Five Reasons Why the Upside Potential of Gold Outweighs the Downside Risk

by Tony Davis – Atlanta Gold & Coin Buyers ……….

I recently met with a nice couple that was selling gold coins to meet a short term need, but that still has a good bit of gold bullion on hand.  They have seen the price of gold fluctuate from a high of $1,900 to approximately $1,160 an ounce in just a couple of short years, and are concerned that we could once again test the bottom end of the trading range.  This led to a discussion about the current price of gold and whether there appears to be more upside potential or downward risk.  I then proceeded to provide our customers with five reasons why I believe that the upside potential outweighs the downside risk that I thought I would share with our readers.

Quantitative Easing

In recent months, the Federal Reserve has discussed tapering their bond buying program; with many of the opinion that the tapering will begin in September of this year, but based on the following chart from the St. Louis Federal Reserve Bank, it’s clear that the Fed’s foot is firmly on the monetary accelerator:

With a record high monetary base of approximately $3.5 trillion, we run the risk of rising inflation rates if/when the banks begin to lend again. Historically, gold has been an excellent hedge against rising interest rates and inflation, and was one of the safest investments during the high inflation years of the Carter Administration, during which the price of gold increased four-fold from 1975 – 1980.

It’s hard to imagine that there is going to be any significant pullback with respect to the current loose monetary easing policy, as anytime the Fed hints at a possible pullback, the stock market plunges.  In this writer’s opinion, the only likelihood of a reduction in the FED’s bond buying program is if interest rates begin to rise to an unacceptable level.

Foreign Demand

Foreign demand for gold remains as strong as ever, even though some countries are attempting to curtail gold buying.  While China’s gold buying pace may have slowed ever so slightly as of late, the following article from Mineweb.com http://www.mineweb.com/mineweb/content/en/mineweb-gold-analysis?oid=200385&sn=Detail shows that China is still on a record gold buying pace this year.  Also, while India has recently increased the import tax on gold to 10%, and is doing everything in its power to reduce gold purchases, it’s highly unlikely to reverse thousands of years of Indian’s affinity for precious metals.  This is not only evident in India’s huge import of silver during the first half of the year, http://www.scrapmonster.com/news/indias-silver-imports-exploded-during-h1-2013/1/9470, which is not subject to the same restrictions and import taxes as gold, but also through an apparent black market that is forming in the country http://www.resourceinvestor.com/2013/08/07/gold-replaces-narcotics-as-the-most-valued-smuggle?t=precious-metals&ref=rss&utm_source=twitterfeed&utm_medium=twitter&utm_campaign=RI.

Central Banks

Central Banks, especially those of emerging markets, have been net buyers of gold over the past couple of years and that’s not likely to change anytime soon.  They tend to buy on the dips, which is why there appears to be an artificial floor as to how low gold can drop.  Why are central banks buying gold bullion?  This is likely because most major currencies are being devalued by their respective central banks, making investing in most currencies a losing proposition.  Some speculate that the net buying of gold may be an attempt for countries to position themselves to move to some type of gold standard.  This recent article from Zero Hedge http://www.zerohedge.com/news/2013-08-04/did-china-just-fire-first-salvo-towards-new-gold-standard seems to indicate that this is certainly a possibly, as the Bank of China recently proposed a move toward another Bretton Woods system to help strength global liquidity, but at this point, it’s merely speculation.

Mining Costs

The drop in the price of gold this year has taken a toll on the mining industry, causing many mining companies to close less productive and expensive mines, reduce headcount, and write down losses, as outlined in the following Forbes article http://www.forbes.com/sites/afontevecchia/2013/07/25/goldcorp-and-why-gold-miners-are-getting-crushed-massive-cost-inflation-falling-prices/ .  With estimated gold mining costs of $1,000 – $1,200 an ounce http://www.cnbc.com/id/100851209, gold mining companies are having a difficult time making ends meet in the current environment.  The high cost of doing business in many foreign countries isn’t helping matters.  The closing of mines and reduction of staff will eventually create supply squeezes in the market.  In fact, we’re already seeing a reduction in output from South Africa http://www.mineweb.com/mineweb/content/en/mineweb-gold-analysis?oid=200501&sn=Detail, one of the largest producers of gold in the world.

Debt/Deficits

The United States has had annual deficits in the $1 trillion range over the past few years; although, this year’s deficit may come in at closer to $600 billion.  There has been no discussion of a balanced budget, but rather a goal of reducing the annual deficit.  At the moment, the official debt of the United States is over $16 trillion (closer to $17 trillion), which puts our debt to GDP ratio of over 100%.  Clearly, the current path is unsustainable, and will likely lead to higher interest rates in the future, which should have a positive effect on the precious metals market.

Conclusion

In conclusion, while the short term price of gold is almost impossible to predict, we believe that the long term drivers for positive movement in the gold market are in place and that the upside potential outweighs the downside risk.  Record level monetary easing should continue to put downward pressure on the dollar, which is typically positive for the gold market.  Secondly, foreign demand for gold is near an all-time high, and there’s no indication that this trend will wane anytime soon.  Thirdly, many central banks (especially those of emerging markets) are net buyers of gold and will likely continue to buy on dips in the market, which should help to establish a floor in the price of gold. Fourthly, mining costs will likely remain stable and possibly even increase from current levels due to high regulations and lower grade ore, and last but not least, until or unless record level debts and deficits are addressed, we run the risk of higher interest rates, which should bode well for the gold market.

Tony Davis is the owner of Atlanta Gold & Coin Buyers, a full service Atlanta based coin and bullion dealer specializing in buying, selling and appraising coins and coin collections of all types and sizes.  Visit his website at www.atlantagoldandcoin.com for additional information on the products, services and educational resources offered by his company. Tony can be reached at [email protected] or at 404-236-9744.