This year has been an ugly one for gold bulls, but this article answers 5 major questions about gold and provides reasons to stay positive about the future of gold.
There are a number of conventional factors that influence the price of gold. Real interest rates, inflation, seasonality, commitment of trader's reports and currencies come to mind. Additionally, in the modern era close attention must be paid to paper gold, developing nation demand and currency appreciation.
What is the effect of Real Interest rates?
Real interest rates are the difference between the nominal rate and the rate of inflation. Currently this real interest rate is negative. The nominal interest rate is 0.25% and the rate of inflation according to the U.S. Federal Reserve is 1.4%. This means the real interest rate is equal to -1.15%.
The U.S. dollar is in fact a depreciating asset. Historically as real rates fall below zero, the price of gold appreciates. Real negative rates spur rotation from dollars into non-deprecating assets, such as gold.
What is the impact of Inflation and expected inflation?
One of the strongest reasons for being bullish on gold is the idea of inflation. Since 2008, the M0 money supply has experienced a 4-fold increase. The M0 in 2008 was $750,000 million and currently is over $3,109,805 million. While the numbers are hard to picture, quadrupling the money supply can effectively lead to the definition of inflation: reducing the purchasing power parity of individuals. To those non-economists this can be read as each unit of currency purchasing fewer goods. This inflationary environment causes the domestic currency to depreciate and creates a bullish case for owning an asset that holds its value or appreciates such as gold.
What is the international impact on gold?
Emerging economies have become increasingly large players in the physical gold market. China and India are now major buyers of physical bullion, evidenced by the huge physical purchases during this last steep decline in gold. The appreciation of developing nation's currencies vs. the USD adds an extra variable to the increased demand equation. The appreciation of foreign currency allows international buyers to purchase gold at levels that were previously unattainable.
What is the short-term outlook for gold?
Several factors provide a positive short run outlook for gold. Seasonally, gold has performed well in the back half of the year with the 10-year average being positive for all 6 months.
The Commitment of Traders report indicates the commercials are the most bullish they have been in 8 years. Extremes in this indicator have historically been major turning points for gold. The average all-in cash cost of major gold producers is somewhere in the neighborhood of $1200-$1400 per ounce depending on who you ask. This price indicates a producer price floor meaning prices below this zone for a sustained amount of time will cause producers to cut back production, lowering supply.
What is the long-term outlook for gold?
There are several fundamental reasons to be bullish on gold long term. Gold is a finite resource, and it has a store of value. Additionally, it is a hedge against a depreciating currency and investor fear. With current high country debt levels, governments will be hard pressed to drastically raise interest rates. For this reason countries real rates will remain close to or below zero.
Bottom Line: To be bullish on gold, one must have a long-term perspective. Forget about the current bumpy ride and focus on the big picture. Focus on negative real interest rates and a currency system that is consistently debasing itself.