For thousands of years, gold has been valued as a global currency, a commodity, an investment and simply an object of beauty. As financial markets developed rapidly during the 1980s and 1990s, gold receded into the background and many investors lost touch with this asset of last resort. Recent years have seen a striking increase in investor interest in gold. While a sustained price rally, underpinned by the fact that demand consistently outstrips supply, is clearly a positive factor in this resurgence, there are many reasons why people and institutions around the world are once again investing in gold.
Methods of investing in gold
Investment in gold can be done directly through bullion or coin ownership, or indirectly through certificates, accounts, spread betting, derivatives or shares.Investors using fundamental analysis analyze the macroeconomic situation, which includes international economic indicators, such as GDP growth rates, inflation, interest rates, productivity and energy prices. They would also analyze the total global gold supply versus demand. In 2005 the World Gold Council estimated total global gold supply to be 3,859 tonnes and demand to be 3,754 tonnes, giving a surplus of 105 tonnes. While gold production is unlikely to change in the near future, supply and demand due to private ownership is highly liquid and subject to rapid changes. This makes gold very different from almost every other commodity.
Gold versus stocks
The performance of gold bullion is often compared to stocks. They are fundamentally different asset classes. Gold is regarded by some as a store of value (without growth) whereas stocks are regarded as a return on value (i.e. growth due to anticipated real price increase plus dividends). Stocks and bonds perform best in a stable political climate with strong property rights and little turmoil.
Since 1800, stocks have consistently gained value in comparison to gold due in part to the stability of the American political system. This appreciation has been cyclical with long periods of stock out performance followed by long periods of gold out performance. The Dow Industrials bottomed out a ratio of 1:1 with gold during 1980 (the end of the 1970s bear market) and proceeded to post gains throughout the 1980s and 1990s. The ratio peaked on January 14th, 2000 a value of 41.3 and has fallen sharply since.
Investors who invest in stock and gold can recall a time when a share of Google's stock and an ounce of gold were both near $700. On January 4, 2008 23:58 EST, it was reported that an ounce of gold outpaced the share price of Google by 30.77%, with gold closing at $859.19 per ounce and a share of Google closing at $657 on U.S. market exchanges. On January 24th 2008, the gold price broke the $900 mark per ounce for the first time. The price of gold topped $1,000 an ounce for the first time ever on March 13, 2008 amid recession fears in the United States. Google closed 2008 at $307.65 while gold closed the year at $866.
Technical analysis
As with stocks, gold investors may base their investment decision partly on, or solely on, technical analysis. Typically, this involves analyzing chart patterns, moving averages, market trends and/or the economic cycle in order to speculate on the future price.
Using leverage
Bullish investors may choose to leverage their position by borrowing money against their existing gold assets and then purchasing more gold on account with the loaned funds. This technique is referred to as a carry trade. Leverage is also an integral part of buying gold derivatives and unhedged gold mining company shares (see gold mining companies). Leverage via carry trades or derivatives may increase investment gains but also increases risk, as if the gold price decreases, the investor may be subject to a margin call.
Bulls versus bears
Since April 2001 the gold price has more than tripled in value against the US dollar, prompting speculation that the long secular bear market (or the Great Commodities Depression) has ended and a bull market has returned. In March 2008, the gold price reached above $1000 before falling under $800, which in real terms was still well below the $850 peak in 1980. In the last century, major economic crises (such as the Great Depression, World War II, the first and second oil crisis) lowered the Dow/Gold ratio (which is inherently inflation adjusted) substantially, in most cases to a value well below 4. During these difficult times, investors tried to preserve their assets by investing in precious metals, most notably gold and silver.
Factors influencing the gold price
Today, like all investments and commodities, the price of gold is ultimately driven by supply and demand. Unlike most other commodities, the hoarding and disposal plays a much bigger role in affecting the price, because most of the gold ever mined still exists and is potentially able to come on to the market for the right price. Given the huge quantity of stored gold, compared to the annual production, the price of gold is mainly affected by changes in sentiment, rather than changes in annual production.
According to the World Gold Council, annual mine production of gold over the last few years has been close
to 2,500 tonnes. About 3,000 tonnes goes into jewelry or industrial/dental production, and around 500 tonnes goes to retail investors and exchange traded gold funds. This translates to an annual demand for gold to be 1000 tonnes in excess over mine production which has come from central bank sales and other disposal. Central banks and the International Monetary Fund play an important role in the gold price.
At the end of 2004 central banks and official organizations held 19 percent of all above-ground gold as official gold reserves. The Washington Agreement on Gold (WAG), which dates from September 1999, limits gold sales by its members (Europe, United States, Japan, Australia, Bank for International Settlements and the International Monetary Fund) to less than 400 tonnes a year. European central banks, such as the Bank of England and Swiss National Bank, have been key sellers of gold over this period.
