Gold: Moving On Up . . . Again
The snap-back in the U.S. dollar gold price this past week to $1,100 an ounce may mark the beginning of a new upward phase in the metal’s long-term bull market.
Neither the announcement of prospective IMF gold sales nor the U.S. Federal Reserve’s quarter-point rise in its discount rate had more than a fleeting affect on precious metals markets . . . and neither will derail gold’s ascent to new record highs later this year.
Gold’s own positive fundamentals, the high level of investor interest in key geographic markets, and global monetary economic developments promise to push the yellow metal higher from recent levels first to $1,150, then $1,200 - and I expect we’ll see gold touch $1,500 an ounce before year-end 2010.
It is noteworthy that as the greenback rose against the euro in recent days, gold’s dollar-denominated price still managed a healthy recovery. Perhaps this is the signal we’ve been expecting, the signal that gold can - and will - move higher even as the dollar is also advancing against the major Western industrial world currencies.
Fiddling by the Fed
Thursday’s announcement by the U.S. Federal Reserve, America’s central bank, that it was raising its discount rate, the rate at which it lends reserves to banks, from half a percent to three-quarters of a percent resulted in some knee-jerk selling and brought the price of gold down briefly under $1,100 an ounce.
In my view, the Fed now has its back to the wall as foreign central banks and private investors here and abroad show increasing reluctance to continue purchasing U.S. government debt.
Indeed, the Treasury’s recent auction of 10-year bills and 30-year bonds was far from fully subscribed. While credit-rating agencies may not have downgraded U.S. debt, the traditional buyers of U.S. Treasury securities are doing so on their own.
This past week’s discount rate has little to do with current monetary policy since relatively little lending by the Fed takes place at the “discount window.” It was, however, a psychological move intended to reassure central banks and other investors that it’s safe to hold U.S. government debt - a ruse that won’t fool many for long. Instead, investors will become increasingly reluctant to continue buying more and more of our government’s debt.
This will result in either higher long-term interest rates (sufficient to offset the rising perceived risk associated with U.S. debt) or will require the Fed to buy the U.S. Treasury’s debt - which is equivalent to printing money. Every Econ 101 student knows that monetizing debt in this fashion is ultimately inflationary . . . but somehow those entrusted with safeguarding the dollar don’t get it.
Future increases in the Fed’s policy lending rates (the Fed Funds rate, the discount rate, and the rate it pays banks to deposit excess reserves with the central bank) - or other steps taken to restrain monetary growth or reverse the quantitative easing of the past few years - will likely be greeted with reflexive reactions in financial, currency, and gold markets . . . but setbacks for gold, while possibly sharp, will be temporary unless and until the Fed is willing to push interest rates above the “actual” rate of consumer price inflation - in other words, until real (inflation-adjusted) interest rates move from negative territory into solidly positive ground.
IMF Gold Sales Hardly Matter . . .
Significantly, last Wednesday’s news that the International Monetary Fund would soon begin the second phase of its gold-sales program with open-market sales “conducted in a phased in manner over time” seems to have had only a brief negative price reaction with prices dropping toward - but not below - the $1,100 level and then quickly recovering.
Despite prospective IMF gold sales, the official sector will continue to be a source of support for gold. Last year, India and China led the list of official gold buyers. India purchased 200 tons (at an average price of $1,045) directly from the International Monetary Fund while China purchased significant - but unreported - quantities from its domestic mine output.
But China’s Official Purchases Do Matter
For some time now, we’ve suggested that China could be the next big buyer from the IMF, particularly if prices dipped below those paid by India for its purchases last year. Now, however, China (and other central banks) can purchase IMF gold anonymously - with less concern about looking good by acquiring metal at prices beneath those paid by the Reserve Bank of India last year. And, as prices rise, some countries may feel compelled to buy sooner rather than later to avoid missing the boat altogether.
News that China’s largest sovereign wealth fund, the China Investment Corporation (CIC), recently purchased 145,000 ounces (about 4.5 tons) of gold in the form of gold ETFs. While not the central bank (and not a significant quantity given the country’s huge foreign exchange reserves), it is likely that this investment was approved by the central bank and may, indeed represent a “stealth” purchase on behalf of the PBOC.
In any event, I view this as a very bullish, but largely unnoticed and little discussed, development for gold, signaling both China’s interest in acquiring more of the yellow metal, and its “official” point of view on future gold-price trends. If nothing else, it could encourage increased Chinese private-sector gold investment purchases beginning next week when the country resumes business after this past week’s New Year’s celebrations.
Moreover, news that China’s official sector is buying - whether direct purchases by the PBOC or by the CIC as the central bank’s proxy - could very well encourage official purchases by other reserve-rich central banks or sovereign wealth funds wishing to diversify their reserve holdings and reduce their U.S. dollar exposure . . . and it could also encourage more private-sector investment demand for gold within China as well.
American Myopia
Americans look at gold prices from a U.S. dollar perspective. So it went largely unnoticed by many in this country that the yellow metal’s price in euros, Europe’s single currency, touched a record level in recent days. Chartists across the Atlantic are already taking note of this development - and speculators jumping ship from euro-denominated debt may begin to see gold in a more positive light.
In my view, the perception of the dollar as an appreciating “safe-haven” currency - as is most often reported in the financial press these days - is erroneous and misleading. Instead, think of the dollar and its sister currencies as leaky boats in rough seas. They are all taking on water - only the dollar a little less rapidly and the euro a little more rapidly - and they are all at risk.
How can the dollar be a safe haven . . .
- When monetary policy is leaning toward future inflation?
- When government debt is at record levels in absolute terms and as a share of Gross Domestic Product?
- When mandated unfunded Federal expenditures for social security, medicare, and other social programs are sure to push U.S. Treasury debt sharply higher in the next few years?
- When our nation’s trade and current account deficits continue to grow?
- When foreign central banks and private investors are increasingly reluctant to acquire evermore U.S. debt?
- When a dysfunctional government seems incapable of dealing effectively with these issues?
- When America remains embroiled in expensive foreign wars?
- When states from New York to California are in worse fiscal shape than even Greece?
- When “real” unemployment is near 20 percent of the actual workforce, new weekly jobless claims remain high, housing foreclosures continue apace, and commercial real estate teetering?
- And, when recent signs of improvement in the economy are due mostly to Federal stimulus programs or temporary inventory rebuilding and not to any fundamental improvement or optimism on the part of households and businesses?
East Trumps West
Much of the recent buying interest is emanating from Eastern markets - particularly India, China, and other Asian nations that are enjoying early recoveries in economic growth and personal incomes. Moreover, in these markets we are seeing buying mostly of physical gold - the real thing - and many of the buyers are unlikely to sell their metal back anytime soon, if ever!
In contrast, much of the selling over the past couple of months has been of paper gold - particularly futures and options -by traders and speculators in Western markets taking short-term positions without much regard for the yellow metal’s intrinsic value or positive fundamentals.
This process is transferring ownership from weak hands to strong, from traders and speculators who think in hours and days, to long-term accumulators who think in years and decades . . . and for whom gold is traditional form of savings and wealth preservation.
Over the long-term, Asian gold demand will depend on sustainable growth in business activity, employment, and personal incomes. Hence, steps taken by the People’s Bank of China or the Reserve Bank of India - recently and in the future - to prevent economic overheating and a resurgence of high inflation are healthy developments for gold.
Some small share of rising household income in these emerging economies will find its way into gold (whether bars, coins, or investment-grade jewelry), given traditionally high savings rates and a tradition of holding some savings in the form of gold in many of Asia’s strongest economies. And, at the same time, rising personal incomes and wealth will also boost demand for gold jewelry.
