Oct 15

Gold Without Crisis

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Top Gold Mining analyst questions the long-term support for gold, absent today’s "crisis mentality"…

A PhD METALLURGIST who began his career working with Xstrata (then MIM Holdings Limited) at Mt. Isa, Queensland, Tony Parry is now a senior analyst with Sydney, Australia-based Resource Capital Research.

Previously working as a mining equities analyst with James Capel Limited (now part of HSBC), as well as in equity sales and mining corporate finance – marketing to institutional clients in the UK and Europe – Tony Parry established his own consultancy in 1993, advising many small-medium enterprises on strategic planning.

Today, when building his long-term models for Australian junior Gold Mining companies, he uses a long term Gold Price of US$900 per ounce. But Tony thinks gold’s fundamentals are weak and that fear is artificially propping up the price, as he explains here to The Gold Report…

The Gold Report: Tony, you joined Resource Capital Research as a senior analyst in 2008. Tell us about your coverage sector.

Tony Parry: At Resource Capital Research, we cover exploration and development companies, typically those with emerging production profiles that have not been picked up by the market or major brokerage firms and need further research coverage.

We cover three sectors – gold, uranium and iron ore. We publish major reports each quarter covering a number of significant companies in those sectors, and these reports contain a commodity price outlook for the commodity we’re looking at.

TGR: On the gold side, Australia has quite a history of Gold Mining, especially in the Kalgoorlie area. But in other countries, gold has taken on something of a stigma in recent years. What’s the general sentiment toward Gold Mining right now in Australia?

Tony Parry: Australian mining is a very positive and somewhat booming sector. It’s growing strongly, and there’s no major resistance to further development, apart from the normal environmental and social concerns about developing mining operations.

TGR: What sort of play is gold receiving in Australia’s mainstream media? Is there a buzz about gold at $1300 an ounce?

Tony Parry: It’s exciting times for the gold market; $1300 an ounce is a pretty significant breakthrough and, of course, that’s getting a lot of play in the financial reporting sector. We’re seeing lots of articles on the Gold Price. Every article seems to be placing a bet on gold. So, yes, there’s quite a buzz in the press and there are a lot of people talking about gold.

TGR: Do you think the average Australian is aware that $1300 per ounce is really good for the Australian economy in terms of exports?

Tony Parry: Yes, I think they’re pretty in tune with what’s happening in the resources sector; as I say, it’s such a significant part of the Australian economy. Even in the largest cities there’s no doubt the Gold Price is widely visible.

If you got in a taxi in the capital city of Australia and talked to a taxi driver about what’s going on, he would probably talk to you about the Gold Price.

TGR: What are we looking at in terms of mining’s contribution to GDP there?

Tony Parry: I don’t have the exact numbers, but something like 30% of Australia’s total exports are made up of mining-related commodities. The three big exports in Australia are coal, iron ore and gold, in that order.

TGR: Your firm predicted an average Gold Price of just below $1200 an ounce for 2010; obviously that was a little low. What sort of fundamentals did you see in the gold market and in the global economy that led you to say in a recent report "take away the ‘crisis mentality’ and gold looks precarious"?

Tony Parry: What we were seeing and what we’re still seeing is that the "doomsday mentality" is driving investment demand in the gold market. The simple fact is the "crisis mentality" has not been removed from the equation since we made those forecasts. In fact, the "crisis mentality" is bubbling along very well, perhaps even increasing as European sovereign debt concerns continue to make headlines.

And we’re still seeing major concerns about the US economy and the issues surrounding quantitative easing, which are starting to have an impact on the US Dollar. There’s quite a bit of pressure on the US Dollar.

Perhaps we felt that there was going to be some easing of that crisis mentality in the coming quarter or two, but at the moment there’s no sign of that and it may very well be increasing.

TGR: But in looking through RCR’s September report on gold, your price estimates are quite conservative across the board. In your financial models, you’re now using a long-term Gold Price of $900 an ounce. That seems particularly bearish.

Tony Parry: It does in the current environment. We say in Australia that predicting the Gold Price is a bit of a mug’s game. The fundamentals are pretty tricky to go on, so you’ve really got to go on the psychology of the market. Gold doesn’t have enough underpinning it to make a projection on the fundamentals.

TGR: I agree, but you must see something in those supply and demand fundamentals to project such conservative prices.

Tony Parry: That’s right. At the end of the day we have to come up with some sort of basis for our forecasts. We asked ourselves: is $1300-an-ounce gold sustainable or is that a spike? We believe that in a few years’ time and once everything gets back to normal – and please don’t ask me when that is – we will see gold come off the top quite significantly.

