The Changing Importance of Gold

Includes: GLD, GOLD
by: Daniel Zurbrügg

When we first wrote an article on gold in the 4th quarter of 2008, the yellow metal was trading around $740. We outlined at that time the reasons why gold had performed so poorly despite the challenging economic environment. We argued that the reason for the underperformance was largely due to selling pressure from investors who were looking to sell assets in order to generate much-needed liquidity. We recommended buying gold at that time, and our decision was right; gold prices rose to $930 until early February.

We received so much feedback on our article and questions regarding the outlook for gold from our clients that we decided to write an update in early February. At that time we noted that we expected gold to break through the $1,000 level later this year but expected it to remain in a relatively tight trading range of between $820 and $930. After briefly touching the $1,000 mark, shortly after writing this update in February, gold began to move lower and has since then consolidated in a price range between $860 and $940

Dealing with temporarily higher inflation is not such a bad problem, certainly better than having to fight deflation or even worse, chronic deflation. We believe that while investors bought gold in the recent past for safety reasons, that gold will be seen more as an inflation hedge going forward from here. For the future development of gold we expect the following:
  • Trading within narrow range ($860 – 950) for the remainder of Q2
  • Move towards and eventually breach of the $1,000 mark in Q3/Q4
  • Increased demand as an inflation hedge in the coming 12 to 18 months
  • Increased demand from the jewelry industry and central banks
  • Increasing supply/demand shortfall supporting higher price levels
  • Gold price to move towards $1,400 in the next 12 to 18 months
We expect this upwards movement of gold to take place in an economic environment of increased economic growth, rising interest rates and inflation, further recovery of equity prices and an overall normalization of the global financial system. This de-pressuring of the global economical/financial system should yield increased money flows to emerging markets and “commodity currencies” such as Australian Dollar and Norwegian Crowns.
We expect to see significant outflows from the U.S. Dollar and an increasing trend towards global diversification of global currency reserves. This is caused by most central banks looking to reduce their U.S. Dollar specific risks, a trend that might go on for several years to come. This move would give further evidence that the U.S. Dollar is losing its status as the singular global reserve currency. In our opinion, the share of global currency reserves held in U.S. Dollar could fall by almost 20% in the next 3 years.
This structural rebalancing will support the devaluation of the U.S. Dollar, which has started already, and could result in a corresponding devaluation of 20% or more against other major currencies.