Despite the winding down of East Asia’s Lunar New Year gold buying binge, I expect the yellow metal’s price will continue to move up in the weeks ahead - but not without some struggle as gold works to reestablish upward momentum and renewed credibility.
Historically, with the arrival of the Lunar New Year, gold demand and the metal’s price typically enter a seasonally weak period — but the typical seasonality is no longer a reliable guide to gold price prospects.
The usually weak summer months this past year saw gold run up to new historic highs above $1,900 an ounce . . . and, contrary to expectations, the seasonally strong autumn months saw gold prices fall sharply, all the way back down to $1,525 or thereabouts.
Changes on the Demand Side
Now, with winter upon us, I don’t expect gold prices will drop with the temperature as they often have at this time of year. Instead, I believe that there have been important changes on the demand side of the gold market that now overpower or outweigh any remnants of seasonality.
For one thing, institutional investor participation has grown by leaps and bounds, as has retail demand for bullion coins and small bars.
Similarly, official-sector gold accumulation has become an extremely important non-seasonal factor effectively removing several hundred tons of gold from the market in each of the past two years.
I expect central bank demand not only to continue but possibly expand in 2012 with China and Russia leading the pack — and a growing number of countries underweighted in gold relative to U.S. dollar-denominated reserves joining in this official-sector gold rush.
These buyers - private investors and governments alike - don’t care what the weather is. Instead, their behavior is a reaction to macroeconomic and political developments in their own countries and around the world without regard to the time of year.
And, institutional traders and speculators - who lately account for much of the short-term volatility in the metal’s price - are often governed by new and changing trading modalities and algorithms.
For example, the increased importance of “portfolio rebalancing” by index, commodity, and hedge funds has, for now, introduced a new element of seasonality, one that weighed heavily on gold in late December and early January when many of these funds were large-scale sellers of gold, mostly in futures and other derivative markets, but nevertheless with negative price consequences that are now past.
Shrinking Free Float
Continuing Chinese gold accumulation has important long-term significance that is not generally acknowledged by many gold analysts and market pundits. Simply put, China’s private-sector gold purchases are unlikely to be sold back to the world market any time soon, certainly not for many years to come and even at much higher prices.
Not only are gold exports from China illegal - but many, if not most, Chinese savers and investors buy gold with no intention of selling sometime in the future just because prices rise, inflation subsides, equity prices tumble, or any of the other drivers that might trigger sales by Western investors. For the Chinese, these are long-term, quasi-permanent holdings.
The same can be said of central-bank gold purchases, not just by the People’s Bank of China, but by most of the central banks that have been building gold reserves in recent years.
As a result, the supply of available gold in the marketplace — what I call “free float” – is diminishing . . . and any pickup in gold demand for jewelry, investment coins and bars, official reserve accumulation, etc. will have a more high-powered affect on the metal’s price than might have been the case a few years ago.
More Money Will Fuel Gold’s Ascent
Prospects of further monetary easing by the world’s three top central banks - the U.S. Federal Reserve (the Fed), the European Central Bank (the ECB), and the People’s Bank of China (the PBOC) - also know no season and are also becoming more supportive.
In each region, signs of slowing economic activity, unacceptable or worsening labor-market conditions, and continuing restrained consumer price inflation suggest that central banks will press harder on the monetary accelerator in the months ahead.
As in the past, quantitative easing or other steps to raise credit availability by the Fed, the ECB, and the PBOC could fuel surprisingly big moves in the price of gold in the months ahead.
Wild Cards
Finally, there are a number of “wild cards” that may affect gold prices - for better or worse - in the days and weeks ahead. At the top of my list:
- America’s political log-jam and Washington’s inability to reach a consensus on important federal debt and budget measures;
- Heightened tensions in the Middle East - with saber-rattling by Iran, oil-price uncertainties, approaching Egyptian elections, and the threat of civil war in Syria;
- Europe’s continuing sovereign-debt crisis, further downgrades by the credit-rating agencies, the looming Greek default and departure from the euro-zone, possibly followed by other deeply indebted countries.
- And, perhaps most importantly, how the U.S. dollar reacts in world currency markets to any of these unfolding developments and to further monetary easing by the U.S. Fed.
