Tuesday, October 28, 2008

Problems with Gold: Why not Rise?

Traditionally, whenever most of the world currencies face the creditential problems, or whenever the money supplies surges and drives hyper-inflation, gold should be the ideal haven. However, it seems not the case now. Why?

The blind spots of the above position are:

1. It ignored the credit crunch is caused by the burst of property and finance market bubble and hence the massive write-off of asset value. In another sense, it also means the "evaporation" of "money on the book". Thus, money supply is not "excessive" in the market.

2. It ignored the fact that new money supply from FED and central government has not flown to the market, as shown by first LIBOR and now AAA finance and Mortgage Rates. Instead, the lowering of bond yields and the surging JPY and USD show that the money supplied to the bank has returned to the supplier through sales of overseas asset and then purchases of government bonds, particularly US government bond.

3. It ignored the fact that Gold has already hitted new high previously, at the time before credit crunches has become serious. When the risk of inflation drops, the function of gold as hedging against USD has weakened.

4. It ignored the fact that there were speculations on gold market previously, and that the gold futures market has grown 10 times larger (or even above) than the spot market, a hint of speculation over actual demand. With the credit crunch and tightening of new loan, speculators can no longer continue to play at large.

5. It ignored the implausible return of Gold Standard. The nominal World GDP on 2007, in USD, is 54.62 trillion. Meanwhile, the total mined gold weighed about 30,000tonnes. If we use Gold Standard and keep the existing capital reserve ratio at 8% (and hence the same money muliplier) and that the gold mining rate can keep up with the multiplier, then at current price of gold at 730USD/ounce, our gold reserve can only support a size of world economy at nominal GDP of about 9.64trillion USD, only 18% of the current economic activities. Besides, by Gold Standard, the world economy growth is controlled by the demand and supply of gold (and silver) but not by the demand and supply of human consumption and productivity.

Nevertheless, it does not mean that gold price will simply plummet back to before Iraqi War level. It only means that gold price may be up and down with a narrow band-width and a bottom price at 600USD/ounce. If eventually Keynesian economy takes place in the world successfully, a long position for gold may be viable in longer term.

No comments: