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The price of gold has gone from $280 to over $1,400 per ounce in 8 years. Will this bubble burst?
Few will dispute that the price of gold has risen rapidly over the past decade. Some are calling it a bubble while others claim it is merely a return to rational levels. What is a bubble? Is gold in one now? Will it burst in 2011?
What is a Gold Bubble?
One source describes a price bubble as speculation in a commodity causing the price to increase, thus creating a self-feeding machine that boosts prices up even higher. The prices inflate rapidly and hit terrific highs. Typically following this is a nasty downward crash.
Another source suggests that a financial bubble is when market prices steeply deviate from an objective analysis of intrinsic value.
It is difficult to pinpoint any one cause to a bubble, but a common denominator appears to be a highly speculative buying frenzy. What is the difference between a sustainable price advance and a bubble?
Sustainable Price Advances
Prices go up to meet demand and inflation. A price jump is sustainable when the demand is likewise stably climbing.
For instance, if you have a limited supply of corn and the population continues to grow, it is probablye that the value of corn will continue to rise with demand. Unless a large portion of the population suddenly becomes allergic to this staple commodity, demand should remain strong. This is one of the benefits that consumable commodities receive. There is an on-going need for more.
Potentially Dangerous Price Advances
A dangerous price advance is one built primarily on speculation. Instead of the commodity truly being consumed and the population needing more as a replacement, the demand comes from an increase of stockpiling with the goal of selling it later for a higher price.
Only a small fraction of gold is used industrially. An article republished by the World Gold Council claims that only 12 percent of gold usage is industrial. A large amount of the buying of gold is related to speculation. Some of these are:
- Gold bought by central banks
- Gold purchased by investors as an alternative currency
- Gold producers de-hedging futures contracts
- Gold as a hedge
- Speculative buying and selling on futures contracts
If the intrinsic value of a commodity is tied into its ability to be consumed or to its industrial use, then it is hard to arrive at a concrete valuation for gold.
Factors Driving Up the Price of Gold
Here are just a few of the factors that are driving gold prices high:
- Global debt fears
- Comments from World Bank president, Robert Zoellick, hinting toward the return of a partial gold standard
- Political turmoil
- Quantitative easing inflating the paper currency
- Speculative buying by central banks and investors alike
Will the Gold Bubble Burst in 2011?
No doubt many will take exception to calling the current gold prices a bubble. Others purport that this speculative climb in prices cannot be described any other way. Whatever you want to name the strong price advance of gold, will it continue on in 2011? Many analysts think so, and call for an average price of $1,500 per ounce. Nonetheless, much caution should be exercised. What might drive prices back down?
- Return to a stable economy
- Gold prices become too high creating doubt of further advance from general public and institutions
As the global economy improves, we should keep a close eye on the high price of gold. This precious metal has a long-term history of volatile change without warning. If enough people lose their belief in the power of gold, it can fall from the sky like a brick! When this will take place is a question nobody can answer with certainty.
By Kurtis Hemmerling, Jan 7, 2011
Will this super-power create a buying frenzy for gold in 2011? This article looks at the various factors that will have an effect.
China is a massive nation numbering over an estimated 1.3 billion people in 2011. How will their appetite for yellow precious metal effect global gold prices? First we should look at a few statistics.
China Gold Mining and Reserves
Who are the highest volume producers of gold? Well, in 2009 these are the leading players along with their mine output in metric tons.
- China 300
- Australia 220
- South Africa 210
- United States 210
These four countries made up 40% of the gold mine output in 2009 with China making up 13% of that number alone. The Chinese gold production estimates for 2010 are 327 tons of mined gold. They are a leader in mining and producing this precious metal.
What about the amount of gold holdings in metric tons for 2010 according to the World Gold Council? Is China currently the biggest stockpile of gold in the world?
- United States 8,133.5
- Germany 3,401.8
- IMF 2,846
- Italy 2,451
Interestingly, even though China is a leader in gold production, its reserves only held 3.5% of the global 30,562.5 metric tons in 2010. This begs the question: is China a late-game player who is desperately trying to acquire more gold or are the reserves low because China is selling all of its precious metals to other countries? To answer this we need to look at China’s demand for it.
China’s Demand for Gold
According to China Daily, China’s gold consumption for 2010 is anticipated to be 4% higher than 2009, with 430 tons being bought up. This is roughly 100 tons more than estimates on their production.
Clearly, their demand is much higher than what they can produce. They are a net consumer which provides strength to the current price of gold. But is that an increasing or decreasing trend? Will China’s demand for gold outstrip their increasing appetite? To partially answer that question, let’s look at how the central bank gold reserves for China have changed over time.
China’s Central Bank Reserves of Gold
In April 2009, China announced that it made a net purchase of 454 tons of gold over a 6 year period from 2003-2009. This averages to out to a net acquisition of 75.6 metric tons of gold per year. Of course, China is being careful to buy slowly so as not to create a massive spike in prices.
Another report from the World Gold Council shows that they increased reserves from 395 tons in 2000 to 1,054 tons by the first quarter of 2010. This represents an average of 65.9 metric tons per year. We can then extrapolate that the overall buying of gold has sped up since 2000.
