``If our present inflation, as seems likely, continues and accelerates, and if the future purchasing power of the paper dollar becomes less and less predictable, it also seems probable that gold will be more and more widely used as a medium of exchange. If this happens, there will then arise a dual system of prices — prices expressed in paper dollars and prices expressed in a weight of gold. And the latter may finally supplant the former. This will be all the more likely if private individuals or banks are legally allowed to mint gold coins and to issue gold certificates.” Henry Hazlitt (1894–1993) Gold versus Fractional Reserves
I wouldn’t be in denial that seasonal factors could weigh on asset pricing as we mentioned last week.
This Ain’t 2008
But many analysts seem to have taken a rear view mirror (anchoring) of the seasonal factors on the possible performances of the global stock markets.
Given the fresh traumatic experience from the 2008 meltdown, it is understandable that many have written words of caution about navigating the turbulent periods of September and October.
But unless we are going to see another seizure in the banking system, the 2008 episode seems unlikely to be the appropriate model.
True, we could see some heightened volatility, as a result of the variable fluxes in inflation (as in the recent case of China).
But for us, the focus should be on how the US dollar index would be responding to the stickiness of inflation on the financial markets in the current environment, instead of one dimensionally looking at the stock markets vis-à-vis the seasonal forces.
In my view, gold’s strong performance during this period could be a fitting a precursor see figure 3.
Figure 3: Uncommon Wisdom/Sean Brodrick: Entering Gold’s Seasonal Strengths
If gold functions its traditional role as the archrival or nemesis to paper money, then simplistically a weaker dollar should translate to higher gold prices.
In Four Reasons Why ‘Fear’ In Gold Prices Is A Fallacy we pointed out that one of the major reasons why the mainstream has been wrong in attributing “fear” in gold prices was because of the massive distortions by governments in almost every market.
Hence, gold or the oil markets, which represents as the major benchmarks to commodity indices, hasn’t been on free markets to reflect on pricing efficiency enough to attribute fear.
Instead, over the short term, government interventions working through different channels such as the signaling, an example would be the previous announcements of IMF gold sales [which eventually got discounted], or other forms of direct or indirect manipulation, has been used as a stick to control gold prices.
This, plus the seasonal weakness has indeed brought gold prices to a tight trading range, instead of collapse as predicted by the mainstream, thereby validating our thesis and utterly disproving the “fear” thesis.
Nevertheless, governments appear to have retreated from selling their reserves under the Central Bank Gold agreement which expires on September. Central Bank’s selling during the first 6 months of the year are down 73% at 39 tonnes (commodityonline). Although as the calendar year closes, central bank selling could step up, but this would likely be met by the seasonal strength and won’
Investment Taking Over Traditional Demand
Also, as we also pointed out in February’s Do Governments View Rising Gold Prices As An Ally Against Deflation?, the dynamics of gold pricing has rightly been changing.
Then we said, ``The implication of which is a shift in the public’s outlook of gold as merely a “commodity” (jewelry, and industrial usage) towards gold’s restitution as “store of value” function or as “money”. The greater the investment demand, the stronger the bullmarket for gold.” (see Figure 4)
Figure 4: World Gold Council: Investment Leads Gold Demand
It would seem like another vindication for us, this from the Financial Times, (bold emphasis ours)
``Total identifiable gold demand, at 719.5 tonnes in the second quarter, was down 8.6 per cent compared with same period in 2008, with jewellery consumption down 22 per cent to 404.1 tonnes.
``Investment demand, which includes buying of bars and coins as well as inflows into exchange-traded funds, reached 222.4 tonnes in the second quarter, a rise of 46.4 per cent from the same period a year ago.
``However, the second quarter was the weakest three-month period for investment demand since before the implosion of Lehman Brothers in September 2008…
``Mr Shishmanian [Aram Shishmanian, chief executive of the World Gold Council-my comment] said that although total demand had failed to match the exceptional levels seen when the economic and financial crisis was at its peak, investment demand had enjoyed a strong quarter, underlining a growing recognition of gold as an important and independent asset class.”
In short, yes, investment demand has materially been taking over the dominant role in gold demand over jewelry and industry and will continue to do so as global central banks inflate the system.
China’s Role And The Reservation Price Model
Moreover, China’s government recently loosened up on its investment rules for gold and silver and even encourages the public to participate [see China Opens Silver Bullion For Investment To Public].
On a gold [in ounces] per capita basis, China has only .028 ounces of gold for every citizen, against the US which has .9436 ounces of gold in its reserves for every Americans (Gold World). That’s alot of gold for the Chinese with its huge savings and humongous foreign currency reserves to buy. And that’s equally alot of room for gold prices to move up.
This means that if the inflation process will continue to be reflected on the financial asset prices, then the likelihood is that gold will pick up much steam going to the yearend on deepening investment demand from global investors, perhaps more from Asia and augmented by the seasonal strength.
Moreover, gold will likely serve as a better barometer for the liquidity driven stock markets, in spite intermittent volatility, than from traditional seasonal forces.
Finally, Mises Institute’s Robert Blumen gives a good account of why evaluating the price dynamics of gold shouldn’t be from the conventional consumption model but from reservation prices model.
Since gold prices are not consumed by destruction and where above ground supply remains after being processed or used, the ``owners of the existing stocks own much more of the commodity than the producers bring to market.”
Hence to quote Mr. Blumen, ``The offered price of each ounce is distinct from that of each other ounce, because each gold owner has a minimum selling price, or "reservation price," for each one of their ounces. The demand for gold comes from holders of fiat money who demand gold by offering some quantity of money for it. In the same way that every ounce of gold is for sale at some price, every dollar would be sold if a sufficient volume of goods were offered in exchange.”
Read the rest here.
