Martin M
That was the conclusion drawn by Dr. Martin Murenbeeld, one of the most respected economists analysing the gold market, in his presentation to the Investing in Americas Summit, the conference run by Global Investment Conferences in Nassau this week.
Author: Rhona O'Connell
Posted: Friday , 06 Apr 2007
NASSAU -
In a wide-ranging review of the market and the essential parameters that govern it, Dr Murenbeeld presented eight bullish factors driving the gold price at the moment. In the interests of balance he naturally looked also at the bearish factors, of which he identified just two, so we shall deal with these first and then revert to the bullish arguments.
The first bearish influence is that monetary policy has tightened and that liquidity conditions could deteriorate. This would reduce gold demand (and as he pointed out, also supply) and the price would come down accordingly. Real US interest rates are in the danger zone; Dr Murenbeeld notes that gold prices tend to stall when real short term US rates are approaching 3%. Furthermore the rise in global liquidity has moderated in recent years. The second factor is that recessions reduce demand for commodities, reduce inflationary pressures and gold falls foul of both those changes. The gold price often declines during and after recessions; the only reason it did not do so last time was because of the speed of the reaction of the Federal Reserve in cutting rates.
In his outline Dr Murenbeeld displayed his Gold Monitor Model, which factors in a series of external parameters that have an impact on the price and, running the series back to 1998, calculates that the model pitched gold on Friday 30th March at $640. The fix that Friday afternoon was $661.75 so on that basis, gold is at about the right level and in his words, "there is nothing fluffy about this gold price". Furthermore, trend analysis shows that mining equities, as measured by the XAU index, are undervalued, both with respect to gold and, more importantly, with respect to the S+P 500.
The eight bullish factors:
Ø The dollar must decline further
Ø Dollar reserves are excessive
Ø Gold is "cheap"
Ø Monetary reflation is coming
Ø Supply is limited
Ø Demand developments are revolutionary
Ø The commodity cycle lasts years
Ø The geopolitical environment favours gold
The dollar. Plenty of arguments here with respect to over-valuation but the key parameters are that the current account deficit suggests the dollar is overvalued by up to 25%, certainly when compared with the dollar's decline in 1985 - 1987. This is underpinned by recent arguments from the IMF, which has said that the dollar's real exchange rate appears to be overvalued by between 15% and 35%. Dr Murenbeeld, like many others, also argues that the renminbi needs to be revalued and reminds us that the unification of the renminbi at the end of 1993, prior to which there were two rates, an internal and an external exchange rate, was an effective 34% devaluation of the RMB in the international currency markets and that it is arguable that the Chinese Government should let the RMB float up to the pre-1994 level.
Dollar reserves. He points also to the ballooning level of dollar foreign exchange reserves, notably in the Far East, where the Big Six hold $2.7 trillion between them, roughly 56% of the world total. He notes that while diversification would do wonders for the gold price, it is not feasible even just for China and Japan to raise their holdings to 15% of gold+foreign exchange combined as it would require (at $600/ounce) 16,300 tonnes just for those two nations and that it simply is not going to happen.
A key relationship to note is gold and the OPEC nations' current account surplus. It is no coincidence that the last time gold peaked, so did OPEC's current account surplus. It is well documented, though often forgotten that when the oil price was very strong in the past, the Middle East was a heavy buyer of gold and this fanned the rise in price. Having attained critical mass last time around, it is not necessarily the case that the region would be an exceptionally strong buyer this time, but there is clear evidence of lively buying in the region.
Risk diversification theory would suggest that a shift out of the dollar is inevitable, as is the pervading fear of further dollar declines along with geopolitical trends (note, for example, that some OPEC nations are now invoicing in euros rather than dollars). There is a counter argument to this, however, which relates to the overwhelming size of the dollar market compared with other currencies, which means that widespread diversification is not on the cards.
Gold is "cheap". In constant dollars going back to 1970, gold is not far above its average price for the period ($564/ounce) while it is at an all time low in terms of oil at a ratio of less than seven compared with a 1970 - 2007 average of 16.98:1. It is also cheap in terms of other financial assets, with the ratio to the S+P 500 standing at just over ten.
Monetary reflation looks to be imminent; note that Dr Bernanke has recently referred to the fact that demographic changes (the retirement of the baby-boomers) and increased medical costs mean that federal expenditures are likely to rise sharply and pose difficult choices; while David Dodge has said that policy makers have a responsibility to mitigate the impact of the risks of a drop in US demand not being matched by higher demand in other countries. All of which points, in Dr Murenbeeld's view, to monetary reflation.
Furthermore it is arguable that the housing sector could force monetary easing in the short term while rising government liabilities could make it necessary in the longer term. He argues that we cannot afford the US to go into a recession as it is vital to keep propelling the Chinese and Indian markets in particular and they need US purchasing to remain healthy. Government choices are therefore limited either to unpopular measures with the voters (service cuts, tax hikes) or possibly the printing of more money.
Gold supply is limited. The long lead time between exploration, discovery and coming on stream suggest that in the wake of the price weakness in the 1990s, gold mine output should be declining in the near future while the amount of central bank gold that is potentially in loose hands is very limited, standing at just over 3,740 tonnes. It is also noteworthy that some non-signatories to the CBGA are actually buyers of gold rather than potential sellers.
Demand is healthy. Consumer expenditure in gold demand has risen dramatically in recent years and is likely to continue to do so, while investment demand has been stimulated by the Exchange Traded Funds, while gold is also benefiting from the fresh acceptance of commodities as an asset class. Meanwhile there has been substantial further stimulus for gold demand across Asia with the deregulation of the gold market, notably in India in the 1990s and now in China.
The commodity cycle: Dr Murenbeeld argues that, going all the way back to 1800, the shortest bull cycle in gold has been ten years (1970 to 1980) and also reminds us that there is always at least one counter-cyclical year within the period.
The final bullish argument is the geopolitical arena, which is clearly conducive to higher gold prices and which is well-documented.
Dr Murenbeeld's conclusion is as follows.
There is a ten per cent chance of a "lousy" environment for gold with prices below $600 this year and next. There is a 45% chance of an environment that sees gold end this year at $700 and average $665 in 2007 and $720 in 2008, and also a 45% chance of a high road scenario in which gold touches $805 this year after an average of $717 and averages $863 next year.
On a probability-weighted basis this gives us an average this year of $680, a year-end price of $730 and an average next year of $765.
