The Truth About Gold
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Transcript of The Truth About Gold
BUSINESS INSIDER
The truth about goldImage: AP Photo/Mark Lennihan
table of contents
• a brief intro (3)• what drives gold prices (7)• but wait, that’s not all (20)
• what about real interest rates (24)• so where are prices going (29)• everyone has an opinion (37)
• the actual production of gold (45)• the Fed responds (52)
• appendix (58)
For thousands of years, gold has been used as a currency, investment, and commodity — cementing its importance as an asset
4600 B.C. Earliest evidence of gold used as jewelry
1091 B.C. China legalizes the use of gold as money
560 B.C. to 400 A.D.
Gold coins are minted by King Croesus (present day Turkey); Julius Caesar introduces a gold coin as common currency
1284 to 1300 Venice and Great Britain issue the gold ducat and florin, respectively
1511 to 1700
Spain launches its hunt for gold and finds massive reserves in Brazil in 1700. By 1720 the country is producing more than 60% of the world’s supply
1799 Gold production begins in the U.S.
1848 Gold rush gets underway in the U.S., with more than 300,000 people moving to California
1900 The U.S. passes the Gold Standard Act
1933 to 1937
The Gold Reserve Act of 1934 ends the minting of gold coins and raises the price of gold to $35 per ounce to trade in to the treasury (formerly set at $20.67)
1971 President Nixon ends the ability to trade U.S. dollars in for gold
1980 Gold sets a then-record high of $870 per ounce
2001 to 2007 China becomes the world’s largest producer of gold after deregulating its market
2004 The first gold ETF begins trading
2008 to 2010
The “Great Recession” in the U.S., and a larger global slowdown, push gold prices over $1,000 for the first time ever
Source: U.S. Global Investors
The price of gold remained unchanged following the Gold Reserve Act of 1934 (which set a fixed rate). But in the 70s the price of gold began fluctuating as markets set pricing PRICE OF GOLD (TROY OUNCE PER USD)
Chart: Eric Platt/Business Insider, Data: Bloomberg
Over the past five years, the price of gold has rallied to record highs, making it the center of the investment conversation
PRICE OF GOLD (TROY OUNCE PER USD)
Chart: Eric Platt/Business Insider, Data: Bloomberg
Then, after hitting highs in ‘11, gold retreated. Where it’s going next is anyone’s guess…
PRICE OF GOLD (TROY OUNCE PER USD)
Chart: Eric Platt/Business Insider, Data: Bloomberg
So … What Drives Gold Price Movements?
For some time, gold had been seen as an inflation hedge For most of the 70s and 80s, gold seemed to be driven by inflation Since 2000, that correlation hasn’t persisted
Chart: Eric Platt/Business Insider, Data: Bloomberg
In the last decade, booming demand from emerging markets has been a major driver
In 1999 Asia accounted for 39 percent of global gold demand
By 2010 the Asian market reached 57 percent of total market demand Those increases are being driven by India, China, and Vietnam
Map by Eric Platt/Business Insider, Data from Google Maps
Over the past decade, gold prices have followed the uptick in Asian demand
Source: GMO, GFMS Ltd., World Gold Council, Bloomberg
GMO’s Amit Bhartia and Matt Seto charted the two figures through 2010 — the results highlight Asia’s importance in gold pricing
And gold has generally been bid up in overnight trading in Asia even as it sells off in London AM trade
PRICE OF GOLD INDEXED (2007 = 100)
Prices in India — currently the world’s largest market — are driven by consumers
Gold prices appreciate in November at the time of Dhanteras, the start of a five-day gold buying period
However recently both countries have logged slower gold demand growth — concurrent with gold’s sell off
Jewelry sales remain the largest input of gold demand, although it declined marginally year-on-year
Source: World Gold Council
