(Excerpts from my speech to the 7th annual CHINA GOLD & PRECIOUS METALS SUMMIT, Shanghai, China, December 5th through December 7th, 2012)
(Posted: December 12, 2012)
Gold in recent months has been stuck in a trading range between $1675 and $1750 an ounce - disappointing many bullish investors and quite a few gold-market analysts (like myself) who had expected the yellow metal to be ending the year approaching - or even exceeding - its all-time high-water mark near $1924 recorded back in September of 2011.
Recent attempts to rally higher have been thwarted by stepped-up speculative selling and softer physical demand with many buyers now conditioned to wait for the next dip.
At the bottom of this range, bargain hunting in the form of stepped up physical demand from central banks, sovereign wealth funds, and some of the gold-friendly hedge funds has created a floor under the market.
Changes in the aggregate gold holdings of exchange-traded funds (ETFs) have been a fairly consistent leading indicator of future gold prices over the past few years.¬† Globally, gold ETFs purchased nearly 250 tons (about 800 million ounces) this year through November - and the total quantity of ETF gold held on behalf of investors now amounts to more than 2,600 tons.
It may well be that money flowing into gold exchange-traded funds is a consequence of the very accommodative monetary policies now being pursued by the Federal Reserve and many other major central banks across Europe and Asia - with rapid central-bank money growth a causative factor explaining both strong demand for ETF gold and the long-term upward trend in the metal’s price.
My own reading of the Federal Open Market Committee minutes from its last policy-setting meeting - along with statements and speeches by various Fed officials in the past few weeks - suggests there is a good chance the Fed will announce further expansionary monetary-policy measures in the next few months.
Predictions (from the OECD and other respected forecasting groups) of a worsening synchronized global economic slowdown - and a spreading sense of global gloom and doom - are contributing to the Fed’s sense of urgency, boosting the odds of further monetary accommodation sooner rather than later.
This fourth round of Quantitative Easing (or QE4) is likely to have more bang for the buck compared with QE3, which included among its measures the sale of short-term Treasury securities to fund its purchase of long-term Treasury notes and bonds.
With its inventory of short-term securities now mostly depleted, any future purchase of long-term securities must be funded with newly created bank reserves - which is, in essence, printing new money - some of which will find its way into gold and probably other asset markets.
Surprisingly, America’s fiscal crisis - and the much-discussed approaching fiscal cliff - have had little observable and immediate influence on the price of gold in recent weeks and months, if only because amid all the confusion, no one really knows how this crisis will sort itself out.
But, however it sorts itself out, we expect some combination of spending cuts and revenue hikes are in America’s economic future.
Unfortunately, a more restrictive U.S. fiscal policy is exactly the wrong medicine for an ailing economy at this critical time, raising the odds of a recession or worsening recession-like conditions characterized by a palpable deterioration in employment/unemployment indicators for the U.S. economy.
This bad news for the economy is - as bad news often is - good for gold.
Fiscal policies that promise slower business activity, falling after-tax household incomes, reduced household spending, slower recovery in the housing and construction sectors increase the likelihood of still-more stimulative Federal Reserve monetary policies.
America’s inability to get its fiscal house in order is compelling the Fed to pursue an aggressive monetary policy.¬† But printing more money - indeed printing unprecedented quantities of money - will, sooner or later, result in a resumption of the U.S. dollar’s long-term downtrend both at home and overseas . . . and, as night follows day, a substantial and unprecedented appreciation of the dollar-denominated gold price.
Indeed QE4 may be right around the corner . . . and QE5 could come by mid-to-late 2013 ¬†. . . as the Fed struggles to prop up a still-faltering economy. If the past is a reliable predictor, these efforts by the Fed (and similar policies by other major central banks) suggest much higher gold prices ahead.
Whatever monetary- and fiscal-policy choices are made by the old industrial nations - the United States, Europe, and Japan - these economies and most other industrialized and emerging economies together face at least a few more years of painfully slow growth - and, for some, outright recession!
