From the May 01, 2010 issue of Futures Magazine • Subscribe!

Gold highs near an end?

The nearly decade-long ascent in the price of gold has been accompanied by an unprecedented display of passions regarding this unique yellow metal. All conceivable aspects of gold’s trading patterns, as well as its current and future functions in the economic and monetary system of the world, have been scrutinized and hotly contested. The global financial crises in recent years have furthered the extremism manifested in such discussions.

Sadly, much of what has been debated has only served to confuse the investing public and divert its attention from the metal’s underlying fundamentals. The mantra of the recent period has been uniquely a price and performance-oriented one. As a result, we find ourselves in an arena where bold assertions of $5,000 and $10,000 gold being “just around the corner” are routinely made. There is perhaps one number that might actually be worth pondering, and that is that all of the world’s above-ground gold stockpile amounts to only 0.6% of global wealth, which is not exactly a cure-all for what ails the planet’s economies today — not by a long shot.

Many neophyte gold buyers embrace the view that the liquidity injections the financial system has witnessed since late 2007 will inevitably engender ultra-high inflation levels down the road. However, the answer to how much or how little inflation we actually will experience will be revealed in the approach that global central bankers employ as various economies recover. Their exit strategies will be the key to effectively countervailing potential inflationary pressures by the drainage of this excess of liquidity from the world’s economies.

In fact, many of the abstract questions being posed at the moment are focused on whether the world might fall into further deflation or a possible depression, or whether it veers off in the opposite direction and has to contend with a hyper-inflationary spiral. Few imagine that central bankers might be able to steer a middle course and successfully avoid either extreme outcome. Similar theoretical questions revolve around gold at this point, as well. Is this just the beginning of a sustained mega-rally in this market or the last gasp of a very old and tired gold bull market?

A closer look at the current state of the gold market’s fundamentals might be helpful in getting one back on the proverbial track and cutting through all the noise being made by alarmist hard money newsletters and book-talking, newly minted market gurus. This market, at this time, exhibits some serious flaws and imbalances that ought not to be ignored by would-be buyers all too eager to over allocate in the asset at the urging of their favorite newsletter writers.

According to the latest statistics published by the World Gold Council, mine supplies of gold experienced a 7% year-on-year gain in 2009, rising to 2,572 tons (see “Demanding cash for gold”). In 2008, we thought that the more than $40 billion in exploration expenditures that the mining community undertook since 2002 in the wake of rising gold prices would result in such an outcome. Last year’s mine supply additions came at a time when analysts within and outside the industry were seeing “peak gold” conditions. As it turned out, these could be some distant peaks they were seeing.

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