Following the Money

In today’s commentary, I offer several arguments on why I expect the price of gold to continue to rise from its current level and why I believe money will flow into gold.

Who owns the most gold right now? While it may come as a surprise, according to the World Gold Council, the United States holds 57% of its currency reserves in gold. France follows with reserves of 54%, while the British pound is backed by gold reserves of only 8.6%. Canada has only 0.2% of its reserves in gold. When you add in consumers’ holdings and institutional holdings with government holdings, India is the world’s largest owner of gold.

My next question, if so many analysts are saying gold is no longer the true backer of money (this is the same group telling us the U.S. dollar is the real money), why does the U.S. government have 57% of its reserves in gold? Maybe someone should tell these analysts the metal may still be a “store a wealth” after all.

Here are some thought provoking points on gold:

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— A chief investment strategist and portfolio manager at Sprott Asset Management Inc. told analysts at a gathering last week that he expects the price of gold to reach US$1,000 per ounce by the end of the decade. This strategist noted that the huge, growing U.S. deficits will likely soften creditor nation demand for U.S. dollars, driving gold.

— Gold has risen decisively above the US$400 per ounce price only twice: In the early 1980s when gold hit US$850 per ounce and in 1988 when it hit US$500 per ounce. What is most interesting to me is the relationship between the Federal Funds Rate and the price of gold bullion. In the previous two high price points noted above, interest rates were much higher than they are today. Now, we have a 46-low in interest rates and gold is up a hefty 57% from its 2001 low. The Federal funds rate has only been at 1% twice since the Federal Reserve was created… after the Great Depression and today.

— World Central Bank selling of gold bullion from respective reserves is almost exhausted. Only France remains as one of the last big sellers, and it remains to be seen if it will sell the 100 tonnes per year of gold bullion European central bankers have limited the country to selling. There is a real lack of new major gold mining projects coming onto the market. A slowdown in the economy that may dampen demand for jewelry will be offset by less supply.

— Gold bugs will remember an article in Barron’s last year that noted while global capital has increased 100-fold over the past 20 or so years, the gold market has only doubled. There just isn’t that much gold inventory out there… in hand or in the ground. What will happen to the price of gold if U.S. foreign creditors wake up to the deficit-ravaged U.S. economy and switch their focus to gold from U.S. dollars?

The great hockey player Wayne Gretzky once said he “skates to where the puck is going, not to where it is.” From those conservative investors who believe massive U.S. deficits could cause a run on the U.S. dollar, the action will sooner or later go to the gold market. It may not be there now, but where else will the money go? Follow the money to where it’s going, not to where it is.