Gold Confiscation: A Real Risk?

Just how serious is the possibility of a 1933-style confiscation of US-held Gold Bullion...?

The GLOBAL ECONOMIC recovery isn't looking good, says Julian Phillips of the Gold Forecaster.

The G8 meeting this weekend saw divisions that could lead, as the IMF put it, to losses of trillions of Dollars and millions of jobs. Now it is reported that Ben Bernanke and his close allies at the board in Washington are worried by signs that the US recovery is running out of steam.

The leading indicator published by the Economic Cycle Research Institute has collapsed to a 45-week low of minus 5.7 following the most precipitous slide for half a century. Such a reading typically portends contraction within three months or so.

Furthermore, money velocity is slowing. Broad M3 has contracted at an annual rate of 7.6% over the last three months, so we may well face a huge bout of money printing again? If that is the case, confidence in currencies (and not just the Dollar) will lurch lower again.

Perhaps that's why, in a recent gold conference, HSBC's top gold and silver trader John Levin pointed out that some top US asset managers were genuinely fearful of the possibility of government confiscation of gold. Bottom line, gold still represents the ultimate form of payment, it is always accepted. In a world drowning in debt, gold's debt-free nature appeals even more strongly and will particularly to governments whose currencies are failing to retain confidence.

As Levin explained, on being told that the bank's US vaults had sufficient space available for their gold, he was told by more than one manager that they did not want their gold stored in the USA, but preferably in Europe. Because they fear that at some stage the US Administration might follow the path set by Franklin D. Roosevelt in 1933 and confiscate all US gold holdings as part of the country's strategy in dealing with the nation's economic problems. Are their fears well grounded? Has the G8 taken steps towards the day when governments would their citizen's gold in their vaults again? Surely this view is a bit extreme? And why do top US asset managers want gold in the first place?

The job of asset managers is to seek the greatest return but with prudence. They have to see what may lie ahead and guard against dangers that may threaten the assets under their wings. They are highly qualified and capable men (and typically men) who understand the ins and outs of investment management. They were carefully chosen for their capabilities and good investment management sense. They have built up a body of knowledge that places them on top of the investment world. Such knowledge usually encompasses monetary matters of the sort that would include gold. As such we would suggest their opinions do have value. But surely the US is in less danger financially than Europe?

Well, no. It was recently reported that forty-eight US states will be in deficit this year and the combined shortfall will probably exceed $300 billion. That puts Greece's expected 2010 budget shortfall of around $28 billion into perspective. Greece's shortfall is put at around 13.6% of GDP, whereas there are a good number of US states anticipating deficits of more than 20% this year, including some, like California, New York, Florida and Illinois, with far bigger economies than Greece.

There are around a dozen US states with bigger economies than Greece and most of these anticipate 2010 deficits at this kind of level! And look what news of the Greek deficit, once it was generally publicized, did to the markets! Fears of currency inflation and falling confidence in the US Dollar are very real when seen in this context.

Often, gold market observers focus only on the buying of gold by central banks. But of equal importance is the visible fact that the signatories of the Central Bank Gold Agreement (exclude the IMF from this for this purpose) are no longer selling gold anymore. They want to keep their gold. The times that now lie ahead will bring to the fore why central banks hold gold in the first place.

Central bank buyers of Gold Bullion are those that have far too low a percentage of gold in their reserves and are doing what they can to buy more. China is now contracting with foreign mining companies directly for their gold ore. This silently shouts that gold is wanted by central banks across the world. Extend that one step further and the only gold easily available to a government is that of their own citizens.

The meeting this weekend of the G8 did not convince observers that governments are going to resolve the global economic crisis, nor send it firmly on the road to recovery. Yes, deficits will be reduced, but growth will suffer badly. Europe will affect the US economy. With the velocity of money slowing and the M3 money supply shrinking, we are now alarmed at the probable crises that are on the horizon, because of this incomplete performance of politicians.

It may well be that we have taken a step towards confiscation of gold. How many more steps are there before this happens? Will they too, be taken?

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Gold Prices After the G20 Meeting

What does the G20 meeting mean for Gold Prices short-term...?

THIS WEEKEND'S G8 and G20 meetings began disappointing the press before they even began, says Julian Phillips at GoldForecaster.

The US approach to growth, sovereign debt containment and debt repayment contrasts sharply with the European approach. This division should be added to fears that sovereign debt cut backs will not be achieved in the end.

The global financial mood is depressing, and is giving rise to falling confidence in the future of the global economy. Despite the best efforts of governments and the media, few are now convinced that growth will rise significantly. However, no currency or economic collapses are likely soon in our opinion. Instead, the dangers of GDP slipping from the current "L" shaped recovery back into recession are growing.

Government action should be coordinated globally if its present problems are to be resolved. And as China continues to grow – and as such a lot of the growth inducements are coming from Western governments – it is clear now that a Yuan revaluation is going to be well within single figures at best, until China is ready to place the Yuan firmly in international markets.

Is this background by itself enough to make Gold Prices rise?

The market mood for gold at present sees it completing a particular step of short-term consolidation after hitting record highs last week. But inside the Gold Price, what is there from which we can answer our question?