Filed under: Gold Briefs | American Precious Metals Advisors, central banks, China, euro, European Central Bank, fiscal policy, gold investment, Jeffrey Nichols, monetary policy, Quantitative Easing, Russia, sovereign risk, U.S. dollar|No Comments
(Posted January 9, 2012)
In contrast to the closing months of 2011, gold has begun the new year on a more positive note. Whatever the metal’s short-term prospects — indeed even if gold takes another dive — we believe 2012 will be another stellar year for gold investors.
Gold topped out at an all-time high just over $1,924 an ounce in early September - a whopping gain of some $600 or about 50 percent from last January’s low point. But as investors know all too well, gold prices can be quite volatile - with big upswings often followed by big downswings, albeit around a rising long-term trend. Such has been the experience of the past four months with gold shedding roughly 30 percent from its all-time high to its recent late-year low point of $1,522. But, let’s not forget, even allowing for this deep price correction, gold still closed the past year with just about the best annual gain of any asset class!
Looking ahead, 2012 could well turn out looking much like the past year for gold - with sizable gains, possibly as much as 50 percent (or more) from the recent lows, but also with occasional big declines that may lead many observers of the gold scene to mistakenly declare an end to the yellow metal’s bull market. Just as gold bears have been wrong over and over again in the past decade, so will they continue to be wrong in 2012.
The story of gold in recent years has been a tale of institutional traders and speculators - including hedge funds, commodity funds, and the trading desks at the big banks and financial firms - producing great two-way volatility as they rushed into gold (as we saw last summer) and then, not just unwinding long positions, but shorting the metal in a big way (as we saw this past fall).
Driving these institutional players, in addition to momentum and technical trading indicators, has been the flight from the euro into U.S. dollar assets - and the appearance of dollar strength pushing gold lower, particularly at times of massive euro capital flight.
Importantly, much of this negative activity has taken place in gold derivative markets - but, all the while, long-term physical demand has remained fairly robust.
Buying from the Asian gold-market giants - China and India - for both jewelry and investment has continued to remain firm in spite of higher prices that years ago might have discouraged continued accumulation.
Having just returned from two weeks in China and meetings with many players in the country’s gold market, I can tell you that gold demand remains strong despite the recent slowdown in economic activity, thanks to personal income growth albeit at a slower pass, rising wealth among those most likely to buy gold, and also inflation fears. Moreover, higher gold prices, rather than discouraging demand, have attracted new investors to the market.
Meanwhile, global net central bank gold buying has not just continued but has accelerated as reserve managers look for opportunities to shed U.S. dollars — and euros too — in favor of something that has a longer track record as a reliable store of value.
Central bank reserve managers, ever sensitive to buying without disrupting the market, have used episodes of price weakness to step up their buying. This behavior now reduces downside risk while it is also helping set the stage for a surprising sizable snap-back in the metal’s price.
What few gold pundits realize is that the amount of physical gold available in the world gold market - the “free float” - is shrinking, thanks not only to Chinese and other Asian buyers, many of whom are unlikely to sell, but also due to renewed interest and accumulation of gold by a growing number of central banks. For central banks, the holding period may be measured in decades if not longer. As a consequence, future demand will have a much more high-powered affect on the price of gold - and this is one of the reasons we expect much higher prices in the years ahead.
Short-term trading in derivative markets may, at times, produce a great deal of gold-price volatility — and can trigger significant price corrections — but, in my book, it does not affect the long-term price trend. What governs the price of gold over the long term are the market’s real-world supply and demand fundamentals - and these have been decidedly bullish and are becoming even more so. Hence, my long-standing long-term forecast of higher gold prices over the next several years.
Filed under: Gold Briefs | American Precious Metals Advisors, central banks, China, economics, euro, gold, gold investment, gold price, India, Jeffrey Nichols, monetary policy, U.S. dollar|No Comments
I recently had the pleasure and privilege of speaking again this year at the China Gold & Precious Metals Summit in Shanghai and to several private seminars organized by clients elsewhere across China. Here’s the text of my presentation:
First My Forecast
Forecasters, whether of the economy, or the stock market, or the gold price are frequently wrong . . . but we are never in doubt. It is up to you - the investor - to listen, evaluate, doubt, and make your own decisions about gold’s future price and the role the metal might play in your own investment portfolio and personal savings plan.
