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Psychologically, that $1300 level was important – it appears to have pumped more steam into the gold rally and transformed even the most dedicated gold bears into bulls. But the uptrend shows no signs of reversal anytime soon, says Jeffrey Nichols, senior economic adviser to Rosland Capital and the managing director of American Precious Metals Advisors.

A widely recognized expert in precious metals, Nichols has worked with everyone from mints to Gold Mining companies to develop financing and investor relations. Here he tells Hard Assets editor Lara Crigger about whether gold’s nearing bubble territory, why food prices affect gold, and why $1500 gold by year end is just the beginning.

Hard Assets Investor: Gold just broke $1300 per ounce earlier this week, and you’ve publicly stated you believe it could go as high as $1500 per ounce by the end of the year. Why is $1300 such an important level? And why do you see $1500 in our near future?

Jeffrey Nichols: $1300 is an important level mostly for psychological reasons, because it’s a round number. People love round numbers, particularly technically oriented traders. So that’s one reason. The other is, it worked hard the last couple of months to finally break through. And now that it has, it seems to be establishing a new floor above or around $1300. So, from a technical point of view, it looks to me like it’s gathering steam for another effort at moving higher from these levels.

I’m optimistic about the $1500 per ounce forecast by year end, which, incidentally, is the forecast that we’ve had for a year or longer. In the next couple of months, gold has a variety of factors going for it. First and most simply, seasonal demand.

HAI: Right. We’re getting into the holiday season, all across the world.

Jeffrey Nichols: That’s probably what pushed us over $1300. In the Western world, jewelry manufacturers start gearing up and building inventory for the Christmas season, so that brings Christmas forward for jewelry manufacturers and that’s just now beginning to kick in.

But gold demand for jewelry and small investment items in India also has a very strong seasonal aspect to it. Some of it is because of festivals and the marriage season; some of it is because the beginning of September is harvest time for many of the farm communities in India.

This year, harvests will be quite good, because we’ve had, from the Indian point of view, a very good monsoon. Unfortunately, in Pakistan, the same storm caused all that havoc, but India got none of the problems, only the benefits. So agrarian income will be good this year, and some of that income naturally finds its way into gold.

One of the important things about Southeast Asian demand, in general, and Middle Eastern demand, is that it doesn’t require economic crises to do well. What it requires is good growth in personal income. From India to China, to Malaysia, Thailand, Vietnam, the Philippines – all these countries are enjoying very strong economic growth. People in these regions Buy Gold for a variety of reasons, one of which is as a form of savings. So when incomes are strong, some portion will go into gold.

HAI: Now as gold moves higher, are we starting to near bubble territory?

Jeffrey Nichols: I don’t think that at all. In fact, over the last couple of years, there have been several episodes where analysts and investors have either said we’re in a gold bubble, or worried that soon we’d be in a bubble. I don’t think that’s the case.

First of all, participation in the gold market may be more than ever before, but it’s still fairly limited in terms of Western investment demand. For investors in Europe and the US, their participation in gold is still relatively small scale compared to their holdings of stocks and bonds.

Also, we haven’t seen a rush into gold. It’s been orderly, and it’s been for good reasons. Now, come back to me in three years or whenever we’re nearing the top of the Gold Price cycle, and I might give you a different answer, because when you get to a top, you often get that type of action. In 1980, you could say we were in a bubble. All that activity and demand for gold compressed into a very small period of time. In the matter of literally a few days, gold just went through the roof.

HAI: Right. Now we often overlook the effect of the commodity markets on gold, but gold is a commodity, first and foremost, and what happens in those markets does make an impact. You’ve said we’ll see higher food prices in the future; how do rising food prices impact the price of gold?

Jeffrey Nichols: Rising food prices are an element of overall inflation. When we go to the supermarket, we see tighter prices for foodstuffs across the board. It’s not just one or two items that are out of whack. It’s agricultural commodities in general, and we can literally see and feel that effect on our household budget. People don’t see the consumer price index when they go shopping; there’s no shelf that says Consumer Price Inflation.

But on the shelves are all sorts of things where prices are higher from week to week: cocoa prices, given poor harvests; coffee prices are very high. Beef prices are rising, not only because feed stocks are more expensive, but also because of changing dietary patterns in what was once the developing world.

One of the things I’ve always loved about being a gold analyst is the fact that so many things around the world – whether it’s politics, economics, food prices, oil prices, currency markets, monetary policy in the US, monetary policy in Europe, developments in China and India – come to play in the gold market. And it makes it very interesting as an analyst.

HAI: When you invest in gold, you have to take a holistic sort of approach, right?

