Technical arguments in favour of gold continue to shine

There are a number of data sets arguing for the continued high price of gold, including fundamental supply and demand factors.

Gold is no different in respect of such fundamentals.

What is different is that it has been used and valued as an asset since even before the first gold coin was struck at about 500BC, long before instruments such as equities or bonds were invented by Europe’s financiers.

Ongoing demand for gold is strong. In the first quarter of 2011, it gained 11% on the same period a year ago to 981.2 tonnes, according to the World Gold Council (WGC).

In dollar terms, this translated to $43.7bn against $31.4bn: an increase of nearly 40%.

Investment was a key source of demand, up 26% year-on-year to 310.5 tonnes. Gold bars have been a particular favourite.

The geographic location of this demand has also shifted, as China became the largest single investment market for bars and coins in the quarter.

China also figured prominently in the jewellery market. Together with India, it accounted for 349.1 tonnes of gold jewellery valued by the WGC at $16bn.

Meanwhile, supply remained moribund. Mining production growth hit 7% year on year in the quarter, but recycling of gold fell, meaning overall supply dropped by 4% compared with the same period in 2010

But what about the future of supply and demand? Here again, there are factors at play which provide little indication that the price of gold could ebb away any time soon.

The WGC thinks Chinese gold demand could double in the next decade. One reason is that in the short term, inflationary expectations remain high the reason the country’s central bank has raised the reserve ratio for banks, to stop hot money in the economy.

Longer-term expectations are for income levels to keep rising. Chinese consumers tend to have high savings ratios and are looking to protect their wealth by buying gold.

InflatIon Impact

China is not the only market concerned about inflation. The ECB recently indicated it is going to toughen up its rates because of rising Eurozone inflation.

What this means is that real returns are increasingly threatened. Gold is seen as a hedge against this threat.

There are other reasons to fear inflation. The turgid pace of policy makers in the West dealing with debt loads is raising suspicions that inflation could become seen as a tempting alternative to overcome years of austerity in places such as the UK, Ireland and Greece.

In fact, inflation is what policymakers have tried to stimulate in Japan many times in the past two decades, even as the country’s debt has grown to record levels.

Quantitative easing by western central banks has raised fears that the value of paper money is being reduced.

 

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For investors, there is certain evidence suggesting that portfolios can be made more efficient by using exposure to gold as an asset alongside equity and fixed income instruments.

There has been a reversal of the policy to sell off official gold reserves. Since Q4 2009, monetary authorities globally have become net buyers of gold.

This is because emerging market central banks have been buying, while their counterparts in developed economies have been slowing their inventory run down.  

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