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What Will Drive Gold Price Higher?

April 10, 2008
Thomas Tan, CFA

Thomas Tan, CFA

0 followers
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

About the author:

Thomas Tan, CFA
GuruFocus - Stock Picks and Market Insight of Gurus

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Comments

DaveinHackensack
DaveinHackensack - 6 years ago
For what it's worth, Thomas, Jim Cramer agrees with you that this is just a temporary pull back in the gold bull market. He sees gold going to $1600 per ounce.

gav_sharma
Gav_sharma - 6 years ago
Cramer is a foooolll
kfh227
Kfh227 premium member - 6 years ago
"What Will Drive Gold Price Higher?"

Late night infomercials.

kfh227
Kfh227 premium member - 6 years ago
gav_sharma Wrote:

-------------------------------------------------------

> Cramer is a foooolll


He is mad alright. And a pathetic investor. Hjis popularity is simply due to his speaking ability and enthusiasm. Those two talents a a dollar will often get you a donut. He's lucky to be successful and there is not much more to say about it. He is equivalent to a lottery winner, but he actually has to"work".
commodity
Commodity - 6 years ago
Jim Rogers is a commodities expert.

I take his advice.I get it for free.

His record is unreal.Study it.

People tell you that gold is going to 2000

and then want to sell you some.

If they really knew it was going to 2000

then WHY are they selling it to you?
ccyork
Ccyork - 6 years ago
I agree Jim Rogers is a great investor.

He has recently said that gold will continue to rise and he will buy more after it corrects, but not now.
DaveinHackensack
DaveinHackensack - 6 years ago
"He is mad alright. And a pathetic investor. Hjis popularity is simply due to his speaking ability and enthusiasm. Those two talents a a dollar will often get you a donut. He's lucky to be successful and there is not much more to say about it. He is equivalent to a lottery winner, but he actually has to"work"."

When you offer opinions on as many things as Cramer does, you're going to be wrong a lot of time. I certainly don't agree with everything Cramer says; as I mentioned on the small cap values board recently, I went against Cramer's recommendation on PCR (See "Bucking the Lighting Round: Jim Cramer versus PCR"). But Cramer is worth listening to, if for nothing else than as a barometer for the market.

Next time you're in Barnes & Noble, you ought to pick up a copy of his autobiography, "Confessions of a Street Addict" and read the first 70 pages or so, to learn about Cramer's background and how he made money at his hedge fund (it's not a way you or I would be able to replicate, but it's worth reading nonetheless). Cramer himself acknowledges that he's been lucky (particularly by being befriended by Marty Peretz when he was at Harvard), but it's clear that someone that hardworking, smart, and driven would have been highly successful regardless.

"He has recently said that gold will continue to rise and he will buy more after it corrects, but not now."

Has Jim Rogers said what price he'd buy more gold at and what his long-term price target for gold is? Does Rogers ever get specific like that?

John Krantz
John Krantz - 6 years ago
Cramer is no fool. Very smart guy.

He is just not in the business of making ordinary investors money. He is in the business of pumping stocks for himself and his hedge fund buddies.

http://www.footnoted.org/urge-to-merge/booyah-dissecting-jim-cramers-new-contract/

""Finally, there was a personal note about Cramer’s current marital status. In Cramer’s last contract, there was a clause that permitted Cramer’s wife, Karen Backfisch-Olufsen “to engage in extensive securities activities.” In the new contract, the word wife was removed and replaced with the words, “any Cramer family members (including any spouse)”

Ya really think its his wife picking those stocks in "extensive securities activities"? wink, wink.
DaveinHackensack
DaveinHackensack - 6 years ago
"Ya really think its his wife picking those stocks in "extensive securities activities"?"

His wife co-ran his hedge fund, and it was her idea to go to cash right before the 1987 crash, so I wouldn't be surprised if she has her own ideas about picking stocks. Again, read the first part of Cramer's autobiography. It's in there. If your suggestion is that he's going to tell her ahead of time what stocks he's going to mention on the show, and then she'll buy them right before the show and dump them after he mentions them -- I doubt it. He's got plenty of money as it is, and that would probably be illegal and not worth the risk.
John Krantz
John Krantz - 6 years ago
But this is the same Cramer who admitted manipulating markets and trading on insider info when he ran his hedge fund, and then tried to take it back when the SEC threatened him. Not the most ethical thing to do there. Going by his own autobiography isn't exactly unbiased info.

Call my cynical, but I operate by the rule that most anyone who makes a living promoting shares has ulterior motives, if they were so good at market mastery they would just make a living doing that. I'm sure his wife knows what she is doing too, maybe he helps her out? I would not be suprised at all. He always seems to have held the stocks he reccomends for a while before they have a big run up and he announces his great find to the public. His show just smacks of a scaled up version of one of those penny stock promotion websites to me. thestreet.com is a good resource though, mostly because of Doug Kass.

Cramer and his CNBC comrades publicly cheerleaded every bubble until it popped and then pretended they didn't cheerlead irrationally (cramer) or deny the bubble's existance (Kudlow).

Do you remember his 80 to 100 to 120 rule? That was the dumbest investing "advice" I ever heard in my life. And he swore buy it. Someone as smart as Cramer knows it was idiotic. But he isn't paid to offer sane advice. He is paid to be a Market Minstrel, the pied piper that uses his Svengali personality to pump Mr. Retail investor into chasing the dreams of stock market wealth over a cliff. " WATCH TV AND GET RICH!!!! " I can't believe this guy hasn't resorted to late night infomercials.

