Aug 22 2011 1:56PM
The Neverending Story of a "Gold Bubble"
Gold continued to make headlines last week, reaching
nearly $1,900 an ounce on Friday before resting around the $1,850 level.
Gold’s 15 percent rise to new nominal highs over the past month has
rekindled “gold bubble” talk from many pundits. Long-term gold
bulls have been forced to listen to these naysayers since gold reached
$500 an ounce. If you would have joined their groupthink then, you
would’ve missed gold’s roughly 270 percent rise since.
That said, gold is due for a correction. It
would be a non-event to see a 10 percent drop in gold. This would
actually be a healthy development for markets by shaking out the
short-term speculators while the long-term story remains on solid
Forty years ago this week, President Richard
Nixon “closed the gold window,” ending the gold-backed global
monetary system established at the Bretton Woods Conference in 1944 and
kicking off a decade of stagflation for the U.S. economy.
At the time, $1 would buy 1/35th an ounce of
gold. Today, $1 will net you about 1/1,178th an ounce of gold. Put
differently, “One U.S. dollar now buys only 2 cents worth of the
gold it could buy in 1971,” says Gold Stock Analyst. This means
that consumers have lost roughly 98 percent of their purchasing power
compared to gold over the past 40 years.
The U.S. dollar isn’t the only asset
gold has outperformed during recent decades. The yellow metal has also
seen periods of relative strength against the S&P 500. This chart from
Gold Stock Analyst pits the performance of gold bullion against the
S&P 500 since 1971—you can see that gold immediately rallied
following Nixon’s announcement before peaking at $850 an ounce in
1980. At that price, one ounce of gold was 7.6 times greater than the
S&P 500, according to Gold Stock Analyst. Gold’s relative
performance then declined for the next 20 years, with the S&P 500
taking the lead in 1992 and peaking at 5.3 times the value of gold in
1999. Currently, gold’s value is roughly 1.6 times greater than the
What drove gold’s relative
underperformance from 1980 to 1999? It was a shift in government policies,
which have historically been precursors to change—a key tenet of
our investment process here at U.S. Global Investors.
Gold Stock Analyst points out that Federal
Reserve Chairman Paul Volcker began steering the U.S. economy toward
positive real interest rates in 1980 and Volcker’s goal was met in
1992—the same year the S&P 500 overtook gold.
In order for gold’s relative value to
return to 1979-1980 peak levels of 7.6 times the S&P 500, Gold Stock
Analyst’s John Doody says gold prices would have to hit the $10,000
mark. Obviously that scenario is unlikely, but it does put all this
“gold bubble” nonsense into perspective.
One point to pop the “gold
bubble” talk is that negative real interest rates are poised to
stick around for a while. We’ve previously discussed that negative
real interest rates—one of the main drivers of the Fear
Trade—have historically been a miracle elixir for higher gold
prices. The magic number for real interest rates is 2 percent.
That’s when you can earn more than 2 percent on a U.S. Treasury bill
after discounting for inflation. Our research has shown that commodities
tend to perform well when rates fall below 2 percent.
Take gold and silver, for example, which
have historically appreciated when the real interest rate dips below 2
percent. Additionally, the lower real interest rates drop, the stronger
the returns tend to be for gold. On the other hand, once real interest
rates rise above the 2 percent mark, you start to see negative
year-over-year returns for both gold and silver.
It’s important to point out that
it’s the political policies not political parties that drive this
phenomenon. During the 1990s, when President Clinton was in office, there
was a budget surplus and investors could earn more on Treasury bills
(about 3 percent) than the inflationary rate (about 2). This gave
investors little incentive to embrace commodities such as gold, and
prices hovered around $250 an ounce.
Since 2001, increased regulation in all
aspects of life, negative real interest rates, welfare and entitlement
expansion funded with increased deficit spending have created an
imbalance in America’s economic system. It’s this
disequilibrium between fiscal and monetary policies that drives gold to
outperform in a country’s currency. Today, the Fed capped interest
rates near zero back in 2008 and the federal budget deficit has ballooned
to $1.4 trillion. In fact, both the deficit as a percentage of GDP
(negative 11 percent) and federal government debt as a percentage of GDP
(nearly 65 percent) are at the highest levels since 1950, Citigroup
research shows. This has helped fuel gold’s rise through $1,000,
$1,500 and now $1,800 an ounce.
