Do you know that a single ounce of gold can be drawn into 50 miles of thin gold wire?
Do you know what the London gold fixing is?
Do you know that gold has its own interest rate market, where a lender places gold with a bank in return for payment of interest?
Do you know the difference between ‘allocated’ and unallocated’ gold?
We could go on and on with these types of questions but we won’t.
Truth is, if you’d asked us the same questions a couple of weeks ago, our answer to all of them would have been ‘nope, didn’t know that.’ However, that would have been before we read a book, entitled ‘How to Profit in Gold,’ by Jonathan Spall.
Mr. Spall has been involved in the precious metals markets as a trader and salesperson for 25 years, having worked at Deutsche Bank (and other institutions) while currently employed at Barclays Capital. He takes that wealth of knowledge and experience and distills it into a surprisingly easy to read and entertaining 199 pages. From what drives the price of gold, the lenders and borrowers of gold, exchange traded funds and their impact on gold, gold myths and reality and the rules for trading gold, Mr. Spall covers immense ground when it comes to the yellow metal. While the book doesn’t delve too deeply into the history of gold (there are plenty others that do), it lends itself more to be a manual or handbook of the way gold trades and the factors that affect its price. If that enthuses you, check it out. At the very least, you’ll be a more knowledgeable gold investor.
True to form, we had to try and get Mr. Spall to do an interview and that is exactly what we did. So wipe your eyes, grab yourself a glass of water and settle in for ‘How to Profit in Gold.’
Q: What prompted you to write ‘How to Profit in Gold‘ after already having written ‘Investing in Gold: The Essential Safe Haven Investment for Every Portfolio‘? In other words, what did you hope readers would take away from this book?
A: I have been involved in the gold market for over 25 years. I became interested in the topic even longer than that as it was a field that my father worked in. However, I have so often been disappointed in the way in which gold is written about that I decided to do something to redress the balance. I had previously written “how to” style books on the gold market, predominantly for central banks, that my employers gave out to customers. These were well received and often referred to as the “gold bible”. Ultimately I decided it was time to seek a wider audience and approached a number of publishers.
I was fortunate enough to find a lot of interest in my proposal and I eventually decided to work with McGraw Hill who published “Investing in Gold” in 2008. With the fast moving developments in global markets it seemed natural to update the book and particularly as the incredible success of ETFs became ever clearer and, additionally, it was no longer a case of which central bank was looking to reduce its holdings of gold but which were buying it instead.
In terms of what I was hoping that readers world gain – well, when I look at books on gold – a great many of them seem to be written by academics rather than those whose job it is to work in trading rooms. Some are obviously excellent but others seem to be divorced from the reality that I know having spent my career in gold trading and sales, including living for 6 years in Hong Kong and a further 3 in Sydney being involved in this industry. So I hope that I have managed to impart what it is like to work in this market for a living and what we, and our clients, look at when we determine our trading positions.
Q: Mr. Spall, in the book you mention that gold is a quasi commodity and quasi currency – can you elaborate a little on this please? Why do you think it is important to keep this in mind?
A: For many people gold represents the ultimate hedge against the US dollar and inflation – although in my opinion it is really a hedge against any sort of financial disruption and uncertainty. So it is bought and sold based on the financial outlook. To get an idea of how much of the gold price movement is due to the US dollar, rather than to the metal itself, it is important to look at gold in terms of other currencies – such as the Euro. When gold is rallying both in USD and EUR terms then there is something more than simply the currency aspect that is driving the price. It is key to watch gold‘s performance against other currencies and not simply the US dollar.
Equally, some investors solely think of gold as a quasi currency. They are little versed about the global physical market. By that I mean where bars and coins are bought as the main store of family wealth. For example, some 2,500 tonnes of gold is mined each year but it is commonly estimated that somewhere between 15,000 to 20,000 tonnes of gold is in private hands in India and roughly two thirds of that is in the rural economy. So to simply ignore a segment of the market that holds over 5 years of global annual production is perverse. These farmers will not trade their gold because of quantitative easing but instead if the monsoon (rains) fail and consequently their crop is poor. At this time gold could be sold to repay loans and to buy seeds and fertilizer for the coming season.
Received wisdom was very much that if gold traded above $1000 then the physical markets in countries like India and China would collapse and instead a flood of scrap would hit the market. This has proved to be far from the truth – indeed physical demand has held up better than expected while flows of scrap have been far less than anticipated.
When evaluating the gold market it is important to keep both of these in mind and remember that gold identifies a unique place in the investing spectrum.
Q: You’ve mentioned that it is impossible for China to accumulate a significant portion of their currency reserves in gold – why do you think that is?
A: Currently China reports, to the IMF, that it holds some 1,054.1 tonnes of gold. This equates to 1.5% of their reserves. For gold to be a “significant portion of their currency reserves” then presumably that would mean a holding of some 10% or so. I have chosen that figure as it was the theoretical percentage that the Central Bank of Russia thought was appropriate for gold holdings within reserves (LBMA Conference – Johannesburg 2005), it is also less than the 15% allocation to gold that the European Central Bank decided on when it was inaugurated.
