“The road to hell isn't paved with gold, it's paved with faith. Faith in a dollar that's backed by a belief that people have faith in other people's belief in it.”
- Jarod Kintz, This Book is Not FOR SALE
Through the ages,
men and women have cherished gold, and many have had a compelling desire to
amass great quantities of it - so compelling a desire, in fact, that the
frantic need to seek and hoard gold has been aptly named "gold
fever." Gold was among the first metals to be mined because it commonly
occurs in its native form - that is, not combined with other elements - because
it is beautiful and imperishable, and because exquisite objects can be made
from it.
The fundamental factors
that determine the gold prices are - Central Banks selling and buying large
quantities of bullion metal under monetary policy, International conflicts
& crisis, and the demand for the jewelry by the industry and investors. The
supply of newly mined gold (and thereby cost of mine production) is not a key
factor determining the gold price as mining adds only about one (1) percent to
the total supply each year. Nearly all gold in the world that has ever been
produced is still held in same form; therefore the impact of mining production
on the gold price is practically negligible. In another words, the gold hoarded
as a monetary asset, and is not consumed like other commodities and thus the
gold market, unlike other commodity markets, cannot be in a supply deficit.
Historically,
the 1970’s experienced gold bull market as the US and European economies were
characterized by low growth, high inflation and an unemployment rate. A common
reason cited for holding gold is as a hedge against inflation and currency
devaluation. Currency values fluctuate, but gold values, in terms of what an
ounce of gold can buy, might stay more stable in the long term. Because gold
holds value outside of politics, the world over gold is attractive as a
low-risk, solid investment in the midst of floundering currencies. Further,
increasing national debt and an expansion of money supply made the currencies
less valuable. All these factors led investors to diversify their portfolios
towards material assets, and gold in particular. In the next two decades, the
gold price followed a completely different pattern; the gold market was bearish
from 1980 to 2001 due to an end of the economic stagflation of the 1970s, with
a stabilized economy and controlled inflation. More recently, in year
2008-2009, gold prices dropped due to financial crisis in the US.
Economic/financial crisis leads to asset liquidation and dollar shortage, which
leads to the appreciation of dollar & depreciation of gold. Accordingly
thereafter in the year 2011, gold were at all time high due to the US debt
ceiling crisis.
The
gold prices are consistently falling since mid-June 2012. In late July this
year, the price of gold fell almost 15%, from $1300 in Jan 2015. Following are
the reasons why the Gold is slipping currently:
1) Likely Rate Hike in the US
With
the US Fed likely to raise rates first time in nearly a decade, the fear of
recession in the world's largest economy is easing. Gold does not earn any
interest or dividend. If the US raises rates, interest income from US bonds
will also rise. The relationship between interest rates and the gold is
inverse- implying an increase in interest rate leads to decrease in gold
prices. As a result, investors seek better returns by investing in holding Zero
yield assets, treasury bills or other debt securities. So investors are
preparing to move away from gold to bonds.
Fallout
of the stabilizing US economy is the strengthening dollar which also impacts
the Gold prices. The US dollar index, which tracks the price of the US dollar
against the world’s currencies, has increased by more than 20% in the past
year. The Gold is priced in dollar and a
stronger dollar means lower price of gold.
2)
Geopolitical Stability
Gold is a hedge
against inflation. The easy-money policy after the 2008 crisis led to fears of
high inflation. But inflation stayed low in the US, Japan and Europe. Investors
are now reluctant to buy gold. Furthermore, Iran nuclear deal has reduced
chances of a conflict in the Middle East, and Greece too has avoided default. Greek
bank, after a third bailout package agreement extended a €6.25bn bridging loan
for the cash-starved country. As a result, the Greece economy stepped back from
default possibility. Accordingly, risk-averse investors are comfortable holding
high risk assets that earn better returns instead of holding gold. As
geopolitical risks wane, investors are selling gold.
3)
Lower Demand from Chinese and Indian Central Banks
The
economic boom in China led to huge demand for gold. With the country now facing
an economic slowdown, in the first six months of 2015, demand has fallen by
about 24%, leading to lower prices. China
has increased its gold reserves by 57% to 1658 metric tons in last six year.
People’s Bank of China revealed that it has been buying far less gold than
expected. The analysts were expecting, it would announce reserve holding of at
2000-4000 metric tons (meaning there is a lot more gold in the Chinese retail
market than expected, which otherwise would have gone to the coffers of the
Central bank).
Traditionally
among the largest gold buyers, central banks, especially from emerging
countries, are buying less. But they are piling up dollars to counter outflows
once the US raises rates. India's forex kitty in gold stands at 6%, down from
7%, five years ago.
