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Taking the Measure of Gold
(June 6, 2011) On Friday June 3rd, the London PM fix was $1540.00, nearly achieving the former record price of $1540.25 reached on May 3rd. In between, a substantial sell-off in almost all commodities left its mark, while gold and oil were among the first to recover.
In the midst of May's commodities sell-off, gold had lost over 4% of its dollar value in a commodity melee which took gold prices briefly down to the $1476 level by the middle of May. Silver, which fixed in the London market at $48.70 on April 28th, has seemingly found stability around the $35 level, some 27% off its recent top.

Uncertainty over the economy and an ever-increasing looming debt imbalance has kept upward pressure on gold prices. Gold, although trading near all-time highs, still maintains its position as the true alternative investment in a world in which the very currencies used to measure wealth are themselves under intense scrutiny.

As a defensive store of value, gold’s advantages of portability, fungibility, and worldwide acceptance are well known, and have always been a fundamental part of gold’s appeal. Less recognized is another aspect of gold’s appeal – as a play on emerging markets. As first-quarter statistics from the World Gold Council reinforce, gold’s strength is due in no small part to broader investor participation, especially in China and India.

Gold imports by China may increase after investment demand more than doubled in the first quarter, with the country overtaking India to become the largest market for gold coins and bars, the World Gold Council said. China produced 340 metric tons of gold last year and consumption was about 700 tons, leaving a gap of 350 tons to 360 tons," Albert Cheng, Far East managing director at the council, said yesterday. “With increasing demand in China we will have to rely on imports to fill the gap between demand and supply.” China is the world’s largest gold producer and second-largest in overall consumption.” – 2011, May 20. Bloomberg News.

The downdraft in stocks over the past week in reaction to disappointing economic statistics pointed out the real possibility that our country’s economic problems are far from over. The phrase ‘double-dip recession’ was heard again, and efforts by the current administration to characterize the economy as slowly growing out of its former troubles are increasingly sounding empty and out of touch with reality. As the Economist noted in a June 4th article, "Recoveries from financial crises are usually subdued, but America's is starting to look comatose."

Bad new about the US economy naturally increases the chance of action by the Fed. This possibility has been so widely anticipated over the past few months that it already has a name – QE3. “Quantitative easing” is simply a process in which debt is created, and then monetized. The politically incorrect term for this is ‘printing money,’ an act which was once frowned upon.

Bill Thomson, chairman of Private Capital, Hong Kong, and director of Finavestment in London, speaking on June 3rd at the Investment Times Singapore Investment Roundtable, remarked about the dollar and a possible QE3:

The US dollar has abused its reserve currency status and has lost much credibility in the past decade. It is always managed with the interests of the US at heart rather than the global community. I don’t believe there will be a formal QE3 unless the US economy deteriorates markedly. But equally I do not expect the Fed to shrink its bloated balance sheet anytime soon. It is quite possible that the US dollar will rally modestly now that QE2 is ending but it remains vulnerable to fresh declines in the autumn and beyond while US fiscal and monetary policy remains broadly accommodative.

Ernest Kepper, speaking at the same roundtable, painted a rather gloomier picture for the dollar:

The trillions of dollars Washington wasted trying to buy jobs have now run out and the illusory recovery those dollars bought is fading, as is growth in jobs, consumer spending, and gross domestic product. The Fed will continue printing money when its quantitative easing programme is supposed to end in June. President Obama is running for re-election, and the only option this president has for the economic recovery is to print money as Congress will not support any new stimulus bills. Since job growth is far too weak to stop printing money now, QE3 is guaranteed and hundreds of billions more US dollars will be printed. This will result in rising consumer prices, a plunge in the US dollar, and increases in the cost of living.

With yields on ten-year Treasuries falling below 3%, US investors are faced with a continuing low interest-rate environment, and although US stocks have showered equity investors with some fabulous profits during the market’s great runup over the past year (indeed, since the bottom of the market in March 2009), this past week’s market action has certainly skewered a great deal of investor confidence.

Obviously, in an environment of falling interest rates and a shaky stock market, investors begin to look elsewhere. In the face of fewer attractive or prudent alternatives being available, there are reasons to believe that US investor demand for gold will increase. Gold has a ten-year track record that is virtually without equal, gold is gaining favor as an asset allocation in a growing number of investment portfolios, and even for those who are not fans of the shiny yellow metal, it may be the ‘least worse’ item to take in trade for excess US dollars.

Gold’s recent strong relative performance measured against other commodities reinforces our view that we are in a genuine gold bull market measured in dollars, euro, yen, and many other currencies.

Yet US investors have been relatively complacent about gold over the past year or so, even with gold hitting new highs and Chinese consumption now annually taking off the market over a quarter of newly-mined supply.

What will it take to motivate more US investors to own gold? Possibly, if gold continues to creep upward along its path of least resistance, it will take the approach of new higher ‘headline’ prices ($1700? $2,000, anyone?) for demand to really take off.


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