AGE Gold Commentary is our regular report analyzing trends in precious metals and rare coins. We monitor domestic and international markets and extrapolate from our 30 years in metals to place current events into a hard asset perspective. View archives.
2/20/2006: Why is the world suddenly buying gold?
In this issue of Gold Market Commentary:
Gold hits new 25-year high Gold hits new 25-year high
Other metals gaining
Danger time in America?
Why is the world suddenly buying gold?
Classic U.S. coin update
Gold hits new 25-year high
Gold market action over the past five months has been absolutely stunning. From August 2005 to early February 2006, gold gained by 32%, climbing from $431 to a 25-year high of $572. The last time gold so gained strongly was during its legendary bull run from August 1979 to January 1980, when the price skyrocketed from $300 to an all-time high of $850.
But just as important, recent months have confirmed that gold is now in a true international bull market. From 2002 to 2005, as our regular readers know, gold enjoyed what we call a secular U.S. bull market. During this period, the price in U.S. dollars but was relatively stagnant in euros, yen, francs, and other major world currencies. Since August 2005, however, gold has been gaining dramatically in most major currencies as well as in dollars. Between August 2005 and January 2006, gold gained 31% in euros, 37% in Japanese yen, 27% in Swiss francs, 28% in Chinese yuan, and 31% in Australian dollars. As we explained in our December alert, this shift to an international bull market opens the door to a much higher gold price, and means the current bull market has room to run for years to come.
Click here to see 5-year gold price charts in U.S. dollars and a variety of major foreign currencies.
In the past several weeks we’ve seen some real volatility in the gold price, including several three-day price swings of $25. In one 30-hour period, gold fell by $10 in U.S. trading, surged up $8 in Japan several hours later, steadied in Europe, and then gained another $4 in the next U.S. session. That’s a lot of ground to cover for a net gain of $2 per ounce!
Be prepared for more short-term volatility as swelling international demand and profit-taking settle into the market. Upward price movement (or downward, for that matter) attracts speculative short-term "momentum traders" who help to push the market a little farther and faster than it would normally go on fundamentals alone. When momentum stalls, the speculators take profits and exit the market, exaggerating net price movement. This is precisely what’s been happening to gold recently. After pushing to a new quarter-century high of $572, momentum stalled and the price fell sharply to $548 on profit-taking, largely by funds. The next day it surged back over $560, and then fell again.
In a market racking up huge gains so quickly, profit-taking is natural and healthy. Gold is now establishing a new trading range underneath its recent highs, and is likely to consolidate in the $535 to $560 price range for the time being. But we still believe $600 is coming in 2006, and we expect a gold price of $675 to $750 in the next 24 to 36 months.
Other metals gaining
Silver, platinum, and palladium have all surged strongly since our December update. From August to early February, silver rose from $7.00 to $9.82 for a whopping 40% gain. Prior to January 24, silver had breached the $9.00 mark only briefly. But in recent weeks, as the new silver ETF fund became more reality than a rumor, the white metal charged from $9.00 to $9.91 in just five sessions before momentum stalled, profit-taking kicked in, and it drifted back into the $9.25 range. Silver can be more volatile than gold, and quicker to give up short-term gains. We expect it to settle into the $9.20 to $9.70 trading range for now.
Platinum traded at $900 in August 2005, breached the $1000 mark by mid-December, and fell back to $960 at year end. So far in 2006, it pushed as high as $1079 in early February, succumbed to profit-taking, and established a near-term range of between $1,000 and $1,050. Our regular readers know we’ve been wary of platinum above $750, believing it lacks the upward price potential of the other traditional precious metals. Plus, we knew it would only be a matter of time until the auto industry wised up and switched from expensive platinum to cheaper palladium in their catalytic converters. In December, GM announced it was doing just that, and other car makers are following suit. (See Platinum rally may end as GM, carmakers switch to palladium.)
Between 2003 and 2005, palladium generally languished between $180 and $225 per ounce. In January 2004, with the price right at $200, we issued a palladium buy alert. Within a few months palladium rose to $300 before slipping back into the $200 range. In early November 2005, it began to show signs of life again, moving over $225 for the first time in over a year on the news of a supply deficit. We issued a strong palladium buy alert at $235 (see Precious metals gaining across the board), and it moved up nicely to $315 in early February for a quick 34% gain.
