KK Bullion – Gold Bullion and Investing in Gold

President Nixon abolished the gold standard in 1971 and in 1973 the IMF officially abolished gold as part of the monetary system. Still almost 40 years later gold seems to follow the U.S dollar more than anything else. Traditionally gold seems to move up as the Dollar goes down but recently this pattern has been broken since gold has been going up along with the Dollar. What this actually means is a difficult question to answer but most market analysts believe that gold is acting more and more like a currency. As almost all of the main fiat currencies (Dollar, Euro and Yen) are losing their value, investors need to diversify their portfolio to protect their wealth.

Behind the scenes there is even more confusion about the state of the Dollar and what will happen in the future. Since 2001 the Dollar has lost 30% of its value and since the creation of the FED it has lost 96% of its value. Being the most common reserve currency in the world the value of the Dollar should be relatively stable or at least that is what the investors are hoping.

The largest financiers of America, such as China, have started to move their reserves away from the Dollar and this is creating problems for the FED since no one wants to buy government treasuries. The FED is now forced to buy the treasuries itself and this leaves money bouncing between banks and the government. The banks benefit from this since they get easy money from FED to fill the holes in their balance sheets created by the Credit Crunch. Buying government bonds with the money is way more profitable than lending the money to general public since bonds create around 3% return compared to 1% coming back from loans. This creates a lack of physical money in the economy and slows down the recovery since people can’t get loans from the banks.

The national debt of US stands at $14 trillion and will soon reach 100% of its GDP. With high unemployment rates and slowing economic growth the government is struggling to fund this debt. As a result the FED will keep printing more Dollars, which will decrease the value of the Dollar even more and drive investors to buy more steady assets, such as gold bullion.

On top of the problems with the Dollar, there is an issue with US gold reserves. According to the government, the USA holds about 8.000 tonnes of gold in Fort Knox but there hasn’t been an independent audit of the gold since 1953. It is known that after the 1953, millions of ounces of gold have been sold outside the US but no official figure has been released regarding the current gold deposit. There is a good reason for that since if the US gold reserves are considerably smaller than expected, one can only imagine how deep the Dollar would dive.

The next few months will show what direction the US economy will take since after Labour Day on 6th September the holiday season ends and all the big players come back from their summer break.

We believe that gold investments will keep producing good and secure returns for investors as the growing retail and investment demand from east and west is likely to keep pushing the price towards new records later this year.

Gold has been taking steps towards the June levels in last few days as more worrying news from the U.S has been released. The existing home sales figure dropped 27.2% in July, the biggest one month drop ever, and new home sales followed the day after by dropping down 12.4% to 276,000 units annual rate, the lowest since the series started in 1963.

All the signs from the western economies are suggesting that the recovery is slowing down and might even slide back into a recession. Ireland joined the not so admirable club with Spain, France, Italy and Greece, who have been downgraded by Standard & Poor’s. The U.S is releasing negative figures almost on daily basis and government bonds are more expensive than ever because investors are looking for a safe asset to tie up their money to avoid any further loses.

All this sounds very negative for stock markets and I’m not trying to say that it isn’t but not all assets are losing their value. Precious metals, especially gold, have been performing well in recent weeks as stocks and fiat currencies have been suffering. The total demand for gold in the second quarter was 1050 tonnes, which is 27% more than a year ago.

September is the month when investors are coming back from their summer holidays and everything is getting busier after the summer break. This normally pushes the gold price up since investors are revaluating their portfolios after realising that everything isn’t as it used to be before the holiday.

Looking at purely technical analysis, we can notice that on average the value of gold goes up 2.51% in September and from the last 21 Septembers 17 has been positive for gold. This is driven by rising physical demand from India as the county is entering the autumn gift-giving season. Also the Muslim holy month of Ramadan is pushing up demand in August and September. Although, at the moment the price increase is driven by investment demand not the retail sector since the ever growing price is cutting the retail dealers profits and they are waiting for a price drop before stocking up.

The most important factor affecting the gold market in the long-run will be the way central banks and governments are going solve the over expanded credit cycle issue. Whether governments stop the printing press and let unhealthy institutions die away or print so much money that the debt will be just wiped out – followed by hyperinflation – the average citizen will have to think very carefully where to put their savings.

Gold would be a potential solution since it will not lose its buying power during deflation or inflation. The value of gold might be high or low compared to other assets but the buying power is likely to remain rather unchanged. For example during the period of the gold standard in 1940s, you could change an ounce of gold to $35 and with that $35 you could buy a very nice suit. Today when the price of gold is around $1200 per ounce you can still buy a very nice suit with the same amount of gold, although numerically the price has gone up by 3430%.

