But if the global credit crisis and subsequent economic fallout has taught investors one thing, it’s that we are not living in normal times – this evidenced by central banks across the Western World employing quantitative easing measures (with varying degrees of success) to kick start their domestic economies in order to avoid slipping back into recession.
Meanwhile, currency debasement – not least that of the US dollar, which many analysts now argue is in a long-term bear trend – has become the watchword. And with the value of paper declining, gold, unsurprisingly, has consolidated its position as a long-term store of value and the investment of choice.
Yet this doesn’t tell the full story. Indeed, in many ways gold proved to be a sideshow in 2010 – its 28 percent increase in value paling into insignificance against the 97 percent gain for palladium and 80 percent for silver as global industrial demand began to accelerate. While the latter’s price touched a 30-year high of $30.49, the gold-silver ratio, denoting each metal’s relative performance, touched a four-year low, ending the year at 46.0, after having been at 64.9 as of end-2009.
Add into the mix the eurozone debt crisis, culminating in multibillion bailouts for Greece and Ireland, and it isn’t difficult to find the major drivers of investment demand for gold and other precious metals.
Latest available data (Q3 2010) from the World Gold Council illustrates the point. It shows total gold demand at 922 tonnes, an increase of 12 percent from Q3 2009. In value terms, demand grew 43 percent to $36.4bn over the same period. Demand for gold jewellery increased by eight percent from Q3 2009 (a record $137.5bn in value terms), with four of the best performing markets – India, China, Russia and Turkey – accounting for 63 percent of global demand.
Elsewhere, retail investment rose 25 percent (from Q3 2009) to 243 tonnes – the largest contribution to total demand growth coming from bar hoarding, which increased 44 percent from the previous year.
The total value of net retail investments during the quarter was a record $9.6bn, representing a 60 percent increase from Q3 2009.
However, total gold ETF (Exchange Traded Funds) demand fell by seven percent from Q3 2009 to 39 tonnes, following a surge in the previous quarter due to heightened sovereign risk and ever-present currency worries.
Industrial demand has now recovered back to pre-crisis levels of 110 tonnes, reflecting an increase of 13 percent from Q3 2009 – the recovery having been driven by improving demand for consumer electronics goods globally, in particular from emerging markets such as China and India, as well as an increased range of new technology products with gold components.
Despite the largely positive fundamentals, Charlie Morris, who manages HSBC Global Asset Management’s Absolute Return Service, errs on the side of caution. Thusfar the bank has maintained a significant position in the metal for three reasons. First and foremost it is seen as a ‘value trade,’ where the long-term target, according to the bank, is $2,600/oz – based on comparisons to commodities, money supply, inflation and other real assets. However this target could take several years to be realised.
Secondly, structural demand exceeds supply with a queue of potential buyers ranging from central banks to private individuals, but a relatively tight supply from the mines. Therefore, falls in the gold price are likely to be limited by supportive buyers.
Finally, the behavioural characteristics have been more attractive than either equities or other commodities, as gold has lower volatility, high liquidity and offers diversification benefits due to its low correlation.
“That said, following the strong rise in price, the correlation with generic ‘risk assets’ has increased and so the diversification benefits have slipped away at a time when it is quite extended from trend in dollar terms,” says Mr Morris. “We have therefore taken the prudent course of action and halved our position in gold bullion to six percent to reflect the fact that we remain bullish over the long term but acknowledge that gold has run ahead of itself at a time when the diversification benefits have become less obvious.”
Meanhile Tom Kendall, gold analyst at Credit Suisse, believes fears over the past year of currency debasement, political upheaval and inflation – resulting in substantial flows of money moving into gold from institutional and private investors – will continue in 2011, albeit at a more sedate pace.
“We expect most of those concerns to persist through 2011,” he says. “The forecasted creeping rise in US interest rates, particularly at the long end of the curve, would pose a challenge to higher USD gold prices were we in a more ‘normal’ global environment.”
“However, although we expect the recovery in global industrial production and fixed asset investment to continue, financial markets are likely to remain ‘sub-normal’ for some considerable time to come,” he says.
Despite US interest rates expected to begin creeping up, Mr Kendall says short term interest rates in real terms are expected to remain near zero or negative. Both factors should help feed bullish gold market sentiment.
Inflation will also continue to feature high on the list of gold investors’ concerns in 2011.
While gold is by no means an exclusively macro-economic play, flows in the physical markets remain hugely relevant to understanding both price direction and, in particular, support and resistance levels. And with central bank/sovereign funds expected to be net buyers of significant volumes in 2011 – for the first time in many years – the bullish portents remain good.
Mr Kendall argues that not only has gold re- established strong credibility as a reserve asset over the last two years, he also believes there has been more of a ‘generational’ shift in thinking rather than a temporary change in sentiment.
The investment bank, which says the gold bull market will persist into a tenth year in 2011; is forecasting an average price for the year of $1,490/oz but expects it to trade above $1,600 at some point before year-end.
Like Mr Kendall, currency debasement is a theme taken up by Suki Cooper, precious metals analyst at Barclays Capital. In its 2011 Outlook, issued in January, BarCap is forecasting the price of gold to average $1,495/oz, with a high of $1,620.
“We expect investment demand to propel gold prices to fresh record highs this year,” says Ms Cooper – this based on a clouded macro environment against a backdrop of low interest rates, growing uncertainty surrounding currency debasement and medium-term inflation fears, as well as geopolitical tensions continuing to stoke investors’ appetites for a portfolio diversifier and a safe haven.
Conversely, jewellery demand is expected to weaken, though scrap supply will likely respond to higher prices, resulting in a notional gold surplus. However, the bank expects this to be absorbed by investment demand.
Looking ahead, the elephant in the room will remain, as ever, China – the Beijing authorities in December raising one-year lending rates and the one-year deposit rate by 25 basis points to 5.81 percent and 2.75 percent respectively.
The rate increases – the second since mid-October – had been flagged well in advance after Chinese leaders announced in early December a shift to a ‘prudent’ monetary policy from a ‘moderately loose’ one in response to inflation hitting a 28-month high in November of 5.1 percent.
Market consensus is for three further rate hikes of 25 basis points this year.
For gold, higher interest rates may negatively hit domestic demand as it raises the opportunity cost of holding the metal. And that may have an effect on the market more generally in terms of gold’s price potential on the upside.
Despite tighter monetary conditions in China, demand for high tech goods and electronics due to the metal’s well-known resistance to oxidative corrosion and excellent quality as a conductor of electricity should provide some price underpinning.
Moreover, the People’s Bank of China issued guidelines in August 2010 outlining the further development and deregulation of the domestic gold market – the implication being that the Chinese government is supportive of investment in gold. Despite changing macroeconomic conditions in the interim there is little likelihood of the government retreating from this stance in the short to medium term at least.
On the industrial front, global mine supply, after years of underinvestment in the 1980s and 1990s, has failed to respond to record high nominal prices in the interim. Expectations are for little likelihood of this changing for the next several years at least – an imbalance that may be further aggravated as advancements in nanotechnology, as well as environmental and biomedical applications, lead to greater demand for the yellow metal.