With this warning, let me tell you my own forecast:
I have no doubt that gold will move up sharply in the years ahead, reaching heights that might lead some to label me a “gold bug.” I believe that the price of gold will, over the course of this decade, reach a multiple of recently prevailing prices.
Prices of $3000, $4000, and even $5000 an ounce are very likely during the course of this long-lasting bull market, a bull market that still has years of life left to it.
Not withstanding the recent sharp price decline, I’d be very surprised to see gold dip into “three-digit” territory - that is below $1000 an ounce - ever again.
But, gold prices will remain extremely volatile - with big swings both up and down along a rising trend. In fact, big corrections - such as the decline from the September 6th all-time record high near $1,924 an ounce to the recent low near $1,580 (a decline of nearly 20 percent) - will lead many investors, analysts, and pundits to declare the death of gold . . . or, at least, the death of the bull market we have enjoyed over the past dozen years.
Yet, historically, a gold-price decline of 20 percent is not so unusual. At the time of the Lehman bankruptcy in 2008, gold fell by more than 20 percent and was slow to recover - but recover it did. And, in the 1970s, gold corrected several times by 15 to 20 percent and once by considerably more - all in the midst of a great bull market.
Moreover, although the U.S. dollar-denominated price of gold is well off its historic high, when valued in most other currencies, the metal’s price remains near its record highs.
The future price of gold is a function of past and prospective world economic, demographic, and political developments. My job for the next hour or so is to briefly review some of these developments and trends - so that you can come to your own “golden” conclusions.
Gold’s Bullish Building Blocks
Let me quickly list the gold’s bullish building blocks - and then, as time permits, I’ll discuss a few of these bullish factors, in somewhat more detail. You will notice that many of these factors are interrelated - but it is easier, for the sake of this discussion, to think of them as separate and distinct.
- The first bullish building block is past and prospective U.S. Federal Reserve monetary policy, characterized by low or negative real rates of interest and unprecedented central bank monetary creation.
- Second, the U.S. federal government budget impasse, rising U.S. sovereign debt, and eroding U.S. creditworthiness.
- The third bullish building block for gold is the expected future depreciation of the U.S. dollar in world currency markets . . . and the continuing decline in the dollar’s purchasing power for American consumers.
- Fourth, the growing insolvency of some European nations - leading to the disintegration of Europe’s Monetary Union and the eventual abandonment of Europe’s common currency, the euro, by at least some of the EU member countries.
- Fifth, the expected acceleration of global inflation - fueled by excessive monetary creation, world population growth, and changing diets in favor of more meat and protein . . . and led by persistently high and rising agricultural and industrial commodity prices from one country to the next.
- The sixth bullish building block for gold is increasing political instability in the Middle East and North Africa . . . as authoritarian regimes are overthrown . . . but sectarian divisions in some countries prevent orderly transitions to democracy . . . with implications for world oil supplies and prices. And then, of course, there is Iran - which remains an unpredictable “wild card.”
- Seventh, the growing affluence of the “emerging-economy nations” and the associated growth in both jewelry and private investment and savings demand for gold - especially here in China - as well as India and other gold-friendly countries.
- My eighth bullish building block - one that I believe is especially important to the long-term development of the gold market - is the affect this rising wealth is having on emerging-economy central banks . . . prompting some countries that are over-weighted in U.S. dollars and underweighted in gold to diversify their official reserves through the prudent acquisition of the yellow metal.
- Ninth, the development and popularity of new gold investment vehicles and channels of distribution - especially gold exchange-traded funds - that facilitate physical gold investment by both retail and institutional investors.
- Tenth, the legitimization of gold as an investment class and rising investor participation . . . together reflecting a growing appreciation of the benefits of including physical gold in a well-diversified portfolio . . . and the entry of new, large-scale, professional investors - including pensions, endowments, insurance companies, sovereign-wealth funds, and especially hedge funds.
- Eleventh, the “stickiness” of much of the recent private sector and central bank gold demand. This is shrinking the available “free float” in the world gold market . . . and it means that less metal will be available to gold-hungry buyers, except at increasingly higher prices. Indeed, many of today’s new investors have no intention of ever selling, even at much higher prices.
- And, twelfth in my catalog of bullish factors supporting a continuing long-term rise in the price of gold is the fact that world gold-mine production, although growing, will not keep pace with the expected growth in global gold demand. Even a rash of new mine discoveries would take five to 10 years - or more - to contribute significantly to supply . . . and, meanwhile, existing resources are being depleted, nationalized by unfriendly governments who tend not to be good mine operators, or are simply mined out.
