Gold Prices turned higher a decade ago, and haven’t stopped since. Why…?
HINDSIGHT is always a satisfying exercise, because you have all the facts, you know what happened eventually and you simply have to find the reasoning now established by history, writes Julian Phillips in his Gold Forecaster.
Forecasters can be thus judged efficiently as to whether they were right or wrong only in the light of history after the event. Whereas forecasting at the time is an entirely different matter, because you have no facts from the future. What you do have is the past and the present. Now you have to extrapolate these forward to construct tomorrow’s picture.
Forecasting requires giving each present fact its due portion in that future and its correct weighting together with a good dash of insight. Hopefully you will do the job well and be correct. This may sound simple but it isn’t. To help you look forward we look at the last decade in the gold market.
Take the Gold Price. From 1985 despite all the good pointers to higher prices, few foresaw the vigor of the attack by the world’s monetary authorities on gold and yet that was the prime influence on the Gold Price.
When 1999 came most believed the all the world’s central banks were keen to sell all the gold they had to get this barbarous relic out of their vaults. Then came the "Washington Agreement". On the surface looked as though it followed the line of thought that central banks would continue to be unrestrained sellers. Britain appeared to confirm that picture as it sold half its reserves at the lowest price seen since then. This point in time and price is affectionately known as the "Brown Bottom" of gold, after the then-Chancellor of the Exchequer, Gordon Brown. What seemed an innocuous agreement simply limited the volume of sales per annum to 400 tonnes from all the signatories put together.
What was understood only later was that this cap on sales removed the fear of unlimited sales. The signatories felt that this limitation would protect gold producers from seeing a lower Gold Price and deter future gold production. But significantly, this limitation on "Official" supplies went further than this, it reassured the market that not only was the Gold Price underpinned but "Official" supplies were capped. The intention of the Agreement was to hold the market steady at those prices.
A further look at the demand / supply numbers showed that if demand rose, total supply would not increase. Traders demonstrated this when they went long and took the Gold Price from just over $300 to $390 and then took it back down again to $326. This was enough to scare the Gold Mining companies that had hedged their future gold sales. They soon realized how quickly the hedges they had could become very unprofitable as the Gold Price rose. Suddenly gold miners themselves saw that the Gold Price would fall no further so there was no point in continuing to hold them.
De-hedging started and the miners went to the market to buy back their hedges. This allowed them to make money as the Gold Price rose. Cutting these hedged positions realized profits there and removed potential losses. This was done in such high volumes, right through to 2010, that it accounted for almost the entire amount of gold sold by the signatories to the Washington Agreement and its successor, the Central Bank Gold Agreement – around 400 tonnes per annum.
So supply was limited to newly mined gold, which could not rise quickly for the easily mined deposits had gone. It takes around 5 years from the discovery of gold in the ground to taking that gold out of the ground and to market.
Over the years the Gold Price slowly rose on the back of the traditional demand such as India and the jewelry trade. Then came the accelerant, the gold Exchange Traded Fund (conceived by the World Gold Council’s James Burton). This allowed various types of funds to Buy Gold via the shares of the ETF, which bought gold with the proceeds of the sale of these shares, and thus directly impacted the Gold Price, while avoiding the corporate risks attendant on mining companies. Funds such as these had not been allowed to hold bullion itself, until then. These were brand new investors bringing a new type of gold demand to the market from the States. Until then traditional investors in gold bought bullion direct from the London gold market, had the costs and difficulties in storing bullion, which precluded other types of investors from being in the market. So great was the impact of this new demand that these funds in total now hold more than the central banks of Switzerland and China do.
Nevertheless the market was still focused on traditional demand as being the mainstay of the gold market and controlling the Gold Price. They still do today. It is a commonly held belief that investment demand will vanish as quickly as it came. Then we will see the Gold Price turn back to India and jewelry demand at prices well below today’s price.
But investment demand extended from primarily US fund demand to a much wider type of investment demand. The reason was because of an underestimated fundamental that most commentators ignored and rejected. As in 1999 the precipitant turned out to be the European central banks. The second European central bank gold agreement saw the ceiling of 500 tonnes hit only once or twice during its 5 year life.
In the last years of the agreement the sales started to drop quickly. In the last year of the agreement the sales tailed off steadily in the first and second quarter of that year until in the last quarter hardly any gold was sold by them whatsoever. In the first year of the Third Agreement, sales have been close to zero (with 6.2 tonnes sold for coinage – not in the spirit of the agreement). What should we learn from this? The sales had done their job of supporting the advent of the Euro on the world’s foreign exchanges, obviating the need for further sales. The first clause of all the Agreements stated that "gold would remain an important reserve asset". Gold would remain in the firm grip of central banks from then onwards in Europe. In itself it reassured investors that when the dark days arrived gold would have a use in the monetary world.
Now came another shot in the arm for gold. Asian central banks and Russia started to Buy Gold and seriously. The implication was that gold would have a use in times of monetary stress. In itself this meant little, but once the US Dollar started to weaken against the Euro, confidence in the world’s leading reserve currency began to falter. Currency values had become vulnerable to falling. Gold rose when currencies fell and the safety of ones wealth came under pressure.
For eighteen months gold had difficulties in rising beyond $1,200 for a variety of reasons. But then the transition of gold from a ‘commodity’, an industrial metal, a piece of non-corroding decorative jewelry, to an investment people with money buy, came about.
The falling Dollar, the various Sovereign debt crises, future currency crises, deflation, potential inflation or even hyperinflation appeared on the horizon, each persuading investors that gold was a good place to keep hold of one’s wealth. The days of monetary stress have arrived.
From now on gold’s evolution will be the most vigorous of its several stages of development. We are on the edge of a whole new way of looking at gold and its relevance in the global economy.
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