In his latest analysis piece, Frank Holmes talks about how the Fed and other
drivers are pushing gold higher. After prices fell 10 percent in December, many
investors wondered if the bull market in gold was running out of steam. That was
before Federal Reserve Chairman Ben Bernanke swooped in with a "red cape"
and fired the bulls back up. Since the Fed reassured the world that interest
rates will remain at "exceptionally low levels" for another two years, gold
has jumped more than three percent. UBS described the situation simply, "if
investors needed a (further) reason why they should be long gold now, they got
it yesterday … a more accommodative policy is a very good foundation for gold
to build on the next move higher." To gold bugs, two more years of near-zero,
short-term interest rates means negative real interest rates are here to stay,
and this has historically been a strong driver for higher gold prices. Bernanke
and the Fed aren't the only central bankers in the fiscal and monetary
bullring. Brazil has cut its benchmark interest rate a few times and China
lowered its reserve rate for banks in December. According to ISI Group, 78
"easing moves" have been announced around the world in just the past five
months as countries look to stimulate economic activity. One of the main weapons
central bankers have employed is money supply, which has created a ton of
liquidity in the global system. Global money supply rose 8 percent
year-over-year in December, or about $4 trillion, according to ISI. I mentioned
a few weeks ago how China experienced a record increase in the three-month
change in M-2 money supply following China's reserve rate cut. Together,
negative real interest rates and growing global money supply power the Fear
Trade for gold. The pressure these two factors put on paper currencies motivates
investors from Baby Boomers to central bankers to hold gold as an alternate
currency. Adrian Ash from Bullionvault says global central banks are on a buying
spree and they have been since the Fed cut interest rates by 25 basis points in
2007. Central bankers' shift to buying gold was a significant sea change for
the yellow metal. You can see from the chart below that official gold reserves
have historically been much higher, averaging around 35,000 tons. In the 1990s,
central banks began selling, with reserves hitting a 30-year low right around
the time the Fed began cutting rates. Adrian says that gold holdings are now at
a six-year high with the current amount of gold reserves just less than 31,000
tons. These are countries large and small. In December, Russia, which has been
routinely adding to the country's gold reserves since 2005, purchased nearly
10 tons; Kazakhstan purchased 3.1 tons and Mongolia bought 1.2 tons. UBS says
"although reported volumes are not very large, it is still an extension of the
official sector accumulation trend." Not all central banks are recent buyers,
though. The "debt-heavy West" has sold its gold holdings, while emerging
markets increased their gold reserves 25 percent by weight since 2008, says
Adrian. Reserves as a percent of all the gold mined has also declined, with "a
far greater tonnage of gold finding its way into private ownership," says
Adrian. Since 1979, you can see the percentage of reserves to total gold has
declined at a much faster pace as individuals increasingly perceived gold as a
financial asset. Adrian points to China's Gold Accumulation Plan as a recent
example of this trend. A joint effort between the Industrial & Commercial Bank
of China (ICBC) and the World Gold Council (WGC), the program allows Chinese
citizens to buy gold in small increments as a way to build up their gold
holdings over time. The WGC reported in September that the program had
established 2 million accounts during its first few months in operation and the
amount is growing by the day. These programs open the door for gold as an
investment to a whole new class of people in China but that's only a fraction
of the tremendous demand for gold that we are seeing from China. In addition to
the Fear Trade, gold is driven by the Love Trade, which is the strong cultural
affinity the East, namely China and India, has to the precious metal. In 2010,
the Indian Sub Continent and East Asia made up nearly 60 percent of the
world's gold demand and 66 percent of the world's gold jewelry demand,
according to the WGC. Indian jewelry demand has historically increased during
the Shradh period of the Hindu calendar, but last year, high prices and a
volatile rupee kept many Indian buyers on the sideline. If you thought $1,900
was too much to pay for an ounce of gold, imagine how Indians felt when the
rupee fell against the U.S. dollar, causing a gold price spike in rupees. Gold
in Indian rupee terms rose more than 35 percent from July to November, roughly
three times the magnitude of gold priced in U.S. dollars, yuan or yen. This
currency swing significantly impacted Indian gold imports, which dropped 56
percent in the fourth quarter, according to data from the Bombay Bullion
Association. "Indian buyers will be back" after they adjust to the higher
prices, says Fred Hickey. In one of his latest editions of "The High-Tech
Strategist," he cites late 2007 as a recent example when the Indian gold
market experienced a similar rough patch. That year, gold demand in India fell
off a cliff after prices spiked more than $1,000 an ounce in one quarter,
tarnishing the country's love affair with gold for a "brief period." Fred
says their cultural affinity for gold as an important store of wealth and
protection against inflation will drive Indian buyers back into the market. The
trend was already changing in 2012, as UBS reported that the first day of
trading saw physical sales to India were twice what they usually are, according
to Fred. Although this is a very short time frame, I believe the buying trend
will continue in this gold-loving country. In China, "just as in India, gold
is seen as a store of wealth and a hedge against inflation," says Fred. Demand
has been growing, especially in the third quarter, when China's gold purchases
outpaced India. "Physical demand for gold from the Chinese has been voracious
all year," says Fred. As of the third quarter, China had already obtained 612
tons, eclipsing its total 2010 demand, according to the WGC. Across the Chinese
retail sector, gold, silver and jewelry demand was the strongest performing
segment in 2011, says J.P.Morgan in its "Hands-On China Report." Growth in
this segment far outpaced clothing and footwear, household electrical
appliances, and even food, beverage, tobacco and liquor, all of which
experienced more modest growth. J.P.Morgan says the bulk of the increase came
from lower-tier cities "where income levels are rising the fastest and
improvements in retail infrastructure have allowed for rapid store expansion."
Increasing incomes coupled with government policies that support growth have
been the main drivers for rising gold prices. Take a look at the chart below,
which shows the strong correlation between incomes in China and India and the
gold price. As residents in these countries acquire higher incomes, they have
historically purchased more gold, driving gold prices higher. We anticipated
that the Year of the Dragon would spur an increase in the buying of traditional
gifts of gold dragon pendants and coins. Gold buying did hit new records, says
Mineweb, with sales of precious metals jumping nearly 50 percent from the same
time last year, according to the Beijing Municipal Commission of Commerce. This
should serve as a warning to all of gold's naysayers. Gold bullfighters
beware—you now have to fight the gold bull while fending off a golden Chinese
dragon. U.S. Global Investors, Inc. is an investment management firm
specializing in gold, natural resources, emerging markets and global
infrastructure opportunities around the world. The company, headquartered in San
Antonio, Texas, manages 13 no-load mutual funds in the U.S. Global Investors
fund family, as well as funds for international clients. For more updates on
global investing from Frank and the rest of the U.S. Global Investors team,
follow us on Twitter at www.twitter.com/USFunds or like us on Facebook at
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www.youtube.com/USFunds. All opinions expressed and data provided are subject to
change without notice. Some of these opinions may not be appropriate to every
investor.
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