$2,000 Gold Will Come From the East

For every investor in the Western world who sells an ounce of gold, picture a multitude of eager buyers in the East who are thrilled by the long-term investment opportunity.

Though not a particularly technical means of understanding the complex dynamics of global supply and demand for gold, that image does illustrate an important aspect of the bullish trend for gold demand that continues to play out on the world's stage.

Much has been made recently of the decision by George Soros to sell the vast majority of his fund's stake in the SPDR Gold Trust (NYSE: GLD  ) during the first quarter of 2011, emboldening the predictable chorus of bubble babble that plays incessantly in the background behind gold's symphony of sustained upward momentum. But while Soros and several other fund managers were busy locking in impressive gains from gold, an incredible surge in gold demand from Asia continues to pave a rising concrete floor beneath long-term gold prices.

The World Gold Council released its quarterly review of global demand last week, which revealed that China's total investment demand surged an astonishing 123% over the prior-year quarter to oust India from the No. 1 position with 90.9 tons of demand. Thanks to a world-dominating market for gold jewelry, India retains the lead for total gold demand, but the growth trend visible from China strongly suggests an imminent ascent to become the world's foremost market for physical gold.

Understanding China's role in the outlook for gold prices
The persistence of massive budget deficits, loose monetary policy, an unrepentant degree of leverage and derivative exposures within Western financial behemoths, and the U.S. dollar's uncertain future as the world's primary reserve currency ... all of these factors and more combine to ensure that economic developments in the Western world will continue to command the spotlight as fundamental drivers behind gold's ongoing secular bull market.

But to examine the outlook for gold exclusively in those terms is to ignore the central role that Eastern culture, economic trends, and prevailing demographics are each likely to play in subsequent phases of gold's multiyear advance.

Gold's immutable legacy as an enduring store of value is firmly rooted in both cultural traditions: East and West. However, whereas the Western world shifted to an unmistakably negative prevailing attitude toward gold during the 20th century -- devolving ultimately into widespread prejudice against advocates of investment exposure to gold -- China is described by the WGC as sharing a "similar gold culture and heritage" with India. Thus, it may come as no surprise that we are witnessing a much faster cultural reprioritization of gold as a broadly popular investment asset in China than we have observed in the West to date. Indeed, for all the widespread bull-market hoopla surrounding gold, total consumer demand for gold (jewelry and investment demand combined) in the United States actually fell by 3% over the trailing 12 months through March 31, 2011; while in China that demand grew by 37% over the prior-year period.

Buyers of gold in India and China are cognizant of the debt-driven currency distress prevailing in Europe and the U.S., but I believe Western gold observers tend to overlook demand-stoking factors of a more local nature. Excessive rates of economic growth in the East will tend to erode a saver's purchasing power just as surely as the currency impacts of easy monetary policy and bailout boondoggles will do in the West. Wherever one encounters negative real rates of return on cash, there too shall one find a powerful incentive for individuals to look to gold. India's real deposit rate for 2011 is forecast to be more sharply negative than that in the United States, and China remains in negative territory as well despite concerted efforts to apply the brakes to growth.

From that improving picture of what motivates individuals in the East to purchase gold, one must then apply the powerful multiplier effects present in the strong demographic trends unfolding in key markets like China and India. As routinely as these factors are weighed in forecasting bullish demand trends for industrial commodities, the extent to which they are overlooked by those offering bearish outlooks for gold strikes this Fool as a curious phenomenon. Sure, China will require plenty of copper and industrial commodities to build cities and related infrastructure for its rapidly urbanizing population, but among the future buyers of gold in China one must adequately consider the "200 million affluent and middle-income consumers" that KPMG China estimates "will emerge in China's smaller cities in the next decade." Another 60 million such consumers (and savers) are expected to crop up within China's top-tier cities during the same time frame.

