Gold from a larger perspective
It can be said that the gold price is inversely correlated with the dollar (see diagram) and that the gold price seems to develop well when stocks and bonds are developing less well
From a larger perspective, what governs the price of gold?
If we expand the perspective to include the financial history of the 20th century, we can discern two periods of rapidly increasing prices for gold-related assets: 1928-1937 and 1971-1980. Both periods lasted for nine years. In 1971-1980 the gold price rose from $35/oz reaching a peak of $859/oz in 1980.
During 2006 the demand for gold, expressed in tons, from the jewelry industry decreased by 16%. The value of the purchases from the jewelry industry, however, still rose by 14% to a new all-time high. Demand for gold jewelry is governed by a strong general economy and increases over time, but the factual consumption of gold is by-and-large a function of the price. During previous years we have observed how demand from the jewelry industry has increased along with a decreasing gold price. In a gold market which has a daily turnover of the same order of magnitude as the annual production of the jewelry industry, this industry is not the driving force behind the price development - the development in the world's financial markets has a far greater impact.
Gold production reached a peak in 2001, of 2,604 tons. Since then it has been down trending and during 2006 production decreased by around 2% to 2,467 tons. The largest decrease in production was in South Africa, where it now has reached the lowest levels since 1922. In the major mining countries, such as Canada, Australia, USA and Russia a production decrease was noted as well. The world's currently largest mining country, China, did however increase its mining production by 7%.
The decrease in gold exploration during the 1990's also makes it difficult to count on any increases in production henceforth. The lead time from exploration to mine is very long, and has become ever longer with increasing environmental requirements.
On the stock market the increase in the gold price has made gold stock one of the foremost markets during the last five years. The development could have been even better had the cost development in the industry been more favorable.
According to the Raw Materials Group, the cash cost has increased by around 5% during the same time period. The reason for this is the heavy pressure on costs, currency effects and the fact of mining ore of lower grades. The companies have also had difficulties keeping their reserves intact, despite strongly increased exploration. They attempt to solve this problem by purchasing reserves, through acquisitions of competitors and exploration companies. This seldom, however, results in an increase of the amount of gold reserve per share, which is the most important variable, along with the profits, in making the price of a share to go up.
Since year 2000 China has returned as a participant in the gold market, which could prove to be important in the future. A gold exchange has been started in Shanghai, and since July 2003 it is again legal for private individuals in China to purchase gold. In earlier periods of history China, just like India, has imported large quantities of gold, and many expect a similar development in the future.
During the last years the investment market for gold has come alive. This has resulted in a, for the gold market, new financial instrument being created: ETF. ETF means "exchange traded fund". This is a share which is equivalent to 1/10 oz physical gold. It could be compared to old fashioned paper money, which in principle was a receipt for gold deposited. This is an enormously interesting development, and it opens up the possibility for all the stock markets in the world to buy gold. This also sets up a very cost effective way for private individuals to buy gold without having to think about storing it in some way. The World Gold Council has set as a goal to have gold ETF's listed on all the stock exchanges in the world.
Summary
In summary, we can state that there is very much that speaks for a favorable development of the gold price in the future. The strong expansion of the world economy creates an increased demand for jewelry, while deregulation around the world for the first time has created a situation where gold can be freely traded in a cost effective way. Sales tax on gold in EU has disappeared and major markets have been opened. Central banks, which for a long time have been net sellers of gold, are now for the first time seeing with surprise how the market takes care of their gold and converts it into paper gold (ETF's), just like the old goldsmiths did hundreds of years ago, when they founded the first banks. Our money, on the other hand, gets less and less back up by any real value as the banks decrease their holdings. All central banks, however, are not still on the selling side. Particularly Russia is increasing its gold reserve, and they also don't hesitate to question the dollar as a reserve currency. However, in order to have the same explosive development of the gold price as in the 1970's there is one other component missing, and that is a clearly rising tendency toward inflation in the western countries.
The gold prices are the London a.m. USD/SEK is Riksbankens (Swedish National Bank) Click to enlarge