Technically, gold remains range bound with good support, as we saw last week, between $1,515–$1,522 and overhead resistance in the $1,545–$1,555 range. A break out in either direction, perhaps triggered by news of a more fundamental nature, could signal a bigger move. Should prices fall, we would view this as a "scale-down" buying opportunity.
Zoned Out
Eurozone finance ministers meeting over the past week-end once again could not agree on a bail-out package for functionally bankrupt Greece, which runs out of cash to pay its debts in the next few weeks. And even if they could agree the European Central Bank (ECB) threatens to declare a Greek default if private lenders don't share the burden with Greece's public-sector creditors.
The chief risk is that a number of major French and German banks would have to mark down the value of Greek debt on their books, leaving them undercapitalized and in need of recapitalization by the ECB to remain solvent. Further, as credit ratings decline for all of the peripheral countries, their rising interest costs to refinance maturing debt make it all that much more difficult to keep their heads above water.
Quite possibly the Greek parliament in a vote of confidence this week for Prime Minister Papandreou will accept more austerity measures as part of the deal to win Eurozone funding, but even this "favorable" outcome will only provoke more rioting in the streets of Athens by public-sector workers unwilling to accept more of the burden of adjustment and a further erosion in their living standards.
Chances are the Eurozone finance ministers and European Central Bank will find a way to postpone the hard decisions that will ultimately end Europe's failed experiment with a single currency. But, sooner or later, whatever happens, it is difficult to imagine a scenario in which gold does not emerge the winner, even if the immediate short-run reaction is a sell-off in gold, as we have seen at the start of past financial panics (think Lehman Brothers) as investors seek the liquidity of cash.
Eyes on the Fed
Meanwhile, U.S. and world stock markets are now undeniably in a downtrend if not a full-blown bear market. And incoming economic indicators are pointing to a second phase in what is quickly becoming a double-dip recession. So far, most Washington politicos and Wall Street bankers are in denial, refusing to see the worsening signs of renewed recession. Instead, they are arguing for restrictive economic policies that, if enacted, would exacerbate the developing downturn and which the history books would liken to the policy mistakes of the 1930.
The Fed also fails to see, at least publically, the writing on the wall—and is preparing to end its program of monetary easing through the purchase of government bonds, a program that both creates new money in an attempt to liquefy the economy and finances the Federal debt at low interest rates without having to go hat in hand to our foreign creditors. All eyes and ears in the gold and world financial markets will be focused later this week on the June FOMC meeting and Chairman Bernanke's press conference for the Fed's assessment of the economy, inflation and employment prospects and any hints of forthcoming adjustments to Fed policy.
If the Fed, indeed, ends its program of quantitative easing at month-end as scheduled, it will—in my view—soon be forced by rising unemployment and sluggish business activity to resume monetary stimulus in one form or another. Perhaps not QE2—a second round of quantitative easing might be difficult to swallow—but a rose of some other name.
We think the only viable and politically acceptable means for America to dig itself out of its unbearable burden of excess debt—federal, state and local, housing and other private-sector debt—is to pursue a policy of higher inflation that will deflate the ratio of outstanding debt to nominal gross domestic product (GDP) to historically acceptable and manageable levels. Indeed, under Chairman Bernanke's lead, the Fed is already quietly pursuing this policy of targeting somewhat higher U.S. price inflation.
Pursuit of a mildly inflationary monetary policy will not however excuse the Congress and Administration from developing a responsible believable program of long-term spending restraint and deficit reduction. However, now is not yet the time to impose these restrictions on an ailing economy—though articulation of a realistic bipartisan plan for long-run deficit and debt reduction would help calm world financial and currency markets.
Adjusted for consumer price inflation (CPI), using official government data, which tends to seriously underreport actual inflation felt by U.S. households), suggests that gold should be selling today for at least $2,500/oz., and considerably more if we account for the government's underreporting of actual inflation.
Paper Tiger
Europe's troubles and the collapse of the euro as we now know it will make the dollar look good by comparison. . .and a rising dollar against the euro could briefly dent gold as traders fall back of the historical inverse relationship between gold and the U.S. dollar exchange rate vis-a-vis competing currencies in world foreign exchange markets.
But a rising dollar would be nothing more than a "paper tiger" soon to be deflated by America's budget mess, sagging economy and renewed U.S. monetary stimulus. As noted at the outset of this brief essay, a setback for gold should be greeted by investors as another buying opportunity as it surely would by those central banks wishing to build gold holdings without disruptively sending gold prices higher.
Hot Summer Ahead
Most gold pundits are anticipating a traditionally quiet summer of the yellow metal. Historically, gold prices have exhibited strong seasonality—with relative weakness in the Northern Hemisphere summer months and maximum relative strength late in the calendar year. Largely, this seasonal pattern has been a reflection of culturally determined buying habits in the major gold-consuming countries and regions. For example, India—often the biggest gold-consuming nation—usually enjoys a pickup in gold buying in September when harvests boost income and spending in the agrarian sector, a sector with a high propensity to buy gold for jewelry or saving with any excess income that comes their way. Around the same time begins a string of festivals that continue into May, festivals that are propitious for marriage, hence requiring gold dowries. These festivals are also believed by many Indians to be a lucky time to buy gold as an investment.