This is traditionally a quiet season for buying gold amongst the biggest consumer market, India. But it is clear that there are very large buyers in the Gold Investment market who are seeking to buy large amounts without chasing prices. These players have identified themselves to some extent as central banks. Not all of them are visible, however, nor are the sovereign wealth funds who are buying gold too visible. Their buying practice is to set price limits that they will pay and then wait for the offers of gold. Hence they too are not clearly visible when prices don't move.

Large long-term investors are buying price exposure through Exchange Traded Funds, and have bought 124 tonnes so far in the last month. They tend to Buy Gold as the price starts to rise.

Traders, in contrast, have changed their practice from one of pushing prices and leading the market (as they did five years ago) to following the direction of the market and profiting when others move the price. They find current conditions more difficult as a result. The net result has been that prices don't fall as far as the charts might indicate, but are rising higher than expected.

The meeting this weekend of the G8 and G20 will have no more effect, we expect, than past ones. Encouraging statements will be made about good intentions, but with no believable plan of action. As now is the time for them to act, the climate of uncertainty and fear will continue to persist. Unfortunately, politicians have other matters on their agenda and don't perform well, until a crisis is upon us. So we will have to wait for that crisis. Crises then tend to appear out of nowhere, hitting markets hardest and producing differing levels of panic.

To emphasize the point, markets have looked to governments to calm them when financial uncertainty persists. Government actions to date, taken inside the financial markets have not turned the global economy back to strong growth in the last three years. Banks have succeeded in softening most of the new regulations that will apply to them emasculating their effectiveness. Political considerations often precede effective reformation and regulation as a result. This discourages markets.

So, all in all, the G8 and G20 will likely add to the fears that markets presently face and encourage more Gold Price rises.

On the other side of the market, there is almost no flexibility in gold supplies. Gold Mining is extremely inflexible, so tends to remain unchangeable in the short-term. Only by inciting sellers to come to the market can new supplies arrive. That takes a price sufficiently high to convince sellers that now is the time to sell. When this selling comes it is called 'scrap' sales.

But scrap supply is only as flexible as the Gold Price rises. Too low, and no scrap sales come through. Too high, and scrap sales can swamp the market. But there are no hard and fast rules to that formula. If the general expectation is for a $1500 price, then hoarders will keep a tight grip on their gold until that price is reached even when they want profits.

What's more, in this day and age, gold owners are holding Gold Bullion and coins, as well as jewelry across south-east Asia and India, as a counter to the uncertainties in other markets. This support is literally priceless!

Put another way, if you want the Gold Price to come down, then regain the confidence of the consumer and rectify the national economy. If you don't, people will continue to buy gold.

Demand is growing through a broadening of Gold Investment demand. In different countries and through new different investors the market is deepening. This investment demand is coming from people in different walks of life. As confidence decays, new investors appear. This type of demand is now controlling the bulk of the market. Where jewelry demand had waned last year, we now see it return to activity, but with its gold content firmly in the buyer's mind. In fact, as gold is not consumed but usually recovered, gold in all uses should be categorized as investment gold.

We continue to believe that new investors will keep coming, and coming over time from central banks right down to Joe Citizen. Their driving reason will be that they want to have gold for rainy days when it can be used to provide value where currencies don't. That force is global and growing!

So will the Gold Price rise short-term? Yes, it will. But beware; there are surprising changes about to happen in the gold market, as we explain to subscribers of GoldForecaster...

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Gold vs. Mining Stock Performance

Gold Mining shares have not moved up in line with the Gold Price. Why...?

THE DISPARITY between gold and Gold Mining stocks has shaken quite a few investors, writes Julian Phillips of the Gold Forecaster.

Based on past market moves, they'd expected share prices to move roughly in line with the Gold Price in the belief that holding Gold Mining shares would produce the same if not greater gains. But with miners underperforming the metal, it's time to look at the 'why'.

First, and most importantly, what is a Gold Mining share? This is the most important question investors must ask, when deciding what to invest in, in the gold world. We have to recognize that a gold share is not gold. It is a share in a corporation that is involved with unearthing gold. But there is no guarantee that the Gold Price being earned is going to feed through to the investor.

The Gold Mining company – in terms of corporate risk – is no different to any other corporation. The risks involve employees, Directors, Unions, resources, production, cash flows, Dividend policies, to name some of the risks.

Now add to that market conditions (bull or bear markets), liquidity of shares in the market (which may have nothing to do with the quality of the corporation), and also price earnings ratios.

On the bright side, gold shares have the ability to perform better that gold itself for the good ones have a better profit capacity than the Gold Price (through profit margins) than gold itself. The income to a Gold Mining company accrues by the quarter or longer, so it is reliant on the average Gold Price over the period, for its income. And there is no doubt that a carefully chosen mining share that performs well in a 'bear' market does outperform the Gold Price over time and can be a better investment than gold itself.

Gold itself...?

• Gold Bullion carries no corporate risk at all.
• It is not dependent on people's efforts.
• It has so many more aspects than shares in a mining company.
• It is considered as the real money in many parts of the world.
• It is considered as an important reserve asset by central banks.
• It is unprintable.
• It is a 'counter' to the risks inherent in currencies.
• It is money, 'in extremis'.

But imagine Gold Investing from a professional fund manager's point of view. There you are, wanting to invest in gold. You look at the different options in front of you. Your task is to maximize total return on capital employed. But, you have to achieve this minimizing risk, as far as possible in the present investment climate. Unfortunately, the risk-reward ratio in today's investment climate is far higher than seen before 2007.