Together these dozen bullish building blocks have resulted in a notional gap between world supply and aggregate demand - a gap that has been and will be closed only by high and rising prices in the years ahead.
American Economics
Let’s look more closely at some of these bullish factors . . . and let’s begin at the epicenter of the world’s economic earthquake - Washington D.C.
The U.S. economy still faces significant and painful consequences from its many years profligacy, years in which both the government and private sectors simply spent more than we could afford, on things we didn’t need, and, worst of all, with money we didn’t have. Now we are paying the piper - and it will be years before the massive overhang of public and private debt is no longer a heavy burden on the economy.
As a result, the U.S. economy is in the midst of a persistent and prolonged recession - a long-lasting slowdown that is not fully reflected in the official government statistics, not fully recognized by the most-widely quoted mainstream economists, and not likely to go away anytime soon.
Despite a recent pickup in consumer spending, improving employment indicators, and wishful thinking from the White House and many economic forecasters, the U.S. economy remains in the midst of a persistent and prolonged recession or worse.
Normally, a recessionary economy would be countered by aggressive short-term fiscal stimulus - with more government spending and less taxation - to give a temporary counter-recessionary boost to aggregate demand.
But fiscal policy is moving in the opposite direction - and is likely to continue in the wrong direction, making a lasting economic revival even less likely anytime soon.
The U.S. federal government came close to shutting down a few months ago when it bumped up against its mandated borrowing limit. It is likely that we will see a replay sometime next year as federal borrowing again nears the debt ceiling and as the 2012 federal budget debate demonstrates Washington’s inability to put partisanship aside and deal sensibly with the country’s economic problems.
America’s inability to get its fiscal house in order will, sooner or later, result in a resumption of the U.S. dollar’s long-term downtrend . . . and renewed appreciation of the dollar-denominated gold price.
With America’s fiscal policy in disarray, it will again fall upon monetary policy and the Federal Reserve to counter recessionary business conditions - especially persistently high unemployment - without aggravating inflation expectations.
So far, the Fed’s key inflation indicator - the so-called “core” inflation rate (which excludes food and energy, as if these items are not part of every family’s budget) - has been subdued by a weak economy. But, sooner or later, just as night follows day, years of unprecedented U.S. and global money-supply growth, must result in higher prices and accelerating inflation.
But, no matter how hard it tries, the Fed can’t succeed on its own. Without significant and meaningful U.S. fiscal reform - with believable long-term spending and revenue targets - the dollar’s role as the preeminent official reserve asset will likely continue to diminish.
Even without well-conceived long-term fiscal reform, the austerity demanded by domestic and world financial markets (what some have called the “bond-market vigilantes”) will come in dribs and drabs - a tax increase here, a spending cut there - but however it comes it will impose significant fiscal drag on an already teetering economy.
To counter a deteriorating economy and offset the negative effects of fiscal tightening, the Federal Reserve, for all its talk to the contrary, will be compelled to step even harder on the monetary accelerator, with another round of quantitative easing very likely early next year - with implications for future inflation, the U.S. dollar exchange rate, and the price of gold.
In my view, any further weakening of business conditions in the United States will prove to be very bullish news for gold. This is because the Fed is much more likely to pursue an aggressive “easy-money” monetary policy - by printing more money, more quickly, and in bigger quantities - than would be the case in an economy already on the road to recovery.
Although they would never say so, the Federal Reserve and U.S. Treasury may be quite happy to see a weaker dollar and somewhat higher price inflation.
Why? Because a few years of higher inflation, an invisible tax, would reduce the real value of America’s debt as a percentage of nominal GDP, and bring this ratio (the debt-to-GDP ratio) back down to historically acceptable norms. And, right or wrong, conventional economic theory says a weaker dollar would stimulate the U.S. economy through an improving trade balance.
Across the Atlantic - Breaking Up Is Hard To Do
Meanwhile, as U.S. policymakers fiddle, a number of European countries with their economic backs to the wall - including Greece, Ireland, Portugal, Spain, and most recently Italy - are slashing government spending and raising taxes at great social and political cost, hoping to avoid insolvency and default on their sovereign debt.
