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Friday 27 November 2009 | Blog Feed | All feeds
By Ambrose Evans-Pritchard Economics Last updated: November 26th, 2009
43 Comments Comment on this article
Stephen Jen from the hedge fund Blue Gold Capital has a warning for those who think that gold has risen far too high, is necessarily in a speculative bubble, and must soon come clattering back down.
Mr Jen is an expert on sovereign wealth funds from his days at Morgan Stanley. The gold story — essentially — is that the rising economic powers of Asia, the Middle East, and the commodity bloc are rejecting Western fiat currencies. China, India, and Russia have all been buying gold on a large scale over recent months.
Why should that stop when the AAA club of sovereign debtors is pushing towards the danger threshold of 100pc of GDP?
These new players account for almost all the accumulation of foreign currency reserves worldwide over the last five years, so what they do matters enormously.
After crunching the numbers, Mr Jen found that the share of gold in their reserves is just 2.2pc compared to 38pc for the Old World (perhaps we should just call them the deadbeats from now on). They would have to buy $115bn of gold at current prices to raise their bullion to just 5pc of total reserves, and $700bn to reach just half western levels.
The killer-term here is at current prices since any such move in the tiny global market for gold would send prices into the stratosphere.
Mr Jen says that you know where you are in the currency markets — more or less — because there are concepts of “fair value” used by experts. Ditto for the equity markets, where you have P/E ratios (warts and all I might add, since the actual reported P/E of the S&P 500 was a record 141 in September before the agency stopped publishing the figure — a far cry from the forward earnings in vogue).
How on earth do we determine what fair value should be for gold? “We have no such concept,” he said. Actually, that is not quite true. You can use the dollar monetary base as a proxy.
Mr Jen said China alone accumulated $150bn in reserves in the third quarter, pushing the total to $2.3 trillion. These are colossal sums. China is amassing almost as much each month as the United States ($63bn) has built up in the entire history of the country. True, the US understates the value of its gold, but you get the picture. Something big is going on.
So far, China has just 1.7pc of its reserves in gold, or 34m troy ounces. I was told by a top Chinese official that they are buying on the dips so as not to crowd out the market, which means of course that gold cannot “crash” unless you think China itself is going to crash — or stop building reserves (which is possible: Albert Edwards from SocGen says China may be in current account deficit next year, leading to a yuan move — down, not up).
The gold proportions are: Hong Kong (0), Singapore (0), Korea (0.2), Brazil (0.6), India (4.8) after its shock purchase of IMF gold, and Russia (5.5). Yes, the West still has a lot in percentage terms — US (86), France (78), Italy (72), Switzerland (33), Germany (25) — but they don’t count for so much any more.
It is true that the Old World could meet demand for a while (a short while actually) by selling some of their gold. But will they do so? They did not use up their quota for the last year under the Washington accord. My own guess is that they too are wondering whether it makes any sense to keep selling metal in order to buy the fiat paper of the bankrupt peers (note that the Bank of England’s own pension fund has got rid of almost all its Gilts, buying inflation protection instead). Britain may become a net buyer of gold under the Tories, Who knows?
Bottom line: “The scope for EM central banks to buy more gold is substantial, if they choose to do so,” he wrote cautiously in a note to clients.
Will they choose to do so?
“I suspect they will,” he told me.
Personally, I have been feeling vertigo with gold near $1180. All my contrarian instincts cause me to dislike momentum stories — but there again, maybe this is not momentum. Perhaps it is a civilization shift. Can’t make up my mind.
COMMENTS
After pondering where the current financial crisis is taking us I have been wondering how all the excess dollars in the world will be stored. Two thirds of US dollars are held outside the USA. Some people are suggesting that Oil should be priced in Euros. We don’t want want Oil priced in Euros. Can you imagine the pressure to devalue the Euro then! However it does raise the question of what happens to all the dollars as they try to repatriate which they are trying to do anyway. One answer could lie in Gold with China and Iran already announcing their intentions. To protect itself this could require the US to remove it’s gold suppression scheme, controlled through the paper market, which is becoming more and more transparent. Just take a look at JP Morgans Gold derivatives position from Q2 to Q3 last year which jumped $15 billion. I wonder where the money came from Stopping manipulation would allow even more dollars to be soaked up by soaring gold prices to stop a run on the dollar and trapping the repatriation of the dollar in gold . This could be good for all Governments that hold gold as they effectively would increase spending whilst pointing out that as a percentage of their wealth they are still being prudent. Makes you wonder what has happened to the missing $2 trillion dollars that the US are refusing to disclose and where that went in the interests of National Security. Even Bloomberg under the freedom of information act has failed to find out. Have they (the US) once again readied themselves to make it illegal to privately hoard gold in the US? Lets hope Gordon Brown sells his diversifications into Dollars and Euros and buys back Gold quickly. What a clever chap he would be!. A neat trick if they can pull it off.
