CHINA GOLD: MORE THAN MEETS THE EYE

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The gold world has lately been abuzz with news and speculation about the true volumes of gold supply, private-sector demand, imports, and central-bank reserve accumulation.

In recent weeks, every gold analyst and pundit seems to be jumping on the bandwagon.  But this is nothing new for our clients and readers of NicholsOnGold.

For several years now, we have suggested that China’s actual annual gold production, consumption, and imports have been running considerably higher than that suggested by official and semi-official statistics coming out of the Asian giant - and that China’s central bank has been accumulating many tons of gold each year but for now chooses not to report these purchases in the country’s official reserve statistics.

Indeed, I’ve been talking about surreptitious gold accumulation by the People’s Bank of China (the PBOC) ever since my speech to the China Gold & Precious Metals Summit in 2008 (see http://nicholsongold.com/2008/12/the-world-economic-crisis-and-the-outlook-for-gold-speech-to-the-china-gold-summit-december-4-2008/) — and I’ve been reiterating this theme in speeches and reports ever since.

Underestimated Supply

China’s total gold supply from domestic mine production and other sources is, without a doubt, much higher than reported or discussed by analysts and observers of the Chinese gold scene. Actual gold mine production - and supplies from other sources - could easily be close to 400 tons and possibly much more.  Here’s why:

• The China Gold Association (CGA) numbers reflect production by their members only — but omit gold mined by non-members. These include many small, often rudimentary, unofficial mining operations some of which are illegal existing in the “underground economy,” no pun intended.
• The CGA data also excludes production from mines owned and operated by the military, which is significant according to my sources. And not to be overlooked is by-product output from the country’s copper, silver, and other metal-mining activities. Again, this is significant though hard to know just how significant.
• Also missing from the CGA reports are the huge quantities of gold contained in copper and other precious-metals bearing concentrates imported and processed by Chinese smelters and refiners.
• In addition to these unreported sources of supply, analysts and commentators seem to forget about secondary supply — that is from recycling of jewelry, investment bars, and industrial scrap. Just to get an “order-of-magnitude” possibility, in recent years global secondary supply from scrap recycling has contributed more than one-third of total world supply. If scrap contributed only five or ten percent of China’s total gold supply it would still be quite important.
• Western analysts estimate China’s total gold imports last year were around 490 tons — but there is little mention of “illegal” imports — that is gold smuggled into China. We know smuggling is quite significant in some countries — Vietnam and India, for example. We can only imagine how many tons of gold in the form of tael bars, wafers, coins, investment-grade jewelry, etc. is carried into China each year by travelers and professional smugglers.

Central Bank Gold

Now, what about net purchases and total official reserves held by the People’s Bank of China?

Chinese miners and refiners are required to sell each and every ounce of gold output to the state gold-buying authorities.  But, it seems that some of this (more or less the volume of unreported production, as discussed above) is retained by the PBOC and other government entities acting on behalf of the central bank.

It is not at all unreasonable to conclude that the Chinese government may be squirreling away perhaps 50 to 100 tons a year into accounts that will eventually be included in the country’s reported official reserve figures - and one might speculate that these figures could turn out to be considerably higher.

In my most recent speaking tour on behalf of clients across China late last year and published on my website on December 15th (see http://nicholsongold.com/2011/12/797/), I said:

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.

Filed under: Gold Briefs | American Precious Metals Advisors, central banks, China, gold, gold investment, gold mining, Jeffrey Nichols, mine production, scrap, Secondary Supply|No Comments

World Economic Trends and the Future Price of Gold

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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’s Long March Upward Continues

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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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Up, Up, and Away: The Bullish Case for Gold

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Keynote Speech by Jeffrey Nichols
The New York Hard Assets Conference - May 9, 2011

The recent correction in precious metals prices and mining shares has led some investors, analysts, and financial journalists to conclude we’ve already seen the ultimate bull-market peaks in gold and silver.