Unfortunately, as in the United States, the fiscal restraint demanded of these countries is the wrong medicine - and is more likely to kill the patient than cure the disease.
Despite the best of intentions, government revenues are falling as these countries fall deeper and deeper into recession. Instead of increasing access to credit, the financial situation of these countries continues to deteriorate . . . and capital markets are demanding higher interest rates to refinance maturing sovereign debt - so much so that the costs are becoming unbearable and are putting these countries deeper in the hole.
As we are just now beginning to see, there is only so much “belt tightening” that electorates in these countries will accept. Sooner or later, newly elected governments will likely reverse course, opting for less austerity in favor of more stimulative fiscal initiatives.
Europe’s deteriorating economic performance is already forcing the European Central Bank to pursue more accommodative monetary policies.
The widening disparity between the stronger “core” economies (led by Germany and France) and the weaker “periphery” countries will further threaten the viability of Europe’s common currency, the euro. Safe-haven capital flight from the questionable euro into both the U.S. dollar and gold has, thus far favored the dollar - masking the greenback’s inherent weakness and, counter intuitively, contributed to the yellow metal’s retreat from its early September peak.
Any efforts to save the bankrupt periphery economies, as we have seen over and over again, will continue to be too little, too late . . . and, at best, will only postpone the ultimate day of reckoning.
What is missing is a shared sense of common statehood such as we enjoy in the United States. Americans are, first and foremost, Americans - not New Yorkers, Floridians, or Californians. But Germans are Germans and Greeks are Greeks. They just don’t see themselves as Europeans first - and Germans just don’t see why they should work hard to bail out the Greeks or the Italians who, they say, don’t work hard enough, retire too early, and have it too easy.
Moreover, the disparity between inflation rates, economic productivity, and international competitiveness that separates the poorer periphery nations from the wealthier core economies is a gap that will prove too wide to bridge with a single currency.
Europe’s weaker economies are simply not competitive versus their stronger northern neighbors. In the days before a single currency, countries could regain their competitiveness by depreciating their own currencies - but, with a single shared currency, this is no longer an option for individual members, each lacking their own currency and exchange?rate policy.
The only thing now holding the European single?currency monetary system together is the high cost of divorce - and the seeming impossibility of managing a break?up.
Even if the euro somehow survives, its role as a reserve asset has been badly damaged, further enhancing the appeal of gold to central bank reserve managers skeptical about accumulating more euro-denominated reserve assets.
A tarnished euro, periodic funding crises, and fears of a eurozone break?up will benefit gold in the months ahead - even if the lion’s share of scared money finds a safe haven and shelter from financial uncertainty in U.S Treasury securities and other dollar-denominated assets.
To sum up the economic situation: I don’t think either the United States or European economies are heading toward total collapse. Instead, we will muddle through with several years of sub-par economic activity, high unemployment, and rising inflation.
Chinese Liberalization Promotes Rising Demand
As a foreign visitor in China, I feel presumptuous talking to you about gold-market trends and developments in your own country. But, no discussion of gold is complete without reporting on China’s importance and profound influence on the world market and the metal’s price.
As you know, private gold investment was banned and the local market was tightly controlled for more than five decades following the Communist Party victory and ascension to power in 1949. Ever since the legalization of private gold investment and the gradual liberalization of the market beginning in 2002, China’s 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 market, its encouragement of private gold investment, and the development of new investment vehicles and channels of distribution.
Rapid growth in household incomes, an expanding middle class, and rising wealth have also been important, contributing to the growth in gold demand for jewelry as well as for personal savings and investment.
In recent years, China’s central bank, the People’s Bank of China, has also been a significant buyer. Two and a half years ago - in April 2009 - the PBOC revealed it had bought some 454 tons of gold over the preceding six years, an average of about 75 tons per year.
Since then there has been no hard evidence of additional buying . . . but my guess is that your central bank continues to buy regularly from domestic mine production and scrap refinery output - perhaps as much as 50 to 100 tons per year. For its part, the PBOC not long ago said it will “seek diversification in the management of reserve assets,” possibly implying their intention to accumulate gold without actually saying so.
As a result of China’s sizable appetite for gold, it has become a powerful driving force in the world gold market - and its influence on the future price of gold is likely to continue, if not grow, in the next few years reflecting demographics, economic growth, rising personal incomes, episodes of worrisome inflation, the continuing development of the domestic gold-market infrastructure, and, importantly, central bank reserve diversification.