So now you look at Gold Bullion and gold shares. What points do you factor in? The first is that it is not one or the other, but can be both. Factors you would look at would include:

• In the eighties, the Gold Price shot ahead of gold shares when it flew to its peak at around $850, leaving the solid gold shares far behind. Is today a similar scene?
• If not you would likely look at the biggest most solid Gold Mining shares out there, after all, they won't go bust easily? But are they likely to live up to the growth expectations of companies whose growth of production is rapid. As it is the majors are currently struggling to replace waning current production.
• A company that is expected to grow income, irrespective of the Gold Price, promises to perform far better than a major.
• As it is the risks in all markets are high, so you may well balance this against an expectation of a higher return. Good juniors Gold Mining shares would likely fall into this category, such as the kind we focus on at Gold Forecaster. There is no doubt about it, such shares would warrant the increased risk.

Of course, Buying Gold itself would remove a tremendous degree of risk, as opposed to Gold Mining shares, in extreme times. Many investors in the past turned to the biggest and most solid gold shares to reduce risk, saying they won't go bust, but that's not what you look for as an investor, surely? So you would measure one of these reliable but underperforming big gold shares against gold itself? After all, holding gold for the same period as one of these would give a similar return, would it not? This is because a gold share should, over that time, reflect the average of the Gold Price over the same period? In this case, gold itself would offer less risk and over time be a better investment, on a risk-reward measure.

But big investors go for gold itself, for far more than its profit potential today. When you consider that gold will rise in value as times get worse, whereas corporate risks rise dramatically in such times (see mid-2007 to date), then gold's additional qualities take it into a category of its own, way ahead of most equities. That's why central banks hold it and that's why very big investors hold it.

So, will shares catch up to the Gold Price? The answer to such questions is never as easy as we would like, because the world is never simple. In fact, there are a series of answers:

• In extreme times investors shy away from equities, so gold shares would not keep up with a rising Gold Price.
• In inflationary times equities in general do rise, as does the Gold Price. In such a scene, gold shares will rise and perhaps outperform the Gold Price.
• When deflation is hammering values, gold will rise but investor capacities are reduced, taking most equities down with them, including exerting a restraint on gold shares.
• Should an environment exist that precipitate a government confiscation of gold, then international Gold Prices will rise, but Gold Price in that country will not. Should gold mines in that country have to receive a government 'Fixed" Gold Price, then those gold share will underperform international Gold Prices. Post 1933, this is what happened in the USA.

So there is a place for both, in different economic scenes at different times. But one should require a good performance from good gold shares that will do well in bad times too.

Looking to Buy Gold today...?

Gold – Not a Commodity

Gold's price behavior during the global financial crisis marks it out from other commodities...

The DEBATE CONTINUES as to whether demand for commodities, and thus their price, will fall or not, writes Julian Phillips of the Gold Forecaster.

Reports say that the Chinese government will slow the Chinese economy down to the point where their hunger for resources will slow and commodity prices fall. If they do fall will the world's appetite for gold fall to? And will the Gold Price fall?

This month has already seen China report a 48% rise in its exports for May. A 32% rise was expected, but this jump was a surprise. When analysts look at China they cannot help but relate the activities there, to the structures in the developed world. But China is completely different to the West.

In the first place the Chinese government has a tight control over the economy there and what it wants happens, quickly. In the second place this country has gained traction on a self-sufficient and growing economy, where massive infrastructural development that is larger than the world has seen since World War II.

China is developing basic infrastructure for 1.4 billion people, twice the population of the United States and Europe put together. The hunger for resources that this can produce far outweighs the impact of a gentle policy of restraint to calm growth from 11% to 8%. China is keenly aware that it will need resources for decades to come, and has a policy of buying foreign resource producing assets to feed that hunger for the long haul. So we would be surprised is the upward trend in commodities would be slackened by cooling economic policies.

What we have been seeing is a "street smart" China acting in markets to cool speculation and not allowing it to drive up prices they will have to pay. Instead, strategically standing back when prices roar and waiting for pullbacks and greater quantities being offered by sellers is paying dividends in the form of lowering the cost of commodities. This, we expect, will continue to be their policies regarding commodities now and going forward.

But is Gold a commodity? That is the real question in the context of today. By this we mean to ask whether gold is subject to the same type of consumption demand as a commodity? The answer is simply no! Gold's price action over the last decade has little to do with jewelry or industrial demand or commemorative coin demand. Instead, since the turn of the century, investors and increasingly central banks have emphasized that it is considered by them an important reserve asset.

The major fund community will confirm now that it is a long-term investment that they will not use, but keep as a 'counter' to the potentially bad news expected from other markets. Indeed, these investors believe the Gold Price will rise as other markets fall.

In the Indian sub-continent, gold has been and will be considered as financial security for families. In China the same beliefs are held. In China, with limited investment options available and a relatively unsophisticated investment community (although a perspicacious one), gold appeals to this nation of savers and to the strong primal needs that accompany a people used to difficult times. So, no, gold is not a commodity, as such.

