Powerful forces could push gold prices higher this year and over the next several years. Making an investment in gold before catalysts build could be critical to your portfolio.
Gold has been the standard for monetary value across millennia and has been one of the strongest performing asset classes over the past decade. It’s cultural and emotional significance act as a constant support for prices even when other assets fall.
Now gold faces an inflection point where prices could turn dramatically higher on six catalysts. From fundamental forces like supply and demand to market forces like global currency debasement and investor sentiment, prices could top all-time highs within the next year.
Several of these catalysts are already coming through in demand for gold and could lead to momentum in prices. With the supply of gold limited and the amount of time it takes to increase production, upward movement in the price is likely to snowball as each catalyst takes hold.
Investors should consider taking a position in physical gold before price momentum begins and cost-average their position as the theme develops.
Reason #1 to Make a Gold Investment in 2015 – Demand could Surge
According to the World Gold Council, global demand for gold increased 3% in the first quarter of 2015 from the previous three months. Demand for gold jewelry was strong on increased buying in India and a lift of import controls. Demand for gold in exchange traded funds saw its first net increase in more than two years and could note the beginning of a new investment cycle.
If gold were to return as a popular investment vehicle, it could cause prices to surge. Gold demand from every other source has been relatively strong over the last year and the additional demand could overwhelm supply.
Gold is an important use in technology with the rapid adoption of tech gadgets driving tech’s portion of gold demand significantly higher. Gold’s conductivity and resistance to corrosion make it a necessity in high-specification components. Gold has also recently seen surging demand within the automotive sector on commercial viability in catalytic converters.
Central banks have been net buyers of gold since 2010 with demand expanding on a clear diversification from the U.S. dollar. Central bank demand has increased from 2% of total gold demand in 2010 to 5% of demand currently.
Many bears calling for the price of gold to decline past $1,200 an ounce overlook the strong emotional and cultural value that supports prices. No other investment enjoys as much cultural cache as gold. From reaching for the “gold ring” as a maxim for success to the “gold standard” and “good as gold,” people attribute special value to the metal.
From a status symbol to a testimonial of a sacred bond, gold is widely prized around the world for ceremonial uses. Gold demand in India alone is expected to increase as much as 19% in 2015 to 1,000 metric tons, according to the World Gold Council. Gold for jewelry demand rose to the most in nearly two decades in 2014 especially during festivals like Akshaya Tritiya in April through Diwali later in the year, boosting India beyond China as the world’s largest consumer.
Gold demand from consumers may have already begun the trend with a surge in Europe and India. Demand in India, 29% of global consumer demand, jumped 15% in the first quarter of 2015 compared to the prior year while European demand was higher by 12% against the prior year.
As demand for gold surges, if supply is not able to keep up, 2015 could see volatile swings to the upside in price.
Reason #2 to Make a Gold Investment in 2015 – Capital Expenditures to Hit Supply
In response to the steep drop in the price of gold, miners have cut back their investment spending on production. The average capital spending in 2014 at five of the largest miners was less than half that spent in 2012 with many spending nearly a third of their peak spending budgets.
The drop in capital spending came as many miners rushed to protect cash flow when gold prices dropped below all-in cash costs of production, around an average of $1,300 per ounce for the largest miners. This spending cycle is common in commodities, a steep decline in capital investment following boom years. The drop in capital spending invariably leads to production failing to meet demand and prices recover. Even as prices recover past cash-costs, miners are typically slow to restart spending programs and the supply-deficit builds which leads to a spike in price.
According to the World Gold Council, global gold supply dropped by 4% in the first quarter of 2015 from the prior three months. Against the drop in capital spending, this is probably just the beginning of a trend in weak supply.
Beyond the trend to weak supply on lower capital spending, production of gold is typically volatile on geo-political issues as well. Mining supply from emerging markets in Latin America, Africa and Central Asia & Eastern Europe account for nearly half (42%) of global supply.
