GOLD: PRICE EXPLOSION – High demand and inflation fears drive market
Photo: Vitaly Smolygin, Creative Commons license
If the eighteenth century English lexicographer Samuel Johnson was right that “the lust of gold [is] the last corruption of degenerate man”, the world must be teeming with degenerates right now.
A speculative rally, fuelled by the prospect of central bank buying, plus strong retail demand in India and China, has pushed up the price of gold by about 25 per cent in the past year.
When the London Metals Exchange reopened for business on 4 January 2005, the spot price for the precious metal was $427 per Troy ounce. It closed at $507 per ounce last Friday.
This rally has been particularly galling for chancellor Gordon Brown, who, in an attempt to diversify the UK’s reserves, sold off 60 per cent of the Bank of England’s gold at an average price of $274.9 per ounce in 17 auctions between 1999 and 2002. It was not one of his brightest moves as Chancellor — Brown’s great bullion sale is estimated to have cost the UK taxpayer £1.6 billion.
While the current surge in gold’s price is less spectacular than the $850 per ounce spike seen in January 1980, it has been so inexorable that some analysts are predicting it could soar to more than $1,000 an ounce before the decade is out.
The price has risen more or less constantly from a low of $252.8 an ounce in July 1999 — a trough driven by fears over the Bank of England’s disposal and selling by other western central banks — to break through the psychologically-important $500 barrier earlier this month. But what has driven this spectacular rebound?
First there is a fundamental imbalance between supply and demand: there are simply more buyers out there, including retail customers buying jewellery as a secure investment in fast-growth economies such as India and China, than sellers.
And, as with any commodity, there is a limit to the amount that mining companies can extract in any given year. “The commodities slump of the 1980s and 1990s meant there was not a great deal of investment in finding new reserves, ” says Stuart Thomson, strategist at broker Charles Stanley Sutherlands. “And it takes time to get new mines on stream.”
According to the Australian Bureau of Agricultural and Resource Economics (ABARE), world production grew by just 1 per cent to 2,496 tonnes in 2005, with new production in Indonesia, China, the US and South America offsetting big declines in South Africa, where production has fallen due to depletion and the strength of the rand. Next year, Abare says, global production is set to rise by just 2 per cent to 2,538 tonnes.
On the demand side, Sutherlands’ Thomson says a “strong level of speculation is supporting the squeeze”. Japanese private investors have been active buyers, their appetite fuelled by the depreciation of the yen against the dollar. There are also rumours that central banks in emerging economies, such as those in South East Asia, Russia and South Africa, are poised to dump their dollar reserves in exchange for gold. The effect on the gold price could be “explosive”, according to Philip Klapwijk, chairman of consultancy GFMS and director of the Global Precious Metals Fund.
And as Mike Lenhoff, senior strategist at Brewin Dolphin, puts it: “Gold is going up because . . . it’s going up! . . .
“There’s nothing more powerful or persuasive than positive momentum to hook investors. Having climbed steadily since 2001, and now gone through the dollars-500 level, the gold market has not only plenty of momentum but also plenty of wannabe gold bugs.”
Buyers of gold are also driven by fears of a return to inflation — they are particularly concerned about the US fiscal imbalance. Many see gold as a hedge against inflation, which erodes the value of investments in currencies, bonds and equities.
Lenhoff says: “We know that the central banks are concerned about inflation… The message from the gold market is that it will rise, even though this prospect is not reflected in bond markets.”
However, Thomson believes such fears are overdone. “The world has changed a lot since the 1970s. Chinese inflation fell to 1.3-per cent in the year to November and UK inflation is only at 2.1 per cent, even after the third oil crisis.”
Also, in the event of economic meltdown, gold is seen as one of relatively few investments that can hold its value. Lenhoff says: “Political instability, wars and pestilence have been the time-honoured motives for holding gold bullion.” If there are terrorist attacks on oil installations, or an avian flu pandemic, expect gold’s price to soar still further.
But Simon Weeks, chairman of the London Bullion Market Association, sounds a cautionary note. “Gold is riding a wave of sentiment at the moment. But when the froth dies down, I think people will step back and say we are over-extended.”
This article was published in The Sunday Herald on 18 December 2005. Read article as published on Herald Scotland