It took years, if not decades, for the United States and most other major economies to get ourselves into this mess - by consuming more than we could afford, with money we didn’t have, accumulating debt we couldn’t possibly repay!
Debt can be a magic economic elixir - at least for a while.¬† It allows consumers, investors, governments and, indeed, entire nations to borrow from the future . . . in order to accelerate consumer spending, investment, government services and entitlement programs, and even military spending - much of which has been purchased in recent years against the promise of repayment some day in the future . . . in some cases by our children and grandchildren.
Moderate amounts of debt-driven consumption and investment may, at times be an acceptable and low-risk mechanism to accelerate economic growth and raise a country’s standard of living.
But a happy outcome requires wise spending on goods and services that ultimately increase the borrower’s ability to repay - in other words, spending that ultimately generates higher rates of economic growth.
Instead, for the past few years - and probably the next few years - the legacy of high debt levels will limit private- and public-sector spending . . . and assure the persistence of painfully poor rates of economic activity with unacceptably high rates unemployment.
In certain cases, a nation (or a business) may kick-start economic growth by repudiating and writing off its outstanding debt - in a sense, starting anew . . . but this would-be solution brings its own set of risks and dangers to the borrower.
Rather than outright debt-repudiation, the U.S. Federal Reserve and the central banks of many other countries are seeking to minimize the economic pain by pursuing accommodative monetary policies with artificially low real (inflation-adjusted) rates of interest
By doing so, central banks are sowing the seeds of future inflation.¬† And, by printing much to much money they are making each dollar, euro, yen and yuan worth less.
So rather than outright debt-repudiation, central bankers are depreciating the real future burden of their country’s debt - and bringing the ratio of debt to nominal GDP down to acceptable levels.
Let’s now turn our attention to one of the least-discussed prospective developments likely to greatly influence the price of gold over the next five to 10 years, if not much longer.
This is the rising tide of uncertainty and volatility in geopolitics, world financial markets, and in the global economy.
One thing is for sure: The future isn’t what it used to be - and the world today is characterized by a variety of trends and developments that together are creating more uncertainty and increasing volatile future.
Perhaps the most important of these is the declining influence and hegemony of the United States as a global policeman and enforcer assuring a modicum of predictability and orderliness among nations . . . along with an expanding number of hot spots around the world, hot spots where the U.S. can no longer contain, minimize, or postpone the geopolitical, economic, and financial market fall-out.
At the same time we see America’s power and influence diminishing, China - and a number of other countries from the the newly industrialized world - are increasingly expressing and acting upon their own views, national interests, and priorities - which often differ from those of the United States.
Here, in East Asia, a rising tide of nationalism, competition for vital natural resources, and the re-ordering of economic and political relationships among countries could erupt into more serious and contentious conflicts - if only by accident or miscalculation as one country or another flexes its strengthening military muscle.
There are other obvious “hot spots” or dangerous developments that are now contributing to greater uncertainty and market volatility - and these are not likely to go away anytime soon.
- At the top of my list is the rising probability of war between Israel and Iran - likely with the participation of the United States - over Tehran’s nuclear program.
- Then there is the increasing radicalization of an already nuclear-armed Pakistan - and the acquisition of weapons of mass destruction by the Taliban, Al Qaida, or other renegade groups.
- Next, the Arab Awakening across North Africa and the Middle East is already jeopardizing world oil markets - and prices at the pump - should Saudi Arabia or the Gulf Emirates follow Egypt and Syria into increasing political and social disorder.
- Disruptive terrorist attacks by Islamic fundamentalists or other madmen, either of the violent sort we’ve already seen in New York or London . . . or of the cyber variety that could upset not only internet links - but also banking, financial markets, communications networks, electric power grids, and the like . . . any of which could trigger a drop in economic growth or worse.
- Let’s not forget the uncertainty and risks - social, political, and economic - associated with still-unresolved European sovereign debt, banking insolvencies, deepening recessions . . .
- As I mentioned earlier, the quickly approaching “fiscal cliff” in the United States - and longer term - the unsustainable U.S. federal budget imbalances that ultimately threaten the U.S. dollar’s role as the leading world currency and reserve asset.
