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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.
American Economics
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.
Rising
Participation
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.
Jeffrey Nichols
NicholsonGold.com
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