This is only one side of gold’s
long-term story. Another point to pop the “gold bubble” talk
is that we’re entering what has historically been gold’s
strongest period of the year in terms of demand. In the past, gold prices
have bottomed in August but recently gold’s strong seasonal period
has extended into the dog days of summer as the holy Muslim holiday of
Ramadan moves forward on the calendar by 10 days each year. This year
Ramadan began August 1.
In its latest Gold Demand Trends report,
the World Gold Council (WGC) confirmed that the Love Trade is burning
bright in Asia. The WGC council said Chinese and Indian buyers continue
to be the “predominant drivers” of gold demand, accounting
for “52 percent of bars and coins and 55 percent of jewelry
demand.” China’s demand grew 25 percent, while India saw an
increase of 38 percent. WGC attributes this growth to “increasing
levels of economic prosperity, high levels of inflation and forthcoming
key gold purchasing festivals.”
But China and India aren’t the only
emerging markets feeling the love for gold. Vietnam, Indonesia, South
Korea and Thailand – labeled by the WGC as the “VIST”
countries – are additional key gold-consuming countries.
The WGC’s chart below shows a
potential opportunity in increased demand for gold, especially in jewelry,
in the VIST countries. In 2010, demand rose to 253 tons after a sharp
drop in 2009. Jewelry demand, however, was historically low while
investment demand grew considerably.
Similar to China and India, the VIST
countries have had a 2,000-year long relationship with gold which is
intertwined in their culture, religion and economy. Jewelry and
investment demand are one and the same, says the WGC: “The demand
for gold as a store or accumulator of wealth, as an auspicious gift or as
insurance against unforeseen risks, is to a large extent independent of
the form it takes.”
This strong tie to gold means that, as
wealth among residents of Vietnam, Indonesia, South Korea and Thailand
increases, price is less of a consideration, and gold will continue to be
at the top of their shopping lists.
At some point in the future gold prices
will fall, that’s for certain. However, don’t expect it to
happen soon. We believe the one-two punch of the Fear Trade and Love
Trade will keep gold prices at elevated levels for another few
Don’t forget to register for “A Case for Investing in
Gold,” a special webcast featuring Frank Holmes and the World
Gold Council’s Jason Toussaint. Sign up here.
U.S. Global Investors, Inc. is an investment
management firm specializing in gold, natural resources, emerging markets
and global infrastructure opportunities around the world. The company,
headquartered in San Antonio, Texas, manages 13 no-load mutual funds in
the U.S. Global Investors fund family, as well as funds for international
By Frank Holmes,
Chief Investment Officer
Please consider carefully a fund’s investment
objectives, risks, charges and expenses. For this and other important
information, obtain a fund prospectus by visiting www.usfunds.com or by calling
1-800-US-FUNDS (1-800-873-8637). Read it carefully before investing.
Distributed by U.S. Global Brokerage, Inc.
The Global Resources Fund (PSPFX) ranked 1 out of 131, 17
out of 54, and 1 out of 32 global natural resources funds by Lipper for
total return for the 1-, 5- and 10-year periods as of December 31,
2010. The World Precious Minerals Fund was ranked 24 of 83, 26 of
52 and 6 of 32 for total return among gold-oriented funds by Lipper for
the 1-, 5- and 10-year periods ended December 31, 2010. The World
Precious Minerals Fund was ranked 1 of 71, 34 of 51 and 18 of 29 for
total return among gold-oriented funds by Lipper for the 1-, 5- and
10-year periods ended December 31, 2009. Lipper Fund Awards are presented
annually for consistent return over 1-, 5- and 10-year periods.
Consistent return incorporates risk-adjusted return and the strength of
the fund's performance trend. The top-scoring fund within each
classification receives awards. Lipper's Performance Achievement
Certificates are awarded to funds with returns that topped their Lipper
category over 1-, 5-, 10- and 15-year periods. Certificates are awarded
for all Lipper classifications and for the overall fund universe. Past
performance does not guarantee future results.
Foreign and emerging market investing involves special
risks such as currency fluctuation and less public disclosure, as well as
economic and political risk.
Gold, precious metals, and precious minerals funds may be
susceptible to adverse economic, political or regulatory developments due
to concentrating in a single theme. The prices of gold, precious metals,
and precious minerals are subject to substantial price fluctuations over
short periods of time and may be affected by unpredicted international
monetary and political policies. We suggest investing no more than 5% to
10% of your portfolio in these sectors.
Because the Global Resources Fund concentrates its
investments in a specific industry, the fund may be subject to greater
risks and fluctuations than a portfolio representing a broader range of