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The Gold Surge Mystery

If you’re reading this piece, there’s a good chance that you are (like your correspondent) a child of the 80s.

Gold Bars
AP
Gold Bars

You might remember that the beginning of that decade marked the first live birth of a Giant Panda Bear in captivity, the maiden launch of Pac-Man and the sad and tragic murder of John Lennon.

An average house in the UK cost £13,650 ($21,840), census data showed the US population to be just over 226.5 million and Michael Jackson’s “Rock with You” topped the Billboard charts.

That same week, gold hit its (then) record-high of $850 a Troy ounce on 21 January.

A lot has changed since then, but some things stay the same: we‘re back to breaching all-time highs for the price of bullion; three times last week, in fact, before topping out at $1,058 an ounce. And Michael Jackson is still topping the musical charts as the world’s most downloaded artist.

Three decades ago, hyperinflation fears gripped investors as central banks defended currencies with double-digit interest rates and oil prices soared. Gold as both a “store-of-value” and an inflation hedge trade had buyers literally lining up on the street to grab pieces of the bullion.

Today the drive for gold is no less intense – and no less emotional – but clearly very different, both in practical and momentum terms.

Firstly, the inflation element of gold’s recent advance is mysterious. Bond investors – those most acute to rising consumer prices – are pricing in only a modest 1.9 percent inflation assumption over the next 10 years in the United States.

Over the previous 10 years, gold has had a very, very low correlation to core US consumer prices (under 10 percent by some calculations). Besides, if you adjusted the 1980 Gold price record of $850 for inflation, you’d get something in the region of $2,300. Clearly, we’re some ways from that figure, even as we hover around record highs today.

Secondly, the changing nature of how gold is purchased has upset the supply/demand dynamic. Consider that investment appetite for bullion when the decade-long rally began was only 7 percent of total demand, according to metals consultant GFMS.

Today, it’s 34 percent, thanks in part to the proliferation of Exchange Traded Funds (8 percent of global demand, according to the World Gold Council) and the participation of powerful hedge funds such as Greenlight Capital.

But jewellery demand, which includes the traditional “Indian Wedding Season” season and gift-giving observances in Muslim and Christian cultures, will drop 20 percent this year due to high gold prices and the current global recession.

Precious metals retailer Kitco says global mining output rose 7 percent in the first six months of this year, as the $40 billion in capacity over the past decade bears fruit. That should add 450 tons annually, or 5 percent, to global gold over the next four years.

So far, so bearish. But gold bulls have a case to be heard.

To begin, the metal is on a nine-year tear of annual gains, the best performance in at least 60 years. And it might still be undervalued, especially when you match it against an unlikely peer. Previous gold peaks have pegged it roughly to the equivalent of the Dow Jones Industrial Average.

In 1933, when gold traded at $32 an ounce, the Dow sank to 50 in February of the same year. In 1980, gold’s $850 high came in a week when the Dow closed at 873 points.

Today, John Hathaway of the Tocqueville Gold Fund sees gold rocketing to $5,000 or $10,000 an ounce to more closely reflect the current levels of the Dow, which now sits at 9,800. Put another way, gold is trading at a nine-times discount to the famous average.

Others point to an interesting counter-intuition in the recent Gold rally.

The Hulbert Gold Newsletter Sentiment Index, or HGNSI, tracks the gold market sentiment of thousands of newsletters in the sector. The HGNSI currently sits around 32 percent, compared to a 30-year record high of 90 percent.

And the bets continue to pour in. Non-commercial “net longs” in COMEX gold futures hit and an all-time high on Oct. 9, according to the U.S. Commodity Futures Trading Commission.

Of course, many market observers who are agnostic on the metal will simply point to gold’s inverse relationship to the dollar, which is floating around 13-months lows against the major currency pairs, as the principal driver of price momentum.

Whatever the reason for the recent record run, skeptics can’t ignore the momentum – and gold bugs must pay heed to the warnings. One thing’s for sure: the precious metal remains a key component to any complete investment portfolio.

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