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Gold’s recent
price performance, strong physical demand for the metal in important world
markets, worries about European and U.S. public debt, continuing aggressive
monetary stimulus by the U.S. Federal Reserve, and news of substantial long
positions by some prominent institutional investors and sovereign wealth
funds together have contributed to the resumption of gold’s long-term
upward march.
We believe that
after a three-month period of correction and consolidation beginning in early
December 2009 (when gold hit an all-time record price of $1,227 an ounce)
gold has begun advancing anew - and could well register new U.S.
dollar-denominated highs by midyear.
Positive signals in recent price performance:
Gold prices are
already at record highs denominated in euros and British pounds, a reflection
of declining confidence in those currencies and perceptions of rising
sovereign risk on the debt of a number of European nations.
Meanwhile, the U.S.
dollar-denominated price gained about one percent in February despite the
dollar’s sizable appreciation in world currency markets.
Importantly, this may be signaling a breakdown in the inverse lock-step
correlation between gold and the dollar that has characterized these markets
in the past few years - and could be paving the way for gold to begin moving
higher again even if the dollar continues to gain against other key
currencies.
From a technical
point of view, gold managed to hold up early this year despite several tests
of the $1,100 price level, easily bouncing back each time to slightly higher
price levels. This has encouraged some short-term speculators to adopt
a more positive view of the market. Accordingly, selling by
institutional traders, which triggered and fed the metal’s decline over
the last quarter, appears to have run its course. Some are establishing new
long positions.
Strong demand in key
markets:
European investment
demand for physical gold has picked up in the past month - despite the record
high euro-denominated prices. With declining faith in the future value
of the euro and a reluctance to continue looking at the dollar as a safe
haven, some Europeans are now turning to gold as the ultimate safe haven.
India, historically
the biggest gold-consuming market, has seen a big jump in gold investment -
and imports - in January and February. A few weeks ago, we reported
Indian gold imports in January of approximately sixty tons. Now, we
hear that February’s imports will again be quite strong. The
estimate by the Bombay Bullion Association of 30 to 35 tons is likely to be
on the low side (as it often is) - and actual imports could be closer to
January’s sixty tons.
Anecdotal evidence
suggests that gold investment demand in China is also rising. Thailand,
Vietnam, Taiwan, and other East Asian gold-consuming markets (where gold is a
traditional savings vehicle as it is in China) are also seeing rising
interest. China’s robust economic recovery and growth in
household income is leading to more investment and jewelry demand. At
the same time, rising agricultural prices are encouraging some additional
“inflation-hedge” demand for gold.
Moreover, news a few
weeks ago that China’s sovereign wealth fund, the China Investment
Corporation, had recently purchased a few tons of gold is surely viewed as an
official endorsement of gold investment by China’s monetary
authorities.
There has also been
greatly reduced scrap supply from the recycling of old jewelry and investment
bars in the region extending from the Arabian Gulf states (Saudi Arabia, Abu
Dhabi, Dubai, etc.) across to India and Southeast Asia up to China.
This certainly reflects the more positive outlook for gold held by investors
in these countries. It also reflects improving economic circumstances and
reduced “distress” selling.
Aggressive US
monetary stimulus continues:
Despite the recent
hike in the Federal Reserve discount rate (the rate at which the Fed loans
reserves to banks), the U.S. central bank is maintaining a very aggressive -
and, in our view, ultimately inflationary monetary policy. At last
week’s Congressional testimony, Fed Chairman Ben Bernanke stressed yet
again the central bank’s intention to maintain low rates for an
extended period.
Another monetary
indicator, the Monetary Base (currency in circulation plus bank reserves)
surged by some $90 billion in the two weeks ending February 24th.
This represents an annualized rate of growth of nearly 200 percent - and
tells us that the Fed is pushing liquidity into the economy just as hard and
fast as it can.
In the long run, the
dollar’s purchasing power - and consumer-price inflation - is a
reflection of the quantity of money in circulation. The Fed keeps
telling us that inflation is not a problem because of the high degree of
slack (unused productive resources) throughout the economy. But the
1970’s, a decade of stagflation in the US, shows us that even in the
absence of robust economic activity and low rates of capacity utilization,
excessive monetary creation leads to excessive price inflation.
U.S. Treasury debt -
from foreign borrowing to printing more money:
As in the 1970s,
foreign central banks and institutional investors - who are the main holders
and buyers of U.S. Treasury debt -now appear increasingly reluctant to roll
over existing positions, let alone continue building ever-larger portfolios
of U.S. Treasury short-term bills, medium-term notes, and long-term
bonds. Indeed, the Treasury’s last
auction was greatly under subscribed.
This suggests that
the Treasury will soon be forced to pay higher interest rates - to compensate
buyers for the increasing risk they attach to U.S government paper - or turn
to the Federal Reserve as the buyer of last resort. In other words,
rather than borrowing to finance our national debt the Fed will be forced to
“monetize” a growing portion of America’s annual deficits
by simply creating new money. This is essentially the same as
“quantitative easing” - the purchase of government, agency,
mortgage, or other debt by the Fed - to stimulate economic growth. But rather
than stimulate the economy, this policy will likely debase our currency and
accelerate inflation.
Jeffrey Nichols
NicholsonGold.com
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.
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