Gold – why it should be part of your portfolio

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Gold went through USD1,300 in September as poor US economic data led to a mini panic and people fleeing to safer havens as the fear of deflation reared its ugly head again as it looks as though the Fed will revert to that wonderful phrase of Quantitative Easing, a.k.a. printing money like it has gone out of fashion.

The yellow metal was also helped by the fact that the consumer is not a happy chappie at the moment and is the unhappiest he/she has been for over a year. This is good for gold as unhappy people look for what they deem to be a safe haven.

In its latest report, HSBC states that, “Currency intervention … by the Bank of Japan, political pressure on China from US to allow more exchange-rate flexibility, declines in consumer sentiment, and data showing significant wealth destruction make a powerful cocktail of reasons for gold to go higher. Prices may correct, we believe, if the 21 September Fed meeting does not usher in QE, but we see no reversal of the long running gold rally.”

There are other reasons to look to gold. As I inferred in the first paragraph, the West has taken on huge amounts of debt to try and keep their economies afloat. This problem has not gone away, as can be seen by what has happened in America. It has spent trillions of dollars in trying to stimulate the economy and the job market is getting no better.

We should also take into account central banks. They are not selling at the moment but buying it in ever increasing amounts. India bought 200 metric tons from the International Monetary Fund at the end of last year which is only a start apparently.

Ten years ago, China had less than 400 metric tons of gold. It now has over 1,000. This is a percentage increase of over 160% in ten years. It is head and shoulders above most countries when it comes to importing gold. Last year China was said to have gold reserves of nearly 34 million troy ounces. This may seem a lot but the Chinese are still at a very small 1.7% of the entire foreign exchange reserves. To put this into perspective, if China wants a gold reserve of say ten percent then it would have to buy well over 6,000 tons of gold or almost two and a half times the total worldwide annual productions of the precious metal. It has to import because if it just relied on its domestic mining facilities then it would take two decades to achieve.

On top of this, the Chinese government has actively encouraged people to invest in gold directly. Over the last year, the demand for gold was over 530 tons. This is not just due to demand by jewelers but, more importantly, investment. Compare this with what happened just a couple of years ago when only 17 tons were purchased.

Also, in August, China brought in major reforms for the gold market. Foreign coins can now offer their gold coins at the Shanghai Exchange and more banks are being allowed to bring in gold from overseas whilst, at the same time, more domestic gold based investment products are being brought into the marketplace. Because of all this the demands of Chinese investors will be felt all over the world.

But it is not just the Chinese and Indians who are buying gold. The global foreign exchange reserves have increased greatly over the last few years and, as of a few months ago, were at over USD8 trillion whilst the gold reserve ratio has gone down significantly over the last thirty years. As Dr. Martin Murenbeeld, chief economist for Dundee Wealth Economics has pointed out, “Investment demand in the second quarter of 2010 more than doubled compared to the same period in 2009, and accounted for more than half of total global demand. Investors bought the most gold since the first quarter of 2009, at the depths of the Great Recession.”

The gold bull market has been a slow and steady one and, therefore, there is no sign of a bubble. Apart from a couple of instances there have been no massive price spikes that are typical with ‘bubble’ scenarios. Also, there is a big factor which has not been relevant before and that is we are now seeing a lot more people in the developing markets being able to actually afford gold as a middle and affluent class is growing all the time. In the past, people in these countries have usually reverted to gold to store their wealth.

As regular readers of this column know, I am a great believer in history and economic cycles. If we go back over the last couple of hundred years then the shortest gold cycle has been ten years. This present gold bull market started in 2001.

Another reason for gold increasing in value is that the world’s mine production is around 2,500 metric tons. This is about twenty five percent more than it was twenty years ago but the net mine supply is less than it was in 1990. Poor Research and Development over the last couple of decades means that supply will continue to be hampered. This is also due to the fact there has been an increase in scrap supply and lower quality discoveries along with higher replacement costs. Over the last twelve months the demand for gold has gone up 36% but supply has increased by only seventeen percent.

The world’s economic and political situation is not helping either. Gold usually performs well in times of trouble and we certainly have this now with the euro teetering on the brink of disaster, the US dollar not far behind. Without doubt it has benefitted from the woes of other countries over the last few years but it has to be remembered that over USD10 trillion is expected to be added to the American debt burden over the next ten years and the country’s trade imbalances are massive. These problems do not do the US dollar any favours and support the safe haven status of gold over the long term.

Finally, do not forget the continued wars in Iraq and Afghanistan. On top of this you have the possibility of Iran and North Korea developing their own nuclear weapons.

Gold loves these conditions and people love gold. Make sure you do too.