Also in September, in the United States and other Western nations, jewelry manufacturers begin stocking up and fabricating gold jewelry for the December Christmas gift-giving season followed closely by the February 14th Valentine's day, which is also accompanied by much gold jewelry gifting.
Around the same time, the Chinese or Lunar New Year occurring in January or February heralds in a period of gold demand for jewelry fabrication and gift giving across Greater China and is also seen by many as a propitious time for gold investment.
But these seasonal factors are diminishing—largely because investment demand, which knows no season, is growing rapidly in importance and, to some extent, displacing jewelry demand. First, there is the expansion of secular, long-term, hoarding gold demand reflecting the growth in incomes in Greater China and India. As incomes rise, so does demand for gold jewelry and bars, in these countries, which increasingly occurs independently of seasonal, festival, marriage, or gift-giving considerations.
In many countries, too, we are seeing an increase in official or central bank buying: In recent years the list of gold buyers has included China, India, Russia and a host of other countries for whom seasonality plays no role whatsoever in the decision to accumulate gold reserves and diversify away from the U.S. dollar.
And, importantly, powerful economic and geopolitical forces that also exhibit no seasonality are now increasingly governing short-term investment and speculative trading demand for gold. The extent to which the typical summer "doldrums" for gold will be overwhelmed by unfolding economic and political events remains to be seen.
But, clearly, gold-price direction and volatility will be affected in the weeks and months ahead by the economic developments discussed above, namely U.S. monetary and federal budget policies as well as Europe's sovereign debt crisis and the coming disintegration of region's common currency.
Moreover, what we haven't talked about the potential for events across North Africa and the Middle East to trigger a rush into gold—because instability spreads to Iran and/or Saudi Arabia; because Afghanistan or Iraq deteriorate into all-out civil war; because democratic reform in Egypt or Tunisia is replaced with new tyrants less friendly to the West; because regime change in Libya, Syria, or Yemen herald in worse; or because oil supplies and prices become less secure. Clearly, events in this region are not proceeding as first imagined by Western powers.
So, it remains to be seen if the coming summer will be a period of calm and relative stability for gold. . .or a period of great "sturm und drang" with sharply rising prices and greater volatility. Odds favor the latter. Whatever the immediate future holds in store, we remain firmly committed to our bullish gold price forecast with the metal trading at or close to $1,700 later this year with still higher prices in the years ahead.
Just a few weeks ago, gold and silver prices were soaring, almost beyond belief. A growing chorus of investors, analysts and financial journalists opined that the "bubble" in precious metals prices would soon pop—and many predicted an imminent long-term bear market was just around the corner.
And, when precious metals prices tumbled—gold from its all-time intraday high of $1,576.50 on May 1st to an intraday low of $1,463.20 just four days later and silver from $49.59 on April 28th to $32.44 a couple of weeks later—pundits were quick to declare that the bubble burst. . .and many pronounced that the bull market in these metals was over, done, kaput, much like the end of the world that was also predicted around the same time and similarly garnered much media attention.
As gold and silver rocketed higher in March and April, I warned that prices were rising too far, too fast; and chances of an imminent correction were also rising day by day. So, it came as no surprise when gold and silver prices shifted into reverse—but I never doubted that this was anything more than a healthy correction in a long-term bull market, one that had years to go and would ultimately carry gold and silver prices to multiples of their recent highs.
Although gold's recent correction generated much media attention, from peak to trough it amounted to less than 10%. Early in my career as an economist and precious metals analyst, in the midst of a major long-term bull market, I saw the yellow metal retreat some 50% from over $200 an ounce in 1974 to near $100 in 1975. I also remember what followed: Gold rose by more than 700% to a long-term cyclical peak of $875 in January 1980.
Silver's recent correction, about 35% from its April high to its May low point, attracted even more attention because the preceding advance had been so meteoric. But, like gold, silver saw a number of short-term corrections in the midst of the great 1970s bull market, the biggest fall amounting to more than 60%.
What's a Bubble?
A "speculative bubble" or "financial mania" is generally defined as a rapid run-up or spike in the price of an asset or asset class (equities, bonds, commodities, real estate, or even tulips, for example) caused by excessive or exaggerated expectations of future price appreciation, appreciation unrelated to market fundamentals, realistic trends in supply and demand, or "intrinsic" value. Bubbles are driven by emotion, fear of "missing the boat" as an asset appreciates and they are generally characterized by a high volume of trading and public participation.
By this definition, the recent rise in gold and silver prices was hardly a bubble. While speculative demand by "momentum" traders in futures markets contributed to the rapid ascent (just as selling by the same traders contributed to the subsequent swift decline), these speculators are hardly irrational players driven by emotion. Quite the opposite, they take long and short positions based on trading algorithms or years of experience watching markets rise and fall. Instead, the long-term bull market in these precious metals has been and will continue to be, driven by rock-solid long-run fundamentals including macroeconomic, geopolitical and demographic trends, as well as each metal's own supply/demand situation and outlook—all of which suggest gold and silver prices have a long way to go.
