Jeffrey Nichols, Senior Economic Advisor to Rosland Capital
Managing Director, American Precious Metals Advisors
Gold is coming to life again – and looks poised to move higher in the weeks and months ahead. Having fallen precipitously from its all-time high just over $1,923 an ounce in early September to a recent low near $1,540 in early October, a peak-to-trough correction of some 20 percent, gold has been, of late, range-bound, trading between $1,640 and $1,680.
Having moved to the top of this range and even slightly higher, I sense gold is just now resuming its long march upward, a march that could, before long, carry the price to the $1,850 region and perhaps even to its historic peak of $1,923 by the end of the year.
The Safe-Haven Paradox
Ironically, Europe’s continuing sovereign debt crisis – a situation that should promote fear-driven demand for gold – has, in recent weeks, weighed most heavily on the yellow metal’s price. In addition, a sharp reversal in speculative positions on futures exchanges and other derivative markets has contributed to gold’s two-month consolidation.
Ordinarily, investors and analysts might expect Europe’s impending economic and political disaster to send gold prices rocketing skyward – but this has not yet been the case. Instead, it triggered “safe haven” demand for the U.S. dollar and boosted the greenback’s exchange rate against the euro to gold’s detriment.
With flight capital and hot money going into the U.S. dollar as a safe haven from Europe’s woes, dollar-denominated hard assets like gold and other commodities have been under pressure, in large measure due to the behavior of institutional traders and speculators, many of whom have reduced their “long” positions or “shorted” gold in derivative “paper” markets.
Gold’s Fortunes Set to Improve
I have no doubts that the recent downward pressure on the gold price arising from the U.S. dollar’s “apparent” strength – and I stress “apparent” – will prove to be temporary. Indeed, in recent days, with demand suddenly surging for investment-size bars and gold exchange-traded funds, it looks like safe-haven gold demand may finally be picking up even as the flow of funds into the dollar continues. “
In any event, gold’s fortunes are set to improve in the weeks ahead: If Europe’s debt crisis subsides, the dollar will no longer benefit from its safe-haven role. If it continues to worsen, investors particularly in Europe are likely to accelerate their rush into physical gold, buying bullion coins, small bars, and ETFs, as they did in mid-2010. But, either way, as traditional physical demand continues to grow, especially in Asia and from central banks in that region and elsewhere, gold is increasingly going into stronger hands that are less likely to sell even at much higher prices.
Short-term trading in derivative markets may, at times, produce a great deal of gold-price volatility but, in my book, it does not affect the long-term price trend. What governs the price of gold over the long term are the market’s real-world supply and demand fundamentals – and these have been decidedly bullish . . . and are becoming even more so. Hence, my long-standing long-term forecast of higher gold prices over the next several years.
Robust Physical Demand
While speculative pressures have pushed gold lower, physical demand has remained quite firm – not just from European’s seeking a safe haven – but, even more so, from Asian markets, particularly India and China, where investors and consumers are taking more gold for reasons that have little to do with the world political and economic situation.
India, for example, is now celebrating (this year beginning on Wednesday, October 26th) the Diwali “festival of lights.” Considered an auspicious time to buy gold – investment-grade jewelry, small bars, and coins – Indians are showing no reluctance to acquire gold at what are historically very high rupee-denominated prices.
Our friends in the Indian bullion community expect continued strong physical demand in the months and years ahead – reflecting growth in personal income, particularly in the agrarian and rural communities that traditional buy and hoard gold, as well as worrisome domestic inflationary pressures. Not to be understated, India’s central bank purchase of 200 tons of gold in 2009 was an official endorsement of the metal’s role as a reliable store of value and savings asset that many private households are now following.
Chinese gold demand is also robust, due to income growth, rising wealth, and also inflation fears. Higher gold prices, rather than discouraging demand, have attracted new investors to the market. And, the central government has been pro-active in promoting investor access to gold by encouraging the development of physical and futures exchanges and retail gold distribution through banks and other retail outlets across the country.
Not counting official purchases by the People’s Bank of China, Chinese consumers and investors are now the world’s biggest end-market for gold. And, this is long-term “sticky” demand, much of which is unlikely to come back to the market anytime soon, perhaps not in our lifetimes, even as the metal rises to a multiple of today’s price.
In addition to solid private-sector physical demand, the official sector has been an increasingly important buyer. Russia and China have been most prominent, buying fairly regularly and stepping up acquisitions whenever the price dips as it has in the past couple of months. The list of central banks buying gold this year includes South Korea, Mexico, Kazakhstan, Thailand, Bolivia, and Colombia.
With both the U.S. dollar and the euro looking tarnished and risky to central bank reserve managers, official-sector gold acquisitions have likely increased in recent weeks at lower price levels where purchases could be made discretely without any noticeable affect on gold-price volatility. And, this too, is sticky gold that is unlikely to return to the market any time soon.
What few gold pundits realize is that the amount of physical gold available in the world gold market – the “free float” – is shrinking, thanks not only to Chinese and other Asian buyers, but also due to renewed interest and accumulation of gold by a growing number of central banks. For central banks, the holding period may be measured in decades if not longer. As a consequence, future demand will have a much more high-powered affect on the price of gold – and this is one of the reasons we expect much higher prices in the years ahead.