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5 Reasons Why Gold Will Rise
ECONOMY
U.S. consumer confidence has fallen more sharply than in any period since records began in 1978. We have seen the nationalization of Fannie Mae, Freddie Mac and AIG; the socialization of the auto industry; the fall of the investment banking industry; almost a trillion dollar in bailouts; the rupture of supposedly rock-solid money market funds; the largest bank failures in history; the implosion of global stock markets; the collapse of home values, retail sales and consumer sentiment; the biggest fall in industrial production in three decades; and an unprecedented shattering of confidence in both commodities and financial assets.
FEAR
As the market does its daily job of balancing fear and greed, it becomes increasingly apparent that fear predominates. Individual investors are abandoning anything with the slightest hint of risk. Last year was the worst year for global equity markets since the Great Depression, with the Dow suffering its worst annual decline since 1931. Anything remotely risky or linked to the performance of the global economy was shunned. U.S. financial institutions are toppling like tenpins and confidence in those institutions has never been lower. Investors are pulling huge amounts of money from hedge funds, stock mutual funds and bond mutual funds in one of the biggest flights to safety the financial industry has ever seen.
DEMAND
The U.S. rate cut to virtually zero lowers the opportunity cost of buying gold and gold ETF holdings have exploded from 7 million ounces to over 30 million ounces in less than four years. Gold is different from other precious metals such as platinum, palladium and silver because the demand for these precious metals arises principally from their industrial applications. Gold’s value does not arise from its usefulness in industrial or consumable applications. It arises from its use and worldwide acceptance as a store of value and a safe haven. Other precious metals have also been classified as Defensive Assets, but have not performed as well as gold during this crisis. For example, investment accounts for about 90% of the demand for gold, while investment makes up only one-third of the total demand for platinum. Therefore, although gold has done well, platinum’s demand from industrial uses has fallen rapidly, particularly because of the high concentration of uses of platinum in new automobiles – an endangered species in an economy in which automakers are begging for funds from Washington just to keep them afloat.
REFLATION
Gold benefits from the cure for deflation, rather than from deflation itself. At some point, the market is going to get over its concerns about deflation and become concerned about inflation – that will be the real inflection point for gold. The Federal Reserve, the European central banks, the Swiss national bank, and the Bank of England have as much as doubled their balance sheets. Huge amounts of money supply growth will be sending so much money sloshing through the system that they will eventually generate a bad case of inflation. While inflation isn’t apparent today, stimulus packages and bailouts mean much more money in the system, which is classically inflationary. Historically low U.S. interest rates, U.S. dollar weakness, and the longer term inflationary pressures of the Federal Reserve throwing trillions of dollars at the U.S. economy make the environment favorable for gold and other tangible assets. Of the major assets, only Treasuries and gold have escaped the selling panic that has gripped the markets. Rushes on gold have caused mints around the world to run out of popular gold coins. Because of the inflationary impact of government bailouts, analysts believe that when gold reaches $1500 it will be the floor, not the ceiling.
THE DOLLAR
The dollar has benefited from the global flight from risky assets, as well as the unwinding of bets made with borrowed dollars. That has come as a surprise to many who expected that increased government spending and a collapsing U.S economy would cripple the dollar. In the longer term, the dollar’s health remains dependent upon foreigners’ appetite for U.S. assets, which will decline as the economy falters and the government continues to inject additional liquidity. Dollar weakness, plentiful liquidity and policy reflation will be persistent themes in the future. Massive fiscal and monetary stimulus have combined to weaken the dollar, but are expected to do so in an orderly fashion, since no country wants a strong currency in a deflationary world.
GOLD PRICES
We expect to see an eventual breakout in gold prices once the dollar softens more decisively and once reflationary policies gain economic traction. The current gold price indicates that U.S. monetary and fiscal policy is finally getting ahead of the deflation curve. Liquidity conditions will be easier and easier as the year progresses – part of the fight to support the economy and reduce deflationary pressures. Such conditions are consistent with higher gold prices and we expect to see gold prices continue to rise, with a breakout to $1500 becoming a new floor.
