John Maynard Keynes famously labeled gold a “barbaric relic.” After bottoming in the summer of 1999, the relic has rebounded, more than doubling in value by the spring of 2006. Since gold began to emerge from the doldrums, important changes have been underway in geopolitical, economic and capital market conditions. What is the sustained rise in the gold price telling us? Common wisdom links its price movements to a familiar list of usual suspects: jewelry demand, asset class diversification, geopolitical risk. Many of these factors can be readily observed. Other drivers are more elusive, with puzzling inconsistencies. The rise of this precious metal offers lessons to curious economic detectives. As financial planners assemble an overall picture, gold provides clues about both the obvious, and the less visible forces at work.
A Useful Indicator
Aside from its beauty, durability and emotional appeal, gold has valuable features as an indicator of the larger economic picture.
As a tiny asset class and scarce commodity with limited supply, changes at the margin show amplified effects. Two-thirds of total world gold production—constituting 3.4 billion troy ounces—has been mined over the past 50 years. “In 2005, mines produced about 2,500 tons, with the remainder coming from central banks’ selling and gold scrap sales,” says Rob Lutts, president and chief investment officer at Cabot Money Management in Salem, Mass.
Slow supply cycles reinforce the impact. At a certain level, added demand must create an inflection point and stimulate new mining activity. Building a mine, however, is labor- and capital-intensive. It takes an average of 10 years and presents environmental and regulatory challenges.
Both demand and supply sides can move sharply. For example, during the Asian contagion crisis of 1997 and ’98, consumers dramatically reduced jewelry consumption by a “whopping” 46 percent, Lutts points out. And in another case, when European central banks agreed to limit gold sales in 1999, the price spiked up $70 that autumn.
Gold, therefore, serves a signaling function. It can send messages to market observers at an early stage about where other asset classes may be heading. Financial advisors should attentively monitor the price of gold as one of the measuring tools that provide clues to overall market direction.
Visible Drivers
Some of the important price drivers are plain to see. It is incontrovertible that economic growth and per capita income have been racing ahead in emerging markets such as China and India. Consumers in those countries and the Middle East have been snapping up gold jewelry, which is part of the Indian wedding tradition. Since last year, China has liberalized ownership laws, allowing citizen to store their own caches.