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Three of the world’s four richest investors are batting for gold, so the wonder is why its price isn’t a lot higher.
It is hovering around $US1775 an ounce and well below its record just over a year ago of $US1923; bullion has yet to beat its 1980 peak of $US2467 in today’s dollars.
Billionaire hedge fund traders including George Soros, who two years ago called gold “the ultimate bubble” at $US1275 an ounce and subsequently sold down his holdings, and John Paulson, who famously bet against sub-prime mortgages before they imploded, have lifted their holdings of gold substantially through exchange-traded funds.
These are low-fee managed funds listed on the New York Stock Exchange, which invest in bullion, tracking its price cent for cent.
Paulson’s own hedge fund is reportedly 44 per cent gold.
Ray Dalio, founder of Bridgewater Associates, the world’s biggest hedge fund, is also buying gold – in his case more to diversify than take a punt.
The dissenting billionaire is legendary investor Warren Buffett, who argues that if the global economy is going to collapse, buying a cave would be better.
Either way many analysts expect the price to reach $US2000 sometime soon.
“We said 2012 was always going to be a modest year; we think next year will be a cracker,” says the chief executive of London-based bullion broker Sharps Pixley, Ross Norman, who in January predicted an average gold price of $US1765 this year. “If you look over the last 60 years there’s been a ratio, a slow glacial movement between equities and gold and back.”
He expects it to rise to $US4000 “over the next four to six years” due to monetary easing by central banks, especially the US Federal Reserve’s so-called quantitative easing (QE).
Designed to stimulate lending and spending, QE is de facto money printing as the Fed credits banks’ accounts with it by buying securities.
Greg Canavan, editor of Sound Money, Sound Investments says in the next few years $US5000 is “entirely reasonable” because “gold is the only unencumbered asset in the financial system. It’s the only asset on central bank books that isn’t someone else’s liability.”
Previous QEs boosted the gold price. It rose 70 per cent between the introduction of QE1 in December 2008 and the end of QE2 in June. The QEs have come hand in glove with near zero official interest rates, which not only reduce the opportunity cost of holding gold – the lack of income becomes less of a problem when the alternatives pay next to nothing – but also make it easier for speculators.
Central banks lending gold to the market at almost zero interest rates is an attractive leveraged play.
The third QE, dubbed QE Infinity by stint of being open-ended, has already triggered another rally in the past month.
But Norman anticipates some profit taking with the catalyst for the next gold run being the fiscal cliff in the US, which comes to a head in the new year. This is the confluence of mandated spending reductions and tax increases as earlier cuts expire.
Unless there is a compromise in Congress in the offing, the combination would shrink the US economy by 4 per cent in 2013.
The uncertainty surrounding the fiscal cliff is bound to help gold, although such a deep recession would likely rule out inflation for years to come.
Because its proponents view gold as an alternative currency, and often have an apocalyptic view of the fate of fiat money and hyperinflation, forecasts of its price can run into tens of thousands of dollars, as one analyst points out.
Yet in a scenario of rising inflation, interest rates should also rise, increasing the opportunity cost of holding gold and eventually capping its price. In any case, US government bonds have already become an unlikely rival safe haven to gold.
With little practical value, and most supply tied up in central bank vaults, gold is the most speculative commodity of all.
As one gold analyst says off the record of its appeal “who knows where it will go? That’s its appeal.”
By the same token, price trends can extend over decades. Gold took 10 years to reach its peak – unbeaten in real terms – in 1980, and its subsequent collapse lasted 20.
“Gold has been in a current uptrend for the best part of 11 years but history tells us that trends in gold can persist,” says Forex.com research director Kathleen Brooks.
But not even the most bullish expect gold will rise in a straight line. One dampener could be the US elections.
Norman points out that gold has risen an average 17 per cent a year since its bull run started in 1999 but the three election years of 2004, 2008 and so far 2012 were conspicuous underperformers.
The intriguing twist this time is that the Republicans are campaigning on a return to the gold standard.
This may not have traction as an election issue but it coincides with a little publicised proposal under the new Basel III international banking regulations, which could become the basis for a de facto gold standard.
Under the new rules, the status of gold held by banks would be elevated from a Tier 3 asset, where holdings are discounted by 50 per cent to Tier 1 capital.
“Holding $1 million in gold was counted as half, now it’ll be one for one,” says Coates.
In effect gold would be the same as cash as a form of money. The US Federal Reserve has said it will adopt all the Basel III capital proposals.
Whether the change will be attractive to banks remains to be seen. While gold earns no income, a rise in its value would boost a bank’s capital allowing it to lend more.
But even if it doesn’t boost bank demand for bullion, this imprimatur will certainly give it street cred among investors.
Financial planners and super fund managers have come around to holding bullion, previously viewed as too speculative with no investment return, because it diversifies a portfolio and moves independently of shares and other markets.
An increasing number of financial advisers recommend holding about 5 per cent of a portfolio’s value in bullion.
UBS Wealth Management goes further, suggesting holdings of goldmining shares, bullion ETFs and a gold fund such as Baker Steel Gold as well.
At the very least there seems to be a floor under the gold price.
A solution to the debt problems of Europe and the US seems years away, which will feed market uncertainty to the benefit of gold.
Tensions in the Middle East, especially surrounding Iran, and the higher oil prices as a result also underpin the gold price.
The costs of extracting ore are rising globally as energy costs soar.
This is compounded by ageing mines along with deteriorating ore grades and labour disruptions in South Africa, and the lack of major new discoveries.
On the demand side, the major positive is that central banks, alarmed at the prospects for the US dollar trapping them in a depreciating reserve currency, have become net buyers of gold. They were partly responsible for its slump when they were net sellers for a long period.
The game-changer for gold has been the meteoric rise of exchange traded funds, which make it easier to hold bullion.
The biggest, the SPDR Gold Fund based in New York, has gold reserves of $US76 billion, which is more than China’s.
The fund has been a conduit for the rising gold price because it must purchase bullion when it has more buyers than sellers.
The fact that there were no large outflows when gold corrected in the last half of last year suggests its holders are long-term investors, providing another prop for the price.
But not everything is going gold’s way.
For all the money printing of central banks, the global economic threat isn’t inflation but deflation.
Eventually this will change when deleveraging by households conclude, spending picks up and banks finally lend against their swollen accounts with central banks.
Even then, at some point once the global economy picks up, central banks will need to lift interest rates. If they leave it too late, inflation will take off, forcing rates up anyway.
More immediately, India attempted to double the import tax on gold. Finance minister Pranab Mukherjee was reported as calling it a “dead asset” and urging more financial literacy “so people will invest in market instruments” such as shares and bonds.
Indian households are the biggest non-central bank gold buyers.
The high price has also dampened the demand for gold jewellery.
Broking analysts forecast a long-term gold price of $US1250 an ounce, which they expect it to reach around 2017, a report by Goldman Sachs found.
“Most of the gold ever mined is still available (it has not been consumed), which is clearly a very large number,” the report says.
Central banks hold about 31,000 tonnes and taking annual production as a measure of demand – whether for speculation or jewellery – at just a fraction of a tonne it can be argued there’s a huge oversupply.
But Goldman Sachs concludes traditional demand and supply analysis is meaningless for gold because it hinges so much on speculation and can be considered an alternative currency.
Even so it forecasts a drop because real interest rates in the US are likely to turn positive in 2014. At the same time it points out that the link between bullion and negative real interest rates in the US failed to materialise in the June quarter.