The Case for Gold Today 26 comments
-
Font Size:
-
Print
- TweetThis
"With the exception only of the period of the gold standard, practically all governments of history have used their exclusive power to issue money to defraud and plunder the people." - Friedrich Von Hayek
I’m not advocating a return to the gold standard but when governments lose on printing money, as is the case today, investors should buy gold.
The analysis set forth in this article is focused on gold but the same conclusions are largely applicable to the other precious metals with monetary characteristics: silver and platinum.
Gold has been trading in a $900-$1,000 which all time high, slightly above the 1980 brief peak above the $800 range, however, on an inflation adjusted basis (please see chart below) it is still way below the peak and average range during the stagflation period of the seventies; a period that greatly resembles of current macro-economic setting.
I expect gold to continue to appreciate substantially in the medium and long term, with strong chances of moving in a sustained fashion above $2,000 within the next two to three years.
There are perhaps about 130,000 tons of gold above the ground, with about half in jewelry, 40% in bars and coins (of which 30% with central banks and 10% with individuals) and the remaining 10% are in dental and industrial applications.
The total annual demand of gold is currently just under 4,000 tons and breaks down roughly as follows:
- Industrial and Dental: 400 tons (10%)
- Consumer: 3,600 tons (90%)
o Fashion jewelry: 800 (20%)
o Investment jewelry: 2,600 tons (60%)
o Investment (bars and coins) 400 tons (10%)
This demand far outpaces mining production of 2,600 tons, and is met by the following supply:
- Mining: 2,600 tons (65%)
- Net central bank net sales: 800 tons (20%)
- Scrap: 600 tons (15%)
Demand growth should accelerate fueled by the need for a hedge against increased inflation, and against ongoing political and financial uncertainty, as well as growth in emerging markets middle class income.
Gold as an inflation hedge and insurance against political and financial distress
The point on inflation is self-evident as many emerging markets have double digit inflation rates (e.g. Russia 15%, Vietnam 20%, Turkey 11%, Chile 10%, Argentina 10%), or close to that (China 7%, Brazil 6%, India 8%).
In the United States, headline inflation is at about 5% and the public is becoming increasingly aware of the lack of accuracy of the reported inflation figures.
There is much controversy about the effectiveness of gold as an inflation hedge, with substantial research pointing to real estate and stocks as being better hedges. Even if this is the case, considering the ongoing bursting of the real estate bubble and negative trend in equity prices, it seems quite likely that gold will be the preferred hedge. In any case, there is consensus that there is a negative correlation between the value of the dollar and gold prices (see chart below) and that gold substantially maintains its buying power over long periods of time.
The risks of insolvency of the domestic financial system, with a growing number of financial institution bankruptcies, and the resulting risk of ballooning US government debt (from propping up GSEs and possibly in the near future FDIC and Federal Home Loan Bank systems), provide politically expedient incentives for the US government to keep interest rates low and print money to inflate its way out of this crisis.
With growing unemployment and the social costs of high inflation, protectionism and international political instability will be on the rise.
In times of uncertainty, investors turn to gold as a hedge against unforeseen disasters since gold is one of the few investments that is not simultaneously an asset and someone else's liability.
Emerging Asian middle class income growth
Growth of middle class incomes in emerging economies in Asia with a traditional strong appetite for gold will favor demand growth, independently of the above cited factors.
Indian middle classes have strong appetite for precious metals jewelry. India is already the largest worldwide consumer with annual demand of 650 tons. India, China and Turkey, for example, spend a much higher % of their GDP in gold than the US or Western Europe) and witness the reaction of the Vietnamese public to inflation, at least until a government ban became the largest worldwide importer of gold bullion.
Gold ETFs
The emergence of gold and precious metals ETFs such as GLD, CEF, and several others, and their growing availability to investors around the world is also likely to fuel demand. The first gold exchange-traded fund to trade in the United States, the StreetTracks Gold Shares (GLD), was launched in November 2004 and has been a success since. By the end of 2007 GLD reported holdings of 600 tonnes of physical gold bullion held in trust for its investors. If GLD was a central bank, it would nearly make the top 10 in the world for gold holdings. Gold ETFs provide the same economic benefits, although not entirely, of holding physical gold for ultimate insurance against extreme scenarios when the four horsemen of the apocalypse are unleashed and physical ownership is irreplaceable.
Gold supply
Supply is growth is likely to lag demand as central banks, which have been heavy until recently, are likely to curtail their sales of gold and will likely become net buyers (more on this below). Increased mining production and scrap recovery is unlikely to make up entirely for this.
Gold production has been rather flat for the last ten years (please see chart below) in spite of healthy price growth which indicated there is limited spare capacity. Brand new mine locations, especially the larger ones, can take 8-12 years for production to commence. Smaller mines can begin more quickly but if in the newly discovered category, they require eight years as a probable minimum. Open pit operation start-ups are faster, but not that much faster, and re-opening former operating mines requires the permitting process to start all over again, adding several new layers of paperwork not formerly encountered.
Chart courtesy of GFMS, Ltd.
Also, to some extent, the same problems as the oil industry arise with the gold industry. Gold mines are located in many regions where the political climate (see chart below) makes it difficult for private sector investment, particularly foreign investment, as the risks of nationalization are high. On the other hand, government owned companies often lack the skills and incentives to invest in exploration and adding capacity.
Central banks: from net sellers to net buyers.
We are presently witnessing a change of financial paradigm with the diminution of the dollar's role as the single dominant global transaction and reserve currency, and the emergence of a multi-currency system, where gold as a percent of global reserves will increase.
Gold as a percent of monetary mass may also increase, but this does not necessarily mean a return to the gold standard. However, it may be the natural reaction to the excesses that are currently being committed by monetary authorities in the United States.
