Gold Rush Rally
Gold Rush Or Gold Flush?
2009 was an extraordinary year for the gold market. From a low of $811 at the beginning of 2009, an ounce of gold touched a nominal all time high of $1226 in December, up 40% from the start of the year. Although this gain is closer to 25% in constant currency terms (Eur/Usd rose from a low of 1.25 in mid February of last year to above 1.51 at the time of peak gold), the rise since the end of the nineties is nonetheless 400% in nominal terms.
Amongst this buying frenzy, some commentators are suggesting that gold has become the latest asset to enter a speculative bubble, while others look to macroeconomic fundamentals to argue that investment demand is, and will remain, unquenchable.
Gold sceptics often point to the metal’s lack of utility. Aside from jewellery and small electronics applications, gold is of little practical use in industry. You can’t use gold for payment of taxes or mortgages and it is expensive to store. Furthermore, gold yields no return unlike equities (that pay dividends), bonds (that pay a coupon) and bank deposits (that pay interest), thereby increasing the effective cost of storage.
Gold is simply of no use except as an investment.
Warren Buffett, a legendary gold agnostic, famously opined: “Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. Anyone watching from Mars would be scratching their head”. Influential economist Nouriel Roubini, a New York University professor who predicted the financial crisis, in a recent report described gold as “a barbaric relic” that has “significant risks of downward price correction”.
From a supply perspective, sceptics have more ammunition. The world’s central banks hold 32,000 tonnes in their vaults, which is enough to meet global demand – as measured by last year’s consumption – for another 8 years. Furthermore, according to GFMS, the London based gold consultancy, global mine supply rose 6% to 2553 tonnes in 2009, a six year high.
So what is driving the gold bulls into such a buying frenzy?
Consider the plight of central banks outside of the US, particularly those in economies that run a large trade surplus such as Japan, Germany, Canada and China. A weak US dollar, zero interest rates, and a pile of new dollars hot off the printing press at the Federal Reserve have central bank officials contemplating the real future value of their currency reserves which, for the most part, are made up of US dollars. In particular, China and Japan, by far the largest holders of long term US government debt (they hold $798 billion and $746 billion respectively, with the UK a distant third holding $230 billion) are becoming concerned about their savings and the credit worthiness of their debtors (the US government debt is now approaching $13,000 billion, or 90% of GDP).
At the recent World Economic Forum meeting in Davos, Terry Smith, chairman of the committee on world’s banking crisis, opined that two thirds of the world’s assets are denominated in currencies that are being debased by key policy actions. Countries like China are not happy about that.
Put simply, foreign central banks are now looking for a reserve asset that offers a more long term store of value in the face of economic and systemic uncertainty. And the perception is that gold is in their cross wires. In evidence of this, India’s reserve bank recently bought 200 tonnes of bullion from the IMF. Whilst this in itself is significant, more so is the expectation that other governments may follow suit, lending huge psychological support to the market. Of incomparable importance would be if China followed this trend; China’s central bank reserves are so vast that if it were to double its gold reserves (currently standing at 2% of total reserves) it would be required to buy half the global annual mining output. Indeed, with gold representing on average 10% of reserves at G7 member central banks, and only 2.5% in those of emerging market nations, gold is set to benefit even from any normalisation in emerging market gold reserve ratios.
Gold prices have been further boosted by a slowdown in central bank supply. Sales from central banks have virtually dried up in 2009, dropping 90% year on year to 24 tonnes.
Adding further momentum to the gold surge is the recent emergence of gold bullion backed exchange traded funds (ETF’s) which offer institutional investors a readily tradable vehicle to own a fraction of gold stored in a vault. ETF buying has boosted the commodity market in general, with assets in commodity ETF’s rising from $35 billion a year ago to over $75 billion today.
Gold sceptics will argue that these macroeconomic fundamentals have been fully priced in to the 2009 rally; if 2010 is to bring improving economic conditions, an end to the era of cheap dollars and increasing interest rates, gold buyers may finally get the jitters. Philip Klapwijk, executive chairman of GFMS told the Financial Times: “As the macroeconomic environment gradually normalises the gold market’s dependence on investment speculation will become all too apparent with a substantial price retreat at that point on the cards”.
On this gold market conundrum, the Lex column in the Financial Times recently surmised: “Like flowers, gold is more attractive than useful and supplies could meet 375 yeas of industrial demand. However, calling a market is difficult as there are plenty of scary trends, such as debasement of the dollar. After all this is one asset that rises on both fear and greed”
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About the Author
Dr. Mark Perry is a Risk Analyst with WorldSpreads Ireland in Dublin. www.worldspreads.ie
GoldRush Rally Start 2009 – LP640 Scuderia Superleggera and more
