Weekly Precious Metals Commentary

July 26, 2010

Gold was flat last week, but silver, platinum, palladium and copper all increased, so gold's small decline probably reflected short-term timing decisions by paper-gold (ETF) traders on Wall Street.  Gold was up and down but only changed 0.1% for the week. This morning (Monday), gold is down $10 to $1180. The pundits blamed today's drop on "better-than-expected housing news," implying that a stronger economic recovery is bad for gold.  That's old-fashioned 1970s thinking. Gold is more than a crisis hedge or an inflation hedge. It is also a "prosperity hedge" and "deflation hedge," since this 10-year bull market has accompanied a huge emergence of the middle class in Asia and generally flat prices for the last decade.

Gold 52 weeks ago (July 27, 2009): $965.00 Gold's London low for 2010: $1058 on February 5

Gold's average price during 2010: $1158.02 Gold's London high for 2010: $1261 on June 28

China Causes a Short-term Commodity Correction

Overall, commodities have fallen sharply in the last three months, ever since China cut back on its red-hot economy due to a runaway housing bubble.  Since May 1, most industrial commodities are down (much further than gold): -18% for aluminum, -13% for copper, -19% for lead and -27% for nickel. The price of steel is down 15%.  Last year, China accounted for 66% of world iron-ore imports and about 40% of global consumption of aluminum, copper and zinc, according to the Australian Bureau of Agricultural and Resource Economics, but  China's purchase of iron ore fell 15% in June (vs. a year ago, in volume terms), and Chinese copper consumption fell 31% (year-over-year). While most industrial commodities seem to be in a correction phase, the long-term trend is clearly toward more Chinese consumption of GOLD.

Chinese Stock Up on Gold

Gold fever has been sweeping China as the Chinese appetite for gold matches the hunger for a rapidly improving standard of living. Precious metals commentator David Levenstein reports on Gold-Eagle that the Shanghai Gold Exchange posted a sharp increase in total gold volume for the first six months of this year, up 59% compared to the same period last year.  Volume reached 3,174.5 metric tons, according to Song Yuqin, vice general manager at the exchange. "Gold and silver trading volume expanded sharply in the first half of this year because a declining stock market, the government's efforts to cool the property market and the general volatility in the global financial market have all fueled the investors' enthusiasm," Song said. Hou Huimin, deputy secretary-general at the China Gold Association, believes gold prices will keep rising through next year.  "I expect China's gold demand to rise by 11-12% this year because Chinese investors have shown their willingness to buy more when prices are on the rise," said Hou Huimin. "I expect prices will rise over the remainder of this year and next year." China Gold Group, owner of the country's largest gold deposit, reported sales of gold products such as bars and coins jumped as much as 40% over the past six months, according to Song Quanli, deputy party secretary at the company. "We have witnessed some really good sales in our retail outlets," said Song.

In the meantime, Silver is still the "poor man's gold," and it is far more affordable for middle-class Asian consumers.  According to legendary commodity investor and author of "Hot Commodities," Jim Rogers, silver is "really depressed on a historic basis." Silver will probably take several years to reach its $50 (one-day) peak in 1980, but it shouldn't take too long to eclipse its 30-year peak of $21, set in 2008.  In olden days, silver traded at a 16-to-1 gold ratio, but that was artificial, mandated by the Western silver interests in the U.S.  In the relatively free markets in metals since 1975, gold has averaged 60 times silver. Gold is now trading 66 times silver, giving silver a slight comparative edge. Unlike gold, silver has a number of applications in popular green technologies, such as solar energy and water purification.  It's also an anti-microbial used to fight bacteria. Only about 889 million ounces are mined annually (about $16 billion at current prices), making silver a narrower and more volatile market than the gold market.

Gold has its own unique set of supply and demand characteristics, unrelated to silver or to industry. Gold is owned by central banks; silver isn't.  Any trend toward central bank buying could boost gold, as well as the continuation of low real interest rates, which takes away the "no interest rate" knock on holding gold. Unlike silver, gold is currently trading above its 1980 high of $850, but in real terms gold is still lagging its 1980 peak price. (Gold bears constantly remind us of that fact, but they forget to compare gold to a more realistic measuring rod - its average price in any given year.)  In the late 1970s, gold was barely $100 in 1976 and at rapidly eclipsed $200 and $300 in July of 1978 and 1979, before spiking up to $850.

