The Price of Gold Bullion

Top 5 Best Reasons to Invest in Gold
Profit Confidential has been bullish on gold shares for a decade now. And our love for gold bullion has not lost its shine. Back in 2002, when the price of gold bullion was trading under $300.00 an ounce, we first started recommending gold-related investments.

There continues to be a lot of value in the stock market today, and it’s commodity-related. But with expectations for declining economic growth in the world’s major economies, it’s easy to see why oil prices are around $96.00 a barrel, not $125.00.

Like the broader stock market, the price of gold bullion is holding up extremely well, and a big reason for this is the sovereign debt crisis in the eurozone. The price of gold bullion should be trending a little lower than it is, but even if emerging economies continue to slow, we don’t expect to see the price of gold bullion dip much below $1,400 or $1,300 an ounce in the next recession.

The risks in the global economy certainly outweigh the current economic fundamentals. When the price of gold bullion was roaring higher, gold stocks were keeping pace. Gold mining companies were able to raise a lot of cash for expansion, and many producing miners are sitting on strong cash balances today.

The stock market definitely approaches gold stocks with a herd mentality, and timing the price of gold bullion for taking on new positions is difficult. Astute investors will actively monitor the price of gold bullion and acquire gold stocks in this market and in the next U.S. recession, but immediate capital gains won’t happen if the spot price isn’t moving higher. Corporate fundamentals for many mid- and top-tier gold producers are excellent, and stock market valuations in this sector are attractive.

Stock market valuations for many gold stocks are very fair at this time. Gold stocks corrected with the rest of the stock market, but didn’t recover as much due to the spot price and investor apathy. Institutional investors had a real fervor for gold mining stocks, but now they have no appetite for risk. This is why the best stock market performers in recent months have been big, brand-name companies that pay dividends.

What do you want to look for in a gold mining stock? Look for companies with a strong management team, lots of cash in the bank, growing production, and low cash costs. With the price of gold bullion currently trading above $1,600 per ounce, the stock market continues to offer lots of good options for gold investments.

And we’re not alone in thinking so.

The price of gold bullion has prompted prominent billionaire investors George Soros and John Paulson to dramatically increase their gold stakes this month, as market analysts fear economic dangers lay ahead.

Paulson purchased 4.5 million shares of SPDR Gold Trust for his $21.0-billion hedge fund Paulson & Co. That leaves an eye-watering 44% of Paulson’s U.S.-traded equities tied to the price of gold bullion. On the same day, the Soros Fund Management revealed it more than doubled its shares of gold bullion. (Source: Mineweb, August 15, 2012,)

The decision by Soros is interesting, considering he thought the rising price of gold bullion made it “the ultimate asset bubble” in September 2010.

“I call gold the ultimate bubble,” said Soros during an appearance on Reuters television. “It [the price of gold bullion] may be going higher, but it’s certainly not safe and it’s not going to last forever.”

Soros made his comments and dumped the majority of his holdings when the price of gold bullion was hovering at $1,275 per ounce. After watching the price of gold bullion skyrocket to $1,900 per ounce and settle out at its $1,600 level, Soros appears to have rekindled his love for the commodity.

Billionaires aren’t the only investors turning to gold bullion in this period of economic uncertainty.

Thanks to the stability in the price of gold bullion and rise in demand, the World Gold Council recently released a report that shows central banks are buying gold bullion in record volumes. The development is good news for gold investors, as it shows that central banks have not lost confidence in gold, nor are they deterred by the price of gold bullion. This is significant, as central banks set a country’s monetary policy by making changes to money supply and setting interest rates. (Source: World Gold Council, August 16.)

Central banks, including those in Kazakhstan, the Philippines, Russia, and the Ukraine, were lured in by the price of gold bullion and increased their holdings in the second quarter to 158 tonnes. That’s more than a 100% increase over the second quarter of 2011, when the central banking sector bought 66 tonnes of gold bullion, representing 16% of total gold demand. According to the report, it was also the highest level of buying since central banks became net buyers of gold in the second quarter of 2009.

Through the first six months of 2012, global demand for gold bullion stood at 2,090 tonnes. That represents a 14% increase over the five-year first-half average of 1,829 tonnes. While the price of gold bullion trended in a tight $100.00 range during the second quarter (around $1,600 an ounce), the bull market is still intact, as demand continues to increase with the growing need to protect capital with non-printable assets.

