Gold bullion is the oldest known currency of time dating back 5 thousand years and still remains an important part of the world financial system today. It is the only currency that represents ‘Ultimate Safety’. Gold is the only financial asset that’s not simultaneously someone else’s liability. Today, the price of gold is bouncing off 20 year lows due to wide spread central bank selling from 1999-2004 as the banks preferred interest bearing certificates to holding gold bullion. Gold is now in the first phase of a new bull market for this precious metal. When the U.S. Dow Jones stock averaged peaked at 11,908 in year 2000, gold bullion was trading near its 20 year low of 253 USD an ounce Even today after a stunning rebound north in price for gold bullion, total world gold stock capitalization is minimal in the 100 billion USD range especially when it is equivalent in value to one large American technology stock. The price of gold tends to behave inversely to the value of the U.S. stock market and the US-dollar, when stocks and the USD are falling, the gold price tends to rise. Any confidence crisis, investors seek to park their money in gold as it plays the role of a global safe-haven currency. Below is a quick review of BankINTRO.com’s currency research in relation to gold, the only currency of time.
CENTRAL BANK SELLING: on September 26, 1999, fifteen European nations signed a 5 year term for an agreement limiting central bank selling to a total of 400 tonnes a year, this became known as the ‘Washington Agreement’ responsible for governing central bank selling. On December 6, 1999, the Dutch central bank decided to sell up to 300 tonnes of gold over the next five years and on December 8, 1999, the upper house of parliament of Switzerland approved legislation to allow its central bank to begin selling 1,300 tonnes of gold beginning in May 2000. As of March 2001, Switzerland still had about 1,080 tonnes to sell, Netherlands at 200 tonnes. The Bank of England in September 2001 completed the last of 14 gold sales of 20 tonnes which reduced Britain’s gold reserves by a total of 415 tonnes down to a level of 300 tonnes from 715 tonnes. As of December 2001, Germany’s Bundesbank held 111 million ounces of gold ranking it number two in the world behind the United States with 8,135 tonnes. During August 2003, Greece itself unloaded 20 tonnes of gold. Although total gold sales by central banks in 2003 amounted to 700 tonnes approximately, there was minimal impact on the price of gold. It is widely expected that the Washington Agreement will be renewed on September 26, 2004 for a new 5 year term but the new agreement will allow for a ceiling of 500 metric tonnes per year compared to the previous 400 tonnes. This quota applies to EU member nations plus the European central bank except for the United Kingdom and Denmark which have not signed on. Some analysts have suggested that the actual amount sold by these European member banks will actually be much lower than the 500 metric tonnes allocated. The United Kingdom has already announced no intention of selling anymore gold.
At present, current estimates have worldwide central bank holdings of gold bullion close to 32,000 tonnes comprised of 17,000 tonnes of bullion and 15,000 tonnes of gold receivables. On the flip side of the central bank selling argument is central bank buying. Today, there seems to be a global wealth shift from Western nations to the Far East. Recently, central banks from Argentina and Russia have been buyers of gold in addition to several Asian central banks.
DEMAND and SUPPLY: the general story for the gold market has supply at approximately 2,500 tonnes from mining and another 500 tonnes from scrap/recycling. Total demand is in the vicinity of 4,000 tonnes from jewellery, fabrication, coins, bars, etc. The approximate 1,000 tonne shortfall is made up of 400 tonnes from central bank sales and another 600 tonnes in the form of gold loans provided mostly by central banks for those parties speculating (ie. hedge funds) and those implementing mining hedges. During year 2003, demand exceeded supply by 640 tonnes. With central bank sales stalling coupled with gold producers cutting back on hedging programs, demand is exceedingly supply by a wide margin as it has for the last several years. BankINTRO.com believes the upside price potential for gold at time of review is still in favour with the makings of a drastic upward spike movement in price a real possibility in the near term. Some analysts have given the 350 USD to 1 XAU (gold ounce) as a break-even price for North American mining producers while others have suggested that 400 USD is a correct valuation for long term profitability and economic solvency for the global gold mining industry due to massive capital costs involved in developing a mine, depreciation, exploration monies required, etc.
India is currently the world’s largest consumer of gold followed by the United States. Since the 1997 Asian currency crisis, Southeast Asia has recorded a large 35 percent jump in demand for gold bullion. Total above ground world gold supply is estimated at 147,000 tonnes or approximately 4.8 billion ounces. China and India are increasing their gold consumption as their respective economies modernize with increased wealth accumulation. Several Western central bankers have been selling reserves at record low prices from 1996 to 2002.
World leading producer countries include South Africa, Canada, United States, Australia, Russia, China and Ghana. Hedging programs to help profitability for mining companies during low gold prices in the 1990’s have basically stopped as many firms have unwinded their positions as higher gold leasing rates and low short term U.S. interest rates coupled with a rising gold price have removed the incentive for profitable hedging. Many of these large corporations reducing their hedging portfolio include South Africa’s AngloGold Ltd, Denver based Newmont Mining Corp. and Canada’s Barrick Gold.