Central banks held relatively little foreign exchange [FX] reserves sixty years ago - the bulk of their reserves were in gold. FX reserves totaled $10.96 billion in 1949, gold reserves were just shy of 28,879 tons, and the gold reserve ratio was over 70%. Today it has declined to under 10%. This is decline is likely to reverse as emerging market economies diversify their reserves and increase their gold holdings. The IMF is a big seller as it uses up its reserves to make up for its operational deficit, reflecting the reduced need for its lending.
Below is a raking of central bank gold reserves:
Emerging markets have remarkably low ratios of gold reserves, particularly China. China’s foreign exchange reserves, the world’s largest, hit 1.53 trillion dollars at the end of 2007, around 70 percent of which is believed to be in U.S. currency-denominated assets, particularly U.S. Treasuries. Thirty years ago China held 95% of its foreign reserves in gold.
For example, the Qatar Central Bank quadrupled its gold holdings in the first quarter of 2007. It didn't have much to begin with but now it has more - but not nearly as much as it had back in the 1980s according to World Gold Council statistics.
Russia announced a couple of years ago a long term goal of increasing its gold holdings to 10% of total reserves. India, Turkey and the Middle-East have also been important buyers.
Investors choosing to ignore these trends do so at grave peril to their wealth. As Churchill once said: "The time for procrastination and delays and excuses is over, we are into a period of consequences”.
Disclamer: The author is long gold and silver.
Related Articles
|
-
The Seeking Alpha 100
See allThe top 100 stock
market authors
selected for publication
Seeking Alpha 100 » -
Fastest Climbers
Authors with the largestSee all
increase in followers
in the last 7 days
Fastest Climbers » -
Top Commenters
Top commenters,See all
as ranked by their peers
Top Commenters » -
Top Instabloggers
The 100 most active
Instabloggers.-
1
TraderMark
-
2
Don Dion
-
3
Cliff Wachtel
-
4
Mike Havrilla
-
5
James Quinn
Top Instabloggers » -
1
-
Top StockTalkers
TopSee all
StockTalkers.
Top StockTalkers »
This article has 26 comments:
On the other hand, if you live in the US like I do, it's hard to see a way out of our current economic mess that does not include 1970s style inflation.
The higher the price, the less they buy. I suspect the other 90% of retail sales follows the same rule.
Now consider how the world is broke and you have a major use of gold (retail sales) drying up.
Slowing economies will reduce industrial use; further dampening price increases.
Finally, the gold charts show a tired bull.
The only chance for gold to up is a flight to gold out of fear. Some major world shocking event that throws the perceived safety of paper money in serious doubt; definitely not a long shot given the US financial cancer which is spreading worldwide as we speak.
And I never would have thought from such a bullish article with pretty charts and graphs..
Gold will fall very soon, good luck.
I'm a gold bug, but then I spend about 20 hours a week on economic research, so I don't base my opinions on nothing. Gold and silver will rise and the dollar hasn't hit anywhere near bottom yet. Hang on.
I know this is a massive over simplification but still fun:
Given the $12 trillion fiat dollar supply today, the U.S. price of gold should be $46,875 an ounce.
The biggest gold bug, the U.S. Treasury, is hoarding 8,000 tons of gold which adds up to 256 million ounces.
12 trillion divided by 256 million = $46,875.
Given that the dollar is the world's reserve currency, world gold should be $12,500 an ounce.
The world gold reserves are 960 million ounces.
12 trillion divided by 960 million = $12,500.
I'd rather be a gold bug than a fiat fool. Fiat currencies always fail spectacularly and suddenly.
gold will be falling, lets see what happens, she did it again yesterday...
Look, it is in "our best interest" for our politicians to lie to us about the situation so half of us don't head for the banks en masse to pull our worthless paper out, or head to the hills with our rifles and canned goods, or head to the rooftop and just get the damn thing over with already.
They lie, and manipulate, and lie some more and here we are... Well guess what? The end of the road is here. We will be lucky if they can manipulate another 12 months out of this mess. The sh##t has already hit the fan. The poor mess of fools who believed their brokers and left their money in their brokerage accounts hve been wiped out! Their savings and retirement funds are gone! Their credit cards are maxed from oil prices and rising costs of goods and now the banks have raised their credit card rates and cut their limits! They are tapped out! Many of these same folks are embroiled in the sub prime mess and can't pay their mortgages... Businesses are cutting jobs, laying off workers, shutting down plants.. Hello everybody!!!
It may not be happening to me or you (I have my golden egg), and CNN may not be covering the millions it is happening to.. but that doesn't mean it is not going on!
Now, you tell me again how buying gold doesn't make sense.....
With the advent of GLD, CEF and other gold mutual funds, I would submit that if it hasn't started yet (& I think it has) I it is likely that governments will find ways to debase gold. Every naked short sale is a sale of gold that does not exist, just as they are debasing the dollar. Who would buy this naked short gold? I submit that it would be the gold ETFs and mutual funds. They could show it on their balance sheet as gold they own . . . just like the mortgage industry showed their near-worthless paper as assets.
If the bullion banks got called on their naked short gold, all they would have to do is 'go broke' and the government would print even more money to bail them out. If the gold ETFs are also working in concert with the government, and there was a run on gold they could not meet because a certain percent of their gold is in worthless naked short gold paper, the government could print money to bail them out. How likely is it that the government would pass a 'gold crisis' bill to help investors who can't collect on their gold ETF like they have passed a bill to help out foolish homeowners?
With gold recently behaving so consistantly contrary to economics, it is worth considering that it is purposely being debased like the dollar. At least, I would think such a process is being tested.
thank you.