A Closer Look At Gold

By: Elizabeth Kraus

Commodity prices have faltered in the last couple of weeks, and much of the “smart money” is saying the boom is over. Don’t believe it. As long as the world’s central banks keep interest rates at these very low levels, the speculative interest in commodities will be strong, and so will their prices. Since only minor central banks yet show signs of moving rates, the commodities bull market has further to run. The three catalysts why commodity prices have been rising, and they’re all still true: China and India continue their torrid growth. Global stimulus plans are bullish for gold prices. Speculative investors are big commodities players. If we examine each of these in more detail, we find that while the rest of the world has been mired in recession, China has had a pretty good year, and so has India. China’s third-quarter gross domestic product (GDP) rose 9.5% from the same period last year and India is expected to post an increase of at least 6%.

This has caused demand for raw materials to soar, because lifting the 2.5 billion inhabitants of those countries out of poverty generally requires lots of goods you can drop on your foot. For instance, China leapfrogged the United States this year to become the world’s largest automobile market, with sales of 11 million cars and light trucks. China and India show no sign of dropping back into recession. If anything, demand growth in those two countries is likely to continue, which in turn will put additional pressure on global raw materials supplies.

In general, we have plenty of commodities, but opening up new production takes lots of time and money, so rapid demand growth will push up prices for gold. In addition, we all know money talks. Simulative global monetary policies have tended to push up the prices of all assets – but most notably commodities – in the last year. Those monetary policies aren’t just a U.S. manifestation. Japan has interest rates close to zero and has engaged in lots of “quantitative easing.” Britain has had even laxer monetary policies than the United States, with the Bank of England buying more than $300 billion of British government “gilts.” And China’s M3 money supply grew 28% in the last twelve months.

Monetary policy would have to get quite a lot tighter – with interest rates higher than the inflation rate – before it started choking off commodity prices, and there’s not much evidence of that. Yes, Australia and Norway both raised their base rates by a quarter percentage point in the past two weeks, but both countries are special cases, being commodity producers themselves (Norway produces oil, while Australia produces pretty much everything).

Maybe China is beginning to tighten a little, too. However, the other big boys aren’t. U.S. Federal Reserve Chairman Ben S. Bernanke has said rate increases are a long way off. Britain’s GDP was still falling in the third quarter, so that country won’t be tightening soon. And most of the Eurozone (Spain, Ireland and Greece, in particular) is suffering from huge real estate meltdowns, while other exporting countries worry that the euro is becoming too strong against the dollar – so euro rates won’t rise fast either.

The bottom line is, without higher interest rates, the commodity boom will continue. This is a known fact, and the reason why investors are piling into commodities, physical gold and bullion. Since the supply of most commodities is a small fraction of the volume of hedge funds outstanding, prices could shift quite sharply as supply disruptions occur. Until China and India stop growing or world monetary policy tightens a lot, any blips in the gold market are just that – blips.

So, in contrast to gold’s naysayers and born-again bears, gold’s fortunes remain very bright. What’s more, recent market activity, rather than signaling an end to gold’s decade-long advance, strengthens the case for a sharp snapback in the metal’s price and new all-time highs later this year.

Indeed, with gold’s fundamental price drivers all remaining supportive, I expect another strong advance over the months ahead – with the yellow metal rising to $1,700 an ounce by year-end 2011. Ron Fricke president of Regal Assets stated Friday “The Federal Reserve is trying avoid deflation at all costs and with this reality you can assure gold will continue to grow and will surpass $2000 an ounce.”

While some of the equity markets, including those in the US and Europe, had been seeing renewed activities, and “This had led to a flow of funds from gold to equities in January,” said Anil Rego, CEO, Right Horizons, “the political unrest in the West Asia, especially in Egypt, is expected to offer trigger a safe haven buying in gold.” And when we look at “the economic front, too, most of the companies in the US and Europe have shown some improvement in their performance mainly due to the cost cutting measures, but employment data, housing and real estate data in the US have not yet shown much of a recovery,” said Rego, “for the year 2011, the metal will perform once again as it did before… and investor can look forward to a great return….”

New Future for the US Dollar and Gold?

Historically, gold and the dollar have typically moved in opposite directions: Think weaker dollar, stronger gold; stronger dollar, weaker gold. But lately, the two have moved up and down together like Siamese twins – rather than in opposition as history suggests. We can now see why: Both gold and the dollar are being driven up and down together as confidence in the euro waxes and wanes.

When there is a correction in gold, it is also caused by the combination of hope that recovery was finally, really underway and the Fed would have to raise rates, due to a supposedly more hawkish FOMC and a supposedly more hawkish congress. The hope has been significantly dashed by FOMC statement and economic news of recent days. But then the market was spooked by the sudden and dramatic shrinkage of open interest in gold futures. Now that both the longer-term fundamental wet blanket and the short-term technical dirt have been removed, the Gold fire will be rekindled.

Allow me to reiterate one critical point. The oxygen for this Gold fire is more than anything else the Fed’s fundamentalist Keynesianism doctrine. The dollar can go up or down. The economy can recover, sputter, or go down the drain. But until the Fed learns how not to use its “printing technology,” the Gold trade will not end!

Another point I must reiterate is that, in a move which provides a glimpse of the future of US dollar and gold, China has allowed its currency to be traded for the first time in the United States. This is a bullish sign for gold investors. It is an important step in the country’s plan to make the renminbi an international currency. China’s central bank is looking for ways to expand renminbi trade. The explicit move is an endorsement by Beijing since the state-controlled Bank of China Ltd is at the forefront of this development.

Although a floating currency allows price moves in both directions, it is general consensus that the renminbi will strengthen against the US dollar due to trade imbalances between the two countries. The impact on commodity markets and gold, will depend on the extent and speed to which China allows its currency to rise.

The impact of a free floating yuan will affect commodities in three angles: economic strength and prospects of global recovery, direct impact on trade of commodities to and fro China, and the broader knock-on effect on commodity demand. People of China are turning to gold because it is perceived to be “safe”. The government itself also has a massive demand for the bullion. And when compared to other asset classes, gold delivers more return for its daily volatility than other asset classes do.

 Print This Post

Related posts:

1. Yuan vs. Dollar vs. Gold
2. Yuan Trying To Replace The Dollar As The World’s Reserve Currency