In the 21st century, gold will play a growing important use and key component in many technology industries including photonic light. The attributes of gold are indeed unique: natural resistance to oxidation, high chemical & thermal stability, infrared (heat) reflectivity, mechanical softness, high electrical conductivity, does not tarnish or corrode/decompose, and natural beauty. Gold is also unique in that it holds value, it is consistent, convenient, divisible and durable.
KNOWLEDGE: Japan today is the largest creditor nation in the world today. If only 2 percent of total Japanese savings shifted into gold bullion, this would be equivalent to over 20,000 tonnes of gold, a figure in excess of 50 percent of all the gold presently held under the ownership of the world’s central banks. More surprisingly in March 2004, Japan’s Finance Minister Sadakazu Tanigaki suggested that Japan is looking at bringing its modest gold reserves (only 1.5 percent of total Japanese reserves in gold) to a significantly higher level in tune with several other industrialized central banks in the world today. Japan could quite easily buy upwards of 100 tonnes of gold per year. Many of the industrialized world central banks have foreign exchange reserves in gold approaching 35 percent of holdings.
The growing wealth of the Asian region is evident as many Asian countries are now experiencing exploding central bank reserves particularly in US-dollars that is now over 2 trillion USD in foreign exchange reserves in value. India with 1 billion citizens is another region where massive investment demand may follow along with Indonesia with the world’s 4th largest population. China’s foreign exchange reserves in the range of 440 billion USD (April 2004) have only 2 percent of its central bank reserves in gold unlike 25 years ago where this total represented 95 percent. Along with increasing wealth in China, China may play a vital role in the future sustained upward move in the gold price as they have now legalized gold ownership for its 1.3 billion citizens. China with now upwards of 200 million in a middle class, the purchasing power is now enormous as estimates have total savings in the Chinese banking system at 1.3 trillion USD.
The potential for explosive increases in the gold price is for real. Gold again may make a come back as the preferred monetary system. Internet gold backed currencies in the future will supplement the current paper currencies and provide for an alternative method of payment which will become more popular with the passage of time. A major caveat to the current global financial system is that there is too much fiat paper currency floating around in relation to current gold holdings.
CURRENCY: ISO Symbol ‘XAU’, gold ounces. At time of review on September 10, 2004, gold bullion was priced in New York at 401.50 US-dollar ‘USD’ to 1 XAU (gold ounce). The price of bullion has entered a likely new historical bull market as gold has rebounded impressively from the 250 USD to 1 XAU range to the current level over 400 USD over the last three years. Gold bullion is currently undervalued relative to historical valuations when comparing in inflation adjusted dollars. The 1980 spike at 850 USD to 1 XAU would have a year 2003 price equivalent value of 2150 USD when inflation taken into account. Gold is undervalued when analyzed in inflation adjusted dollars as a 400 USD an ounce gold price in the 1980’s is now equivalent today of a 600 to 700 USD an ounce.
Even with central bank sales, several central banks including the United States, Germany, France and Switzerland today hold a relatively large position in gold reserves backing their currency such as the Swiss franc. During year 2002, gold was the strongest major currency in the world. Gold has a direct inverse correlation with the value of the USD. When the USD rises, gold tends to fall in price. From January 2002 to July 2004, the USD fell 40 percent to the Euroland euro ‘EUR’ while gold appreciated 42 percent versus the USD during this time. From year 2001-04, gold rose in USD pricing although when compared to many other major currencies, gold’s performance was flat as currencies such as the Euroland euro, Canadian dollar, South African rand etc. also appreciated to the declining USD during this time. However, it appears that this is set to change with gold now to outperform the majority of currencies rather than its initial rise in USD pricing due to the USD devaluation during this three year time frame.
CURRENCY HISTORY: during the 1990’s, global disinflation amongst the industrialized countries resulted in a lower gold price versus the USD as a wild bull market in U.S. equities and in the USD took hold. The opposite was true during the 1970’s as high U.S. inflation resulted in a much higher gold price. Gold peaked in January 1980 at 850 USD to 1 XAU price spike, year 1981 in a trading range of 300 to 500 USD, mid 1980’s at 500 USD. Other historical quotes include years 1989-96 in a trading range between 350 to 400 USD, year 1998 average at 300 USD, 2000 at 279 USD, year 2001 average at 271 USD .
