Gold: Bull’s and Bear’s Best Friend
By: Daniel Eskin Tue, Oct 27, 2009
There may be a pot of gold bars and precious metal at the end of the rainbow after all – regardless of which direction the global economy heads from here on. Mining commodities such as copper, nickel, aluminum, and particularly gold, have traditionally been regarded as a hedge against inflation and bearish economic times. So it makes sense that gold has recently hit an all-time high and is seemingly on a continued ramp-up. However, I believe that gold and mining will flourish regardless of economic collapse or boom.
First, the bear scenario
History has already proven that gold thrives as an investment in bearish economic times. I don’t need to convince you that this is the case in the current global economy as well. Just for completeness – back to econ101, gold assumes its natural role as a store of value when purchasing power is threatened in the economy. This is the current situation in the United States, and as the dollar continues to decline in value, gold will become more precious globally. People and firms respond by fleeing to safety during times of uncertainty like this.
A recent study performed by IBISWorld (April 27, 2009) on the mining industry supports this hypothesis that gold will significantly rise “due to investors seeing it as a reliable defensive investment”. Despite the fact that 89% of all gold mined is used in jewellery, of which sales are expected to decline with the recession, price increases will be driven by investments. Higher prices of gold and silver have also lead to increased industry revenues by 16% in 2008, and expected to be higher for fiscal 2009.
Overall, as long as investors remain nervous about the economy, government debt / deficits / artificial stimulation, or inflation, gold will continue to be seen as a safe haven and prices would be pushed higher. It’s hard to estimate a ceiling, but doom-advocate Peter Schiff calls gold at $5,000. That may be a little extreme, but is just one of the views on gold’s potential.
Then, the bull scenario
Another consideration is that a steep recession would be followed by a sharp economic recovery, spurted by central bank interest rate cuts and government stimulus. If the government lives up to its recent promises, interest rates will stabilize one year out to prevent excess inflationary pressures. Unemployment will decrease, spending and capital investments will increase and somehow (perhaps magically) government debt will slowly start to stabilize.
However, an important point to keep in mind is the massive loss of reputation and belief in the government’s ability to stabilize the economy that has occurred in the last year; in effect, this will lead investors to be vigilant during the ride up for matters like inflation. Regardless of an economic bullish scenario, investors will continue to use gold as a hedging tool against possible inflationary forces caused by government stimulus (or keeping interest rates too low for too long). Also, in this scenario, physical demand will be spurted in the jewellery (89%), dentistry (7%) and industrial (4%) gold market segments leading to price appreciation.
Just for interest’s sake, other precious metals may also follow gold’s path in the bullish scenario. Based on a recent Societe Generale industry report (October 13, 2009), other precious metals such as copper, aluminum, nickel and lead will benefit from bullish forces. Copper and lead/zinc will benefit from limited supply as industrial consumption increases in China and elsewhere. Lead and zinc will be further boosted by a strong recovery in the steel industry and auto production. Current aluminum build-ups will begin to reverse as well.
However…
However, a third potential scenario is a moderately slow return to economic growth. In this situation, the US stimulus plan would take some time to take effect and the rest of the globe would assume a slow recovery as well. In this case, interest rates would slowly rise as promised by the government and unemployment levels would be extended by semi-weak consumer spending and low growth of business.
The implications of this scenario on gold and precious metals are not as optimistic as in a strictly bear or bull scenario. As market confidence slowly improves, gold may no longer be used as a risk hedge and therefore prices may cease to increase. Furthermore, if the central bank acts as promised and begins to increase interest rates, reduced worries of inflation may also drive the demand of gold lower. Any increases in physical demand of gold would take too long to kick in and the reduced investment in gold would drive the price down prior to increased physical demand.
Conclusion
Gold’s breakout and achievement of an all-time high was a significant event. The potential for gold as an investment is significantly more attractive in the bearish scenario for the next two to four years since fears of economic collapse would weigh much more heavily on gold investors than any of the other factors mentioned above; nevertheless, even if the global economy begins to pick up pace, gold and other relevant metals will still benefit and appreciate in the short and medium term. As mentioned, if neither a bullish or bearish scenario occurs, gold could potentially be exchanged for more lucrative investment opportunities.