Our argument is that the Gold Price is being sustained by strong "safe haven" investment demand. But if you take that demand away, we see weak fundamentals; jewelry demand is quite weak, which has been the main source of gold demand, before investment demand started challenging jewelry demand in recent times.

Gold Mining production is increasing because of the increased prices, so there’s more supply coming on the market. We’re also seeing increased scrap supply from recycled gold.

On the demand side, we’re seeing negligible purchases from central banks, perhaps because they just don’t want to buy more gold at these prices. And as I mentioned, we’ve seen the end producer de-hedging, which has been a demand-side factor in recent times. We may even see more hedging from producers.

If you put all that together, and significantly reduce investment demand, we see gold coming significantly off the top. We wouldn’t be expecting that in the short-to-medium term. But if you ask what’s the fundamental value of gold? At the moment, we say that’s about $900 to $1,000 an ounce. That is probably the ultimate baseline that gold will come back to when it’s safe to go back into the water with the other asset classes that people don’t really trust at the moment.

It could be a number of years, but investment banks will be doing the same; they won’t be factoring the current Gold Prices into their long-term valuation models. And I think that’s fine because if we’re wrong, and a company still looks good on that basis, that’s pretty good news for the company.

But we do see the speculative element washing out in time.

TGR: In your report you said that in the future you could see a sustained inflationary uptrend that could ignite gold’s "store of value" demand. You added that it’s too far off to be a factor in the short-to-medium term. Could inflation prop up gold once this "crisis mentality" subsides?

Tony Parry: That’s a good question. There’s no doubt that inflation is in the melting pot as an argument for holding gold. Quantitative easing is the pump priming the US economy and other economies. The classic theory is that the more money you pump into the system, the higher inflation is going to be in the end. At the moment, we’re seeing more concern with deflation in the US and European economies. You’d have to say inflation is not a strong factor right now.

Longer term, yes, inflation could rear its head. But inflation would require some economic growth to become a real factor, and by then you may see equity markets back into the next bull phase. I have a hunch that by the time that is happening, some of the speculation in gold will have washed out. I see that as a bigger factor than the "big inflation" argument.

For the record, we just published our September quarterly gold report, and we’re feeling less bearish. Given the continued concerns in the market, we expect gold to keep pushing up into the first half of 2011. We’re looking at around $1335 to $1350 during that period.

TGR: In your June report you said that in the last five to seven years, one of the major trends in Gold Mining has been for gold producers to buy out their hedging contracts to gain more exposure to the spot price. But you also said in a recent report that the gold sector could see a "return to net producer hedging at Gold Prices above a $1000 an ounce driven by producer concern that the highs for gold may have been seen for now and the requirement by project financiers to lock in for future margins." That’s remarkable. Have you seen any evidence of hedging above $1000 per ounce?

Tony Parry: Well, I’ll be honest – not a lot at the moment. There’s no doubt that the producer hedge book has run down to virtually zero.

TGR: I’ve talked with a number of analysts who like Gold Mining juniors that are producing, but that also have some strong exploration upside. Do you follow companies that fit that description?

Tony Parry: Yes, but first I want to comment on that thesis. There’s no doubt that exploration is a tremendous driver of shareholder value for emerging companies. What we’re seeing is that a lot of the Australian companies in West Africa are having excellent exploration success. In fact, they’re getting huge gains on their share prices – 200 to 300% – due to exploration success. That’s happening because they are discovering gold at a discovery cost of around $10-$15 an ounce.

Equity markets, doing simplistic valuation multiples on gold resources and reserves, value them typically at $50-$100 an ounce once you’ve got a significant gold resource established, maybe 500,000 ounces or more. If your discovery cost is $10-$15 an ounce and you’re being valued by the market at $50-$100 an ounce, there are tremendous gains to be made through exploration success. You’re getting very high leverage on those exploration multiples. That’s the game at the moment.

TGR: Do you have some parting thoughts on the precious metals sector in Australia?

Tony Parry: Yes, obviously, the Gold Price is up 31%, in US Dollar terms, in the last 12 months. But the Gold Prices in producing countries haven’t been nearly as strong because of the appreciation of currencies. The Canadian Gold Price is up 23% in that 12-month period, as opposed to 31% for Gold Prices in US Dollars. And in Australia, the Gold Price is only up 19%.

