GOLD ANALYSIS

Gold's rise about much more than U.S. economic policy

While some may put gold's rise over the past several years as being a reflection of U.S. monetary policy, there's a lot more to it than that as the metal's fundamentals are changing.

Author: Jeffrey Nichols
Posted: Friday , 17 Dec 2010

NEW YORK (Rosland Capital) - 

Gold began the new millennium under $300 an ounce . . . and under a cloud of pessimism among even many of its most ardent advocates.  By the end of the decade, gold had advanced to more than $1000 an ounce -- to $1087.50 (basis the December 30, 2009 London PM fix) for a gain of roughly 275 percent over the ten-year period. 

And, in the past year, gold's steep ascent has not abated, rising another 32 percent to its recent all-time high of $1,430.95 on December 7th. 

Most mainstream economists would argue that gold's advance over the entire period has been a reflection of overly accommodative U.S. monetary and fiscal policies -- easy credit, excessive private and public spending, and declining real interest rates. 

MORE THAN THE U.S. ECONOMY

As important as U.S. monetary policy may have been to the historical uptrend in the price of gold over the past decade -- and will likely continue to be in the years ahead -- other forces have contributed equally, if not more so, to gold's revaluation in world financial markets and in the hearts and minds of growing numbers of gold investors. 

It is important to recognize that rising gold prices are not exclusively a "Made in America" phenomenon.  Investors, analysts, and journalists, not just in the United States but also around the world, tend to explain every wiggle as well as the longer-term trend in the metal's price to economic events and policies here in the United States. 

I've often discussed these bullish factors in my Rosland Capital Gold Commentaries because it's so important for investors to understand what has been driving gold higher . . . and why our very bullish multi-year gold-price outlook may prove too conservative.

In addition to U.S. monetary and fiscal policy . . . and economic developments here at home, the top drivers pushing gold higher in 2010 were: (1) rising Chinese gold demand; (2) surprisingly strong Indian gold demand; and (3) growth in aggregate official sector demand. 

CHINESE LIBERALIZATION AND RISING DEMAND:

Private gold investment was banned and the market was tightly controlled for more than five decades following the Communist Party takeover in 1949.  Ever since the legalization of gold investment and the gradual liberalization of the market beginning in 2002, the Chinese appetite for gold has been growing by leaps and bounds.  

As a result, China has become a powerful driving force in the world gold market, alone accounting for a few hundred dollars in the thousand-dollar price advance in the years since liberalization. 

Chinese retail physical investment demand will be up at least 75 percent this year to 170 tons while demand for gold jewelry is growing by some ten percent or so this year to 380 tons.  While the country has seen a significant rise in domestic mine production, so much so that it is now the world's biggest gold-mining nation, imports are rising to fill the supply-demand gap.  China's imports of gold could reach 250 tons this year. 

These trends are likely to continue, if not accelerate, in the next few years reflecting demographic trends, strong economic growth, rising personal incomes, worrisome inflation, and the continuing development and maturation of the gold-market infrastructure.  In particular, China's first gold exchange-traded fund will be launched shortly to be followed soon thereafter with other similar exchange-traded products.  Just as gold ETFs grown rapidly in the West so will they in China next year and beyond. 

INDIAN DEMAND HEATS UP:

India's appetite for gold is once again hot as curry.  As in China, economic growth has been strong with GDP up at an annual rate of 8.9 percent -- and inflation has been showing signs of heating up too.  Good summer monsoons brought healthy autumn harvests . . . and, as a result, income to the agrarian sector has been the best in years.  Importantly, the agrarian sector accounts for a lion's share of the country's gold consumption. 

Imports of gold surged during the third quarter, so much so that total 2010 imports could reach 750 tons, up from 595 tons last year -- putting India, for now, far above China as the biggest gold-consuming nation.

India has historically been a very price-sensitive market.  Typically, buying interest falls off as prices rise . . . and, at higher prices, India women are known to take profits, cashing in their bangles and chains, so much so that Indian gold scrap can be an important short-term source of supply to the world market. 

In the past, Indian gold buying and re-selling often locked the world U.S. dollar price of gold into trading ranges with low prices triggering more buying and higher prices triggering more selling.  We saw this trading pattern emerge last year as gold approached and fell back from $1,200 an ounce and, similarly, in 2008-2009 when the yellow metal had difficulty breaking above the $1,000 level. 

In contrast, this year we are seeing very little of this knee-jerk price sensitivity.  Even at recently prevailing all-time high prices around $1,400 Indians seem eager to continue buying suggesting a psychological reevaluation of gold's future price prospects.   

The official sector -- central banks, the International Monetary Fund, and sovereign wealth funds -- last year became a net buyer of physical gold for the first time in at least ten years.  After selling roughly 400 to 500 tons a year over the prior decade, the official sector may have purchased a couple of hundred tons in 2009

I don't believe the officially published data on central bank gold transactions and data on sovereign wealth fund investments in gold are, for the most part, unreported.  So, it's not possible to get an exact reckoning of total gold purchases this year.  In short, we don't know what we don't know when it comes to central bank gold purchases.

China, for example, announced last April that its central bank had purchased 454 tons in the prior six years -- but chose not to report these purchases until more recently.  Many observers, myself included, believe that China continues to buy significant quantities on a regular basis, some if not all from domestic mine production. 

Saudi Arabia also added significant quantities of gold -- 180 tons, in fact -- to its official holdings over the past few years -- but did not report these purchases until this past June.  It is likely that the Saudi Arabia Monetary Authority also continues to buy . . . along with some of the other oil producers with dollar-heavy, gold-underweighted official reserves. 

What we do know is that the list of countries that have bought gold beginning in 2009 continues to grow.  Some of the names on this list include: Russia, Kazakhstan, India, Sri Lanka, Mauritius, Venezuela, the Philippines, Thailand, and even Bangladesh.  And, South Korea recently announced it is considering adding to its official reserves. 

We also know that the IMF gold sales program, which commenced in 2009 and promised to sell 403.3 tons, has nearly run its course.  At the end of October, the IMF had only 32.7 tons remaining to be sold.  With little -- if any -- metal remaining to be sold under this program, one must wonder how the market will react when this temporary source of supply comes to an end. 

Jeffrey Nichols is Senior Economic Advisor to Rosland Capital (www.roslandcapital.com) and Managing Director of American Precious Metals Advisors (www.nicholsongold.com )