Will the Gold Price fall if the commodity trend turns down? We have no need of giving what might be considered an emotional, biased answer. We simply need to look back to when deflation really hit, as the credit crunch struck in mid-2007 to late 2008. At that time, there was an investor implosion as their wealth was decimated by falling asset values and markets. It was not the inherent value that their investments contained that failed, but their capacity to keep ownership of them that failed. One power plant owner borrowed against his part-ownership of his company, to buy a stake that gave him a big majority. Once the share price dropped below the value of his loan, he lost all his shareholding. In essence, that's what hit most markets then.

And what happened to gold? Yes it did fall, at first, but not by that much (20%), because leveraged investors in Gold Futures were swiftly replaced by new investors Buying Physical Gold, driven there by fear and uncertainty from other markets.

The growth of the gold Exchange Traded Funds (Gold ETFs) during those days is a testament to the metal's ability to hold or rise in deflation and collapsing markets. The Gold Price held its value then, before it started to break upwards amidst a new wave of instability. In reality, gold survived the worst and was seen (and is seen) as a safe-haven for wealth.

It is fear of uncertainty and instabilities in global financial markets that is driving the Gold Price up today. For those who keep insisting that gold rises in inflation, we say this is a myopic view ignoring today's Gold Price, which has a nearly zero inflation factor in it. It's fear in Europe, expecting a potential Euro collapse and a need for more financial security in the East of the globe that's lifting the Gold Price upward.

So no, we do not believe that the Gold Price will fall even if commodity prices fall. In fact the question is far too simple a question to give credit to what will happen to gold. Investors in gold should research far more deeply than at present, to see what has driven the world's desire for gold in the past. You can be sure that they were not barbarians. Today the same factors that made gold so attractive in past eras is doing so now. We expand on this in future issues of the Gold Forecaster – Global Watch.

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Gold Investment in China

What happens to Gold Investment if the Yuan is allowed to rise vs. the Dollar...?

The CHINESE GOVERNMENT is encouraging its citizens into Gold Investment, writes Julian Phillips of the Gold Forecaster, and is working to expand the range of gold products available.

Yet the United States government – and others – believe that Beijing will also allow the Yuan currency to appreciate. Surely the Chinese investor will be hurt if this happens?

We know the Chinese government has been adding to its official gold reserves for at least six years now. Local Gold Mining production is not leaving the country, nor will it for many years to come. At the same time the Chinese government favors the development of new Gold Investment products, opening up local gold markets and encouraging the major Chinese banks to sell gold across China.

This is a particularly important development for the global gold market in the light of the fact that per capita, the Chinese hold the least amount of gold amongst the Asian nations. The savings propensity of the average Chinese earner is remarkable, for they save around 40% of their disposable income. To date these have been held on deposit at the banks, with the more sophisticated venturing into the equity markets there. But in times of volatile 'spikes', these can behave more like gambling casinos than investment sources.

Gold in the Chinese mind represents true value and leads to financial security. Consequently, the potential for Buying Gold in this nation of 1.4 billion people – now in a rapid process of financial empowerment – is tremendous and could well, in time, make China one of if not the most important investment markets for gold.

The main restraint on Chinese gold buying, whether by individuals or the government, is the small size of the global gold market. Persistent long-term buying is the only way the acquisition of large quantities of gold can be approached. Higher prices over time may well flush out sellers of gold. So we expect Chinese gold buying to remain persistent for the foreseeable future.

For years now, however, the US in particular has been calling for an appreciation in the Yuan. Even the International Monetary Fund (IMF) has told Beijing that it is in the interests of China to let the Yuan appreciate. But no heed has been taken of such demands. Yes, the Chinese have allowed the West to get the impression that they may well let the Yuan appreciate, but a look at the advantages to China of a pegged Yuan to the Dollar tell us another story.

The original reason for the pegging of the Yuan to the US Dollar was to capture the price advantage Chinese goods had over the equivalent products made everywhere else. As the Dollar is the global reserve currency, such prices were easily translated into other currencies. As we see by this week's export report for May from China, the rise of 48% shows what advantages such pegging and pricing brings as the world slowly recovers. Yes import could be cheaper, but that would only save money not promote industry. After all China wants and needs to develop its economy.

We have been touting the future role of the Yuan as a global reserve currency for well over the last two years now. Since then we have seen the tentative steps that the Chinese need to take to ensure their banks can cope with this changed structure. Since expanding Yuan trade in just Hong Kong, it is now spread throughout the main manufacturing hub of Southern China. When they are ready, we do expect to see a flood of Yuan to all their international trading partners, to pay for imports and then to make Yuan available to pay for Chinese exports. As Chinese trade is already global, there will be a point when Chinese importers will price imports and exports in the Yuan. While this process is in transition, we also expect their pricing policies to widen to include allowing payment for Chinese exports in the broad spectrum of global currencies. This will allow China to diversify its reserves and lower its exposure to just the Dollar or the Euro.

When the internationalization of the Yuan happens there would normally be a tremendous fall in the value of the Yuan as it floods markets, but in today's context that fall would be absorbed by the pressure for the Yuan that is now being experienced. When it does happen, we believe that China will want the Yuan to either hold current levels of in fact fall.

Having said all the above, we have to ask you if you expect the Chinese government to promote Gold Investment so strongly to its citizens, then knowingly engineer a fall in the Yuan price of gold? Our view is that the Chinese government would not wish to hurt its own like that, but with a large dose of forethought, would have blended to two policies to the benefit of its own citizens. If they didn't what would happen to Chinese gold demand.