But if you look at the performance of the indices over the same 12-month period, the US-based gold stocks, with the S&P gold index, are up 49% in that 12-month period. That’s performing better than the Gold Price, and that’s to be expected as there are no currency issues there.

In Canada, the gold index is up 18%; so, it’s actually underperformed the Gold Price. You’d have been better off holding gold rather than Canadian gold stocks in that period. That’s partly due to the fact that the Canadian Dollar Gold Price was up just over 20%.

But the Australian gold index in that 12-month period is up 43%, even though Australian Gold Price was up only 19%; so, Australian gold shares have been fantastic performers. And I am sort of bragging.

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Sep 30

LBMA 2010: Back to the Future

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"Gold: Bubble or boom?" is a big concern for the world’s professional gold industry…

The BIG MONEY flows from the biggest trends, of course, writes Adrian Ash at BullionVault, just returned from the London Bullion Market Association’s 2010 Conference in Berlin.

But even the brightest people, and with the best of intentions, can struggle to see today what hindsight will say you could have banked on.

By the summer of 1922, for instance, you needed 100 of Germany’s paper Marks to buy one Gold Coin Mark, against which they were supposed to be equal. Yet the German Chancellor "would [still] accept no connection between the printing of money and its depreciation," notes Adam Ferguson in When Money Dies (London, 1975)…even  as the Weimar Republic’s hyperinflation pushed Berlin food prices well over 50% higher inside one month.

Indeed, "the opinion that the flood of paper is the real origin of the depreciation [in its purchasing power] is not only wrong but dangerously wrong," said the Vossische Zeitung newspaper. So by the time the worthless currency was abandoned 14 months later, it took one trillion paper Marks to buy one golden equivalent, and German banks "turned the Marks over to junk dealers by the ton" for recycling as scrap paper.

Who could’ve guessed?

Now, fast forward almost a century. Today the value of money (like its price versus gold) is at issue once more, and missing the big trend – inflation or deflation, commodities boom or depression – is a big worry for anyone serious about defending their savings. Over the last decade, gold prices have scarcely looked back in their rise from $252 to $1313 per ounce today. US equities, in contrast, have gone precisely nowhere, while commodities have certainly rallied, but hard assets (outside gold and silver) remain off their pre-Lehman tops of 2008. Treasuries and cash-in-the-bank can barely keep up with inflation, meantime, despite the official "core" US measure slipping below 1% per year. Housing looks like the "double-dip recession" cast in concrete.

Edging above $1300 this week, therefore, it’s little wonder that "Gold: Bubble or boom?" was the big theme (both on-stage and off) at this year’s London Bullion Market Association conference, held in Berlin. Besides dealing silver and the platinum-group metals, the LBMA’s membership is the world’s wholesale gold market – the refiners, assayers, vault operators, dealers, financiers and analysts who help move the metal from mine-head to retail production, whether jewelry manufacturers, dental suppliers, chip fabricators or Gold Coin mints. Very much centered in London (where the Association’s biggest bullion-bank members settle some $20 billion of gold trading between themselves each day), this odd little corner of the financial market well remembers the time before today’s current rally…a miserable two-decade run of falling gold prices, falling demand, and falling returns for the market’s suppliers. And no one wants to be late in seeing that the wind’s changed direction.

"When I started in precious metals in the early ’80s," said one head of metals trading to the 500+ delegates on Tuesday morning, "I understood that private clients would hold around 3% of their wealth in Gold Bars and coin…But over the next 20 years, those reserves were really liquidated, down to pretty much zero by 2000."

He’s just added to his own personal gold holdings, he said, buying Gold Bars first cast in 1980 for bank-teller sales to clients in the north-east of England. Yet the vast bulk of attendees – whilst bullish in their average $1450 price forecast for Sept. 2011, and with 60% believing gold would "perform well" even if deflation hit – are a long way from fully invested. A question thrown to the floor showed 74% of the bullion-market professionals meeting in Berlin keep between 0% and 10% of their own private wealth in precious metals. So either they’re shills who lack the courage of their convictions, or they prefer to separate where they keep their savings from where they earn their income, or gold has yet to capture the real investment dollar of even those people closest to it.

More broadly, current gold investment accounts for barely 0.5% of investable wealth worldwide, as Shayne McGuire of the Texas teachers’ pension fund (and now author of two books urging Americans to Buy Gold Now) showed on Monday, down from 3% in 1980 and far below the 5% of 1968 or 20% allocation gold received prior to the mid 1930s.

