Thank monetary politics and emerging Asia for the Gold Price gains of the last 10 years...
GOLD HAS BEEN rising consistently for more than 10 years, says Geoff Candy, host of MineWeb's weekly podcast, and with each new high people are calling for a gold bubble and saying that the Gold Price is going to come off.
Joining me on the line to discuss this today [Mon 20 June 2011] is the head of research at BullionVault, Adrian Ash. You recently wrote a piece that looked to explode a few of the gold bubble myths. Why would you say that gold isn't in a bubble given its rise over the last 10 years?
Adrian Ash: You can understand why journalists and commentators who don't follow the gold market very closely look at it and see there's a bubble. We have just had the second highest weekly close ever in US Dollar terms and the highest ever weekly close in both Euro and Sterling terms – but what a lot of people get confused, I think, is they look at the gold rise over the last 10 years and particularly over the last five years and they confuse longevity with speed. Bubbles really are about that parabolic rise, that parabolic blow off but most typically what you are also looking for is for that to be happening at the same time as the fundamentals no longer hold true.
Aside from whether one thinks gold is a good investment for the long term or whatever, there are just a couple of points which people who look at it and say "It's got to be a bubble because it's gone up" are really missing. The first as I say is that it's steady, it's been rising by about 16% year-on-year for Dollar and Sterling and new investors over the last half decade. That's hardly parabolic. In terms of volatility you anticipate a bubble top, a bubble blow-off being very volatile. But gold's volatility is incredibly low at the moment and it has been over the last few years. Every time it's taken out a new level – whether its $1200, $1300, $1400 or $1500 – volatility on gold on a daily basis has been very low. Right now its running below 11% and that's versus a four decade average of 16.5%. Compare that with silver where you've currently got daily volatility after the big top of last month running over 45% and that compares to silver's average daily roll over the last four decades of 29%. So silver looks a bit hotter, theres no denying it.
Another reason that people say gold must be a bubble is that they then start looking for what's going to blow it up. What's going to take it down – and my favourite really – is when people say "When the economy settles down, gold will come off." You've got to love that when first of all, but more germane is the fact is that gold doesn't have anything to do with GDP. If you look at it against US GDP, the Dollar price versus US GDP, the correlation is slightly negative but it's not specifically significant. The same is true of Chinese growth. Chinese GDP shows zero correlation with the Gold Price. The Indian economy has a slight positive correlation with the Gold Price, but again it's not really specifically significant. The bottom line is, because gold is not an industrial metal, gold's use is social not industrial, and its social use is as a store of value, a store of wealth when people need it – gold's not exposed to the economic cycle. It's not like crude oil or copper or even silver to an extent. It's not exposed to industrial demand.
Geoff Candy: I suppose the corollary to that is the fact that people were perhaps concerned about the rise in Gold Investment demand and the fact that it happened at the same time as perhaps a fear about the global economy and I suppose the concern was whether or not, if that investment demand came off, there would be enough fundamental demand for gold to sustain the higher prices. That does seem to be happening at the moment. What is your view on that?
Adrian Ash: You have to look at what is driving that demand. Yes – fears about prolonged stagflation, fears of a true depression, which we may or may not have been through over the last couple of years (it's been impossible to tell with the amount of money which governments have thrown at it and particularly central banks have thrown at the problem as well). But what is really driving demand there, it's not about GDP, it's about real interest rates. Very boring but it happens to be true with gold.
Obviously people Buy Gold when they fear the inflation ahead and personally [I believe] they are right to do that. But on a big boring and technical level it is about negative real interest rates so when the return on cash is below zero after you account for inflation people will Buy Gold. It's just a fact. It is what happened in the 1970s and its what's been happening progressively over the last decade and particularly in the last three or four years now. The reason that happens is because obviously – the word savings – that still means cash in the bank for most people and if you're getting less than zero, if you know if you put money on deposit today that it will lose purchasing power, including the interest rate over the next 12 months, eventually you start to get sick of this. People need to find something else; I need to find a better way of storing value and gold is a stand-out candidate for that, primarily because of its use across five thousand years of history.
Wherever gold's been discovered in the world and throughout time, it has been used as the ultimate store of value par excellence. People again are doing that today. They are looking at something which is rare, it's tightly supplied, and it's indestructible – and that really makes it stand aside from cash, and debt instruments, bond investments where those are paying you less than inflation.
