Think gold is a bubble driven only by animal spirits and speculation? We think not and have consistently maintained the fundamental driver of gold has been the massive accumulation of foreign exchange reserves by global central banks and their need for diversification.
Nothing illustrates this better than the chart below. We have also included the table to illustrate how much gold China and Brazil would have to buy to get to the same proportional gold position as their fellow BRICs, India and Russia.
We calculate the “global monetary base” as the sum of central bank reserves less gold and the U.S. monetary base. Notice, the gold price broke out in late 2003 along with every other commodity and asset, including housing prices.
The Fed takes a lot of heat for its role in fueling the past bubble but foreign central banks played their part through depressing their currencies, accumulating reserves, and recycling the dollars back into U.S. markets. This created a very powerful positive feedback that drove every asset to the moon and pancaked market and implied volatility.
Our view is that investing in gold is a journey and not a destination. There is no right target price for gold or a fair or fundamental value for the yellow metal. When the major central banks are maintaining a zero (or close to) interest rate monetary policies and foreign central banks are accumulating reserves at a rapid clip, the trend in gold prices is north.
In a tightening mode or when foreign central banks stop accumulating reserves the trend will turn south. Until then, all else is noise and we will be buyers on the “french” dips as the bubbeistas provide the opportunity. We were hoping gold will move back to its 200-day moving average to provide us a nice reentry. We’re not so sure we’ll receive such a gift, however.
One last point. Gold is a relatively benign “store of value” as opposed to other commodities such as crude oil, copper, and foodstuffs, which have negative economic and societal consequences during price spikes. We believe we’re close to the “tipping point” prices in some of these commodities. If central banks have been buying them, say, though their sovereign wealth funds, for example, we think they may start to pull back a bit.