Investing in Gold: 2011

Global Currency Debasement.The US dollar is fundamentally and technically very weak and could fall dramatically. However, other countries are very reluctant to see their currencies appreciate and are resisting the current fall of the US dollar. Thus, we could be in the early stages of a massive global currency debasement, which may see tangibles, and most particularly Gold, rise significantly in price.
Invest Demand. Many experts believe that, when the retail investing public recognizes what is unfolding, they will seek an alternative to paper currencies and financial assets and this will create an enormous investment demand for Gold. Under such circumstances, it may be prudent to own both the physical metal and select mining shares.
Financial Deterioration in the US. In the space of a few years, the United States Federal Government budget surplus has been transformed into a yawning deficit, which has all the signs of persisting. At the same time, the current account deficit has reached levels which historically portend continued weakness in the United States.
Dramatic Increases in Money Supply in the US and Other Nations. US authorities are concerned about the prospects for deflation given the unprecedented debt in the US. Fed Governor Ben Bernanke is on record as saying the Fed has the ability to issue new currency and will use it to combat deflation if necessary. Other nations are following in the US’s footsteps and global money supply is accelerating. Historically, this can create a very “Gold friendly” environment.
Existence of a Huge and Growing Gap between Mine Supply and Traditional Demand. Gold mined is roughly 2500 tonnes per annum, and traditional demand (jewellery, industrial users, etc.) has continued to exceed this by a considerable margin for a number of years. Some of this shortfall has been filled by Gold recycling, but selling from various Central Banks has been a primary source of above-ground supply.
Mine Supply is Anticipated to Decline in the next Three to Four Years. A combination of traditional demand continuing to exceed mine supply, buying prompted by ongoing worldwide economic weakness, and an expected decline in mine supply, may very well lead to greater mid-term shortages. Mine supply will contract in the next several years, irrespective of Gold prices, due to a shift away from high grading (which was necessary for survival in the sub-economic Gold price environment of the previous five years), and the natural exhaustion of existing mines, and environmental pressures on cleaner mining processes.
Large Short Positions. To fill the gap between mine supply and demand, Central Bank Gold has been mobilized primarily through the leasing mechanism, which facilitated producer hedging and financial speculation. Some evidence suggests that between 10,000 and 16,000 tonnes (perhaps as much as 30-50% of all Central Bank Gold) is currently in the market. This is owed to the Central Banks by the bullion banks, which are the counter party in the transactions.
Low Interest Rates Discourage Hedging. Interest rates are low. With low rates, there isn’t sufficient impetus to create higher prices in the out years. Thus there is incentive to hedge and Gold producers are not only not hedging, but are reducing their existing hedge positions, the resultant effect of which is removing Gold from the market.
Rising Gold Prices and Low Interest Rates. Discourage Financial Speculation on the Short Side. When Gold prices were continuously falling and financial speculators could access Central Bank Gold at a minimal leasing rate (0.5 – 1% per annum), sell it and reinvest the proceeds in a high yielding bond or Treasury bill, the trade was viewed as a lay-up. Everyone did it and now there are numerous stale short positions, which must be filled with actual purchases. However, these types of trades now no longer make sense with a rising Gold price and declining interest rates.
The Central Banks are Nearing an Inflection Point when they will be Reluctant to Provide more Gold to the Market.Far Eastern Central Banks who are accumulating enormous quantities of US Dollars are rumored to be buyers of Gold to diversify away from the US Dollar.
Gold is Increasing in Popularity. Gold is seen in a much more positive light in countries beginning to come to the forefront on the world economic scene. Prominent developing countries such as China, India and Russia have been accumulating Gold. In fact, China with its 1.3 billion people recently established a National Gold Exchange and relaxed control over the asset. Demand in China is expected to rise sharply and could reach 500 tonnes over the next few years.
Gold as Money is Gaining Credence. Islamic nations are investigating a currency backed by Gold (the Gold Dinar). The new President of Argentina proposed, during his campaign, a Gold backed peso as an antidote for the financial catastrophe which his country has experienced, and Russia is talking about a fully convertible currency with Gold backing.
Limited Size of the Total Gold Market Provides Tremendous Leverage. All the physical Gold in existence is worth somewhat more than $1 trillion US Dollars while the value of all the publicly traded Gold companies in the world is less than $100 billion US dollars. When the fundamentals ultimately encourage a strong flow of capital towards Gold and Gold equities, the trillions upon trillions worth of paper money could propel both to unfathomably high levels.

Conclusion

Gold is under-valued, under-owned and under-appreciated as an investment tool. It is most assuredly not well understood by most investors. At the beginning of the 1970’s when Gold was about to undertake its historic move from $35 per oz to $800 per oz in the succeeding ten years, the same observations would have been valid.

The only difference this time is that the fundamentals for Gold may be better.