I’m here today to tell you otherwise – but please don’t mistake me for a gold bug. Although, I believe quite strongly that its price will go much higher in the next few years, I don’t think there’s anything magical about the yellow metal.

The future price of gold is a function of past and prospective world economic, demographic, and political developments. My job for the next forty-five minutes is to briefly review some of these trends and developments – and let you come to your own conclusions.

Gold’s Bullish Building Blocks

There is no simple answer or single reason why gold has been moving from strength to strength for some ten years now. Here’s my list of eleven factors fueling gold’s ascent:

· First, U.S. Federal Reserve policy characterized by low or negative real interest rates and unprecedented central bank monetary creation.

· Second, the U.S. federal budget impasse, rising U.S. sovereign debt, and eroding U.S. creditworthiness.

· Third, the ongoing and expected future depreciation of the U.S. dollar in world currency markets.

· Fourth, accelerating global inflation – with high and rising agricultural and industrial commodity prices leading the way.

· Fifth, fear of sovereign debt defaults and bank failures in one or more of Europe’s “periphery” economies. These countries, despite tax increases and deep spending cuts, continue to see their debt ratings and ability to refinance both government and private-sector bank debt deteriorate. Moreover a widening economic schism across the continent calls into question the viability of Europe’s common currency, the euro.

· Sixth, the continuing civil war in Libya and political unrest across North Africa and the Middle East – and the threat to future oil supplies.

· Seventh, the growing affluence of the emerging-economy nations and the associated growth in gold demand – especially the two big population countries, China and India.

· Eighth, central bank buying by countries under-invested in gold and overexposed to U.S. dollars.

· Ninth, the development and maturation of new gold investment channels, especially gold exchange-traded funds, that make it easy for investors to buy physical metal.

· Tenth, the legitimization of gold as an investment class and the expansion of investor interest among retail and, importantly, institutional investors – including hedge funds, pensions, endowments, and insurance companies.

· Eleventh, no more than marginal growth in world gold-mine production for at least the next five years – while some of the gold-mining nations, including China and Russia, absorb more of their own production for domestic jewelry consumption, investment, and additions to central bank reserves.

Together these bullish factors are responsible for a growing gap between new mine supply and aggregate demand – a gap that can be closed only by much higher prices in the years ahead.

American Economics

Let’s look more closely at some of these bullish factors beginning at the epicenter of today’s world’s economic crisis – Washington D.C.

The U.S. economy still faces significant and painful adjustments in the years ahead following many years of profligacy, years in which our government sector and many private households simply spent more than we could afford, on things we didn’t need, with money we didn’t have.

Despite the rhetoric from Democrats and Republicans alike on the need to tackle the country’s deficit and rising debt, there is little evidence that meaningful and sufficient steps will be taken any time soon – that is, unless a run on the U.S. dollar forces “emergency” measures sooner rather than later.

The U.S. federal government came close to shutting down not too many weeks ago – and the rancor in Washington will likely pick up as we again approach the federal government’s debt ceiling and the 2012 federal budget debate gathers steam.

It is likely that continued discord in Washington will leave our central bank, the Federal Reserve, with the difficult, if not impossible, task of maintaining orderly U.S. and world financial markets in the face of diminishing willingness on the part of foreign central banks and institutional investors to continue funding America’s federal financing gap.

How the Fed maneuvers between rising inflationary pressures, on the one hand, and a sluggish economy with unacceptably low GDP growth and unacceptably high unemployment remains anyone’s guess.

So, even if the Fed discontinues its policy of quantitative easing with the expiration of QE2 this June, before long it may have to continue buying U.S. Treasury securities because foreign central banks and private investors will be unwilling to do so without much higher interest rates.

One thing is for sure: Without significant and meaningful U.S. fiscal reform the dollar’s role as the preeminent world currency and official reserve asset will likely continue to diminish.

The announcement a few weeks ago that the world’s largest bond fund, PIMCO, would no longer hold U.S. Treasury obligations may be a harbinger of things to come.