Although central banks do not generally announce gold purchases in advance, some, such as Russia, have expressed interest in growing their gold reserves again as of late 2005. In early 2006, China, which only holds 1.3% of its reserves in gold, announced that it was looking for ways to improve the returns on its official reserves. Some bulls hope that this signals that China might reposition more of its holdings into gold in line with other Central Banks.
Reasons Why Gold Will Rise In 2009
- Secretary of the Treasury Paulson talked of the current crisis being potentially worse than the Great Depression.
- Alan Greenspan told Congress that the financial meltdown had left him in a “state of shocked disbelief.”
- Reputable economists are saying “this looks an awful lot like the beginning of the second Great Depression.”
- U.S. consumer confidence has fallen more sharply than in any period since records began in 1978.
Since September 9, we have seen the nationalization of Fannie Mae, Freddie Mac and AIG; the socialization of the auto industry; the disappearance of the investment banking industry; a $700 billion Bailout with more to come; the bankruptcy of Lehman Brothers; the “breaking-of-the-buck” of the supposedly rock-solid money market funds; the largest bank failure in history; the implosion of global stock markets; the collapse of home values, retail sales and consumer sentiment; the biggest fall in industrial production in 34 years; and an unprecedented shattering of confidence in both commodities and financial assets.
It is increasingly apparent that fear predominates. Individual investors are abandoning anything with the slightest hint of risk. Last year was the worst year for global equity markets since the Great Depression, with the Dow suffering its worst annual decline since 1931. Investors are pulling huge amounts of money from hedge funds, stock mutual funds and bond mutual funds in one of the biggest flights to safety the financial industry has ever seen.
Defensive Asset Class have assets that have similar risk/return characteristics, are positively correlated with each other and are traditional inflation hedges that are negatively correlated with stocks – they do well when stocks do poorly. Historically, the principal Defensive Asset has been gold.
Of the major assets, only Treasuries and gold have escaped the selling panic that has gripped the markets. Gold rose 5.4% over 2008, ending the year above $850 a troy ounce. Gold bullion reached $1,030.80 in mid-March and Mints around the world ran out of popular gold coins and small gold bars after the collapse of Lehman Bros. in September.
The U.S. rate cut to virtually zero lowers the opportunity cost of buying gold and gold ETF holdings have exploded from 7 million ounces to over 30 million ounces in less than four years
Gold is different from other precious metals such as platinum, palladium and silver because the demand for these precious metals arises principally from their industrial applications. Gold=s value rise arises from its use and worldwide acceptance as a store of value and a safe haven.
Other precious metals have also been classified as Defensive Assets, but have not performed as well as gold during this crisis. For example, investment accounts for about 90% of the demand for gold, while investment makes up only one-third of the total demand for platinum. Therefore, although gold has done well, platinum's demand from industrial uses has fallen rapidly, particularly because of the high concentration of uses of platinum in new automobiles – an endangered species in an economy in which automakers are begging for funds from Washington just to keep them afloat.
Gold's price has been bolstered by the view that it is a safe haven in times of economic or political uncertainty, while platinum's industrial demand has fallen precipitously. Platinum reached its all-time high of $2,267.00 per ounce in March, but fell like a rock from there, as did silver. Platinum fell nearly 60% from its March peak, while silver fell 47%. The last time that gold traded for more than platinum was January 21, 1994, when gold closed at $381.70 and platinum at $380.90.
REFLATION
Gold benefits from the cure for deflation, rather than from deflation itself. At some point, the market is going to get over its concerns about deflation and become concerned about inflation – that will be the real inflection point for gold.
Dollar weakness, plentiful liquidity and policy reflation will be persistent themes over the next year or so. Massive fiscal and monetary stimulus have combined to weaken the dollar, but are expected to do so in an orderly fashion since no country wants a strong currency in a deflationary world.
In the past twelve months, the Federal Reserve's balance sheet grew by 146%, the European central banks' by 58%, the Swiss national bank's by 74%, and the Bank of England's by 158%. Huge amounts of money supply growth are on the way.
The Fed and central banks throughout the world are sending so much money sloshing through the system that they will eventually generate a bad case of inflation.
While inflation isn't apparent today, stimulus packages and bailouts mean much more money in the system, which is classically inflationary. Historically low U.S. interest rates, U.S. dollar weakness, and the longer term inflationary pressures of the Federal Reserve throwing trillions of dollars at the U.S. economy make the environment favorable for gold and other tangible assets.
The dollar has benefited from the global flight from risky assets, as well as the unwinding of bets made with borrowed dollars. That has come as a surprise to many who expected that increased government spending and a collapsing U.S economy would cripple the dollar.
In the longer term, the dollar's health remains dependent upon foreigners' appetite for U.S. assets, which will decline as the economy falters and the government continues to inject additional liquidity.