Jeffrey Nichols: Absolutely, and I think the mistake that many people make when they’re looking at the gold market is the focus on one or two things, which tends to be US monetary policy and what’s happening to the Dollar. That’s very important, and that’s playing a role in this whole bull market, at least over the last couple of years and for the next year or two, probably.

But it’s not the only factor and many people talk about it as if it were. They’re missing out on what’s happening in China and India, what’s happening with central banks, the stagnation in mine supply, the introduction and development and expansion of new gold investment products, or what I call the "Gold Investment infrastructure"…

HAI: Right. Gold ETFs opened up the space for new investors.

Jeffrey Nichols: That, in combination with other factors, has had a phenomenal influence on the price, and will continue to do so. ETFs have made gold investing easier and more accessible to more investors around the world, both individual investors and institutional investors. Many of the institutions now Buying Gold would not be in the market were it not for these new instruments.

And for other institutions, it’s just made it easier. They don’t have to deal with gold dealers who they’re not familiar with, haven’t done business with. They don’t have to deal with understanding how the physical markets trade. They don’t have to deal with transportation, storage and insurance issues. They Buy Gold and can sell gold just like they would sell any equity.

HAI: In some ways, I think the physical market is almost like the Wild West. There are certainly a lot of very reputable places to get your bullion, but there’s a heck of a lot of places looking to screw you, too.

Jeffrey Nichols: There are. And it’s difficult for somebody who’s not in the industry to discern one from the other sometimes.

And it’s not just that we have one or a few ETFs here in the United States. ETFs are springing up, and will continue to do so, in other important geographic markets. We have ETFs in India, Europe, Switzerland and the UK.

HAI: How does central bank buying factor into the Gold Price? Certainly we’ve seen massive uptake on their end recently, particularly in China.

Jeffrey Nichols: The central bank, I believe, continues to Buy Gold surreptitiously and does not report its regular purchases of gold. You read the newspapers and it says what central banks this year bought, but whatever the analyst says in the article, you can imagine that it’s actually a good deal more, because of unreported purchases. And it’s probably by more central banks than just the Chinese.

The Chinese announced in April of 2009 that in the prior six years, they had bought many hundreds of tons. And since then, there’s been no increase in reported reserves. I can’t possibly imagine that suddenly they just stopped buying. The impetus and rationale for buying was to diversify their official reserves and reduce dependency on the US Dollar, and both have grown in importance.

HAI: Right. Now gold production has begun to slow down, and mine activity is on the decline. Do you think we’ve hit "peak gold"?

Jeffrey Nichols: It’s hard to say. I don’t think we’re going to see any big increase in gold mined supply at least for several years – probably five or 10 years, if we have a new wave of gold mine exploration and development. But it takes years and years to move from exploration to significant production.

There is exploration going on, and there is new mine development and new production from mines, some of which did not exist a few years ago. But it’s merely offsetting the erosion in production and the depletion of existing mines.

A lot of South Africa is that way: South Africa went from the world’s biggest producer of gold to way down on the list. And it’s going to continue shrinking. Because in South Africa, you have not only a depletion of ore reserves and the need to go deeper and deeper, which makes it more expensive, but you also have labor issues. You have rising electricity and energy costs, and actually insufficient supplies of electricity for the mining industry. The country hasn’t kept pace in developing power sources, so there are periodical electrical shortages and outages. Unions which have much greater power than ever before are demanding higher and higher wages and other benefits – maybe rightly so, but it makes every ounce of gold that much more expensive to mine.

HAI: Meaning miners will just go elsewhere instead.

Jeffrey Nichols: So I think at best, gold’s primary supply – mining production – will plateau over the next few years. Maybe it will go up a little bit, but not enough to matter from a world market supply-and-demand point of view. But it’s possible that we’ll see big discoveries. It’s possible that those big discoveries five or 10 or 15 years from now will result in significant increases in mine production, but not for many years.

But to say that we’re never going to see big increases again I think is a mistake. For one thing, I expect much higher Gold Prices in the future. Not just $1500, but multiples of that. I think in the future the average of the notional long-term Gold Price is going to be much higher than anybody imagined. I don’t think we’re ever going to see gold below $1000 again.

And those higher Gold Prices will make gold mining more effective than it has been in the recent past years.

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The bullish arguments you know already no doubt. Low-to-zero
Western interest rates…plus a growing clamor to buy gold amongst Chinese
households (the Middle Kingdom’s demographics are more bullish still, as
Mitsubishi’s Matthew
Turner showed)…make a compelling case for rising gold investment demand,
even without the risk of government-bond defaults, rising inflation or
continued losses on "mainstream" financial assets.

