Using jewelry for Gold Investment – a joke or not...?
GOLD is a highly emotional market, writes Lara Crigger at Hard Assets Investor.
But exactly which emotions drive which investors? It might surprise you, says Frank Holmes, CEO and chief investment officer of US Global Investors, an investment adviser managing 13 natural resources and emerging market mutual funds.
Here he speaks to Hard Assets Investor about Gold Investing, including his thoughts on the double-dip recession idea, plus what drives gold's seasonality, and why hope – not fear – drives emerging market Gold Investment demand.
Hard Assets Investor: Do you believe we're headed for a double-dip recession? Have we hit a sustainable level in our economic recovery, or are more hard times ahead for us?
Frank Holmes: I think there's still more challenging times ahead for us. Government policies in the developed world are very "anti-money." Not anti-money laundering, but basically anti-money.
A lot of the policies that allowed banks and brokers to leverage their balance sheet from 4 to 25 times, or home loans that go up to 80 times leverage, these were all done with government policies. They haven't worked. So rather than go back to the drawing board and revisit these leveraged policies, instead they're conducting an assault on anyone who made bonuses in the financial sector. This contempt, this sort of attack with jealousy, these policies have become broad-brushed, and it's also against many CEOs. All CEOs are being branded.
HAI: Sure; they make good scapegoats, right?
Frank Holmes: They do make great scapegoats, but all that does is trigger CEOs and other people from spending money. Not only are you seeing this in the fear in the general population, where savings rates are rising, you're seeing a sort of psychological backlash. People are saying that the policies are so anti-business, that all you're going to do is tax us more for flawed policies to begin with.
So that creates a backdrop where it's easy to say that we're going to get a double-dip. When push comes to shove, I think governments will panic and start the printing presses. Maybe this will prevent the double-dip, but at the same time, it will set up the platform for gold and other hard assets to become more attractive to diversify your investments with.
HAI: So given all this printing of money, do you see inflation going forward? Or deflation, maybe even stagflation?
Frank Holmes: Yeah, I think we're going to go from deflationary battles into stagflation. These cycles last 20-25 years, and we're only "halfway through." Based on just the probabilities of cycles, we have another five years of wrestling with this deflationary/stagflation environment.
When I look globally, unemployment isn't just a domestic issue, and that issue is deflationary. Rising unemployment or high unemployment creates deflation. The only inflation we're seeing is in legal bills, accounting bills, anything bureaucratic. Those costs are going up. And it's not just one country.
But I think you need to stand back and look at history.
HAI: How do you mean?
Frank Holmes: Over 400 years, we've had 47 of these crises. And every decade you get some major currency/credit crisis. What you see is that a recession based on rising interest rates takes almost four quarters to turn around. But when it's based on a credit contraction/credit crisis, it takes 16 quarters. And we're halfway through that.
Look at the Asian currency crisis of 1997; it wasn't until 2001 that they bottomed. Russia's was in '98, and they didn't bottom until 2002. In America, we had the S&L crisis, which started with tax reform in '86, and it didn't really bottom until the Resolution Trust Corporation was created, in '91. You get lots of volatility during these periods, so investors have to be able to anticipate before they participate. They have to use volatility to their favor and not become distraught over it.
HAI: How can Gold Investing help people deal with market volatility?
Frank Holmes: Well, gold is now less volatile than the S&P, although gold stocks are much more volatile than the S&P. The average annual volatility over 10 years is one standard derivation less; it is a non-event for Gold Mining stocks to go plus or minus 41%. But gold's volatility is around 15%, whereas the S&P is 19%.
But you still get a lot of negative thought process that gold is bad. There's just a general anti-gold or anti-any form of money. It doesn't matter if in America there's a democrat or republican in power; you see the groupthink model take place.
HAI: Last time we had you on the site, we talked about the seasonality in gold, and you pointed out that September tends to be a fantastic month for gold returns. But September highs tend to be followed by October lulls. Why is that? What's behind the big peak and then the yearly lull?
Frank Holmes: it's very difficult to try to highlight one factor. It has to do with the religious holidays, and their rotation; Ramadan can start in early August or late September. You can also have weather factors of rain, which can delay the consumption of gold in countries like India and Bangladesh, even China. So on top of that, historically you get this October phenomenon with stock markets: If the stock market has a pervasively negative sentiment and there is a move to raise liquidity, then all asset classes tend to get pounded during these short-term liquidity-driven events, even gold.
HAI: But normally, gold and the S&P 500 have a negative correlation to each other: When the S&P goes down, gold goes up.
Frank Holmes: That's correct; however, not during liquidity crises. We saw that in the '87 crash: Gold was the last asset class to fall. It became a source of liquidity, because everything else had been punished so completely.
So you have a set of religious holidays taking place, and historically, you have some events that happen in the financial capital markets in October that lead to a higher probability of triggering a liquidity event. You have election cycles, which usually take place in November; October's 30 days before that. You have year-end trades. So there's a sort of clustering or traffic jam: Cars go in and out of the city easily, except from 7am to 9am. That overlays the normal fiscal commerce and exaggerates this sort of cyclical pattern that we have.
HAI: As more of the demand for gold comes from the investment sector, will these same seasonal relationships still hold up?
Frank Holmes: I think so. You're not going to get away from the religious sentiment of giving, the emotional part of giving. In many of these countries, in India, in China, the consumption of gold over there is about hope, while the consumption of gold over here, as a financial asset, is fear. It's a different source of emotions.
Dominique Moisi wrote a book called The Geopolitics of Emotion on how certain emotions can undermine confidence and others support and enhance confidence. With those he found that the three most important emotions are hope, fear and humiliation. So if you look around the world, here's a society filled with more hope than fear, and it triggers a completely different consumption pattern, especially when it comes to Gold Investment.
HAI: Will that hope-driven buying in China and India be a stronger influence on the gold market than fear-based buying, or at least more sustainable and long-lasting?
Frank Holmes: They're different, but I think fear buying has more spikes to it. Long term, jewelry demand is much more important.
If you want to see where the physical demand would collect, it would be where jewelry demand is strongest. If there's a lot of liquidation by funds and individuals getting out of their gold, then you'll see Asia will always come in as a buyer whenever gold falls below $100. We saw this from $250, all the way up to $1,100; gold spiked. As gold jumps $100 in a period of six weeks, they just stop buying, and as soon as it falls back, then they become a buyer again.
HAI: So when we emerge from the other side of this normal seasonal bump, where do you see the price of gold ending up?
Frank Holmes: Well if you look at the next five years, if gold were to readjust to its 1980s inflation levels, then it would basically double from here. That just lends itself that gold is going to go to higher price levels. Now is it going to happen over the next three days, three weeks, three months? No, but it's in motion. And as gold becomes more accepted as an asset class, and you have more and more people putting 5% of their weighting into gold – and you compare that to the gold supply coming out of mines, since bringing gold out of the mines continues to be a challenge – then naturally your demand is going to be greater than your supply.
So the best thing to do is make sure your loved one buys you lots of high-quality gold jewelry. That's a joke, you know, but really, it's not.
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