Geoff Candy: I suppose we come back again to that when and is there a chance or when would you say real interest rates are likely to turn positive again?
Adrian Ash: No time soon I think is the answer. Take for instance in the UK. We've now got the worst negative real interest rates on cash since 1978. So the net affect to cash savers right now is as bad as it was when inflation was running at double digits, just before the Thatcher era. The difference of course, is that inflation because its running at 5% doesn't seem to be quite so dramatic so it's much easier for Central Bankers to talk it away. We had this last week with Mervyn King in his Mansion House speech to the City of London, basically re-stating, very plainly – it was interesting actually, the most blunt presentation of the case for negative real rates that he's made – where he said to rebalance the economy we need to keep the rate of interest below zero after inflation. It's just what we are going to do. We are not going to change the plan. He made it very plain.
I don't see any change any time soon. The real fetter on central banks and this includes the Eurozone of course, where we know there's a residual nostalgia for strong money obviously because of its geneology with the German Bundesbank, the European Central Bank – there are a lot of people would like to have normative interest rates. They would like to move towards 5% please, but there's no hope of that happening because government debt is so enormous now, [and] this if a big difference to the late 1970s.
In the late 1970s, yes – government debt, US Treasury bonds, became known as certificates of confiscation because you were losing real value in them year after year but the big difference now is that government debt is so enormous as a proportion of GDP that governments cannot bear 5% interest rates. I do think there's a case for looking at the 2007 banking crisis, the 2007 blow up. US interest rates were creeping up towards 5% and the US economy couldn't bear them at that rate and things fell apart and it's just the mountain of debt. What that means of course with regards to Gold Investment, is that people look at what the government's response will be or what the central banks response will be to a debt default.
We can see this in Greece right now. How's Greece moving towards a restructuring? We know it's going to happen whether it happens smoothly, whether it happens dramatically is really neither here nor there, there will be a write-off and creditors will be destroyed. This is what happens after a debt bubble. Always happens after a debt bubble, the creditors will wear it. So people again are looking for something that is indestructible, it's rare, its tightly supplied and I think for as long as we have such enormous government debt, for as long as the write-down cannot be countenanced – defeated by inflation or default, it's coming but at the moment politically it's impossible to talk about here so this kind of dilemma which central banks and governments have now, they can't move either way. They are trying to inflate and the only thing it is doing so far is pushing the cost of living and pushing up the price of gold.
Geoff Candy: Talking about central banks, they are Buying Gold as well.
Adrian Ash: Indeed. I was looking at some numbers last week from the Euro System banks – from the European Central Bank – and bizarrely, although the big Western European Central Banks have been selling down gold now for 20 years, they have actually become net buyers this year. Only marginally [and] only by a couple of hundred kilos. But just on their own Gold Coin book (a lot of European Central banks are responsible for organising gold supply for their mints), previously they would have sold a couple of tons a year to the mint for producing gold coins, but now they are actually buying it on the market in coin and so they've actually ended up, because they are not selling under the Central Bank Gold Agreement now – that agreement is basically over. It's signed, it's going to run for another four years but there's nothing happening there.
So central banks in Europe are basically marginal net buyers and of course we know that emerging market central banks are very strong buyers. Russia in particular has been steadily accumulating now, and obviously there are constant rumours in the market about China. We know China won't declare its hand if it can help it but it's telling that the Reserve Bank of India made that large purchase, 200 tonnes from the IMF, back in 2009. The Mexican Bank has bought about 100 tonnes on the market over the last six months, so there is very strong demand from monetary authorities as well.
Geoff Candy: If we look at the seasonality factors of gold. Clearly it's a topic at the moment, given that traditionally a lot of commentators expect gold to decline over the summer months to some extent. But there has also been a shift, and one would be remiss to talk about the gold sector without talking about India and China and you did just mention them. In general there does seem to be a large amount of seasonal buying on the part of the Asian markets. Has that changed as we have seen an urban middle-class growing in these countries?