Per-capita demand for gold in China has been increasing at an accelerating rate in recent years, and the WGC considers that "near-term inflationary expectations and rising income levels are likely to support the investment case for gold as an asset class, especially given that Chinese consumers are high savers and are looking to gold to protect their wealth." As a result, the WGC concludes: "We believe that Chinese gold demand could double within the next decade. However, given the recent momentum in Chinese gold demand, we would not be surprised to see this result achieved in a shorter time frame."

East versus West
Even before applying those bullish economic and demographic forecasts that portend further increases in gold demand in the East, a present-day snapshot already reveals the relatively minor role that U.S. and European demand plays within the global market. Consumer demand for gold in India reached 291.8 tons during the first quarter of 2011, while China chipped in another 233.8 tons of demand (up 11% over the prior-year mark). Together, those two nations account for 57% of total worldwide consumer demand for gold, and more than 12 times the scale of demand originating in the United States!

So before investors mistakenly interpret profit-taking by gold investors like George Soros as heralding a looming end to this secular bull market for gold, I ask that Fools pause to consider WGC managing director of investment Marcus Grubb's observation of "eastern demand picking up any of the gold coming out of the hands of western investors," and the clear corroboration of that trend by gold traders last January. And to protect oneself from viewing gold through a lens that is excessively focused upon Western market forces, Grubb offers the following reminder:

While of course the demand for gold has been high and continues to be very high in Western markets, because of economic fears and concerns about deficits, concerns about future inflation, currency debasement ... I do think that the focus on that in Western countries does detract from the fact that gold is part of the super cycle in commodities and it is being invested in and purchased in Asia at a very rapid rate as wealth increases and population demographics increase.

While near-term swings in the gold price can prove both sudden and pronounced, I maintain that the dynamics contemplated above imply a steadily rising floor beneath long-term gold prices that will carry the metal comfortably through my target of $2,000 per ounce. I continue to recommend a multitiered approach to gold exposure that might resemble the following: a physical bullion proxy such as the Sprott Physical Gold Trust (NYSE: PHYS  ) , a high-quality growth vehicle such as Goldcorp (NYSE: GG  ) or Yamana Gold (NYSE: AUY  ) , a selection of compelling turnaround stories such as Gammon Gold (NYSE: GRS  ) and Northgate Minerals (AMEX: NXG  ) , and some high-octane upside potential from a small-scale producer such as Brigus Gold (AMEX: BRD  ) .

Looking for more gold stock ideas? The Motley Fool has a new, free report where we reveal "The Tiny Gold Stock Digging Up Massive Profits." Just click on the link to get your copy today -- it's free.

Gold is a hot topic on the blogs at Motley Fool CAPS. Join the free service today and see just how many Fools are taking the long view when it comes to investing in gold. The "Gold" tag at CAPS lists 77 potential investments, and you'll find Christopher's comments on many of them.

Fool contributor Christopher Barker can be found blogging actively and acting Foolishly within the CAPS community under the username TMFSinchiruna. He tweets. He owns shares of Brigus Gold, Gammon Gold, Goldcorp, Northgate Minerals, and Yamana Gold. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a gilded disclosure policy.


Read/Post Comments (13) | Recommend This Article (88)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 24, 2011, at 11:25 AM, JeanDavid wrote:

    If I wanted to be significantly invested in gold to protect myself from a government devaluing its currency, I would take physical possession of the gold I bought. Because investing in a commodities account of any kind, including SPDR Gold Trust exposes me to the risk that the gold is not really there, or that the trust might refuse to redeem my investment either by its own choice, or by government order. If all the outstanding gold or silver contracts were presented for redemption instead of rolled over, it is my understanding that the exchanges could not comply. So my fear of the government not protecting the value of its paper money is very closely related to my fear that the trusts, and futures markets will also not be able to defend the value of those paper certificates. It seems to me if you want to use gold or silver to protect the value, you had better have physical possession of the stuff, not paper certificates of deposit or the like.