The Berlin conference had plenty more to say on those
stories too, as we’ll see below (and as you can see on the slides now freely published
on the LBMA’s
website). But first, what of supply?

Well, all the gold ever produced in history came from a
mine, as Paul Burton of GFMS World Analyst
reminded the conference. But in the last decade, gold mining has failed so spectacularly
to meet the surge in demand, he could only question its "relevance" to
the market’s net outlook. Dollar gold prices quadrupled from
2000 to 2009, another speaker noted, yet annual mine output rose just 1%. And allowing
for the intervening slide in output, said Burton, gold mining output is now so
price inelastic, it took eight years of rising prices to produce any meaningful
blip in output (2009′s year-on-year increase of 7%).

Further output gains look unlikely, Burton went on, thanks
to the gold mining
sector’s "production lag" – both because of an "exploration
lag" (new investment only turned higher in 2003) and because new
discoveries of 1-million ounce deposits have collapsed regardless. The five
years to 2009 saw record-high levels of exploration spending, perhaps totaling
the previous 12 years added together (at least on BullionVault‘s skew-eyed reading of
Burton’s chart from the conference floor. See what you make of it on page 9 here). Yet
all told, GFMS’s best forecast is now for annual gold mining production to
decline by 13% between 2012 and 2019.

That other constant drip-drip of gold supply – the
"official sector" of central banks and outfits like the International
Monetary Fund (IMF) – also looks irrelevant for now, as Burton’s GFMS colleague
Philip Klapwijk
showed in his speech. European states are now holding, not selling their
reserves, but emerging markets (for now) remain mere ankle-biters compared to
the weight of private investment or jewelry demand each year. So net-net, said
the GFMS chairman, central bank activity looks "neutral", despite the
bullish picture for emerging-market demand he also laid out. More notably, and
"something we haven’t seen before", private-sector investment
holdings now outweigh central-bank gold reserves overall. Making investor
sentiment a key plank of any longer-term forecast.

Even without the end of central-bank sales, however, or the
failure of mine output to rise, "The single most important gold supply
issue is scrap," as John Reade of Paulson Europe said in his conference
summary. Re-selling unwanted jewelry "has gone mainstream" noted Jeffrey Rhodes,
CEO of INTL Commodities DMCC, becoming "socially acceptable" in a way
that using pawnbrokers to raise cash never was. Throw in gold coins, dental
bridges, bonding wire from microchips and any other supply "not from a
primary [ie mining] source", and scrap gold matched more than one fifth of
global gold mine output last year, up from just 7% a decade ago. Turkey has
overtaken India as the No.1 source of scrap gold supplies (217 tonnes in 2009,
equal to almost a tenth of world mining supply), but the most dramatic change
has come in the developed West, where "sophisticated electronic assay
equipment has seen the captain’s ball at your local golf club replaced with
gold buying parties," as Rhodes said.

Since 2005 alone, US scrap supply has more than doubled
according to data from GFMS Gold Survey, taking United States’ re-sales from fifth
to second position worldwide in 2009 with 124 tonnes. Italy’s re-sale market
moved from seventh to sixth with a tripling to 78 tonnes of scrap, and the UK
& Ireland have leapt 1505% from virtually nothing a decade ago to nearly 60
tonnes in 2009, bagging the world No.6 slot in the first-half of this year.
Throw in Germany and France, and four European nations make the top 10 scrap
supply nations by growth since 2000. In the first six months of this year,
scrap supplies from each of the US, Italy and UK & Ireland had all outpaced
India (the former No.1, remember), enabling scrap to become the "only
credible counter to investment buying." But should these massive supplies
of scrap in fact be overwhelming investment pressure on prices?

Since "investment buyers and scrap sellers are driven
by the same motivation of price expectations" as Rhodes reminded the LBMA
conference, this price-elastic source of supply could threaten "a perfect
storm of selling once sentiment changes," he believes. But first, that
would require higher prices again, because (for now) even scrap-gold merchants
have turned bullish, he reported, capping flows to refineries in anticipation
of stronger gains ahead. And second (and more critically given the source of
the last few years’ real jump in scrap supplies), "Is the drawer
empty?" as Paulson Europe’s John Reade
wondered in his quick-fire recap before the conference adjourned.