The
tepid growth of the Chinese economy shows no signs of returning to rapid
growth, and when interest rates do begin to rise; investors will divert more of
their savings away from gold and into interest-bearing ‘safe-haven’ debt
securities. In addition, with gold prices falling, gold ETFs are facing
redemption which is forcing them to sell the yellow metal. This has pushed gold
prices into a vicious cycle. We expect the Gold to remain under pressure in the short
term to medium term.
Indian Scenario
Looking at the
Gold prices in India– the gold prices are determined in the international
market and are denominated in dollars. The gold prices in rupee terms fluctuate
along with the international prices and the foreign exchange rate between the
rupee and the dollar. Thus, the depreciating rupee lends support to the gold
prices here in India despite the gold price meltdown internationally.
The Government of
India plans to issue sovereign gold bonds worth Rs 15,000 crore (US$2.4
billion), in the second half of the current fiscal year. The gold bonds are linked
to the price of gold and provide an alternative to investment in physical gold.
The move will help the government raise funds; and such bond issuance would
result in curbing the demand for gold which in the past had been one of the
main reason for
the current account deficit. As, most of the gold demand in India is met by
importing gold (which is paid in US dollars), it leads to current account
deficit. This scheme is expected to bring the gold which is lying in households
and temples into circulation in the economy. This will in turn help recycling
of domestically held gold and reduce the reliance on jewelers on imported gold.
Conclusion
The CEO of
Barrick, the world’s largest gold miner, once announced that gold is the “default
global currency”. But the question is – is it? Can we pay income taxes with
bars of gold or get a soft drink from a vending machine with a quarter grain of
gold or can we really use Gold for an international travel. In the long run,
with all the dollars that the US has printed, if there is no strong alternative
currency and it’s a total havoc, I prefer a gun instead of a Gold bar.
However, in the
short to medium term, the Gold will continue to be dictated by the likelihood
of interest rate hike in the US and the strength of the US economy and thereby
the Dollar. In addition, the current currency war wherein the major countries
depreciate their currency (Dollar, Yen, Yuan, and Euro) by printing money to
pay off debt will also support Gold prices in the near term. If there are
eventual problems with the Dollar and if the dollar depreciates vis-à-vis the
other currencies, the Gold price in the international market may shoot up but
it may not benefit the Indian consumers that much as it will also mean the price
in rupee terms might not see the same appreciation (due to appreciating rupee).
We believe that Gold prices will stabilize somewhere near the production costs,
in the long run and if the psychological barriers are broken, it may even go
further down.
On a flip side
though, going by the rational of the Gold bulls (‘Gold is money’ camp) - the
price they believe gold should trade for, is equal to the amount of the U.S.
monetary base divided by the official gold holdings of the U.S. Given a
monetary base of $4.0 trillion and official U.S. gold holdings of 8,133 metric
tons this yields a “shadow gold price” of over $14,000 an ounce.
Appendix
Uses
of Gold
Aside
from monetary uses, gold is used in jewelry and allied wares,
electrical-electronic applications, dentistry, the aircraft-aerospace industry,
the arts, and medical and chemical fields
Source: Metals Focus,
ICE Benchmark Administration, World Gold Council
Value
of Gold mined till date
It
has been estimated that all the gold mined by the end of 2011 totaled
171,300 tonnes
(source: World Gold Council). At a price of US$1,100 per troy ounce,
one tonne of gold has a value of approximately US$35.3 million. The total value
of all gold ever mined would exceed US$6.0 trillion at that valuation
Central
Banks buying/selling
On
one hand, China, India and Russia central banks have been buying Gold in bulk while
developed countries are getting rid of the Gold reserves - Switzerland has sold
877 tons over the past ten years, France some 589 tons, and Spain, the
Netherlands, and Portugal have each disposed of more than 200 tons.
Countries with Largest Gold Holdings as on
August 2015:
| Rank | Country | Gold holdings (in tonnes) | Gold's share of forex reserves |
|---|---|---|---|
1
|
United States |
8,133.5
|
74.2%
|
2
|
Germany
|
3,183.4
|
68.0%
|
3
|
Italy
|
2,451.8
|
67.0%
|
4
|
France
|
2,435.4
|
66.2%
|
5
|
China
|
1,658.4
|
1.6%
|
6
|
Russia
|
1,275.2
|
13.3%
|
7
|
Switzerland
|
1,040.0
|
6.6%
|
8
|
Japan
|
765.2
|
2.4%
|
9
|
Netherlands
|
612.5
|
57.7%
|
10
|
India
|
557.7
|
6.0%
|
Source: World Gold Council
Consumption
of Gold
China
and India are driving the world Gold demand.