Indian Demand Heats Up
China isn’t the only giant shaking up the world of gold. India’s appetite for gold has also been hot like curry, reflecting - as in China - growth in household incomes, an expanding middle class, increasing national wealth, and, lately, worrisome inflation trends. .
India has historically been a very price-sensitive market for precious metals. Typically, gold demand falls as prices rise . . . and, at higher prices, owners of gold have usually been quick to take profits, cashing in their bangles and chains, so much so that Indian gold scrap has, at times, been an important source of supply to the world market.
But, in contrast to the historical experience, we are seeing much less price sensitivity of demand as Indian consumers have adjusted rather quickly to record high gold prices. Even with the rupee-denominated price at or near all-time highs, Indians still seem to be fairly eager buyers, suggesting a psychological re-evaluation of long-term gold-price prospects among Indian jewelry buyers and investors.
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. And, like China and India, we have seen strong demand from both households and central banks in a number of these countries as well.
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 above-ground stock of gold for jewelry, for investment, and for additions to central bank reserves.
Importantly, much of the gold bought by these countries will probably never come back to the world 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
For now, the U.S. dollar remains the number one world trade and official reserve currency by default. There is simply nothing ready to take its place - certainly not Europe’s single currency, the euro. That said, a recent survey of central-bank reserve managers predicted that the most significant change in their official reserve holdings in the next 10 years will be their intentional build up in gold.
I believe we are moving gradually toward a multi-currency system where an array of national currencies (including the Chinese yuan) - possibly along with IMF Special Drawing Rights and even gold - will together function as official reserve assets and settlement currencies with much less dependence upon the U.S. dollar.
Many central banks have taken a much more positive view of gold in recent years. Indeed, the official sector has been a positive net buyer of gold for the past two or three years. This follows some two decades in which the official sector was a net seller of gold to the market, reflecting mostly large-scale sales by European central banks that mistakenly thought gold was in descent as a legitimate reserve asset and sold at a mere fraction of today’s price.
Just looking at the recent official data actually reported by central banks and published by the International Monetary Fund, the official sector bought 148.4 tons, net of sales, in the third quarter alone . . . and, based on year-to-date data, it looks like net official purchases may total 450 to 500 tons - or more if we include a guess of unreported purchases by China and possibly others, including purchases by sovereign wealth funds that may be buying surreptitiously on behalf of their country’s central banks.
Following many years of net annual sales in the 400 to 500 ton range, the official sector became a net buyer of gold in 2009. This is a “game changer” for the gold market. Instead of supplying hundreds of tons, year in and year out, central banks are now buying at what seems to be a net rate of 400 to 500 tons per year - representing a swing in the annual supply/demand balance of 800 to 1000 tons a year.
I don’t think most market observers and participants fully appreciate just how significant this has been - and will continue to be - for the world gold market.
In addition to China, the list of countries that have bought gold in the past few years is itself growing with new, surprising names joining the club - names like:
? Russia - which has been the most outspoken and one of biggest buyers of gold in recent years making monthly purchases from its domestic mining and scrap refining at a rate of about five tons a month . . . and has more than doubled its gold reserves over the past four years.
? India - which made a strong pro-gold statement, buying 200 tons directly from the International Monetary Fund at the start of the IMF ’s gold-sales program a couple of years ago.
? South Korea - which last summer announced the purchase of 25 tons, its first purchase since 1998 when it collected and resold gold jewelry donated by patriotic citizens to help the country through a period of economic emergency,
? Saudi Arabia - also added significant quantities of gold - 180 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 continues to buy on the sly . . . along with some of the other oil producers that, like the Saudis, are over-weighted in U.S. dollar assets and grossly underweighted in gold,
? Thailand - which bought nearly 40 tons so far this year,
? Mexico - has been the biggest buyer so far in 2011 at some 100 tons,
? In addition to Mexico, other Latin American buyers include Bolivia (which recently bought seven tons following a similar purchase in December 2010), Colombia, and Venezuela (which not only bought some gold this year, but also repatriated much of its gold held abroad in Bank of England vaults),
? Bangladesh and Mauritius - which also bought gold from the IMF gold sales program,
Meanwhile, gold sales by the European central banks have dwindled to practically nothing, only enough to supply their bullion and commemorative coin programs.
