The price of gold has declined more than 20 percent so far in 2013. At below $1,300 per ounce, a fair amount of discussion has been happening around the value of gold.
Since gold does not generate any income and it is relatively expensive to store, its valuation has historically been difficult to assess. Recently, with the U.S. dollar rising and interest rates edging up, hot money began to move out of gold exchange-traded funds (ETFs) and into other channels—notably, U.S. equities.
Now let’s attempt to assess the value of gold.
Gold has always had its own unique value. Because central banks can print money in large quantities to stimulate the economy, gold, which has a finite supply, will always have followers who view it as a way to preserve monetary value. This is especially true in many less-developed countries where the majority of the population does not have freedom or access to move money and invest in the U.S. stock market.
Historically, families in many parts of the world pass part of their fortunes to the next generation in some form of jewelry and gold. In most developing countries, corruption is a major issue and an especially large portion of the wealth is concentrated in the hands of a small number of people. They dare not put everything in bank accounts (today it is more difficult to keep offshore accounts secret), so much of the wealth will be used to buy gold and other precious jewelry, and thus demand outlook in the long term is solid.
Over the past decade, environmental awareness has increased, and public awareness of labor conditions at gold mines in developing countries also has been elevated. As a result, labor and environmental restoration costs for gold mining companies have skyrocketed. As the easy-to-mine gold has already been extracted, mines are digging deeper and deeper underground, thus increasing the cost of production. That is why in the last decade, while the price of gold has more than doubled, stock prices of gold mining companies have been less satisfactory. Such costs will only increase going forward.
Article Continues after the discussion. Vote and comment
[tok id=f58a6a0ad7a5efc688867f0fdbf4bd4 partner=1966]
At current prices, some gold mining companies may lose money, and if these price levels hold long term, an industry wide consolidation is inevitable. At present, the price of gold is near the production cost of the majority of gold producers, and some less-efficient projects are experiencing delays. As such, physical supply from the mining industry will decrease.
Supply from the secondary market may also be constrained. Central banks are unlikely to rush to sell their gold holdings for several reasons. First, the act of selling gold reserves would be viewed as a lack of self-confidence. It doesn’t solve major problems anyway, and if central banks have liquidity problems, the gold will simply change hands between central banks as opposed to hitting the open market. Second, the price of gold has fallen so far from its recent highs that sellers would be limiting their returns. Third, currently with gold prices at or below production costs and demand for physical gold holding firm, even prospective sellers are waiting for better timing.
Chinese Demand
We believe that over the next few years, a major demand for gold will come from China, both from the government and consumers.
Over the last two decades, China has failed to develop a vibrant and self-sustaining private sector, and instead has encouraged state enterprises to become more dominant. As such, its economy has to rely on inefficient investments by state enterprises and an export sector funded mainly by foreign investments and government subsidies.
Other developing countries (for example Vietnam and India) with relatively weak currencies are catching up in infrastructure and labor force skills, which has dented China’s ability to compete in low-tech manufacturing and exports.
Moreover, China’s state-controlled companies are generally not competitive in their sectors internationally. Widespread corruption, the lavish lifestyles of government officials, and the wide income gap between rich and poor have market watchers worried about the stability of Chinese society. When the current Chinese credit bubble bursts as a result of the huge over-capacity in many industries, millions of Chinese workers will lose their jobs, and China’s currency could easily drop 30 to 40 percent.
The majority of Chinese companies are more focused on revenues than their bottom lines. Chinese market insiders have little confidence in the capital markets, and the current housing market has become a huge bubble. So people—including government insiders and consumers alike—have only gold as a realistic choice to preserve their wealth and hedge against currency depreciation.
China’s situation may be extreme, but there are similarities in India and some other developing countries. Given the limited supply and solid demand for physical gold, plus the ever-increasing cost of gold mining, it is reasonable to estimate that gold prices will increase 7 to 8 percent yearly for some time to come given current prices.
In fact, a rebound is already underway. Last week, gold prices increased at the fastest rate since October 2011.
Warren Song and Frank Yu are contributors to the Epoch Times.
Friends Read Free