Many of the countries in these regions have seen economic risk increase significantly on a drop in commodity prices and dollar strength. Strikes at gold mines are a favorite of protestors when economic hardships weigh and supply estimates can be cut quickly. With the drop in the price of gold, many mining companies will be less willing to negotiate and more likely to simply let production slip.
Reason #3 to Make a Gold Investment in 2015 – The Only Real Price Protection
Gold is technically a commodity but has been used as a currency for millennia. The largest economies of the world fixed their currencies to the price of gold as recently as the 1970s.
Over the last several years, investors have dumped gold for its protection against inflation as a chorus of pundits exclaimed the death of global pricing pressures. In the face of sluggish inflation of 1% or lower in the United States and Europe, markets seem to be forgetting that it was only a few years ago that U.S. inflation doubled to 3% in 2012 from the prior year.
On a slow recovery since the Great Recession, monetary authorities have responded by turning on the printing presses. The world’s largest central banks have all increased their balance sheets, buying bonds and pumping money into their economies, since 2008 with Japan and Europe set to continue their programs. Japan’s central bank balance sheet is expected to reach 80% of the economy’s size by the end of 2015 and the ECB is planning on pumping more than $1 trillion into its economy in the 18-months to September 2016.
The value of any fiat currency is directly and negatively correlated with its supply. As more money is pumped into global economies, it becomes less scarce and its value diminishes. Despite a lack of pricing pressure in markets today, inflation has a way of running away quickly if people lack the confidence that central bankers can control growth in prices. With the singular focus on growth and monetary stimulus of late, its doubtful that the same central bankers will have either the credibility or the ability to control inflation when it appears.
That appearance of higher prices may not be as far off as economists would expect. The IMF puts nearly every developed economy on the verge of a cycle of accelerating inflation as of February 2015. Only Canada and Austria are expected to see slower pricing growth.
Against the constant growth in the world’s supply of currency and loss in relative value, gold has seen its intrinsic value increase because supply growth is relatively limited. The supply growth of gold over the last five years is well under that of the world’s currencies and several times slower than perennial currency debasers in emerging markets.
Against the specter of faster inflation, gold has provided an opportunity not only to hedge higher prices but to benefit. The return to gold has beaten U.S. and global inflation by approximately 12% on an annual basis over the last decade. Even over the very long-term since the elimination of the gold standard, the return to gold has beaten U.S. inflation by more than four percent.
Reason #4 to Make a Gold Investment in 2015 – The Ultimate Safety Investment
The International Monetary Fund (IMF) notes that over the six months to April 2015, global financial stability risks have increased significantly. Risks to global stability, seen in the graphic below, have increased in every dynamic except risk appetite. Risks have increased to extreme levels in emerging markets, due to liquidity and issues around dollar-denominated debt, as well as general global market risks.
In the face of higher financial stability risks, asset prices continue to soar as markets reach all-time highs. An IMF heat map of asset valuations, separated into four quartiles of price over the last decade, shows that nearly all assets and across all geographies are relatively over-valued. Stocks in the United States and Europe have approached values not seen since before the housing bubble. Bond prices have surged as central banks push interest rates artificially low.
It’s been more than six years since the trough of the financial crisis and most investors have gotten complacent about the eventuality of another drop in the business cycle. The average bull market back as far as 1939 has been 3.8 years and though bull markets do not die of old age, this one looks ready to be put out to pasture.
The U.S. economy contracted in the first quarter of both 2014 and 2015 only to weakly manage full-year growth. Chinese growth is decelerating and growth in other parts of the world is sluggish at best.
Long-term portfolio returns means diversification so the next recession does not wipe out all the gains made over prior years. Few assets are better suited than gold at achieving that diversification. In fact, gold’s value as protection from portfolio losses actually increases during crises.
The correlation of returns between stocks and gold increases during contractions, something only seen in U.S. Treasuries. As stock prices fall and investors rush to the exits, gold’s value only increases at a faster rate.
The fact that negative correlation between gold and stocks increases during crises means the yellow metal has provided tremendous support during Black Swan (tail-risk) events. Black Swan events are those so unpredictable that they are extremely low probability but bring massive losses and volatility.
