KK Bullion – Gold Bullion and Investing in Gold

On Tuesday after yet another set of bad news from The U.S, gold broke through the $1300/oz barrier and stabilised at $1310/oz. Gold seems to move a lot more in Dollars than in Euros or Sterling which suggests that it might be overbought in Dollars. This might be good news for Sterling investors since if the British government decides to follow the current money printing trend, Sterling is likely to correct its value against the Dollar. So, short-term return for Sterling investors might be greater than the actual rise in the gold price, although in the current climate it is impossible to give any secure short-term predictions.

Long-term expectations for gold remain very positive after the LBMA report provided the green light to higher prices over the next 12 months. The LBMA is known to be very conservative in their comments and the $1450 price target for next September sounds very cautious. The more important message is that everyone from fund managers to governmental bodies seems to believe that gold is the best investment asset in current market conditions.

The biggest news for gold investors this week has been the “currency war” as the Finance Minister of Brazil called the situation. Columbia and Thailand joined the list of nations, which have started to manipulate their currency to keep up with the competition. At the end of the day, whatever other nations do with their currency, China has the final say in this game.

China is the second largest economy after the U.S and holds a huge amount of U.S Treasuries. China is also enjoying almost double digit growth figures and is almost keeping the whole global economy running on its own. One of the main reasons for China’s recent success is the weak Yuan and this is especially annoying the U.S. The U.S government is trying to force China to let its currency to strengthen but this is very a dangerous game to play. If China so wishes, it can trigger the hyperinflation in the U.S just by selling its Dollar reserves and this would totally sink the greenback or what is left of it. If this happens, gold investors will have a very wide smile on their faces as gold would most likely move up as the Dollar dips.

As investors are running out of reliable fiat currencies, investing in gold is starting to seem to be one, if not the only, relatively stable option to protect your wealth. Movements in the gold price are far more subtle than in other assets and the attributes of gold bullion are known in all cultures so selling your gold will not be an issue regardless your location. Gold will not lose its value like stocks if the market crashes and it is hardly consumed in any manufacturing industry. People still buy gold for the same reason as they did thousand years ago, it is the ultimate reserve currency, which will not be wiped away by any of the risks that paper currencies are facing.

Putting aside the current issues for the U.S economy and concentrating on the long-term factors affecting the gold price, we can identify several reasons to invest in gold. Gold is well-known for its capability to act as a buffer against deflation and inflation so I won’t be spending too much time on these factors. More important driver for the gold price in the long-term is the likely devaluation of the U.S Dollar.

As I mentioned in my previous article the Dollar has lost 96% of its value since the abolishment of the Gold Standard and the establishment of the FED. In healthy economic situations gold tends to move inversely to the Dollar and the Dollar has lost 30% of its value since 2001, which explains why the value of gold was going up even before the Credit Crunch. Taking a closer look at the U.S economy, we can see more problems ahead.

Before the Credit Crunch the U.S trade deficit was around $60 billion a month because importing goods, mainly from Asia, was much cheaper than buying the same products from domestic manufacturers. This dragged the Dollar down and pushed to price of gold up. Now, when people are more aware of the issues weighing on the current monetary system and the quality of Asian products is improving all the time, it is likely that consumers will keep purchasing the cheaper foreign products, even after the recession. This will increase the trade deficit even more and deepen the slide of the Dollar.

The most alarming news for the Dollar is coming from the East since China, the fastest growing economy and the biggest financier of America, is trying to internationalise and stabilise its currency. If China is successful in this, it would not have to hold a huge amount of Dollars as a reserve currency anymore. As the value of the Dollar has been decreasing for such a long time, it is unlikely that any government would be interested in buying trillions of Dollars floating into the markets from China. The only place where the Dollars could go is home and these trillions on top of what the FED has already printed would cause significant inflation pressure just when the economy is starting to stabilise in the future. This leads us back to the basic virtues of gold investments.

The main physical driver for gold is also coming from China as its citizens are getting wealthier and the government is encouraging them to invest in gold. The Chinese government agreed on plans to liberalize its gold markets a few months ago, which will help banks and private investors to buy gold from abroad. Analysts have forecasted that the China’s per capita gold demand could match the numbers from India in the near future, which would mean a 200 tonne increase in physical bullion demand.

Recent turmoil in the global economy have made investors realise the shocking state of the global monetary system and made them more cautious in their investment decisions. Even slightly disappointing news is driving them towards hard assets, such as physical gold. Some speculators are convinced that gold is the next bubble to burst but when looking at the inflation related gold price, we are not even near the 1980s figures when gold was hovering at around $2200 per ounce.

To conclude, we feel that gold has a long way to go before the past price barriers are going to be an issue for future price growth.

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%.

$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.

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.

Gold and gold bullion is forecast to rise as high $2000 or more an ounce “in the next leg up” by Frank Holmes of US Global Investors (his Gold and Precious Metal Fund is up 40.1% a year over the past three years).Mr Holmes says that there are several reasons for that not just one. He believes that all other commodities have gone through their inflation adjusted prices of 1980 except for Gold and Silver. So gold is more of a monetary asset, and its money around the world. Gold performs well in either inflation or deflation.

Thomas Winmill of the Midas Fund, one of the top performing precious metals funds believes that gold could see $1500 in the next 12 to 18 months. The fund managers have identified 5 factors which will drive gold prices higher.

1. Declining of the dollar.
2. More inflation in the future.
3. Investors will seek greater safety in gold.
4. Higher oil prices.
5. Gold should follow other commodities.

In a March 3, 2008 article entitled “Gold Beats Financial Assets as Investors Seek Haven”. Bloomberg reported that “Gold, Silver, Platinum and Palladium may be the best – performing financial assets this year as inflation and slow growth erode the value of the world’s major currencies, bonds and stocks.” “ Gold… may gain at least 24% this year as Federal Reserve Chairman Ben S Bernake prioritises cutting interest rates over controlling consumer prices.”

The long term outlook for the dollar are lower highs and lower lows. However, for gold bullion it is just the opposite, higher highs and higher lows. Gold is in a bull market because its core fundamentals are so outstanding.

The gold price is driven by supply and demand. Each year the world’s gold mines produce only 2,500 metric tonnes of gold. The best estimates indicate that the whole planet buys 4000- 5000 tonnes of gold a year. Therefore it is very clear that demand exceeds supply by 60% to 100%annually creating a structural shortage situation.

Also banks are no longer selling enough gold to make up for global demand above the amount of gold mined each year.

Billionaire financier George Soros was starting to buy gold once more. Mr Sorso has been a familiar name in gold. In April gold was at a 10 year low when he bought 10% of Newmont Mining Corporation from Sir James Goldsmith. In May gold prices shot up to $880 an ounce in two a days. Analysts have said that the huge push in gold has been triggered by talk that Mr Soros was changing his investment mix possibly shifting into gold from the weakening bond market as signs of a strengthening economy have raised concerns over renewed inflation in the US.

The key is that during times of crisis and fear gold rises and individual governments cannot stop it. During more predictable times governments are able to maintain control and keep a lid on the price of gold. This causes gold to move in a “stair step” pattern. Historically gold bullion has been immune from inflation since gold is one of the few investments that is not simultaneously an asset and at the same time someone else’s liability