Fed, the central bank of America, decided to keep the interest rates low and continue the Quantitative Easing in its meeting on Wednesday afternoon. This was pretty much what the markets were anticipating but still the price of gold dipped before the meeting since some bargain hunters speculated that another outcome would be possible.

The price climbed back up relatively fast after the announcement so the effect on the markets was fairly minimal. The more important outcome of the meeting is that the U.S government doesn’t believe that the country can climb out of the recession on its own. This should be positive for gold in the long-term since when the Fed keeps printing more Dollars the price of gold is likely to keep going up.

Falling bond yields are supporting the conclusion we can make from the Fed’s announcement since, according to conventional monetary theory, a decline in the bond yields suggest that the economy is slowing down and in extreme conditions it might even face a deflation. This is why Fed decided to continue the Quantitative Easing program since pumping more money into the system should prevent the risk of the deflation.

The drought in the Middle-Asia should also support gold prices since it has destroyed a significant amount of the crop in Russia and Kazakhstan. Because gold sits in the same basket with the other commodities, such as grain, oil, base metals etc, it is sensitive to any changes in commodity prices.

Russian’s Prime Minister Vladimir Putin announced that Russia will restrict its grain exports from 15th August onwards. Last time when the crops were damaged by drought and the restriction were introduced in 2007-2008, the gold price went up $350/oz from $650/oz up to $1000/oz. Though, this time the damage shouldn’t affect prices so dramatically since we have had a surplus harvest in the two previous years, it is none the less supportive of gold.

The debate about what is the most likely outcome of the U.S economic crisis, deflation or inflation, has been going on few months now and seems that both options have a strong support group. Whichever the outcome is going to be, gold should offer a relatively safe protection from both. The latest bull run for gold started in 2001 and between 2001 and 2008 it protected investors from inflation when the economy was growing and credit cycle was expanding. After 2008 it has been a safe haven and insurance for investors in falling markets.

Gold seems to have developed a new feature in the current economic situation since it has been used as liquid money between banks in the past few months. Gold hasn’t been used in this kind of matter in decades, mainly because the U.S Dollar has been the main medium of exchange. The depreciation of the Dollar has been so severe in recent years that banks have been forced to seek another option to secure their liquidity.

The U.S economy is facing many challenges at the moment but we think that the most significant news came from China last week when it announced plans to liberalize its gold markets. This could increase demand for gold considerably in the coming months and years.

Earlier this week the Chinese central bank announced that it will start gradually liberalizing domestic gold markets allowing its banks and producers to seek buying opportunities overseas. Being the largest producer and the second largest consumer of gold, this could be very positive news for the yellow metal. China is the largest growing economy in the world and with the population of 1,4 billion, the size of the new market is mind blowing. The average Chinese citizen saves up to 40% of his income and the government is encouraging them to hold physical gold.

You might wonder why would the largest gold producer open its markets when the price of gold is hitting record high. The reason is fairly simple. The Chinese economy is growing so fast that the domestic suppliers of gold aren’t capable of meeting the growing demand.

Another reason is the weakening Dollar. China is largest financier of America and holds a huge amount of Dollars. China needs to either spend or diversify its foreign exchange reserves to avoid the risk that current actions of U.S government are causing. Even if China doesn’t decide to buy gold from abroad, any movement away from Dollar would be positive for gold.

Before making any hasty conclusions we must keep in mind that it is not in China’s best interest to start buying large amounts of gold from overseas since this would cause the price of gold shoot up. As a result the value of the Dollar would drop even more and as mentioned earlier, this wouldn’t serve China’s best interest – at least not yet. Chinese companies have been active in the western investment markets in the past few months. This could be seen as an attempt to reduce the massive Dollar surplus since all Chinese companies are owned by the government.

In general the gold market seems to be shifting from west to east as the big Asian economies are getting wealthier. China and India have been big markets for gold for a long time but recently countries like Indonesia and Turkey have started to stock up their gold reserves. Gold is also seen more as liquid money in Asia than in western countries, which makes it a more common investment in these growing economies. When adding up the population of China, India and Indonesia, we have almost half of the world’s population getting richer and demanding gold.

The only factor that could hold back the rising demand, at least temporally, is the Chinese government’s plan to implement bank stress tests. These tests would measure what impact a 60% dip in property prices would have in banks liquidity. If the banks fail these tests the impact on markets would be more psychological because 60% drop in housing prices is highly unlikely. Failure could lead to more regulations and delay the markets liberalizations plans. On the other hand if the banks pass the tests, it could kick off another huge gold rally. We are anxious to hear more news from the east in the coming weeks.