Investor concern about U.S. government debt was further underscored last month by Standard & Poor’s surprise warning, issued on April 19^th, that America might lose its “triple-A” rating if it doesn’t act swiftly to address the federal deficit and reverse the growing mountain of federal debt.

Unfortunately, the fiscal austerity demanded by financial markets – whether in the form of spending cuts, tax increases, or some combination of the two – will, in the short run, act as a drag on the economy.

To counter the negative economic effects of fiscal tightening, the Federal Reserve, for all its rhetoric to the contrary, will be compelled to step even harder on the monetary accelerator. For this reason, I think we are likely to see another round of quantitative easing (QE3) with implications for future inflation, the U.S. dollar exchange rate, and the price of gold.

In fact, I think the Fed and U.S. Treasury are intentionally targeting a weaker dollar (to stimulate the domestic economy through the trade balance) just as they are targeting a higher inflation rate (to erode the real value of our debt as a percentage of nominal GDP).

The result will very likely be a replay of the 1970s – a decade of sub-par economic activity, high unemployment, rising world commodity prices (especially oil), double-digit inflation, and a booming gold market.

For now, at least, the U.S. dollar remains the number one world trade and official reserve currency only by default. There is simply nothing ready to take its place.

I believe we may move gradually toward a multi-currency system where an array of national currencies, possibly along with IMF Special Drawing Rights and maybe even gold, will function with much less dependence upon the U.S. dollar.

Interest Rates and Gold

A growing number of economists and Fed watchers believe the United States will start raising interest rates later this year or early in 2012. Whenever policy rates begin to rise, it will be too little, too late, to stem the upward march in the yellow metal’s price.

We have already seen the European Union, the United Kingdom, China, India, Brazil and a number of other major economies raise their own domestic interest rates in recent months. The prospect of more rate increases by these countries, joined by the United States, has some gold investors and analysts worried gold prices will turn south.

But, so far, in just about all of these economies, real “inflation-adjusted” interest rates remain quite negative – particularly if you allow for significant under-reporting of actual inflation rates in these countries. As long as nominal interest rates remain below actual inflation rates, there is no reason to believe that investor interest in precious metals will diminish . . . but there is every reason to believe that investors will want to hold more gold as their currencies continue to lose purchasing power.

Breaking Up Is Hard To Do

Meanwhile, several European countries with their backs to the wall (including Greece, Ireland, Portugal, and Spain) are slashing government spending so deeply that economic activity is shrinking, unemployment rates are rising, and many ordinary folds are rioting. Despite spending cuts and tax increases, government revenues are falling.

As a result, rather than improving their creditworthiness, the “periphery” countries will see their credit ratings marked down still further, forcing the European Central Bank to bail out its most?endangered members yet again by its own program of quantitative easing through the purchase and monetization of member?country sovereign debt.

Safe-haven capital flight from the questionable euro into both the U.S. dollar and gold will contribute to the metal’s expected appreciation and, at the same time, mask the greenback’s inherent weakness.

In my view, the only thing now holding the European single?currency monetary system together is the high cost – and seeming impossibility – of managing a break?up. Even if the euro somehow survives, its role as a second?string reserve asset has been badly damaged.

A tarnished euro, periodic funding crises, and fears of a euro break?up will benefit gold in the years ahead – even if the lion’s share of scared money and safe?haven demand find shelter in U.S. dollar financial markets.

To sum up the economic situation: I don’t think either the United States or European economies or currencies are heading toward total collapse. Instead, I think we’ll muddle through with several years of sub-par economic activity, painfully high unemployment, and high, but not hyper, inflation.

Food and Oil Lubricate the Gold Market

Accelerating global inflation is, to be sure, a monetary phenomenon, the result of unprecedented monetary creation by America’s central bank, the Federal Reserve, and most the central banks around the world. Simply put, we have had too much money chasing too few goods and services.

But there’s more to the story than just too much money. Commodity prices are rising because millions, if not trillions, of people living in China, India, and other emerging economy nations are enjoying unprecedented growth in national wealth and personal incomes.