“Jewellery has been the prime source of demand for gold over many decades, and it remains in poll position. In 2010, it accounted for just over half of global demand and the trend has persisted this year. Consumer appetite is in evidence across the world, particularly in gold’s cultural heartlands, China and India.” – World Gold Council
Demand by central banks has also been a major driver – now topping $82 billion
Source: World Gold Council
Growth has been driven by the rapid ascent in average prices year-on-year
Investment, as a portion of overall demand, jumped 160 basis points to 40.3 percent of total demand in 2011
Geographically, the Pacific region accounts for a substantive 58.1 percent of global gold demand (jewelry and investment)
Source: Thomson Reuters GFMS, World Gold Council
Central banks hold 30.9 thousand tons of gold in reserve Top Countries Holding Gold (as of February 2012):
United States: 8,133.5 tonnes (74.5% of reserves)
German: 3,396.3 tonnes (71.4% of reserves)
Italy: 2,451.8 tonnes (71.0% of reserves)
France: 2,435.4 tonnes (71.1% of reserves)
China: 1,054.1 tonnes (1.6% of reserves)
LARGEST AUTHORITIES HOLDING GOLD IN RESERVE
Chart: Eric Platt/Business Insider, Data: World Gold Council
On the ETF investment side, more than half of all gold is held by the SPDR Gold Trust (GLD) at 41.1M troy ounces Top ETF Holders of Gold (as of April, 30, 2012):
GLD: 41,099,101 troy ounces (53.8%)
ZKB: 7,072,607 troy ounces (9.3%)
IAU: 5,792,446 troy ounces (7.6%)
Chart: Eric Platt/Business Insider, Data: World Gold Council
LARGEST GOLD ETFS BASED ON GOLD HOLDINGS
And those ETFS have been increasing their investments in tandem with gold’s appreciation
Since 2003, there are now 21 major gold ETFs and ETNs
Source: World Gold Council
Those ETFs are focused in the U.S. and Europe Largest North American ETF: GLD (NYSE) with 53.8% of total
Largest European ETF: ZKB Gold ETF (SWX) with 8.9% of total
Largest African ETF: NewGold (JSE) with 1.6% of total
Largest Asian ETF: Gold Benchmark ETS (IN) with 0.4% of total
Largest Australia/Pacific ETF: GBS (ASX) with 0.6% of total
Largest Middle Eastern ETF: GOLDIST (ISE) 0.07% of total
GEOGRAPHIC PLACEMENT OF ALL GOLD ETFS AND ETNS
Chart: Eric Platt/Business Insider, Data: World Gold Council
But that’s not all that drives gold prices …
Gold is also an expression of fear The price of gold moves in tandem with the CBOE’s VIX
index (a measure of expected volatility in the S&P 500) BI divided the spot price of gold by the spot price of
gasoline to isolate gold movements from broad commodity rallies
Chart: Eric Platt/Business Insider, Data: Bloomberg
And investors generally shift assets into gold ETFs when volatility peaks
Citi charted ETF flows to the VIX index and found some graphic corollary between the two
Investors moved to gold after a number of major events, including Lehman Brothers’ bankruptcy and the Sept. 11 attacks
And what about real interest rates?
Many economists have offered the premise that gold rallies when real interest rates fall below 2%
• The real interest rate is simply the nominal interest rate minus inflation
They point to the 80s and 90s when the real interest rate ran mostly above 3%
When inflation began to cycle higher at the start of the 80s, gold’s ascent was cut short
That said, the recent run-up (2001-2011) in gold has yet to eclipse the highs hit at the beginning of the 80s when prices are adjusted for inflation
PRICE OF GOLD (TROY OUNCE PER USD) INDEXED TO CPI
Chart: Eric Platt/Business Insider, Data: Bloomberg
Where Are Prices Going?
At the start of 2012, BI surveyed commodity experts and found an overwhelmingly high price targets — even after the precious metal had sold off
The banks weigh in:
DEUTSCHE BANK: “Consequently, our strongest conviction trade remains long precious metals and specifically gold. In an environment where real interest rates are negative and the US equity risk premium is high we expect this will sustain strong private and public sector demand for gold.”