Keep in mind that aggregate central bank gold purchases probably exceed the official data by a wide margin. The People’s Bank of China, the Saudi Arabian Monetary Authority, and other central banks with large U.S. dollar-denominated official reserve assets have an incentive to buy gold discretely and surreptitiously - simply because the announcement of their buying programs would likely boost the yellow metal’s price and raise these central bank’s acquisition costs.
As we saw in September, after prices took a tumble, official demand responded positively. Central banks, in the aggregate, are bargain hunters, what we call “scale-down buyers.”
But the reverse is not true: We don’t see central bank profit-taking when prices move sharply higher.
Importantly, much of the gold bought by central banks has been bought for the long term - and will likely be held not just for a few days or months or even a few years . . . but for decades or longer, even at much higher prices.
As a result, central banks are now creating an upside bias to the market and are reducing the “free-float” available to meet future demand, even at much higher prices. As a consequence, we can expect less downside volatility - and a more sustainable bull market with much higher prices in the years to come.
Rising Participation
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 around the world “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.
Contributing to increasing participation has been the introduction and growing popularity of gold exchange-traded funds (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 exchange-traded funds not only allow investors to easily and quickly accumulate gold . . . these ETFs also allow investors to easily and quickly shed their gold holdings. At times, this has contributed to upside volatility with swift appreciation in the metal’s price. But, ETFs have also contributed to downside volatility - like the sharp correction we have suffered through in recent months.
Another interesting vehicle that is raising participation, because of its appeal to some investors, is the internet purchase or trading platforms -offered by some gold retailers as well as a variety of financial-service firms - that gives buyers or retail traders direct and immediate access to the market.
These investment vehicles are making gold more accessible and more mainstream to more investors around the world - and 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
With these bullish building blocks in mind, let me reiterate my personal forecast of the future price of gold:
I believe gold’s fortunes remain very bright. To begin with, gold’s key price drivers remain supportive - and most, if not all, will continue to support the rising price for at least a few more years.
Although gold-price volatility - and occasional big declines in the metal’s price - will lead many to prematurely proclaim the death of gold, I believe the bull market has plenty of life in it. My advice to gold investors is to use these sell offs, when they occur, as opportunities for scale-down buying.
In my view, it is only a matter of time before we see gold break through the $2,000 an ounce level. Notwithstanding the recent sharp price decline, I wouldn’t be surprised to see gold at this level during the first half of next year . . . followed by $3,000, $4,000, and possibly even $5,000 (or still higher) in the middle to late years of this decade.
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In case you hadn’t noticed, gold prices have been surging to new all-time high rising to $1,878.90 an ounce in intraday trading on Friday, August 19th.
Whether gold continues to skyrocket, settles into a new trading range around recent levels, or plummets as high prices discourage buyers and encourage profit-takers is anyone’s guess.
At some point, however, we will see a correction, perhaps a sizable one. After all, even strong bull markets never move up in straight lines. I would not be surprised to see gold stumble - falling back $100, $200, or even $300 - before prices begin working their way higher once again.
My advice to gold investors is to use sell-offs, when they occur, as opportunities for scale-down buying. And, those who are underweighted or own no metal should gradually acquire physical metal with their focus on long-term portfolio protection rather than short-term profits.
Adding to my short-term caution has been some price-related relaxation of physical demand and the appearance of increased quantities of gold scrap returning to the market, especially from India and other price-sensitive national markets.
I’m confident gold’s long-term uptrend will continue in the months and years ahead, ultimately reaching a multiple of today’s record level.
Limited Downside Risks
Gold will soon begin to benefit from increased seasonal demand - demand that should support the yellow metal’s price and limit downside risks right through New Year’s Day.
There are three distinct sources of seasonal demand: (1) Western jewelers step up fabrication demand ahead of Christmas gift-giving late in the year; (2) Indian dealers begin stocking up ahead of the late summer and autumn festivals and wedding season; and (3) in December and January, the approaching Chinese lunar new year triggers another sharp rise in gold demand.
For sure, irrespective of the season, Asian demand - principally from China and India - for physical metal will continue to underpin these markets and limit downside risks as buyers step-up on any sharp price dips that may occur.
So, too, will bargain hunting by a number of central banks eager to raise their official gold holdings without disrupting the world gold market by increasing upward price volatility.