All four major precious metals have softened in price from their new 21st century highs; but again, this profit-taking is natural and healthy. We expect them to settle into trading ranges a little below these highs but maintaining most of their price gains. Specifically, gold seems fairly valued in the $535 to $560 range; silver from $9.20 to 9.70; platinum from $1,000 to $1,050; and palladium from $280 to $300. We fully expect to see base-building at these levels followed by surges higher as 2006 unfolds. Buy gold, silver, and palladium on any weakness! We continue to be wary of platinum, which simply carries too much risk and too little reward above the $1,000 mark.
For the reasons outlined below, market fundamentals for precious metals remain excellent. We still believe that $600 gold is coming in 2006, and we expect a gold price of $675 to $750 in the next 24 to 36 months.
Danger time for America?
In 1979, the U.S. was in the midst of a worldwide crisis of confidence that powered the gold price to the unheard of heights of $850 an ounce. Back then, interest rates and inflation were absolutely out of control; energy prices were sky high (for that time), and the nation was mired in a costly Middle East stalemate, the Iranian hostage crisis. Today we’re in the midst of different, perhaps more subtle crisis of confidence. While interest rates and inflation remain relatively low (but rising significantly), our household debt, trade deficits, and government debt are absolutely out of control; energy prices are at levels that were unimaginable in 1979, and the nation is mired in a far costlier Middle East stalemate, the Iraq war. Of course, the U.S. remains, without doubt, the pre-eminent world power. But our debt-ridden economy is beginning to give the world pause – and should give us pause, too. As in 1979, this crisis of confidence is likely to power gold to unheard of heights once again.
By many measures, the U.S. economy seems to be humming along, but all is not well in Pleasantville. Last month, The Economist ran a cover story with the alarming title, "Danger time for America." The opening sentence of this unsettling story spoke right to the heart of the matter: "The economy that Alan Greenspan is about to hand over is much less healthy than is popularly assumed" (The Economist, 1/14/2006). Huh? Wait a minute. The recession is over! With GDP growing and consumer confidence gaining, our boy is rosy-cheeked and ready to rumble, right?! Well, not exactly.
Echoing a growing chorus of economic experts, The Economist, which is by no means a radical voice, suggests that the main reason for U.S. economic growth in recent years has been a massive monetary stimulus engineered by the Fed’s historically low interest rates. Low interest rates have created tons of cheap money, and globalization (e.g., a flood of inexpensive goods from China) has prevented all that cheap money from spilling into traditional inflation. Instead, our exploding money supply has been channeled into highly inflated asset prices – first equities, then housing.
Unfortunately, we know all too well what happens to stock bubbles; and the housing bubble, according many reports, is about to suffer the same fate. So the real problem with these rising asset prices, according to The Economist, is not the prices themselves but the illusion they create of economic health:
"By borrowing against capital gains on their homes, households have been able to consume more than they earn. Robust consumer spending has boosted GDP growth, but at the cost of a negative personal savings rate, a growing burden of household debt and a huge current accounts deficit."
Our current prosperity, then, is less a consequence of real income gains or high productivity growth than of borrowing from the future. Indeed, last year Americans’ personal savings rate fell into negative territory (at minus 0.5%), something that hasn’t happened since the Great Depression. This means we not only spent all of our after-tax income in 2005, but had to siphon off previous savings and increase our borrowing in order to spend even more. The truly alarming thing is that the national savings rate has been negative for an entire year only twice before, in 1932 and 1933, a time of massive business failures and job layoffs. And we’re supposed to be in a period of economic recovery! (See Savings rate at lowest level since 1933.)
But the sad reality is that this recovery is one of the weakest in recent history. Private sector wages have risen only 12% in real terms, compared with more than 20% during the same period in the five previous recoveries, according to Morgan Stanley. In addition, the productivity of the American workplace actually fell at an annualized rate of 0.6% in the fourth quarter of 2005, the first decline since the recession of 2001. For all of 2005, productivity increased by 2.7%, the smallest increase since 2001. Defined as output per hour worked, productivity is one of the most important long-term variables in economics. Higher productivity can mean higher profits, wages and living standards, and keeps inflationary pressures at bay by lowering overall manufacturing costs. (See Productivity falls in fourth quarter.)
The real worry about housing prices, of course, is that they’re bound to flatten or fall sometime. When they do, all of that consumer spending, financed by all of that paper homeowner equity, will come to an abrupt halt—and with it our economic recovery. But by all indications, despite slow wage growth and mounting debt, we keep consuming foreign products at an astonishing rate while running up monumental deficits with our trading partners, especially China. In December, the U.S. trade deficit swelled by $65.7 billion, a new record. For all of 2005, we posted a trade deficit of $725.8 billion, another record. The deficit with China widened to $16.30 billion in December, compared with $14.17 billion in the same month the year before, and closed 2005 at $201.63 billion, another record. But China is hardly the only beneficiary of Americans’ compulsive spending habits: we also set record annual trade deficits with Canada, Mexico, and Japan; and carry record trade gaps with the European Union, South and Central America, and OPEC nations. (See U.S. trade gap widens in December.)
