The 2012/03/01 at 06:05
Laurent Mathiot, CEO of Auraria
Is gold overvalued? After ten years of uninterrupted rise in its price, including a 13% gain in 2011, the question seems legitimate. Analysts reached a consensus in a study from the London Bullion Market Association, forecasting a price of 2,000 dollars (1,525 euros) per ounce and a 12% gain for 2012… The bullish trend seems set to continue, along with the sovereign debt crisis and uncertainties about the Eurozone’s future.
More quantitative easing measures – including the printing of money1 – are to be expected, leading to more inflation in the future. Gold prices are already confirming these concerns with an 8% rise in January 2012! An inflation-adjusted study of gold prices from an historical perspective since 1971 (when the dollar was no longer exchangeable for gold) reveals that 1980’s historical high of 850 dollars (648 euros) per ounce corresponds to about 2,500 dollars (1,906 euros) in 2011: in other words, a +45% gain potential in relation to the current price of 1,700 dollars (1,296 euros)!
Furthermore, according to a study from UBS bank, “Gold as the ultimate money”, comparing gold to other tangible assets such as real estate and oil, gold is still cheap compared to historical averages (expressed in ounces of gold) of the price of oil or a standard home. A study from the World Gold Council, “The 10 Year Bull Market in Perspective”, shows that gold is not in a “bubble” phase – its price measured in real terms and compared to other major assets (real estate, oil, equities…) is still below historical highs.
While gold supply (mainly mining output) is constantly diminishing, global demand for gold shows huge growth potential, from Asia in particular. In 2001 China deregulated its internal gold market, encouraging its population to start buying precious metals. At the same time, China has become the second world economy. The emergence of its middle class with a high savings rate led to a doubling of gold demand over a five-year period despite a strong rise in gold prices in renmenbi2. The Chinese government uses its financial institutions to promote gold production, importation and distribution – with results that have been quick to emerge. The share of physical gold (such as coins and bars) held by Chinese citizens as a percentage of total savings keeps growing: from 1% in 2007 to more than 3% today.
Potential demand for gold from China is expected to soon reach 3,000 tons per year, in other words, more than the total worldwide gold output of 2,500 tons. In the context of a weakening US dollar, India recently decided to pay for oil being purchased from Iran in gold instead of dollars. As the second oil buyer from Iran after China and a huge buyer of gold for jewelry, India is fast becoming one of the largest gold buyers in the world. Such geo-economics moves from the East are sure to have bullish consequences on the price of gold in the future.
Initiatives giving back a monetary value to gold can also be observed in the West, for example on the Swiss Zurich Stock Exchange: in September 2011, Six Securities Services, a leading Swiss trading company launched the possibility of using gold as a means of payment for shares. Up to the beginning of the 20th century, paper money such as bank bills was a mere “promise of future payment”, redeemable for physical gold. In this type of system, paper money can be converted into gold at any time at bank counters, with the monetary supply of a country equal to the value of its gold inventory. Currencies have fixed parities; there are no trade deficits, inflation is low… These are the advantages of a “gold standard” system where gold is the ultimate money.
So what is the role of gold in today’s world of assets? Central banks have globally once again become net buyers of gold despite their systematic selling of gold for a number of decades. This is the case of namely China, India, Russia, but also Sri Lanka, Philippines and Venezuela. If Asian central banks were to raise their asset allocation rate for gold by only 1%, this would generate 900 tons of extra demand on the market – in other words 36% of global gold production. Central banks are progressively increasing the value of gold as a reserve asset.
This major trend will sooner or later have an impact on the investment policies of institutional investors and money managers around the world. According to a recent International Monetary Fund (IMF) study, the average allocated weight of gold compared to all global assets under management (AUM) is only 1%. This despite the fact that various studies on the virtues of gold in terms of diversification and risk reduction establish that the optimal asset allocation rate is in the range of 5 to 10% of AUM! The ground to cover for a rise from 1% to 10%, or even to 5%, implies a major increase in gold demand in coming years.
Finally, a recent study from Forbes confirms the opinion of many monetary analysts: if a gold standard were to be brought back (meaning that each dollar would be backed by gold), then the price of gold would instantly skyrocket to 10,000 dollars (7,626 euros) per ounce, in other words, six times its current price. This is a strong indication of gold’s monetary value and its long-term equilibrium price…
1 The massive printing of bank notes is a form of money creation that lacks genuine value. While it is no longer supposed to exist, it has been used in the United States in the context of a quantitative easing policy, with the aim of warding off a deterioration of the subprime crisis of 2007-2008. In Europe, to face the debt crisis of certain European Union countries, the European Central Bank (ECB) waived the ban on this practice on 10 May 2010.
2 The renmenbi (“people’s money”) is the official name of the currency of the People’s Republic of China.
Contact: Laurent Mathiot, email@example.com