An Emerging Markets View Of Gold

| About: SPDR Gold (GLD)

In the West, gold is viewed in equal measures of reverence, suspicion, and dismissiveness. Multiple generations of having the world's most dominant sovereign currency, the dollar, will do that. In Asia, however, where the history of monetary upheaval is more pervasive and the collective cultural memory far longer, the view of gold is more practical. In these times of monetary uncertainty emanating from the U.S. and European banking community, this Asian perspective on gold is expressing itself strongly. Trapped in the currency wars between Eastern and Western central banks, individuals in Asia are turning to gold to protect their wealth. In essence, they are taking cover and waiting for the shelling to stop.

In India, gold is the traditional store of wealth in the form of jewelry. This is well known in the gold community where the price of gold is traded with one eye always on the demand from India. What is less well known is that much of Southeast Asia feels the same way. In Vietnam, it is estimated that the population privately holds as much as 1,000 tons of gold, giving the people there the highest per capita gold holdings in the world. If the Vietnamese people were a central bank they would have the seventh largest gold reserve, rivaling that of Iran, Switzerland, and Russia.

Vietnam's relationship with its domestic currency, the dong, is so tenuous that the country has, in effect, three circulating currencies: the dong, the U.S. dollar, and gold. Gold is an integral part of the modern Vietnamese economy, which until very recently was used to settle debts, buy and sell real estate, and make other everyday transactions. There are over 10,000 gold dealers in Vietnam, from the smallest individual business owner to the national jewelry producers. Gold is such an integral part of the Vietnamese economy that it is one of the few places in the world where banks offer interest-bearing CDs based on gold. The current rate is between 4% and 5% for a three-month CD.

But a common theme in 2012 is how emerging market governments are moving to defend their domestic currencies from the exported inflation they know is coming from the Federal Reserve and ECB, as they attempt to stave off a banking sector implosion due to overissuance of sovereign debt. Turkey and India are putting soft controls on gold inflows by raising tariffs or offering high yield bonds issued against an individual's gold. In Vietnam (VNM), the central bank is being more proactive, forbidding the use of foreign currencies (the U.S. dollar) and gold in financial transactions and taking control of the physical gold trading industry.

In China (FXI), the government there is actively buying up as much gold as it can, importing 428 tons through Hong Kong in 2011 and is on pace to import another 479 tons. How much of that is private demand and how much is central bank demand is anyone's guess at this point. We also know that none of China's domestic production is being sold on the international market, as the People's Bank of China is buying it all. The moves by China, and to a lesser extent Russia, to increase its gold reserves is to make its currencies more attractive for international trade, as the country attempts to move away from the U.S. dollar for both gold and oil transactions.

In this current environment, the fundamental story for (GLD) is very bullish. There is no practical response to the sovereign debt crisis, and derivative time bomb associated with it, that does not involve massive monetization of debt. Japan's debt growth path is unsustainable, especially in light of its demographics. These are the three of the biggest economies in the world. Any credit implosion worries over China are mild in comparison. But trading gold is neither easy nor foolproof.

It requires understanding the inflation expectations of the bond market at all times in order to tell whether one should be long or short, when to buy, and when to sell. The endless discussion of the push and pull between asset deflation (credit contraction) and commodity inflation (rising core CPI) is ultimately irrelevant to the discussion because large movements of financial instruments are not based on such simplistic ideas. Money parks itself where it is treated the most favorably over the long term, but day to day it has to respond to the realities of the present. The CPI is a measure of inflation past; it -- like most economic indicators -- is also poorly correlated to gold.

My view is that the inflation expectations of the bond market are rising significantly while the headlines continue to be dominated by talk of an economic slowdown. China's GDP targets have been cut. More than 75% of U.S. economic data underperformed expectations in February and March. Spanish and Italian debt markets are exploding again, with 10-year yields back over 6% and a pause in the U.S. equity market rallies that is putting downward pressure on energy and industrial metal prices. In this environment, many people incorrectly believe gold will trade down -- but that is opposite of what the bond market is telling us. They are expecting inflation in some form, and because of that gold just flashed a major buy signal to me.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.