If any commodity can be said to be larger than life, it is surely gold. Over the last five years, gold has clearly out-performed equities.
Gold made record high at $1,193/ounce on November 25. It has gained 16% this month, the strongest in a decade.
Sri Lanka has bought 10 tonnes of gold from the International Monetary Fund for $375m, confirming a trend of central banks? gold-buying that reverses two decades of heavy selling. The sale was the third from the IMF to a central bank this month, after India bought 200 tonnes for $6.7bn and Mauritius purchased two tonnes for $71.7m. Traders are betting that other central banks, particularly China or Brazil, and SWFs (sovereign wealth funds) from the oil-rich Middle East countries could buy IMF gold (it still has to sell 190 tonnes out of the 403 tonnes it plans to dispose of). India could also buy again.
The latest batch of US Mint sales figures are out and jumping to the forefront are gold coins? both bullion and collector. American Silver Eagle bullion coins officially recorded their best October ever, reaching 29,39,000 in the month.
Gold has been propelled to its all-time high of $1,193 by gold bugs who believe it will always outshine, especially as the value of paper currencies threatens to plunge and inflation looms. Other investors are not driven by doomsday scenarios but see value in gold relative to other assets, from the supply of money to crude oil and equities.
Yet others merely buy into diversification arguments. If you look at gold in terms of how much money has actually gone into it, compared to how much money is still in other asset classes?consider that back in 1982 or in the depths of the Great Depression in the 1930s, gold accounted for huge amounts of investable wealth, probably about one-fifth by some estimates. But today, you?re looking at less than 5% of investable wealth worldwide being invested in gold. So, gold is still under-owned by retail and institutional investors alike.
Gold has also been one of the beneficiaries of the dollar-carry-trade which amounts to borrowing in low-interest-rate US dollars and investing in hard assets such as gold. The movement in gold prices is inversely correlated to the movement in the US dollar since the dollar-carry trade gathered momentum in March of this year.
It?s significant that, on an inflation-adjusted basis, all of the natural resources except gold and silver have surpassed their previous all-time highs. Gold is only approaching the halfway mark to $2,300 an ounce, which would be its 1980 high when adjusted for inflation.
A drop in the sea of central reserves
The yellow metal?s magical and mythical qualities were recently on full display. The announcement of RBI?s official purchase of 200 tonnes of gold from the IMF put an amphetamine-like push into the metal?s price.
The fact remains that what is large in the gold market is a drop in the sea of reserve holdings. The Indian purchase, worth $6.7bn, only negligibly alters the allocation of its $286bn of reserves. It raises the share of gold from 3.6% of reserves to just over 6%. After years of net selling, other central banks have started to buy bullion. Even if China doubled its gold stock ?which would require nearly half a year?s global mine output?it would raise the gold share of its reserves to less than 4%.
Consumer demand for gold in China, the fastest growing economy in the world, reached 120.2 tonnes in the third quarter, up 12% on the same period last year, while jewellery demand increased 8% to 93.5 tonnes, as the 60th anniversary of the founding of the People?s Republic of China on October 1 provided a boost to sales of jewellery and commemorative items.
As gold prices go up, the idea that G-10 fiat currencies are depreciating takes hold, pushing up other commodities like oil as well. Historically, there is a strong positive correlation between gold and oil, and with 2009?s global monetary expansion, that correlation is being further strengthened.
Global gold mine production will rise 3.7% in 2009 to 2,502 tonnes, largely because of strong Indonesian production. However, total supply was down 5% year-on-year at 833 tonnes in the third quarter as central banks switched to the buy side having been net sellers since 1988. Producers also increased de-hedging as they bought back previous agreements to sell gold using fixed price contracts.
The president of Barrick Gold, the world?s largest producer, recently spoke of ?peak gold?.
Rising prices or faltering mines do not equal scarcity. Even investment ?demand? is mitigated by price as one needs to buy only a fourth as much of it as a decade ago to keep actual physical purchases constant. It is not really demand in the same sense as other finite commodities because gold is almost always just being held in order that it might later be sold, to a greater fool, at a profit.
Contrast this with oil. Every year, over four times as much gold is mined and over twice as much recycled as is actually needed by industry, while annual crude supply more or less equals demand for oil. Global oil stockpiles would satisfy just 48 days of crude demand, while the 1,63,000 tonnes of gold that the World Gold Council estimates are above ground would last 375 years, or nearly 3,000 times longer.
Annual gold production is on a downward trend while the growth in money supply in both the US and the Euro zone is bent almost straight up. A lack of confidence in major currencies will push investors toward gold as a hedge against competitive devaluation by the world?s largest economies.
Just like in the US, money supply is exploding in China. September?s 29.5% year-over-year pace of monetary expansion represents the fastest ever recorded in China.
Gold bugs are also buying gold as a hedge against future inflation. The following US Treasury-yield graph indicates that whereas interest rates are not high today, inflation could creep in some time in the future.
Exchange Trade Funds are now buying the equivalent of more than 20% of new production, nearly double last year?s levels. They are buying because they are buying physical gold. Wealthy individuals have long supported luxury goods. Their thirst for gold funds might just give a further boost to this precious metal as well.
The combined increases in open interest in gold futures, and the gold held by the exchange traded funds, have not kept pace with the accelerated rise in the price of the metal; in other words, we have seen a rally on (apparently) weaker volume. That may not bode well for a strong gold market in the near future, although the structural bull market in gold is still intact.
It was Brazil?s imposition of a 2% tax on capital inflows in October?not India?s gold purchases that month?which was the most significant gold-positive signal. The US and Europe are growing at 1 or 2%, while the BRICs grow at three or four times that rate. If investors are restricted from bidding up emerging market assets and their currencies, they will not just give up and buy Fannie Mae mortgages or Spanish bonds. They will buy a substitute that is much harder to control: physical gold.
Many traders and hedge funds are short-dollar, long emerging markets and commodities, and need to book profits due to year-end considerations. Gold is definitely overbought right now, enough so that the risk/reward tradeoff in the short term is probably unfavourable. The most recent leg-up for gold has put it at 19% above its 200-day moving average. However, as recently as 2006 and 2008, the 200-day spread moved well above 25%, and back in 1980, the spread briefly got up to 136%!
What happened to tech stocks, oil and housing will eventually happen to gold. It will have a parabolic move. And since it?s a much more liquid asset than housing, the move will be more like oil in 2007-08 when it jumped from $80 to almost $150 a barrel, or tech stocks in 1999-2000, when the Nasdaq 100 jumped 88%.
When gold is near a top, it will be all over the mainstream media, not just the financial media. People will say that buying gold is a no-brainer, and we?ll probably hear numbers like $8,000 an ounce or more. Miniature gold bullion will be sold in fancy department stores here, as it is now in England, or even in vending machines, as it is now in Germany.
We?re nowhere near the end yet. Till the crescendo is reached, every correction in gold prices represents a buying opportunity.
?The author is a Wharton Business School MBA and CEO, Global Money Investor