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Gold: Global Supply Outlook

Gold Investment demand is surging. But what about gold supplies...?NEVER BEFORE has Gold Investment demand been so high, writes Julian Phillips at GoldForecaster, and it is likely to rise still further.

Normally, when a commodity is in high demand, supply is accelerated and holders of that commodity often take profits, thereby increasing supply as well. 

Economic history tells us the same.  Rising prices and high demand should result in rising supply.  But when it comes to gold, all rules have to be re-written.  That’s because gold is only part commodity. 

It typically takes around five years from the raising of finance for a mine to the start of Gold Mining production. That’s assuming there is a gold resource available to mine in a gold-mining supportive country of sufficient size to make the mine worthwhile. During the last 15 years of last century, support to such ventures from central banks through bullion banks was so strong that the mines would be loaned the gold they were going to produce. They then sold it forward to the time when the mine would produce and often even further out.

This allowed the mine to earn a higher Gold Price (as the price was dropping) and earn interest on that gold until delivery. Then, from production, they repaid the bullion bank (and thus the central bank source) the amount of gold they had borrowed.

While wise at the time, it did quickly exhaust the easily mined deposits of gold, leaving us with a situation today where good gold deposits are getting increasingly rare and difficult to mine. Add to this the propensity of governments to wait until the mines do really well then hit them with heavy taxation. This is deterring new investment in Gold Mining.

The result is that from now on, gold mining companies will be hard pressed to replace the resources they have exhausted. Consequently, newly mined gold production is set to decline from 2010 onwards, irrespective of what the gold price is.

As for central bank sales, from 1985 until 1999 the gold markets sat under the cloud of potential “official sector” sales. Central banks across the globe encouraged an atmosphere that expected unrestrained gold sales. Naturally the Gold Price fell, down from its $850 high of Jan. 1980 to $275 in mid-1999.

Then the “Washington Agreement” was signed, capping European sales at 400 tonnes a year. The gold market breathed a sigh of relief and the Gold Price finally turned up. Sales under this agreement and the next (which ended and was then renewed on 26 Sept. 2009) did at first reach the ceilings levels that were set, right up until the last two years of the second agreement. Amid the global financial crisis, however, they then petered out, with hardly any sales in the last half of the last year of the Agreement.

Since then, no significant European central bank sales have taken place. A total of 1 tonne of gold has been sold to date from the inception of the Third Agreement, nine months ago. It can then reasonably be concluded that European central banks sales have dried up. In their place have come Asian central-bank purchases of 400 tonnes a year.

As we said at the beginning of this article, private Gold Investment demand is now very high. Both Western jewelry and Indian demand had been low until recently, but both of these markets have eventually accepted the current record price levels as being sustainable. Demand from these two sources has now begun to rise again, and it’s clear that today's strong global gold demand comes without the usual froth that accompanies peak demand. This combination of peak demand and restricted supply leaves only one potential source of supply – and a capricious one at that – gold scrap supply.

With no other source of supply, markets usually take prices to a level where holders of a commodity sell and take profits, in the belief that such prices are not sustainable and will soon fall. Since gold hit the high of $1215 for the first time, prices did fall, with many forecasting a low price of $850 an ounce.

This didn’t happen, however. Instead, a low of $1050 was seen, before the Gold Price began to climb again. During that time (and until recently), apparently ‘weak holders’ of gold in India did sell, and were the main suppliers of that market, in particular. Now they too have accepted current prices as a new ‘floor’. 

Most Western consumers have now seen or heard of adverts for ‘gold parties’, rather like the Tupperware parties of the 1960s and '70s, where housewives now get together and sell old, unwanted gold jewelry that’s lain in dressing-table drawers for years. The initial surge of scrap supply from this relatively new source has largely run its course, however, and such supplies are drying up. Once these sellers have sold out, that supply too will dry up too. This source of scrap is not important to the supply side of the gold market. 

The next potential source of scrap gold is from the current Gold Investment holders, those people who bought solely to make an eventual profit. Once they believe prices are as high as they will go, they will sell. These can be termed ‘weak holders’ in the gold market, for long-term investors from central banks, to institutions, to individuals hold gold to preserve wealth, in a world where it is threatened. Such investors hold gold simply to be prudent in the face of uncertainty and instability in the financial world. They may only hold a small proportion of their portfolios in gold. But be sure that they won’t sell until certainty and stability are likely to return to the financial world.

A look at what’s going on now in that world tells us that we may see a squadron of pigs circling the White House at the same time.

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High Gold Prices, High Demand?

Could rising Gold Prices actually boost physical gold demand...?

TRADITIONAL THINKING has a pat answer for this question, says Julian Phillips at the GoldForecaster newsletter.

"High prices cut demand!"

Yet this doesn't seem to be working in the gold market. At the turn of this century, in the days when gold was a 'barbarous relic', the Gold Price stood at just under $300 an ounce. Since then there has been an increase in barbarians.

What has happened since then has been a major, revolutionary change in the structure of the gold and silver markets. Jewelry and industrial gold buyers, alongside rural, agricultural Indian demand, used to dominate the Gold Price. In the developed world gold was not bought for itself and its value. It served a more complimentary role in jewelry, often the cheaper part of a piece of jewelry.

