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Gold Outlook for 2011 – An investment that glitters is clearly gold

The following article was written as guidance for expats who wish to invest in the currently hot commodity market. As can be seen in its movements, commodities gain has trumped that of equities of even emerging markets, and this is a trend that is likely to continue given the current economic climate and low interest rate environment in the US. Investment is a topic that has eluded many, and with this article, I hope to give a firm footing to those wishing to enter these markets.

The sub-prime crisis of 2007-2008 were indeed were on prime importance to me, as I was sitting in the dealing desk of one of the noted brokerage firms in Indonesia. In 2008, we saw that basically nothing was safe from the grip of speculators. We witnessed the downfall of two major banks, Lehman Brother and Bear Stearns. Both banks, over 150 years old (formed before any of us was even conceived, unless we have a 150 year old reader amidst us) were reduced into rubble in weeks, nay days. We saw the freefall of even bluechip stocks. Warren Buffet also proclaimed “The Oracle” in the financial arena bought stocks like a kid in a candy store. US interest rates, unable to sustain at their levels were drastically reduced from their highs of 5.25% to an all-time low of 0-0.25%. That’s right, a financial institution could borrow from the central bank, the granddaddy of banks at the rate of 0%. The financial carnage continued in until March 2009 when stocks and stock indices had hit rock bottom.

When the dust had cleared, we saw the entire financial system was in shambles. Credit had completely dried out and equity indexes had been cut in half.

Fast forward now to 2011, many of the stocks and regional indices with solid fundamental s have not only regained but in fact overshot their pre-2008 levels and set all-time highs. With the commodity rush, we have seen gold hit all-time highs in 2010, and break those highs forming new highs in 2011. Silver was no exception also hitting brand new 30 year highs.

When it comes to commodities, we see that the commodity rush will continue for both oil and gold. However for the sake of this article, let us first look at gold. Gold is one of the precious metals that has been used for perhaps dozens of years. Gold is accumulated not consumed and acts as the ultimate store of value. It is portable (unless one has a full truckload of gold bars, in which case a wheelbarrow is in order). It is also universally accepted as a medium of exchange and has been around for 5000 years.  Gold is typically used as an inflation hedge as it retains its value unlike other paper currencies that devalue over time. A simple example is shown below:

As can be seen, every currency compared to gold has experienced significant devaluation over the last 10 years. As opposed to popular belief, gold has held its value not only against the USD but also against the Indonesian rupiah (a fairly obvious one), the Japanese yen, the Australian dollar as well as the Euro. The implications are simple:  Had one invested $100,000 into gold in the year 2001, this $100,000 would have multiplied into $400,000.

Figure 1: Relative buying power to gold

Considering the recent years, golds importance as an investment vehicle cannot be understated. The shiny yellow metal has appreciated over 25% in 2009 and over 32% in 2010. Gold appreciation just recently hit an all-time high of $1,444.30 just a few weeks prior to the writing of this article, on the 7th of March to be exact. The gold rally is expected throughout 2011 to continue for a number of important reasons:

1. Continuous weakness of USD:  Gold, though a precious metal is traded on the major exchanges versus US dollar. This is unlike stocks where the appreciation of a particular stock is not tied to any other asset class. Since gold is paired with USD, forces pulling down the value of USD are in tandem strengthening gold. With US interest rates at all-time lows, and no signs of any rate hikes before 2012 (yes, you read right), global investors are shedding their USD in favor of other higher yielding investments such as foreign stocks, emerging high yield debt, high yielding emerging currencies (Our Indonesian Rupiah benchmark rate is 6.5%) and of course both soft and hard commodities  including gold. The recent Quantitative Easing action by the US central banks increases the M2 money supply flooding the financial systems with US dollars, pushing the USD further lower.
   
   
2. Safe-haven investment: Gold has always served as a crisis hedge. Back in 1980, gold prices rose up to $800 (Over $2000 in today’s dollars). The reason for that was the international crisis arising from the Soviet invasion of Afghanistan and Islamic Revolution in Iran. The world was in turmoil, and due to inflation that was out of control and due to fear, paper money which is intrinsically only as valuable as a scrap of paper was dumped in favor of gold. History repeated itself during the depths of the Eurozone sovereign debt crisis. Chinese stocks plunged 25% in barely 3 months, due to China being Europe’s major trading partner. The Dow Jones which had formed a high of 11,100 came off its highs correcting 15% - a deep though still a healthy correction. During this time, all other commodities took a plunge as well, the exception being gold which actually formed an all-time high. With the recent events in Egypt, Bahrain, Tunisia and most recently Libya, gold prices are sure to form a new high between $1,500-1,550, and is set to hit $2,000 next year.
   
   
3. Central bank buying: Central banks have for the first time in decades become net buyers of gold. Central banks typically do both buying and selling of physical gold typically but at this point of time, even large banks that house a nation’s wealth are choosing gold are a preferred vehicle of storage versus a host of other currencies.  Among the countries that have been buying gold reserves are India, China, Russia and Bangladesh. India was one of the first among these countries that surprised traders and investors alike when it announced it was buying 200 tons of gold from IMF. China currently has the world’s largest reserves compared to all other nations including the US. The reserves currently amount of $2.6 trillion. However, China, though ranks the sixth in gold reserves, has much more potential as only 1.6% of its entire reserves are in gold. See figure below:
   
   
   Figure 2: Countries with largest gold reserves
   
   
   
4. Inflation hedge: Gold has always held its value against inflation. With inflation looking to be a problem all around the world, from Indonesia, China to even Europe, global investors are going to choose gold rather than paper money to safeguard their wealth. The reason why inflation does not plague gold value is because paper currency can be printed again (as is being done in many crisis-stricken counties), but gold cannot be mined. Gold is hence a finite hard asset that continues to do well in times of high inflation.

With gold currently (April 2011) trading at 1,417, there is still much upside appreciation as much as a rally has taken place, there is still much more to come. So why wait, enter the gold rush. Major banks and international brokerage firms have placed the price objective of gold at $1,550, and some more daring ones have even stated $2,000 as a target (though probably not this year). Even Soros and Paulson – the newest kid on the investment block are heavily invested in silver. Soros sees a gold bubble developing only at 2,000 and Paulson has over 30% of his hedge fund invested in gold.

To learn more contact amrit@mifx.com

The writer used to head the research and education of PT. Monex Investindo Futures, a licensed futures and commodity broker in Indonesia. He has conducted countless seminars on commodities and equities to institutional and retail clients as well as in schools and universities around Indonesia. He has been a speaker on radio PasFM as well as a source contributor for various newspapers and magazines including.

© Amrit Melwani, April 2011

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