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.
Recent 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.
In addition, 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 Gold
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.
China's 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.
Turning westward, 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 alternative.
Sovereign Risk—American Style
Europe's 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 8% 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 pressure.
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.
Indeed, the 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 financial system,
- unprecedented low interest rates for an extended period,
- 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.
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 road).
China Remains a Huge Gold Bull
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.
We think 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 few years.
Turning from 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% of total official reserves compared to average gold holdings of industrial nation central banks well over 50%.
We'd guess that China may have bought another 50 to 100 tons last year from domestic gold mines. . .and will continue buying quietly this year.
Additionally, China 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 ETFs.
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.
Long-Term Building 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.
Senior Economic Advisor to Rosland Capital, a California-based retail precious metals dealer
Managing Director of American Precious Metals Advisors