Why is the world suddenly buying gold?
All of this debt-driven America consumerism helps to explain, at least in part, why the secular U.S. bull market in gold has become an international bull market, and why we think there’s a burgeoning worldwide crisis of confidence in U.S. assets that could fuel the gold price past its 1980 record high.
One of the main ways in which current accounts and capital outflows are balanced is by foreign central banks purchasing U.S. Treasuries with their excess reserves of dollars, in effect loaning dollars back to America. These capital inflows are a prime method of financing the growing U.S. current account deficit and federal budget deficit.
Budget deficits accrue to the gross national debt, which is the total amount the government owes itself and others. For the first time ever, on October 18, the gross national debt surpassed $8 trillion! As we reported last fall, more than 46% of our net national debt – more than $2.1 trillion – is now held by foreigners, especially the governments of Japan and China. Because the U.S. imports so much more than it exports, nations like Japan and China take in far more dollars than they return by purchasing U.S. products; so they balance the net flow of capital by purchasing more and more of our national debt in the form of U.S. securities. But at some point, all that debt could easily seem like a bad investment to these foreign governments. (See Precious metals gaining across the board.)
That time, it appears, is close at hand. Increasingly, our creditor nations are making noise about shifting their money out of dollar-denominated assets and into other assets, like gold, which are less vulnerable to U.S. fiscal irresponsibility. In January, for example, Financial Times reported that China is planning to diversify its rapidly growing foreign exchange reserves away from dollar and U.S. government bonds. An estimated 70% of China’s reserves are invested in U.S. dollar assets—a huge amount, which has helped to sustain the recent large U.S. deficits and prop up the value of the dollar.
"If China were to stop acquiring such a large proportion of dollars with its reserves – currently accumulating at about $15 billion a month – it could put heavy downward pressure on the greenback," said Financial Times. This sea change would have immensely negative effect on U.S. equities, and could trigger panic flights of foreign capital out of U.S. assets. (See China signals reserves switch away from dollar.)
Increasingly wary of dollars and dollar-related assets, China is now talking about increasing its central bank gold holdings. With only 1.4% of its currency reserves presently in gold, compared the 8.7% average for other major countries, China is expected to increase holdings to 2,500 tons from 600 tons in the short term, the nation’s official Xinhua News Agency reported, citing economist Teng Tai, of China Galaxy Securities. (See Gold gains on speculation a weakening dollar will spur buying.) Currently ranked the tenth-largest holder of gold in the world, this increase would move China to number five, behind the U.S., Germany, the IMF, and France, according to the World Gold Council.
Other central banks are following suit. Russia recently announced it might double its gold holdings from 5% to 10% of its national reserve portfolio. Increasing gold reserves could potentially consume Russia’s annual gold output for an estimated three years, further restricting already short supplies from international mine production and driving up prices. Argentina, South Korea, and South Africa have made similar announcements. And it’s only a matter of time until most of Asia starts laying in more reserves. The groundswell is building and prices are rising. All of this increased demand will not only continue to boost the international gold price, but sends a strong signal that the world is losing confidence in U.S. assets as long-term stores of value.
In another major boost to the international gold market, many OPEC nations are beginning to shift their huge reserves of petrodollars away from U.S. Treasuries. According to the IMF, the ten OPEC nations (Algeria, Indonesia, Iran, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, United Arab Emirates, and Venezuela), plus Iraq, raked in a whopping $1.44 trillion in oil income in the last four years. Last year alone OPEC’s receipts, plus those of Iraq, totaled an estimated $555 billion, representing a 44.4% improvement over 2004. The current-account surpluses of the 22 biggest oil-producing nations—both the OPEC and non-OPEC countries—now exceed the accumulated surpluses of all the economies of Asia, excluding Japan.
While some of those nations—Russia or Venezuela—are expected to keep most of their oil spoils at home, smaller nations such as Kuwait, the United Arab Emirates, and Saudi Arabia are looking to park $400 billion, net of imports, somewhere. In terms of asset allocation, OPEC members on the whole shied away from U.S. financial instruments in the second half of last year, with their total holdings of long-securities purchased from U.S. residents rising by a mere $2.7 billion, or 3.1%, during the five months from July to November, according to data from the U.S. Treasury International Capital System Office. The investment slowdown extended to both U.S. government and corporate securities.
