INVESTMENT IN GOLD - PART 3

THIS ARTICLE IS CONTRIBUTED BY CHAN CHEH SHIN

 It is often said that as a guide, gold will move upwards when:

¨       USD weakens

¨       Interest rates are kept low

¨       US starts another round of quantitative easing (QE).

¨       High Inflation, >5%.

¨       Equity market turns bearish

¨       Large gold buys by sovereign nations – e.g. India, China & the Arab nations

¨       Signs of countries turning their USD holdings into gold reserves

¨       Uncertainty over the debt situation in Euro Zone & USA

Let me start from

(1)        Inflation (on the argument that inflation will lead to higher gold price),

Weak USD, low interest rate, QE are the usual suspects that will lead to inflation. But let me express what is the real driving force for inflation and deflation:

Inflation is an expansion of credit phenomenon. Deflation is a contraction of credit. Well, we have had many decades of rampant expansion of credit. Now we will have deflation, and the harder the central banks try to fight it by forcing yet more expansion of credit, the worse the problem becomes. With leverage everywhere in the system, it would not take many defaults to wipe out every financial institution. And there will be many defaults. One default will beget another and once it really begins in earnest, there will be no stopping the cascade.

When the developed market faces waves of slow default (Please note the word slow. This kind of slow grinding motion is more damaging than a sudden burst of default as the fear and anxiety is much darker), the developing market would have no chance not to feel the freeze (Also, the big developing countries are facing great a potential problem which is their own creation).

Conclusion : No inflation => no demand for gold.

(2)        Signs of countries turning their USD holdings into gold reserves. Large

gold buying by sovereign nations – India, China & the Arab nations. Uncertainty in Eurozone and US debt situation.

The argument seems to be: Paper money will not survive. Gold standard will be resurrected!

Let’s look at the issue from another angle - barter trade. We must seriously re-examine the following: 

(i)          When nations exchange goods using gold, isn’t this a barter trade?

For example, China approaches Iran for oil. Let’s simulate the dialogue below.

Iran says:” I hate US, thus I am not taking USD. I like China, but I have no confidence in your financial regulations and transparency in policy making. Thus, I will not take RMB.”

China says: ”No problem, I pay you in gold then.”

Iran says: ”Great! Are you giving me paper gold or physical gold?”

China says: ”Paper gold.”

Iran says: ”Huh? You mean you issue an IOU to me saying I have the right to collect the physical gold from you when I need it??!! I doubt you will open your vault when I fly in with my cargo jets.”

China says: ”Fine, I pay you in physical gold.”

Iranian reacts:”Yeah!!!”

Now, both will face the daunting problem of sending/taking delivery, not to mention creation of storage space.

(ii)   Is there enough physical gold for all nations and speculators/investors  while trade must expand? This means more gold will be needed to go around.

 Conclusion : No barter trade => no demand for gold. 

(3) Bearish equity: It has no correlation for gold demand/price. We had gone through 2007 when China’s stock market tumbled, 2002 developed market downturned, 2000 dot-com bubble crashed, 1998 Asia and Russia crashed. 

Effect on gold : none.