Thanks to the massive growth of other investment choices, "Gold has never played a smaller part in the global financial system than today," McGuire concluded, and while further gains aren’t guaranteed by the "weight of money argument" (as Philip Klapwijk of GFMS called it) the relative lack of investor hoarding hardly smacks of gold’s being a bubble. And while the Western world’s biggest central banks hold huge quantities of the stuff, the world’s biggest foreign exchange holders are all "underweight gold by any measure" (Philip Klapwijk again), with a growing desire at least to address their "overweight Dollars" position.

Indeed, "off-market" sales of Gold Bullion by European and even perhaps – one day in the far future – the US governments "may [in time] facilitate a transfer of bullion from West to East" the GFMS chairman said, reminding delegates of the gold transferred from the US to Europe to settle America’s balance of payments debts in the late 1950s and early ’60s. Meantime emerging economies continue to Buying Gold both "to diversify" their large US-Dollar holdings, and also as "catastrophe insurance", and private investors have similarly seen "the world’s markets flooded with cheap money," said Germany refinery Heraeus’s head of sales, Wolfgang Wrzesniok-Rossbach. His detailed (and best-in-show) presentation on Gold Bars, coins and other retail-investment products Monday afternoon noted the surge in European physical demand during the Greek deficit crisis of early 2010.

One driver is psychological, Wrzesniok-Rossbach said. Because "here in Germany, there is a great desire for security. We are the most over-insured people in the world." More historically, however, German households are asking "Haven’t we seen this before, in 1923…?"

Already scared by two stock-market crashes and a global property crash in the last decade alone, "There’s an entire generation of [Western] investors who may not want to trust governments or mainstream financial products," agreed Natixis bank’s head of precious metals (and LBMA vice-chairman) David Gornall on Tuesday morning. At several points during the global financial crisis, "The US Mint has been right at the limit of immediate physical supply," he noted, but that frenzy has since died down – even as the gold price has continued to rise. Together, that’s created a very un-bubblicious atmosphere on the trading floor.

"When the Gold Price broke new all-time highs [in early Sept.]," reported Steve Branton-Speak of Goldman Sachs, "volatility [in daily prices, measured on a rolling one-month basis] was at a 5-year low. When it then went through $1300, traders just shrugged and said ‘So, did you watch the game last night?’

"Compare that to the frenzy of gold trading we got when Bear Stearns and then Lehman Brothers failed," Branton-Speak continued, a point confirmed by both Gerry Schubert of ABN Amro (who restated the "lack of frantic activity or volume") and several of the traders I spoke to between presentations (and also in the bar of course).

"What looks like a massive boom in demand is actually very small…relatively insignificant," confirmed Jeremy East of Standard Chartered Bank, but gold keeps making headlines because it "punches above its weight in terms of significance."

Asked whether gold is now a bubble, East opted instead for "new paradigm – which is in fact a return to the old paradigm." Concurring with Shayne McGuire’s presentation on pension-fund holdings, Standard Chartered’s head of metals sees gold investment holdings only now starting to recover from the wipe-out caused by two decades of strong interest rates and economic growth between 1980 and 2000. This view, of gold not so much soaring to untold heights as simply returning to its former position as a key asset class ("Back to the future" as one oddly aggressive guy put it to me in the smoking lounge) might seem to downplay its gains. But consider why gold’s not always valued, said Graham Birch, former head of natural resources at Blackrock:

"You don’t need gold when…

  • Inflation is dead
  • Governments are benign
  • Taxes are low
  • Currencies are solid
  • Markets are booming…"

In other words, said Birch, "Nobody wants gold if market returns are high and don’t seem risky." Whereas today?

Part II to follow…

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Sep 30

Don’t Stay "Stubborn Long" of Gold Investing

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Knowing when this bull market in Gold Investing ends is critical…

WE RECENTLY received the following comment in our Q&A Knowledge Base, writes David Galland of Casey Research.

"Investors should be prepared to sell gold as either increased inflation expectations or doubts around debt sustainability force a sharp increase in US Treasury bond yields. Simply put, in an environment of high real interest rates, the allure of Gold Investing could disappear as quickly as it did in the early 1980s when Paul Volcker took control of the Federal Reserve…"

My response…?

First off, I want to congratulate the reader for trying to anticipate the conditions that might mark the end of the gold bull market. Because, make no mistake, the Gold Investing bull market will come to an end – and when it does, it’s not going to be pretty for those who stubbornly stay too long at the party.

