The chief economist for Dundee Securities suggests that a new central bank agreement, heavy reliance on the U.S. dollar by Asian central bank portfolios and dehedging should all continue to be positive for gold.
In a presentation Wednesday to the Mineral Exploration Roundup in Vancouver, Economist Martin Murenbeeld predicted that the medium-term outlook for gold is positive because of macroeconomic and supply/demand factors, such as further decline of the dollar, and higher debt levels that will pressure monetary policy to remain relaxed in the medium to long term.
Dundee’s base scenario suggests an average gold price of $461 per ounce this year. The company’s more bullish scenario puts a 35% probability on a $506 average.
U.S. Trade account – deficit in foreign exchange markets – gold as a solution?
“The U.S. trade account is deeply in the red with the number of key countries,” according to Murenbeeld. The U.S. trade deficit with Japan is around $70 billion, in excess of $100 billion with the Euro area, $65 billion with Canada, and $150 billion with China. “Indeed, the current account deficit throws off about $2 billion a day on foreign exchange markets, which have to be absorbed,” he explained.
Murenbeeld, who called himself a “dollar bear,” said, that using 1985-87 as a guide, he believes the dollar “has at least another 15% to fall.” When interest rate hikes in 1987 ‘led directly to the stock market crash in October of that year,” the dollar did not bottom until it “became clear that the U.S. current account deficit was finally turned around,” according to Murenbeeld. “Gold, meanwhile, continued to rise right through the interest rate hikes, topping out only when the dollar bottomed.”
Dundee Securities feels that the current upturn in the dollar will prove to be a “correction,” and that the dollar will remain in a downward channel. “If so, we would expect gold to remain in an upward channel,” according to Murenbeeld. He predicted that the next major move in the dollar “should come at the expense of the Asian currencies in general, and the Chinese Yuan specifically.”
Murenbeeld theorized that since the U.S. economy has excess capacity, “the Federal Reserve will not want to tighten monetary policy too much.” Since it is believed that the world economy suffers from too much capital and labor capacity and too little demand, he explained, “economy policy is well advised to remain somewhat loose. …Loose policies that are designed to reflate demand are good for gold.”
Meanwhile, the U.S. had a deficit of $413 billion as of September 2004 while total U.S. debt has risen to nearly 200% of GDP. “The last time the debt level was this high was during the Great Depression when GDP contracted sharply,” he declared. Budget deficits also lead to concerns about overall debt. “The household sector is also carrying record debt,” Murenbeeld said. “In the event interest rates rise significantly, the service burden will take a record bite out of disposable income.”
Financial liabilities of the U.S. set to double in 25 years
“Even the U.S. net financial liabilities are set to double over the next 25 years, and it could be worse in the event the U.S. government cannot control its budget deficit in the coming years,” Murenbeeld said. He suggested that the government must choose among several options including putting more financial responsibility on the household sector, cutting services, and printing more money.
Murenbeeld believes that the new Central Bank Gold Agreement (CBGA) involving 15 nations offers advantages such as market transparency, the continued absence of uncertainty and fear of central bank gold sales, higher gold prices for official sales, and benefits for producing countries in Africa and elsewhere. “The agreement did increase the amount of gold to be sold each year,” he noted, adding “in light of gold returning by the way of dehedging, I believe the market can handle the increase.”
Murenbeeld suggested that Asian central bank reserves represent a potential source of future gold demand. “A small shift in these countries’ preference to gold (lessening their dependence on U.S. dollar reserves) could represent a dramatic new demand for gold,” he said. For instance, if China were to adopt the 15% rule for gold as a percent of reserves as the European Central Bank as decided, China could buy 7875 tonnes of gold, he added.
In the meantime, a decline in mine production output has resulted from the weakness in gold prices in recent years. “This is a positive for the medium-term gold price outlook,” he declared. As gold producers are dehedging, “there is a positive impact on the gold price, but the 400 or so tonnes annually dehedged adds only about $20-$25 to the gold price,” according to Murenbeeld. Therefore, dehedging has not been the main driver of gold prices in recent years, he suggested.
Another positive factor for gold in the medium term is the competition that has developed among gold bullion investment products including the World Gold-sponsored gold ETF on the NYSE, Murenbeeld stated. Meanwhile, “the tremendous wave of gold liberalization that is sweeping South Asia is bound to have a positive impact on gold demand,” he declared.