How is the second half of the year shaping up for the price of gold bullion?

South Korea’s central bank bought another 16 tonnes of gold bullion in July. (Source: Reuters, August 2, 2012.) Over the last 13 months, South Korea’s central bank increased its gold bullion reserves by five times, bringing its total holdings to 70 tonnes.

Kazakhstan’s central bank has made it publicly known that it plans to increase its gold bullion foreign reserves from 12% to 15%. The underlying strength in the price of gold bullion has made it an easy decision for the central banks of emerging markets to continue to fortify their holdings in gold bullion.

What is the largest consumer and miner of gold bullion up to? As one of the fastest-growing economies, it shouldn’t be a surprise to learn that China wants to be a large player in the global trade of gold bullion. Why? So it can set the price of gold bullion like New York City and London do.

The Shanghai Gold Exchange allows the trading of gold bullion, but its membership is limited to only a few investors. Now the Shanghai Gold Exchange is proposing to move gold bullion from the exchanges to another platform, which would open the accessibility to banks and major investors around the world. (Source: Financial Times, July 19, 2012.)

The Chinese economy tends to be pretty exclusive—where international access is extremely limited to foreign institutions. This opening up to banks and investment houses around the world is a significant move for the Chinese economy and the underlying price of gold bullion.

The proposed changes may go into effect as early as August 31, 2012, and would make gold bullion the first commodity to openly trade on this platform.

As a result, China can then say that the price of gold bullion that will be set on this platform can be used by people around the world, and that it is an accurate reflection of the price of gold bullion that people can quote; similar to the price of gold bullion set in London and in New York. China’s argument will be that its platform is open and readily accessible to anyone in the world.

And accessibility is important to China…what with Hong Kong being the free-enterprise portal to the Chinese economy. In spite of the rising price of gold bullion, China’s appetite for the commodity seems insatiable. To better address China’s increased demand for the precious metal, Hong Kong is set to open a new gold bullion vault in September of this year. (Source: Bloomberg, July 26, 2012.)

The state-of-the-art vault will have the capacity to hold 1,000 metric tons, roughly one-quarter of all of the gold bullion in Fort Knox. With this vault, Hong Kong will join the elite ranks of London, New York, and Zurich as the only major storage facilities for gold bullion. It’s no coincidence that this new vault also ties in perfectly with China’s desire to acquire, trade, and set the price of gold bullion internationally.

It also illustrates how important a role China thinks gold bullion will continue to play in the global economy. The new vault and Chinese-operated gold platform also goes to show that in spite of another looming recession, the Chinese government continues to have faith in the price of gold bullion and will also continue to be a stronger buyer of the commodity.

It is interesting that the world’s largest communist country has the patience to wait for the price of gold bullion to fit into its buying criteria before stepping in to shore up its holdings. In this instance, it might be prudent to follow in China’s footsteps.

So while the central banks of the East and the central banks of emerging markets continue to have faith in the price of gold bullion, here in the West, naturally, talk of a gold bullion bubble has resurfaced.

At Profit Confidential, we’re gold bullion bulls. If investors want to bash gold bullion on the grounds that it is not money or no longer part of the monetary system, that is fine. But, saying that the price of gold bullion has created a bubble much like the housing market is completely false!

The definition of a bubble includes the notion that everyone is aware of the commodity and everyone wants it. Lest we forget “tulip mania”—the world’s first speculative bubble from the 1630s; more recently we can point to the U.S. housing bubble. Whether it’s a Dutch tulip bulb or a U.S. house with a white picket fence…everyone wanted to get in on the action and capitalize on the frenzy.

During the U.S. real estate boom years, you couldn’t attend a party or talk to friends without the subject of taking out a second mortgage, buying a home, and “flipping” it coming up. And why not? The prevailing wisdom of the day was that the U.S. housing market would never go down in price. After all…the U.S. housing market was economically and intrinsically more sound than tulips. History was not going to repeat itself.

It did.

Oddly enough, you don’t really hear many people talking about the need to purchase gold bullion, because governments are printing money like crazy. Or people talking about the price of gold bullion. While central banks in the East snap up gold bullion, there is little talk of the price of gold bullion in the West.

