A Golden Opportunity

By Daniel Longenecker

Market analysts would love know the future. The problem is—they can’t. So how can a prospective investor know what to expect in the coming years? I believe that investors should investigate proven market factors like supply and demand. In the gold market, several factors have surfaced that indicate shifts in the supply curve and demand curve for gold. Market forces of supply and demand can be trusted to accurately predict prices in a free enterprise system. Thus, decreases in gold supply, increases in gold demand, and the history of demand spikes all suggest that the price of the precious metal will rise in coming years.

How could gold supply decrease when gold mines operate around the clock? The answer lies in the decreasing available supply. China recently has bought up billions of dollars worth of gold from the west. One estimate states that China has increased its gold holdings by more than 1,600 metric tons in the past five years, a change worth more than 77 billion dollars [1]. Instead of allowing gold price to rise, gold ETFs (commercial commodity hoards, often comprised of natural resources, which trade ownership similarly to corporate stocks) have exported heaps of gold to the Far East, to meet their demand. But since gold is a scarce good, the ETFs are depleting irreversibly [2]. Thus, this supply shifter, the move from commercial ownership of gold to governmental ownership of gold, indicates that available supply is decreasing dramatically, and when supply decreases, price rises (Figure 1).

Figure 1. Supply Decrease Curve [3]

Secondly, an increase in demand will increase the price as well. With the massive United States government debt and the U.S. government’s credit rating demotion [4], trust in the dollar has decreased. James Turk writes, “An erosion of trust means that people are less willing to accept the counterparty risk that comes with financial assets … People as a consequence move their wealth into tangible forms of money, which of course means gold.” [5]  His statements make sense, since people are most likely to trust a five thousand year old, tangible asset with trusted scarcity. Thus, the diminishing trust in the dollar will increase the demand for gold, and when demand increases, price rises (Figure 2).

Figure 2. Demand Increase Curve [6]

Lastly, history states that financial panic attacks tend to drive up precious metal prices. Even after the inevitable price spike, like shown here in 1980, the price of the precious metal tends to stay significantly higher than from before the spike (Figure 3).

Figure 3. Price of Gold from 1974-2004 [7]

Although no one can tell if a price escalation will occur in the near future, several events could tip off a panic attack. If some event caused some people to distrust the credit rating of the U.S. government, it could easily result in a run on the government, which would spiral out of control. Another possibility of a panic attack could occur if an ETF or commercial gold holder defaulted on or could not fulfill a moderate sized gold order. Whether or not the ETF had the gold, people would worry that they might not be able to obtain gold. This would produce the same type of price-spiking panic attack.

Even though humans have sought after gold for thousands of years, indications show that gold might become even more precious in the coming years. Decreased available supply due to China’s gold-hoarding policies may increase the gold price. Likewise, gold price might rise due to enlarged demand. And lastly, the gold holder’s dream: a financial panic attack could shoot gold price through the roof. All in all, investing in gold now seems like a golden opportunity!

References:

[1] http://www.zerohedge.com/news/2014-01-19/shanghai-daily-china-expected-announce-it-has-more-doubled-its-gold-reserves

[2] http://www.wallstreetdaily.com/2014/06/11/gold-demand-rising/

[3] http://2012books.lardbucket.org/books/economics-principles-v1.0/s07-applications-of-demand-and-sup.html

[4] http://www.foxnews.com/politics/2011/08/05/us-official-says-sp-reconsidering-us-credit-downgrade/

[5] http://www.zerohedge.com/news/2014-02-15/james-turk-erosion-trust-will-drive-gold-higher

[6] http://2012books.lardbucket.org/books/economics-principles-v1.0/s06-demand-and-supply.html

[7] http://www.finfacts.ie/Private/curency/goldmarketprice.htm