Thursday, February 7, 2008

An English Gent Opining About Gold

Lord Rees-Mogg on Gold
In January 2007, the gold price was around $600 per ounce; at the end of January 2008, the gold price touched a new peak of $929 per ounce. That is a rise of 50% in 12 months. The rapidity of the rise invites the question of whether it can be sustained.
I have expected for some years that the gold price would, in fact, rise to $1,000 per ounce, and I still regard that as a reasonable forecast. But even $1,000 per ounce no longer looks all that impressive. It is the equivalent of about $400 in real terms, if one takes 1980 as the base year. To reach a new high in real terms, gold would have to rise to about $2,500 per ounce, and that is still a long way off.
The latest price increase has been caused by anxieties about the power supply crisis in South Africa. The normal rule of investment would be that interruptions of the power supply are likely to be temporary. In terms of labor militancy, a power shutdown is like a strike, and the rule is “buy on a strike, sell on a settlement.” However, the electricity supply situation in South Africa is particularly worrying for the long term, not just the short term.
In the past, the South Africans have supplied electricity to Zimbabwe, which has had to be cut off, worsening the economic crisis of the Mugabe regime. The cause of the shortage is the failure of South Africa to build the new power stations required by the South African economy. It takes a decade or so to develop a major electrical supply program. There has also been inadequate maintenance. Local observers think that there will be a considerable delay before an adequate supply is available in the gold mines. There will not be a quick fix.
However, the price of gold is influenced by many factors, of which physical supply is only one. Gold is a unique commodity in that well over 90% of all the gold ever mined is thought still to be in existence. Obviously, this is true of bullion, but it is also true of jewelry. Some industrial processes effectively destroy the gold they use, but even then, the metal is so valuable that it pays to recover and reuse it when possible.
Production and consumption determine most prices, but they do not determine the price of gold. The best way to understand the gold market is to regard gold as a kind of shadow currency, competing with paper currencies and influenced by expectations of inflation and global movements of interest rates.
However, this is pretty complex. For instance, recession fears, such as exist at the present time, normally lead to expectations of lower interest rates, which will reduce the carrying cost of gold and tend to raise the gold price. Yet the fear of a recession is essentially a fear of deflation, and gold is regarded as a hedge against inflation. Historically, the demand for gold is not determined by any single factor, except possibly fear. Gold can be seen as a defense against a number of different threats.
At present, the weakness of other currencies, particularly of currencies normally used as reserves, is probably the strongest reason for gold’s long-term rise in dollar terms. In short, the world has too many dollars. That situation seems unlikely to change in the near future. If confidence in the dollar is genuinely restored, that will be the day to sell gold. It is a day that still looks a long way off.

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