real estate.
The Chinese government is also encouraging its gold mining industry to invest in mining companies around the world.
2. Indians' love affair with gold has deep cultural and historical significance and they consistently buy. Indians love to buy gold the way Americans love to buy houses (CBS 60 Minutes). On average, each Indian currently owns ~2/3 of an ounce of gold, (25,000 tonnes with a population of 1.2B). India imported, on average, less than one gram per person last year. Indians continue to purchase gold despite the government threatening to raise the import tax to 6% in an attempt to reduce India's gold imports. This is a plus to the investor, since the Indian government is not making the same mistake as the U.S. government by creating an asset bubble through easy credit. Additionally, Indians save more than 30% of their GDP.
The Indian government will fail to substantially limit gold imports because over half of Indians do not have access to commercial banks and because significant amounts of gold will be smuggled if the import tax is raised too high.
China and India together make up about one third of the world's population and hoard about a third of their income.
3. Embargoed Iran is selling oil for gold to China, India, Turkey, etc. Iran is under embargo because of its nuclear program and the embargo does not allow the international banking system to clear currency used to pay Iran for its oil (Seeking Alpha). This embargo will take full effect next month. However, it will be legal to trade gold for Iran's oil and there is reason to believe that is what at least the three countries mentioned above have started doing.
If Iran is able to export its oil at 2012 rates then it should theoretically be able to exchange its oil for ~600 tonnes of gold.
4. Gold production is costing more. Approximately 4,300 tonnes of gold were processed in 2012 and ~70% of that was mined. The all-in cost to replace the mined gold from new ore now averages ~$1,500 per ounce. This high cost puts the floor for gold around $1,700 once profit is considered.
5. Western countries continue to debase their currencies. Since the financial crisis in 2008, the "new normal" has been for governments to do extraordinary things in order to stabilize their economies. When this happened prior to 2008 in other countries, severe inflation attained untenable levels and populations suffered.
The U.S. government, which has more gold reserves than any other country (8,134 tonnes), will borrow, in 2013, an amount greater than what its gold is worth at the current market rates of $1,650 per ounce. Complacency among Americans about how serious the United States' problems are, is reflected by having an abysmal savings rate of <5% and by increasing borrowing.
By purchasing $40,000,000,000 worth of mortgage backed securities per month, which is over half of the mortgages originated, the Fed is artificially inflating U.S. home prices again.
6. Manipulation of the price of gold by different countries. The Chinese want to make their currency the reserve currency of the world and are buying gold to this end. April 2009 was the last time that China admitted buying gold to increase its reserves, after which gold prices shot up. By not annually admitting to the amount of gold that they are accumulating, China is wisely attempting to keep the price of gold lower than it normally would be so as to buy it at a discount.
The U.S. has a history of manipulating gold prices. When FDR banned gold ownership by U.S. citizens in 1933, he established a price that the citizens would be paid for their gold of $20.67 an ounce. The following year the established price was raised to $35 per ounce. Everyone that had been forced to surrender their gold lost the difference.
The Gold Anti-Trust Action Committed sued the Fed and won the right to see the minutes from a 1997 meeting of the G-10 Gold and Foreign Exchange Committee. The minutes from the meeting show how the various central banks discussed manipulating the price of gold (pdf).
It is in the best interest of the U.S. and the other struggling western nations to suppress the price of gold. By doing this it continues the charade that the Fed's remedial efforts are helping instead of exacerbating the problems with the economy.
Seeking Alpha author Nicholas Jones elaborated on how central banks manipulate the gold futures market in his article entitled Gold Futures' Dirty Secret.
7. Gold is a Tier 1 asset as of January 1, 2013, and is now considered equal to cash and government bonds (in most of the world). Thanks to the Basel III rule change, gold is now a tier one asset and can be mortgaged for its market value. This rule change also means that those organizations and individuals that can only own fiscally sound low risk investments, may now own gold. Bruce Pile wrote a very enlightening Seeking Alpha article about the Basel III rule changes. The U.S. has postponed implementing the Basel III rule changes indefinitely.
8. Central banks around the world are buying bullion. According to the World Gold Council, the central banks that reported to them had a net increase of bullion of 700 tonnes in 2011 and 2012 combined (Download Word).
9. The sentiment of past gold bulls is turning bearish. Sentiment shift has often been a contrarian indicator of future price actions of stocks and commodities. Some gold bulls have now been predicting a market downturn in the price of gold. These include Jim Rogers and Tom O'Brien, who is the editor of The Gold Report, and some Seeking Alpha contributors (here, here, and here).
10. The price decrease at the end of 2012 was due to capital gains tax avoidance. Admittedly, there is no evidence that the price decrease we saw at the end of 2012 was due to the possibility of a capital gains tax increase. However, gold had been on a 12 year run in the U.S. and President Obama clearly stated his intention of raising capital gains tax rates. It is my belief that many people sold their gold at the end of 2012 to avoid paying this increased tax and will reestablish their positions in January of 2013. This was the same reason that many companies and individuals took their 2013 dividend payments in 2012.
I believe that now is the time to prepare for the upcoming extreme economic shocks. A white paper (pdf download) outlining how gold protects in both an inflationary and deflationary environment was authored in 2011 by Oxford Economics which stated;
Our scenario analysis using the Oxford Global Model shows that gold may perform especially strongly in more extreme economic scenarios featuring high inflation, a weak dollar and elevated levels of financial stress. But gold also performs well in our deflation scenario, where very high levels of financial stress triggered by sovereign defaults in the EU causes a flight to safe assets.
Seeking Alpha contributor Sheldon Sutherland discussed some interesting ways to invest in gold in his article entitled Are Gold And Gold Mining Stocks Undervalued?
I believe we will see a similar scene depicted somewhere in the world in the near future. (Hungary - 1946)