A Bubble in Gold Prices...?
Hot money in, but no way out for central banks priming the surge in Gold Prices...
WITH THE Gold Price now trading above $1100 an ounce, many investors are starting to wonder if the fundamentals really support the yellow metal's seemingly unstoppable upward rise, reports Lara Crigger at Hard Assets Investor.
But it's not just a weak Dollar and inflation fears driving gold upward, says Adrian Ash – editor of Gold News and the head of research at BullionVault, the world's fastest-growing online gold service for private investors.
Formerly head of editorial at Fleet Street Publications, the UK's leading publisher of financial advice for private investors (and regulated by the Financial Services Authority), Ash now regularly contributes to many top gold analysis sites. His views on precious metals have been sought by the Financial Times, the Economist, Bloomberg and others.
Here Ash speaks to Hard Assets Investor on the real reasons behind gold's rise, why gold is actually a terrible inflation hedge, and whether or not we're nearing a gold bubble...
Lara Crigger, associate editor, HardAssetsInvestor.com (Crigger): Gold has been on a real tear lately, and analysts often point to the falling Dollar and inflation fears as the reasons behind its rise. But is that really all that's going on here?
Adrian Ash, head of research, BullionVault (Ash): I think there are several elements behind gold going so much higher. Firstly, the attitude toward the Dollar is a really big part of that, because gold is priced in Dollars.
But it's really quite mechanical to say Dollar down, gold up. You have to look further, and Gold has done nominally well against all major currencies too. It's up three times over against the Euro; it's performed very strongly against the Japanese Yen. Against a global basket of the major currencies of the world, in fact, it's made all-time highs. Currency depreciation is a major concern, driving a lot of money toward gold over the last decade. Then there was the government response to this financial crisis.
You can't deny studies that show gold was actually a terrible inflation hedge for the best part of the 20th century. But it was a great inflation hedge during the 1970s, and during a genuine currency collapse, like Mexico in the '80s and '90s, or Southeast Asia in the late ‘90s, or Weimar Germany in the '20s. Certainly it is a fantastic store of wealth when inflation reaches hyperinflation proportions. Gold has been a good defense against deflation, however. If you look at the last couple of years, we had deflation in asset prices. Again, gold has done very well in defending its value over those times, because people move to gold when businesses and banks are failing. They want that physical security that gold offers.
Crigger: So gold will do well regardless of whether we have runaway inflation or catastrophic deflation on the horizon.
Ash: It comes down to this: Gold tends to do well in times of financial stress. And inflation or deflation – they're two manifestations of the same thing, which is the destruction of wealth. High inflation destroys bond investors and cash savings. But then deflation does the same thing, killing banks and debtors indiscriminately, and meaning cash holders and bond holders are destroyed again. The net effect is the same: A loss of wealth. Gold's appeal steps forward there, as it's rare, physical, tangible property.
Crigger: Even though spot prices have shot up lately, investments in the gold ETFs have remained relatively flat lately. Why is that?
Ash: In the past three months, really since the end of summer, the move has been driven by leverage. If you look at the exchange-traded funds or businesses such as ours – yes, we're still doing very well, but we're not seeing the same kind of flood of new business that we saw six or nine months ago – it's very much about institutional traders instead. They're using the very cheap money they can now access. Hedge funds, prop desks at the banks...these guys are basically leveraged up on everything. That's why we see correlations getting very strong again between emerging markets, non-US currencies, precious metals, and equities across the board.
It's very much the reflation rally of 2003-2007 replayed. The broader markets have wanted to get back to that trend. So many financial players have been looking to get back to a world they understand – Dollar down, everything else up – that's why I think you've seen such huge gains across the board between September and October.
Obviously, a lot of hot money has come into gold, and it's coming in through the futures market, so the chances of a sharp correction are much greater than if you had a bulwark of cash buying the physical Bullion.
Crigger: Given this influx of leveraged players in the market, how long do you think gold's upward trend will continue to last?
Ash: It depends on a couple of things. Firstly, what triggered the sell-off in Gold Futures last time, after the March 2008 high of $1032 per ounce? The speculative position in gold futures was then very long, and wanted to get longer. But as the banking crisis kicked in, a lot of the prime brokers – the investment banks who'd enabled hedge funds and other large speculators to take huge positions – had to shut them down, because credit was drying up. The cost of finance was going through the roof. So if you look at the destruction in long positions in mid-2008, any repeat of those circumstances, I think, would probably see prices come off quite hard.
Then again, that environment encouraged physical buying again by retail investors. I'm not saying there would necessarily be a replay of that if that were to happen. But certainly, the kind of environment that would force hedge funds out of long gold positions would likely encourage people to go buy physical.
On the other hand, if the hedge funds were to decide they'd had enough, and were ready to move on, that's a different story. Again, look at the reflation rally of 2003-2007. There was recycling: People would move on from one hot trend to another. Sometimes it was the Euro, sometimes it was oil, or gold. But the three of them in general moved together. So if they were to decide to take a breather on gold for the moment, in the absence of any other kind of shock, you might well see a lack of the same kind of urgency we had in the middle of 2008, and gold would fall.
Crigger: Are we nearing bubble territory in gold?
Ash: Well, obviously any bubble requires cheap finance. So the accusation can certainly be made. But I think where that is amiss is that there simply isn't the overwhelming move into gold by the broader public that you really associate with a bubble.
If you look at gold in terms of how much money has actually gone into it, compared to how much money is still in other asset classes – consider that back in 1982 or in the depths of the Great Depression in the 1930s, gold accounted for huge amounts of investable wealth, probably about one-fifth at some estimates. But today, you're looking at – even at the most generous estimates – less than 5% of investable wealth worldwide.
So my point is that gold is still under-owned by individual investors, and it's certainly under-owned on an institutional basis.
Crigger: So clearly there's still room left for investors to jump in...?
Ash: Well, I think it's obvious what my view is! But what gold has done over the past few years has surprised everybody. Looking forward, yes, I think people are right to say that gold's only going to go higher if there's further trouble ahead. And I think it's pretty reasonable to say that there probably will be.
We've got zero interest rates across the Western world. We've got billions in government debt having to be issued at those historic low rates. How do you get out of that? How does the Federal Reserve, or the European central banks begin to move away from these extraordinary accommodations? I really just don't know.
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