The price of gold has, at various times, been linked to almost everything including political uncertainty, the price of oil and wars. As is typical of any commodity, the price of gold reacts in the short term to any factor which affects, or is perceived to affect, demand or supply. However, certain key characteristics of the market determine gold price movements in the longer term.
The market price of gold is demand driven and that demand is fueled by inflation expectations. Gold serves as one of the hedges against erosion in the real value of the U.S. dollar. In fact, the price of gold has been a leading indicator, by about a year, of changes in the direction of U.S. inflation. It has moved up prior to increases and has fallen prior to declines in the rate of inflation. This relationship has developed since 1968, with the gradual severance of official ties between the U.S. dollar and gold. As such, it is a relatively recent phenomenon.
The troughs in the price of gold have been at successively higher levels after each bout of inflation since 1968. This implies that there has been the expectation of a return to higher inflation rates. So far, this assumption has been valid. Historically, governments with chronic budget deficits have resorted to excessive growth in the money supply to alleviate the problem. Today’s higher gold price would indicate that the U.S. is not expected to react any differently.
By the same token, the increase in the price of gold from the trough in 1985 points to higher U.S. inflation rates over the next few years. Growth in the U.S. money supply at rates in excess of 10% is confirmation that U.S. inflation rates will be higher.
Analysis of demand shows higher consumption of those components which are related to investment or hoarding during periods of higher prices — a striking contrast to normal demand patterns. It is eloquent confirmation that the gold market is demand driven.
While industrial demand does display some response to higher prices, it is more affected by economic activity. Demand for jewelry, on the other hand, is price sensitive and serves to moderate investment demand.
On the supply side, the key is the enormous above ground stocks of gold. Most of the secondary supply, obtained from the recycling of old scrap and dishoarding of old jewelry represents liquidation of above ground stocks. Gold is, therefore, one of the few mineral commodities which can quickly respond to higher prices with an increase in the quantity supplied to the market. Reasonable forecasts of the quantitites coming on the market at a particular price are possible.
While mine production from South Africa has been declining slightly over the past few years, it has been expanding elsewhere in the Western World. These trends can be expected to continue for a number of years, given prevailing high prices and the level of exploration activity generated by thes e prices. In the short term, however, mine production is not overly sensitive to price and forecasts can be reasonably accurate.
Sales of gold by countries with centrally planned economies have also been at significantly high levels over the past few years. Forecasts of these sales are not reliable because of the wide yearly variation and the lack of information on these sales. Historically, periods of two or three years of high sales have invariably been followed by periods of low sales.
Too many forecasts of gold prices ignore these key characteristics of the market. A forecast of higher prices implies higher investment demand due to the expectation of higher U.S. inflation. At the same time, it implies a decline in jewelry demand and an increase in secondary supply. A forecast of lower prices implies the opposite — lower investment demand, higher jewelry demand and lower secondary supply.
The higher average prices for 1987 ($435 per oz to August) will be derived from investment demand of 20-25 million oz, jewelry demand of 28-32 million oz and secondary supply in the range of 15-20 million oz for the year. The price points to higher U.S. inflation next year.
Over the longer term, eventual solution of the U.S. budget deficit problem, steady expansion in mine production and a readily available secondary supply can only lead to a continuation of the overall downtrend from the peak of 1980 in the average annual real price of gold. / Robert Rodger, P. Eng., is an independent consultant based in Montreal.
The price of gold has, at various times, been linked to almost everything — political uncertainty, the price of oil, war. As is typical of any commodity, the price of gold reacts in the short term to any factor which affects, or is perceived to affect, demand or supply. However, certain key characteristics of the market determine gold price movements in the longer term.
The market price of gold is demand-driven and that demand is fueled hy inflation expectations. Gold serves as one of the hedges agaisst the erosion in the real value of the U.S. dollar. In fact, the price of gold has been a leading indicator, by about a year, of changes in the direction of U.S. inflation. It has moved up prior to increases, and has fallen prior to declines, in the rate of inflation. This relationship has developed over the period since 1968, with the gradual severance of official ties between the U.S. dollar and gold. As such, it is a relatively recent phenomenon.
The troughs in the price of gold have been at successively higher levels after each bout of inflation since 1968. This implies that there has been the expectation of a return to higher inflation rates. So far, this assumption has been valid. Historically, governments with chronic budget deficits have resorted to excessive growth in the money supply to alleviate the problem. The higher gold price would indicate that the U.S. is not expected to react any differently.
By the same token, the increase in the price of gold from the trough in 1985 points to higher U.S. inflation rates over the next few years. Growth in the U.S. money supply at rates in excess of 10% is confirmation that U.S. indflation rates will be higher. Inflation rates vary widely on a year-to-year basis. Forecasts of longer-term inflation trends are likely to be unreliable. Demand
Analysis of demand shows higher consumption of those components which are related to investment or hoarding, during periods of higher prices — a striking contrast to normal demandd patterns. It is eloquent confirmation that the gold market is demand-driven.
While industrial demand does diuisplay some response to higher prices, it is more affected by economic activity. Demandd for jewelry, on the other hand, is price sensitive and serves to moderate investment demand. Supply
On the supply side, the key is the enormous above-ground stocks of gold. Most of the secondary supply, obtained from the recycyling of old scrap and the dishoarding of old jewelry, represents liquidation of above-ground stocks. Gold is, therefore, one of the few mineral commodities which can respond to higher prices with an increase in the quantity supplied to the market. Reasonable forecasts of the quantities coming on the market at a particular price are possible.
While mine production from South Africa has been declining slightly over the past few years, it has been expanding rapidly elsewhere in the western world. These trends can be expected to continue for a number of years, given prevailing high prices and the level of activity generated by these prices. In the short term, however, mine production is not overly sensitive to price, and forecasts can be reasonably accurate.
Sales of gold by the cpe countries have also been at significantly high levels over the past few years. Forecasts of these sales are not reliable because of the wide yearly variation and the lack of information on the basis for these sales. Historically, periods of two or three years of high sales have invariably been followed by periods of low sales. Price forecasts
Too many forecasts of gold prices ignore these key characteristics of the market. A forecast of higher prices implies higher investment demand due to the expectation of higher U.S. inflation. At the same time, it implies a decline in jewelry demand and an increase in secondary supply. A forecast of lower prices implies the opposite — lower investment demand, higher jewelry demand and lower secondary supply.
The higher average price for 1987 ($435(US) per troy oz to August) will be derived from investment demand of 20-million-25 million oz, jewelry demand of 28 million-32 million oz, and secondary supply in the range of 15 million-20 million oz for the year. The price points to higher U.S. inflation next year.
Over the longer term, eventual solution of the U.S. budget deficit problem, steady expansion in mine production and a readily available secondary supply, can only lead to a continuation of the over-all downtrend, from the peak of 1980, in the average annual real price of gold.
Mr Rodger is an independent consultant with 15 years experience in various mining operations.
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