This is not to say we won't see future price volatility in gold—and, even more so, in silver—with price swings that again attract attention, leading some to predict that sharp corrections are the start of a long-term bear market rather than a great buying opportunity like we saw in recent weeks when gold neared $1,470 or silver traded under $34/oz.
Monetary Assets
Importantly, both gold and silver are monetary assets, a characteristic not shared by equities, bonds, commodities or real estate. As monetary assets, they are bought by a growing number of investors and savers who hold and hoard these metals, not only for profit when prices rise, but also—or even more so—as lasting stores of value in lieu of USDs, euros, yen, yuan, rupees or whatever currency circulates in their home countries.
Even central banks are again buying gold as a monetary asset and store of value rather than acquiring and holding more depreciating foreign-currency assets. Many of those in China, India and other Asian nations who buy gold or silver as monetary assets, have contributed to higher prices for these metals—but they are not acting irrationally or emotionally. Instead, as their household incomes rise, they are following the long historical and cultural traditions of their ancestors who over the millennia have held and hoarded these metals as lasting stores of value.
Even in the U.S. and Western Europe, many are buying gold and silver, not for fear of "missing the boat" and losing the opportunity for quick profit on a rising asset. Instead, they are reacting to the current economic and political environment that on both sides of the Atlantic and environment, that has a growing number of investors and savers who are worried misguided government actions and policies are threatening their future economic security and wellbeing. There is no simple answer or single reason why gold and silver have been moving from strength to strength for more than a decade—irrespective of the occasional price setbacks or corrections that have led some would-be Jeremiahs to foresee the death of gold and silver as worthy investment and savings assets.
Bullish Building Blocks
Over the past many years here on NicholsOnGold, in many public speeches, articles and client presentations, I have discussed at length some of the building blocks underpinning the long-run bull market for gold and silver—but for readers worried that the world of precious metals, as we know it, is facing an early demise here are the highlights of the bullish case for gold and silver:
- Current and prospective U.S. monetary and fiscal policies promise further erosion in the USD overseas, an acceleration in CPI at home and growing demand for gold as a hedge asset. Even with the end of quantitative easing next month, the Fed will feel compelled by persistently sluggish business conditions, high unemployment to keep real inflation-adjusted interest rates low or negative and the economy awash in liquidity. Moreover, despite all the rhetoric from both political parties, Americans will not soon agree to take the tough steps necessary to rein in the Federal budget and shrink the country's immense Federal debt.
- Inflation is not just a U.S. disease. It is accelerating virtually everywhere—China, India, Europe, America, Africa and the Middle East—thanks to many years of easy money policies worldwide, high and rising oil prices (in part, a consequence of political unrest and uncertainties in some of the oil-exporting countries) and, for a variety of reasons, rising agricultural and industrial commodity prices.
- Fear of sovereign-debt defaults and bank failures in one or more of Europe's "periphery" economies is also prompting many investors and fund managers to buy gold as the preeminent safe-haven asset. These periphery countries—including Greece, Portugal, Spain and Ireland—continue to pursue self-defeating fiscal policies. Despite tax increases and deep spending cuts, their debt ratings are falling and the cost of refinancing sovereign debt is increasingly prohibitive. Moreover, the stronger "core" countries—led by Germany and France—are increasingly reluctant to bail out their southern neighbors. As a result, the viability of Europe's common currency, the euro, is increasingly doubtful—and a break-up of the single-currency system would send gold and silver prices sharply higher.
- Political turmoil across North Africa and the Middle East is prompting an increase in world gold demand—both as a reflection of heightened geopolitical uncertainties and in response to higher oil prices. Civil war in Libya continues and protests are raging in Syria, Bahrain and Yemen. No one knows where this "Arab Spring" will stop, which country may be next and what the long-term consequences will be for political stability within these countries and throughout the region, or for future world oil supplies and prices.
- The growing affluence of the emerging-economy nations, especially the two big-population countries, China and India, has already had—and will continue to have—a profound influence on the world gold and silver markets with rising long-term demand and prices of these metals. China's already huge and growing appetite for gold—both jewelry and investment—will continue in tandem with economic growth, rising personal incomes, worrisome inflation expectations and pro-gold government policies. Long-term gold demand from India and other traditional Asian gold markets is also rising, reflecting (as in China) growth in personal incomes and wealth, worrisome inflation and the development of new gold investment vehicles and distribution channels.
- Increasing central-bank interest in gold will continue to underpin the yellow metal's price -as countries (such as China, Russia and some of the OPEC nations) under-weighted in gold and over-weighted in U.S. dollar reserves seek the diversification offered by gold. Mexico purchased more than 93 tons earlier this year, joining a long list of countries that have increased gold holdings in the past couple of years. In addition to China, Russia, India, Saudi Arabia and Mexico—all big buyers—the list of central banks that have increased gold reserves in the last couple of years includes Thailand, the Philippines, Sri Lanka, Mauritius, Kazakhstan, Venezuela, Bolivia, Peru and probably others that have bought gold surreptitiously and choose not to report an increase in their official gold holdings.
