The Case for Gold Today

by: Charlie Bottle posted on: July 28, 2008

“With the exception only of the period of the gold standard, practically all governments of history have used their exclusive power to issue money to defraud and plunder the people.” - Friedrich Von Hayek

I’m not advocating a return to the gold standard but when governments lose on printing money, as is the case today, investors should buy gold.

The analysis set forth in this article is focused on gold but the same conclusions are largely applicable to the other precious metals with monetary characteristics: silver and platinum.

Gold has been trading in a $900-$1,000 which all time high, slightly above the 1980 brief peak above the $800 range, however, on an inflation adjusted basis (please see chart below) it is still way below the peak and average range during the stagflation period of the seventies; a period that greatly resembles of current macro-economic setting.

I expect gold to continue to appreciate substantially in the medium and long term, with strong chances of moving in a sustained fashion above $2,000 within the next two to three years.

There are perhaps about 130,000 tons of gold above the ground, with about half in jewelry, 40% in bars and coins (of which 30% with central banks and 10% with individuals) and the remaining 10% are in dental and industrial applications.

The total annual demand of gold is currently just under 4,000 tons and breaks down roughly as follows:

• Industrial and Dental: 400 tons (10%)
• Consumer: 3,600 tons (90%)
  o Fashion jewelry: 800 (20%)
  o Investment jewelry: 2,600 tons (60%)
  o Investment (bars and coins) 400 tons (10%)

This demand far outpaces mining production of 2,600 tons, and is met by the following supply:

• Mining: 2,600 tons (65%)
• Net central bank net sales: 800 tons (20%)
• Scrap: 600 tons (15%)

Demand growth should accelerate fueled by the need for a hedge against increased inflation, and against ongoing political and financial uncertainty, as well as growth in emerging markets middle class income.

Gold as an inflation hedge and insurance against political and financial distress

The point on inflation is self-evident as many emerging markets have double digit inflation rates (e.g. Russia 15%, Vietnam 20%, Turkey 11%, Chile 10%, Argentina 10%), or close to that (China 7%, Brazil 6%, India 8%).

In the United States, headline inflation is at about 5% and the public is becoming increasingly aware of the lack of accuracy of the reported inflation figures.

There is much controversy about the effectiveness of gold as an inflation hedge, with substantial research pointing to real estate and stocks as being better hedges. Even if this is the case, considering the ongoing bursting of the real estate bubble and negative trend in equity prices, it seems quite likely that gold will be the preferred hedge.