Gold and Precious Metals

The real reasons to own gold

Gold has been attracting more and more attention in recent years.

As recently as 2006 if you had suggested a large investment in gold bullion to just about anyone then you would probably get a strange look. People just didn’t see the point of owning something with no earnings.

This was strange because gold had already been in a bull market for several years by that point. Measured in US dollars, the most usual unit used for pricing gold, the average price of the yellow metal was $271 per troy ounce in 2001. It had fallen for 21 years since the end of the last bull market in 1980. But by 2006 the price averaged $603 per troy ounce, a rise of 123%. And yet gold was the preserve of a few people on the fringe who were considered eccentric or mad by mainstream investors. They were the often maligned “gold bugs”.

Gold Price USD 20 years – April 16

Gold price chart April 2013
Gold price chart April 2013

 

Probably people who hadn’t invested were just jealous, given the big gains that had already been made in those five years. Seven years later in 2013 the price of gold is around $1,390 per troy ounce, at the time of writing. That’s an additional gain of 131% since 2006, and a full 413% above the average level in 2001.

And yet still gold is misunderstood by most investors and analysts.

For sure it has become more mainstream than before. I know of Swiss private banks that have been recommending their clients put 10% of their portfolios into gold. This was unheard of just a few years ago.

But what is strange is that the reasons given for owning gold are still off the mark. It’s certainly true that gold is a hedge against the rampant money printing of developed country central banks. And that it’s also protection from an unstable global financial system, that contains far too much debt and other financial leverage (financial derivatives).

However I think there is a much more important force at play when it comes to what is driving gold. Hedge funds and short term speculators in the paper markets can certainly drive the price in the short run – up or down. But in the long run it’s the buyers of physical gold, set against the supply coming onto the market, that determine where the price is heading.

…75% of all physical gold supply is bought by the world’s growth countries, also known as the “emerging markets”

And those buyers have nothing to do with US futures markets or London hedge funds. Using figures from the World Gold Council, I estimate that 75% of all physical gold supply is bought by the world’s growth countries, also known as the “emerging markets”. This demand comes from jewellery buyers, investors in bullion and coins, and in recent years from central banks spread across Asia, Russia, the Middle East and Latin America.

But two countries stand out as the dominant forces in world demand for gold. And they’re both enormous. These are India and China. Their combined population is nearly 2.6 billion people, which is around 37% of the global total.

24 Karat Gold Shirt own by business man Datta Phuge in Central India.
24 Karat Gold Shirt own by business man Datta Phuge in Central India.

In fact India and China combined made up 53% of global demand for gold jewellery, bars and coins in 2012. The figure could be even higher, since a lot of foreign buying is channelled through European countries and doesn’t show up in the local figures.

By contrast, the USA made up just 5.1% of global demand in these categories during 2012. And yet so much analysis of what drives the gold market is focused on the behaviour of US investors.

Of course Chinese and Indian demand for gold will fluctuate from year to year. But it’s my view that both those countries will continue to grow strongly for many years to come, barring some major political upset. Combine that with the strong cultural links to gold in both these Asian giants and it makes a strong case for continued strength in the gold price.

 …Indians, Chinese and other people from the world’s fast growing countries are getting wealthier each year. And gold is a traditional way to demonstrate wealth…

Vast numbers of Indians, Chinese and other people from the world’s fast growing countries are getting wealthier each year. And gold is a traditional way to demonstrate wealth and power for a great many people in those countries. As this expanding wealth, spread across such a vast population, meets the limited supply response from gold mining and recycling it’s a fair bet that the gold price will continue to rise.

My advice is to get some gold if you don’t already have it. And take advantage of any price dips to accumulate more. The gold price fell hard on 12 and 15 April – as you can see on the far right of the chart – but conditions are still in place for the longer term bull market. Given the fundamental conditions, gold should resume it’s bull market before too long. But it may not be straight away. During the last bull market in the 1970s gold fell in price by nearly half between late 1975 and mid 1976. But it then went on to scale much greater heights than before.

With the conditions that exist today, gold should continue to shine. Now could be the best buying opportunity for many years.

Until next time OfWealthers,

Rob Marstrand

robmarstrand@ofwealth.com

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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.