To get to 10% of gold in their reserves then this would imply a purchase of some 7,000 tonnes of gold – or nearly 3 years of global annual production. If China, as the world’s largest gold producer, were to divert all domestic production into the coffers of the central bank then this would take some 25 years to reach 10%. Clearly by this time the reserves would have grown anyway.
Unsurprisingly, in June 2010, Reuters reported that “The gold market is too small, illiquid and volatile to be suitable for asset allocation, China’s State Administration of Foreign Exchange (SAFE), said in its annual report.” From China’s point of view it is undoubtedly the case that the gold market is too small to allow them to accumulate the quantities of metal required for true diversification. However, I do expect the country to continue to acquire metal from domestic production and thus the amount of gold held in its reserves to continue to increase.
However, while the economics do not work for China, the same is not necessarily true for other countries as the recent purchases by India, Saudi Arabia, Thailand, Mauritius, Sri Lanka, Bangladesh and news that South Korea’s central bank is evaluating the gold market all evidence. There are other central banks who are also looking at gold at the moment but who have chosen not to make their intentions public. Additionally there have been purchases by sovereign wealth funds, who are not required to report data to the IMF, and who have chosen not to issue press releases on their purchases of gold.
Q: What is the EcbGA and why do you think it was important?
A: The EcbGA is the European central bank Gold Agreement. The weird mixture of upper and lower case is to signify that it is European central banks that reached an agreement on timetabling gold sales rather the European Central Bank.
This agreement was signed, in Washington, on 26th September 1999 and was against a backdrop when seemingly every country was looking to divest itself of gold – even those countries that were thought to be friendly to the metal. Matters reached their nadir during the summer of 1999 when it looked as though the UK and Switzerland were leapfrogging each other in their eagerness to sell. Given that central banks held in excess of 30,000 tonnes of the metal the fear was that much of this metal was being mobilized and with a consequent catastrophic outcome for the gold price.
The original idea behind the agreement was that it allowed for certainty in terms of how much gold could be sold and was initially 400 tonnes a year for the first 5 years. When the agreement was renegotiated in 2004 the limit was raised to 500 tonnes. For the first 8 years or so the quota (not target) was pretty much filled as UK, Switzerland, Netherlands, Spain, France, Austria, Sweden etc. sought to reduce the amount of gold that they held. More recently this selling interest has evaporated as the rationale for gold ownership has swung through 180 degrees.
The achievement of the EcbGA was to remove the threat of imminent disposal of gold by the world’s largest holders of gold and ultimately allow sentiment to improve.
Obviously this is a topic that spans some 11 years and much more detail is provided in How to Profit in Gold.
Q: In the book you refer to something known as the ‘trust bonanza’ to which you attribute the poor performance of gold relative to inflation (U.S. CPI) – can you elaborate on this topic a little more and do you think this phenomenon might occur again some time in the future?
A: Having said all that I did about physical gold markets, to me the primary driver of gold is sentiment and emotion. To many of my clients (hedge funds, central banks, gold miners, money managers etc.) I have been introducing the idea of the “trust gap” and which first appears on page 4 of “How to Profit in Gold“. This is a notion which seems to resonate strongly as I travel around the world.
My argument is that when you trust monetary authorities to control the global economy then there is little point in owning gold. There is belief in fiat money, inflation is under control and a simple adjustment in interest rates is all that is needed to return things to an even keel. So indexing US CPI and gold to January 1975 the chart shows that gold lagged behind inflation for much of the 1980′s, 1990′s and really only ending in 2005. I believe that this illustrates the market’s belief in the rigour of such figures as Paul Volcker at the Federal Reserve and Karl Otto Poehl and Hans Tietmeyer in the Bundesbank.
However, in the late 1970′s, early 1980′s and more recently, gold has far outperformed inflation. These were periods characterized by oil price shocks, the Russians having invaded Afghanistan, US hostages held in Tehran and the general unpopularity of governments. Similarly, we currently have military involvement in Afghanistan and Iraq, governments whose approvals ratings are slumping being the “norm” around the globe and concern that the only economic policy is to push the problems as far as possible into the future to hopefully avoid deflation. A problem that central banks in private will candidly admit to having few ideas on how to defeat it.
So rather than being just a lump of metal when there is trust in money and government we are in a situation where gold is seen as the ideal hedge against the sort of financial dislocation/uncertainty that we are currently witnessing.
Q: Lastly, how would rate your current sentiment towards gold, bullish, bearish or neutral and why?
A: I remain bullish for gold, mainly because of this issue of the “trust gap”. Once trust is lost it is hard to regain and I wonder how leading economies manage to rebuild this trust? In my opinion this will occur when the monetary authorities have the confidence to start raising real interest rates and when they are seen to be directing events rather than simply playing catch-up. Until that time investors will continue to allocate funds to gold.
The alternative end to this rally in gold will be when gold goes “parabolic” also known as a “blow-off top”. So that the price races ahead seemingly uncontrollably with moves of several hundred dollars a day becoming commonplace until the rally collapses in on itself. However, I think this scenario is far less likely than the former.