- With regard to prospects for the Eurozone, I think it is only a matter of time before first Greece, then Spain, and possibly other still-sovereign European states decide that the consequences of more fiscal restraint (and, with it, rising unemployment and declining living standards) are just too much distasteful medicine for an ailing and sickly patient - and opt instead to opt out and go it alone . . . and who knows where this might lead!
Climate change is yet another source of uncertainty and risk for the global economy - with possible consequences for gold.
Global Warming is already having a significant influence on farm output, agrarian income, and food prices in some countries and regions.¬† For example, below-average monsoons this past year hurt harvests and lowered household income in India’s farming regions - reducing this past year’s appetite for gold in this traditionally important gold-consuming country - and likely contributed to a lower metal’s price in the world market.
Last year’s weather restrained harvests in some important grain-producing regions contributed to higher food prices and political turmoil in some countries - most notably Tunisia, where widespread riots broke out, the country’s political leadership fled (with most of the central bank’s gold), and the Arab Spring was given birth.
Irrespective of how these and other potential threats and challenges are resolved, we must recognize that there is today a growing number and more diverse range of nations, public and private institutions, and other entities with sufficient economic power, political clout, or financial wherewithal to greatly affect the global economy and world financial markets - with possibly significant consequences, one way or the other, for the future price of gold.
An interesting sidebar to this discussion of uncertainty and risk has been the development of immediate and equal access to financial, economic, and political information - information that is incorporated, often almost instantly and sometimes without being well-understood, into market pricing for gold along with other commodities and assets.
Taken to its extreme, we have seen the growing influence of computer-generated, high-frequency, program and technical trading models that can trigger massive buying or selling of one or another financial asset (selling that has been aptly named a “flash crash”) all in a micro-second without any human participation or intervention.
Gold has always thrived on uncertainly¬† - and, as uncertainty continues to rise in the years ahead, those who hold the yellow metal will be amply rewarded.
That said, an important conclusion or piece of advice for investors, central bankers, and others with an interest in gold: In a volatile, high-risk, volatile world prudence calls for managing against a range of risks by looking at how assets inter-relate, rather than searching for the one or two assets that might perform best in a more certain and low-risk world.
(Posted: December 15, 2011)
I recently had the pleasure and privilege of speaking again this year at the China Gold & Precious Metals Summit in Shanghai and to several private seminars organized by clients elsewhere across China.¬† Here’s the text of my presentation:
First My Forecast
Forecasters, whether of the economy, or the stock market, or the gold price are frequently wrong . . . but we are never in doubt.¬† It is up to you - the investor - to listen, evaluate, doubt, and make your own decisions about gold’s future price and the role the metal might play in your own investment portfolio and personal savings plan.
With this warning, let me tell you my own forecast:
I have no doubt that gold will move up sharply in the years ahead, reaching heights that might lead some to label me a “gold bug.”¬† I believe that the price of gold will, over the course of this decade, reach a multiple of recently prevailing prices.
Prices of $3000, $4000, and even $5000 an ounce are very likely during the course of this long-lasting bull market, a bull market that still has years of life left to it.
Not withstanding the recent sharp price decline, I’d be very surprised to see gold dip into “three-digit” territory - that is below $1000 an ounce - ever again.
But, gold prices will remain extremely volatile - with big swings both up and down along a rising trend.¬† In fact, big corrections - such as the decline from the September 6th all-time record high near $1,924 an ounce to the recent low near $1,580 (a decline of nearly 20 percent) - will lead many investors, analysts, and pundits to declare the death of gold . . . or, at least, the death of the bull market we have enjoyed over the past dozen years.
Yet, historically, a gold-price decline of 20 percent is not so unusual.¬† At the time of the Lehman bankruptcy in 2008, gold fell by more than 20 percent and was slow to recover - but recover it did.¬† And, in the 1970s, gold corrected several times by 15 to 20 percent and once by considerably more - all in the midst of a great bull market.