There is a further upside. Of China’s reserves, only 1.7% (based on total worth) is estimated as being in gold. This is quite a low as the average for listed countries is 11.1% and the Euro area has 60.7% of its reserves in gold as of December 2010. If the Chinese government decides to come in line with global figures, there needs a large bump in the amount of gold they buy.
Factors That Promote China’s Demand Increase
- Since 1990, the Chinese economy has seen rapid increase. Their GDP has climbed roughly 9% annually from 2007-09. An increase in personal income will provide further buying and investment opportunities.
- China represents 30-50% of the global raw materials demand.
- China continues to buy large stakes in commodity companies around the world.
- From 2003 until the end of 2009, China has doubled its share of the global gold demand from just over 5% to over 10%. This also translates into an average growth rate of 13% per annum from the beginning of 2005 until the end of 2009.
- De-regulation of the gold market has also helped an increase of buying in China.
Is China Enough?
Of course, we have a global gold market in 2011 that needs to be considered. India, which is also a large buyer of gold, must be factored into the equation. Will they turn to other investment types such as condo’s and property or will gold hold its luster? Will rising interest rates and equity markets draw the attention away from the hedging power of gold around the world? Will the US dollar strengthen?
Much remains to be seen but as for China, it appears that its hunger for precious metals and commodities can only add some support to gold prices in 2011.
What are the odds that the price of gold will reach 2000 dollars per ounce in 2011? Some forecasts and predictions say…
Forecasting or predicting the price of gold is not an easy task. There is not a simple formula or chart to consult when guessing where bullion prices will be in 2011. The entire economy is similar to a living breathing organism with many complex parts. Isolating any one aspect is done with the risk of being inaccurate. The price of gold is a difficult number to determine in the overall economic outlook.
To even begin the less than scientific process of forecasting the price of gold, an investor would need to comprehend what is fundamentally behind gold prices. What drives the price of gold up or down?
Fundamentals Behind the Gold Price Forecast of 2011
First, who is buying gold? There are some business applications for gold such as contacts and wires in semi-conductors, or the use of gold in medical instruments. But has the rising price of gold from 400 to 1,200 dollars per ounce in 5 years really come from the the industrial or even the jewelry market? There is another factor to consider.
The value of paper currency can be quite volatile. The FOREX market will take a currency pair for trading and chart the relationship. Look at how the US dollar and the Yen changed relative values over time. In 2002, one US dollar was worth 135 Yen, and in 2010 this amount fell to a mere 85 Yen. Why is the price of paper currency so unstable?
- Political unrest
- Economic depression
- Rising Inflation
There are many other mico-factors that affect gold prices, but essentially it is seen as a form of currency with backing. Gold trading is an alternative monetary system when the local government is in distress. Gold can be easily traded anywhere in the world so its value is not tied directly into the country of one’s origin. Gold is the warm blanket that many pull around them when fear of the outside world looms.
With the economic and political problems around the world it is easy to understand why many would desire a form of currency that has intrinsic value.
Who is Buying Gold and Driving Prices Up?
When the economy plunges or when political unrest occurs, who buys gold?
In recent years there has been a large surge of interest amongst the commodity market traders, but many others are buying gold too:
- Ordinary people can open up their trading platform and buy and sell future contracts of gold.
- The government can accumulate gold in its reserves. While paper currency is good for funding local projects, gold is a better form of payment when dealing with other countries.
- Banks may add gold to their reserves as well.
- Stock traders can buy and sell gold based ETF’s or exchange traded funds.
All of these sources create a buying and selling pressure that will ultimately drive up the price of gold or crash it down.
Price of Gold Forecast and Prediction for 2011?
There is no definitive answer to where the price of gold will be in 2011. The best an investor can do is to look at possibilities based on historical data. If an investor assumes that paper currency will continue its debasing trend, what would be a high estimate on gold prices per ounce? To answer that one needs to look for the highest that gold has been in the past.
January 21st, 1980 saw the price of gold reach 850 US dollars per ounce. To understand how much money this is worth today one would need to adjust the figures according to the Consumer Price Index. 850 dollars in 1980 is worth 2,250 US dollars in the year 2010. If gold were to repeat the value of a previous high it could double from the price it is trading at in June of 2010.
Other analysts suggest that because the current economic output is many times greater than 30 years ago, the peak price of gold could even reach 5,000 dollars per ounce.
On the other hand the argument could be made that markets are based on mass psychology and trader emotions. Some might suggest that the average person would not believe that the price of gold could ever reach up to 5,000 dollars, thus creating a resistance to that level ever being achieved. Some analysts believe that as the market recovers in 2011 and beyond, the price of gold will retreat dramatically as the economic woe gets pushed to the backs of people’s minds and their hedging tactics are tossed aside.
How to Play the Gold Market
Nobody has the complete picture on the future of gold prices. If one feels that the current economic and political unrest are a sign of things to come, then gold could very well continue its advance in price. If one feels that the economy will continue to recover then they should exercise caution when buying gold related investments.
Jeffery Nichols, “High Gold Price Volatility Sees Almost $90 Fall Before Small Bounce,” 08 December 2009, Mineweb.
M.R. Subraman Chennai, “Where is Gold Headed?”, Nov. 29, The Hindu Business Line.