During these events over recent history, gold has protected investors by more than 7% (735 basis points).
As currency impact of a stronger dollar weighs on corporate income statements and investor returns, gold has emerged as the best protection against exchange rate risk. Since gold is priced in U.S. dollars, it is negatively correlated with the greenback and many other currencies.
Gold has historically provided a lower cost hedge on exchange rate risk compared to buying foreign exchange forward contracts. Using gold as a currency hedge has also led to lower pullbacks on average. Since 2001, the average unhedged pullback in emerging market equities has been 13.1% from the peak price. The average pullback on a portfolio hedged with foreign exchange forward contracts has been 12.5% against an average pullback of just 9.2% when the risk was hedged with holding about 10% of the portfolio in gold.
Reason #5 to Make a Gold Investment in 2015 – Investor Sentiment Upside
Beyond fundamentals to the upside, investors could once again take gold prices into the stratosphere. The first quarter 2015 saw the first net purchase by gold ETFs in more than two years with U.S.-listed funds growing significantly.
Investment in physical gold and ETF demand surged to 1,730 tons in 2011. Demand in 2014 for physical gold and ETFs was less than half that amount at 20 tons. As the price of gold builds off its base at $1,200 an ounce on other factors, investment will return quickly. As we’ve seen in the past, rising prices and investment returns have a tendency to feed into a cycle that pushes prices even higher.
There is not enough excess capacity to increase gold supply if investment were to return as a major driver of demand. The resulting imbalance in supply-demand could quickly send prices back to record highs.
Reason #6 to Make a Gold Investment in 2015 – U.S. Investors Need Gold
Against a strong rise in the value of the U.S. dollar in the last quarter of 2014, market consensus forecasts have the dollar depreciating against 14 of 27 major currencies including the Chinese yuan, Australian dollar, and Korean won by 2016.
The market seems to have forgotten that a runaway trade deficit and absolutely no fiscal responsibility have led to the long-term decline in the dollar since the early 1970s. The inevitable collapse of social payment systems like social security will only weaken the dollar further over the long-run.
The smart money has been exiting dollars for more than two decades as the long-term trend destroys value for dollar-based spenders. Asset managers have systematically decreased their allocation to the greenback, from 63% in 1999 to 53% in 2012.
As the graph above illustrates, the greenback is prone to short-term periods of strength on its value as the world’s reserve currency and protection in times of crises. A debilitating current account, sluggish economic growth and the insolvency of social programs promise to restore the long-term trend lower. A weaker dollar makes imported goods more expensive, bad news for a country that imports a great deal of finished products.
Protecting your quality of life against dollar debasement means seeking shelter in a store of value that can not only provide return upside but also protection during crises.
How to Buy Gold
Though investor demand has returned to exchange traded funds, physical investment in gold remains the only real investment for protection and return. ETFs are subject to risks in record-keeping, computer hacking and are more closely correlated with stocks. Only physical gold provides true diversification and an absolute store of value. Physical investment in gold is available in a wide range of coin and other bullion bars. Coins are the most popular vehicles because of their portability and smaller denominations.
Knowing from whom to buy precious metals is just as important as how you buy. Brokers and custodians must be carefully vetted before buying and storage. Many overnight shops have appeared over the last several years to take advantage of investor complacency and misinformation.
The Certified Gold Exchange has built a reputation as the market leader in gold and other precious metals over more than two decades of service. An A+ rating by the Better Business Bureau is a testament to its level of quality customer satisfaction and fair dealing. Account representatives are specialists in their specific metal and non-commissioned so you know your satisfaction is their only agenda.
Certified Gold Exchange offers bullion bars and coins as well as PCGS or NGC certified coins. Call a certified account representative at (800) 300-0715 or by clicking through to How to Buy.
World Gold Council (2013), Gold Investor: Risk management and capital preservation – Volume 4, ‘Why invest in gold? Gold’s role in long-term strategies’
World Gold Council (2015), Global Demand Trends: First Quarter 2015
International Monetary Fund (2015), Global Financial Stability Report: Rising and Rotating Risks