Moreover, although the U.S. dollar-denominated price of gold is well off its historic high, when valued in most other currencies, the metal’s price remains near its record highs.
The future price of gold is a function of past and prospective world economic, demographic, and political developments.¬† My job for the next hour or so is to briefly review some of these developments and trends - so that you can come to your own “golden” conclusions.
Gold’s Bullish Building Blocks
Let me quickly list the gold’s bullish building blocks - and then, as time permits, I’ll discuss a few of these bullish factors, in somewhat more detail.¬† You will notice that many of these factors are interrelated - but it is easier, for the sake of this discussion, to think of them as separate and distinct.
- The first bullish building block is past and prospective U.S. Federal Reserve monetary policy, characterized by low or negative real rates of interest and unprecedented central bank monetary creation.
- Second, the U.S. federal government budget impasse, rising U.S. sovereign debt, and eroding U.S. creditworthiness.
- The third bullish building block for gold is the expected future depreciation of the U.S. dollar in world currency markets . . . and the continuing decline in the dollar’s purchasing power for American consumers.
- Fourth, the growing insolvency of some European nations - leading to the disintegration of Europe’s Monetary Union and the eventual abandonment of Europe’s common currency, the euro, by at least some of the EU member countries.
- Fifth, the expected acceleration of global inflation - fueled by excessive monetary creation, world population growth, and changing diets in favor of more meat and protein . . . and led by persistently high and rising agricultural and industrial commodity prices from one country to the next.
- The sixth bullish building block for gold is increasing political instability in the Middle East and North Africa . . . as authoritarian regimes are overthrown . . . but sectarian divisions in some countries prevent orderly transitions to democracy . . . with implications for world oil supplies and prices.¬† And then, of course, there is Iran - which remains an unpredictable “wild card.”
- Seventh, the growing affluence of the “emerging-economy nations” and the associated growth in both jewelry and private investment and savings demand for gold - especially here in China - as well as India and other gold-friendly countries.
- My eighth bullish building block - one that I believe is especially important to the long-term development of the gold market - is the affect this rising wealth is having on emerging-economy central banks . . . prompting some countries that are over-weighted in U.S. dollars and underweighted in gold to diversify their official reserves through the prudent acquisition of the yellow metal.
- Ninth, the development and popularity of new gold investment vehicles and channels of distribution - especially gold exchange-traded funds - that facilitate physical gold investment by both retail and institutional investors.
- Tenth, the legitimization of gold as an investment class and rising investor participation . . . together reflecting a growing appreciation of the benefits of including physical gold in a well-diversified portfolio . . . and the entry of new, large-scale, professional investors - including pensions, endowments, insurance companies, sovereign-wealth funds, and especially hedge funds.
- Eleventh, the “stickiness” of much of the recent private sector and central bank gold demand.¬† This is shrinking the available “free float” in the world gold market . . . and it means that less metal will be available to gold-hungry buyers, except at increasingly higher prices.¬† Indeed, many of today’s new investors have no intention of ever selling, even at much higher prices.
- And, twelfth in my catalog of bullish factors supporting a continuing long-term rise in the price of gold is the fact that world gold-mine production, although growing, will not keep pace with the expected growth in global gold demand.¬† Even a rash of new mine discoveries would take five to 10 years - or more - to contribute significantly to supply . . . and, meanwhile, existing resources are being depleted, nationalized by unfriendly governments who tend not to be good mine operators, or are simply mined out.
Together these dozen bullish building blocks have resulted in a notional gap between world supply and aggregate demand - a gap that has been and will be closed only by high and rising prices in the years ahead.
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.
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.
After reaching a new record high of $1,430.95 last Tuesday, December 7th, gold fell back quite precipitously, mostly on profit taking by institutional traders and speculators in “paper” derivative markets.¬† By week’s end, the metal traded as low as $1,372 to register a loss of nearly $60, about four percent, from the all-time high.