  • Report this Comment On May 24, 2011, at 12:45 PM, tdonb wrote:

    I have been thinking about getting a physical bullion proxy, and am wondering about the tax implications with http://caps.fool.com/Ticker/PHYS.aspx and http://caps.fool.com/Ticker/CEF.aspx. Do you know anything about how the taxes work on those? Thanks again.

  • Report this Comment On May 24, 2011, at 12:52 PM, tdonb wrote:

    Found this on PHYS: http://www.sprottphysicalgoldtrust.com/Investors/Tax-Informa.... Looks like you can get it for 15% somehow.

  • Report this Comment On May 24, 2011, at 12:53 PM, XMFSinchiruna wrote:

    tdonb,

    Those are indeed important considerations. Please consider the following article a Foolish primer on the issue:

    http://www.fool.com/investing/general/2010/06/01/how-to-get-...

  • Report this Comment On May 24, 2011, at 4:34 PM, skypilot2005 wrote:

    May 24, 2011, at 11:25 AM, JeanDavid wrote

    "So my fear of the government not protecting the value of its paper money is very closely related to my fear that the trusts, and futures markets will also not be able to defend the value of those paper certificates. It seems to me if you want to use gold or silver to protect the value, you had better have physical possession of the stuff, not paper certificates of deposit or the like."

    I feel you need to factor in the probability of occurrence. If you feel it will occur, what is the probability it will happen gradually or all at once?

    The link to Sinch’s June 1, 2010 piece above has some great information for you to consider before deciding on taking physical possession or not.

    Taking physical possession carries increased costs and risks, as well. I suppose it depends on your viewpoint and your degree of certainty. I feel a lot more comfortable now that on-line trades are executed in seconds and that we have access to our accounts online from virtually anywhere.

    I don’t feel a need now, to stack gold next to my stash of aluminum foil I would wrap around myself in case of nuclear attack.

    But, that’s just me.

    Sky Pilot

  • Report this Comment On May 24, 2011, at 5:54 PM, bartbertholic wrote:

    Good article -- thanks

  • Report this Comment On May 24, 2011, at 7:38 PM, rfaramir wrote:

    “total consumer demand for gold (jewelry and investment demand combined) in the United States actually fell by 3% over the trailing 12 months through March 31, 2011”

    Never would have guessed that! Maybe these ‘high’ prices are inducing Americans to sell to the Asians already.

    “Excessive rates of economic growth in the East will tend to erode a saver's purchasing power just as surely as the currency impacts of easy monetary policy and bailout boondoggles will do in the West.”

    What?? As production of real goods and services grows (the only definition of ‘economic growth’ that matters), prices should tend to fall. If they don’t, then someone is increasing the money supply, robbing you of purchasing power when it should be rising. Of course, if you are letting yourself be distracted by official government GDP numbers, then you will fail.

    “negative real rates of return on cash” is cause for riots in the streets! That is practically direct theft!

  • Report this Comment On May 28, 2011, at 6:44 PM, wantingtoretire wrote:

    Like all things, when the going gets tough you need options. There are no silver bullets. Many people expect the dollar to collapse but that doesn't mean you shouldn't hold dollars. You will need to trade for food and gold will be difficult to trade at street level. You will need to hold gold and silver and to be able to protect it with force. It will be worth a lot of dollars. Getting gold converted in to the tradeable currency or currencies may be difficult.

  • Report this Comment On May 30, 2011, at 12:07 AM, YoungFool37 wrote:

    Gold produces nothing. If your fear is crippling inflation, then any other commodity is an equal and likely less overbought store of value, though if your goal is merely to hold value, you are a poor investor. Gold's value is a function of its usefulness as an agent in the production of goods, which is being widely eroded by better, cheaper candidate materials. It quickly becomes obvious that the majority of demand putting upward pressure on prices is of a speculative nature - people continue to buy it because they believe more will jump on the "buy gold" bandwagon creating more of this sort of demand and driving the price ever higher. It is unsustainable in the long run, exactly like every other bubble. Invest in something with real returns and increasing value, not price.