GOLDMAN SACHS: “We expect gold prices to continue to climb given the current low level of US real interest rates. Further, with our US economics team forecasting slower US economic growth throughout 2012, we expect US real interest rates to remain lower for longer, supporting higher gold prices.”
MORGAN STANLEY: “Beyond the safe haven status associated with uncertainty surrounding the European sovereign debt crisis, we also believe that: 1) the gold to oil ratio highlights that, on a long-term real purchasing power basis, gold is close to fair long-term value; and 2) the prospect of sustained negative real interest rates reduces the opportunity cost of holding non-yielding assets.”
LOW MEDIAN HIGH
$1,850/oz. $1940 $2,200
Estimates on this page as of 1/15/12
But since then, targets have been cut nearly across the board as gold faltered. Citi now predicts 2012 prices of $1,720 per troy ounce
“Gold prices should remain supported given low real interest rates and continued financial interest from central banks and private investors. However, price action could be volatile as markets are caught between changing inflation and monetary policy expectations, political turnover and sudden demand for liquidity.”
- Citi’s Edward Morse
Photo by Christopher Furlong/Getty Images
Morgan Stanley’s Hussein Allidina remains bullish on gold despite the likely end of QE. Morgan now projects a 2012 PT of $1,825 per troy ounce.
“We do not believe the removal of trades predicated on additional liquidity and further unconventional monetary policy signal the end of the bull market in gold. This 'liquidity trade' is only part of the investment case and has also been overwhelmingly focused in the paper gold market, rather than in the physical investment market. Indeed, the recent price weakness appears to have encouraged further physical demand for gold, reflected in heightened inflows into physical ETFs.”
Image: Mario Tama/Getty Images
UBS, which used to have an above-consensus gold estimate, slashed its price target 18% at the end of the first quarter to $1679
“UBS believes that capital flows are accelerating out of emerging markets and that tighter liquidity is hurting commodity demand. Furthermore, China has not been stimulating private construction, lowering commodity intensity. Coupled with the risk of a cyclical slowdown in the US that may trigger renewed credit stress, UBS has reduced its near-term commodity outlook.”
— UBS’s Brian MacArthurImage: TwicePix/Wikimedia Commons
So how has it actually performed against other assets?
First, a look at gold prices fluctuated next to crude oil
PRICE OF GOLD (TROY OUNCE PER USD) DIVIDED BY PRICE OF CRUDE (BARREL)
Chart: Eric Platt/Business Insider, Data: Bloomberg
In nominal value, markets have kept up with increases in gold prices
PRICE OF GOLD (TROY OUNCE PER USD) DIVIDED BY S&P 500 INDEX
Chart: Eric Platt/Business Insider, Data: Bloomberg
But over the past decade, the price of gold has far outpaced U.S. house prices
After hitting highs in 2006, the S&P Case-Shiller Index has lagged gold price increases
PRICE OF GOLD (TROY OUNCE PER USD) DIVIDED BY S&P C/S Index (SEASONALLY ADJUSTED)
Chart: Eric Platt/Business Insider, Data: Bloomberg
And everyone has an opinion …
Warren Buffett“Gold, however, has two significant shortcomings,
being neither of much use nor procreative. True, gold has some industrial and decorative utility,
but the demand for these purposes is both limited and incapable of soaking up new production.
Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end.”
Image: Michael Loccisano/Getty Images
Ben Bernanke"Gold standards are far from perfect monetary
systems … have to go to South Africa and dig up tons of gold, and move it to New York and put it in the basement of the Federal Reserve bank of
New York."
Image: Mark Wilson/Getty Images
Ron Paul“What did the Romans do to their currency? The
Byzantine Empire had a gold standard for a thousand years and they did quite well and they
didn’t fight wars. But the Roman empire eventually destroyed their currency. They put in wage and price controls before they diluted the
metals. They inflated. They thought wealth could come by fooling the people.”