Cash-strapped households, remember, can only sell their
unwanted gold bracelets once. How high would prices need to go before more
cherished pieces could be sent to the smelters? Apply the same question to
private gold investments in fact (ETF holdings have proven notably
"sticky", if not yet as "long-term means forever" as gold
coins), and you get to the nub of the "bubble or boom?" debate.
Because at some point, according to pretty much every speaker, the circumstances
now boosting global investment demand will recede – and with them, therefore,
the gold price will fall back as well. As we’ve already seen (in Part I),
the bubblicious frenzy needed to mark the top of spike remains plainly absent.
Leaving only the circumstances behind this current boom to consider.

"The current bull market has much deeper roots than the
credit crisis," the LBMA was reminded by former Blackrock head of natural
resources Graham
Birch (now a farmer). Pointing to gold’s nadir of 1999, "continuous
disinvestment" was needed to keep prices down, and when Europe’s big
central banks agreed to cap their sales that September, it marked the start of
this rise. Roll on 11 years and 350%, however, and "Just because gold’s a
safe haven doesn’t mean it’s a cheap safe haven," Birch warned Berlin.
Which raises the question of cost and utility for new buyers today.

"I think people long gold should not be concerned
reading this slide," said John Reade in his summary, pointing to slide 14
of William White’s opening
keynote speech. Chairman of the OECD’s Economic & Development Review
Committee, White had prefaced his 20 minutes of gloom-and-doom (salted with
uncertainty, fear and doubt) by saying that the OECD itself would certainly
disagree with everything he was about to say. Reade reminded the delegates that
White’s copyrighted sales-line should be "Scaring investors since
2003," as he accurately picked the shape of the bubble well ahead of
schedule, and hasn’t been proven wrong yet.

"Investors should be positioning for ‘tail
events’," White concluded. "But which ones?" Somewhere between
deflation, slow growth, de-coupling of Asia from the West, or a lurch into
rapid hyperinflation or a new series of bubbles fed by ultra-loose monetary
policy, "Is there room for gold in a world like this?" asked the former
Bank for International Settlements forecaster.

"The answer has got to be yes. But quite what
role…well, that’s for you to decide!"

A handful of private investors have begun to make that
decision, as Wolfgang
Wrzesniok-Rossbach of the Heraeus refinery showed in detail. But the real
weight of money – the institutional mandates caring for your insurance and
pension savings – has scarcely bothered to buy gold ’til now, a point made at
length by both Shayne McGuire and Graham Birch on Monday morning. Across in
Asia, "People don’t need convincing on gold," said David Gornall of
Natixis, noting that 81% of global "bar hoarding" demand comes from
Asia, with buying amongst the "traditional buy-side countries" such
as India and Thailand – as well as the fast-growing world No.2 for gold demand,
China – continuing to grow despite record-high gold prices.
Even there, "the emergence of retail physical gold investors has resulted
in structural changes in distribution, product and buying behavior," as
Sunil Kashyap, managing director of Bank of Nova Scotia-ScotiaMocatta
explained. Yet all told (and absent the "bubble" idea which the
conference demolished time and again), what looks like a new paradigm might in
fact mean more a return to old patterns – globally – of gold buying and
hoarding…with a little "mobilization" thrown in by the scrap market
when times get tough.

India and Turkey, after all, have long been both top buyers
and scrap suppliers to the international gold market. Rising investment demand
here in the "rich West" (which, to repeat, remains well off a
"bubble" today) represents a simpler, unleveraged way of retaining
your savings than most Western households have grown used to. But gold was a
core chunk of private wealth holdings not so long ago, back before the
debt-fuelled boom we’ve enjoyed since WWII began – a boom which must now end
with "rebalancing" between the world’s debtors and creditors, as George Magnus of
UBS made plain Monday morning. The kind of dislocation required won’t be much
fun for either, which again looks good for gold demand, if not necessarily
prices.

All told today – and seeing the world’s fastest-growing
economies continue to buy and hold ever more gold as their wealth increases –
maybe US and European savers are only just getting back to the future. Either
way, that "bubble in gold" doesn’t exist. Not by a long way just yet.


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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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Here is a quick summary of the pro-gold argument:

• Central Banks are now buying gold
• Easy to find gold has already been mined
• The Population has increased 53% since the last “gold rush” in 1980
• The majority of the population increase has ocurred in India and China and these people love to own gold
• Mining costs are increasing
• Red tape and bureaucracy slow down the opening of new mines
• Greenlight hedge fund went from owning GLD (a gold ETF) to owning physical gold
• Currency concerns point to gold good investment
• Politicians are making a lot of mistakes

Even if you are not as sure about the future of gold. I believe that is a solid prudent investment that everyone should make. Even as a hedge that gives you peace of mind. Buying gold can be justified on several levels.

Check out the full original article.