The fundamentals driving the price of gold higher have not changed and will continue to push prices higher in the long- term.
Recently, while reading the "Special Report Gold" from Erste bank, I noted a saying from Charles de Gaulle. And, I found it most appropriate. Evidently he said, "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."
It occurred to me that most investors do not really know what government money is. All they know is that money is a medium of exchange, and the word fiat money has little relevance. However, when you understand that the current monetary system used by governments has no intrinsic value and is not backed by reserves, then perhaps this will prompt you to know more. Governments around the world have declared 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 risks 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. As these fiat monies depreciate, it requires an ever increasing amount of monetary units to buy one ounce of gold. In the end, gold becomes the ultimate currency. 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 underlying problems with these currencies.
Central banks and governments do not like this as they need strong currencies to reflect a picture of strength. This was the case with the US dollar for years. Holding US treasuries yielded good annual returns. And, as most of the commodities were traded in dollars, people had to buy dollars to buy these commodities. The dollar was king. But, this scenario is changing and prudent investors who understand these dynamics are protecting their wealth by diversifying into gold.
Gold has often been called the "crisis commodity" because it tends to outperform other investments during periods of world tensions. The very same factors that cause other investments to suffer cause the price of gold to rise. A bad economy can sink poorly run banks. Bad banks can sink an entire economy. And, perhaps most importantly to the rest of the world, the integration of the global economy has made it possible for banking and economic failures to destabilize the world economy.
Another major reason investors look to 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. Economist Stephen Harmston of Bannock Consulting had this to say in a 1998 report for the World Gold Council, "…although the gold price may fluctuate, over the very long run gold has consistently reverted to its historic purchasing power parity against other commodities and intermediate products. Historically, gold has proved to be an effective preserver of wealth. It has also proved to be a safe haven in times of economic and social instability. In a period of a long bull run in equities, with low inflation and relative stability in foreign exchange markets, it is tempting for investors to expect continual high rates of return on investments. It sometimes takes a period of falling stock prices and market turmoil to focus the mind on the fact that it may be important to invest part of one's portfolio in an asset that will, at least, hold its value."
Today is the scenario that the World Gold Council report was referring to in 1998.
In addition to the abovementioned factors, 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 Phillipines added gold to their reserves.
My point is, even though 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. But, as governments create (print) more money during the next few years we are going to see a further debasement of their currencies and this will push the price of gold higher. And, the eventual consequence of all this money creation is going to be inflation and probably hyperinflation. When this happens the price of gold will be propelled into another level
The price of gold seems locked in a trading range between $1185 and $1220 per ounce. It is showing signs of support at the $1200 level, although a break above $1220/$1230 an ounce is needed to set the stages for much higher gains. Prices will probably remain relatively flat over the next several weeks as the seasonally slow summer doldrums drag on.
About the author
David Levenstein is a leading expert on investing in precious metals .He brings over 30 years experience in futures, equities, forex and bullion.
For more information go to: www.lakeshoretrading.co.za
Information contained herein has been obtained from sources believed to be reliable, but there is no guarantee as to completeness or accuracy. Any opinions expressed herein are statements of our judgment as of this date and are subject to change without notice.