US NATIONAL DEBT

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Euro Jitters Affect Short Term Value of Gold; But Asian Demand Provides Long Term Upside and Short Term Support

March 30, 2010

Jeffrey Nichols, Senior Economic Advisor to Rosland Capital

Managing Director of American Precious Metals Advisors


Gold managed to end last week over the psychologically important $1,100 level, after briefly falling to an intraday low of $1,085 an ounce last Wednesday. This recovery reflects an apparent resolution of the Greek sovereign debt crisis, bringing with it a stronger European currency, a weaker U.S. dollar and a bounce in the dollar-denominated price of gold.

The unexplained sinking of a South Korean naval ship late last week gave gold an additional boost . . . and serves as a reminder that scared money still looks to gold for safety and security at times of heightened geopolitical uncertainty.

Physical Demand in Asia Limits the Downside

The appearance of strong physical demand with gold under $1,100 in the past week across virtually all of the key Asian gold markets -- India, China, Hong Kong, Thailand, Singapore, and Indonesia -- speaks volumes about the future price of gold in the months and years ahead.

First it suggests that downside risks are limited. If the European sovereign debt crisis again raises "safe haven" demand for the U.S. dollar at gold's expense, price-sensitive Asian gold buying will likely again provide strong support as it did this past week.

Second, it serves as a reminder of the region's growing importance in the world of gold. Although different in many respects (economically, politically, culturally) they all share an historical affinity and allegiance to gold as an adornment, as a symbol of wealth and good fortune, and as a preferred vehicle for saving and investment.

Longer term, as the region's share of global income and wealth continues to grow, it will demand a growing share of global gold supply -- both annually and in terms of accumulated bullion ownership by the private sectors in these countries as well as by their central banks. We believe that demand across the region will be sufficient to push gold prices to new all-time highs over $2,000 an ounce and, quite possibly, over $3,000 in the next several years.

Not surprisingly, China and India, the world's two most populous nations, are also the two biggest gold-consuming and investing countries.

India is an extremely price-sensitive market. Gold demand (as measured by bullion imports) falls rapidly when buyers "feel" prices are too high . . . and demand rises when buyers "sense" prices are too low. So it is notable that Indian demand has picked up sharply this year -- and even more so in the past week. This pick up indicates that recent price levels, which a year ago not only scared buyers away but evoked selling and a rise in scrap supplies, are now perceived by Indians as attractive.

China, too, has seen increased buying this past week from jewelry manufacturers and investors. We have said over and over again that prospective growth in China's appetite for gold is a key factor in our very bullish long-term view on the price of gold. Now comes the World Gold Council (WGC) in the past week with a report echoing our long-standing views and confirming the untapped growth potential of China's gold market. According to the WGC, China's investment and jewelry demand totaled 423 tons (over 13 million ounces) last year -- and is likely to double over the next ten years. We think these estimates and projections are conservative and put last year's demand at 450 tons or more with a doubling of the market expected a few years earlier.

To the Asian gold buyer, it is the local currency price that matters, not the price of gold denominated in U.S. dollars. Expected appreciation in China's yuan, India's rupee, and the currencies of some of the other Asian gold-buying nations will slow the rise in the local-currency denominated prices to consumers and investors in the region -- and this shift in exchange rates, along with the regions strong economic growth, will be an important factor supporting strong growth in Asian gold demand over the years ahead.

Euro Fears Could Still Harm Gold -- But Not For Long

Looking to the immediate future, the euro, the dollar, and by extension, the U.S. dollar denominated gold price all remain hostage to Europe's ongoing sovereign debt crisis.

The announced Greek rescue package is sufficiently vague that its success over time remains questionable. Moreover, the attention of the currency and financial markets could shift focus from Greece to one or another EU nation with excessive sovereign debt.

Before too long, gold will be able to move higher regardless of the ups and downs in the euro/dollar exchange rate. The dollar-gold relationship is already weakening as world financial markets come to realize that the United States has its own sovereign debt crisis.

Lackluster demand for U.S. Treasury securities over the past month is the first sign that investors -- central banks as well as institutional investors who typically buy America's public debt and finance our twin trade and federal budget deficits -- are becoming concerned that the risks associated with the dollar will erode the value of these investments over time.

The recent increase in yields on medium- and long-term U.S. government debt is indicating rising investor concerns about America's sovereign debt. And it is these concerns that will drive the gold price higher -- even if the dollar's relative strength versus the euro remains firm.

We agree with former Federal Reserve Chairman Alan Greenspan who recently said that the rise in Treasury yields represents a "canary in the mine" that may signal further gains in U.S. interest rates as investors demand a higher risk and inflation premiums to hold U.S. Treasury and other public and private U.S. debt. Greenspan said higher yields reflect investor concerns over the "huge overhang of federal debt which we have never seen before."

Just like the 1970’s we have the perfect recipe for stagflation. These trends will increase the U.S. Treasury's interest costs and worsen our federal government deficit. They will also spill over into the mortgage market and slow the recovery in America's housing and construction sector. It will also raise the cost of corporate debt retarding capital expansion by the private sector. The result will be more pressure on the Federal Reserve to monetize Treasury debt (print more money) in the hopes of staving off or postponing the rise in interest rates . . . and the result will be rising inflation even in the absence of a robust economy.