Recently by Jeff Clark: The Buzz Around Gold Is GrowingLouder
Is the mania here?
When most investors hear the word mania they think of a runaway market induced by greed. You know, that animal-like instinct we all occasionally feel, the one promising riches from a market on a rip-roaring tear.
Gold is up 28% since July 1, a mostly one-way rocket ride thats transpired in just 36 trading days. Its up 35% year-to-date, and its still summer. But it isnt greed driving our runaway gold price.
Welcome to the Fear Mania.
Pick your headline the downgrade of US debt, solvency concerns with European banks, the sudden negative outlook for the global economy, or crashing stock markets. While none of those are exactly shocking developments to most readers here, it caught much of mainstream off-guard, driving them to safe havens. Gold has responded.
Heres some evidence that were in a fear mania. First, as economic fears suddenly took a turn for the worse, investors didnt rush into stocks. They didnt even really pursue other precious metals.
Heres a look at how the four primary precious metals have performed as fear in the marketplace increased. Notice how the returns shifted as the gloom ratcheted up.
What Metal Performs Best in a High Fear Environment? Asset YTD Return Return From April 1 Return From June 1 Return From August 1 Gold 35.0% 31.9% 23.5% 16.6% Silver 42.7% 15.4% 13.1% 10.3% Platinum 8.3% 7.2% 4.0% 6.9% Palladium -4.5% -0.7% -2.1% -7.6% Prices through August 22
Since industrial and jewelry uses comprise roughly 93% of all demand for both platinum and palladium, a reasonably positive economic outlook is required for these metals to perform their best. We dont have that right now, and when a strong economy will return is highly debatable.
Silver started the year with a bang but even it lagged gold as negative economic news made bigger headlines. Industrial use alone comprises 52% of all demand for silver, so it, too, is vulnerable in a slowing economy. (The price will soar again, though, as weve seen the past few days, when bad economic news leaves the front page and investors once again pursue it as an alternative currency.)
There are more clues were in a fear mania. Many U.S. investors dont realize this, but only 8% of bullion and jewelry demand comes from North America. A full 92% of the critical drivers of physical demand originate elsewhere. Gold in these countries (China, India, Vietnam, Indonesia, South Korea, Thailand, etc.) has been intertwined in culture, religion, and economy for 2,000 years. We can thus garner hints about the gold market from these regions, where the metal is a longstanding and ingrained part of the financial makeup.
First, are they pulling back on their purchases in light of rocketing prices? Or perhaps even selling to grab a profit? The World Gold Council reported last week that signs of strength in the market remain concentrated in India and China It is quite hard to see what is going to dent strength of demand at the moment. And this from the UK: Even at these elevated price levels, interest in physical gold remains excellent, said Ross Norman, CEO of Sharps Pixley.
A second clue from this large group comes from scrap sales. One would think now is the optimal time to cash in your old gold jewelry, with prices reaching such unexpected highs. So scrap sales are up, right?
From the Wall Street Journal yesterday: Scrap sales are down by 50%-60%. People are feeling that gold is the only safe place left for investments, said Pawan Chokshi, an Ahmedabad-based bullion dealer. There are hardly any scrap sales happening and I think thats a phenomenon cutting across India. Even at these prices, people are feeling that its better to invest in gold rather than sell their old gold.
Martin Grubb of the WGC said this to Reuters last week: The price elasticity of recycling seems to be changing. Normally, you would see a lot of recycled gold coming back into the market at such a high gold price but recycling was very muted in the second quarter, and so far the evidence is that there isnt a lot of recycling coming back now, either.
According to Grubb, these regions have adjusted to the current price environment and expect the upward price trend to continue. If fear were muted, scrap sales would be rising at these price levels, not falling dramatically.
And last, dont forget central banks. South Korea just disclosed a big bullion purchase, buying 25 tonnes last week, more than doubling its holdings. Mexico, Russia, and Thailand have already been major buyers this year. In fact, year-to-date, governments have almost tripled their net gold purchases over 2010, increasing their holdings by 203.5 tonnes this year, up from a 76-tonne rise last year.
Central banks have fiat fear and are diversifying their reserves away from the dollar and other afflicted currencies. And this is not a trend that will change on a dime, as most of these countries have a tiny percentage of their reserves denominated in gold. Theyll be buying for quite some time. Remember, they were net sellers of gold for 23 years, becoming buyers just last year.
The bottom line is that gold is doing exactly what its supposed to do. Global fear is high, and these are the exact circumstances where gold fulfills its ultimate role.
There are direct investment implications here. First, if you believe there is further shock-and-awe type bad news ahead, youll want to favor gold over most other assets and even other metals. Second, prices in a mania tend to go higher and further than what most expect. I certainly wouldnt chase it here, but I wouldnt be without some exposure either. Last, high levels of fear also increase volatility. Expect big swings in gold going forward, and that includes corrections. The next one could be a doozy.
In the big picture, think about this: The relentless rise were witnessing is just the beginning. We havent even hit an inflation-adjusted price from 1980 yet; were at least 21% away from that, and thats assuming the government measures inflation correctly. Heres an excellent video demonstrating that were not yet in a bubble; it also shows just how high the price could climb.
You might not think the price will fetch the high four-digits in this Fear Mania. But dont forget what comes next.
The Greed Mania.
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Jeff Clark is editor of BIG GOLD in Casey’s Daily Dispatch.