We hear a lot of noise today about how fear is dissipating with the collapse of the VIX and that the gold trade is therefore over. This motivated us to look at how the GLD trades with big moves in the VIX to confirm if gold is really driven mainly by fear.
We looked at 10-day % changes in both the VIX and GLD and charted the observations on the scatter plot below. If gold were purely a fear trade, the two should consistently move together and the majority of the observations should be in Quadrant II & IV. This is not case, even for large moves in the VIX.
We have written of our belief that the big driver of gold going forward will be central bank buying and their need to diversify massive foreign exchange reserve holdings. The average central bank portfolio maintains a 90% allocation to the dollar and euro, both, of which, now have serious “store of value” risks.
To illustrate the potential buying power of central banks, we constructed the following table to show how much gold China and Brazil would need to buy in order to reach a similar gold allocation of their fellow BRICs, Russia and India. That is, to move from “Straw BRICs to Gold BRICs.” To reach the average of Russia and India’s reserve allocation to gold of 7.4%, China and Russia would have to buy about 3,600 tonnes of gold, which is more than three times the total gold holdings of GLD!
Because we believe central banks will be the major driver in 2011, it is our opinion gold will outperform silver next year.
Gold is, again, testing and holding its 50-day moving average, though we wouldn’t be surprised to see a further correction and move toward the 200-day moving average as the global rise in real interest rates puts more pressure on the metal. We don’t think the rally is over, however, as central banks will continue to accumulate reserves and buy gold until zero interest rate policies and quantitative easing begins to reverse.
The gold trade is not about the destination, but the journey. There is no fair or destination price for gold. And the journey upward will continue as long as zero interest rates remain in place and central banks continue to print money and accumulate foreign exchange reserves.
