More highs for gold

The US debt stand-off continues and depending on which expert you listen to, the seriousness of the issue varies.

Some claim it’s not such a big deal and that there’s a fair amount of brinkmanship going on. Their belief is that a deal will get done – sometime soon – and things will return to relative normality.

It’s undoubtedly true that a deal will eventually get done, but about the credibility of the US financial system and the nation itself? The longer this episode drags on the rest of the world cannot help but compare the events in the US with those in Europe and Japan.

The scary aspect from my perspective is that a resolution of the debt ceiling issue will not in any shape or form address the critical underlying issue of the US economy. The wild spending by government will continue, with the maintenance of ultra-low interest rates. The message to US citizens is to borrow cheaply and to spend, spend, spend.

It’s the same approach that created the mess in the first place. Dating back to President Bush Snr, the US has since systematically trashed its fiscal position, with an ever escalating level of debt. Both sides of politics have been party to the act.

The chart above tracks the performance of the A$ versus the US$ since the middle of 2006. What’s clear is that the value of the US currency has been on a steadily decline, with the exception of the GFC in mid-2008, where investors reacquainted themselves to some degree with the US dollar.

This was only temporary and the sell-off continued. 

The rise of gold since 2000 has coincided with investor acknowledgement of the scale of the debasement of the US dollar.

This is reflected in the chart below, which clearly outlines the relative performance of gold and the US$ in percentage terms. Since 2000 gold has risen by 476% whilst the US$ index has fallen by 27%.

The rise in the price of gold in 1999 coincided with the gradual decline of the US dollar.

The key point is that the economic malaise that has enveloped the US economy is not any shape or form a new phenomenon. It dates back to the 1990s, when US growth was bankrolled by easy credit and lending-fuelled housing boom.

The reality today is that the US has not taken its economic medicine. Perversely, the remedy promoted by the Fed is more of the same stuff that drove the US economy into the mire in the first place, culminating with the GFC.

Unlike politicians in Europe, the US has so far steadfastly opposed any measures that might be considered even mildly unpopular; to help cut the gap between spending and revenue.

There could not be a clearer message to investors right now than gold’s climb to further record highs of US$1,625 per ounce.

Gold’s inexorable climb is still very much underway and this is just the latest signal for investors to act. It’s not only about wealth accumulation; it’s also about wealth preservation.

Unsurprisingly, investors have cried “enough” as they stampede away from the world’s major currencies, driving gold prices to record levels, especially in US dollar terms. 

The world’s most indebted nations have debased their currencies to such a degree that permanent damage is being done to their collective international reputation.

Certainly Asian investors are well and truly cogniscant of the risks and are preparing accordingly. Gold fever has gripped Asian investors and in all likelihood will spread to central banks.

Asian giants India and China, the world’s two biggest consumers of the precious metal, expect to see demand continue to climb for the rest of the year, as growing wealth and stubbornly high inflation make bullion an attractive asset.

India and China together made up 57% of first-quarter global consumer demand for gold, according to the World Gold Council.

According to Antaike, a state-backed metals consultancy based in Beijing, China’s gold demand is expected to rise by around 20% to nearly 700 tonnes this year, from 570 tonnes in 2010. In India, the wedding season in mid-August is expected to drive up sales of gold, a fixture in dowry and gifts.

During 2010 central banks became net buyers of gold for the first time in 21 years, as developed nations of Western Europe and North America reduced selling in the wake of the global financial crisis while emerging economies tried to diversify their holdings of foreign currencies, especially the US dollar.

China has the world’s biggest foreign reserves, which stood at $3.2 trillion at the end of June. Gold holdings of 1,054.1 tonnes make up just 1.6% of its reserves, though China ranks sixth among the world’s top official holders of gold.

The People’s Bank of China plans to sell 500,000 1-ounce gold coins, or 66% more than its earlier target of 300,000. It also tripled sales targets for half-ounce, quarter-ounce, 1/10-ounce and 1/20-ounce gold coins to 600,000 each from 200,000 earlier. The increase in sales of these coins alone will represent a rise of 560,000 ounces in gold demand, or 17 tonnes.

This is why I remain convinced of the strong upside with respect to the gold price and I have confidence that the price can comfortably reach the US$2,000 per ounce mark within the next two years.