The Outlook For Gold: Facts And Figures

Includes: CEF, GDX, GDXJ, GLD, IAU
by: Robert Hallberg

Gold is in the midst of a secular bull market that has been going strong since 2000 and delivered more than a six-fold price increase. The main driver behind the rising gold price has come from investment demand.

Uncertain economic conditions, sovereign debt worries, and currency debasement are all factors that have driven investors to own gold. You may already know the basic reasons for owning gold: Currency protection, inflation hedge, store of value, and insurance against a financial meltdown. Add supply and demand imbalances and you have a strong argument for holding gold in the foreseeable future.

Late to the party as usual, the man on the street and the mainstream media seem to finally be waking to the decade-long bull market in gold. It looks like gold is entering an “awareness phase” of the bull market, with growing buzz and questions whether gold is in a bubble or if we will have soaring prices right around the corner.

The chart and analysis in the article will attempt to determine how far along we are in this gold bull market and what we can expect moving forward.

The chart show worldwide demand of gold since 2001. The overall trend is up. Although, demand for gold in jewelry has been declining, investment and industry demand more than make up for declining jewelry demand.

Demand for Gold

The next chart shows overall investment demand, which has been exploding since 2001. Gold ETFs have been a popular investment vehicle since their inception around 2003. However, starting in 2010 a new trend of selling “paper gold” and buying physical gold seems to have emerged.

Investment Demand for Gold

More importantly, central banks are no longer selling off their gold, but rather are increasing their holdings. In 2009 central banks became net buyers of gold for the first time in over two decades. You can see the shift on the chart below. This new dynamics will completely change the landscape and drive the gold price much higher in the years to come.

Central bank purchases of gold

China’s newfound appetite for gold is very bullish on the yellow metal. China’s gold holdings aren’t the largest by volume, but they stand out when compared to its percent of total reserves, which amounts to only 1.6% of their total reserve assets of $3 trillion.

There seems to be a lot of room to grow. Emerging opinions of Chinese economists and advisers suggest that the country’s central bank should increase its gold reserves as a hedge against the falling values of other currencies. Even the annual report by the People’s Bank of China expresses an interest of increasing its gold reserves, and the key decision-makers have already started the process of this policy change.

Chinese Demand for Gold

The official demand is only half of the story. China has been increasing its appetite for gold at a rate of 14% per year since it deregulated its markets in 2001. In addition, the government has gone as far as promoting ownership of gold for its citizens. The Chinese have turned gold bug almost overnight, and a number of investment products and checking accounts linked to gold have been popping up all over China.

Is gold a bubble?

There have been widespread talks in the mainstream media about gold being a bubble waiting to pop. Although gold has been in an 11-year-long bull market, I believe that we are still far from bubble territory. Most of the people in the world do not own gold, despite the growing buzz, and gold still only represents a fraction of the world’s total assets. The chart compares gold to other global financial assets.
Gold versus other financial assets

We are far from the highs of 1968 or 1980, with plenty of room to the upside.
Gold versus other assets

How far will gold go?

There are various tools investors can use to help determine the future price of gold. Rather than to measure the price of gold in US dollars or other fiat currencies, you can compare gold’s purchasing power against other benchmarks. One popular method is to measures how many ounces of gold it takes to buy the Dow. This ratio also indicates the market’s confidence of hard assets like gold versus paper.

There is a historical relationship where, at different points in time, gold and the Dow trade at a 1:1 or 2:1 ratio. At these points in time, gold has reached its peak in terms of purchasing power relative to other financial assets. It currently takes around 8 ounces of gold to purchase the Dow, but not too long ago, at the height of the technology bubble, it took 44 ounces. The Dow has fallen 80% in value measured in gold, and it is my belief that during this bull market this ratio will once again be 1:1 or perhaps even less.

Gold-Dow Ratio

Gold went up 24 times during the last bull market that peaked out in 1980. If a similar move is repeated, gold will end up around $6,250 per ounce. But with much greater problems in the world today then we had during the 1970s, there is a chance to gold will produce an even greater return this time around.

Future of Gold

Investment Implications

With a high probability of rising gold prices in the foreseeable future, investments in gold bullion and smaller positions in gold ETFs and other gold derivatives should be a profitable strategy.

SPDR Gold Trust (NYSEARCA:GLD) is one of the most popular gold ETFs. The trust holds physical gold in a custodian bank, and is designed to reflect the price of gold on the market, less expenses and liabilities. Although you are subject to the risk of relying on a custodian to actually hold your gold, this ETF is a very cost-efficient instrument and an excellent trading vehicle.

The iShares Gold Trust (NYSEARCA:IAU) seeks to correspond to the day-to-day movement of the price of gold bullion. The shares are backed by gold and held at a custodian bank in New York, Toronto, London and other locations.

Market Vectors ETF Trust (NYSEARCA:GDX) attempts to replicate the NYSE Arca Gold Miners Index. GDX represents a mix of 30 small, mid tier and large capitalization gold mining companies. GDX’s holdings include some of the biggest and best producers in the industry, and they are far better positioned to withstand a downturn than many other gold mining companies.

Market Vectors Junior Gold Miners ETF (NYSEARCA:GDXJ) is made up of 72 junior gold miners. The index provides exposure to a wide range of small to medium capitalization gold mining companies globally that generates at least 50% of their revenues from gold and silver mining. Because of its holdings, GDXJ is more volatile than most other ETFs invested in precious metals. This ETF is suited for investors who wish to speculate on price movements in gold, but refrain from holding individual junior miners.

The Central Fund of Canada (NYSEMKT:CEF) is heavily invested physical gold and silver bullion. The fund currently holds over 95% of its assets in gold and silver, which makes the fund highly affected by the price movement of these two metals. This is a relatively safe and cost-efficient way to invest in gold and silver.

Disclosure: I am long GLD, GDX.