$1 quadrillion, this is the value of the U.S derivatives. $1 quadrillion tied up in totally unregulated markets and the only information we can get about this pile of “money” is what bankers are willing to tell us. The value of derivatives market is more than 20 times the global economy as Jeff Nielsen mentions in his speech. This is the main reason why the U.S economy is struggling to get back on its feed and gain the investors trust again.

In 2008 when the state of the global economy was uncovered, Walls Street banks had to get the U.S accounting regulations changed in order to access these assets without letting the markets know the actual value of these papers. Without these changes the banks would have been reporting their own bankruptcies not record breaking profits, says Nielsen.

According to Nielsen there is no solution to the U.S economic problems and deflation or hyperinflation, is almost inevitable. This causes investors to face a dilemma since both of the outcomes are possible and preparation for both at the same time is difficult.

This kind of defensive investing tactic is known as wealth preservation. The most common wealth preservation asset is physical gold since it is seen as the ultimate save heaven. The value of gold cannot be weakened by inflation or rising debt. The value of “paper assets” can be easily influenced by governments, which makes them risky in economic stress situations when governments are trying to save the economy. This is not the case with gold since there is a clear limit of gold production and the amount of physical gold in the fiscal circulation can be easily defined.

In both situations, inflation or deflation, the final outcome is likely to be a collapse in the value of paper currencies and the only successful way out of this is to hold “good money” as Nielsen calls it. By “Good money” he means precious metals, which are known as the best assets to keep their value in economic turmoil.

Looking at market data over the last ten years we can observe that gold has been the best performing asset, outperforming the second best, government bonds, by 240%. Gold has been producing 14.3% annual profit compared to 5.9% return from bonds. Gold is the least volatile asset class and this explains why its value has been going up even before the recession. As the amount of debt in the markets is increasing all the time, investors must add more gold in their portfolios since gold, along with other precious metals, acts as a buffer in high economic stress situations.

When considering to the recent drop in the gold price, it is important to keep in mind the difference between trading and investing. Trading is short-term strategy where you purchase as asset with intension to sell it relatively quickly. The time scale could be anything from 30 seconds up to 3 months depending on your strategy. Investing is a long-term plan where you commit to hold your assets for years. As an investor, gold price fluctuations should be seen as a normal market function since there is so much uncertainty in the markets. Almost all senior investors have predicted that the price of gold will be somewhere between $2000 and $5000 per ounce in coming years, which should arouse the long term investors’ curiosity.

Gold Bullion prices fell sharply earlier this week when gold got caught up in short selling before the August options expiry date. The northern summer holidays and recent bank stress test results from Europe have had a negative effect on the gold price but in the long run the markets seem to be bullish for gold for various reasons;

The European bank stress test results slightly relaxed the markets because the sovereign debt risk has moved on the background – or at least that’s what the governments are saying. The ground for every investment is belief, and politicians along with government economists are more than happy to reinforce the fading image of the sovereign debt. Even if the reality is totally different, the governments are prepared to do everything in order to keep up the faith in the financial system. If they fail the result is likely to be a financial disaster, which happened for example in Germany in 1920s in a form of a hyperinflation.

The bad news for the governments is that the truth tends to pop out in the end and as they see the increase in money supply as the solutions to the problem, we might face the hyperinflation again in the future.

The biggest questions mark for gold markets is the U.S and more precisely the FED. The U.S has piled up a huge amount of debt in recent years and cannot afford another recession so they have to turn to the FED to seek a resolution to the problem. Because the price of gold is cited in Dollars and the FED is printing more and more Dollars to save the economy, it is also making gold more attractive in the long run.

The two giant economies from Asia, China and India, are on the way to becoming major players in the gold markets. Especially China has raised its influence in recent years for two reasons; it is the largest financier of America and it sits on an enormous pile of Dollars. Making the Dollar worth less is not in any interest of China. The other reason is the fast economic growth and the market deregulation in China, which will keep pushing the value of the Renminbi up against the Dollar, and the demand for gold is likely to follow.

When talking about the amount money in the market circulation, the numbers are as follows: there are $40 to $50 trillion in bonds and about $30 trillion in equity markets. We are on a historic lows comparing to the 1970s and 1980s when considering the amount of gold in these numbers, it is only 1-2%. It is recommended that investors hold 10-20% of their portfolio in gold so there is still lots of room for gold in the markets spectrum.

To sum up all this, we could say that the recent drops in the gold price could be seen more as a buying opportunity rather than a change in the bullish markets views and getting rid of physical gold might turn up to be a very hasty decision.

