When any market rises, we are asked why we did not buy more of it and should we get in now? After dropping 44% from its 2011 peak, gold was up 16% in dollars in the first two months of this year. With the fall in the pound, this gave a 23% return in sterling terms. So the perennial question arises; should we buy now? I have wrestled for over 30 years with what drives the gold price. The problem is that none of the numerous possible drivers appear to work consistently over time.
Many currencies were initially based on gold and a number of countries continue to hold significant gold reserves. The US is the largest of these, followed by Germany, France, Italy and the International Monetary Fund. However, China and Russia have been adding gold to reserves in recent years. Despite total reserves falling in recent months, China has continued to buy gold but at about 2% of reserves, this coming from a low level.
So our first thought is that gold is a currency held by central banks as part of reserves. However, some countries have abandoned this, so it is not a constant or reliable source of demand.
Gold has also been considered as a hedge against inflation. This worked in the ’70s and the early ’80s when inflation soared into double digits and the gold price rose dramatically. This came to a head in 1980 when gold peaked at $850 an ounce. Some people have extrapolated this using inflation to justify a price over $2,500 per ounce. I believe it is a mistake because it omits the bubble-like nature of that peak.
At the start of January 1980, gold was at $572 per ounce but fell back to $480 by the end of March. It then dropped to $300 an ounce and stayed in the doldrums for 20 years until the next run-up started in 2002. Inflation peaked later and the next run-up coincided with a period of falling inflation. So inflation is not a consistent driver.
In many parts of the world, particularly in China and India, it continues to be considered a significant store of wealth. The Indian wedding season in the second half of the year is referred to as a time of seasonal demand for the yellow metal. So strength in the Chinese and Indian domestic economy may help demand for gold. However, Chinese growth has recently slowed and the gold price has rallied.
Because of its nature, very little of the metal is actually ‘used up’ or cannot be recycled. Which, when added to the continuous supply of new gold from mining, means the total amount of gold is always increasing. However, it has been said that all the gold in the world that has been mined so far would fit into a 23-metre cube, so it remains in limited supply. China, as well as one of the largest buyers of gold, is the biggest producer. South Africa and Australia have the largest established deposits still in the ground. So there are plenty of sources of gold in the ground if the price is right to get it out. If we view it as a currency, then it has positive supply and no interest rate attached to it. Not a good dynamic for investment.