Japanese Hungry for Gold ETFs

While gold treads water in the traditional summer trading range, a new development in Japan could accelerate a possible next big move up in the fall.  The first exchange-traded funds for gold launched on July 2 when they were listed on the Tokyo Stock Exchange.  The gold ETF assets could explode eight-fold by this time next year, according to Osamu Hoshi, deputy general manager at Mitsubishi UFJ Trust and Banking Corp., a member of Mitsubishi UFJ Financial Group Inc.

Itsuo Toshima, regional director in Tokyo of the World Gold Council, said the WGC is recommending that Japanese institutional investors increase gold allocation to as much as 5 percent of their assets for diversification. "Institutional investors who put a large part of their funds into the Japanese government bonds are showing interest in gold investment," said Toshima.

The Japanese gold ETFs represent a new source of demand for physical gold.  If they explode 800% in a year as Hoshi projects, it would remove a large chunk of supply from the market and add to upward price pressure.

Gold is the Best "Deflation Hedge" (as well as Inflation Hedge)

Much is made of gold's superior performance in 1979-80, when inflation raged into double-digits, but in previous generations, gold was also a reliable deflation hedge - holding its value (or rising) while most other prices were falling.  Our two major times of chronic deflation were 1878 to 1901 and 1929-1941.   

1878-1901: In the first instance, prices declined 40% during the core of America's Industrial Revolution, 1878-1901, when Morgan silver dollars were the pocket money of the day.  Gold and silver were fixed at $20.67 and $1.29 per ounce, respectively (a 16-1 ratio), but overall prices declined about 2% per year for a generation, annualized. For instance, good meals were available for about a dime (or less) back then.

1929-1941: Prices also declined during the 1930s, due to tight monetary restrictions by the Federal Reserve, which reduced the money supply by fully one-third from 1930 to 1932. In 1934, privately-held gold was confiscated at $20.67 per ounce, after which President Franklin D. Roosevelt raised the price of gold arbitrarily to $35 per ounce (a 41% devaluation of the dollar).  So, gold rose while other prices fell.

Today, we have generalized flat prices in the developed world, with outright deflation in Japan (-1.4%) and Ireland (-1.7%). Among the 30 OECD (richest) countries, average core inflation rose at just a 1.3% annual rate in May, down from 2.1% two years ago. In the largest euro-zone nations, inflation is 0.7% in Germany, 0.6% in France and 0.1% in Spain. Gold is clearly beating low-inflation "over there," as the gold price in euro terms is up dramatically this year, due to a widespread run from paper money into gold.

Government Admits New Laws Actually Cost Money, Raising Deficits

Last Friday, the White House raised its forecast for the fiscal 2011 federal budget deficit to $1.4 trillion, or about 9.2% of GDP, up from its previous projection of $1.27 trillion.  That means the federal budget deficits for Fiscal 2009, 2010 and 2011 will each be above $1.4 trillion. In addition, the White House is projecting another $8.5 trillion of additional debt over the next decade.  On top of that bad news, the White House also expects the U.S. unemployment rate to only decline to 8.1% by 2012.  This is after saying (last year) that the 2009 stimulus (spending) package would help keep the jobless rate below 8%.

The White House budget office's higher projected deficit numbers reflect the expected impact of the new healthcare law, the financial-regulation bill, the new student loan laws and other measures enacted since the fiscal 2011 budget was first drafted.  Ironically, the White House budget office said the healthcare law, which was initially promised to cut deficits (or at least be budget-neutral), is expected to add $51 billion in debts from 2010 to fiscal 2012 - even before the plan takes full effect and raises deficits more.

In a Financial Times article on Thursday, European Central Bank (ECB) President Jean-Claude Trichet said that U.S. policymakers who want to keep "stimulating" (i.e., running higher deficits) are mistaken. Trichet also took specific aim at the Obama Administration, saying, "With the benefit of hindsight, we see how unfortunate was the oversimplified message of fiscal stimulus given to all industrial economies under the motto: 'stimulate', 'activate', 'spend.'"  It is highly unusual for the ECB to criticize U.S. policies, but Trichet is clearly saying that Europe's austerity is working, while U.S. spendthrift solutions are backfiring. This points toward another big dollar decline, and soaring gold prices in dollar terms.

Rare Gold Coin Frenzy

Demand for $2.50, $5 and $10 Indians are increasing due to three major dealers current advertising. Dealer and collector demand for the new book by Mike Fuljenz "Indian Gold Coins of the 20th Century" has also contributed to the current buying frenzy for Indian gold. Major dealers report Indian gold coin shortages in the market.