Ambrose,
I have been buying gold in bullion form and now ETFs for the last decade since reviewing the history of fiat currencies and their general decline by inflation over the years since 1910. Gold is a thin issue and is clearly subject to classic market forces as there are no bureaucratic ways to fix gold prices.
I also view the current gold rush as a Winnegabo Example whose stock prices surged in the early 1980s for no good reason in the face of high gasoline prices and serious corporate leadership problems. Stock prices would not correlate reasonably with earnings but were probably propelled by a genericized trademark and other trendy factors. The hype finally abated and the stock returned to reasonable levels thus obediently obeying the predictions of stock pickers. The difficulty here was that many investors missed a 100% run up in price.
Gold is mysterious and alien to many investors although gold was the first refuge for many for thousands of years when economic times were difficult. Today the luster of gold is in its ability to ostensibly protect investors from the crashing dollar in my view. There is a buy gold circus in progress with kazoos and tinsel and bright lights and the price is soaring.
I refuse to sit back and miss a Winnegabo Opportunity and hold decaying paper. Besides, I can sell at any time.
The US has $65bn of foreign exchange. It has trillions of dollars of dollars, so the comparision of its forex reserves with china’s is misleading. Indeed when you think of it China’s ‘huge reserves’ are in fact simply loans to the US.
On gold the problem surely comes in what you mention as being ‘the tiny gold market’. Of course if the price went up by 10 times it wouldn’t be so tiny, but then the Chinese might feel a little silly spending $100bn and receiving a house size piece of gold.
It’s true it is hard to come up with a fair value of gold, but the cost of mining $400/oz to $1,000/oz depending on how you look at it, and the willingness of jewellery consumers at various price points surely gives some guide.
Mattyturner speaks of a “house sized piece of gold.”
The entire known world inventory of gold would fit nicely in a cube with a 65 foot edge. Ore is down to about 5-7 grams final yield of pure gold per ton and a Troy ounce is 28 grams. That house you cite might cost 2 trillion dollars or maybe even 5 or 6 if in the suburbs.
The “value” of gold is currency relative. In the US it is now about 1200 dollars per Troy ounce, but in Zimbabwe the value depends only on how fast the government can add zeros to the left of the decimal point on their “currency.” I have faith that Obama and his leftists can orchestrate a neat lift to this commodity and boost it to $3000 or more.
The fair value [read price] of gold is given daily in the Spot Market.
Capitalism in action.
Fourth time of trying to post – thank you (not) wordpress!
So in haste – why just gold (aside from ease of storage, desirability and stability) why not other stable (not readily perishable) commodities – other metals, uranium, oil? Diversity is meant to be good for a portfolio.
Unlike individuals, a state the size of China has little trouble finding space for storage or providing security (huge army standing pretty much idle).
The could even stockpile timber – by planting millions of saplings (imported of course – got to convert dollars into goods) – using peasant labour – would also double up as a carbon capture/trade option.
They could even buy land (think they are already doing so in Ethiopia) – understand Dubai looks cheap and Zimbabwe cheaper yet (you did say it might be the ultimate contrarian option) – China could relocate millions of landless peasants to a land of sun and opportunity (and a regime that makes there’s look benign).
Quite understand not wanting to hold currency issued by a country you don’t trust (since it is I think an IOU).
Please let me know your view on this Ambrose.
Blessings for the fascinating articles.
Father Ignatius Brown
@rycK on Nov 26th, 2009 at 1:43 pm “I have been buying gold in bullion form and now ETFs for the last decade”
and
“there are no bureaucratic ways to fix gold prices.”
rycK, you surely cannot be serious with that comment? You are being ironic, aren’t you? Please tell me you are.
Those ETFs you are holding say they are redeemable in gold. However, there’s approx 100x the value in ETFs than there is in physical gold on the surface of planet earth. Therefore, 90% of ETFs cannot be redeemed, ever. This is Fractional Reserve Gold. Pray, what is that if its not price fixing?
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