Investors should keep in mind that bull market never moves straight up. If it does, it’s called a bubble, and bubbles eventually tend to burst. Instead, gold markets have been moving exactly as predicted, with big sudden movements up and down on the way to much higher prices in the future.

This has happened many times in the past and the summer potholes in the gold price have happened nearly every year. 2009 was an exception because investors sought a save asset to invest their money in the falling markets, which pushed the price of gold up against the expectations. Even this summer the gold has been doing surprisingly well, it hit the record high at the end of June, against the normal market pattern.

So what is likely to happen in the next 6 months?

The price of gold has been coming down from the record high in the last few weeks and the most common explanation for this is the re-evaluation of U.S economy prospects by some gold traders and investors. The other reason is the abatement in perceived European sovereign risk.

Although, this is just the other side of the coin since the economic news in recent weeks has strengthened the rising expectations of U.S economy downturn, also known as “double dip”, along with it the fears of U.S consumer price deflation. The markets are going through a rough path and obviously investors have mixed views of this since some gold selling have been necessary to cover other financial obligations. After all, it’s the investment demand, which is driving the gold price.

Meanwhile in Europe the relative successful refunding of Greek government dept has relieved some of the fears in the markets and strengthened the Euro. Although this is still just a very minor step towards the solutions of the sovereign debt crisis and the Euro will need many more pushes until it will regain its value against the Dollar.

The recent price falls in gold price and any further short-term declines in the coming days or weeks should make the gold even more attractive for the long-term investors.

Inflation has been relatively well under control and the markets are more afraid of the deflation at the moment. This is in the interest of the U.S government since FED is trying to save the economy by pumping more money into it. In the future this will most likely lead into inflation. When the supply of U.S dollars continues to grow more rapidly than the demand for them, each dollar becomes worth less and in the end even worthless, which will push up the general price level.

Not just the demand for Dollars is growing less rapidly than the printing pace in U.S but also amongst the chief financiers of America, particularly in the People’s Bank of China, which will force FED into an even more expansionary and inflationary mode.

Some investors are trying to deny the inflation scenario by saying that there is so much slack in the economy because of the unemployment and idle capacity that there’s plenty of room for rising economic activity and money supply growth without inflation. This explanation does not stack up against thousands of years of recorded economic history. Most of the times high inflation doesn’t occur when economy is growing strongly but when it is sluggish and sinking…and when people are losing their trust in the monetary system.

Rosland Capital’s gold analyst Jeff Nichols comments: “Today, we are witnessing a loss of confidence in the dollar both at home and even more so abroad, that is capable of driving inflation higher even in the absence of high rates of capacity utilization and low rates of unemployment. This loss of confidence has already contributed to the rise in gold prices over the past few years … and will continue to drive gold still much higher in the years to come.”

We can only hope that the loss of confidence doesn’t turn into a rout since the effects on the gold price would be gigantic. Even a controlled inflation tends to push the gold price up not even mentioning hyperinflation.

“Betting against gold is the same as betting on governments. He, who bets on governments and government money, bets against 6000 years of recorded human history.” As Charles de Gaulle, the former president of France said.

It seems that not many investors know what government money or fiat currencies are, they only see money as the medium of exchange. The current monetary system used by governments has no intrinsic value and is not backed by reserves, which should arouse your curiosity.

Governments around the world have confirmed their currencies as legal tender and the value of this is simply established through a network of currency traders around the world. As fiat money is not linked to physical reserves, it has a risk of becoming worthless due to hyperinflation. This occurs when governments rescue themselves with the printing press, making their currency worth less and gold worth more. Gold has always risen the most when confidence in government is at its lowest. In the end when people lose faith in a nation’s paper currency, the money will no longer hold any value.

Historically, all systems of fiat currencies have ended in total failure, and this is one of the main reasons why we have seen the price of gold move upwards over the last nine years. Gold has always protected people’s wealth when their country’s monetary system has failed. When the price of gold increases, it acts like a barometer, measuring the relative value of global currencies.

If the price of gold rises in dollars or Euros, you can pretty much bet on there being some problems with these currencies. We have seen this happening in the last few days after U.S released more disappointing news about the possibility of its economy sliding back into the recession. Although, the traditional lack of demand in the summer is preventing the value of gold hitting the $1200oz benchmark.

Another major reason for investors to look at gold as an asset class is because it will always maintain an intrinsic value. Gold will not get lost in an accounting scandal or a market collapse. On top of that gold is practically indestructible. It cannot be wiped out by a fire or even a war.

We have also seen a change of attitude of many central banks around the world, and for the first time in twenty years they have become net buyers of gold instead of net sellers. During the month of June the central banks of Russia, Venezuela and the Philippines bought more gold to their reserves.

