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World Economic Trends and the Future Price of Gold

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 6^th 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.

Filed under: Speech | American Precious Metals Advisors, central banks, China, economics, ETFs, euro, Exchange-Traded Funds, fiscal policy, gold, gold investment, gold price, India, inflation, Jeffrey Nichols, mine production, monetary policy, Quantitative Easing, Russia, Sovereign Wealth Fund, U.S. dollar|No Comments

Gold Sizzles

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 19^th.

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

Gold’s Long March Upward Continues

Despite gold’s recent run up to new historic highs, I believe the yellow metal’s price has far to go - both in future percentage appreciation and duration before the great gold bull market comes to its ultimate cyclical end.

Right now, there is no evidence of a buying frenzy to suggest we are anywhere near a long-term top . . . but there are plenty of rock-solid fundamentals that suggest the market is healthy with plenty of room to move higher. Moreover, the world economic and geopolitical environment remains very supportive - and seems likely to remain pro-gold for years to come.

My forecast, published here on NicholsOnGold and in other speeches and reports, of $1700 gold by year-end 2011, now seems within easy reach.

And this is just the beginning of gold’s next great leap upward, a leap that will carry the metal to $2000 an ounce in 2012 - with prices heading still-higher, quite possibly to $3000, $4000 and maybe even $5000 an ounce by the mid-to-late years of the decade.

From a long-term perspective, gold prices near $1500, should we ever return to that level, $1600, or even $1700 an ounce will prove to be bargains.

As I have cautioned in the past, expect high two-way price volatility and periodic sharp corrections, corrections that some will mistake as the end of the bull market - but consider these opportunities for “scale-down” buying, opportunities to acquire additional metal at bargain-basement prices.

A Pause that Refreshes

Rising some $300 an ounce from its January 2011 low point and more than $120 in just the past few weeks, gold has scored a series of successive all-time highs. Now, however, there is certainly some risk of a sharp short-term correction, particularly if the political-economic news on either side of the Atlantic looks less threatening to financial market stability.

A political compromise to raise the U.S. Treasury debt ceiling and agreement to narrow the Federal deficit in future years that avoids any downgrading of Treasury debt by the rating agencies would remove or reduce an important source of anxiety that has contributed to gold’s recent strength. News of positive movement toward or actual completion of an agreement could trigger a swift - but temporary - gold-price retreat.

Speculative long positions held by institutional traders on world derivative markets have increased sharply in recent days. Should the market lose upward momentum, speculative pressures could quickly turn negative. Moreover, if the short-term news turn bearish for gold, liquidation of these long positions and/or institution of new speculative short positions could leave the market especially vulnerable to a swift correction .

Adding to my short-term caution has been a 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 in recent weeks as prices rose above $1550 and approached $1600 an ounce.

I expect Indian and Chinese scrap reflows will diminish significantly over time, even at high price levels. In the meanwhile, should gold approach or fall below the $1550 level, scrap supplies will quickly abate and price-sensitive demand, smelling a bargain, will re-appear.

Hot Summer, Hotter Autumn

Contrary to the view expressed by most serious gold analysts, we said in past reports that gold would not pause for its typical summer vacation — and it hasn’t! Nor would we see this summer a seasonal relaxation in price volatility. Indeed, it has been a very hot summer as gold moved up smartly to achieve new all-time highs with plenty of fireworks and price volatility both up and down.

However, come September, positive seasonal factors will kick in - and, other things being equal, give gold still more firepower. There are three distinct sources of seasonal demand, all of which will likely contribute to demand and higher prices as we move into the later few months of 2011: First, jewelry manufacturers step up fabrication demand ahead of Christmas gift-giving late in the year; second, Indian dealers begin stocking up ahead of the autumn festivals and wedding season, and in expectation of good harvests and healthy household incomes in the gold-friendly agrarian sector; and, third, later in the year and in early 2012, we should expect a sharp rise in gold investment and jewelry demand associated with the approaching Chinese lunar new year.

For sure, irrespective of the season, price-sensitive Asian demand - principally from China and India - for physical metal will continue to underpin these markets and limit downside risks.

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.

Central Banks Rediscover Gold

Official statistics published monthly by the IMF show that central banks, as a group, have been busy buying gold. Russia, India, China, Saudi Arabia, Mexico, and Brazil have been among the big buyers in recent years and a number of other countries have added smaller amounts of gold to their official reserves. One big surprise was Mexico’s purchase of some 100 tons earlier this year as a hedge against the possible decline in the value of their U.S. dollar reserve holdings.

Moreover, a recent survey of 80 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 reserves. They also predicted that gold will be their best performing asset class over the next year and sovereign debt defaults will be their principal risk.

Sovereign Debt Crisis Prompts Safe-Haven Demand

European Central Bank president Jean-Claude Trichet a few weeks ago raised the alarm level on Europe’s debt crisis to “red,” warning that the crisis is nowhere close to being resolved . . . and he also warned of the “potential contagion effects across the [European] Union and beyond.”

Meanwhile, Europe’s sovereign debt problems are worsening and the likelihood of sovereign default by one or another of the more vulnerable periphery economies is increasing, despite the past week’s patchwork aid package that avoided (or more likely postponed) a sovereign default by Greece.

Despite all the talk among finance ministers and the European central bank, it looks like the future fate of “periphery’ country debt is increasingly in the hands of the credit rating agencies who view any delay in full repayment as partial default.

