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Gold in an Uncertain World

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Published : December 17th, 2012
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Category : Gold and Silver





(Excerpts from a  speech to the 7th annual CHINA GOLD & PRECIOUS METALS SUMMIT, Shanghai, China, December 5th through December 7th, 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.



Data and Statistics for these countries : China | Egypt | Greece | Iran | Israel | Japan | Pakistan | Saudi Arabia | Spain | Syria | Tunisia | All
Gold and Silver Prices for these countries : China | Egypt | Greece | Iran | Israel | Japan | Pakistan | Saudi Arabia | Spain | Syria | Tunisia | All
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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
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Jeffrey you have summed it all. Gold thrives on uncertainites and these are only increasing be they be economic, social, geo-political or willed by God. But the difference lies in our changing attitudes to these rising calamities and inter alia the response of gold prices. In the past year gold's up move has been anything but static inspite of manifold increase in these calamities. Diversification it appears remains the better bet, rise in gold prices over the past five years notwithstanding.
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Jeffrey you have summed it all. Gold thrives on uncertainites and these are only increasing be they be economic, social, geo-political or willed by God. But the difference lies in our changing attitudes to these rising calamities and inter alia the respo  Read more
Papli - 12/17/2012 at 11:57 PM GMT
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