After the recent poll, I have understood that the two main questions my readers would like me to address are: "Is it safe to invest in Gold?" and "What is the Economic Outlook for 2010?". I will try to answer here the first question. I will explain why investing in Gold is safe and why it may be not.
Two main reasons why investing in Gold has been for years considered as a safe investment are:
1. Gold's value follows to some extent the inflation rate, therefore protects from high inflation
2. The market for Gold is liquid.But is it true? Can we find out information that shows that indeed Gold Price and inflation are correlated? Is it the same in all the countries? Well, we can try to do it for the U.S. and find information about Gold Prices and also inflation through the CPI for the U.S.
1. Here is how it looks like. It does not seem very correlated, the CPI curve is more smooth than the Gold curve and it makes sense because Gold values are more volatile (market force) than the CPI which as more momentum and less dynamic.
Another way to plot this data is an (X,Y) graph:
What this graph shows is that there is some correlation between CPI index for the U.S and the price of Gold denominated in dollars from 1970 to 2008 (Correlation factor is C=0.76). Notice how the 2009 value is far from the trend, two possible reasons for that, or the CPI is too low for such value of Gold, or the Gold price is not any longer a function of the CPI. I believe that there is only three possible outcomes for 2010: a sharp drop of Gold price bellow the $1,000 bar, a CPI going above the bar of the 300 points index (an inflation greater than 50%), or a little bit of the two scenario: stabilization of the Gold Price above the $1,000 mark and annual inflation between 3% and 10%. But we are missing many element for this analysis: the strength of the dollar as a currency, the price of oil ($/bbl), social and economical outlook for 2010, employment rates, consumer spending, level of investment.
2. If you have physical gold, you can always sell it at anytime. There is also other products like Gold futures, Gold index (XAU), or Gold ETFs. In few words, well, it is liquid.
Conclusion:
I would say, yes it is not a bad idea to have Gold in one's portfolio but I would not consider it as an investment because it does not produce any stream of cash low that you can rely on. Better, I recommend to see it as, what it really is: a commodity with a supply/demand dimension. And as commodity, Gold is subject to high volatility, this is the reason it might not be safe as it seems to buy Gold.
If you have any questions please leave a comment.
2 comments:
lots of analysts are predicting to see gold and silver double in next year or so, due to lack of confidence in dollar stability and with china and india racing to double up their reserves of gold? what do you suggest
It is very difficult to forecast any future price (look at the poll we did in November to try to forecast the Price of Gold on January 1st, 2009), however if what you say is true then you need to quantify it. First quantify the supply of Gold, then quantify the demand of Gold. look here
First the supply, one can believe that the supply will remain constant during the next two years, because it cost a lot of effort to create new capacity, so it may remain around 3,500 tons.
Second the Demand, your point Imran, is that it will increase significantly because China and India want to increase their reserves of Gold. Question, can we quantify it?
Let's look at China Gold holding. 1,054 tons which represents 1.9% of their reserves. The U.S. has 8,133.5 tons of Gold. If China wants to double their reserve, they will have to buy about 1,000 tons of Gold (and if we assume $1,000 per troy ounces) it represents about 32.1 billion USD. Chineese reserves are around $2.3 trillion, with 70% in USD currency, or $1.6 trillion. Therefore China has the means to double their reserves, and also diversify their reserves.
What is the drawback for China?
Well, by doing so they might further depreciate the dollar and reduce the value of their own reserves and reduce the purchasing power of the U.S., thus reducing their exports... therefore shooting themselves twice in their feet.
Conclusion: I believe that if China and India reserves increases it will be at a minor rate through their increase in production (China is the first Gold Producer as of 2009, and has been increasing its production on average by 31 tons per year) and by acquisition. How much pressure would that represent on the demand side of the equation? I do not really know. IMHO it could be between 50 tons to 500 tons. What is the impact of the demand increase on the supply/demand equation? Well,... a price increase! How much? I don't know, it could be 10% increase as 100% increase. However this increase need to be grounded in the Economic reality, and find its balance with the dollar value and as such the inflation in the U.S., the Euro zone, Japan, etc. You cannot do much a coin of Gold... ;-) but you can buy stuff with dollars ...
Suggestions:
1. For personal investment, do not consider gold as an investment, but as a reserve of fund.
2. Price of gold might continue to increase due to a higher demand than supply but I believe it is unlikely to double in one year.
3. Gold is "not an investment" because it does not create any value, do not count on it to give you back a 100% ROI. Gold is a commodity.
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