His show is fun to watch, and my young kids love watching it (hey beats cartoons), but he is the antithesis to "sane investing in an insane world" imo. If I ever saw one of my stocks as a Cramer pick I would put that down as a bullet point on my reasons to sell now list. I've tracked some of Cramers most interesting, sane sounding picks personally for a while now out of curiosity, and invariably they tumble, and tumble hard within a year, no matter how good they sound. These aren't lightning round picks either. I guess one way of investing using Cramer is to bottom feed the best ideas a year after he reccomends them and now says "sell sell sell sell sell sell!!!!!"
ccyork
Ccyork - 6 years ago
DaveinHackensack Wrote:

-------------------------------------------------------

> Has Jim Rogers said what price he'd buy more gold

> at and what his long-term price target for gold

> is? Does Rogers ever get specific like that?


Jim Rogers rarely gets specific about price targets or time horizons, but he will often say exactly what he is buying and selling today

in an exception to his normal lack of price target specificity, he recently said he will cover his financial shorts when he sees Fannie Mae at $8, and i don't think this was hyperbole

he has stated repeatedly that he usually buys and shorts ETFs because his lawyers advise him not to deal in individual stocks

the last time i saw him interviewed, he was buying his own agricultural commodity index (RJA), the yen, and the swiss franc that day

he has said he is short the investment bank ETF (which i suppose could be IAI)

he is always shorting the dollar, but has recently said he expects a rally in the dollar and the financials soon and would consider that an opportunity to put on more shorts

these are just a few examples. overall, he's far more transparent about his investments than warren buffett is, to be sure
DaveinHackensack
DaveinHackensack - 6 years ago
John Krantz,

"But this is the same Cramer who admitted manipulating markets and trading on insider info when he ran his hedge fund, and then tried to take it back when the SEC threatened him. Not the most ethical thing to do there. Going by his own autobiography isn't exactly unbiased info."

Cramer's candid about how he ran his hedge fund in the book. He explains his learning curve from relying on fundamentals to playing the analyst game (and how his wife helped teach him this game). Like I said, it's worth reading. Cramer doesn't sugarcoat this, and it's rare, candid look from the inside.

"Call my cynical, but I operate by the rule that most anyone who makes a living promoting shares has ulterior motives, if they were so good at market mastery they would just make a living doing that."

Cramer made gobs of money on Wall Street, before starting TheStreet.com and going on TV. He doesn't own any stocks personally, and I'd be highly surprised if his show were just a scam to pump stocks for family members.

I get the cynicism, and that's generally healthy, but there's a lot of unwarranted Cramer-bashing here. Sure, Cramer throws a lot of crap against the wall, and he makes plenty of mistakes, but he's usually honest about them, and you can learn a lot from his mistakes as well as from his successes. He also demonstrates the capacity to learn from them.

I agree that he was wrong to call the 80-to-120 "rule" a rule: he should have just called it what it was, a pattern he had recognized from previous bull markets. Unfortunately, the bull market ended soon after he talked about that idea. Cramer was quick to recognize the severity of the credit crisis and he's been on target so far with his comments on the ag and commodity booms, as well as some of his comments about international investing (I agree with his bullishness on Brazil, but I think he's too dismissive of the political risks of investing in Russia). Cramer has also recommended some good mutual funds on his show, like Heebner's CGM Focus Fund.

Kudlow has always been a permabull. The rest of the CNBC crew, with the exception of Erin Burnett, perhaps, are mostly airheads.

You and I both watch the show and are skeptical of Cramer's recommendations. We agree on that. I just think people are too hard on the guy sometimes.
John Krantz
John Krantz - 6 years ago
I'll admit, I haven't read "Confession's of a Street Addict", but I'll give it a shot.

It just seems he gets a lot of people jumping in the market who aren't ready, and who don't think for themselves. Like a cult personality who uses charisma and sensational advertising to sell books and attract viewers. I really think a lot of people got burned badly with 80-100-120 rules and things like that...Understand too that when he was saying all this, its not like the credit crunch or recession were unseen. Plenty of people called it. Personally I get behind the guys who get it right first. Incidently Doug Kass, contributor to thestreet.com, is such a person, and I hold his opinion in high regard.

Perhaps I am too hard on him. I don't know him personally and I only go by his public persona. He could be a really good, upstanding guy who happens to be a little overly bullish. But understand I'm digging at the Cramer "persona" or "business", because that is the only thing I see. He's a public figure so that's what I go by. I've learned to steer clear of people who sell themselves and their products the way he does.

Some of his book reccomendations are really good. 'Microtrends' by Mark Penn was an excellent read for an investor.

Jehnavi
Jehnavi - 4 years ago
Spot gold price is first determined in US dollars, which can be seen on the goldprice.org. It is then transformed into other currency value of around twenty nine major countries throughout the world.

A normal gold contract is traded in 100 troy ounce bars. A trader buys a gold contract and receives actual gold at the end of the contract, which usually benefits him. The procurement is in any form – gold bullions, jewelry, bars, coins, and so on. There are various Comex outlets all over the country, and one can easily procure gold from any of these locations through a national exchange company.

Jehnavi
Jehnavi - 4 years ago
As the name suggests, price of any commodity paid at the time of purchase is known as spot price. Similarly, the price of gold, any quantity, that you pay immediately on purchasing it is known as [url=http://www.financeandmarkets.net/spot-gold-price.html][/url]spot gold price. In some cases, price is paid a day or two in advance. In short, spot gold price is the current price of the gold in the market.
Jehnavi
Jehnavi - 4 years ago
Commodities and stocks have black eyes, on Thursday, falling with the decline attributed to fears about Europe's ability to hold the sovereign debt crisis and growing doubts about the strength of the global recovery. New York, gold futures comparative earlier losses as some investors bought on dips. Fell 0.4 percent. Silver has fallen more than 2.2 percent. Platinum and palladium were pursued further, plunging 6.8 percent and 11.0 percent respectively.

Thanks

Spot Gold Price

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