Gold bears have been a gleeful group of late, pointing to the recent decline in gold exchange-traded fund holdings as evidence of investor disinterest in the yellow metal. Gold bears also see the market’s rather lackluster performance over the past year and a half - and the failure of prices to move higher - as further evidence the decade-long bull market has run its course.
Yes, gold has retreated some 20 percent from its September 2011 all-time high (near $1,924 an ounce) to its subsequent low (just over $1,520).
Yes, Gold ETFs have seen some substantial and high-profile withdrawals in recent weeks.
These developments in no way diminish my belief that the bull market in gold has plenty of life ahead with the yellow metal’s price doubling (or more) from recent levels in the next few years.
Historically, cyclical upswings in stocks, bonds and commodities have often been measured in decades and bull markets typically end with a rapid advance to record heights followed by a swift and resounding crash. This looks more like equity markets today while gold’s appreciation over the past decade has been a measured advance and its recent performance bears no resemblance to a bursting bubble or a mania run its course.
The bears are also pointing to the recent strength of the U.S. dollar in world currency markets and the record highs on Wall Street as confirmation that gold is past its prime.
In my view, the appearance of dollar strength does not reflect a healthy currency. The U.S. dollar is merely the least unattractive contestant in a beauty pageant of ugliness. As such, flight capital, especially from Europe, seeking a safe haven has been gravitating to dollar-denominated U.S. Treasury debt.
Nor is the record-breaking streak on Wall Street a sign of a healthy economy. Who could possibly believe that! It is a consequence of the Fed’s super-accommodative monetary policy and the need for many investors to register positive returns in a near-zero interest-rate environment.
What about the decline in global gold ETF holdings? For all the attention in the financial press, the nearly 10-percent decline in gold ETF holdings from their all-time high in December really tells us very little about market fundamentals and price prospects.
First, it is quite possible that some of these sales were from institutional investors choosing to buy and hold the real thing, directly and under their own control, rather than hold a piece of paper representing ownership but not directly accessible by ETF investors.
Second, many hedge funds and institutional investors are driven by the need to perform well in short term - and simply could not resist jumping on Wall Street’s bandwagon where profits in the next month or quarter looked more attractive to them. Once gold again shows some real life (and it will), those who jumped ship will get back onboard, expecting gold to deliver relatively attractive short-term gains.
Third, gold sold by ETFs has to go somewhere - and where it’s been going is of great importance. On the other side of the market have been central banks, buying for the very long term and unlikely to re-sell anytime soon, perhaps not for decades or longer. It’s as if the gold has been permanently removed from the marketplace and indefinitely unavailable to meet future demand - not just from ETF investors but also from investors and jewelry buyers of every stripe. This means that prices will have to rise much more than might be expected as more buyers compete for a smaller supply of available metal.
In fact, central banks are likely to continue building their gold holdings in the months and years ahead -so that available supply, what I call “free float,” will continue to shrink as gold moves from weak to strong hands.
Ironically, America’s former cold-war rivals - Russia and China - have been the biggest and most persistent central-bank buyers, followed by a diverse group of newly industrialized and emerging economy nations including Mexico, Korea, Brazil, Mexico, the Philippines, Kazakhstan, Ukraine and others.
Both Russia and China see central-bank gold accumulation as an important step toward playing more important roles in the evolving global economic and political order - while ending America’s dominance in the world monetary system.
Moreover, for those central banks under-weighted in gold and over-weighted in dollars and euros, their motivation has been to diversify their official reserve assets and reduce their exposure to the U.S. and European currencies. With America unable to address its Federal budget deficit and limit its mounting sovereign debt and with economic policy on both sides of the Atlantic in disarray, central banks around the world have a strong incentive to buy and hold gold as a currency hedge and insurance policy.
When the dollar looks less attractive as a safe haven and easy gains on equities look less certain to investors, gold will once again be the leading beneficiary of the Fed’s easy-money policies. In the meantime, support for higher gold prices will come from continued central-bank buying as well as strong private-sector demand from China, India, and retail buyers around the world.
