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December 17, 2009

I host a monthly investment discussion group.  It’s composed of a group of professionals who have invested assets outside of their primary home, take an interest in their investments and make decisions related to them.  We range in age from our early thirties to our late forties.

Last evening we discussed gold, the gold standard, fiat currency, the recent run up in gold prices and, most importantly, given how gold is priced and where we think it goes from here.

What influences the price of gold?  Supply and demand.

Supply comes from mines, government sales and old gold scrap (people selling jewelry etc.).  Demand comes from jewelry purchases, industrial and dental, bar, coin and retail investment and investment vehicles like exchange traded funds.

From Q1 2008 to Q3 2009 total supply increased by 17% and total demand decreased by -8%.  All other things being equal, this should mean that the price of gold will go down.

What is the case for an increase in the price of gold?

Big countries like China and India purchasing gold from the IMF.  While this doesn’t increase the supply of gold, it does increase demand and Joe Retail Investor may run into gold thinking that this move will cause a jump in gold prices.  Trying to time the market (which is impossible in my view) and buy on the recent dip in prices.  Worries about Obama’s massive fiscal deficits and the impact on the US dollar with the inevitable run up in inflation.

What is the case for gold going down?

Interest rates remaining unchanged until 2011 will reduce the potential for big inflation in 2010 and reduce demand for gold as a hedge against inflation.  The slow recovery of the US economy will reduce demand for gold as the ultimate safe haven and will stabilize the US dollar (gold prices run inversely to the greenback).

More generally, although gold has had an exceptional run over 2009, historically it provides pretty dismal returns.  From 1983 to its peak in 2009 gold returned 180% where US Treasuries return 1089% and the S&P 500 returned 2182%.

Our group predicted where we think gold prices will be when we meet again this time next month: $1300, $1050, $1300, $1100 and $1240.

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