Rosland Capital News

Gold Unlikely to Fall Below $1000 - Jeff Nichols: CommodityOnline

Published 1/25/2010 | Read more: CommodityOnline.com

Gold gained over 24% in 2009 recording a high of $1226 in December which led analysts to predict the yellow metal to zoom to $1500 and beyond in 2010. But dollar strength and tight liquidity conditions due to monetary policies announced in China and banking restrictions on risk taking by US President Obama have cast shadows in the commodities sector.

However, Jeffrey Nichols, Senior Economic Advisor, Rosland Capital LLC still believes gold will climb to $1500 this year although the market would be quite volatile, he told Sreekumar Raghavan of Commodity Online.

Sreekumar: Most analysts and commentators on gold have predicted a bullish phase for gold in 2010 thanks to dollar weakness and inflation worries. Do you expect rapid economic recovery by end of 2010 and consequent rise in risk appetite pulling down gold prices to below $1000 levels of 2009?

Jeffrey Nichols: I think it very unlikely that gold will ever again fall below $1000 an ounce… and, if it does, this would be a great buying opportunity for long-term gains rather than a reason to turn bearish on my gold-price forecast.

We are not anticipating a rapid or robust economic recovery in the United States or other Western economies – but a “double dip” followed by a multi-year period of stagflation, much like we experienced in the 1970s, a period of rapidly rising gold prices that culminated in the January 1980 spike to $875 an ounce.

In fact, I believe gold will reach a new historic high this year of at least $1,500 an ounce. And, looking further ahead, we should not be surprised to see gold at $2,000 – and possibly $3,000 an ounce –before the bull market eventually comes to an end.

SK: Some analysts have pointed out that even a small increase in hedge funds, pension funds increasing their exposure to gold, China shifting its foreign exchange assets from dollar to gold will prove bullish for gold. How far do you think this is a possibility?

JN: I believe that one of the important factors pushing gold higher in the next few years will be a continuing expansion of investment demand worldwide, reflecting, in part, the development of what I call the “gold investment infrastructure” – the introduction and greater use of new gold investment vehicles and channels of distribution in the various markets around the world.

In India, for example, this would include the introduction of a local ETF, new “paper” products representing physical ownership that are being offered by some banks and brokers, the westernization of gold investment with jewelry planning a shrinking role and physical bullion or related paper products gaining importance, the distribution of gold coins through the postal service making gold more accessible in the agrarian regions of the country, the growing importance of the gold spot exchange, internet platforms that have been introduced by financial service firms, etc.

In China, gold investment bars have become readily accessible through banks and retail shops across the country – and some are offering gold pass-book accounts or accumulations plans that allow more low-wage households to participate.

In the U.S. and Europe, the growing acceptance of gold Exchange-traded Funds (ETFs), have been important in expanding the market – and, in particular, attracting new investors, both retail and institutional. Importantly, some institutional investors are legally prohibited from investing in commodities or futures markets – but they are allowed to own ETFs because these legally are considered equities rather than commodities.

With regard to China shifting reserves into gold, this has been an important factor for several years and continues to be, as the country each year buys a share of its own domestic gold-mine production. Importantly, this means less gold is available in the world market.

But it is not just China – central banks in the aggregate became net buyers of gold in 2009 after two decades as net sellers. Over the last 20 years, the official sector sold on average roughly 400 tons of gold, but last year the official sector was a net buyer of more than 150 tons – a significant shift that has had a meaningful influence on the metal’s price. Central banks as a group are expected to continue buying in the next few years… and this is an important plus for gold.

SK: In view of the bullish phase, do you recommend exposure beyond 10% (usually recommended) for gold in an individual's investment portfolio for the short to medium term?

JN: We do not make specific investment recommendations since gold’s share in a portfolio depends on each individual’s or institution’s investment objectives, time horizon, age and employment/retirement situation, exposure to the risks against which gold offers protection, inclusion of other gold- or precious-metals related assets, etc.

