Regardless of the near-term prospects for gold, the long-term fundamentals promise substantial appreciation later this year and beyond. We remain firm in our conviction that gold prices will touch or surpass $1,500 in 2010— and continue to move higher in subsequent years.
Gold at recent price levels offer investors and savers without a "core" position in the physical metal an opportunity to buy insurance against the very real possibility of future stock and bond market declines, accelerating inflation and a shrinking dollar, and turmoil in U.S. and world financial markets.
In contrast to what most "mainstream" economists believed only a few weeks ago, the industrial world economy is not improving. Instead, new cracks in the foundation are appearing. Moreover, as we have discussed in recent reports, the U.S. and other industrial economies will soon be heading into a "double dip" with declining business activity, declining consumer spending, declining employment, and declining equity markets.
This is a recipe for stagflation—a prolonged multi-year period of low growth with high inflation. And, as we saw in the decade of the 1970s, the coming stagflation will again be accompanied by a sustained and significant appreciation in the price of gold and its sister metals, silver and the PGMs, to levels that most cannot yet imagine.
All in the Same Ship—Syncing Together
Just look at the sovereign bankruptcies now spreading across Europe: Does anyone really think that countries like Greece, Portugal, Spain, and others can possibly repay their public-sector debts on schedule without a dole from the European Central Bank?! Even the most well-intentioned policies—raising taxes and cutting expenditures to lower government deficits—are doomed to fail because they would only push these economies into deeper recessions while provoking public unrest from unemployed workers and the politically powerful labor unions.
At some point, sooner or later, the European Central Bank (ECB), for all its talk of monetary restraint, will be forced to circumvent the prohibition barring purchase of member-country public debt. Like the Fed in the United States, the ECB will be forced to monetize the public-sector deficits of its most fiscally profligate members.
Here in the United States, private rating agencies are warning that America's own "triple A" rating on Federal debt is at risk. Meanwhile, states ranging from California to New York are in shoddier shape fiscally than Greece. . .and, it remains to be seen, how Washington policymakers will bail out individual states that, by law, may not run budget deficits.
Just imagine how much worse America's fiscal dilemma will be as U.S. interest rates (and, hence, U.S. Treasury borrowing costs) begin to rise, either from a tightening of monetary policy or, more likely, as rising inflation expectations are reflected in higher nominal interest rates.
In today's jittery world financial environment—with large-scale currency traders and speculators betting one way or another—the yellow metal is not immune from further price erosion. Certainly, if gold declines further in the next few days or weeks, we would be "scale-down" buyers.
As we have said repeatedly, today's perception of the greenback as a "safe haven" preferable to gold, the "ultimate" safe haven, makes no sense. At some point, sooner or later, gold will disassociate itself from the dollar's exchange rate against the euro and other industrial-country currencies—and begin appreciating against all of these currencies.
The fact of the matter is that all of these countries are all in messes of their own making, messes that cannot easily be cleaned up, messes caused by years (if not decades) of imprudent policies and excessive spending by both governments and households. . .and all face the same stagflationary consequences: an erosion of living standards, diminished personal wealth for most, and rising living costs for all.
Selling Paper, Not Physical Gold
Importantly for gold, most of the selling in recent weeks has been by institutional traders and speculators who, for the most part, lack any long-term allegiance to gold nor understand the metal's intrinsic worth as an enduring store of value, as an insurance policy against the risks that threaten other forms of savings and investment, and as portfolio diversifier for individuals, institutions, and central banks.
And, importantly, much of the selling has been of gold derivatives (futures and forward contracts) and other "paper" gold products (like ETFs)—not physical metal itself.
At the same time, most long-term gold investors have not participated in the recent spate of selling—but, if anything, have bought more metal, mostly in physical form, at lower prices.
Americans have a very parochial view of the world. We think that everything important happens here in America. When it comes to gold, nothing could be further from the truth. In fact, most of the physical gold demand so far this year has come from China, India, and other Asian nations with rebounding economies, rising incomes, and long cultural traditions of gold savings and investment.
