Gold and Precious Metals

The golden inconstant

Over the long run there is plenty of evidence for an idea called the “golden constant”. This is the concept that over the centuries an ounce of gold has preserved more or less the same value when exchanged for goods such as food and clothing. In other words the gold price rises along with price inflation. But in the short run prices can oscillate significantly around the longer term trend. Is now a time to be holding gold?

The price of gold has been up and down this year. First it rose 14.5% to $1,382 per troy ounce on 16th March. I noted at that time that the climb looked too fast and the price could fall again.

Soon afterwards it did just that, eventually reaching a new low of $1,191 per troy ounce on 6th October, down 1.3% since the start of the year. At the time of writing it’s trading at $1,229 per troy ounce, up just 1.8% since the start of 2014.

According to a model developed by Atlas Pulse – which compares the price trend of gold with a basket of wages, food, housing and commodities since 1970 – gold “should” be trading around $1,211 per troy ounce. This assumes that the golden constant has been working since around the time the US dollar was finally decoupled from physical gold (in 1971).

(Atlas Pulse is a service that does an excellent job of analysing both old school precious metals and ultra new school cryptocurrencies such as Bitcoin.)

This suggests that gold is trading more or less at fair value, having been overvalued in recent years. It’s now back at the trend line, although could still fall further.

But what of the reasons for owning gold itself? Is the price going to go up or down?

Much of the analysis that’s published focuses on short term investor behaviour, in the USA or elsewhere. But according to the World Gold Council 58% of gold demand is driven by uses in jewellery and electronics.

This means that whatever is happening in short term investment markets, it’s physical demand that is the real driver of overall demand. And how that is met by new supply is what will determine the gold price.

…the average all-in production cost for gold is $1,350 per troy ounce, according to GFMS-Thomson Reuters.

It’s also interesting to note here that the average all-in production cost for gold is $1,350 per troy ounce, according to GFMS-Thomson Reuters. This means that, on average, gold mining is a loss making business at the current price of $1,229 per troy ounce.

The implication is that mined production is likely to fall if the price doesn’t rise soon, as mines are closed. Or that as supply falls the price will be driven up by demand. Either way it should result in a higher price than today’s level, provided demand holds up. We just don’t know when.

So who is driving demand? Mainly people in the developing countries, especially the two giant gold buying nations of China and India. In particular the World Gold Council reports that Chinese consumers and investors bought 1,200 tonnes of gold last year. That’s 20% more than the total holdings (note: not sales or purchases) of US-listed gold ETFs.

So the big question is this: Will demand continue to increase in countries like China and India?

Most likely the answer is yes, just so long as per capita incomes keep rising. Wealthier people buy more gold, especially in countries which have a deep cultural affinity for it.

The World Gold Council recently produced two charts which illustrate this relationship well. They compare gold expenditure per capita of population to gross national income per capita. In simple terms, GNI can be thought of as all the income generated during a year by residents of a country, whether generated at home or abroad.

First here’s the chart for China, in renminbi yuan:


And here’s the same for India, in rupees:


These show a clear link between growing prosperity and growing levels of gold purchases in both these giant countries.

Ultimately you have to ask yourself one question when it comes to knowing if the gold price will rise in coming years and decades: Will China, India and other developing countries become progressively richer?

Here at OfWealth we believe that they will. For that reason we think gold makes an excellent long term investment as part of an overall portfolio.

Gold prices may be inconstant and fluctuating in the short run, but gold isn’t going anywhere. Except perhaps onto the wrists, necks and ears and into the vaults of hundreds of millions of people in China and India.

Stay tuned OfWealthers,

Rob Marstrand

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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.