- A growing recognition and appreciation of precious metals, both gold and silver, as a legitimate investment class is prompting greater participation from both retail and institutional investors in the United States and Europe. At the same time, the development of new products and channels of distribution—especially the growing popularity of gold and silver ETFs (ETFs)—makes gold and silver more convenient, more attractive and more accessible to more investors around the world. It is especially noteworthy to see the entry of a number of leading hedge funds, pensions, endowments and insurance companies—some as short-term traders but many as long-term investors with a time horizon often of many years or decades.
- As demand continues to grow, I expect no more than marginal growth in world gold mine production for at least the next five years. Moreover, some of the biggest gold-mining nations, like China and Russia, are increasingly absorbing more of their own production for domestic jewelry consumption, investment and additions to central bank reserves.
Together these bullish factors are responsible for a growing gap between new mine supply and aggregate demand—a gap that can be closed only by much higher prices in the years ahead. Call it a "bubble" if you will—but gold and silver prices are heading higher, much higher, in the months and years ahead.
The recent correction in precious metals prices and mining shares has led some investors, analysts and financial journalists to conclude we've already seen the ultimate bull-market peaks in gold and silver.
I'm here today to tell you otherwise—but please don't mistake me for a gold bug. Although, I believe quite strongly that its price will go much higher in the next few years, I don't think there's anything magical about the yellow metal.
The future price of gold is a function of past and prospective world economic, demographic and political developments. My job for the next forty-five minutes is to briefly review some of these trends and developments—and let you come to your own conclusions.
Gold's Bullish Building Blocks
There is no simple answer or reason gold has been moving from strength to strength for some 10 years now. Here's my list of eleven factors fueling gold's ascent:
- U.S. federal budget impasse, rising U.S. sovereign debt and eroding U.S. creditworthiness.
- Ongoing and expected future depreciation of the U.S. dollar in world currency markets.
- Accelerating global inflation—with high and rising agricultural and industrial commodity prices leading the way.
- Fear of sovereign debt defaults and bank failures in one or more of Europe's "periphery" economies. These countries, despite tax increases and deep spending cuts, continue to see their debt ratings and ability to refinance both government and private-sector bank debt deteriorate. Moreover, a widening economic schism across the continent calls into question the viability of Europe's common currency, the euro.
- The continuing civil war in Libya and political unrest across North Africa and the Middle East—and the threat to future oil supplies.
- The growing affluence of the emerging-economy nations and the associated growth in gold demand—especially the two big population countries, China and India.
- Central bank buying by countries under-invested in gold and overexposed to U.S. dollars.
- The development and maturation of new gold investment channels, especially gold ETFs, that make it easy for investors to buy physical metal.
- The legitimization of gold as an investment class and the expansion of investor interest among retail and, importantly, institutional investors (including hedge funds, pensions, endowments and insurance companies).
- No more than marginal growth in world gold mine production for at least the next five years—while some of the gold-mining nations, including China and Russia, absorb more of their own production for domestic jewelry consumption, investment and additions to central bank reserves.
- Together these bullish factors are responsible for a growing gap between new mine supply and aggregate demand—a gap that can be closed only by much higher prices in the years ahead.
American Economics
Let's look more closely at some of these bullish factors beginning at the epicenter of today's world's economic crisis—Washington D.C.
The U.S. economy still faces significant and painful adjustments in the years ahead following many years of profligacy, years in which our government sector and many private households simply spent more than we could afford, on things we didn't need, with money we didn't have.
Despite the rhetoric from Democrats and Republicans alike on the need to tackle the country's deficit and rising debt, there is little evidence that meaningful and sufficient steps will be taken any time soon—that is, unless a run on the U.S. dollar forces "emergency" measures sooner rather than later.
The U.S. federal government came close to shutting down not too many weeks ago—and the rancor in Washington will likely pick up as we again approach the federal government's debt ceiling and the 2012 federal budget debate gathers steam.
It is likely that continued discord in Washington will leave our central bank, the Federal Reserve, with the difficult, if not impossible, task of maintaining orderly U.S. and world financial markets in the face of diminishing willingness on the part of foreign central banks and institutional investors to continue funding America's federal financing gap.
How the Fed maneuvers between rising inflationary pressures, on the one hand and a sluggish economy with unacceptably low GDP growth and unacceptably high unemployment remains anyone's guess. So, even if the Fed discontinues its policy of quantitative easing with the expiration of QE2 this June, before long it may have to continue buying U.S. Treasury securities because foreign central banks and private investors will be unwilling to do so without much higher interest rates.
One thing is for sure: Without significant and meaningful U.S. fiscal reform the dollar's role as the pre-eminent world currency and official reserve asset will likely continue to diminish. The announcement a few weeks ago that the world's largest bond fund, PIMCO, would no longer hold U.S. Treasury obligations may be a harbinger of things to come.
Investor concern about U.S. government debt was further underscored last month by Standard & Poor's surprise warning, issued on April 19, that America might lose its "triple-A" rating if it doesn't act swiftly to address the federal deficit and reverse the growing mountain of federal debt.