The attraction of gold in that role was its beauty and the fact that it didn't tarnish and mark skin. The sheer volume of the cheaper side of the jewelry market gave weight to this demand. In India, the relatively poor agricultural sector demand supplied 70% of India's demand for gold to be used as jewelry/financial security for newly weds. Food prices did not rise that much, so the income available for gold buying remained relatively static. Higher Gold Prices to them did mean that less gold was bought.

These buyers are still there, but buying lower volumes of gold, with the new Indian middle-class buyers coming into the market as non-seasonal but strong buyers!

India began to enjoy strong growth early last decade, and the accompanying urbanization – plus a rapid increase in the size of the middle class – means dependence on the poorer agricultural sector has diminished. The Gold market has thus deepened and widened its demand shape. The Hindu family tradition that favors gold so much does not diminish with this process. Just as life insurance to the developed world stays in place with greater wealth, so gold retains its attractiveness with the Indian community. After all, since the year 2000, who can argue with the performance of gold?

We expect that, as prices find support at higher prices, new and bigger demand will appear in this particular gold market.

In the West, meanwhile, the transition in the gold market from cheap jewelry to investment in Gold Coins and small bars is similar to the process we are seeing in India. But decoration of the body beautiful was replaced by a growing demand for gold as wealth and as a protection from the loss of confidence in the money systems. As we have seen, the quality and quantity of demand dropped initially, as jewelry demand faded, but is now gathering pace and actually increasing on both fronts, especially if we add the small coin and bar demand to it.

As gold moves up the ladder of exclusive and expensive decorative items again, higher quality gold jewelry demand (accepting higher prices) is growing again. At even higher Gold Prices, this trend will continue to grow and jewelry buying will increase, we believe.

Perhaps the most dramatic change in demand as prices rose was seen with the advent of the gold Exchange Traded Funds (Gold ETFs). Many institutions had almost unwillingly climbed aboard the gold train through the shares of the gold mining companies, because they were forbidden from owning actual physical gold. When the Gold ETFs arrived they had an opportunity not only to own indirectly physical gold, but to directly affect the price with their buying.

The demand these securitized trust funds has attracted has been remarkable, relative to the size of the gold market. The tonnage of gold held in such funds has placed their holdings fifth in the table of Gold owners including central banks, so far. China and Switzerland own less then these funds do. These investors are entirely new to the gold market itself. Please note that such buyers hold for the long-term as a protection against other market's falling values. The more unsure they are of the future of various aspects of the global economy and its money, the more gold they will buy. Relative to their buying capacity, they have barely dipped a toe into the market.

As these buyers have shown, when they believe prices will rise, they buy for the long-term!

The story of central banks and gold, in contrast, is a sad one. Both politicians and bankers strove at the start of this century to establish a doctrine that paper currencies, with no gold backing, better serve as money than gold does. By persuading people that central bankers were capable of being a satisfactory "lender of last resort" – and that gold was a barbarous relic that had no place as money – they sanctioned a dual policy of selling and sidelining gold as money, thus accelerating the supply of gold to the point that the easy gold pickings were exhausted.

Then came the bad times starting in 2007, followed by the realization – verbalized by the German finance ministry – that gold was a "useful counter to the swings of the Dollar."

First Germany refrained from joining the broader Eurozone gold sales. Then the European banks stopped selling almost entirely. Once the International Monetary Fund (IMF) has completed its 403 tonnes of sales (half of which went to the Indian central bank in October), it will stop too. But meanwhile, China and Russia have started buying to the extent that central bank – net, worldwide – buying is running at around 400 tonnes a year, so far.

Now central banks have had to revert to their underlying belief (never in fact abandoned?) that gold is a vital reserve asset, particularly when dreams fade and realities take over. And higher Gold Prices in their case have led to a cessation of sales and substantial buying!

As gold and silver prices rise just like a thermometer measuring global financial uncertainty and instability, more and more investors are entering these markets for the first time, not for profit per se, but for protection against such fears and in an attempt to preserve the wealth they have. These investors come from the entire spectrum of investors across the length and breath of our world.

This is the quintessential reason why demand for gold will rise as Gold Prices rise.

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Gold: Sell in May and Go Away?

Will a classic dose of the "Summer Doldrums" knock the Gold Price lower in 2010...?

The GLOBAL GOLD MARKET has always seen India as the largest individual source of demand for gold, writes Julian Phillips at Gold Forecaster.

Indian demand has reached 850 tonnes in the best years and even in the worst years held over 300 tonnes. And thanks to the Hindu festival calendar, it has been possible to track the seasonality of this demand fairly easily during this time.

This demand has been labeled by Western analysts as "jewelry demand", we believe wrongly. But this title helps us to understand the Indian market for gold. Indian gold demand is centered on the family, the strongest of Hindu India's institutions. With an unbreakable distrust in the police, the civil service and the government, gold is part of a "black" (or underground) economy, outside the banking system. Gold's greatest quality is that it is money and can operate outside the visible money 'system' with banks at its heart.

In the Hindu family it is the husband that owns the families assets, but the wife brings both the liquidity and financial security to the new family through her dowry. The dowry is a gift to the couple from the wife's parents. It's fashioned as jewelry decorating the bride (and only from 24-carat gold) as she is "given" to her husband.

