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Can gold continue riding high?

Investment | Commodities

By Justin Modray, published 23 August 2011.
Helpful? 51

The global downturn has seen the gold price soar to over $1,800 per oz. Can its meteoric rise continue or will the gold price fall back with a crash?

[I've updated this article from last year as it's still as relevant as it was then.]

Gold is an interesting investment. Unlike shares and gilts its value doesn’t depend on the financial health of companies and governments. And unlike property it can be easily bought and sold worldwide, i.e. it’s very liquid.

It’s for these reasons that investors usually turn to gold in times of strife, which mostly explains why the gold price has shot through the roof in recent years – it’s risen by more than 125% over the last two years to over $1,800 per oz. (you can view a dynamically updated chart here).

But will gold continue to ride high? Or is this as good as it’s going to get? To try and answer these questions we need to look at the factors affecting gold supply and demand.

Gold Supply

There are three main sources of gold:

  • Mined gold – supply tends to be fairly constant at around 2,600 tonnes a year, although mining companies usually hold some back to be sold at agreed price in future (to protect against falling prices), known as ‘hedging’, which reduces actual supply.
  • Recycled gold – existing gold (e.g. old jewellery) that is melted down and recycled. Supply currently runs at around 1,600 tonnes a year – almost double 2007 levels as more people sell off their jewellery during the global downturn (and/or are tempted to sell by a high gold price).
  • Official sales – occurs when governments sell off some of their gold reserves – fairly low versus the other two and currently negative.

Gold Demand

The three main areas of demand for gold:

  • Jewellery –traditionally accounts for the majority of gold demand, but sales have waned during the global downturn and are likely to be around 2,000 tonnes this year. India and China account for about half the total global demand, with the Middle East and Turkey accounting for about a quarter.
  • Investment – investment in gold has soared over the last 10 years, from just 166 tonnes in 2000 to more than 1,400 tonnes over last year. Europe is the biggest investor, followed by India.
  • Industry (including dentistry) – demand tends to be fairly constant, between 350-450 tonnes a year.

Demand vs Supply

Although gold supply has kept pace with rising demand (from investors) in recent times, this is more due to an increase in the supply of recycled gold than lots more gold being dug out of the ground. If investment demand continues to grow then this will largely need to be met from more recycled gold (as mining gold supply is unlikely to change much), which in turn means a higher gold price to tempt more people to sell off their jewellery for recycling.

Jewellery demand is affected by global prosperity, especially in India and China. As both countries continue to grow at a fast pace longer term jewellery demand looks set to rise, albeit with setbacks during periods of economic difficulty (more due to falling demand from the Middle East/Turkey than India/China).

Investment demand is more fickle. While likely to remain robust for as long as global economies (especially Western) struggle, a period of sustained stockmarket recovery will probably see some investors ditching gold for stocks, reducing demand for gold.

Good times

If economies and stockmarkets emerge from these difficult times sooner than expected then investment demand for gold is likely to fall. However, recycled supply will probably fall too and demand for jewellery is likely to increase. The extent that these cancel each other out is hard to predict. At best the gold price might remain stable medium term and grow longer term (if the growth in emerging market jewellery demand is sufficient). At worst the price could plunge back towards 2006 levels ($600 per oz).

Bad times

If economies and stockmarkets continue to struggle then investment demand will likely continue to prop up overall demand, despite falling jewellery demand. Any increase in demand may be partly met from an increase in recycled gold, but the extent this will lead to a higher price probably depends on how deep the economic problems are. In desperate times people are more likely to sell their gold jewellery because they have to, rather than being tempted by a high price. Overall the gold price will probably remain fairly stable with some prospect for rises (as wqe've seen in recent weeks) depending on the extent of investor demand.

Conclusion

I think growing emerging market demand for jewellery will ensure a decent rise in the gold price over the next 20 years. But shorter term is far harder to predict.

If economic and stockmarket volatility persists I can see the gold price remaining in its current range, maybe even breaking $2,000 per oz if major global economic fears persist. But if the economic and stockmarket gloom lifts we could see the gold price heading south of $1,000 per oz in time.

I’m quite bearish about the outlook for stockmarkets and economies over the next couple of years so wouldn’t argue against holding gold at present. But I think it makes more sense to do so with the longer term picture in mind rather than trying to make a quick buck shorter term – you might, but it’s a high risk strategy.

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Readers' Comments (3) - To post a comment please register or login .


Comment by pvcdoc at 3:11pm on 05 Nov 2010:

One further point is that gold is priced in US dollars, so if that currency weakens (perhaps because of excessive Quantitative Easing) then the price will increase to compensate.


Comment by BernieB at 2:17pm on 29 Aug 2011:

I bought some gold jewellery in Saudi Arabia in 1982. It was priced according to weight, daily Market rate, and negotiation, not design. It didn't regain the price I paid for it until 2006, which is a long time to wait to take profits! The historic price graph at http://www.kitco.com/scripts/hist_charts/yearly_graphs.plx showing price variation looks a bit bubbly.


Comment by webwiz at 12:33pm on 08 Sep 2011:

A possible strategy for making a profit from a devloping bubble is as follows. Invest a certain amount. When the value has risen by 5% sell 5%. Repeat, keeping the value of the investment roughly constant, until the first sign of bubble bursting then sell out. You will show a profit if your multiple withdrawals of 5% exceed the capital loss. To use this strategy means keeping a very close eye on the price of the asset. Use at your own risk!