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Musings on Gold

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I've been following gold professionally for some 40 years, ever since joining Citibank as an international economist back in 1973.  One of my early assignments was to write a report for senior management on the future role of gold in the world monetary system.  Gold had already risen from $35 an ounce in August 1971, when President Nixon ended the U.S. dollar’s official convertibility into gold, to $120 an ounce in mid-1973 when I joined Citibank as one of the most junior economists.

Though I thought the price of gold could rise, if only because its price had been suppressed and private demand quashed since the 1930s, I saw no return to anything that might resemble a gold-based world monetary system.

At the time, few mainstream investors, and even fewer economists, imagined gold would rise so spectacularly, as it did, to $875 an ounce, if only briefly, by January 1980.  Since then, gold has continued its roller-coaster ride, reaching $1,924 in September 2011 and subsequently falling back to the $1,650 to $1,750 range in the past year.

My views today are quite similar to what I wrote in 1973: I see gold prices continuing to rise . . . but little chance the yellow metal will resume its former role as the lynchpin of the world monetary system.

Today, gold is still considered by an “alternative” investment, out of the mainstream, by many individual and institutional investors – and by many in the mainstream media as well.  Over the past decade, gold has moved higher, much to the surprise of many in the investment community who still continue to hold the yellow metal in low esteem.

As a result, most investors are today still underweighted in gold – and many own none at all.  This is true, not only among private investors, but also importantly among central banks.  While the U.S. and many European central banks retain large official holdings – and seem loath to sell any – many of the newly industrial and emerging-economy nations remain grossly underweighted in gold.  Even those who have been substantial buyers of gold in the past few years – including China, Russia, Saudi Arabia, Mexico, and India to name a few – hold only a very small portion of their total official reserves.

This underweighting of gold in both private portfolios and official reserves bodes well for gold-price prospects in the years ahead – and is one of the key factors suggesting that the price of gold could easily double by the end of this decade.

Don’t be distracted or disappointed by gold’s recent setbacks.  The price decline from its all-time high in September 2011 owes much to short selling by a relatively small number of institutional speculators and short-term traders out to make a quick profit operating in gold derivative (or paper) markets where little physical gold actually changes hands.

The resulting price weakness has masked the continued tightening of gold’s own physical market fundamentals – and the movement of metal into relatively stronger hands, owners who are unlikely to sell anytime soon, perhaps for decades if not longer.

This is certainly the case with most of the central-bank buying the past three years.  Central banks – eager to increase their holdings of gold and decrease their holdings of paper currencies (U.S. dollars, euros, British pounds, etc.) – are unlikely to part with newly acquired gold anytime soon, probably not for decades or longer.  Instead, the official sector is likely to demand a significantly more physical gold as it becomes available in the world market.

Similarly, in some countries – most significantly the People’s Republic of China and other East Asian nations with relatively healthy economies – private-sector jewelry and investment/savings demand will remain an powerful bullish gold-price driver as personal incomes and household wealth rise, the middle and wealthy classes continue to expand, stock markets and real-estate investments look overvalued, and as inflation concerns remain ever present.

It’s no accident that I’ve not mentioned the fiscal cliff, or the overhang of public and private debt or central-bank monetary policies in the United States and Europe.  Nor have I mentioned the likely growth in retail and institutional investment interest in gold in the United States and European economies.  Although I believe these factors – especially the continued easing of monetary policies – will become increasingly bullish for gold in the months ahead, they are not prerequisites for the resumption and continuation of gold’s long-term bull market during 2013 and beyond.