Adrian Ash: I think it's demonstrable that you have [seen a change]. If you take Indian demand first. Obviously India remains the world's largest source of private household demand. Last year was phenomenal. The 2010 numbers out of India were really quite staggering with the numbers produced for the World Gold Council by GMFS Limited equate to about 2.6% of GDP last year in India was spent by private households on gold. It's a phenomenal weighting, and the key point is that over the last five to 10 years as we have seen this emerging middle class coming through, there hasn't been substitution out of gold add into "sophisticated" financial products or into other consumer goods. [Instead] you've actually seen the proportion of household savings in both India and China going into gold increasing as wealth has risen. Perhaps Western analysts forget just how poor the vast bulk of people are in these countries, so as they get a little bit more money and they get a little bit more wealthy, they start to have some discretionary income, some disposable which they can now choose to keep hold of – the first thing they are doing is keeping it in gold.
That does mean, certainly over the last 40 years there has been a typical seasonal pattern in the Gold Price, take the Dollar Gold Price for instance you typically see a rise in the spring and then a peak which then drifts away over the summer and rises again in the northern hemisphere autumn and then if you're in a bull market it ends the year higher than the spring peak, if you're in a bear market you end the year a little bit lower. But that is the most common pattern, the most common shape in gold Dollar prices over the last 40 years.
In nine of the last 10 years, you've had that pattern nailed on. There's been a peak in spring, it's drifted back in summer and then it's risen starting almost exactly on 1 September it is almost like a starting gun, bang off goes the Gold Price again. It's a new high late towards the close of the year and finishes the year higher than its spring peak – there are a couple of things there to take note of if you try to time the market. Firstly the growth in Chinese demand is having an impact in the underlying pattern there and so the bulk of Chinese buying, the real peak of Chinese buying comes through at Chinese New Year, late January early February and that's actually time to move a bit of the weight of the strength of gains from Diwali – the Indian Festival of Lights in October/November – through towards the start of the calendar year and that's because you are seeing such phenomenally strong growth being Chinese gold demand.
Another thing to bear in mind for the summer lull is that it is actually a lot shorter than people hope. Over the last decade from the spring peak to the summer low, has on average been five weeks and the low has never come after the beginning of August. So if you are going to try and time the summer lull and you if you think there is one developing, there's not much sight of one to-date, you might want to try and be early in buying back in.
Geoff Candy: Given what's going on in the US and Europe at a political level we've got the concerns around the debt ceiling, the end of the QE2 in the US, that surely is going to impact on the Dollar. Is it likely to impact on gold or has a lot of that been priced in now?
Adrian Ash: It's a good question. What is the impact of the end of QE2? Obviously the gold market, the long-term gold bulls, are going to be looking for QE3 and we might see that under another name – there are going to be various discussions going on right now between the Federal Reserve and the Treasury about how they can speed things along a little bit without being seen to have gone for QE3, and we might see some kind of repackaged approach to that coming through anyway. And so much of the gold market, the gold bull market, over the last 10 years has been about monetary politics rather than about politics per se.
You will remember when tanks were rolling into South Ossetia back in 2008, and the Gold Price wasn't really doing a great deal at the time and a lot of people were surprised by that. Similarly with the Arabs, spring this year. The Gold Price wasn't jumping on the news flow coming out of North Africa and the Middle East. It's really about monetary politics – if you look in 2010, obviously the Greek debt crisis really lit a fire under the Euro Gold Price. Similarly then, last summer after Ben Bernanke made his speech at Jackson Hole promising QE2, which was in August, off went the Gold Price again, bang – basically the market anticipated cheap money coming through, devaluation of the Dollar, off goes the price, same again in 2007, as the banking crisis was clearly upon us, the Federal Reserve was making plain what it was going to do to the Dollar to try and mitigate this. That's when the Gold Price took off again against all currencies.
So I think you do have this interesting confluence coming up over the summer of the nominal end of QE2, plus the debt ceiling arguments going on at the moment in Congress. To be blunt that's noise because we know what central banks are going to continue to do, both in the West and across emerging markets as well. Indian and Chinese real interest rates are very much below zero as well. Similarly for consumer and households there, the savers in those emerging economies Buying Gold, defending wealth because cash won't.
Geoff Candy: Finally clearly signs are relatively good for gold for the rest of this year at least.
Adrian Ash: I often get anxious when I can't see a problem with the gold market to be honest. Obviously at Bullionvault our business is helping people buy and own and trade physical gold bullion as efficiently and low cost as they can and we are as a business presently taking our long term bull market and as I say I get anxious sometimes when I look at the gold market and I can't see a problem with it. But as I say just looking at monetary policy and looking at the outlook there, yes it is difficult to see it coming off any time soon.
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