Despite reports to
the contrary, gold looks like a steal. Even if we see further price
weakness in the days and weeks ahead, we stand by our forecast that gold will
again hit its record high of $1,227 an ounce by midyear and will reach $1,500
by year-end 2010. We do, however, also expect continued volatility with
big swings in both directions around an upward trend this year and beyond.
For one thing, we
think the best of the economic news is now behind us, certainly with regard to
U.S. inflation rates, consumer spending, and industrial production, is now
behind us — and that indicators in March, April, and May will begin
painting a gloomier picture of the economy — put a picture that
supports a rising gold price.
action points to good support around $1,100 an ounce. As gold traders
and investors gain more confidence that this support level will hold, more of
those who shed long positions or went short in December and January will
return to the long side of the market.
gold’s strong negative correlation with the dollar, measured against
either the euro or a basket of currencies, is breaking down. This is
positive forward-looking indicator of gold’s coming strength.
Historically, gold’s biggest advances have occurred at times when gold
was moving up against not just the dollar but the other major currencies as
well — and it looks like we are entering just such a period.
Around the World of
And, it’s not
just institutional traders and speculators who are returning to the market
lately. India, the world’s largest gold consuming nation, has
been buying more gold in recent days. Indian gold demand is extremely
price sensitive and often leads the market. The appearance of more buyers
in the past week is a sign that many on the subcontinent see recent lows in
rupee as attractive entry points.
But Indian buying is
not only a reaction to the market. It can be, at times, so substantial
that it becomes an important force driving the world market. Importantly,
we are entering a seasonally strong period for India gold buying ahead of the
coming marriage season — and this could lend addition support,
especially if the price dips toward or below recent lows.
jewelry and investment demand has also been muted in the weeks following the
mid-February New Year’s celebration . . . and this, too, should soon be
picking up to lend support to the world market.
gold’s recent rally to record highs in euro and sterling is a sign of
the metal’s broadening appeal to European investors in the face of
European sovereign debt fears. Some investors selling the euro have
chosen gold — in addition to or in place of — the greenback as an
— American Style
sudden debt crisis — triggered by the downgrading of Greek sovereign
debt late last year — led to a swift sell-off of the euro and an eight
percent surge in the dollar in the space of only six weeks. Since then,
worries about the United Kingdom, Portugal, Italy, Ireland, and Spain in
addition to Greece have pushed up long-term interest rates in those countries
and put the common European currency along with the British pound under
Now it looks like
the United States may be next in line: Anyone with their eyes wide open
should see the root causes of Europe’s sovereign debt crisis —
historically high government deficits and accumulated debt — present in
the United States.
single-most important factor promising higher U.S. dollar-denominated gold
prices are inflationary U.S. monetary and fiscal policies characterized by:
- unprecedented provision of liquidity into the
- unprecedented low interest rates for an extended
- unprecedented Federal budget deficits and
accumulated debt in absolute terms and as a percentage of GDP, and
- a dysfunctional government that remains incapable
of dealing effectively with these immense issues.
U.S. Treasury auction of bonds and notes was an especially worrisome sign of
problems ahead. Foreign central banks and institutional investors, who
are the traditional buyers and holders of U.S. government debt, exhibited a
reluctance to continue financing our public-sector deficit at current
interest rates. In other words, some lenders are beginning to demand
higher interest rates to compensate for higher inflation expectations and
higher perceptions of sovereign risk on U.S. Treasury securities.
Before long, U.S.
policy makers will face the choice of paying higher interest rates (which
will chock off some private-sector borrowing and push state and local
borrowers with big deficits to the wall) . . . or monetizing America’s
growing Federal debt (with more inflation and higher interest rates down the
China Remains a Huge
The gold market has
reacted negatively to recent news from China. We disagree with this
assessment and believe that China will continue to be a major bullish factor
in the world of gold for years to come.
