Gold Prices: Bull Market Looks Set for 12th Year

An interview with the World Gold Council's Marcus Grubb...

GOLD looks set for its twelfth straight annual gain. Marcus Grubb, managing director, investment at the World Gold Council in London, speaks to Hard Assets Investor about the current state of the gold market and what is behind the yellow metal's recent run-up.

Hard Assets Investor: Gold and silver are near four-month highs. What's behind this? There hasn't been a lot of news going on in the last couple of months and gold has been pretty stagnant. Why the sudden move?

Marcus Grubb: A number of factors are crystallizing to create a path of least resistance that now is upwards rather than downwards. One of them is the fact that looking into the second half of the year, talking to investors around the world, there's still a lot of concern about the health of the financial system and the Eurozone in particular. And also some challenges in the US around the fiscal cliff and the sustainability of the economic recovery. However, it is clear that the US is recovering better than many other Western countries around the world.

This has led investors to continue to weight towards more cautious asset allocation, increase their exposure to gold. And I think to some degree they may be diversifying from overweight positions in Treasurys and US Dollars.

HAI: Are you expecting gold to appreciate for the twelfth straight year?

Marcus Grubb: Yes, we are expecting this to be a twelfth year of the bull market for gold. And we also expect a better second half in terms of the supply-demand dynamics of the market. The first half of the year was quite challenging. We saw a small decline in gold demand. A lot of that was driven out of India. The Indian market has had some specific challenges this year—import tax, strikes in the jewelry sector—and then most importantly, a weak currency against the US Dollar, and one of the weakest in Asia against Dollars. 

Gold has been very expensive in India as it's been consolidating in Dollars for about a year. It's actually been near an all-time high in terms of Rupees, which has had a dampening effect on gold demand for the first half.

In the second half of the year, you usually see stronger demand in India. We have the stocking period ahead of the Diwali Festival in October and November. And then we have the end of the monsoon rains before that, and usually you see incomes increase in rural areas and gold purchasing picks up in September, October as well. The Rupee will probably still be weak, but we do think you should see a seasonable pickup and demand in India. And that will, among other things, help demand in the second half.

HAI: What do you see as the biggest influence on Gold Price right now? Is it sovereign debt? Is it central banks Buying Gold?

Marcus Grubb: It's three things really. Underlying jewelry demand still remains a fundamental underpinning for the market and that's still the case in India and China, which are nearly 45-50 percent of demand. The longer-term picture is still very buoyant, even if both countries are seeing GDP growth forecasts downgraded at the moment. You're likely to see more wealth creation in both countries, with possibly 1 billion new consumers in the next decade. Urbanization is continuing in both India and China. That is your fundamental underpinning for gold.

The second thing is, as you said, the central banks have been major gold buyers this first half. They've been very important in maintaining the balance in the gold market in the first half of this year. Without them, we'd have seen a significantly weaker market. They're in record territory in terms of gold purchases. If they keep going at this rate of 254 tonnes for the first half, we'll have a record since the early1960s that will confirm central banks have thoroughly moved onto the demand side of this market. They're doing it to diversify from Dollars and from Euros again because of fears about the financial system and about the world economy.

The third point is the continuing concern around the world, especially specifically around the Eurozone and what may happen to Greece, what may happen to Spain. Will the constitutional court decision in Germany go the right way on Sept. 12, allowing a broader bailout structure to be put in place around the ESM [European Stability Mechanism], or will it be effectively stymied by that vote?

There's plenty of scope for more financial system and Euro problems in the second half of the year. That is leading investors to continue to load up on gold positions, and around the world, to investors continuing to hold onto the gold they've got because of the risks that are potentially there for the second half of the year.

HAI: What would it take to slow down the central bank gold purchases?

Marcus Grubb: The good news for the gold market is I don't think much will stop central bank buying. A large part of the demand is based on developing countries where central banks are moving their gold weightings up towards a more average level for the segment as a whole. It's interesting to note that the buying is all coming from developing countries' central banks; not from the European and US central banks, who in the past have timed the gold market very badly. This demand is coming from the new countries: Latin America, Central Asia, India and the Far East. And these are all countries that tend to have much lower weightings to gold. The average of most of the buying central banks is probably under 10 percent, and in some cases under 5 percent.

First of all, there's a structural need for these central banks to purchase gold. Even if the climate was better, there's a structural need for them to have a higher gold weighting. But let me answer your question about what it would take to slow down purchases. If the world economy was in a more steady state with moderate growth, low inflation, low unemployment, strong currencies and interest rates moving back towards positive real interest rates to restrain inflation pressures, that would do it. But as we all know, that nirvana of nicely balanced world economies is a long way off at the moment.