Several factors suggest that the European debt crisis will continue to worsen:

Longer term, the more restrictive fiscal policies the periphery nations (Portugal, Ireland, Italy, Greece, and Spain - the so-called PIIGS) have been asked to accept will push their economies deeper into recession - and increase, rather than decrease, government deficits and borrowing needs for years to come.

More immediately, the downgrading of sovereign debt by the rating agencies raises interest rates and borrowing costs - and pushes these countries closer to the brink (a lesson that the United States needs to learn before it also finds itself with higher Treasury borrowing costs should we suffer a cut in our own debt ratings on U.S. Treasury securities).

As credit ratings decline for the peripheral countries, the rising cost of refinancing maturing debt make it all that much more difficult to keep their heads above water. Reflecting the recent deterioration in credit ratings, Greek two-year bond yields last week were over 35%, Spanish 10-year bonds hit a record 6.3%, and Italian 10-year bonds were also yielding around 6%. Higher borrowing costs will increase government deficits and make repayment of past debt all the more difficult.

An important aspect of the crisis is that default on European sovereign debt, debt that is held by many European banks, will require the banks to write-down these questionable assets, leaving them with insufficient capital and effectively bankrupt.

The broader effect of bank failures on the European economy, capital markets, and banking system could be far more devastating than the Bear Sterns and Lehman Brothers debacle in the United States - and would likely result in the European Central Bank along with the U.S. Federal Reserve flooding financial markets with newly created money, depreciating paper currencies, inflating prices, and boosting gold.

I continue to believe that ultimately the euro, Europe’s single currency, will be replaced by a multi-currency system - with the core countries possibly retaining the euro while the periphery nations will revert each to their own monetary unit or a deeply devalued renamed euro of their own.

With no solution in sight, Europeans will continue to abandon the euro for “safe havens” including gold and, ironically, the U.S. dollar. At the same time, the problems of the euro will discourage its acceptance as a reserve currency by some central banks - and make gold an even more attractive alternative.

Meanwhile, Back at the Fed

The U.S. economy is still mired in recession, or worse. Nearly everyone knows it, even if the official statistics show some positive growth in real GDP. Unemployment remains stuck at over 9 percent. The huge inventory of foreclosed homes held by banks continues to weigh heavily on home prices. Various economic indicators released in the past few days and weeks are pointing to the second dip in what may be called 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 future history books will liken to the policy mistakes of the 1930.

The Fed also fails to see, at least publically, the writing on the wall. Having ended its program of quantitative easing at the end of June 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. Contrary to popular belief, the Fed can stimulate the economy and liquefy the financial system through open-market purchases of securities and even real assets, not just Treasury securities but stocks, corporate bonds, commercial paper, mortgages, credit-card debt, student loans and even real estate.

The resumption of quantitative easing (QE3) or some other program of monetary stimulus will be reflected in a swift and significant jump in gold prices.

As I have said in past reports and speeches, 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 pragmatic policy of higher inflation that will deflate the ratio of outstanding debt to nominal gross domestic product (GDP) to historically acceptable and manageable levels. This is what we did in the 1970s, a decade of stagflation, and we’re already doing it again. Indeed, under Chairman Bernanke’s lead, the Fed is 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 bi-partisan plan for long-run deficit and debt reduction would help calm world financial and currency markets.

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 in the months and years ahead.

Other Pro-Gold Trends Continue

Meanwhile, other important pro-gold trends continue unabated. These bullish trends include:

The growth in Chinese, Indian, and other Asian gold demand accompanying their expanding economies, growing wealth, rising inflation, and historic affinity to gold in jewelry and as a saving and investment medium.
The expansion of the gold investment infrastructure around the world - such as the development of gold exchange-traded funds and other forms of physical gold . . . or the implementation of gold distribution systems through banks and other retail outlets in China, India, and elsewhere).
The recognition of gold as a worthy asset class for inclusion in investment programs and portfolios of individuals; pensions, endowments and other institutions; sovereign wealth funds; and central banks.
The relative stagnation of new gold-mine production (certainly in comparison to the growth in gold demand) and the rising costs of discovery, development, and operation of new mines.

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Dog Days of Summer: Cooling Off for Gold Unlikely

The days and weeks ahead could be tumultuous for gold with the yellow metal’s price primed to move one way or the other depending on news from European finance ministers, the European Central Bank, the Greek Parliament and, last but not least, the Fed’s FOMC policy-setting committee and Chairman Bernanke’s news conference later this week.

Technically, gold remains range bound with good support, as we saw last week, between $1515-$1522 and overhead resistance in the $1545-$1555 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. Moreover, 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.

Adjusted for consumer price inflation, using official government data (data that tends to seriously underreport actual inflation felt by American households), suggests that gold should be selling today for at least $2500 an ounce . . . and considerably more if we were to 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. To a large extent, 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 pick up 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 14^th 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 demand for gold reflecting the growth in incomes in Greater China and India. As incomes rise, so does demand for gold jewelry and investment 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 later.

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 $1700 later this year with still higher prices in the years ahead.

Filed under: Gold Briefs | American Precious Metals Advisors, central banks, China, economics, European Central Bank, fiscal policy, gold, gold investment, gold price, India, inflation, Jeffrey Nichols, Mideast, monetary policy, money supply, Quantitative Easing, sovereign risk, U.S. dollar|No Comments

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