"PERFECT GOLDEN STORM" » Investment climate

Investment climate

The biggest difference between investors in 2004 and investors during the 1990s is that today’s investors have been through the Internet bubble. Although some people seem born to repeat error, “Once burned, twice shy” is the more common reaction to financial disappointment. Even many investors who are once again putting money into tech stocks see the wisdom of diversifying a portion of their portfolios into tangible assets. As a result, investor demand for gold, the ultimate “hard asset,” has increased, contributing to the rise in the price of the metal. Many financial advisors who only a few years ago pooh-poohed the idea of owning gold are now recommending (sometimes only when asked) that their clients include gold in their investment portfolios. The world supply of gold in 2003 was $53 billion, an infinitesimal sum compared to the trillions of dollars invested in stocks and bonds. A tiny change in allocation toward gold would send the price of gold rocketing.

The boom in housing prices triggered by interest rate reductions has at least one parallel with the Internet bubble. Many buyers are basing their decisions largely on the belief that no matter how high the price is today, it will be higher tomorrow. We have learned from experience that such thinking is true — until suddenly it isn’t. The sharp rise in stock prices in 2003 has made many investors happy — and worried. The stock market has climbed higher and faster than the underlying economy. The average price/earnings ratio of the S&P500 was at about 29 at the end of 2003. Prior to the boom-boom 1990s, investors considered 15 a reasonable P/E ratio. Many tech stocks, among others, have P/E ratios reminiscent of the Bubble days. The average P/E ratio of the companies on the Dow Jones Technology Index was 52.12 on Feb. 18, 2004. The bull market for gold has continued despite the real estate boom and 2003’s stock market gains. A contraction in real estate, equities, or both, is likely and would make gold even more attractive to many investors.

Regardless of changes in the US real estate and stock markets, global demand for gold is likely to accelerate, particularly in Asia, where the concept of gold as a safe haven is deeply entrenched throughout the continent. Japan’s financial condition is if anything worse than that of the US. Real estate values continue to sag and the precarious solvency of Japanese banks undermines recovery from over a decade of recession. Japanese citizens nevertheless save money at a far higher rate than in the US, typically depositing their money into extremely low-interest or even zero-interest savings accounts. These accounts, though, had been guaranteed against loss by the Japanese government, like FDIC guaranteed accounts in the US. In 2002, Japan passed a law reducing the guarantees. That triggered the “Japanese Gold Rush,” the purchase in 2002 of a national record 98.1 tons of gold, which contributed to the global bull market in gold. A phase of the new law that provides full protection only for zero-interest accounts (and not even all of those) becomes effective April 2005. That prospect is expected to drive up Japanese demand for gold in 2004 beyond the 2002 record, with further record purchases in 2005 and beyond.

The entire world supply of physical gold (as opposed to futures contracts, which may be bought and sold many times) for 2003 was 4,133 tonnes. A tonne is a metric ton, equal to 2,204 lbs., or 35,264 oz. The average price per oz. during 2003 was $363.38. Multiply it all out: world gold sales for 2003 totaled (rounded off) $53 billion. As of June 2003 the accumulated savings of Japanese households was the equivalent of $11.4 trillion. A fraction of 1% of those funds used to buy gold would have an enormous upward effect on the price of gold.

Economic growth in China, a country of 1.2 billion people, is creating a middle class larger than the entire population of the United States. A new law allows Chinese citizens, for the first time since 1949, to invest in gold. With their local currency pegged to the declining US dollar, Chinese savers have a special incentive to buy gold. According to the China Daily (Sep. 25, 2003), about 20% of respondents to a national survey said they were willing to convert 10 to 30% of their savings in gold. Individual bank savings in China total over $1.3 trillion. Less than 1% of that sum would substantially increase global demand for gold.

A tiny change in allocation toward gold by individual and institutional investors in US stocks and bonds would propel the price of gold upward even more powerfully than similar reallocations in Japan or China. Investors hold approximately $11.1 trillion in US stocks and $24.4 trillion in bonds issued by entities within the US. Taken together, that’s $35.5 trillion. Half of one percent of $35.5 trillion is $177.5 billion: over three times the value of all the gold sold in 2003. (The stock estimate is from multiplying $3.7 billion by 3,000. $3.7 billion is the average market capitalization of the companies in the Russell 3000® Index, which encompasses 98% of the market capitalization of US stocks. 3,000, of course, is the number of companies in the Index. Those figures are for March 2004. The bond estimate is from adding credit-market debt of US domestic non-financial sectors, minus household debt, to credit-market debt of US financial sectors. That data, from March 2003, comes from economagic.com.)

In March 2003, in response to investor demand, the world’s first gold bullion security was registered on the Australian Stock Exchange. Investors can buy shares, each of which is backed by approximately 1/10 of an ounce of gold bullion. In December 2003 a similar security was registered on the London Stock Exchange, and a New York Stock Exchange listing is in the works. While GoldNewsToday recommends that you own physical gold rather than paper assets representing gold such as these securities or shares in mining companies, there is no question that the increasing popularity of exchange-traded securities will contribute to raising demand for physical gold. That will be one more factor propelling the metal to a higher price.
Eighty percent of the physical gold sold in the world is used to manufacture jewelry (especially in Asia gold jewelry is also thought of as an investment). Despite the 60% increase in the price of gold since April 2001, global demand for gold jewelry has remained high. A smaller amount of gold is also required in the manufacture of automobiles, PCs, and other consumer, medical, and industrial electronic equipment. Rapid increase in purchases of consumer products in China has raised global demand for virtually every industrial commodity, including gold.

Bottom line: The idea of putting a portion of their assets into gold is becoming more and more attractive to investors throughout the world. Investors who were burned by the Internet bubble see the wisdom of diversifying into tangible assets, and increasingly wealthy segments of the population in Asia grew up on the idea that gold is a safe haven in turbulent times and can now legally buy gold. Increasing investor demand, along with jewelry and industrial demand, will continue to drive up the price of gold.

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