Earlier this year,
China’s monetary authorities — fearing run-away economic
activity, real estate and stock market bubbles, and rising consumer prices
— took its first steps toward restraint by raising reserve requirements
and cautioning banks to limit lending to certain sectors of the
economy. Now, markets are worried that further tightening will curb the
country’s appetite for gold and other commodities. And this has
dampened both investment and speculative demand for gold in world markets.
sustainable, moderate growth of the Chinese economy will continue — and
that appropriate measures of monetary restraint (including higher interest
rates) will assure, rather than choke off a durable recovery and long-lasting
expansion in economic activity.
This is a very
positive scenario for gold. China has a high savings rate — and
gold is a traditional medium for saving and investment in that country.
Moreover, the government prefers private gold investment as an alternative to
over-heated real estate, equities, and other speculative assets.
As long as household
income grows, as long as China’s middle class expands, as long as the
country continues on the road to greater prosperity, we expect both
investment and jewelry demand from China to be one of the most important
forces driving U.S. dollar gold prices to new historic highs over the next
China’s private-sector gold demand to official-sector demand, Chinese
officials have recently cautioned that China’s central bank, the
People’s Bank of China, would not be the big official buyer of gold
some (including us) have anticipated. In short, Yi Gang, the director
of China’s State Administration of Foreign Exchange and vice governor
of the People’s Bank of China, said last week that any official
purchases would be too disruptive to the gold market.
However, we think
China’s central bank (or state-controlled enterprises and investment
funds) continues to accumulate gold surreptitiously, certainly from domestic
mine production, if not from world markets, just as it has done over the past
seven or eight years.
Last April, China
announced its official gold reserves increased by 554 tons since 2003, over
which time reserves had grown to 1,054 tons. At this level, China is
still extremely underweighted in gold. Its bullion holdings account for
only about 1.5 percent of total official reserves compared to average gold
holdings of industrial nation central banks well over 50 percent.
that China may have bought another 50 to 100 tons last year from domestic gold
mines . . . and will continue buying quietly this year.
may continue to buy through surrogate state-owned organizations as it did
recently when the China Investment Corporation, the country’s sovereign
wealth fund picked up approximately 4.5 tons through the purchase of gold
Like many other
central banks, the People’s Bank of China does not make a habit of
announcing in advance its plans to purchase gold. It would not be
surprising to someday learn that it is now buying gold in small quantities,
not only from domestic production, but in world markets on price dip directly
or through surrogates.
Blocks Remain In Place
For new readers, in
brief, here are the major long-term building blocks that we think assure higher
gold prices in the years ahead:
- Inflationary U.S. monetary and fiscal policies — with record monetary creation and record
government deficits promising rising inflation and a diminishing
appetite to hold U.S. government and some private-sector debt.
- An inherently unstable European currency and divergent fiscal policies across the
continent that threaten the future of the euro and the European Union as
it now exists.
- Expanding investor interest in gold — both demographically and geographically
— with more people and institutions around the world (China,
India, and elsewhere in Asia, for example) currently and potentially
investing in gold via new gold investment channels and vehicles that
make gold more readily accessible than ever before.
- Rising central bank and sovereign accumulation — with the official sector now a
significant net buyer of gold last year and this year after two decades
in which central banks as a group sold on average some 400 tons a year.
- Declining world gold-mine production — Even in the face of sharply rising
prices, global gold-mine will continue falling for at least another few
years as existing mines are depleted, ore grades drop, operating depths
fall, and the costs of developing new mines rise
Managing Director, American
Precious Metals Advisors
Senior Economic Advisor, Rosland Capital
Jeffrey Nichols, Managing Director of American Precious Metals Advisors,
has been a leading gold and precious metals economist for over 25 years. His
clients have included central banks, mining companies, national mints,
investment funds, trading firms, jewelry manufacturers and others with an
interest in precious metals markets. Please check his website and register to
his free newsletter by clicking here.