As to the possible triggers for gold’s big sell-off, the reader’s contention is directionally correct when he points out that this could occur when real interest rates (T-bill rates minus CPI) become high enough. At that point, as a non-yielding asset, gold will become less attractive to investors looking for income. And, gold will fall.

However, the situation today is significantly different than during Volcker’s term as the head of the Fed.

The first difference can be seen in the chart here that I just dredged out of the archives of The Casey Report. Besides painting a picture that many of you will think obvious – that inflation is the biggest driver of interest rates – you can also see that gold’s stunning rise in the second half of the 1970s occurred during a period of strongly rising interest rates. So, rising interest rates and rising Gold Prices are not mutually exclusive.

The second difference between now and then becomes clear in the next chart showing that while there certainly was an inflation problem during Volcker’s reign, there definitely was not a debt problem.

At least, there wasn’t a problem compared to today…

The implications of the nation’s current debt load loom large in this discussion. Aggressively raising interest rates, as Volcker did back in the day, would not just dent today’s US economy, it would destroy it. As it would evaporate a significant amount of the trillions of Dollars now sitting in government debt, much of it held by pensioners.

Put another way, Volcker raised interest rates as energetically as he did because he could. Today, that couldn’t happen – at least not without pushing the US economy into a death spiral. That’s why we’ve long compared the scenario faced by today’s policy makers to being stuck between "a rock and a hard place."

While the smoking ruin solution I wrote about a few weeks ago – where the government steps aside and lets the free market do its worst, so that it can then do its best – is certainly possible, the more likely scenario is that the Treasury and the Fed will keep reacting to each new chapter in the crisis by further degrading the currency in the hopes that at some point the debt becomes manageable. Of course, there is the real risk that at some point along the path, our creditors will lose faith and demand higher interest rates.

But what happens if interest rates begin to move up based on credit concerns, and not in response to a noticeable uptick in price inflation? At that point, couldn’t we see positive real interest rates relative to CPI – therefore reducing the appeal of Gold Investing?

If interest rates begin to rise for any reason – including concerns over creditworthiness – the obvious damage to the economy and to the government’s ability to service its debts will only heighten concerns over repayment. Almost overnight, creditors will begin to fear either overt debt defaults or the covert default of yet more inflation, and demand even higher rates.

At that point, with interest rates beginning to spiral, few people will be looking to buy bonds but will remain fixated on the return of capital, versus return on capital.
Being repetitious, debt is the single biggest economic challenge facing the US – and much of the developed world. In time this debt will get resolved, it always does, but it’s not going to be pretty.

As I see it, unlike the inflation of the 1970s that could be treated with a strong dose of tight monetary policy, the debtflation we now face can only be resolved through default. Given that no US government will want to join the ranks of history’s sovereign deadbeats, the inflation option remains the most likely course.

And in that scenario, gold is still a solid investment and so should be a core portfolio holding.

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Sep 30

Gold Investment Keeps Growing

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The World Gold Council explains what’s happening with Gold Investment today…

MANAGING DIRECTOR of investments at marketing and research group the World Gold Council in New York, Jason Toussaint here speaks with Hard Assets Investor about the metal’s rise – and why he sees it set to continue.

Hard Assets Investor: The World Gold Council is a very important organization, representing the gold industry. Tell us a little bit about it…

Jason Toussaint: The World Gold Council is a market development organization that is owned by the largest Gold Mining companies in the world. Back in the ’80s, they decided to pool their resources into one organization, which we now know as the World Gold Council. And our goal…our mission in life, if you will…is to create and sustain demand for gold.

We do that across a number of primary sectors, four sectors to be precise. We have a Gold Investment sector, which I manage on a global basis, informing and educating the public about the merits of gold in portfolio construction and long-term diversification. We have a government affairs division, which works with central banks, many of them around the world, to understand gold as a reserve asset. We have an industrial sector, which is dealing with semiconductor manufacturers, etc., to increase and find more uses for gold in the industrial segment. And then, of course, last but not least, the jewelry sector, which is the most important and has the largest demand.

HAI: In the Gold Investment area, I suspect your job has gotten a lot easier in the past several years.

Jason Toussaint: The biggest shift that took place – and I would call it a paradigm shift in this market – is not necessarily the merits of Gold Investment, because those have been around for quite some time, and we’ll discuss those, but the access. When we launched the SPDR Gold Shares here in the US in 2004, having an exchange-traded product with all the guaranteed two-way markets – infinite liquidity, if you will – of trading on the market, it overcame a lot of the issues that investors have had in the past with accumulating gold.

HAI: We should just state that the World Gold Council created the GLD, the very popular Gold ETF that has really taken off among investors.