Economic news in the United States (of improving cyclical indicators and initial reactions to the President’s deal with Congressional Republicans on tax policy and unemployment benefits), in Europe (of some agreement within the Eurozone on funding Irish debt), and in China (on monetary tightening by the central bank) appeared to trigger last week’s gold-selling spree.
But, physical demand remained firm in key consuming markets, particularly India and China.¬† And, we heard that “bargain hunting” from the official sector, central banks and sovereign wealth funds, has also appeared to support the market at prices under $1,390.
Despite last week’s news and knee-jerk gold-price retreat, economic trends and prospects in the United States, Europe, and China will actually support rising prices in the year ahead and give us confidence that gold will soon be trading above $1,500 an ounce — less than five percent above its week-ago record high and about seven percent above the current price of $1,398 (at the time of writing).
U.S. Monetary and Fiscal Policy — Pro-Gold
Don’t be fooled by the recent spate of positive U.S. economic indicators and rising optimism among many mainstream economists about America’s growth prospects and predictions of economic acceleration in 2011.
Instead, continued economic weakness and recession-like, if not outright recessionary business conditions, mean that the Federal Reserve will keep the pedal to the metal for some time to come.¬† And, as in the past year, continuing aggressive quantitative easing will push gold prices higher.
Last week’s rise in long-term yields are credited by some analysts and observers for taking the wind out of gold’s sails.¬† But, in our view, higher long-term yields are no threat to gold, as higher yields reflect rising inflation expectations and diminishing confidence in the U.S. dollar, particularly among some overseas holders of U.S. Treasury debt.
Don’t be fooled that Congressional passage of much-debated legislation to retain rather than raise current tax rates and extend unemployment benefits to millions of long-term idled workers will provide sufficient stimulus to keep the American economy above water — and relieve the need for further “gold-positive” Federal Reserve monetary stimulus.
Instead, expectations that passage of this economic policy package will result in substantially bigger U.S. Federal budget deficits for years to come are already raising medium- and long-term interest rates.
Much, if not all, of the presumed stimulus arising from passage of these policies, however noble, will be offset by higher bond yields.
Indeed, Washington’s inside-the-beltway economists and most of their private-sector colleagues have not accounted for the economic drag arising from higher yields, drag that will require still-more monetary stimulus from the Federal Reserve.¬† So, what at first glance appears to be a negative for gold will, over time, prove to be yet another plus for the metal.
Europe — More Sovereign Risk Ahead
Don’t be fooled that Europe’s financial crisis has been solved by the recent bailouts extended to the Irish and promised to other overly indebted Eurozone countries.
Excessive fiscal restraint across the continent is socially, politically, and economically untenable and unsustainable.¬† Why? Because spending cuts and tax increases will hurt personal incomes and corporate profits — diminishing tax revenues and harming the creditworthiness of some Eurozone member nations, quite the opposite of the intended consequence.
Sooner or later, the unintended result will be renewed fears of the euro’s demise as the zone’s common currency and renewed capital flight into both gold and the U.S. dollar, the latter as the least vulnerable of the two tarnished currency’s.
China — Growth Assured Despite Monetary Tightening
Don’t be fooled that the recent and prospective monetary tightening by China’s central bank, the People’s Bank of China (the PBOC), will diminish the country’s growing appetite for gold jewelry and investment.
PBOC policy actions — raising interest rates and some bank reserve requirements — are in response to super-strong economic activity and accelerating domestic price inflation.¬† But, real interest rates (after adjustment for inflation) are actually falling . . . and are more, not less stimulative.
At most, Chinese authorities are trying to cool a hot economy and slow the annual rate of GDP growth from over ten percent to a more sustainable pace around seven percent.¬† We have long argued that the country’s long-term bullish influence on the world gold market would continue so long as the economy¬† — and, with it, personal income growth — continue 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.
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.¬† This maturation of the gold market continues apace — as evidenced by the forthcoming launch of gold exchange-traded funds in that country.
While news of monetary policy tightening by the People’s Bank of China may trigger some short-term selling, China’s long-term gold demand is likely to grow rapidly in the months and years ahead¬† . . . and is likely to have a powerful influence on the future world price of gold.