Historically, gold has performed well when the major United States stock markets were in turmoil, these times included the 1930’s deflation and in the 1970’s inflation. During the 1700 and 1800’s, gold & silver was used by nations to settle balance of accounts as trade via marine shipping became a widely used means to promote global trade. Gold provided stability to the global monetary system as the gold standard was in play from year 1880 to 1914. The creation of the Federal Reserve System in the United States in 1913 basically killed the gold standard. On August 15, 1971, U.S. President Nixon made the USD fiat currency. The USD then became the world’s first currency no longer backed by gold or another precious metal. At this time, gold was priced at 35 USD to 1 XAU. Today, the USD is playing the role of the world’s reserve currency, similar role to the gold standard previously. Essentially, the USD has replaced gold in this role within the global monetary system. It is much easier to settle balance of international payments with the USD then it is with gold. However, the USD is based upon confidence, and one crisis, the value of the USD can fall quickly and gold again will show its credibility as the world’s reserve currency.
Some Bullish Reasons for Gold
Declining mine supply and the difficulty finding new deposits.
Large short positions.
Declining value of the USD. Massive fiscal & current account deficit position within the United States.
Potential for sustained energy crisis with plus 45 USD per barrel oil.
Negative real interest rates.
Reduced central bank selling and renewed buying from Asian central banks - reversing trend?
Small market capitalization of publicly traded gold companies.
Increasing demand - retail and investment.
Introduction of Exchange Traded Funds (ETF’s) - easier to own physical gold.
Astounding value of derivatives.
Global currency debasement with large growth in money supply.
Terrorism and increased geopolitical risk.
Gold is recognized as money.
Islamic Gold Dinar is starting to Replace the US-dollar within Muslim Countries
The world consists of 2 billion Muslims, the majority residing in the Middle East and Asia. The new Islamic gold dinar now circulating is gaining popularity, the currency is managed by the Islamic Development Bank for its 51 member countries. The new Islamic gold dinar was introduced in mid 2003 by Malaysia as a new trading currency with a goal of replacing the US-dollar for commercial transactions as a medium to reduce dependency on Western finance treasury as many in the Islamic world see an unjust global monetary system. Further, many Muslims wish to see the success of their new gold currency as many Muslims are upset with the U.S. government for seizing & freezing billions of US-dollars from Muslim bank accounts for fighting terrorism. A backlash against the circulation of the USD within the Muslim world is in the works. One gold dinar weighs 4.25 grams and is comprised of 0.916 percent pure gold.
CURRENCY FORECAST: overall picture for gold is bullish in our view at BankINTRO.com with a price target of 500 USD to 1 XAU (gold ounce) by year-end 2005. Over the last few years, there has been an annual gold deficit with demand greater than supply, but the annual supply shortfall has been supplemented through short sellers and professional bullion dealers borrowing/leasing large quantities of gold from central banks. This is potentially setting up for a net short squeeze in gold bullion with a potential explosive upside potential in the price of gold. Complimenting the supply/demand equation is the fact the gold prices are tied/quoted in USD, a lower USD results in a higher gold price. America’s massive trade and corresponding current account deficit and sky high stock market valuations are two current red flags for the USD (please see write-up for UNITED STATES in this BankINTRO.com currency index). BankINTRO.com believes the USD crisis is not over until the U.S. authorities bring the U.S. current account deficit from the current 5 percent of GDP shortfall to under 2 percent. In order for this to occur, the USD will likely fall further in value to a level of 1.60 USD to 1 EUR (Euroland euro). Gold has been a historical area of safe-haven for many to hedge themselves from the risk of a wealth collapse, a war/terrorism strike and a collapse in confidence in a national currency.
BankINTRO.com also believes that gold will play an important role in the use of currencies with continual threats of deflation & inflation, political instability along with economic shocks that are most likely to continue well into the future. The intelligence of politicians and central bankers among the world’s nation’s and currency blocs are now under a larger microscope with the arrival of the Internet in the management of their finances and corresponding currencies. Many citizens may now decide to avoid a potential wealth loss through currency depreciation as many governments have cranked up the electronic printing presses thus debasing the value of their currencies. Citizens of all countries have the ability to quickly move monies into those currencies and global banks that are prudently managed including gold bullion, Swiss franc and gold based Internet currencies. Finally as discussed, another major factor in gold’s favor is the recent announcements by several of the largest gold mining producers who are unwinding their hedge position by reducing the amount they sell forward as prolonged negative U.S. interest rates have made hedging less attractive thus creating a favorable environment for the gold price to propel to a higher level.
BankINTRO.com envisions a three phase gold bull market that is developing. The first phase consists of the US-dollar depreciation that has taken place since 2001 and the beginning of loss of confidence in this world’s reserve currency on October 2000. This USD devaluation from 2001 - 04 and beyond has resulted in the gold price going from the 250 USD to 1 XAU to the 400 USD level. The next phase will culminate in global investment demand for the yellow metal say from year 2005-2009 that may result in a gold price approaching 700 to 1000 USD to 1 XAU. The final phase will see a speculative mania phase similar to what took place in United States hi-technology stocks in the late 1990’s. During this phase, the gold price may go over 3,500 USD an ounce. Similar to silver, gold provides for a very interesting speculation going forward.
UPDATED: September 10, 2004