Image: T.J. Kirkpatrick/Getty Images
Peter Schiff“What’s so appealing about gold is that it does have intrinsic value. It’s paper money, it’s the dollar and
the euro that ultimately have no intrinsic value. They are just pieces of paper with numbers written
on them. The government can put any number they want on that paper, but gold is real. The
government can’t create gold out of thin air, it has to be mined. The big picture is all bullish for gold.”
Image: Jessica Hill/AP Images
Jim Grant“To me the gold price takes the form of a very
uncomplicated formula, and all you have to do is divide one by ‘n.’ And ‘n’, I’m glad you ask, ‘n’ is the world’s trust in the institution of paper money and in the capacity of people like Ben Bernanke to
manage it. So the smaller ‘n’, the bigger the price. One divided by a receding number is the definition
of a bull market.”Image: Bebeto Matthews/AP Images
Nouriel Roubini“But, since gold has no intrinsic value, there are
significant risks of a downward correction. Eventually, central banks will need to exit quantitative easing
and zero-interest rates, putting downward pressure on risky assets, including commodities. Or the global
recovery may turn out to be fragile and anemic, leading to a rise in bearish sentiment on commodities
– and in bullishness about the US dollar.”Image: Chiang Ying-ying/AP Images
John Maynard Keynes
“The choice of gold as a standard of value is chiefly based on tradition. In the days before the
evolution of Representative Money, it was natural, for reasons which have been many times
told, to choose one or more of the metals as the most suitable commodity for holding a store of
value or a command of purchasing power.”
Image: AP
So how do you actually mine gold?(and who does it?)
Gold mining is intense (here’s a very quick explainer)
1. Mine is excavated, elevator shaft installed, cooling systems set up,
etc.
2. Explosives are used to unearth ground in tandem with workers
checking the walls
3. Materials are sent up to ground level
where a sieve filters gold from excess earth
4. Particles are then smelted together to about 90% purity
5. The mining company then ships the rough bars to a
refiner where the bars will be melted down
6. The refiner reworks the gold into a bar over 99% purity,
stamps with a unique identifier and ships to
its final owner
Image: CNBC
The physical production of gold is not central to the U.S. or Europe — in fact, countries like China, Russia, and Australia are huge producers
And production does not simply mean mining — scrap supply/recycled gold accounts for more than a third of the world’s supply
Increased production of gold will be driven by two new large projects in Latin America
(+): Pascua Lama on the Chilean-Argentinean border and Pueblo Viejo in the Dominican Republic; as well as increases in Mexico and Brazil
(-): Declines at Yanacocha and Lagunas Norte in Peru
Map by Eric Platt/Business Insider, Data from Google Maps
These three miners are some of the largest in the industry
UBS recently cut guidance on many gold mining companies because of the weakness in commodity prices
EPS price targets are now on average 37 percent lower than earlier this year
Goldcorp Kinross Newmo
nt
And there’s not that much gold in the world…
According to Warren Buffett, if you were to pack all the gold in the world into a cube, it would measure 68 feet on any given size
That’s slightly shorter than a tennis court’s length
Image: Julian Finney/Getty Images
The Fed responds…
After repeated attacks in 2012 to end the Fed and return to a gold standard, Ben Bernanke hosted a lecture series at GWU — here’s what he said:
Image: Federal Reserve Bank
One of the big problems: the U.S. would be exposed to bad policies of other countries using the gold standard
Image: Federal Reserve Bank
Also, investors can attack the commodity, causing huge fluctuations
Image: Federal Reserve Bank
And lastly, a gold standard can cause huge medium term issues The Fed pointed to a global shortage of gold in the 19th century that hurt
farmers who faced declining crop prices, but non-fluctuating mortgage and debt payments
Image: Federal Reserve Bank
APPENDIX: Historical Gold Demand
Source: LBMA, Thomson Reuters GFMS, World Gold Council
BUSINESS INSIDER
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