Gold to rise: TD study

A study by TD Economics into the causes of gold’s misfortunes over the past two decades concludes that prices are likely to trend modestly higher in the coming years.

The report, titled Gold’s Lost Lustre, was prepared by economists Craig Alexander and Priscila Kalevar of the Toronto offices of TD Bank Financial Group. In preparing the study, they relied heavily on data collected by London-based Gold Fields Mineral Services.

Gold’s appeal as an investment asset has eroded steadily in recent years, owing to low inflation and the fact that returns on equities and fixed-income investments have been superior to gold investments. Also, gold’s appeal as a safe-haven investment has been partially supplanted by the U.S. dollar.

Since the demise of the gold standard under the Bretton Woods system in 1971 and the amendment of the International Monetary Fund’s articles of agreement to drop the use of gold in its regular transactions in 1978, the yellow metal has lost its monetary role as the basis for valuing currencies and as a medium for settling international transactions. As a consequence, from 1990 to 2000, net official gold sales totalled 3,600 tonnes, or roughly half the world supply shortfall.

However, gold’s reduced role in these areas has been more than offset by its increased use in jewelry (up 45% in the past decade) and other products. During this same period, total demand for gold increased by 2.6% annually, compared with mine supply, which has grown at the annual rate of 2%. During the 1990s, 70-80% of world demand for gold was accounted for by the manufacture of jewelry.

The authors state that although central bank gold sales have grabbed headlines, gold lending has been just as important in terms of increasing market supply of the precious metal and depressing its price.

Gold lending has increased by about 270% since 1990, with roughly 14% of the world’s official gold reserves out on loan in 2000.

The authors describe the development of gold lending as being fuelled by demand from bullion banks and gold producers and by a desire by central banks to earn some interest income from their gold reserves. Mining companies are the primary borrowers of gold, accounting for more than two-thirds of the amount lent in 2000.

The authors state that “with newly mined gold and scraps falling short of world demand, it is clear that central bank gold sales and the increasing practice of gold lending have been the main culprits behind the weakness in gold prices.”

Writing in a follow-up article in October, Alexander and Kalevar state that “gold prices are unlikely to fall significantly lower in the coming months, while the medium-term outlook for demand and supply suggests that the price of gold will gradually rise in the years ahead.”

TD expects gold demand to rise, boosted by what it predicts will be a global economic recovery in 2002. The recovery would be characterized, in part, by the buying of luxury goods such as gold jewelry.

However, TD says central bank gold sales and lending “will continue to act as a restraint on gold prices for some time to come.” But their effect will be mitigated by the 1999 Washington Agreement on Gold, which limits central bank gold sales to 400 tonnes per year and stipulates there will be no expansion of gold lending until 2004.

Currency trends will also provide some support to gold, say the authors, noting that the U.S. currency is overvalued and should depreciate on a trade-weighted basis by 5% in 2002. This depreciation is expected to boost the price of gold to US$290 per oz. by the end of 2002.

TD concludes that continued growth in world gold demand, combined with the above-mentioned limits on gold sales and lending by central banks, should allow the price of gold to reach US$320 per oz. by 2004.

Gold’s Lost Lustre is available in pdf format on TD Economics’ home page at: www.td.com/economics