Even if economic growth decelerates somewhat this year and next in these populous nations, as some economists now anticipate, they will nevertheless continue to pursue commodity-intensive infrastructure development (think steel, copper, aluminum, cement, etc.).

And, similarly, slower growth or not, millions of households in these countries will have the means to buy more commodity-intensive consumer goods than ever before.

As a result, high and rising food and agriculture prices are under pressure from a healthy rise in personal consumption in these nations. People with a few more yuan or rupees in their pockets are now eating better, eating more, and eating more grain-intensive “meaty” western-style diets.

So, high and rising global food prices are, in part, a monetary phenomenon . . . and, in part, they are demand driven as millions of consumers eat better – but, in recent years, there is still more to the rise in food prices.

Agricultural inflation is also a consequence of weather-related problems in some of the planet’s most important grain-, corn-, and rice-producing regions: Too much rain, or too little, combined with record heat waves in some places, has taken a big bite out of food production. Now, dryness and weather-related planting delays are threatening poor harvests again in the 2011-2012 crop year.

Many climatologists claim agricultural supply problems, as we have seen repeatedly in recent years, are a symptom of global warming – and are likely to continue, if not worsen, in the future.

High food prices also have had a profound indirect affect on world inflation: Indeed, the high cost of food has been politically destabilizing in some of the countries where food accounts for a big share of household budgets. Remember, earlier this year, high food prices were credited with triggering rioting, unrest, and revolution – first in Tunisia, then in Egypt.

In turn, conflict and political uncertainty has affected world oil markets – and, as we all know, pushed the price of oil (and other energy products) much higher with immediate consequences for inflation everywhere.

Many oil analysts had been warning that oil prices would be heading much higher even before the outbreak of political unrest and revolution in North Africa and the Mideast, due to the growth in demand for oil from both the emerging economies, namely China and India again, and from some of the oil-producing nations themselves.

So, it looks like households around the world – in the United States, Europe, India, China, Latin America, and Africa – will have to endure rising prices for food, energy, and other commodities for a host of complicated reasons beginning with but not limited to excessive monetary growth from one country to the next. Whatever its cause, accelerating global inflation spells higher gold prices ahead.

Chinese Liberalization Promotes Rising Demand

Let’s turn our attention to China: This country has already had – and will continue to have – a profound influence on the world gold market and the metal’s price.

Private gold investment was banned and the market was tightly controlled for more than five decades following the Communist Party takeover in 1949. Ever since the legalization of gold investment and the gradual liberalization of the market beginning in 2002, the Chinese appetite for gold has been growing by leaps and bounds.

Much of the growth in China’s gold demand over the past few years has been a result of the government’s liberalization of the domestic gold market, its encouragement of private gold investment, and the development of new investment vehicles and channels of distribution.

As a result, China has become a powerful driving force in the world gold market – and this trend is likely to continue, if not accelerate, in the next few years reflecting demographics, strong economic growth, rising personal incomes, worrisome inflation, and the continuing development and maturation of the gold-market infrastructure.

China’s first gold exchange-traded fund (a hybrid that invests in overseas gold ETFs) was launched this past December and was quickly fully subscribed. I anticipate Chinese-listed gold exchange-traded products – and other new channels of gold investment – will grow rapidly in the next few years with a significant and lasting effect on the world gold market and the U.S. dollar gold price.

China – Continuing Growth Despite Monetary Tightening

The recent and prospective monetary tightening by China’s central bank, the People’s Bank of China (the PBOC), will not – in my opinion – diminish the country’s growing appetite for gold jewelry and investment.

PBOC policy actions – raising interest rates, adjusting bank reserve requirements, and allowing some gradual appreciation in China’s currency, the yuan – are in response to super-strong economic activity and uncomfortably high domestic price inflation.

