At a time when central banks all over the world are pumping money into their economies, record amounts of cash are being sunk into a shiny hard rock. This rock cannot be consumed, has minimal industrial uses, and has negative cash flow due to storage and security costs. Nonetheless, gold serves as a currency of last resort, and the huge sums flowing into gold threatens to drain liquidity from the economy at the very moment when it is most required.
Of course, for every buyer of gold, there must be a seller. Gold miners and European central banks are traditionally net sellers of gold. Miners are likely to reinvest the cash in more mining equipment and gold exploration projects, which in my view, is a largely non-productive investment that does not increase the welfare of society. A society with more gold merely incurs more storage and security costs. Central banks tend to sell gold to raise foreign currency (or in the case of European banks, to raise euros) with which to repay bonds, which recycles the cash back into the economy, and so is more innocuous. Still, the silver lining is that central banks have no limits in quantitative easing, and can always print more money to counteract the “gold drag” on the economy.
Gold is likely to continue its climb as European central banks tamp down on their gold sales, and gold miners cannot possibly keep up with the surging demand. Central banks are trying very hard to fight deflation and pump a little inflation into the economy, which will encourage people to stop hoarding cash and start spending. When that happens, gold is likely to appreciate still further, since it is a traditional hedge against inflation. Gold bugs are rejoicing, while gold skeptics point in vain to the many other productive hard assets and excellent companies with pricing power that are likely to keep their value with inflation. I, for one, find it difficult to value gold, and would not be able to sleep at night if I invested in gold, and so prefer to head towards the contrarian camp and invest in things I understand.
{ 3 comments… read them below or add one }
One key point that this article doesn’t address is the demand for Gold in the developing countries such as India and China. Gold is ingrained in these cultures as a status symbol. I know from personal experience that the most popular gift for women in India and China is Gold jewelry. So, there is a concrete value for Gold. Also, it stimulates economies in these countries. Here are few examples:
– Mining Industry
– Jewelry making industry (Traditionally take 2/24 Carats off the top to make Jewelry and stabilize the metal for durable use)
– Jewelry Wholesalers
– Jewelry Repair/Polish vendors
– Jewelry Retailers
– Banks/Security deposit boxes
– Insurance Industry
If people are rational, then rising gold prices should depress demand for gold jewelry. But it is true that rising incomes in India and China should boost consumption in jewelry, which should boost economic activity in the jewelry industry. This is just cyclical growth, but its better than no growth. I just hope that the ensuing gold bubble doesn’t torpedo the economy a second time.
Yeah. These pesky metals bubbles. I’ve been hoarding BU US90% rolls for 40 years. I’m really bummin’… “:^) Our time is near. Pray for our nation and soldiers! Pray for politicians with brains, please. BUY SILVER. Save your assets. NF