What do you think will happened in the next four years?
Disclosure: long gold.
Image credit: Charles Tilford under a Creative Commons License; Bullion Vault under a Creative Commons License.
Charles Tilford
Last 3 posts by Daniel Eskin
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Tags: Gold, Mining, Precious Metals
Hello,
You have written a very thoughtful, well researched article which is informative and helpful to me. I study gold and silver from a macro economic and justice stand point. I thought these comments might shine some light on some of the historical and macro economic as well as the central bank issues surrounding gold.
The parameters of gold are far different than they were in the 1970s. At that time central banks were flush with gold compared to today. Ironically, the reason Nixon took the UNITED STATES and by extension the world off the Gold standard was because of a familiar problem. We were “spending way too much money” and the War Machine was the usual culprit at that time.
After Nixon took us off the Gold Standard the world followed and governments started “spending way too much money,” but without gold to backstop the “money” the party was on.
To keep that pesky gold down, the central banks no longer bound by law to back their currency with other than promises and IOUs, were free to sell whatever amount of gold was necessary to keep the price of gold down or worse lease out their national treasure but never being required to report it leaving the vault.
They lost control temporarily around 1980 but then stepped and used brute force and lots more selling, leasing, swapping and so on to change the rules, especially in regard to silver.
That operation continued and the picked up a lot more energy when Summers introduced his thesis related to gold prices and interest rates and starting in the late 1990’s the gold suppression scheme was accelerated and was best exemplified when England sold about half of its national gold treasury at the absolute bottom of the market.
Gold and the gold standard represent the antithesis of borrow and spend and of fiscal conservatism. It is much more difficult to go to war when you can just print up a new stack of debt notes without worrying about repaying them at today’s dollar worth.
To me the other side of the coin is that we are in a debt bubble. We also have a collateral quality dimple or perhaps I should say crevasse. As the Fed has moved from lender of last resort to buyer of last resort with massive amounts of agency paper and what appears to me to be collateral of questionable valuation, the dollar and other deeply and irrevocably indebted currencies like the yen will never be repaid at their current purchasing power.
Gold is not about the dollar, its about its incorruptibility in the face of broken promises and IOUs that can not be repaid.
Its about governments being irresponsible because they can and its about a systemic illness in the political system that would allow a half a trillion or so in OTC derivatives to go unregulated.
Up until recently many of the largest central banks cooperated in the gold suppression scheme in my opinion but you can only sell off, lease out, swap or otherwise deplete your gold reserves so far before it becomes evident that you will need to buy some more gold or pay a heavy price in national credibility and in financial viability in my opinion.
As the long term gold price suppression operation and its mechanisms are more and more broadly recognized, despite the fact that the mainstream financial media will not do the full spread interview with GATA that they should, more mainstream investors will begin to realize how much potential price energy is built into gold and silver especially as a result of the long term weight of highly concentrated primary dealer and central bank manipulation on the gold and silver ball prices is.
While all other major commodities seem to have passed their inflation adjusted highs in the last run up, silver remains at less than 1/6th of its inflation adjusted high and well below ½ of its non inflation adjusted high. While gold is in the neighborhood of ½ of its inflation adjusted high. This is pretty clear evidence (among a much larger body of evidence put forward by GATA) that gold and price remain under long term price suppression.
So yes, Gold and Silver can and will shoot up to meet their actual value. How high that is open for debate but to at least inflation adjusted highs around $2,300 for gold and $130 for silver are where they would be if we had free markets. Ultimately, despite ever increasing levels of intervention, there is a limited supply of central bank gold and naked short derivatives are slowly being exposed for what they are and eventually demand and supply and the need to have some actual trustworthy store of value (i.e. money) will decide the issue despite the illegal and ongoing manipulation of gold and silver prices in my opinion.
Duffminster
http://www.duffminster.com/SilverandGold
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Thank you very much! Look forward to having you visit back here.