Gold Outlook 2011: Irreversible Upward Pressure And The China Effect

In some parts of the world gold is viewed as the protector of wealth. In North America, gold is viewed as a speculative investment. Our economists regard a rising gold price as an admission of defeat, and their disparaging attitude toward higher gold prices took on a more desperate tone in 2010. Nevertheless, gold had another remarkable year, up 25% in 2010, its tenth straight annual gain. Meanwhile, over the same 10-year period, five major currencies – the US and Canadian dollars, the euro, the British pound and the yen – have lost between 70% and 80% of their value. In reality, gold is not rising; currencies are falling in value, and gold can rise as far as currencies can fall. Nick discusses the three dominant medium-term trends that pushed up gold prices in 2010 (central bank buying; movement away from the US dollar; China) as well as three longer-term, irreversible trends that will put upward pressure on the gold price for years to come (the aging population; outsourcing; peak oil). In addition to these trends, more and more investors will be competing to buy a shrinking gold supply. As safe-haven demand accelerates, there will be a transition from the $200-trillion financial asset market to the $3-trillion aboveground gold bullion market. About half of that $3 trillion is held by central banks as reserves; the remainder is privately held, and not for sale at any price. If the world’s pension and hedge funds moved only 5% of their assets into gold, it would trade at over $5,000 per ounce. Nick’s conclusion: Without any new financial crises, both mid- and long-term trends indicate that gold – and silver – will continue rising through 2011 and well beyond.

What Drives the Price of Gold?

Writing for Investopedia, author Jean Folger takes a look at what factors have been driving the price of gold, which is currently trading at record highs.

Central Bank Reserves

Central banks hold paper currencies and gold in reserve. The World Gold Council has stated that central banks have recently become net buyers of gold, the first time this has happened in decades. As the central banks diversify their monetary reserves – away from the paper currencies they’ve accumulated and into gold – the price of gold rises. Many of the world’s nations have reserves that are composed primarily of gold, including the United States, Germany, Italy, France, Portugal, Greece and the Euro area. China has publicly sated that they would like to acquire at least 6000 tonnes of gold

Value of the U.S. Dollar

The price of gold is generally inversely related to the value of the United States dollar: a stronger U.S. dollar tends to keep the price of gold lower and more controlled; a weaker U.S. dollar is likely to drive the price of gold higher. This is because people have a tendency to invest and trade in dollars when the dollar is strong. During times of economic uncertainty and when the dollar is weak, however, people prefer to invest in gold. The massive debt and money printing in the US indicates that further devaluation of the dollar will continue for the foreseable future, thus driving the price of gold higher.

Worldwide Jewelry and Industrial Demand

In 2010, jewelry accounted for approximately 54% percent of gold demand, which totaled 3,812 tonnes, according to the World Gold Council and The London Bullion Market Association. India, China and the United States are the largest consumers of gold for jewelry in terms of volume. Another 12% of demand is attributed to medical and industrial uses for gold, where it is used in the manufacturing of medical devices like stents and precision electronics like GPS units. Gold prices can be affected by the basic theory of supply and demand: as demand for consumer goods such as jewelry and electronics increase, the cost of gold can rise.

Wealth Protection

During times of economic uncertainty, as seen during the recession of the late 2000s, more people turn to investing in gold because of its enduring value. Gold is often considered a “safe haven” for investors during uncertain times. When the expected or actual returns on bonds, equities and real estate fall, the interest in gold investing increases, driving up its price. Gold can be used as a hedge against currency devaluation, inflation or deflation. In addition, gold is viewed as providing protection from political instability, as evidenced by the recent unrest in the Middle East and North Africa (MENA), which may be partly responsible for gold’s recent rally to new highs.

Gold Production

Major players in worldwide gold mining include China, South Africa, the United States, Australia, the Russian Federation and Peru. The world’s gold production affects the price of gold, another example of supply and demand. Gold mine production increased by about three percent in 2010 to about 2,652 tonnes. Despite this small increase, however, gold mine production has been in a decline since the early 2000s. One factor is that all the “easy gold” has already been mined; miners now have to dig deeper to access quality gold reserves. The fact that gold is more challenging to access raises additional problems: the miners are exposed to additional hazards, and the environmental impact is heightened. In short, it costs more to get less gold. These add to the costs of gold mine production, resulting in rising gold prices.

The Bottom Line

We have long been, and will likely continue to be, enamored by gold.  The demand for gold for wealth preservation and portfolio protection, the amount of gold in the central banks’ reserves, the value of the U.S. dollar and the desire to hold gold as a hedge against inflation and currency devaluation, all help drive the price of gold, one of the world’s precious metals.

BMG Bullion President and CEO, Nick Barisheff, recently gave a speech at the Empire Club in Toronto, where he talked about the irreversible upward drivers for gold and his outlook for the market in 2011. To view the transcript of Gold Outlook 2011: Irreversible Upward Pressure And The China Effect .

Gold at Record Highs

Gold may extend its record to as high as $2,500 an ounce in the next year if sovereign debt concerns escalate, Citigroup Inc. said.

The metal climbed to a record $1,921.15 an ounce on Sept. 6 as concerns about debt crises and slowing economic growth boosted demand for a protection of wealth. The metal could “briefly spike” to between $2,000 and $2,500 in the next 12 months and will likely stay above an average $1,200 a year in the long-term, Citigroup predicts.

Bullion is headed for an 11th straight annual gain, the longest winning streak since at least 1920 in London. The metal is up 27 percent this year as investors seek to diversify away from equities and some currencies. Investors’ assets in exchange-traded products climbed to a record 2,216.8 metric tons last month, more than the holdings of all except four central banks, data compiled by Bloomberg show.

“The threat to the global financial structure during the credit crisis has led to high net-worth individuals seeing gold as an insurance against such instability in future,” a team of analysts including London-based Jon Bergtheil wrote today in a report. “This insurance role will likely continue to assist demand while concerns remain about sovereign risk and the longer-term issue of whether the dollar will still be the world’s reserve-currency in 5-10 years time.”

Gold for immediate delivery traded at $1,806.60 an ounce by 10:37 a.m. in London. The metal will average $1,650 next year, the bank said. – Bloomberg

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