Unfortunately, the fiscal austerity demanded by financial markets—whether in the form of spending cuts, tax increases, or some combination of the two—will, in the short run, act as a drag on the economy.
To counter the negative economic effects of fiscal tightening, the Federal Reserve, for all its rhetoric to the contrary, will be compelled to step even harder on the monetary accelerator. For this reason, I think we are likely to see another round of quantitative easing (QE3) with implications for future inflation, the U.S. dollar exchange rate and the price of gold.
In fact, I think the Fed and U.S. Treasury are intentionally targeting a weaker dollar (to stimulate the domestic economy through the trade balance) just as they are targeting a higher inflation rate (to erode the real value of our debt as a percentage of nominal GDP). The result will very likely be a replay of the 1970s—a decade of sub-par economic activity, high unemployment, rising world commodity prices (especially oil), double-digit inflation and a booming gold market.
For now, at least, the U.S. dollar remains the number one world trade and official reserve currency only by default. There is simply nothing ready to take its place.
I believe we may move gradually toward a multicurrency system where an array of national currencies, possibly along with IMF Special Drawing Rights and maybe even gold, will function with much less dependence upon the U.S. dollar.
Interest Rates and Gold
A growing number of economists and Fed watchers believe the U.S. will start raising interest rates later this year or early in 2012. Whenever policy rates begin to rise, it will be too little, too late, to stem the upward march in the yellow metal's price.
We have already seen the EU, UK, China, India, Brazil and a number of other major economies raise their own domestic interest rates in recent months. The prospect of more rate increases by these countries, joined by the U.S., has some gold investors and analysts worried gold prices will turn south.
But, so far, in just about all of these economies, real "inflation-adjusted" interest rates remain quite negative—particularly if you allow for significant under-reporting of actual inflation rates in these countries. As long as nominal interest rates remain below actual inflation rates, there is no reason to believe that investor interest in precious metals will diminish—but there is every reason to believe that investors will want to hold more gold as their currencies continue to lose purchasing power.
Breaking Up Is Hard to Do
Meanwhile, several European countries with their backs to the wall (including Greece, Ireland, Portugal and Spain) are slashing government spending so deeply that economic activity is shrinking, unemployment rates are rising and many ordinary folks are rioting. Despite spending cuts and tax increases, government revenues are falling.
As a result, rather than improving their creditworthiness, the "periphery" countries will see their credit ratings marked down still further, forcing the ECB to bail out its most-endangered members yet again by its own program of quantitative easing through the purchase and monetization of member-country sovereign debt.
Safe-haven capital flight from the questionable euro into both the U.S. dollar and gold will contribute to the metal's expected appreciation and, at the same time, mask the greenback's inherent weakness.
In my view, the only thing now holding the European single-currency monetary system together is the high cost—and seeming impossibility—of managing a breakup. Even if the euro somehow survives, its role as a second-string reserve asset has been badly damaged.
A tarnished euro, periodic funding crises and fears of a euro breakup will benefit gold in the years ahead—even if the lion's share of scared money and safe-haven demand find shelter in U.S. dollar financial markets.
To sum up the economic situation: I don't think either the U.S. or European economies or currencies are heading toward total collapse. Instead, I think we'll muddle through with several years of sub-par economic activity, painfully high unemployment and high, but not hyper, inflation.
Food and Oil Lubricate the Gold Market
Accelerating global inflation is, to be sure, a monetary phenomenon, the result of unprecedented monetary creation by America's central bank, the Fed and most the central banks around the world. Simply put, we have had too much money chasing too few goods and services.
But there's more to the story than just too much money. Commodity prices are rising because millions, if not trillions, of people living in China, India and other emerging economy nations are enjoying unprecedented growth in national wealth and personal incomes. Even if economic growth decelerates somewhat this year and next in these populous nations, as some economists now anticipate, they will nevertheless continue to pursue commodity-intensive infrastructure development (think steel, copper, aluminum, cement, etc.).
And, similarly, slower growth or not, millions of households in these countries will have the means to buy more commodity-intensive consumer goods than ever before. As a result, high and rising food and agriculture prices are under pressure from a healthy rise in personal consumption in these nations. People with a few more yuan or rupees in their pockets are now eating better, more and more grain-intensive "meaty" Western-style diets. So, high and rising global food prices are, in part, a monetary phenomenon. . .and, in part, they are demand driven as millions of consumers eat better—but, in recent years, there is still more to the rise in food prices.
Agricultural inflation is also a consequence of weather-related problems in some of the planet's most important grain-, corn- and rice-producing regions: Too much rain, or too little, combined with record heat waves in some places, has taken a big bite out of food production. Now, dryness and weather-related planting delays are threatening poor harvests again in the 2011–2012 crop year. Many climatologists claim agricultural supply problems, as we have seen repeatedly in recent years, are a symptom of global warming—and are likely to continue, if not worsen, in the future.