It was the case that 70% of Indian gold demand emanated from the agricultural sector. The marriage and its timing is therefore, the foundation of Indian gold demand. Hindus believe that there are auspicious days and non-auspicious days on which to get married. These are institutionalized in the various Hindu festivals in the autumn through to the spring in the northern hemisphere. In turn, seasonal factors dictate when these will be.

In the closing days of May, the agricultural sector turns to the planting season at the start of the Monsoon (heavy rainy) season. Crops grow through June to August when they are harvested and sold. The heaviest cash flow then starts towards the end of August. Autumn sees the start of important religious festivals considered the best time to Buy Gold. The marriage season reaches a peak in May. All are conscious that this jewelry is investment gold.

In the developed world Jewelry demand is likewise seasonal. The start of the high season is at the end of August each year. After the summer holidays, jewelers focus on the end year festivities and the gift-giving, at that time. That's when they Buy Gold ahead of manufacture. The season tends to follow through right to May too, with the quiet time from May to end August.

In the West it's important to understand that 'jewelry' is not the same as it is in India. In the West gold is usually just a small part of a piece of jewelry. Hardly any jewelry is bought for its gold content. Usually it's diluted to 18 or even 9 carats, a level unacceptable to the Indian market in general. But part of the changing world is that in India, 24-carat jewelry is giving way to small bars of gold in the dowry.

Consequently, the period June-August has been known as "The Doldrums" – named after the area in the Atlantic where the Trade Winds die down to nothing. However, for the last eight years the Gold Price has not fallen significantly in this period, except for one of those years and that not for traditional reasons. So will we see the gold "Doldrums" in 2010...? First, we have to understand why the Doldrums have not struck for 7 out of 8 years.

India has seen growth in their economy such as they have not seen before. The size of the Indian middle class has burgeoned so much that this sector has overshadowed the agricultural sector in its demand for gold. The new middle class is urban and its disposable income available all the year round, not seasonal. Add to that the advance of technology amongst gold dealers. They can now buy forward to the date they want delivery. The banks will permit buying and paying when they, in turn, are paid. This takes the price risk out of their gold holdings. It also allows them to buy when they think the price is right all the year round.

China has faced the same social changes but on a much larger scale. With no gold-giving, marriage traditions, urbanization and its higher paying opportunities has given rise to a big increase in gold demand all the year round. This demand is also long-term investment giving financial security. The Chinese are big savers (40% of their small incomes) and are likely to be so for the next generation.

The combination of this structural change in the market has virtually taken seasonality away from the Gold Price. Seasonality is not yet eliminated, but because investment demand is so large it is overwhelming current jewelry demand. This trend is growing by the year. As a result we do not expect what is left of the Doldrums to knock the Gold Price. The structural change taking place in the gold market is not just in its seasonality but in the entire shape of demand.

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Why Do Central Banks Hold Gold?

What's the point of Gold Bullion reserves, if not to be sold when times are hard...?

SINCE the start of the fourth Central Bank Gold Agreement last year on September 27th, gold sales by European central banks have been nearly non-existent, writes Julian Phillips at GoldForecaster.

This slump in gold sales came before the Euro began to implode, however. Now fractures have appeared in the Eurozone itself. Governments have to fiercely cut back expenditures. They must do this to the extent that the reaction is certain to be social unrest.

As it is, Greece is not only suffering already but its key revenue driver, tourism is suffering badly (25% down already this year). So cutting tax revenues and balancing the government's books is even more difficult. To many people out there, the gold holdings of such banks should be sold to shore up such shortfalls. But would European central banks agree?

Take a look at the table here (supplied by BullionVault). In all cases, the contribution that the proceeds of gold sales could make would, in all cases, barely dent the problem.

So selling gold is not a cure for Europe's national debts. But you may ask, what purpose do gold reserves serve, if not to be sold when times are hard? The only way to answer this is to take an individual as the nation.

Imagine this individual has some gold hidden away for a rainy day. He is asked by his bank manager to repay his overdraft, but he can't – not without a long-term plan to pay it off slowly against income. His bank manager tells him to liquidate his Gold Bullion and put that into the account. But if he were to do this, selling his final "back-up" reserve, any emergency that hits him out of the blue from then on will simply destroy him financially.

So he decides that when those dire times hit, he will keep his gold for the time when nothing he says and does is believed or accepted. Then, when he produces gold it has a value that his actions cannot affect. It has a value everywhere to anyone. This external value is what will keep him in business and allow him to slowly recover. Essentially that is the role of Gold Bullion as a reserve asset.

You may then ask why European nations chose to sell gold starting from the late 1990s. But every time nations sold gold over the last 35 years it has been not to raise emergency funds, but to try to give credibility to a new role for a currency.

The US did it in the 1970s, as the US Dollar – as well as being the world's petro-currency – went international. Nixon cut the Dollar's link with gold first in 1971. The Treasury then sold gold throughout the decade that followed.

The International Monetary Fund (IMF) sold gold in the late 1970s because it and the US wanted the Fund's Special Drawing Rights to replace gold in the monetary system. (note that national governments would not accept this, which is why the SDR remains a paper currency only in the IMF's books.) Then, in the late 1990s and early 21st century, Europe sold gold when the Euro was launched.