We may see frequent drops in the price of gold we have to bear in mind that this is normal market function. As the price of gold is influenced by so many different factors, it will always fluctuate. As governments are likely to print more money during the next few years to prevent the double dip recession, we are going to see a further debasement of their currencies and this will push the price of gold higher. Eventually all this money creation is going to lead to an inflation or even hyperinflation. When this happens the price of gold is likely to go through the roof.

Bank of International Settlements says on its 2010 annual report that it holds 346 tonnes of gold from gold swaps with other counterparts. The figure was nil in 2009 and apparently it has gone up to 382 tonnes since the repost was released. So what does this mean?

Swaps are financial instruments that allow the exchange of one asset to another. In this case it has been physical gold for a currency. Gold swaps are usually undertaken by central banks, one central bank agrees to swap gold for foreign exchange deposits with an agreement that the gold will be sold back to them in the future at an agreed date and price. Gold swaps usually happen when the cash-taking bank wants foreign exchange but doesn’t want to sell its own gold holdings.

The Wall Street Journal notifies that the swap has been made between B.I.S and commercial banks. We know that none of the commercial banks have 382 tonnes of gold on their books. From this we can conclude that it is likely that commercial banks have made a deal with one or more of the central banks and they are acting on their behalf since they want to stay anonymous.

Swaps like these are renewable after the agreed time expires, therefore it’s impossible to estimate how long the swap will last. The central bank, which requested the swap, must be certain that it can reclaim the gold back at some point in the future. If it can’t, only then B.I.S can sell the gold. Any sell of this scale would be loudly proclaimed in the markets and reported in the press.

In the current economic situation where the sovereign dept risk is on everyone’s lips, gold swaps allow a central bank’s reserves to be lent in a credit-secure fashion. In other words, the lender can benefit from greatly reduced credit risk since the gold can be held in an allocated account, usually at the Bank of England.

Any of the countries, which are struggling to keep their credit rankings, could follow this route. Practically this would concern Ireland, Portugal, Spain, Italy, the U.K. and the U.S.A. Sales are not permitted under Euro system for fiscal reasons but we are talking about swaps now. If the swap was made by one of these countries, it would be major news for the monetary system because the collaterals that the country offered weren’t just good enough so they had to use their gold.

The most significant factor in this or these swaps is that gold is used in international settlements after being sidelined for many decades in the monetary system. This confirms that gold is back in business. If the lender fails in reclaiming the gold back, B.I.S has to decide between selling the gold forwards or keeping it on its holdings. Keeping the gold on its books would back up the assumption that the gold is again active in the monetary system.

What appears to have happened is that one or more nations have some shortfall in its accounts and they needed foreign exchange to counter it. If the nation/nations fail to return the funds to B.I.S then it would have to decide whether to place the gold with another central bank or alternatively keep it on its books. This would put the transaction into a whole new category since it would mean that one or more of the developed world’s central bank’s credit is not good enough for other governmental institutions. If someone finds out which country this is, it would put the global financial market into a quite spin. No wonder B.I.S is trying to keep a low profile.

The price of gold dropped to a six-week low yesterday after the Bank for International Settlements received 346 tonnes of gold in swaps with other counterparties by the end of March and it would appear that the figure had reached 382t by the end of April. According to BIS annual report, it took 346 tonnes of gold in the last financial year. This surprised the markets and left investors bemused about the motives behind the swap.

As the news reached the markets, the price of gold dropped to its lowest since May to $1,185,05 a troy ounce as some investors were afraid that the gold mentioned in the BIS report could depress the markets. In its annual report, which was released last week, BIS mentioned that it exchanged foreign currencies for gold, but it also noted that BIS has an obligation to return the gold at the end of the contract.

The dropping price of gold generated a buying phenomenon among the Asia consumers as it was seen as the long waited purchasing opportunity. This made the gold price to bounce back up in the afternoon.
Traditionally the backbone of gold demand, the jewellery buyers in Asian countries, such as India, have been quiet in recent months as the price of gold has hit a record high. However, the Asian markets picked up well yesterday as the prices fell.

Edel Trully, precious metals strategist at UBS in London said: “From the lows we have seen today, gold has recovered impressively. Physical buying has been quite visible, particularly from Asia”.

Buying from investors has also been relatively quiet recently, contributing that gold has lost its momentum.

Nonetheless, GFMS, the precious metals consultancy, repeated its forecast for gold to reach the $1,300 an ounce point by the end of the year, adding that the physical demand should prevent the price falling below $1,150.