Why Gold Will Shine In The Near Future

Gold investors have been suffering in the last 3.5 years. The outlook for gold, however, is quite positive, according to John Hathaway. Driven by extremes in sentiment, the fact that the gold production will fall at current price levels, the advances in institutionalizing the Chinese gold market, the world monetary system, it seems that gold investors will be rewarded in the future. In a recent interview with The Gold Report, Tocqueville Asset Management fund managers Doug Groh and John Hathaway share their view on the gold market.

The gold mining industry can’t produce any more gold at these prices or lower prices, so that impacts the supply side of the picture. It certainly meets the test of being a contrarian investment. In the opinion of Hathaway and Groh, sentiment is pretty much rock bottom. It has gotten better with this rally, but in the bigger scheme of things, people still scoff at the idea of gold. That is one sign of a bottom.

bernstein_gold_sentiment_index_2006_2015There has been a lot of “fuzz” about the rally of the U.S. Dollar, and how it will affect gold prices because of its inverse correlation. However, it seems that the correlation between the U.S. Dollar Index (DXY), which is the comparative strength of the dollar compared to the euro and the yen, and the gold price is very low. It’s a meaningless relationship over time. From time to time, commentary will refer to one causing a movement in the other, but if we look at the relationship over a long period of time, it really hasn’t mattered.

correlation_gold_dollar_1970_2015

Looking back over the last 20 years, the dollar has been weak relative to gold. Gold is up in dollar terms quite substantially.

gold_vs_dollar_1995_2015

An important evolution in the gold market, with implications on the world’s monetary system, is the Shanghai Gold Exchange. It has the potential to challenge the U.S. dollar as the world’s reserve currency over the next several years. The Shanghai Gold Exchange could even replace the London Bullion Market Association, the London gold fix. Western market conventions such as the gold fix and the Comex will eventually play second fiddle to price discovery in a place like Shanghai, Singapore or Dubai. That’s where physical gold is being traded.

At the same time, it’s important to pay attention to how many more deals the Chinese are doing in renminbi, their currency. It could be some time before China’s currency replaces the dollar as the leading reserve currency, but it is already starting to crowd out the dollar’s unquestioned status, particularly for trade deals. Many people, particularly in the emerging markets, really don’t like the dollar, and that is encouraging competition for the top spot. It’s not going to happen overnight, but it’s something to watch.

God forbid the dollar ever loses its monopoly on reserve currency status. It would change the world. People would have less of an interest in owning U.S Treasury bonds, for one thing. It may mean that inflation numbers, which have benefitted from the strong dollar, could turn less favorable, which is what all the central banks are trying to do anyway.

In case the renminbi would replace the U.S. dollar as the world reserve currency, there would be a positive impact on gold due to a loss of trust in the dollar-reliant system. Jim Grant, publisher of the Interest Rate Observer, said it best: “The price of gold is the inverse of confidence in central banking.” If dollar strength continues relative to other currencies, for a while that’s not a bad thing because competition keeps prices low in U.S. dollars. But ultimately, it’s a destabilizing factor because it’s bad for emerging markets that have borrowed in U.S. dollars.

To the extent that the strong dollar actually becomes a headwind for economic growth in places like Brazil and India, it’s a negative for global growth and it becomes a problem. And it becomes a destabilizing factor for the global economy because it means that the U.S. economy will be challenged by imports and loss of market share because of cheaper European and Asian currencies. Let’s not forget that gold has already risen in every currency except the dollar in the last year and a half.

Courtesy of John Hathaway, Doug Groh, and the Gold Report.

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