With turmoil overseas and energy prices on the rise, investors are worried. They’re worried about geopolitical risk. They’re worried about a falling dollar. And they’re worried about inflation becoming entrenched as the Federal Reserve continues to administer its cheap-money medicine despite rising price pressures.
As a result, gold is on the move. After being caught in a funk since last fall gold prices have taken flight. Prices are nearing $1,500 an ounce. But now, some analysts are calling for prices to move towards $5,000 within the next few years. And it could happen sooner than you think.
This is because, according to the folks at Standard Chartered, gold is moving into a new “super-cycle” as a number of structural factors including consumer demand from Asia and tepid supply growth combine to push prices higher. The team, led by Dan Smith, is looking for prices of $2,107 an ounce in 2014 as their base case forecast.
But there is the potential for much more. In their words, “statistical modeling suggests a possible ‘super-bull’ scenario of gold prices rallying up to $4,869 in nominal terms by 2020.” It’s all about supply and demand.
For investors, the initial focus should be on precious metal commodity ETFs like the Gold SPDR (NYSE: GLD) and the iShares Silver Trust (NYSE: SLV). But over the long haul, and as increased supply comes online, it’s the stocks of gold and silver miners that should outperform. Easy exposure can be had from the Global X Silver Miners (NYSE: SIL) — which holds the likes of Silver Wheaton Corp. (NYSE: SLW) — as well as the Market Vectors Gold Miners (NYSE: GDX) — which holds Barrick Gold Corp. (NYSE: ABX).
Demand is coming from the increased wealth in Asia. The evidence shows a strong relationship between rising incomes in places like China and India and increased gold demand. Much of this is cultural, with gold holding a place of special religious reverence.
Data from the Shanghai Gold Exchange shows that China’s imports reached 230 tons in the first 10 months of 2010. In the first two months of 2011 alone, industry experts cited by Standard Chartered estimate imports have already hit 220 tons.
David Davis, an old-hand mining engineer in South Africa who tracks precious metals for Standard Securities, notes that poor, peasant farmers in India, if the monsoons are good and the crops are bountiful, will go and splurge on a grab of gold.
Indeed, the “super-bull” scenario depends on China and India: This outlook assumes that the average income her head in China and India reaches 30% of the U.S. level by 2030. This seems very possible. Standard Chartered is looking for India alone to create nearly 500 million new manufacturing and service jobs over the next 20 years — jobs that will expand India’s middle class from 10% of the population today to 90% over the period.
It won’t be a straight shot to $5,000 an ounce, however. That’s because history shows that gold tends to rally in the period leading up interest rate hikes, it stalls a couple of months before the actual move higher. The European Central Bank became the first rich-world monetary authority to tighten policy last week. And the Fed’s $600 billion “QE2” program is set to end in just two month’s time.
Also, the long-term picture is still cloudy as increased supply is poised to come online. Gold mine output tends to lag price peaks by about 10 years because of the difficult logistics involved in locating, extracting, processing, and transporting virgin gold from the earth. So far, production growth has been subdued: Mine output expanded 7% in 2009 but only 3% in 2010.
Still, production is ramping up: A recent survey by consultancy PWC found that 71% of gold mining companies planned to spend extra cash on developing new projects. With cash margins up 40% year-over-year towards the end of last year, at $655 an ounce according to GFMS data, there is “plenty of money available to spend, which will help to power the next upswing in mine investments and projects.”
Because of the slow start of supply growth, and the rapid economic rebound enjoyed by the likes of India and China recently, prices are likely to continue to drift higher over the next three years until mine production ramps up.
For more, be sure to check out my other recent post on the subject here.
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