This ‘love trade’ could drive gold prices higher

Monday, 31 December 2018
Melbourne, Australia
By Selva Freigedo

Editor’s note: Bernd Struben, Sam Volkering and the staff at Port Phillip Publishing are taking a break for the holidays. We’ll be back at our posts on 2 January 2019. While we’re away, we hope you’ll enjoy some complimentary back-issues of Global Investor.

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The following article was originally published on 8 November 2018.

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Have you been enjoying the Diwali celebrations?

Diwali is also known as Deepavali, which in Sanskrit means ‘rows of lighted lamps’. It is a popular festival for Hindus, Sikhs and Jains around the world.

The festival honours the return of Prince Rama from exile after 14 years and his struggle to rescue his wife Sita from the hands of demon Ravana.

To celebrate Prince Rama’s crowning, the kingdom lit lights all across it. That’s why Diwali is a festival of lights.

It celebrates victory of good over evil…of light over darkness.

During Diwali there are lights, fireworks, prayers and…gold. In fact, it is very common during Diwali to give gold to loved ones.

India is one of the largest markets in the world for gold, and gold plays an important role in major festivals like Diwali, or in weddings.

As you can see below, much of the world’s demand for jewellery comes from India and China. And that demand is increasing.



chart image

Source: Exchangetradedgold.com
Click to enlarge

Gold is mostly seen as a ‘fear trade’ as a way to protect your investments. Yet as we heard from gold fund manager Frank Holmes, there isn’t much said about what he calls gold’s Love Trade.

Frank is the CEO and chief investment officer of U.S. Global Investors, which specialises in gold and precious metals.

And as Frank told The Inner Circle on 3 November, growing incomes in India and China could drive demand for gold higher.

Frank is quite excited about gold.

Why?

From 2000 to 2011, we saw a monster bull market in gold. Trough to peak, the price per ounce climbed from $264 in November 2000 to $1,900 in August 2011 — a 620% return.

But from its peak in 2011 to today, it’s been a long road down. Today, it sits at about $1,230 an ounce. That’s roughly a 35% drop.

But believe it or not, gold is actually holding up exceptionally well at these levels.

Most people forget that gold is money. Behind the U.S. dollar, the euro, and the yen, it’s the fourth most liquid form of money in the world.

Money always flows where it can get the highest rate of return. So the thing that has the greatest impact on the gold price — at least over the short term — is “real,” or inflation-adjusted, interest rates.

When the real rate of return on cash and cash alternatives such as bonds is negative, you’re losing money. This tends to be a boon for gold.

When gold hit its peak in August 2011, the yield on the benchmark 10-Year Treasury note was about 2%. But the official rate of annual inflation was almost 4%.

Who’s going to buy bonds at those levels?

Since about 2013, the yield on the 10-Year Treasury note has outpaced inflation. So money has been flowing back into bonds.

That’s what makes me say that gold has held up well. With positive real interest rates, like we have today, you’d think gold would be at $700. But it’s almost double that.

Frank is a big believer of ‘peak gold’, an idea similar to ‘peak oil’. It refers to the notion that oil production at some point would peak out and supply would dry out, making prices go higher.

But that hasn’t happened to oil. Instead, the US came about with fracking.

But things are different with gold.

[N]othing like that has happened with gold — another natural resource that has to be taken out of the ground. There’s been no game-changing technological breakthrough in how gold is mined. The process of discovering, developing, and producing gold is still very costly and time-consuming.

Also, even with the billions of dollars that have been spent on gold exploration over the past decade, there haven’t been any major discoveries of high-quality gold in a safe location.

That tells you that we risk reaching a peak scenario for gold. That’s going to create a floor under the price.

The way Frank sees it, there are two main drivers for gold demand:

The first is the one that dominates the media — the “Fear Trade”.

Will the stock market crash? Is the government deficit out of control? Is inflation rising? These are the sorts of questions that unsettle investors and send them into gold as a hedge.

We may already be seeing signs of this. The S&P 500 fell 7% in October. Gold, meanwhile, rose about 2%.

If there’s a major sell-off in stocks, I’d expect to see gold soar even higher.

As we told you last week, with risks building in the system, much of the demand is also coming from central bankers. As Frank continued:

For the first time in nearly a decade, the Reserve Bank of India added to its gold reserves. It added 8.46 metric tons of gold to its stock during the 2017-18 financial year that ended on June 30.

Russia has also been a big buyer of gold. So far this year, the Central Bank of Russia has added about 20 tons of gold a month. In July, it added nearly 29 tons — the largest monthly increase since November 2017. […]

All told, central banks are expected to buy 450 metric tons of gold this year. This will be the first year that central banks’ gold purchases have increased since 2013.



chart image

Source: US Inner Circle
Click to enlarge

The other side of demand is what Frank calls the Love Trade. That is, buying gold in the form of jewellery.

As you can see in the graph below, jewellery drives much of the global demand for gold.



chart image

Source: Exchangetradedgold.com
Click to enlarge

As Frank continued:

Together, China and India make up about 40% of the global population. And they’re big buyers of gold in the Love Trade.

There’s a whole season for buying gold in these two countries. It’s based on a series of cultural celebrations that happen in rapid succession around this time of the year. […]

That’s why gold tends to perform well toward the end of the calendar year. It’s down to the Love Trade in these two countries.

Both countries are seeing their GDP per capita — a good measure of wealth levels among individuals — climb higher. In 2008, the GDP per capita in India was about $1,150. Ten years on, it’s $1,963. That’s an annual growth rate of 5.49%.

The numbers are even better out of China. In 2008, the GDP per capita was about $3,800. In 2018, it’s $7,329. That’s an annual growth rate of 6.8%.

For comparison, the compound annual growth rate for U.S. GDP per capita over the last 10 years is 0.8%.

People in China and India are getting richer. The middle class is growing. They have more disposable income to spend on gold for the Love Trade. That bodes well for the future price of gold.

What to do

Love trade…fear trade…peak gold…central banks stocking up on gold. As we heard from Frank, any or all of these four factors could drive the price of gold higher.

That’s why it is a great time to buy gold.

The best way to get exposure to gold is to buy gold directly. But storage can be expensive.  

Another way to invest is through gold stocks. Or gold miners, as we recommended last week. Check out the latest recommendation here.

Best wishes,


Selva Freigedo Signature

Selva Freigedo,
Editor, Global Investor

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