The Conversation (0)
Looking forward into the next few decades, the relative position of the US is expected to change as the economic power and geographical base shifts towards faster growing emerging economies, particularly in Asia.
Gold prices were discussed in a recent interview on BNN with Marcus Grubb, Managing Director of Investment for the World Gold Council. Mr. Grubb’s investment thesis on gold price determinants underscores considerable focus on the US, reflecting its economic and financial weight and the US dollar’s role as the major reserve currency for the international economy. Moving beyond some of the near term solvency problems in the US, global austerity issues and debt contagion in Europe, a fundamental long run relationship between the price of gold and demand would provide investors with valuable context and insight. Looking forward into the next few decades, the relative position of the US is expected to change as the economic power and geographical base shifts towards faster growing emerging economies, particularly in Asia.
Inflation outlook
Asian markets, most notably China and India, have traditionally long track records of strong demand for gold, both as a store of wealth and for jewellery. Increasing income and wealth levels in the region have resulted in sharp increases in gold demand. The potential implication of this increasing demand is that the price of gold would appreciate faster than the rate of US inflation, generating a positive rate of return. Additionally these countries historically have higher levels of inflation than demonstrated in developed countries, and the need to protect the real value of wealth against this may increase demand further.
As well as rapidly growing demand, the increasing cost of mining may have a significant impact on the market going forward. With the assumption that all easy sources of gold are exhausted, rising production costs are likely to limit supply if prices fall back too far from their current high levels.
This scenario was exhibited most recently with Barrick Gold Corp. (TSX:ABX). The world’s biggest gold miner reported strong earnings as the result of surging precious metal prices, improving payback prospects for several massive gold projects that are in development. However, the company said that currency moves, along with higher material, energy and labor expenses are factors which may lead to decreased production levels. Given the competitive nature of the markets, these multiple supply limitations can prove to be catalysts for gold price appreciation and may result in the value of gold rising, in real terms, over time.
Deflationary case
Any major global financial shock that could plunge most of the world into a period of deflation might be compared with the example of Japan in the 1990s. Mr. Grubb suggests a wave of sovereign defaults occurring in the peripheral eurozone countries could create relatively large marginal losses for creditors and corresponding declines in asset values. Inter-linkages in the global financial sector and the prominence of the eurozone would imply international exposure to a financial disturbance on any scale.
Under this scenario the price of gold would receive a major initial boost due to the sharp rise in financial stress. Combining the stress with a greater monetary loosening would intensify the effect of a stronger dollar and real interest rate movements into positive territory due to deflation and the initial upward pressure on bond yields resulting from a reduction in government creditworthiness. Meanwhile, as riskier asset classes— particularly real estate and equities— would underperform, cash and bonds should yield slightly positive returns.
A portfolio manager’s view
Further commentary on current and future gold prices was supported by Frank Holmes, the Chief Executive Officer at US Global Investors (NASDAQ:GROW). Mr. Holmes explained, “to simplify things for investors . . . there are two demands that are part of this gold equation. One of these is the fear trade, which captures most of the attention of the media of Europe and [North] America, but there is also this love trade. The love trade relates to 50 percent of the world’s population[‘s] belief in giving gold to the ones they love.” Although most of the attribution goes to the fear trade, “when you add this fear trade and this love trade, showing up at the same time in this window, we see all time highs in the price of gold.”
Securities Disclosure: I, Dave Brown, hold no direct investment interest in any company mentioned in this article.