HAI: You mentioned recently in an interview that the second half of the year also is going to depend heavily on Western investors getting into the game, and specifically US investors. We just saw on Friday [Aug. 17, 2012] that the SPDR Gold (NYSE Arca: GLD) pulled in some $850 million in new assets. Isn't a lot of that money coming from the West and the US?

Marcus Grubb: Yes, Western investment has been quite strong this year. And it was obviously in the second quarter. And as you say, there have been some big inflows into US ETFs and GLD in the last few weeks.

But over the first part of the year as a whole, it's a different story in that much of the sales in bullion bars and coins and ETFs have been concentrated in Europe rather than in North America. But it's quite a skew in the demand towards Europe. And in a way, I think the US investor has somewhat gone to sleep in terms of the gold story.

If you look at the mint statistics for Buffalos, Eagles and other minted products in the US, they're pretty much down month-on-month most of this year. And while overall ETF tonnages are at all-time highs now in August for physical Gold ETFs—at more than 2,500 tonnes—that isn't the case in the US ETFs. For example, GLD is still below its all-time high in tonnage, as are other US ETFs.

The big question of course is that we're going to see a lot of action in North America in the second half of the year. The debt ceiling debate has been pushed off towards the Q1 next year. But you still have the elections, of course, and the debate about policy up to the election. And then you've got the fiscal cliff, which I'm sure will be part of the debate about the level of stimulus the economy requires to reduce unemployment.

And there are some quantitative easing expectations entering the market again in the US that's helping push the price up a little bit at the moment. So the bottom line is that there is the prospect that the US investor moves back into gold quite heavily in the second half depending on how some of these factors pan out.

HAI: Do you find that demand does fall off when volatility goes away? I mean, in some ways you could argue that a stable Gold Price is pretty much a nice hedge.

Marcus Grubb: I think traditionally the market is somewhat bifurcated where volatility is concerned. Often, volatility is a negative for jewelry consumers. And, of course, half of their decision-making process is investment, but other parts of it have to do with cultural attachment to gold, the beauty of the pieces, the ornamentation and the emotional value of them. In some markets, volatility can be detrimental. It makes purchasing more difficult and/or it undermines the investment value of the pieces if the price is moving around a lot.

Where investment is concerned, volatility is not necessarily a bad thing, especially if it is associated with a rising price trend, because the investment driver is higher. Investors Buy Gold for its mixture of properties as an asset, as a hedging asset and as a store of value. But it would be foolish to think that investors don't Buy Gold also for its return characteristics. It's a mixture.

The interesting thing to me about gold today, and for the last 11 years, is that you are able to have your cake and eat it too. If you look over the long sweep of history, gold is delivering super-normal returns compared to its own history and other assets classes. And it is a fantastic diversifier and insurance policy. So you would be very remiss not to have gold in a portfolio now, because of the fact that you're getting both benefits of gold at the moment.

HAI: What is your current recommended allocation of gold in an individual's portfolio?

Marcus Grubb: We don't make overt recommendations because of the nature of our organization. But what we have done is produce a stable of research that looks at, for different types of investors and different currency bases, what would be a potentially optimal allocation to gold.

It pretty much ranges between 1 to 2 percent in the smallest cases, and up to as high as 10 percent depending on your currency base, and depending on your appetite for risk across a broad portfolio. The research work we've produced finds that for a midrange risk preference, and for a pretty diversified portfolio, something in between 4 and 5 percent is a pretty fair assumption for an optimal gold weighting. That kind of portfolio containing that amount of gold would almost always outperform one that did not.

HAI: What are the current gold demand percentages for the investment, jewelry, central bank and industrial use categories?

Marcus Grubb: This quarter was somewhat unusual in that central banks came in at a pretty whopping number. I think something like 16 percent. Though I must clarify that central bank demand is very lumpy. It's usually spread out more over the year. And it certainly will be when we look at the whole of the year.

But in general terms, where we are today is that jewelry is somewhere around 42 percent of demand and still the largest category, both quarterly and annually. But that's from something like 70 percent about five years ago. Investment is now somewhere around 31 percent fluctuating, but it's up at a near all-time high, certainly in recent years. It was higher in the 1980s, but in recent years it's been at a high of around 35 percent. It was only about 19-20 percent about five years ago. It's about 11 percent for technology and industrial demand.

When you look at the supply side, mine production is pretty much flat over the last eight to 10 years, or slightly up. New mine production has been pretty static throughout that period.

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