JOHANNERBURG (Commodity Online): Gold has gained some new status in 2009 with more and more investors putting their money on gold.

In 2009, Gold price surged 24.6% to close at $1,096 per ounce after breaking through the $1,000 psychological resistance level. 2009 marked the 9th uninterrupted gain in gold price. Prior to that gold price fell for 20 years.

Between 2004-2008, 60% of the gold came from mines, 28% from recycling of gold from scrap and another 12% from sales by central banks.

When gold price was still falling prior to 2001, gold output from mines continued to rise from about 1,200 tonnes in 1980 to a high exceeding 2,500 tonnes in 2001. Since then, gold output fell gradually despite strong recovery of gold price.

The exhaustion of old mines was not replaced by new capacity partly due to limited investment in the past when gold price was low. For the time being there is still no indication that mine production will increase from new mines or marginal mines.

Due to exhaustion of its reserves, China overtook South Africa to become the leading gold producer in 2008. The other prominent producers in order are USA, Australia, Peru, Russia, Canada and our neighbour Indonesia.

About 68% of gold was used in jewellery with the balance of 18% and 13% going to investment and industry purposes, respectively.  India is the world’s largest consumer of gold jewellery. Affluent Chinese pushed China to the number two position in retail gold market, overtaking the US in 2007. As a group, Middle East is also a prominent jewellery consumer.

Jewellery demand fell last two years, partly due to hike in price and partly due to economic conditions. The fall in demand in 2008 was about 9% but that widened to 22% estimated by Credit Suisse in its January report, said the Edge Financial Daily.

According to the World Gold Council, the total amount of gold that has been mined is estimated at 163,000 tonnes. Based on the current value of $1,100 per ounce, it is worth about $6 trillion which is 2/5th the size of US economy and double the size of Japan economy. As expected, most of this gold is already made into jewellery and held by individuals. That accounts for slightly more than half of gold. The balance is used in industrial applications, held for investment and in the vaults of central banks.

Collectively central banks hold about 29,000 tonnes worth about $1 trillion. The single largest holder of gold is by the US, about 8,200 tonnes. Countries having between 2,000-3,300 tonnes include Germany, France and Italy. The International Monetary Fund (IMF) was the world’s third largest holder of gold with about 3,200 tonnes at end of 2008.

In terms of percentage of external reserves, gold accounts for 80% of US foreign reserves. Many developed countries have more than 50% of the external reserves kept in gold and they are Portugal, Greece, Germany, France, Italy, Austria and the Netherlands. It should be noted that although many developed countries have a large proportion of their foreign reserve in the form of gold, their external reserves as a percentage of GDP are relatively low.

On the contrary, most of the developing countries which have amassed a substantial amount of current account surplus, mainly through exports, do not invest in gold. Most of them do not have more than 2% of their foreign reserves in Gold and that includes Japan. The reason is simple. The rising external reserves earned by many developing countries especially those from Asia were made during the past 10-30 years. During that period, gold price did not perform and there was no reason to put money in non-performing asset class.

In fact, many central banks were trying to pare down their holdings in gold after gold price fell from its peak at $850 an ounce in 1980. For the past 20 years central banks sold about 8,000 tonnes of gold or about 400 tonnes per year, equivalent to 16% of yearly mine production. The persistent disposals by central banks pressed down gold price to a low of $252 in 1999. Aggressive sellers of gold were Switzerland and UK. UK, under her finance minister then and present prime minister, Gordon Brown, sold most of the gold around the bottom which is commonly coined as Brown’s Bottom to denote the poor timing.

The excessive selling by central banks depressed gold price for a long period. The 14 European central banks subsequently agreed to limit their disposals to 400 tonnes a year in September 1999. The accord was raised to 500 tonnes in 2004 but again reduced to 400 tonnes per annum in September 2009. If not for the curtailment by central banks, gold price will probably dip below $200 and it may not recover as fast.

After the recovery of gold price from 2001, central banks were still net sellers. Between 2004 and 2008, the disposal by central banks accounted for circa 12% of gold supply.

Other than central banks, a flood of money into commodity funds including gold ETF is an important factor supporting gold price last year, especially during the 1st quarter of 2009. Institution and retail purchases of ETF, such as ETF SPDR, became a self-fulfilling prophecy to move gold price higher last year. One disturbing sign is that there are profit-taking activities, especially among institutional investors when gold price headed towards US$1,200. Investors’ action this year and their unity are crucial to determine how the gold price will go.

Gold has done poorly in the 1980s and 1990s both as an inflation hedge as well as preservation of value. Including the recent appreciation, gold probably yielded 2% per annum (pa) over the past 40 years. It is only when gold has started to show its shine again recently that people started to regard gold as a good hedge for inflation. So far, there are no gurus encouraging investors to buy gold for wealth creation. Gold is definitely not suitable for the faint-hearted conservative investors as its price is volatile. In a way it is a high-risk investment. This can be seen from the standard deviation of return which is similar to that of world stocks at about 15%-17% over the past 20 years.

Consensus is that gold price will appreciate over the immediate future as the US$ is likely to depreciate further due to its high budget and trade deficits. This is generally true for gold and most commodities including crude oil. There are also instances where gold moves in the opposite direction of the US$. While the US$ may be on the downtrend in the long run, being the international reserve currency, it will not fall in a straight line as other central banks do not want the US$ to depreciate excessively.  We will see regular rebound of the US$.
(Source: The Edge Financial Daily)

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