Gold hit a record intraday high of $1,174 per ounce and COMEX gold futures closed higher for the fifteenth time in the last sixteen trading sessions. The December COMEX contract rose $17.90, or 1.6%, while spot gold bullion closed at $1,165.31, up 1.3%. Investment banks are rushing to raise their gold price targets – Bank of America Merrill Lynch being the latest, as it now forecasts $1,500 gold over the next eighteen months.
What is driving the gold bull market? The confluence of five significant factors has caused investors to rush into gold and investments that offer leverage to the gold price. The acceleration of these trends or a pause in them will determine gold’s next big move.
1. Fighting Deflation and the Negative Impact on the U.S. Dollar
The widely publicized easy monetary policies employed by the Federal Reserve, highlighted by zero interest rates and a $1.72 trillion quantitative easing program, have combined with profligate legislative and executive branch stimulus spending to create a $1.4 trillion budget deficit and, consequently, a flight away from the U.S dollar. As Bloomberg reported late yesterday, “About $12 trillion of fiscal and monetary stimulus, the world’s lowest borrowing costs and a record $4 trillion of government bond sales between 2009 and 2010 will weigh on the U.S. currency.” Michael Churchill of Classical Insights recently opined, “The dollar’s value is not something the Fed is supposed to care about – it is not part of its official mandate (unwise as that may be).” The resolve and determination of both U.S. and global bankers and politicians to fight deflation presents a macro-economic backdrop supportive for higher gold prices.
2. Low Rates of Return on Capital
The most obvious example of the lack of return available in competing asset classes is the disappearance of yield from money market accounts. Clearly the U.S. is the best example of this phenomenon as its banks offer essentially zero return on cash deposits. However, this is not solely an American issue as yields have plummeted across the globe. The opportunity cost of holding a sterile asset such as gold has been nearly eliminated. Gold, which pays no rate of interest, no longer faces competition from money markets – or even intermediate-term bonds, evidenced by the paltry 0.72% yield on the two-year Treasury bill. Dividend yields, near 2%, are well below the historical norm, and equity markets have failed to deliver, with the S&P 500 producing a negative return over the past decade. Former Treasury Secretary Larry Summers and Robert Barsky wrote in their acclaimed 1988 paper “Gibson’s Paradox and the Gold Standard”, the price action of gold is driven by the reciprocal of the real rate of return available from the global capital markets. The current lack of return or yield available has driven investors into gold.
3. Central Banks Become Net Gold Buyers
High-profile purchases of gold bullion by central banks – highlighted by India’s $6.7 billion gold purchase from the International Monetary Fund (IMF) last month – is a phenomenon that has both a fundamental impact as well as a psychological one. The psychological impact of growing central bank hoarding on private investors is as important as the resulting reduction in supply from the reversal of central bank net selling to net buying in driving the price of gold bullion. The Russian central bank was the most recent sovereign nation to announce an increase in its gold hoard – in order diversify away from the U.S. dollar. Additionally, the net flow of gold reserves from developed countries to those with emerging economies presents an interesting topic for discussion as it pertains to the shifting balance of economic power underway across the globe. BlackRock’s Evy Hambro, who manages two of the world’s largest commodity funds, forecasts that in 2009, for the first time since 1988, central banks will be net buyers of gold.
4. High-Profile Institutional Investors Emerge
This past year has witnessed the entrance of high-profile institutional investors into the gold sector. John Paulson recently announced that he is launching a gold fund January 1, 2010, and will invest $250 million of his own money in the venture. Paulson has been moving aggressively into the gold sector over the past year, investing roughly $3 billion of his firm’s capital into gold and gold mining stocks. Mr. Paulson is not alone. David Einhorn of Greenlight Capital, Paul Tudor Jones of Tudor Investment Corp., Kyle Bass of Hayman Advisors, and Eric Mindich of Eton Park Capital have all disclosed to their investors significant allocations to the gold sector over the past year. With the entire market capitalization of the gold mining stocks being smaller than Exxon Mobil (XOM), some have speculated that the supply of shares does not exist to accommodate the large generalist institutions. Billions of dollars could chase the gold price and the gold miners much higher by the mere fact the sector cannot accommodate a tidal wave of capital. But the chase to position ahead of Paulson’s launch on January 1st is underway – and greed is the operative word with gold’s upward trend picking up steam as of late.
5. Declining Risk Aversion, Heightened Speculation, and Enhanced Liquidity
Germany’s finance minister Wolfgang Schauble recently sounded a warning with respect to the confluence of low U.S. rates and the weak U.S. dollar, stating “more likely today is a scenario in which excess liquidity globally creates a new asset market bubble.” However, it is not solely U.S. policymakers who have their foot on the accelerator – China’s M2 growth is at an all-time high of 29% on a year-over-year basis. Central banks and political leaders across the globe, through loose fiscal and monetary policies, have spurred investors to increase their risk appetites. The S&P 500 is up 62% off its March lows, China’s Shanghai Composite, India’s Sensex, and Brazil’s Bovespa are higher by 81.7%, 76.4%, and 76.6%, respectively, thus far in 2009. The oil price and copper price are higher by 126% and 119%, respectively, leading to the conclusion that the gold price rise is by no means occurring in isolation. Correlations have risen across a broad spectrum of asset classes, and the tailwind from renewed speculation and liquidity, no doubt spurred by a weak dollar, has helped to propel gold higher.
While there are other short-term factors that influence the gold price, these are the five chief fundamental factors influencing the gold market. The weakening or diminution of any of these pillars has the potential to cause a correction to ensue. They all bear monitoring and close scrutiny as gold commands the front pages of the financial press.
Gold Price News provided by GoldAlert.