In a world of paper currencies and paper promises, I can think of many reasons right off the top of my head why the price of gold will continue to go up in the long term, however since this essay's length is limited, I'll just mention 5 of them. In short, while it may feel like a bubble to some, I believe we are just warming up.
1. The smart money is already piled into gold. Some of the world’s savviest money managers have taken large positions in gold. I mentioned John Paulson, David Einhorn, Paul Tudor Jones and Jim Rogers I forgot to mention George Soros, who increased his holding in gold in the third quarter with gold mining stocks and with the SPDR Gold Trust ETF (GLD). This week the Wall Street Journal reported that John Paulson, who I did mention last week, is launching a new gold fund, which will include $250 million of his own personal investment.
Other well-known fund managers publicly piling into gold include Bill Gross, Kyle Bass (Hayman Capital), Paolo Pellegrini (PSQR), John Burbank (Passport Capital), Evy Hambro (Blackrock), Donald Coxe (Coxe Advisors), and David Tice (Prudent Bear Fund). I would expect other major mutual funds, hedge funds and pension funds to follow their lead.
2. Central banks are net buyers of gold for the first time in 22 years. This is a major secular change. According to a report by precious-metals research firm GFMS, for the first time since 1987, central banks around the world bought more gold in the second quarter than they sold. India recently bought 200 tons of gold from the IMF and China is expected to purchase the other 200 tons offered for sale.
3. In June there was an item in Bloomberg about Northwestern Mutual Life Insurance Co., the third-largest U.S. life insurer, having bought gold for the first time the company’s 152-year history. According to the report, the insurance company has accumulated about $400 million in gold. I would expect that other insurance companies might follow suit.
4. China holds $2 Trillion in Foreign Currency reserves and only 2% in gold, vs. a 10% worldwide average. The Chinese are seeing the value of their foreign currency reserves turning to dust every day. If China makes the logical move to increase its gold reserves and reduce its fiat currency exposure to even just the worldwide average, gold prices could move substantially higher.
5. Gold is scarce. The gold industry has not replaced gold reserves mined in over a decade meaning near term shortages. We might get to a situation where there is simply not enough physical gold available to cover the massive quantities of gold that has been pledged. This situation could push the price of gold to the stratosphere. Hong Kong has recently pulled all its gold holdings and deposits from London and brought them home. While investors chase gold to get into something more stable than the dollar, producers aren't keeping up. Gold production was down 3% last year, and it was flat in the most recent quarter. Although mining companies are spending more on new production, especially in China and Russia, that is not enough to offset dwindling output from mature mines. Central banks hold a lot of gold. But they are not interested to sell and in any case, they are bound by an agreement that imposes limits on sales.
However, the road to the top will not be a straight line, and since that is the case it makes sense to take advantage of the inevitable corrections. Let's examine the chart (charts courtesy of http://stockcharts.com) of gold to check if we are close to another buying or selling opportunity. In this essay, I will focus on the precious metals stocks.