But, real interest rates in China (that is after adjustment for inflation) are actually falling . . . and have become more stimulative and supportive of gold. Moreover, Chinese monetary authorities would like to see more, not less, private gold investment, hoping to reduce speculative investment in real estate and the stock market.

At most, Chinese authorities are trying to cool a hot economy and slow the annual rate of GDP growth from around ten percent to a more sustainable pace around seven percent. I have long argued that the country’s long-term bullish influence on the world gold market would continue as long as China’s economy continues to chug along at a moderate rate – with or without worrisome rates of consumer price inflation.

If inflation accelerates, as it has recently, led by rising food and commodity prices, that’s just icing on the cake, boosting gold demand still more.

Indian Demand Heats Up

China isn’t the only giant shaking up the world of gold. India’s appetite for gold is also hot like curry.

As in China, economic growth has been strong with GDP rising smartly – and inflation has been heating up as well.

India has historically been a very price-sensitive market for precious metals. Typically, buying interest falls as prices rise . . . and, at higher prices, India women are known to take profits, cashing in their bangles and chains, so much so that Indian gold scrap can, at times, be an important source of supply to the world market.

In contrast to the historical experience, we are now seeing much less price sensitivity of demand as Indian consumers have adjusted quite quickly to record high gold prices. Even at recently prevailing prices in the $1400 to $1500 an ounce range, Indians still seem eager buyers – suggesting a psychological re-evaluation of gold-price prospects.

As in many other countries, Indian gold investment is benefitting from securitization and the growth in gold exchange-traded funds. First introduced in 2007, there are now 10 gold ETFs with physical gold held on behalf of investors totaling more than half a million ounces (about 15.5 tons) when I last checked a few months ago – and holdings will likely grow as more mainstream stock-market investors participate.

India and China are very important markets for gold, in part, reflecting their huge populations and growing wealth. But there are many other countries across Asia and the Mideast that share an historical, cultural, and even religious affinity to gold as a traditional monetary medium for saving and investment. Even gold jewelry in many of these countries is purchased for its investment characteristics, as a symbol of wealth and social status, and as an amulet or talisman bringing good fortune to its owner.

Longer term, as many of these countries prosper and as their share of global income and wealth continues to increase, they will demand a growing share of the world’s above-ground stock of gold for jewelry, for investment, and for central bank reserves.

Importantly, much of the gold bought by these countries will probably never come back to the market, at least not for many years to come and only at much higher price levels or if political and economic developments prompt distress sales, something we will not likely see in the next few years.

Central Banks Buying More

Central banks collectively have taken a much more positive view of gold in recent years.

Just last week, it came to light that Mexico’s central bank, the Banco de Mexico, purchased some 93.3 tons this past February and March. That’s about 3.5 percent of annual world gold-mine output worth more than $4 billion at recently prevailing prices.

After net sales of roughly 400 to 500 tons a year over the prior decade, the official sector (including central banks, the International Monetary Fund, and sovereign wealth funds) became a net buyer of gold in 2009.

Net official purchases may have totaled as much as 100 to 200 tons in each of the past two years, even allowing for the IMF’s 403 ton gold sales program, which ended some months ago.

Last year, net official purchases continued as a number of central banks, principally in Asia, added to their official reserves while sales by European central banks were minimal – and have now virtually ceased except for some small reductions for domestic gold coin programs.

Officially published data on central bank gold transactions are not to be believed as some countries buy gold surreptitiously, choosing not to report purchases . . . and data on sovereign wealth funds are, for the most part, unreported. So, it’s not possible to get an exact reckoning of net annual purchases or sales by the official sector.

China, for example, announced two years ago that its central bank had purchased 454 tons in the prior six years – but it chose not to report these purchases until April 2009. Some observers, myself included, believe that China continues to buy significant quantities on a regular basis, possibly 100 tons or more annually, probably all of which comes from domestic mine production.

Saudi Arabia also added significant quantities of gold – 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 also continues to buy . . . along with some of the other oil producers with dollar-heavy, gold-underweighted official reserves.