In the first two instances, the impression was given by the US and the IMF that gold sales would go on until gold was no longer part of the system. This forced the price of gold to fall from its peak of $850 to $275. Accompanied by "accelerated production and sales" of gold in the market, this campaign was believed, until this century.

But when European central banks decided to sell, they emphasized that it was still an important reserve asset and that they would sell no more than a maximum amount. The removal of the unlimited gold sales allowed the market to quantify the impact on the Gold Price. As a result, the Gold Price has moved from just under $300 to the peak of $1250 thus far – an average price increase of 43% per annum on the lowest price.

Now, no longer a "barbarous relic" as J.M.Keynes called it during the Great Depression, gold is preserving value at a time when currencies are losing theirs. Each week in the GoldForecaster newsletter we report the activity of central banks in the gold market, and while Eurozone selling has been minimal, other central banks – notably in Asia – have bought over 350 tonnes since September of last year.

Behavior was similar in 2009 when over 400 tonnes of gold were bought by central banks in total, and sales turned to a trickle. Since February of this year, European central banks have sold just one tonne of gold between them.

The true value of gold for a central bank – and for a nation – is that when its currency is threatened, whether by deflation or inflation, confidence falls in national currencies. Amid the worst circumstances of war-time, gold is exchangeable, even between enemies. This quality transcends its value as "just" money.

Fortunately, of course, we are not there yet. This is not such a desperate time that all else has failed. So central banks will keep a firm grip on the gold they have, for now, while others with too little – particularly in Asia – will do all that is reasonable to acquire more.

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Factors Driving the $1200 Gold Price

How Gold got to $1200 and what could support it now...

AFTER ALERTING our subscribers at $1050, and again at $1150, that gold was turning up while others were pointing to a downturn, it's important to review the 'why' of the matter, writes Julian Phillips at GoldForecaster.

After all, the Greek problem has been around for a while now. So has the potential drama from East European countries, plus the poor quality pace of the Greek bailout...the global sovereign debt problem...and the fact that the US could be right in there too.

Then there are the worries over the global economy. Is it going to be a double-dip recession, or has growth really found traction? Uncertainty and falling confidence is now the norm!

Why did the crisis hit now? Call it 'realization', call it 'coming out of denial', the impact of the sum total of the problems is summed up in that old saying, "He who sows the wind, reaps the whirlwind". It is being called the "contagion" danger, but it is simpler than that.

In the markets, when a pennant formation builds up around a narrowing trading range, buyers and sellers move to a point where they are equally balanced, then like a see-saw, the slightest additional weight either side tips the balance, one way or the other. That's what these crises are like. But on top of that, once it tips say to the buying side, the sellers become buyers then momentum builds up. So does panic and fear. You can smell it. That's what we're seeing right now.

Fears that Greece just does not have the competence or capacity to rectify their debt position are gaining ground. They have addressed the smaller but similar problem of austerity before, but to no avail. Spain, even though it is no longer in recession, just does not have the economic structure to repay its debt, not under current circumstances. Ireland, Italy, the UK and the US could fall into the same category.

It's becoming a world-wide problem, in fact, with China and Germany and other surplus countries the only ones able to supply the funds (unless more debt is issued and bought directly by central banks). So it's a structural problem...rather like a bank creditor not having the ability to increase cash flow, while cutting costs. He can promise anything he likes and raise interest levels as high as he likes, but all he does is send out distress signals.

In our pages we warned that such problems would bring social consequences and here we are. Debt financing, without a convincing way to repay that debt never ends happily. All the promises do is to confirm desperation. Certainly, that's what the markets are telling us right now.

We have also warned of a de-coupling of the Gold Price from the Euro/Dollar exchange rate for several months, and we are seeing it now. With gold over $1200 an ounce – and the Euro back to late 2004 levels vs. the Dollar at $1.30. The reason is not Dollar strength but Euro weakness. The panic in the markets is because of fear and uncertainty for the entire global currency system, added to the sovereign debt problems.

The UK is now saddled with a 'hung' Parliament, and so Sterling is in the firing line, too. It's possible that, with a currency of its own, outside the Eurozone, Sterling will fall heavily. A re-introduction of the "Dollar Premium" is possible as the UK returns to 1970s-style capital controls.

That's why we are now seeing the Gold Price at record levels in all currencies.

Gold investment demand from central banks, to funds, to institutions, to wealthy individuals, is driving the price as fear and uncertainty mount. One commentator said that "when the fear subsides the Gold Price will fall". But fear, when it runs deep, scars the fearful. It takes a long time to lose that fear. Sometimes it takes years. And that's the investor.

On the other side, fear only subsides if there's good cause for it to do so. In this case, the sovereign debt problems have to go away first. What will this take? First, debt levels have to be reduced and economies re-structured so that this can happen. Then, the currency markets have to be reformed, so that exchange rates don't move as wildly as they are now. If successful, calm will return, but even then, it'll take years for confidence levels to recover to what they were.

From now on we believe that a growing number of weekly investment strategy meetings will recommend that a percentage of funds be held in gold for the long-term. This will ensure that the Gold Price will hold $1200, we believe. Central bank demand alone is capable of ensuring that the Gold Price is underpinned. New buyers will have to pay a rising price.

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