Jason Toussaint: Correct. We sponsored, through a subsidiary based in New York – World Gold Trust Services – the SPDR Gold Shares, GLD. It’s now valued at just below $50 billion, and we are the second-largest ETF in the world. What is very interesting, if we look back to when we launched the product in November 2004, it surpassed $1 billion in assets under management in its fourth trading day. So, we were absolutely tapping into latent demand by investors who wanted to start Gold Investing, but didn’t necessarily know how.

Before the ETFs, if you wanted to invest in gold, it was buying Gold Bars and coins, primarily, which is fraught with issues such as price discovery, where do I purchase these things, and so on. And then, of course, costs associated with transport insurance and storage.

HAI: Put a number on it – what percentage of gold demand, prior to the ETF, was represented by investor demand?

Jason Toussaint: Before the exchange-traded funds, Gold Investment demand was roughly 15% of aggregate gold demand. Now it’s upwards of 20 to 30%, pretty much doubled. And I think, kind of coming back to the access vehicle, looking at SPDR Gold Shares and, frankly, other Gold ETFs backed by physical bullion available in the world, has really made gold investable for the first time, for many classes of investors.

Take, for instance, you mentioned pension funds. Pension funds are absolutely asking about the merits. We work with them closely now, about why they should Buy Gold. And then, more importantly, how they do it. Because you can imagine, if a pension fund wanted to buy a billion Dollars’ worth of gold previously, then they would need to worry about, "Well, where do we store it? How is this valued? How do we trade it?" etc. And, trading gold is quite specialized. By putting it on exchange, it is now part of the professional investment process.

HAI: So we’ve seen a doubling in investment demand – but it’s probably not going to double again in a short period of time?

Jason Toussaint: We absolutely do see Gold Investment demand continuing. Even at $50 billion, I like to tell people we’re just barely scratching the surface now. There is a vast market out there that does not hold gold.

HAI: How large is the total capitalization of the gold market, roughly?

Jason Toussaint: Six trillion Dollars.

HAI: Six trillion? So, in the scheme of things, it’s not really all that big – global GDP, what, $60-$70 trillion?

Jason Toussaint: Right.

HAI: You talk about maybe a large investment manager like BlackRock running $3 trillion. But $50 billion, compared to $6 trillion – you definitely see that there’s more room to grow in there.

Jason Toussaint: Absolutely. But then, we need to also understand that the primary driver is jewelry. And the primary buyers of gold jewelry, the largest markets, if you will, are the Middle East, India and China. And looking at continued demand, and the relative balance between jewelry and investment, I think what we will see is a continued increasing demand for jewelry in those markets. Because, if you think of their domestic growth rate, and the fact that in the case of China and India, most importantly, the creation of a new middle class, new wealth and an affinity towards gold, that is, I think, a very, very long-term structural shift in gold demand, which I think is often overlooked.

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Aug 20

What’s Driving Gold Right Now?

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It’s important to understand the underlying driving force for gold. Here is an interesting article that highlights this.

The key factors driving Gold Prices, plus those less-important elements…

RIGHT NOW, it appears that the Gold Price is being linked to the state of global economic growth or lack thereof, writes Julian Phillips of The Gold Forecaster.

Is it? Or are there other factors that contribute to the rise in the demand for gold? A look at the different types of demand gives us perspective on the real influences on the Gold Price.

Start with China’s contribution to the Gold Price, because this week saw an announcement that China is now the second largest economy in the world as well as being the world’s largest exporter. This is a landmark announcement as this country is headed fast to be the world’s largest economy with the world’s largest foreign exchange reserves.

As a nation, we do believe China is Buying Gold, eventually for their reserves, from local production as well as in the market. Additionally, the government and its institutions are encouraging the rapidly swelling numbers of newly enriched middle classes to Buy Gold. It is hard to give you an accurate number on this because such growth has never been seen before.

But there is a brake on the relationship of the growth of this class as regards gold. The Chinese are savers and because of their skepticism, recent experience of being poor and inexperience, they are not quick to change from the simplest of saving-account deposits to other investments. But overall they are happy with gold as an investment and are moving across to it, particularly as they understand the benefits of a rising price. Their obedience to government directives is helping the process. They have the lowest per capita holding of gold in Asia. We attribute this firstly to the long history of hardly any disposable per capita in the country. This is changing fast.

