Gold: Betting Against Roubini


On June 3rd, Nouriel Roubini published an article that gained a lot of attention, where he predicted gold prices to reach $1000/oz by 2015. As the observant reader will notice, he is far from the only one being bearish on gold. As a matter of fact, his views seem to be shared by a majority of opinion leaders and investment banks.

So, will Nouriel “I predicted the financial crisis” Roubini be correct about his gold price predictions? The arguments he is providing can be summarized as follows:

1. Serious geopolitical financial risk has subsided and gold as a “fear trade” has fewer triggers

2. Inflation has remained low in spite of massive monetary easing

3. Gold earns no income

4. Interest rates will rise (increasing the alternative cost of holding no-income assets)

5. Central banks of highly indebted nations (such as Italy) may need to liquidate their gold holdings

6. Gold has been over-hyped by conservative American politicians

Just like most research published by Roubini, his analysis is highly superficial, and just in line with the mainstream view (sorry Nouriel, you were not the only one, and definitely not the first one “predicting the financial crisis”).

That does not necessarily mean he will be wrong about his prediction, even though (as I will elaborate on below) his arguments are flawed. Like for any investment asset (be it gold, stocks or real estate) current price formation is determined by the public’s expectations about future prices. If the majority of market players expect the price to go to $1200/oz, then the price will go to $1200/oz, as buyers will hold off their purchases in anticipation of a price decline, and sellers will continue selling as long as the price is above what they expect it to become in the future. By singing soprano in the choir of gold bears, Roubini is influencing the price expectations of the public and contributing to a potentially self-fulfilling prophesy.

When it comes to public opinion on the markets, the American and European public tend to go in tandem, with European opinion trailing the consensus view in the United States.

What the American and European public opinion leaders seem to have ignored, is that the market for gold has undergone a massive structural shift in demand over the last 12 years, dramatically impacting how the price of gold responds to macroeconomic fundamentals. In the first quarter of 2013 the United States accounted for a measly 4% of global gold demand, and Europe for only 6%. China accounted for a whopping 33% of global gold demand, and India for 28% according to the World Gold Council, with other mostly emerging economies accounting for the rest. Furthermore, ETF demand was only 6% of total demand.

Do American commentators still think the market is like it was in the 1980s, when the United States and Europe together accounted for nearly 80% of global gold demand? Roubini certainly seems to think so; all of his arguments would hold true if that was the case.

With the supply of new gold increasing with only a few percentage points per year, the price of gold is overwhelmingly determined by Asian buyers. It is highly questionable how much they worry about United States recession risk, inflation- and interest rate expectations in the United States, and how much they care about the views of Ron Paul and other monetarist American politicians.

They are rather likely to be more preoccupied with the preservation of their domestic purchasing power, local traditions, and increases in the price of gold in their domestic currencies (which, for example in Iran, has been exponential due to hyperinflation, visualized by Turkey becoming the third largest gold buyer in the first quarter of 2013, as Iranians buy most of their gold via Turkey due to the international trade embargo).

It is the Asian buyers who predominantly have driven a five-fold increase in the gold price since 2001. And they have bought more gold simply because they have become richer. For example, average dollar wages in China have doubled in the years between 2008 and 2013. Official inflation numbers in India have averaged nearly 10% p.a. during the same period, with unofficial estimates being at least 5% points above that. As the informed reader will know, the gold price has doubled over the same period as gold imports by these countries have surged.

With the recent price decline, gold has never in modern history been cheaper for the Chinese and Indian public as measured by how much gold they are able to buy. Get it? This point is so important that I will repeat it: For nearly half the population of the world, societies with strong tradition for buying gold, which have been the key influencers in driving the gold price, gold has never been cheaper! And that thanks to sell-off by ETFs, who are guided by people who think the American public has listened too much to Ron Paul!

And, unless prices resume their ascent, gold will become cheaper still for the Indians and the Chinese. McKinsey & Co and the Boston Consulting Group have for example both published reports projecting Chinese wages to reach $20,000 by 2030.

In the near term, with central banks in the United States, Europe and Japan seemingly engaged in a competition about who has the most expansive monetary policy, spending and consumption in these economies are set to increase. This is surely to result in even more imports from Asia, further fueling wage growth in export oriented economies.

And the gold price? Once the sell-off by disillusioned monetarists in the United States and Europe has subsided (perhaps in the course of few more months, perhaps sooner), the gold price will resume its long term surge, as dictated by its true economic fundamentals. Until then, there might still be buying opportunities.


About abwehra group

The Art&Science of Trading Gold
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