That said, we do believe a minimum of five percent of an individual’s (or household’s) total investment assets is a prudent allocation for most individuals… and that this should be in physical gold – not ETFs, nor other paper products backed by gold, and not gold-mining shares. Investors interested in mining shares should consider these equity investments higher risk vehicles to be bought only in addition to their physical bullion holdings

SK: Much of the recent rally in gold is attributed to central bank buying that was initiated by Reserve Bank of India. Going ahead, central banks could reverse their decision if dollar gains strength on say a rise in US interest rates.

Secondly, if several of the mines that have been encouraged by rising prices dig out more gold say by 2012-13, do you think prospects of a bull-phase beyond 2012 looks improbable?

JN: Yes, central bank buying has been an important factor – and India’s purchase of 200 tons from the IMF, coming as a surprise, gave the market a nice boost… and encouraged more investor buying in India and elsewhere.

I do not think that central banks, as a group, will reverse their collective judgment to acquire more gold reserve assets. This is particularly true for the Asian nations with current account surpluses and growing dollar reserves. These nations are greatly underweighted in gold relative to U.S. dollar foreign exchange holdings – and they will continue to seek opportunities to diversify their risk by acquiring gold.

Moreover, this is a long-term decision – and not based on short-term shifts in exchange rates or changes in U.S. interest rates. Only a dramatic “Volcker-like” rise in real (inflation-adjusted) interest rates would encourage central banks to willingly hold more dollars. Any increases in U.S. interest rates in the next few years will NOT be sufficient to offset the rise in inflation and inflation expectations. In other words, nominal interest rates may rise… but real interest rates will not.

With regard to gold mine production prospects and the price of gold in the next few years, I do not anticipate any significant rise in world output in the next five years sufficient to alter the upward trajectory of gold prices. The development of new mines is necessary simply to offset the depletion of reserves and the decline in production at existing mines… and, any major new projects would likely take at least five years, and probably more, to develop and begin production.

SK: How do you assess the performance of the gold ETFs in recent times and which do you recommend?

JN: Gold ETFs have been an important development making gold investment much easier, more accessible, and less costly (in terms of commissions and transactions costs) for investors – retail and institutional – around the world.

But as noted above, we recommend ownership of physical gold – small bars, bullion, coins, and even numismatic coins. Certainly, one of the main reasons for owning gold is to reduce risk – and physical ownership is the lowest-risk form of gold. As a “paper” gold vehicle, ETFs are subject to a variety of risks not shared by physical investment where the investor takes actual possession of his/her bars and coins.

SK: Is gold rally a 'bubble that can collapse any time'?

JN: The bull market in gold is certainly not a bubble that can collapse at any time. From the 2001 low point near $255 an ounce, gold today is up over 300 percent – outclassing and outdistancing virtually every other asset class.

The future rise in gold anticipated over the next few years in built not on a weak speculative base but on solid fundamentals. There are four cornerstones supporting the gold bull market:

First, an expansionary U.S. monetary and fiscal policy that assures rising inflation and a depreciating dollar over the next few years. With the unemployment remaining high, home repossessions continuing, low consumer demand, and a high level of economic angst across the country, tightening monetary policy is not a politically acceptable option.

Second, continuing rapid growth of investment demand in China – even with the recent and expected future steps to curtail monetary growth and bank lending. There is great pent-up demand for gold – after nearly six decades in which private gold investment was illegal – and more Chinese will be gradually buying gold as a traditional savings and investment vehicle as long as personal incomes continue to rise and even if inflation remains low.

Third, rising gold investment demand around the world, due to the expansion of the gold investment and distribution infrastructure, particularly the attractiveness and ease of entry afforded by ETFs to many investors – and the acceptance of gold as a legitimate investment class by many individual and institutional investors.

Fourth, as noted above, a change in central bank attitudes toward gold – and continuing net official demand in the years ahead.