Much of this demand—especially from India—is price sensitive. In other words, as prices decline, many will buy greater quantities. Our friends and colleagues in India estimate that January gold imports were an incredible 60 tons—possibly an all-time monthly high. And, February imports could be still higher, given the decline in the metal's dollar price and the recent strength of the Indian rupee further depressing the local-currency price.
At least for now, India has reestablished itself as the largest gold-consuming nation, regaining the lead position from China, which held that position in calendar-year 2009.
In the past, most of India's gold investment has been in the form of high-caret jewelry, often purchased by individuals and households for savings, wealth-preservation, wedding dowries, cultural and religious events, and passing wealth to younger generations.
Interestingly, we hear that there is a "westernization" of India's gold investment behavior with more gold than ever before purchased in the form of bars, ETFs, and other "paper" gold products now offered by some banks, brokerage firms, mutual fund companies and online gold retailers.
Our Chinese colleagues tell us, as well, that physical gold investment is rising in their country—though it's hard to imagine January demand, counting both jewelry and investment, is anywhere near India's consumption during the first month of the year.
In China, as in many of the other east Asian markets, gold demand is at least as dependent on rising incomes as it is dependent on price considerations—so we are confident saying (even in the absence of market statistics) that with the smart economic recovery underway in many of these countries physical gold buying is up so far this year.
Physical market trends and developments in these countries, and in the West, serve as an automatic market stabilizer: As prices decline due to gold-derivative position-taking and short selling by traders and speculators, physical demand around the world rises and less scrap (from the recycling of old gold jewelry) diminishes physical supply.
Central Banks—in the Wings
Also, providing some support under the market is the expectation of and potential for central bank gold purchases.
The People's Bank of China (PBOC) is seen as the most likely candidate to announce official gold purchases. Last April, central bank officials revealed purchases of gold from domestic mine production over the prior several years of 454 tons, bringing its total holdings up to 1,052 tons. Since then, monthly purchases from domestic production have probably continued at an annual rate of some 75 tons or more, although the PBOC has not yet announced any increase in its official gold reserves.
China has also been touted as a prospective buyer of IMF gold. Remember, last year's big buyer was India, purchasing 200 tons directly from the International Monetary Fund at an average price of $1,045—not much below recent market prices.
Following India's purchase, many thought China was next in line to buy IMF gold. But, it's likely that the People's Bank of China, even if they had wanted to purchase the remaining IMF gold on offer—now about 190 tons—were, as a matter of "face," not willing to do so at prices above what the Reserve Bank of India had paid.
Should prices dip below $1,045, China might make a fast deal acquire gold directly from the IMF. Although, this would be an "off-market" transaction, the announcement effect alone would likely give the gold price a good kick up.
We think a number of other central banks wish to diversify their official reserve holdings by acquiring more gold—but, in recent months, have waited for the opportunity to buy at lower price levels. At just what price level these purchases might appear remains to be seen—but in the unlikely event that gold falls much below $1,000 an ounce we think a few central banks will be eager buyers. And, this will be sufficient—along with gold's other positive fundamentals—to send the yellow metal's price higher. Ultimately, much higher!
Bullish Building Blocks
To review briefly, the major building blocks supporting a rising gold price over the next few years are:
- U.S. monetary and fiscal policies will remain extremely expansionary and, ultimately, inflationary.
- Strong continuing central bank demand for gold as more countries strive to diversify their official reserve holdings.
- Expanding investor interest in the United States and around the world—with more individuals and institutions viewing gold as a legitimate asset class, inflation hedge, portfolio diversifier, and insurance policy.
- Expanding and maturing geographic markets—particularly China, India, and elsewhere in Asia—where incomes and wealth are rising, new distribution channels are evolving, and new gold investment products are better meeting the needs of local populations.
- Shrinking global gold-mine production for at least the next five years.
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