The People’s Bank of China, the PBOC, and other central banks have an incentive to buy gold discretely and surreptitiously – simply because the announcement and acknowledgment of their buying programs would likely affect the yellow metal’s price and raise these central bank’s acquisition costs.

What we do know is that the list of countries that have bought gold since the beginning of 2009 continues to grow. China, Russia, India, Saudi Arabia, and now Mexico have been the biggest buyers. Other gold-buying countries include Kazakhstan, Sri Lanka, Mauritius, Venezuela, Bolivia, the Philippines, Thailand, and Bangladesh. Even the Ukraine and Tajikistan central banks have added small amounts to their official reserves in the past year.

Meanwhile, in recent days, it has been suggested by senior German officials that Portugal ought to sell some of its official gold holdings to ease its difficult debt problems. Should such a sale take place it is very likely that a number of other central banks would quickly line up as potential buyers, with Germany’s Bundesbank and the European Central Bank probably at the front of the line.

Recent year gold sales by the IMF have demonstrated that large-scale official sales need not disrupt the market – and that central banks underweighted in gold are willing buyers when given the opportunity to make off-market purchases.

Increasingly, many investors – both retail and institutional – are looking at these official-sector gold purchases and concluding they, too, should be diversifying their savings and investments with some physical gold.

Rising Participation

A few weeks ago, a big headline in the Wall Street Journal proclaimed “World is Bitten by the Gold Bug.” Gold bears seem to think that suddenly everyone has gone mad buying gold – and, because so many piled so quickly and recklessly into gold, they argue we have already seen the top and the metal will just as quickly lose value as investors shed their holdings.

Even though more people than ever before are buying gold, participation by both retail and institutional investors in the United States and many other countries remains very low. Moreover, many investors already holding gold remain underweighted with less than optimal and prudent holdings.

I expect participation rates will rise in the months and years ahead as more savers and investors “catch the gold bug” and begin to see the virtues of gold as a reliable store of value and insurance policy against an assortment of risks to their economic and financial wellbeing.

Of great importance to the future price of gold has been the introduction and growing popularity of gold 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 occasional swift appreciation in the metal’s price. But, ETFs have also contributed to downside volatility – like the sharp correction we saw just last week.

Developments in key geographic markets along with new more convenient 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

I see the clock ticking, so let me say something very briefly about world gold mine output and wrap up with my gold-price expectations.:

While production has increased in the past couple of years, growth in total ounces produced will continue to be modest for the next few years, maybe 1.5 to 2.0 percent annually – and total world mine production will continue to fall far short of the expected growth in jewelry, investment, and central bank demand for at least the next five years or longer.

Well, now that we’ve circumnavigated the world of gold and accounted for the key trends and developments, what can we say about the metal’s price prospects?

I believe gold’s fortunes remain very bright. To begin with, gold’s key price drivers all remain supportive . . . and there are so many of them, so many reasons to expect the long-term trend will continue upward for at least another few years.

What’s more, recent market activity – from a technical or chartist perspective – rather than signaling an end to gold’s decade-long advance, strengthens the case for a snap-back in the metal’s price with new all-time highs in the months ahead.

It’s sometimes said that forecasting is particularly difficult, especially when it’s about the future – and this is even more so when it comes to forecasting the future price of gold. It’s more an intuitive art than an exact science . . . although many an analyst and economist would have you believe otherwise.

That said, it’s my hopefully well-informed opinion that the price of gold will very likely hit $1700 an ounce by the end of this year – and I wouldn’t be at all surprised to see it even higher.

At the same time, gold prices are likely to remain volatile registering big short-term swings both up and, as we saw last week, down. Sizable intermittent price declines may lead some investors, and more than a few journalists, to question the bull market’s staying power. I can only warn you not to get prematurely caught in a bear trap.

Looking further out, I believe we are likely to see gold at $2000 an ounce in the next year, and possibly $3000 or even $5000 an ounce before the gold-price cycle moves into reverse in the middle or later years of this decade.

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