Gold set for another good year as investors seek safe havens

The eurozone debt crisis is expected to continue into 2011 and drive investors to gold with supply issues also expected to keep the price high, it is claimed.

Last year marked a step change for the bull market in gold, according to Adrian Ash, head of research at gold trading and ownership service BullionVault. It saw a switch to steadier growth in investment demand, rather than short term crisis buying, and was fed by a broadening awareness of just how deep and long lived fiscal deficits have become.
 
After the interlude of the banking crisis, when debt free gold as an alternative to savings accounts, offered an immediate haven, fears of inflation are now being driven by weak monetary policy, he believes.

‘Most people rightly think of gold as an inflation hedge. But it's only now, 10 years into this bull market, that this old normal so clearly applies for gold. It has reverted to its more historic role as a refuge from excessive government debts and from the currency crises they threaten to spawn,’ said Ash.

‘When the return on savings is less than the rate of inflation it doesn’t matter that gold doesn’t provide you with an income. Tightly supplied and indestructible, it offers a natural and obvious alternative to cash,’ he explained.

He pointed out that inflation expectations are rising as 2011 begins but the Bank of England and US central bank look highly unlikely to raise rates this year and not even the hawks, such as Thomas Hoenig at the Federal Reserve and Andrew Sentance in London, are talking about raising rates anywhere near high enough to pay savers a decent real return on their cash.

He believes that in Europe, it is the Eurozone debt crisis driving strong growth in gold demand. ‘The fear, especially in Germany, is that 2011 will see either inflation, debt default, the end of the Euro, or all three at once. This is also a growing worry for central bank reserve managers, who tried to diversify away from the US Dollar over the last 10 years, only to find political risk added to the money-supply inflation they were suffering in the US currency,’ said Ash.

After the 60% increase in gold reserves reported in early 2009, many analysts wonder when the People’s Bank of China will next announce a further sharp increase. ‘But the real gold story from China, the world’s fastest-growing economy, remains private household demand.  Chinese consumers bought more gold in the last two and a half years than Beijing’s central bank owns altogether,’ he said.

‘With cash deposit rates in China now barely half the official rate of consumer price inflation (2.25% vs. 5.1%), demand for inflation-proof gold has risen by 14% year on year by volume since 2005, averaging 38% annual growth by value. Beijing is loathe to raise interest rates, fearing a flood of hot money from Western markets desperate for a real return. The net result, with Chinese price-inflation already at 28 month highs, is continued erosion of cash values to domestic savers,’ Ash explained.

He also pointed out that despite huge growth in exploration spending, gold supplies still lagged the peaks of 1998 to 2003, and major new discoveries remain absent. ‘Scrap supplies from existing gold owners picked up the slack during the financial crisis, but just as Indian households, still the world’s top buyers, have steadily adapted to rising prices to maintain their demand, so scrap sellers are starting to demand fresh record high prices,’ he said.

Looking ahead, the only serious challenge to continued growth in global gold demand remains sharply higher real rates of interest. ‘But with Western governments desperate to keep rates low so they can finance their record peace time deficits  and with emerging economies led by China desperate to avoid hot money inflows as a result  a grinding loss of purchasing power for cash savers looks assured in 2011. Gold will remain the obvious, and increasingly popular, alternative,’ he concluded.