The Current Gold Market
Over the past two decades, most of the industrialized world as well as a large number of developing countries have experienced economic growth and stability combined with low inflation. As a result, the gold price has basically retreated and at best went sideways for most of this period. Central banks started to sell down their gold reserves in order to generate cash which was invested mainly in US$ denominated bonds and US dollar treasury securities. The languishing gold price made it less profitable for mining companies to invest money in exploration. As a result, there was a worldwide reduction in new gold mines and consequently a large drop in gold mine production.
In addition, over recent years doubts about the long term viability of the value of the US dollar have increased. It is the combination of these two events and the emergence of powerful sections in the demand for gold through the economic powerhouses in Asia (mainly China and India) that have potentially changed the outlook for the gold market.
An increase in demand for gold and a stable to slightly falling supply through mine production of gold have resulted in a strong recovery of the gold price over the past 5 years. Due to the long lead time of mine production (it can take up to 10 years to get a large gold mine into production) not even the prevailing higher gold prices have yet led to higher gold production. On top of these basic supply and demand factors in the gold market there are traditionally other factors that determine investment in gold and therefore the future outlook for gold prices:
Safe Haven
Gold has, among some other assets, been an asset which was used during volatile and uncertain times. It has been seen or perceived to be seen as a safer store of value. Gold does not rely on an issuer’s promise to pay like bank note or government bonds for instance. Gold also tends to be more stable than other asset classes in times of uncertainty and is used to diversify an investment portfolio.
Inflation Hedge
Gold has demonstrated over a long time that it keeps its purchasing power. Over the long term, however, most of the leading currencies in the world have lost their value due to the impact of rising prices for goods and services. Due to high growth in world GDP and with it an even larger increase in money supply, we are currently experiencing a growing fear of future inflation and as a result an increase in gold investment to counter the potential inflation effects.
US Dollar Hedge
A ballooning US trade deficit is seen by many economists around the world as a potential reason for a long term decline of the value of the US dollar. This would have a significant impact on the value of all US dollar holders. In particular, Asia’s central banks have over the past decade substantially increased their investments in US treasury stocks and bonds. Gold has traditionally had an inverse correlation with the value of the US dollar. In times of a falling value of the US dollar against other currencies gold rose in value and vice versa.
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