So where are those petrodollars going? A sizeable portion is finding safe haven in gold. In fact, tax-free gold trading just began on the new, fully automated Dubai Gold and Commodities Exchange (DGCX), the Middle East’s first derivatives exchange. And according to the World Gold Council, retail investment demand for gold rose by 38% and jewelry demand by 11% in the Middle East through Q3 of last year.
Oil exporters aren’t the only ones bidding up retail gold on the international market. India’s growing middle class of more than 300 million people, many of whom are reluctant to entrust their hard-earned savings to banks and other financial institutions, are also seeking safe haven in the yellow metal—particularly, in the form of gold jewelry.
The world’s largest gold importer, India accounts for a quarter of all gold jewelry sales worldwide. The World Gold Council estimates gold buying in India was up nearly 33% to 850 tons in 2005. It was also the fourth-fastest-growing commodity import, representing 8.1 percent of all Indian commodity imports. An estimated 13,000 tons of gold, or around 8.4 percent of the total global supply, is believed to reside in India.
And China is rapidly becoming an important retail buyer of gold. Chinese gold purchasing increased by 9% through Q3 of last year, according to the World Gold Council, and the trend is upward. After long forbidding ownership of gold, China has been steadily deregulating its gold market for several years and could easily become the world’s largest gold market in the near future. The Shanghai Gold Exchange was created in 2003 to give professional investors and companies a means of trading the metal. Gold trading volume on the exchange increased 36% in 2005. In addition, The Shanghai Daily reported earlier this month that the China Gold Association is now considering forming the country’s first gold fund with partners. The fund would exceed 1 billion yuan ($124 million), and facilitate even more investment opportunities in gold.
So there you have it: the world is buying more gold because, at least in part, U.S. assets simply don’t inspire much confidence anymore. We haven’t even discussed growing concerns about international inflation (especially of oil and all commodities) and geopolitical risks (such as Iran’s nuclear development, the election of Hamas, and the ongoing war in Iraq), which we’ll discuss in detail next time. Danger time for America? Quite possibly. But one thing is for certain: it’s a good time for gold!
Once again, in the current debt-laden and inflationary U.S. economic climate, and with international demand catching fire, we’re now targeting a gold price of $675 to $750 per ounce in the coming 24 to 36 months. Remember, back in January 2004 we predicted a gold price of $480 to $550 within 12 to 24 months, and we hit the price-range and time-frame almost exactly. (See 2003 in review: Gold touches 15-year high.)
Classic U.S. coin update
Just as the appetite for gold is growing worldwide, the appetite for classic U.S. gold coins is growing here in United States. National supplies of U.S. rare coins are now razor thin. We’ve attended two major coin shows in the last six weeks: the FUN show in Orlando and the Long Beach Coin Exposition in California. At each show we saw three or four buyers for every quality coin available. At the FUN show we got lucky: we were able to meet our very stringent requirements for quality coins. We quickly sold most of those acquisitions, as we expected. Long Beach, however, was the most disappointing show in years. The availability of coins meeting our standards for eye-appeal and technical merit was small at best, we were only able to bring back half of what we hoped to find. Pockets of below average coins are available on the national market, but we will not offer them to our customers because they are below our quality standards, despite their PCGS or NGC grades.
Nonetheless, we did find some nice pieces, which we’ve posted to our online inventory of classic U.S. gold coins. Prices have risen strongly in the past six months, as we expected. The current state of the market (high demand with very low supplies) suggests this pricing uptrend will continue throughout 2006 and beyond. We’ll post a more in-depth report on the state of the classic U.S. coin market on our web site soon.
We’re lucky enough have a good stock remaining of two classic U.S. gold coins that remain undervalued in today’s coin market but still offer exceptionally good value and strong fundamentals: $20 Saint-Gaudens from the Denver and San Francisco Mints, in Mint State 63. Combining them for savings, we’re calling them our Power Pair #3. These D-Mint and S-Mint Saints are 20 to 40 times scarcer than the Philadelphia-minted Saint-Gaudens, but are selling, in most instances, for small premiums only 5% to 10% over the common P-Mint coins.
Generally considered be the most beautiful of all U.S. coins, Saint-Gaudens double eagles are always popular. Our Power Pair #3 also offers exceptional relative scarcity, excellent quality, and low prices relative to the current market. In our book, these coins represent an excellent and under-appreciated value in the current market, and should not be missed!
Click here for detailed information on our new Power Pair #3.
That’s it for now. We’ll keep you informed as market conditions warrant.
Dana Samuelson, President and Owner
Dr. Bill Musgrave, Vice President
AGE Gold Commentary
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