2008 proved to be a
"Year of Safety." Two G's representing safe assets i.e.,
Gold and Government Bonds emerged as clear winners in times
of turmoil. Gold as an asset class has been proving year
over year that this under-owned asset surely deserves a
place in each investor's portfolio. In US dollar terms, gold
prices increased for eighth consecutive year with gains of
5% in 2008.
In early 2008, we
saw gold prices rally to all time record highs above $1000.
This rally in gold was a multi-factor drive, i.e., inflation
fears as oil and other commodity prices escalated towards
record highs, geopolitical concerns and, the biggest of all,
the unfolding of the sub-prime debacle with the Bear Stearns
collapse leading to economic and financial upheaval. This
encouraged safe haven buying in gold.
As events unfolded,
prices displayed more volatility. Technically driven sell
calls and profit booking led to a correction in gold prices.
However, the correction was short-lived as growing fears of
systemic risk in the financial sector along with rising
inflationary expectations, dollar weakness and heightened
geopolitical tensions helped gold inch higher.
One by one, mega
financial institutions found difficult to survive. Stock
markets collapsed globally, interbank lending froze... a
perfect recipe for a financial disaster. Investors rushed
for the cover of traditional safe-haven assets like
government bonds and gold.
Even with the safe
haven demand and heightened uncertainty, it caught many by
surprise that gold prices could not even surpass the
previous highs reached earlier this year. This led to
questions being raised on gold's "safe haven" status.
The fundamental
question remains as to why did gold decline even when all
the positive factors for a gold rally were in place?
A financial tsunami
does not differentiate between good and bad, it takes away
everything with it. As global assets plummeted, gold as an
"asset of last resort" was sold to meet margin calls due to
heavy losses on other investments. Heavy hedge fund selling
in order to meet redemption pressures also led to the
decline.
Worldwide recession
fears led to unwinding of commodity index investments which
included gold. This led to more selling. Strong appreciation
of the US dollar as a safe haven after the crisis showed
signs of spreading globally triggered unwinding of long gold
/ short dollar trades. This led to more outflows from gold.
All this clearly explains gold's under-performance even
during such uncertain times. Investors hungry for liquidity
sold gold, as it was the only asset doing well.
As selling pressure
eased, gold prices jumped on the back of strong physical
demand. Investors, in order to safeguard their wealth,
increasingly turned towards gold leading to physical supply
shortages in key consuming areas. Although with increased
volatility, gold kept inching higher. Gold prices ended the
year with positive returns at a time when other assets were
badly hit underpinning its role as an effective portfolio
diversifier.
Going forward, we
expect gold prices to continue its upward journey. The macro
economic and supply demand factors are supportive of higher
prices. The uncertainty that surrounds the global economy
would continue to underpin gold's role as a safe haven.
There is an increasing likelihood that global deflationary
scenario would change to an inflationary one as central
banks globally pump in money created out of thin air,
leading to a rally in gold prices.
Geopolitical
concerns have just been sidelined and are not over yet.
There are various issues in different corners of the globe
like the Israel - Hamas conflict, Indo - Pak war on terror,
Iran's nuclear imbroglio; any of these might flare its head
up and lead to increased tensions. Gold works as an
effective hedge against rising inflation and geopolitical
concerns.
The financial crisis
has been deeply rooted in the US and our central bank has
been the forerunner to pump in dollars to bail out financial
institutions and banks in order to help its economy on its
feet. This increased money supply without any real asset
backing it, would eventually lead to debasement of the
dollar. The dollar would continue to depreciate as it has
since the start of this decade and help gold prices
increase. Gold and dollar tend to move in opposite direction
to each other over the long term.
On the fundamental
side, supply demand factors continue to indicate a tight
market. Demand has been continuously rising whereas supply
just hasn't kept pace even with prices quadrupling.
On the supply side,
mining supply has been declining year on year, with no major
discoveries inspite of increasing exploration expenditure
and increasing mining challenges. This continues to signal
fresh supply tightness. Central banks sales have been
declining significantly.
On the demand front,
traditional buyers in key consuming countries are always
ready to buy at any price declines providing a rising and
well defended floor price. The investment community is more
and more turning towards gold as a safe haven investment and
given its excellent diversification properties as well as
stellar performance in last few years.
More and more
innovative vehicles of investments like Gold ETFs,
structured and capital protected notes are making it
convenient for investors to gain exposure to the precious
metal.
All in all,
demand-supply dynamics points towards continuation of a
deficit market indicating further increases in prices. The
macro economic and supply demand fundamental factors are
supportive of higher prices. Hence, Investors can have a
higher allocation to Gold.
With the financial
crisis not over yet and the recession looming large, central
banks would continue to inject more and more money into the
financial system. Thus the debasement of the currencies will
continue making gold more and more attractive as a hedge
against the dwindling purchasing power and the loss of faith
and confidence in paper currencies.
Thank God we don't
have printing presses for gold -- the only savior to protect
wealth over the long term.
Gold is seriously
undervalued. Buy it before it gets expensive.
Roger Williams
Chief Editor
P.S. You can either
purchase an ETF that holds the physical metal itself (like
GLD) or one that hold stocks of gold mining companies (like
GDX). For more information, please visit
http://ETFglobalinvestor.com