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We are going to explain the facts about gold and the main fundamentals forces that are driving gold’s price up.

September 20, 2011

Economic uncertainty in the United Stats and Europe over the last Two Years is making gold more popular than it has been in decades. in the last 10 years, gold rose from nearly $300 to about $2250 today.  And Expectations are that gold’s price is going to rise further. In this article, we are going to explain the facts about gold and the main fundamental forces that are driving gold’s price up.

Early Civilizations equated gold with gods and rules.Humans almost intuitively place a high value on gold, equating it with power, beauty, and culture elite. Gold’s beauty , scarcity, unique density and the ease by which it could be melted, formed and measured make it a natural trading medium.

Thus, gold gave rise to the concept of money itself: portable, private, and permanent. Gold( and silver) in standardized coins came to replace barter arrangements, and make trade in the classic period much easier.

The rise of gold standard was meant to stabilizes the global economy, dictating that a nation must limit its issued currency to the amount of gold it held in reserve. Great Britain was the first to adopt the gold standard in 1821, followed in 1870 by  other nations. this system  remained in effect until the end of the First World War, after which the United States was the only country still honoring the Gold Standard.
Other countries were allowed to keep reserved of major currencies instead of gold. the arrival o f the great depression marked the end of the U.S export of gold. by mid 20th century, the US dollar had replaced gold in international trade. bottom line: Governments all around the world are using money based solely on promises and faith.

Now despite the fact that gold’s price has hit a new record high, there is still a lot of skepticism in regards to the durabiulity of this price rise.

For instance, many could argue that gold does not pay interest or dividend, gold is non-productive investment and indeed it does not create wealth and does not help economic development. Many investors could even think that such investments are highly illiquid.

Transaction, transportation and insurance cost can  be excessive. Diversification can be difficult to achieve unless you are a billionaire. This argument is clearly states that there is not much benefit from gold and it must be a bad investment. However, we know that gold does not pay interest or dividends. But we also know that this shortcoming does not prevent rising prices. Even if you do not believe that gold is productive asset its usefulness is very different: Gold is insurance against the follies of the government, especially against inflation. If the return from the market is not adequately compensating for the both risk and inflation then demand for gold and other commodities increases. Gold is regarded as a store of value( Without Growth) whereas stocks are regarded as return on value i.e. growth from anticipated real ( as opposite to nominal) price increase plus dividend.

Further, when times are good, the financial markets are booming, the economy is just fine and doing okay, there is no need to look for a store of value or for insurance against bad economic policy outcomes. Besides, gold was held up in a secular bear market that started back in 1980. Then, in 2001, things have started to change. The Federal Reserve in United States implemented a highly inflationary monetary policy, and the Bush administration did the same in regards to their fiscal policy. That was a clear starting signal for a brand new gold and commodities bull market.

Economically speaking, the two main signs of inflation

1-Fiat money, and

2- Budget deficits

Both signs are present today, and not just in the United States. But globally.

As shown before , historically, most monetary regimes were based on money backed by gold and silver. But now the whole world is using money based solely on promises and faith. When the financial crisis hit in 2008/09, governments all over the world reacted the same way: they started a debt binge accompanied by an extremely lax monetary policy. And central banks monetized government debts. They termed the notion” quantitative easing”

These are the very same policies that were present during every large jump in inflation in the history of mankind! And there are the main fundamental drivers behind gold’s advance today. As long as there is no major fiscal and monetary policy change, it is expected that inflation to heat up and gold’s bull market to continue.

On the other hand, Gold demand is rising due to wealth creation in emerging economies where gold still plays a large role as a store of value. Gold demand is even rising in the West as more investors doubt the wisdom of central banks and governments. China, for instance, has admitted to having boosted its gold reserves. Since December 2002 the Chinese central bank added 600 tons of gold to bring its reserves to 1,054 tones. And while more than a thousand tons of gold might sound like a lot, it is a miniscule amount in relation to China’s total currency reserves. The table below helps explain this more.

Official Gold Holdings as of April 2009

No. Country Tones Percent of Reserve

1

USA

8133

0.8

2

GERMANY

3412

71.5

3

IMF

3217

N/A

4

FRANCE

2487

72.6

5

ITALY

2452

66.5

6

GLD(GOLD ETF)

1104

N/A

7

CHINA

1054

1.6

8

SWITZERLAND

1040

41.1

9

JAPAN

765

2.2

10

NETHERLANDS

612

61.7

11

ECB

537

23.7

12

RUSSIA

523

4.0

13

TAIWAN

423

4.2

14

PORTUGAL

382

90.2

15

VENEZUELA

364

35.5

16

INDIA

357

4.2

17

UK

310

18.7

18

LEBANON

287

30.0

19

SPAIN

281

40.5

20

AUSTIA

280

50.5

In other words, this may very well turn out to be just the beginning of a trend for china . For years China has been rumored to be adding to its gold reserves. But until now the Chinese government refused to comment and refused to publish its gold reserves.

The obvious change in this policy is important. it could be that the Chinese government is sending a message, maybe as important as the one the French sent back in the 1960s.

Then, under the Bretton Woods System, the French demanded delivery of  huge amounts of gold from the U.S. This eventually led to the demise of Bretton Woods.

Now China reveals its growing gold reserves. At the same time it has started to openly question the international dollar standard. Doesn’t this sound like the beginning of a new currency order?A currency order that is less dominated by U.S. dollar and replaced with a currency order including gold. No matter where this development finally leads right now, it is bullish for gold.

In addition, gold supply is stagnating or even slightly shrinking despite the metal’s price rise since 2001. This is because it is getting ever more difficult and expensive to gt gold out of the earth. In 2007, the World’s gold supply dropped 2.6% to 3488 metric tones and it dropped further to 3468 in 2008.  If we compare that to total world demand of 3659 tones, we are left with a deficit of 191 tons. This deficit is increasing in 2009. moreover, in 2008 , gold mine production fell 3% to 2407 metric tones, declining for the third straight year. this trend continued in 2009 and 2010. for instant, South Africa’s production dropped an estimated 15% its lowest level in 86 years. Australia’s gold production hit 20 year lows in 2009, falling 13%. Accordingly, the message is clear: do not expect any relief from new supplies of gold.

As long as most of these factors remain in place, it is expected that the long-term bull market to continue. And much higher highs are very likely.

 Source: The Banking Executive Magazine issue 19, July 2010.

2 Comments leave one →
  1. September 20, 2011 2:47 pm

    Baron von Rothschild, creator of one of the most famous financial dynasties of modern times and his most serious students of international finance share a sense of frustration on the subject. In fact if you were to ask five different monetary analysts to explain why the price of gold moves the way it does, you would most likely get seven distinct answers.

    Accurate predictions for the future price of gold are at best an exercise in speculation as are predictions on the future movement in price of any asset class. Nevertheless, one may establish reasonable and logical criteria for forecasting price expectations — based upon fundamental, technical and intermarket analysis.

    • September 20, 2011 3:03 pm

      Usually analysis process is like this, it does not depend on one fact, but rather, on the perception of people for the causes of any phenomenon , whether , it is future price behavior , or item sales, or election success.
      However, the importance of the article is not looking into the causes of Gold price’s escalation just, rather, it highlights also the link between US Dollar as International currency for all countries to use in their international trading arena in replacement to the gold that used to be reference in the past, which gave more stability to the international economy.

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