Case in point, the U.S. Mint reported that demand for gold bullion American Eagles fell by 49% in July to the lowest level since April. (Source: Bloomberg, Aug. 17, 2012.) Has the price of gold bullion made Americans pile into gold like they did the housing market? Definitely not.

Besides the fact that gold bullion is not widely owned by retail investors, there is another criterion that is evident in all bubbles—the sustained price increase until the price peaks and then collapses. A one-year chart shows that between August 2011 and May 2012, the price of gold bullion was in a consolidation phase. Only since May has the price of gold bullion returned to its winning ways.

As long as central banks continue to find the price of gold bullion attractive, you can set aside the argument that gold bullion is in a bubble, because it is not exhibiting any of the characteristics of a bubble.

In fact, we think recent events will lift the price of gold bullion higher during the third and fourth quarters. On August 1, the last Federal Reserve policy meeting ended with a somewhat neutral outcome for investors interested in gold bullion.

This is because some investors had hoped for additional monetary stimulus to be enacted. However, even though this past meeting resulted in no change, the economic situation continues to deteriorate worldwide. As such, we believe that the data will continue to be weak, and we will witness additional monetary stimulus shortly from several of the world’s central banks. This should, in turn, drive the price of gold bullion higher near the end of the year.

Recent comments by Eric Rosengren, the Federal Reserve Bank of Boston President, will reignite additional expectations of monetary stimulus. Rosengren argued that the central bank should enact open-ended quantitative easing. He also suggested the Federal Reserve should boost this monetary stimulus program by a substantial measure. (Source: Bloomberg, August 7, 2012.)

Rosengren and others are stating that the current monetary stimulus policy is not enough to decrease the unemployment rate and increase the growth rate of the country. The suggestion that open-ended quantitative easing should be the new monetary stimulus policy initiative is quite a change in wording for Federal Reserve standards.

This policy initiative would be quite bullish for certain markets, including the price of gold bullion. With the recent payroll data not being overly horrible, many were led to believe that Federal Reserve policy might be on hold. In the face of news that might turn the market negative, the price of gold bullion held up quite well. In turn, we believe there is more to come.

If we take another look at a one-year gold chart, we can clearly see that following profit taking in May, the price of gold bullion has been steadily gaining momentum. This is a sign that there are increasingly more buyers for gold bullion than there are sellers.

Here are our top five reasons why we believe the price of gold bullion, far from being in a bubble, has room to run.

1. Few investors are aware that growing demand and the rising price of gold bullion ushered in the gold bullion bull market in 2001. If we were to take a survey of retail investors, we would probably find that less than five percent have purchased gold mining stocks or gold producing stocks…or are even aware of the current price of gold bullion. In addition, few investors seem to understand how the actions of the government and the Federal Reserve impact the price of gold bullion.

2. The U.S. dollar, a fiat currency once issued by a creditor country, is now issued by a debtor country. The U.S. dollar is the reserve currency of about 70% of world central banks. As the debt of the U.S. has spiraled out of control, the currency of America, the dollar, has gone from a system where it was once partially backed by the price of gold bullion reserves to a currency that is mired in debt.

3. Gold is the only monetary alternative. The monetary policy of the U.S. has been to expand the money supply, create more dollars, and to keep monetary policy expansive. Economics 101 dictates that the more of anything there is in supply, the less the eventual demand. What currency can investors run to when the U.S. dollar gets into trouble? The euro is finished; the yuan isn’t ready. The price of gold bullion and its strong international, borderless demand makes it the only alternative.

4. Inflation will be a huge problem for Americans in the months and years ahead. Too many dollars continue to be printed, short-term interest rates are near zero for five years, the Fed is buying U.S. Treasuries…how can inflation not rise? Or perhaps this is a better question: hasn’t the 10-year-old bull market in gold and the price of gold bullion been warning us about inflation?

5. Supply in the gold market is falling as mines produce less. This is due in large part to developments in South Africa, the largest gold producer in the world. Over the course of the past 10 years, South African production has declined every year in absolute terms, presenting the industry with a formidable challenge to increase total output at a time of rising demand and the rising price of gold bullion.

While a strong U.S. dollar is major headwind for the price of gold bullion, the current economic conditions and strong international demand for physical gold will make gold bullion a strong bullish play for the unforeseeable future.