Nine reasons gold will go past $1500.

23 June 2010

ALEC HOGG: In this special podcast, we speak with Jeff Nichols, managing director of American Precious Metals Advisers. Jeff you're back in the US after being in the Far East for three weeks - what's the general mood like in that part of the world regarding gold.

JEFF NICHOLS: It was a very exciting visit, particularly from the point of view of the gold market. We met many participants, investors, miners, jewellery manufacturers, government officials and to the man, everybody was very bullish about the outlook for gold - in part because of a loss of faith in the US Dollar and in part because the market has just grown so rapidly over there - not only in China but in some of the neighbouring countries and market centres.

ALEC HOGG: In the note that you sent out you believe now, that conservatively the gold price should be through $1,500/oz by the end of the year.

JEFF NICHOLS: Yes - that's been my forecast for a while, but I think the probabilities are higher than I might have attached previously to that outcome. Not only $1,500 by the end of this year, but in the next few years going substantially higher. We've been on record talking about $2,000/oz to $3,000/oz. In the end those numbers could prove to be conservative.

ALEC HOGG: You've got nine different bullet points that you've identified for the gold price and the reasons why the gold price should go over, but I guess if you were to encapsulate them into one sentence, it would be that history is about to repeat itself.

JEFF NICHOLS: Absolutely. You know whenever we've had in the major reserve countries periods of large and rising government deficits and substantial federal or public service sector debt, accompanied by rapid growth in money supply and persistently low interest rates, we've always seen an appreciation in the gold price. So in a sense it's just history repeating itself but this time around, structurally the world gold market is in a much different place with many more participants than we've ever seen before. Many new vehicles that are making gold more accessible than ever before - and as a consequence what we're seeing is an upward adjustment in the demand curve for gold which is going to result in a long term average price - much higher than it might have been a few years ago.

ALEC HOGG: Lets go through those bullet points - there's a lot of interest in them - the first one you mentioned is the US monetary and fiscal policies.

JEFF NICHOLS: Yes - obviously this is what people are worried about. We see projections of the federal government deficit growing from year to year for the next several years. These estimates and projections, especially the ones that are used by the White House and by Congressional Budget Office are optimistic. They're assuming a fairly vigorous recovery in the US economy in the next year and I just don't see that recovery coming. The economy has historically depended on consumers in the US, and consumers are in no way, shape or form ready to resume spending like they might have a few years ago.

ALEC HOGG: So lots of issues there. Europe's sovereign debt problem is your second bullet point.

JEFF NICHOLS: Yes, well the sovereign debt problem has cast substantial doubt on the euro as a possible reserve currency and medium to diversify away from dollars. Central banks collectively have been, in recent years, building their reserve position in euros and that's all now been called to question. It's been estimated that about 25% of international reserves recently have been euros with the remainder being mostly dollars, and a little bit in yen - and the euro was being touted as a possible replacement for the dollar or at least something that would help central banks diversify away from the dollar. Now most central banks are sorry they've taken on such substantial euro positions.

ALEC HOGG: Indeed and better opportunities for them to put some money into gold. The third bullet point you talk about is moderate and good growth rates in the gold friendly countries. What are those?

JEFF NICHOLS: Well the gold friendly countries are those that historically and culturally have an affinity to gold. This would be principally China, but also india and some of the other east Asian countries and centres like Singapore, Hong Kong, Indonesia, the Philippines, going right down to Vietnam. These are countries that historically have favoured gold as a savings and an investment medium. People in these countries have for centuries turned to gold as a store of value and they substitute for financial savings...

ALEC HOGG: As the countries do well, gold will benefit as well. Bullet point number four you say - continued central bank purchases.

JEFF NICHOLS: Last year central banks, for the first time in 20 years, became net buyers of gold and signs point to continued net buying by central banks for the next several years at least, if not longer as they seek to hedge their dollar holdings and feel less comfortable holding more and more dollars. They're going to use every opportunity they have to increase gold positions in a way that's not disruptive to the gold market. So they'll buy on dips, countries that have domestic production, principally China for example and Russia, the Philippines and Kazakhstan - these are countries that have domestic goldmine production and the central banks are buying from their domestic mines in local currencies as a way to build reserves without disrupting the gold market, or the currency markets for that matter. We'll continue to see that.

ALEC HOGG: Another supportive factor that you mention - rising private investor demand in the western nations, as a hedge, I guess.

JEFF NICHOLS: Right - we've seen that especially in the last few months with the problems in Europe triggering strong demand for small bars and coins. But it hasn't only been coming from Europe - we've seen it in the United States, and literally around the world, more and more people are turning to gold because of their concerns about the outlook for currencies, the outlook for stock markets and the fear that something is amiss in the world monetary system.

ALEC HOGG: Not hard to understand that one. Bullet point number six - rising long-term savings rates in India and China and much of that going into gold as well.

JEFF NICHOLS: Right - this is similar to the point I made a moment ago. As long as these countries continue to see growth in personal income, some of that income is going to trickle into the gold market and simply because we're talking about so many people - it doesn't take a lot to make a meaningful difference in gold. One of the bullet points that I talk about is the relatively small size of the gold market compared to world currency or equity markets for example you can have a small shift out of these other markets with hardly a ripple in equity prices or currency valuations, but when it comes into the gold market it has a much bigger effect because gold is after all still a very small market.

ALEC HOGG: And linked to that is bullet point number seven - the maturing of what you call the gold investment infrastructure.

JEFF NICHOLS: Absolutely - the best example of this is the growth in importance of ETFs. Gold ETFs didn't exist six years ago. Now we have over 1900 tons of gold invested via gold ETFs. What ETFs have done is make gold more accessible to more investors around the world than ever before and many who might not have bought physical gold earlier, now find it convenient to buy gold in a vehicle that is very much like buying an equity and for some institutions, for example, here in the States pension funds and endowment funds - there are legal restrictions against investing in commodities or investing in futures contracts, but they can invest in ETFs because they qualify as equities, traded on the stock exchange. And we've seen institutional demand as a consequence grow substantially.

ALEC HOGG: Bullet point number eight is on the other side of the scale - the reduced supply coming out of gold mines.

JEFF NICHOLS: Yes - for a long time now world mine production has been on a downtrend. We've seen little beeps up and down over the years, but the basic trend has been down and I think it's going to continue to be down, at least for the next five or 10 years. Even if we had a substantial gold discovery on a par with the initial discovery in South Africa say 120 - 130 years ago, it would take many years to develop a significant gold mine from a discovery of that sort. So there's going to be a period even in the best of cases for gold mining where supply is going to remain constrained, and where the depletion of existing mines is going to continue to reduce supplies available in the marketplace.

ALEC HOGG: And the final bullet point number nine - you have touched on it before - the relatively small size of gold in the investment market, generally. A small shift could see an explosion...

JEFF NICHOLS: Right - we're already seeing that in some sense. The rise in the gold price in the last year has been for many, a big surprise. It shouldn't have been but the reason it's been a surprise is because the money flowing into the gold market in a sense has a leveraged to magnified effect simply because the market is so small - it doesn't take a lot to move the gold price, whereas it does take a lot to move currencies or stock markets

SOURCE: Alex Hogg, Editor-in-Chief, Moneyweb