High food prices also have had a profound indirect affect on world inflation: Indeed, the high cost of food has been politically destabilizing in some of the countries where food accounts for a big share of household budgets. Remember, earlier this year, high food prices were credited with triggering rioting, unrest and revolution—first in Tunisia, then in Egypt. In turn, conflict and political uncertainty has affected world oil markets—and, as we all know, pushed the price of oil (and other energy products) much higher with immediate consequences for inflation everywhere.
Many oil analysts had been warning that oil prices would be heading much higher even before the outbreak of political unrest and revolution in North Africa and the Mideast, due to the growth in demand for oil from both the emerging economies, namely China and India again and from some of the oil-producing nations themselves.
So, it looks like households around the world—in the U.S., Europe, India, China, Latin America and Africa—will have to endure rising prices for food, energy and other commodities for a host of complicated reasons beginning with but not limited to excessive monetary growth from one country to the next. Whatever its cause, accelerating global inflation spells higher gold prices ahead.
Chinese Liberalization Promotes Rising Demand
Let's turn our attention to China: This country has already had—and will continue to have—a profound influence on the world gold market and the metal's price.
Private gold investment was banned and the market was tightly controlled for more than five decades following the Communist Party takeover in 1949. Ever since the legalization of gold investment and the gradual liberalization of the market beginning in 2002, the Chinese appetite for gold has been growing by leaps and bounds.
Much of the growth in China's gold demand over the past few years has been a result of the government's liberalization of the domestic gold market, encouragement of private gold investment and
development of new investment vehicles and channels of distribution. As a result, China has become a powerful driving force in the world gold market, and this trend is likely to continue—if not accelerate—in the next few years reflecting demographics, strong economic growth, rising personal incomes, worrisome inflation and the continuing development and maturation of the gold-market infrastructure.
China's first gold ETFs (a hybrid that invests in overseas gold ETFs) was launched this past December and was quickly fully subscribed. I anticipate Chinese-listed gold exchange traded products—and other new channels of gold investment—will grow rapidly in the next few years with a significant and lasting effect on the world gold market and the U.S. dollar gold price.
China: Continuing Growth Despite Monetary Tightening
The recent and prospective monetary tightening by China's central bank, the People's Bank of China (the PBOC), will not, in my opinion, diminish the country's growing appetite for gold jewelry and investment. PBOC policy actions—raising interest rates, adjusting bank reserve requirements and allowing some gradual appreciation in China's currency, the yuan—are in response to super-strong economic activity and uncomfortably high domestic price inflation.
But, real interest rates in China (that is after adjustment for inflation) are actually falling. . .and have become more stimulative and supportive of gold. Moreover, Chinese monetary authorities would like to see more, not less, private gold investment, hoping to reduce speculative investment in real estate and the stock market.
At most, Chinese authorities are trying to cool a hot economy and slow the annual rate of GDP growth from around 10% to a more sustainable pace around seven%. I have long argued that the country's long-term bullish influence on the world gold market would continue as long as China's economy continues to chug along at a moderate rate—with or without worrisome rates of consumer price inflation.
If inflation accelerates, as it has recently, led by rising food and commodity prices, that's just icing on the cake, boosting gold demand still more.
Indian Demand Heats Up
China isn't the only giant shaking up the world of gold. India's appetite for gold is also hot like curry.
As in China, economic growth has been strong with GDP rising smartly—and inflation has been heating up, as well.
Historically, India's has been a very price-sensitive market for precious metals. Typically, buying interest falls as prices rise. . .and, at higher prices, India women are known to take profits, cashing in their bangles and chains, so much so that Indian gold scrap can, at times, be an important source of supply to the world market.
In contrast to the historical experience, we are now seeing much less price sensitivity of demand as Indian consumers have adjusted quite quickly to record high gold prices. Even at recently prevailing prices in the $1,400–$1,500/oz. range, Indians still seem eager buyers—suggesting a psychological re-evaluation of gold price prospects.
As in many other countries, Indian gold investment is benefitting from securitization and the growth in gold ETFs. First introduced in 2007, there are now 10 gold ETFs with physical gold held on behalf of investors totaling more than one-half a million ounces (about 15.5 tons) when I last checked a few months ago—and holdings will likely grow as more mainstream stock market investors participate.
India and China are very important markets for gold, in part, reflecting their huge populations and growing wealth. But there are many other countries across Asia and the Mideast that share a historical, cultural and even religious affinity to gold as a traditional monetary medium for saving and investment. Even gold jewelry in many of these countries is purchased for its investment characteristics, as a symbol of wealth and social status and as an amulet or talisman bringing good fortune to its owner.
Longer term, as many of these countries prosper and as their share of global income and wealth continues to increase, they will demand a growing share of the world's aboveground stock of gold for jewelry, for investment and for central bank reserves.
Importantly, much of the gold bought by these countries will probably never come back to the market, at least not for many years to come and only at much higher price levels or if political and economic developments prompt distress sales, something we will not likely see in the next few years.
Central Banks Buying More
Central banks collectively have taken a much more positive view of gold in recent years. Just last week, it came to light that Mexico's central bank, the Banco de Mexico, purchased some 93.3 tons this past February and March. That's about 3.5% of annual world gold mine output worth more than $4 billion at recently prevailing prices.