Bullish Economic Forces to Continue
There is no reason to believe that the forces and factors pushing gold higher - in the past weeks, months, and years - are simply going to disappear anytime soon. I’ve been talking about many of these for years . . . and, I expect I’ll still be talking about these same pro-gold forces for years to come.
At the top of my list of bullish forces supporting the long-term gold-price uptrend are: (1) recognition of recessionary trends in the industrial economies and the implications for future monetary policy; (2) the lack of faith in the U.S. dollar and the euro; (3) increasing Western investor participation - both retail and institutional - in the gold market and the re-legitimization of gold as an asset class; (4) continuing expansion of the big Asian markets, China and India, even if growth moderates in these countries; (5) rising official-sector demand as emerging-economy central banks seek reserve diversification.
Steroids for Gold
The recent rush of gold buying is, in large part, a rational response to rising uncertainty, anxiety, and fear that the U.S. and European economies are stumbling badly . . . and world financial markets are increasingly vulnerable to an epileptic seizure, or worse.
World stock markets and industrial commodity prices are reacting to the same uncertainties, registering the downward shift in expectations about future economic growth.
In recent days, signs of renewed recession on both sides of the Atlantic and Europe’s worsening sovereign-debt crisis are raising expectations that the Federal Reserve and European Central Bank (ECB) will both be compelled to pursue evermore stimulative monetary policies beginning with a new round of quantitative easing in the United States and stepped-up ECB purchases of sovereign debt and/or interest-rate cuts in Europe.
These policies - and the implications for future inflation and monetary debasement - are like steroids for the gold market, causing investors and central-bank reserve managers to seek the protection of gold.
In any event, whatever happens in the U.S. and European economies, it is hard to imagine a realistic scenario that won’t push gold prices significantly higher.
Central Bank Acquisition: More Important Than You Think
Importantly, contributing to gold’s recent swift rise has been the growing interest and stepped-up acquisition of gold by the official sector.
This was underscored by the Central Bank of Venezuela’s recent announcement that it was repatriating much of its official gold reserves from foreign custody. Statistics from the Bank for International Settlements (the BIS) suggest that a number of other countries have, in the past year, repatriated gold rather than store it in the custody of the Bank of England, the New York Federal Reserve Bank, or in the vaults of other central banks.
While these are not purchases of gold affecting the world market supply/demand balance, the trend toward repatriation illustrates the special role gold plays as an asset of last resort among central bank reserve managers.
Increasingly, central banks are buying gold: South Korea announced a couple of weeks ago that it had purchased 25 tons over the past two months, almost tripling its central bank gold holdings. Thailand’s central bank, too, has been an important buyer, recently adding nearly 18 tons to its official gold stocks. Even the Banco de Mexico bought 100 tons earlier this year, joining China, Russia, India, and Saudi Arabia - all of which bought large quantities in recent years. Russia continues to buy gold regularly from its domestic production - and, we think, China does likewise though it chooses not to report its purchases.
Recently published statistics of official-sector gold demand greatly under-estimate actual central bank purchases. In addition to significant on-going purchases by the People’s Bank of China, a number of other central banks are likely buying gold on the sly. At the top of my list of candidates are the reserve-rich OPEC central banks, like Saudi Arabia and possibly Kuwait, which may use their sovereign wealth funds to purchase metal on their behalf without the need to include this metal on the central bank’s books.
News of central-bank gold repatriation - and, even more so, outright purchases - is likely to encourage more central banks underweighted in gold to begin or continue buying. Like much of the new demand coming from private investors, central bankers are apt to be purchasers for the long haul, holding gold as a diversifier and insurance policy against what they perceive to be the growing risk of U.S. dollar and European currency depreciation and debasement.
I expect the rising trend in central bank interest and accumulation of gold will be an important force in the market for many years to come. In the meantime, bargain hunting by a number of central banks eager to raise their official gold holdings without disrupting the world gold market will help limit downside risk.
For more on gold’s day-to-day developments and short-term prospects, follow me on Twitter @NicholsOnGold.
Filed under: Gold Briefs | American Precious Metals Advisors, central banks, China, euro, European Central Bank, gold, gold investment, gold price, inflation, Jeffrey Nichols, monetary policy, Quantitative Easing, sovereign risk|No Comments
