Even we are now in the middle of a correction of a great bull run on gold, I expect this consolidation will take less time to finish than the last correction between mid-2006 to last August.
By the time it is done, we should see gold decisively breaking the $1,000 level at both weekly and monthly charts. Meanwhile, I would like to discuss the new demand driving gold this time which is different than 1970s.
Most of the people refer the current gold bull market as the repeat of 1970s. This is true, especially there are many similarities of price movement between the two. For commodities, at the end of the day, it is demand and supply which drives the prices. I see the demand for gold is more robust now than 1970s. In 1970s, before abandoning the gold standard, gold had been fixed at $35. Once this cap was lifted, we saw gold exploded to over $200 in 3 years. Then there was a severe correction bringing gold back to around $100. After 2 years of correction, similar to mid-2006 to last August, gold again took off in a spectacular run, from $100 all the way to over $800 in 3 years. At the peak of this bull market, people were waiting in line outside the banks to purchase gold. However, in 1970s, the participants were mainly people living in the west hemisphere, particularly in the US, Canada and Europe, with some limited participation from a few other Asian financial centers such as Hong Kong, Japan, Singapore and Taiwan.
This time, I see the participants have been much wider and broader geographically, because the financial market is a lot larger, more global and liquid today than 1970s. It includes the so-called BRIC regions such as Asia (China and India), Eastern Europe (Russia), Latin America, and don't forget about the oil rich Middle East. This should not be a big surprise since these countries such as China have already been the driving force beyond the current boom of many commodities, just look at what has happened to oil, steel, copper, coal, agricultural products, to name a few.
From demand standpoint, the situation of heavy debt consumers in the US may not have as much spare money as 1970s to buy gold this time, however I expect this reduction in demand on individual basis will be more than offset by our now larger population and larger capital base than 1970s. If US dollar falls fast against other foreign currencies, coupled with higher inflation, people in the US will feel a strong need to diversify from paper assets in their nest eggs. They will dump stocks and bonds to purchase gold for protection and safehaven reasons, since commodities, especially gold, will provide better hedge than stocks and bonds in a inflationary environment with falling currency.
There have been some newspaper articles discussing the lost decade by comparing current credit crisis with either 1970s in US or last decade in Japan. There are some differences. US family was actually a lot more affluent then than now. In the 1970s, a single income from a family of 4 could live very comfortably and afford a higher living standard than today. People were not as leveraged, and housing, credit card, auto loan were not an issue at that time. People had a much higher saving rate, more discretionary spending. Interest coverage ratio per average family was much higher, so was the payback ability. Same thing can't be said today. In that sense, it can be argued the current credit turmoil is more painful and difficult than 1970s.
Same thing for Japan in the 1990s. Even more and more Japanese got into the negative housing equity problem due to falling real estate price, as we are facing today, Japanese were never as heavy in debt as us, neither their government. What they chose to do was to use the incomes (both household and banks) to write off the bad loans, year by year slowly and gradually. This is why recession in Japan had prolonged for over a decade, mainly reflecting an inefficient financial system by their government not allowing commercial banks to fail. But this process, even it is long, is less painful short term, as far as there is still net income in the family and net profit for banks.
US will not take the same route as Japan, so I expect the process here will be a lot faster but more painful. Living standard will be lower, assets, especially houses, will lose more value, general equity and bond market will suffer further losses, and inflation will be a lot higher in double digits, at the end of this process. At the same time, I am very pessimistic on the greenback, and see US dollar falling much further in next several years, at least another 25% before we run through the whole process.
This process itself would fuel gold and silver to new all-time highs well into 4 digits. Meanwhile, I see new players not in 1970s mentioned above will drive gold even higher. After many years of gold bear market, in general, investment level in gold is still at a very low level. Let us just look at China. After many years of government controlled market and ration, Chinese citizens have minimum personal assets until recently, let alone gold. This is why you see that China's private and public sectors are already gearing up for increased business in gold trade.
The China Banking Regulatory Commission (CBRC) just issued permits allowing Chinese commercial banks to trade gold futures on the Shanghai Futures Exchange (SHFE). Commercial banks are required to be members of the Shanghai Gold Exchange (SGE), China's sole spot gold trading platform, and the SHFE, before conducting gold futures trading through the SHFE. Chinese commercial banks are spot gold trade dealers, and some of them are granted gold import and export qualification enabling them
participate in the global spot gold trade. All these changes are driven by gold demand from both individual investors and institutions. Due to long tradition of using gold as currency, and modern history of several hyperinflation periods and government changes, Chinese have a strong trust in gold, but not any other paper currencies or assets. The current sluggish stock market probably triggers some rush to invest in the yellow metal. When prices hit a record of $1,030 an ounce recently, people rushed out to buy $300M worth of gold alone in one day. The roughly 10% drop recently does not seem to have dampened enthusiasm among Chinese investors, because they believe there is still lots of rooms for further gains. Meanwhile, many investors are also buying paper gold, a relative new form of gold investment. Figures from the Shanghai branch of the Central Bank show that trade in paper gold products has surged dramatically since the start of the year.
A commonly purchased unit of physical or paper gold in China is one small gold bar, 5 tael, or roughly 6 oz. here. Just do a simple but conservative calculation, 2% of 1 billion people own a single gold bar, it translates to 120 million oz of gold. I think it is a conservative estimate, the ultimate demand in the future including paper gold can be several folds higher cumulatively. Keep in mind that the whole world produces only about 75 million oz gold per year.
Moreover, there is evidence and news China's Central Bank is methodically diversifying its foreign reserves out of the US dollar into other and hard currencies which will include gold, as one of the ways to diversify away from dollar-denominated assets. This kind of activities have been reported by other central banks as well. According to the latest report, China's foreign exchange reserves rose by $118.9B in the first two months of the year to $1.65 trillion. Even a 5% conversion into gold will turn into about 85 million oz of gold, again more than a year's production by the whole world. A 5% in gold is relative small by central bank standard. In 1970s, Central Bank of Taiwan had actually almost all their foreign reserves in gold.
I even see the day when international gold will be quoted in Renminbi along with US dollar and Euro, due to trading activities. China's exponentially growing gold demand alone will influence the gold price dramatically, not talking about other regions. Don't get scared by the current correction on gold. It is a typical and healthy correction before gold assumes its run again.
By Thomas Tan, CFA : See his profile at Vestopia