The demand is not seasonal except that it reaches a high point at the Chinese New Year, a time for people to celebrate and give presents. After New York closes, Asian demand kicks in at the start of their day pointing towards Indian, Indonesian, etc. demand, including that from China. Watching the market right through to before London opens, also gives on insight into demand from there.

Please note, this demand does not take note of the state of European or US economic growth. Most Chinese gold buyers are not aware of Western economics, but want financial security through savings in Yuan and gold.

Chinese demand is going to be large enough to be a major Gold Price driver in 2010 and 2011 and beyond.

Indian demand is also crucial. The monsoon this year (south of Pakistan) has been plentiful and expectations are that the harvest will be a good one. As 70% of gold purchases used to come from the agricultural sector, this time of the year is significant still. But as India urbanizes, the seasonality of gold buying there is lessening. Because the disposable income of Indians in the countryside is limited, the tonnage of actual gold purchased by them is falling. On the other hand, the numbers of the middle class is increasing and so is their disposable income.

To a growing extent this is making up the volumes that could be bought. The volume purchased per annum has been as high as 850 tonnes but can fall to 400 tonnes a year. The monsoon has had as much to do with that alongside rapidly rising prices. Please note that this difference is the same as de-hedging demand from the major Gold Mining companies was at its height.

Although India is growing at 8% per annum, the Indian middle classes are not growing as fast as China’s middle class. The main restraint on Indian gold buying is the fear that the Gold Price will fall after they have bought it. This year we do expect them to be more enthusiastic because the Gold Price has been stable over the last year and more at around $1,200.

They usually start to buy just before or after the beginning of September. That’s in two weeks time. Indian demand goes on through the year to May of next year.

Indian demand has been a major gold demand sources and is going to be a growing force, in line with Asian growth in 2010 and for years to come. As with China, western economic growth or lack thereof, does not affect Indian demand.

Developed world jewelry demand will also play a role. With the northern hemisphere and developed world holidays slowing down to early September, manufacturers of gold jewelry there start to gear up for the year end festivities. They Buy Gold for this time in September so that it can be in the shops in November or earlier. This has, in the past been the largest source of demand for gold.

Developed world demand relates directly to developed world levels of disposable income. These are not good this year, so we expect no increase in demand from that source. Disposable income has been well down since the start of the housing crisis, which began towards the end of 2007. We don’t expect them to rise for at least one year. But the buying that will take place will begin round about the beginning of September and last through to November before it slows to the steady flow up to May of next year.

If the Gold Price does not rise by much this demand will rise in significance, but we feel that it will again be sidelined by rising prices soon.

Industrial demand, in contrast, doesn’t matter so much for Gold Prices. Intel’s recent results and following comments showed us that electronics have now joined the category of ‘necessary’ items for households and businesses. As electronics are the main use for gold in industry, we do not expect there to be any significant drop in demand from industry. Overall, industrial demand is not seasonal, but such demand is not a major factor in the Gold Price.

As for demand from Central Banks, we are of the opinion that the turn in the market, by central banks from seller to buyers, overall is a trend that has barely begun. Russia, China, Saudi Arabia, the Philippines and no doubt to be joined by others in the future, are buyers of gold. Previous sellers have now taken a firm grip on their remaining holdings. Last year central bank buying equaled over 400 tonnes.

The monetary crises that lie ahead in the next year or two will, we believe, will incite much more buying by central banks as confidence in the monetary system continues to decline.

The International Monetary Fund’s sale falls out of this category, but is a supplier at the moment. Of its 413 tonnes there remains around 150 tonnes. We expect to see this absorbed completely within one year. Once this has gone prices will rise to the point where dishoarding begins, so providing the market with supply.

Again this demand is non-seasonal. However, it not only leads investment demand, it has the capacity to absorb all available supplies. Further, once its persistent visibility is accepted, it will incite considerably more institutional investment demand. Central bank demand these days is aimed at giving central banks liquidity when its nation faces international monetary credibility problems. We expect to see this demand rise in 2010 and 2011.

Finally, Gold Investment demand. Apart from the huge demand we have seen for the shares of gold Exchange Traded Funds enormous demand for physical gold bullion has been present in the market place. It is persistent and large. However, it will not chase prices. It is professional and aims at buying certain amounts at particular prices. It ranges from small wealthy individuals through to institutions to Sovereign Wealth funds. You need to know how all these demand forces come together and impact the Gold Price!

