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| Sunil Kewalramani: Is gold in a structural bull market? | | The stock-market panic is not the only reason for rising investment demand |
| Sunil Kewalramani / New Delhi Feb 28, 2009, 00:12 IST |
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The stock-market panic is not the only reason for rising investment demand.
Gold is exhibiting all the classic signs of being in a structural bull market. In the past year, we’ve seen gold go up on fears of inflation, then it rose on fears of deflation. The woes of the banking industry certainly appear to be aiding gold. In a bizarre twist, central bankers actually want the price of gold to rise because it would be an indication that attempts to stave off deflation are working.
The long-term story for gold, however, is as a re-monetisation play as investors lose faith in fiat currencies. The Fed has flooded the market with newly-printed money. Other countries are following suit. Now that all of this money is printed, it may be difficult to pull it back in. This, of course, would lead to currency devaluations. Some believe that the bottom in fiat currencies has begun and hard assets like gold and silver should benefit. Investors in Europe and north America went on an extraordinary shopping spree for gold coins and bars in the final quarter of 2008, snapping up 148.5 tonnes, a jump of 811 per cent compared with the same period in 2007, as the collapse of Lehman Brothers led to a massive increase in safe haven buying. According to the World Gold Council (WGC), this rush into physical gold by western investors pushed global retail investment up almost 400 per cent to 304.2 tonnes.
Gold is about 25 per cent above its peak from the last great bull market in the metal in 1980. In yen terms, gold is still barely half its 1980 level — which might imply that there could be more gold demand to come from Japanese investors (referred to as ‘Mrs Watanabe’). And in sterling terms, gold is double its 1980 peak — which implies either great worries about returning inflation in the UK, or an overdone collapse of confidence in the pound sterling.
The WGC’s data confirmed earlier reports from traders about widespread shortages of coins and exceptional buying interest. Investment inflows into gold exchange traded funds (ETFs) reached 94.7 tonnes in the fourth quarter, up 18 per cent on the same period in 2007, but down from the record 150 tonnes of inflows seen in the third quarter of 2008.
Rising prices for gold around the world mean that those currencies are depreciating. Practically all currencies are depreciating relative to gold. The whole world of currencies is depreciating, including the dollar. But due to the liquidity provided by US debt during the financial crisis, the dollar has appeared to rise in value within the overall currency bear market. All currency ships are sinking, the dollar ship is just not sinking as fast.
For the better part of a century now, the global gold trade has been dominated by the dollar. All over the world, the prevailing gold price is a function of any currency’s exchange rate with the dollar along with the dollar-price of gold.
Since early 2001, there has been a quadrupling of gold prices in dollar terms as compared to a 7-year-span where the S&P 500 eked out a pathetic 11 per cent gain. In stage one, gold was largely driven by the dollar bear. In stage two, investment-demand usurped the dollar to gain gold’s driver’s seat.
Back in July 2008, the dollar started rallying. It wasn’t for fundamental reasons, but because the giant mortgage-backed bond industry was imploding and bond investors desperately sought the safety of US Treasuries. This kicked off the massive dollar panic rally in Q3 CY 2008, and the subsequent stock panic of Q4 CY 2008 accelerated it. Until this anomalous rally erupted, dollar gold remained strong in the high $800s and low $900s.
At this dollar rally’s apex on the very day the stock markets bottomed in late November, the US Dollar Index had reached levels first seen in early 2004 when gold was near $400. Yet gold didn’t even close under $700 in 2008’s panic, vastly stronger than the dollar alone would suggest it should be. Once again this highlights the critical fact that the dollar is no longer gold’s primary driver even though it can still temporarily influence gold at times.
In order to predict the future of gold prices, one needs to keep an eye on gold lease rates; a spike would be a good lead indicator that gold is about to punch higher as this would reflect a shortage of lendable bullion. Rising lease rates will cause gold to go into backwardation as holders of gold may not want to sell their gold forward under any circumstances a trend currently evidenced by the high physical premium being paid for gold coins.
Rising lease rates prefigured the last big move in gold back in the spring of 2007 just as the two Bear Stearns hedge funds were blowing up. Central banks feared counterparty risk for the first time in 20 years and substantially curtailed gold lending and sales. This led to a 40 per cent rally in gold from $700 to over $1,000.
Indians are collectively the world’s biggest gold investors, so the rupee gold price is very important to the health of this global gold bull. Thanks to a rupee collapse during the stock panic to dismal levels underneath where its secular bull started in mid-2002, rupee gold has been very strong. In fact, it surged to new bull highs during the stock panic and ended 2008 near these levels. During all this turmoil, India’s deep cultural affinity for gold investment was strongly affirmed. The rupee gold price is an important one to watch, thanks to India’s enormous influence in the global gold markets. Even though tonnage of gold imports is suffering, rupee expenditure levels are holding up well in India.
Technical chartists say that gold could move into a parabolic fashion once the $1,000 per ounce barrier is broken. From there the speed of the move could accelerate sharply.
For many structural reasons, totally unrelated to the stock panic, the fundamentals of gold remain awesomely bullish. Its strong performance during the stock panic in most of the world is only icing on the cake that will drive additional investment demand.
How high can gold ultimately go? A Dow Jones Industrial Average/gold ratio of 2:1 would be a good sign the bull market in gold is getting well-advanced. We saw this in 1932 and 1980. Only nine years ago in 2000, however, this ratio reached over 40:1. Arriving at 2:1 again does not necessarily mean the Dow must decline significantly from here; more likely it would signify that gold prices surge and the Dow stays range-bound but volatile.
We are in a multi-year gold structural bull market that will eventually take the price to an integer multiple of where it is now. Not a big integer multiple. But enough to approximate how much inflation must shrink the real burden of debt to what the developed-country taxpayer and consumer can afford. That is, after that burden has already been reduced by default, or paid down through austerity.
Within the broader and longer-term positive environment for gold, we need to remember that short-term bursts of emotions might run to extremes. This might be the case in the current situation. Emotions have been running high. Gold is seriously over-bought. While investors need gold in their portfolio, the current price situation might not be the best for buyers. Buy on price weakness, not strength. At the same time, it is never advisable to sell in a structural bull market.
The author is CEO, Global Capital Advisors
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