    Honestly, if you're worried about some sort of catastrophic, end of the world, currency failure, government collapse, scenario, guns and food will probably be worth far more than gold.

  • Report this Comment On May 30, 2011, at 12:24 AM, whereaminow wrote:

    "Gold produces nothing."

    Neither do dollars.

    "If your fear is crippling inflation, then any other commodity is an equal and likely less overbought store of value"

    And such as has been the case for 4,000 years, expect that no one has figured out how to store a bushel of wheat for 30 years in a house safe. So convenience plays a part here, as it always has throughout history. It's not like buying gold to preserve value is a new concept.

    "though if your goal is merely to hold value, you are a poor investor"

    If you don't start investing with the intention of preserving your wealth, you are not only a bad investor but also an idiot. Every investor should begin with protecting their wealth, and then building their wealth. The older you get, the more this becomes appearant.

    "Gold's value is a function of its usefulness as an agent in the production of goods"

    No it's not. The value of gold, like the value of every other economic good on this planet extens from the human mind. It's usefulness is far broader than just the production of goods. It is durable, malleable, fungible, and divisible. That is why the market always chooses gold as money when free from government violence.

    "It quickly becomes obvious that the majority of demand putting upward pressure on prices is of a speculative nature"

    It quickly becomes obvious that you have no idea what you are talking about, and brought nothing to the table that I couldn't read in a statist toilet paper roll like the New York Times.

    Put away this easily refutable Keynesian hogwash. Learn another model of economics. You don't have to believe it, just learn it. How can you reject what you've never learned?

    David in Qatar

  • Report this Comment On May 31, 2011, at 7:51 AM, Sunny7039 wrote:

    On a tangential but related note -- I saw an interview of Henry Kissinger by Charlie Rose tonight. He was there to talk about his latest book, On China. He made two claims that I am pondering/allowing to simmer: first, that the Chinese have lost faith in our ability to manage financial markets due to the 2007-08 crisis (and once they lose faith, it's not something that's likely to come back, at least not in this generation); and second, that the legacy of Mao Tse Tung is gaining in prestige, especially among the young.

    He also said that the Chinese expect to be treated with the respect that they believe they've earned based on their actual achievements. (Now that doesn't strike me as being a radical concept, but maybe I am old school.)

    Investment implications for the next one to two decades? Any thoughts? Thanks.

  • Report this Comment On June 01, 2011, at 4:56 PM, AndreHaeff wrote:

    $2000 per oz gold is viable. Problem is not entirely financial nor China. Problem is US inability to take advantage of its scientific research.

    US research has been outstanding in this and the last century, but increasingly over this period, and particularly in recent decades, the US has not been able to take advantage of its research by reducing it, through development, into production. Production of products which is to say manufacturing is where the big profits are made which ultimately sustain the US dollar.

    This trend, a results of multiple factors , is not easily or quickly reversible. That is not to say that efforts should not be made to try to reverse it.

    But from a realistic perspective, the further devaluation of the US dollar seems likely in the near term which is to say a higher price for gold.

    Andre Haeff 6-01-2011

  • Report this Comment On June 07, 2011, at 12:30 AM, AndreHaeff wrote:

    Further to the above: Once manufacturing does not keep pace with research so that profits can be realized from that research, not only does the US Dollar suffer in value but there is less financing available for more research. The result is an insiduous downward economic spiral in the country, USA in this discussion, where the original research was done usually at great expense and effort of talent. There is then a concurrent upward economic spiral in the country which takes advantage of this research by efficient manufacturing of the same product resulting from that research which fuels further research in that country of a limitness nature. The countries of China , South Korea and others come to mind.

    Conclusion: the USA must capture the total value of its research by efficient and timely manufacture of products emanating from that same research in order to survive economically and support the value of the US Dollar.

    Andre Haeff 6-06-2011

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