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Aug 20

Gold Investment Outlook

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Look at the investment outlook for gold. must read article:

Gold Investment has soared in recent years, but looks set to rise further…

MANAGING DIRECTOR for investment at the World Gold Council in New York, Jason Toussaint here speaks to Hard Assets Investor about why institutions are Buying Gold for their portfolios today…

Hard Assets Investor: I’m really happy to have you here, the World Gold Council is a very important organization, representing the gold industry.

Jason Toussaint: Yes, the World Gold Council is a market development organization that is owned by the largest Gold Mining companies in the world. Back in the ’80s, they decided to pool their resources into one organization, which we now know as the World Gold Council. And our goal, and our mission in life, if you will, is to create and sustain demand for gold.

We do that across a number of primary sectors, four sectors to be precise. We have an investment sector, which I manage on a global basis, which is informing and educating the investment public about the merits of gold in portfolio construction and long-term diversification. We have a government affairs division, which works with central banks, many of them around the world, to understand gold as a reserve asset.

We have an industrial sector, which is dealing with semiconductor manufacturers, etc., to increase and find more uses for gold in the industrial segment. And then, of course, last but not least, the jewelry sector, which is the most important and has the largest demand.

HAI: You work with the Gold Investment area. Is it only recently that we’ve seen larger investors, institutional investors, taking sizable positions, and owning gold as a real asset class?

Jason Toussaint: Right. The biggest shift that took place – and I would call it a paradigm shift in this market – is not necessarily the merits of Gold Investment, because those have been around for quite some time, and we’ll discuss those, but the access. And when we launched the SPDR Gold Shares here in the US in 2004, having an exchange-traded product with all the guaranteed two-way markets – infinite liquidity, if you will – of trading on the market, overcame a lot of the issues that investors have had in the past with accumulating gold.

HAI: We should just state that the World Gold Council created the GLD, the very popular Gold ETF that is currently out there right now, and has really taken off among investors.

Jason Toussaint: We sponsored it, through a subsidiary based in New York – World Gold Trust Services. Its market cap is now just below $50 billion, and we are now the second-largest ETF in the world. What is very interesting, if we look back to when we launched the product in November 2004, it surpassed $1 billion in assets under management in its fourth trading day. So, we were absolutely tapping into latent demand by investors who wanted to invest in gold, but didn’t necessarily know how.

Before the ETFs, if you wanted to invest in gold, it was buying Gold Bars and coins, primarily, which is fraught with issues such as price discovery, where do I purchase these things. And then, of course, there are costs associated with transport insurance and storage.

HAI: What percentage of gold demand, prior to the ETF, was represented by investor demand? And, what percentage, let’s say, was jewelry fabrication?

Jason Toussaint: Before the ETFs, investment demand was roughly probably 15% of aggregate gold demand. Now it’s upwards of…depending on quarter to quarter…20 to 30%. It’s pretty much doubled.

HAI: So, the biggest component of overall demand, the most important, is the investment side now?

Jason Toussaint: Right. And I think, kind of coming back to the access vehicle, looking at SPDR Gold Shares and, frankly, other Gold ETFs backed by physical bullion available in the world, has really made gold investable for the first time, for many classes of investors.

For instance, you mentioned pension funds. Pension funds are absolutely asking about the merits. We work with them closely now, about why they should Buy Gold. And then, more importantly, how they do it. Because you can imagine, if a pension fund wanted to buy a billion Dollars’ worth of gold previously, then they would need to worry about, "Well, where do we store it? How is this valued? How do we trade it?" etc. And, trading gold is quite specialized. By putting it on exchange, it is now part of the professional investment process.

HAI: So we’ve seen a doubling in investment demand – you definitely see that growing further?

Jason Toussaint: We absolutely do see investment demand continuing. Even at $50 billion, I like to tell people we’re just barely scratching the surface now. There is a vast market out there that does not hold gold.

HAI: How large is the total capitalization of the gold market, roughly?

Jason Toussaint: Six trillion Dollars.

HAI: Six trillion? So, in the scheme of things, it’s not really all that big – global GDP, what, $60-$70 trillion?

Jason Toussaint: Right…but then, we need to also understand that the primary driver is jewelry. And the primary buyers of gold jewelry, the largest markets, if you will, are the Middle East, India and China. And looking at continued demand, and the relative balance between jewelry and investment, I think what we will see is a continued increasing demand for jewelry in those markets. Because, if you think of their domestic growth rate, and the fact that in the case of China and India, most importantly, the creation of a new middle class, new wealth and an affinity towards gold, that is, I think, a very, very long-term structural shift in gold demand, which I think is often overlooked.

HAI: Well, we’re out of time right now. I want to thank Jason for stopping by.

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