The Not-So-Secret Secret Behind Gold Prices – It's Mostly About Currency

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Commodities, Precious Metals

A lot of headlines are underscoring the strong year-to-date performance of precious metals. Gold is set to have the best January since 2008, while silver is poised for a record January compared to the last thirty years. Even platinum and palladium are up 15.8 percent and 5.7 percent year to date, respectively.

Yet in large part, the precious metal rise has been due to the strengthening of the Euro against the dollar and investors’ reaction to economic flash points like the Greek debt crisis and Iranian sanctions. Even so, stories abound of a surge in physical buying around the world, as if the gold price is being driven by the man in the street.

In some parts of the world it makes sense. An FT report details the trend of Syrians buying physical gold bars as a hedge against the plunging value of their currency (from 45 Syrian pounds to the USD to 70 on the black market since the onset of the troubles there). Physical gold bar and coin sales are said to have spiked thirty-fold on levels just a year ago, but sales of worked gold jewelery have fallen, showing buyers are simply after a hedge against the currency and a portable store of value as the regime is assailed on all sides by a popular uprising.

In India, already the largest gold consumer in the world, demand surged over the last month as the rupee strengthened and buyers came back into the market. After a brief lull, the wedding season stimulated renewed interest, according to the Economic Times of India, and lower rupee prices encouraged strong demand.

Forbes reported that the second-biggest gold consumer, China, has also been active. This month, the Hong Kong Census and Statistics Department reported that China imported nearly 103 tons of gold from Hong Kong in November, an increase from October’s 86 tons. November was the fifth consecutive month of China’s record gold purchases from Hong Kong. Analysts estimate China bought as much as 490 tons of gold in 2011, double the estimated 245 tons in 2010.

During last week’s Lunar New Year holiday, China saw a gold rush with consumers spending more on buying gold than during the 2011 festival, the blog site BullionVault reported, quoting a lovely line from a Beijing resident: “People seem crazy about gold, snatching it up more like a cheap cabbage than such a precious metal.”

The value of sales at two of Beijing’s top gold retailers, Caibai and Guohua, were said to hit 600 million yuan ($95.28 million) – a 49.7 percent rise on last year’s sales. Although gold prices have risen 25 percent over that period, so has the Chinese yuan by 3.6 percent, so the rise in yuan value also reflects a substantial rise in volume.

It’s the Currency, Stupid

Theories abound for why physical sales have been so robust, but one common denominator is currency.

In Syria, it is fear of a depreciating currency; in India, the strengthening rupee encouraged buyers back in as local market prices fell; but in China, the currency has only increased by 3.6 percent in a year, barely enough for buyers to notice. The Forbes article puts it down to capital flight by Chinese residents unable to actually move their money out the country.

The article talks of capital flight by the wealthy and companies, saying that while figures are sketchy, it appears there was $34 billion of it in the third quarter of last year and $100 billion in the fourth. It also suggests widespread fear of the currency being devalued following a rapid decline of the trade surplus. We doubt the Chinese man in the street is motivated by such pessimistic fears as depreciation of the currency after several years of steady appreciation — there is doom and gloom everywhere, but China is at least still growing (and at 8%+, growing strongly).

Gold buying is more likely in the pursuit of a quick buck. The Chinese are notorious gamblers and the sight of gold rising 20 percent in a year is enough for those with spare cash but no interest in the property market to take a punt. Of course, just like property, gold can (and does) go horribly wrong, but in a market where cash in the bank earns next to nothing and holding gold has no carry cost (unlike property), it is understandably attractive.

Rapidly growing markets like India and China, even with their distortions and problems, create a growing middle class with cash to spare. Both markets will likely continue to be significant drivers, both of sentiment and volume, in the gold market.

–Stuart Burns

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