After net sales of roughly 400–500 tons a year over the prior decade, the official sector (including central banks, the International Monetary Fund and sovereign wealth funds) became a net buyer of gold in 2009. Net official purchases may have totaled as much as 100–200 tons in each of the past two years, even allowing for the IMF's 403-ton gold sales program, which ended some months ago.
Last year, net official purchases continued as a number of central banks, principally in Asia, added to their official reserves while sales by European central banks were minimal—and have now virtually ceased except for some small reductions for domestic gold coin programs.
Officially published data on central bank gold transactions are not to be believed as some countries buy gold surreptitiously, choosing not to report purchases. . .and data on sovereign wealth funds are, for the most part, unreported. So, it's not possible to get an exact reckoning of net annual purchases or sales by the official sector.
China, for example, announced two years ago that its central bank had purchased 454 tons in the prior 6 years—but it chose not to report these purchases until April 2009. Some observers, myself included, believe that China continues to buy significant quantities on a regular basis, possibly 100 tons or more annually, probably all of which comes from domestic mine production.
Saudi Arabia also added significant quantities of gold𤺌 tons, in fact—to its official holdings over the past few years, but did not report these purchases until last June. It is likely that the Saudi Arabia Monetary Authority also continues to buy, along with some of the other oil producers with dollar-heavy, gold-underweighted official reserves.
The People's Bank of China, the PBOC, and other central banks have an incentive to buy gold discretely and surreptitiously—simply because the announcement and acknowledgment of their buying programs would likely affect the yellow metal's price and raise these central bank's acquisition costs.
What we do know is that the list of countries that have bought gold since the beginning of 2009 continues to grow. China, Russia, India, Saudi Arabia and now Mexico have been the biggest buyers. Other gold-buying countries include Kazakhstan, Sri Lanka, Mauritius, Venezuela, Bolivia, the Philippines, Thailand and Bangladesh. Even the Ukraine and Tajikistan Central Banks have added small amounts to their official reserves in the past year.
Meanwhile, in recent days, it has been suggested by senior German officials that Portugal ought to sell some of its official gold holdings to ease its difficult debt problems. Should such a sale take place, it is very likely that a number of other central banks would quickly line up as potential buyers with Germany's Bundesbank and the ECB probably at the front of the line.
Recent year gold sales by the IMF have demonstrated that large-scale official sales need not disrupt the market—and that central banks underweighted in gold are willing buyers when given the opportunity to make off-market purchases.
Increasingly, many investors—both retail and institutional—are looking at these official-sector gold purchases and concluding they, too, should be diversifying their savings and investments with some physical gold.
Rising Participation
A few weeks ago, a big headline in The Wall Street Journal proclaimed, World is Bitten by the Gold Bug. Gold bears seem to think that suddenly everyone has gone mad buying gold—and, because so many piled so quickly and recklessly into gold, they argue we have already seen the top and the metal will just as quickly lose value as investors shed their holdings.
Even though more people than ever before are buying gold, participation by both retail and institutional investors in the United States and many other countries remains very low. Moreover, many investors already holding gold remain underweighted with less than optimal and prudent holdings. I expect participation rates will rise in the months and years ahead as more savers and investors "catch the gold bug" and begin to see the virtues of gold as a reliable store of value and insurance policy against an assortment of risks to their economic and financial wellbeing.
Of great importance to the future price of gold has been the introduction and growing popularity of gold ETFs from one country to the next. Gold ETFs are gold-backed stock market securities that track the ups and downs of the metal's price and represent an ownership interest in actual bullion held on behalf of fund investors. As stock market securities they attract investors for whom direct ownership of bars or coins may be too cumbersome. . .and ETFs allow some institutional investors prohibited from owning physical commodities or futures contracts a legal loophole, if you will, through which they have bought many tons of metal.
On a cautionary note, gold ETFs not only allow investors to easily and quickly accumulate gold but also allow investors to easily and quickly shed their gold holdings. At times, this has contributed to upside volatility with occasional swift appreciation in the metal's price. But ETFs have also contributed to downside volatility, like the sharp correction we saw just last week.
Developments in key geographic markets and new more-convenient investment vehicles are making gold both more accessible and mainstream to more investors around the world; the result, in economist-speak, is a permanent upward shift in the demand curve such that the future long-term average price, stripped of cyclicality, will be much higher than the average price over the past decade or two.
My Gold Price Forecast
I see the clock ticking, so let me say something very briefly about world gold mine output and wrap up with my gold price expectations. While production has increased in the past couple of years, growth in total ounces produced will continue to be modest for the next few years, maybe 1.5–2.0% annually, and total world mine production will continue to fall far short of the expected growth in jewelry, investment and central bank demand for at least the next five years or longer.
Now that we've circumnavigated the world of gold and accounted for the key trends and developments, what can we say about the metal's price prospects?
I believe gold's fortunes remain very bright. To begin with, all of gold's key price drivers remain supportive, and there are so many of them, so many reasons to expect the long-term trend will continue upward for at least another few years.
What's more, recent market activity—from a technical or chartist perspective—rather than signaling an end to gold's decade-long advance, strengthens the case for a snap-back in the metal's price with new all-time highs in the months ahead.
It's sometimes said that forecasting is particularly difficult, especially when it's about the future—and even more so when it comes to forecasting the future price of gold. It's more an intuitive art than an exact science, though many an analyst and economist would have you believe otherwise. That said, it's my hopefully well-informed opinion that the price of gold will very likely hit $1,700/oz. by the end of this year—and I wouldn't be at all surprised to see it even higher.
At the same time, gold prices are likely to remain volatile registering big short-term swings both up and, as we saw last week, down. Sizable intermittent price declines may lead some investors and more than a few journalists, to question the bull market's staying power. I can only warn you not to get prematurely caught in a bear trap.
Looking further out, I believe we are likely to see gold at $2,000/oz. in the next year and possibly $3,000 or even $5,000 before the gold price cycle moves into reverse in the middle or later years of this decade.
As unrest and regime change threatens a swath of countries across North Africa and the Middle East, gold is reverting to its historic role as the preeminent safe haven—but it's price is just beginning to reflect the rise in political and economic uncertainty in the region and around the world. Frankly, given the political prospects for a number of strategic countries across the region, the possibility of long-term uncertainties and the threat to oil supplies, I'm surprised gold has not performed better, especially in light of its own bullish market fundamentals.
Inflation Pressures: Global food and commodity prices have been on the rise for the past year, consumer price inflation has been unacceptably high China, India and other emerging economies, and signs of rising inflation are beginning to appear in the U.S.
U.S. Monetary Policy: Years of reflationary monetary policies in the United States—and the financing of America's federal budget deficit with newly minted money, euphemistically called "quantitative easing" by our central bankers—has, in effect, underwritten higher commodity prices and made the coming acceleration in U.S. inflation inevitable.
Oil Prices: Higher oil and gasoline prices, partly a consequence of Mideast unrest -and partly a consequence of the Fed's dollar debasing policies—are just now beginning to trigger more widespread price pressures across the global economy. Global economic activity will suffer as higher prices—like a tax paid to oil producers, rather than the U.S. Treasury, erode consumer purchasing power and restrain business investment. Faced with stagflation, America's central bankers may talk tough about inflation—but will continue their stimulative policies to both promote employment and reduce the burden of outstanding private- and public-sector debt by currency debasement.
Bullish Fundamentals: Even without North African-Mideast turmoil and higher oil prices, gold's own bullish market fundamentals should be enough to push the yellow metal's price significantly higher this year and beyond. Most importantly, gold will also benefit from unfettered Asian buying and central bank reserve accumulation. Both are sustainable long-term trends that not only bid up current prices, but also put gold in strong hands that will hold it for years, if not generations.
Global Market: Gold investors and traders, sitting in their homes and offices here the U.S. may think that the day-to-day fluctuations, as well as the long-term trend, in the metal's price reflect the wiggles in U.S. interest rates, the Federal budget debate raging in Washington, or the latest news on Wall Street. But what also matters as much, if not more, is the seemingly insatiable appetite for gold in China, India and across much of Asia where many gold investors and jewelry consumers are ignorant of economic developments here in the United States but are buying because that is what they do when their own incomes are growing or their home country's domestic inflation rates are worrisome.
Central Banks: After two decades of net central bank sales, the official sector has also become an important long-term buyer in the past couple of years. Much of the buying of late has come from China and Russia, both of which buy from domestic gold production, thereby denying supply from the world market. And, possibly one or more of the reserve rich oil-exporting countries have also bought gold in light of popular unrest in their own neighborhood or simply to diversify reserve holdings and reduce dependence on the U.S. dollar. In fact, all of the central banks that have bought gold in recent years—a list that includes not only China, Russia and Saudi Arabia but India, Sri Lanka, Bangladesh, the Philippines, Thailand and others—today remain underweighted in gold. All still hold the lion's share of their official reserves in U.S. dollar securities, and all have an incentive to accumulate gold on price declines. By doing so, they limit the downside risk to private gold investors and speculators.
Higher Prices Ahead: So far, there's been no investor panic rush into gold and silver, and the markets show no signs of a blowoff or irrational bubble. Investor participation, both retail and institutional, in physical and futures markets, though growing, remains low. As investor participation continues to grow—as gold and silver go more mainstream—there will be more funds chasing a limited number of ounces or tons of metal. Unlike dollars, euros or yuan, central bankers can't just print more of it.
The uncertain geopolitical outlook and impact of higher oil prices, along with gold's very bullish supply/demand fundamentals and growing investor participation, suggest the yellow metal's price could easily reach the vicinity of $1,700/oz. by late this year—that's about a 19% increase from recent prices—with $2,000 gold likely in 2012 and still much higher prices in subsequent years.
For daily market commentary and analysis, follow me on Twitter @NicholsOnGold.
Jeffrey Nichols
Economic Advisor, Rosland Capital
Managing Director, American Precious Metals Advisors
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