Wednesday, Dec 16th, 2009
In a headline piece on roubini.com, Nouriel Roubini writes an extended article slamming both gold bugs, and the so-called gold bubble, which he believes is far too volatile, and which, contrary to ever increasing claims to the opposite, will likely not get to the mythical price of $2000/ounce, and instead will head lower. The argument presented, as is widely the case, boils down to the trifecta of i)gold having no industrial utility, ii) no intrinsic value (no associated cash flow streams) and iii) costing an arm and a leg to store. While Roubini’s thesis is attractive on the surface (if somewhat Keynesian and thus often reiterated by mainstream Economists), we present some counter arguments to Roubini’s thesis.
Roubini summarizes the current situation:
In the last nine months, concerns about a global depression have dissipated and the global economy is recovering from its worst recession in decade; deflation is still gripping the global economy as the slack in goods and labor markets persists at high levels. So why have gold prices started to rise sharply again in the last few months, in spite of no near-term risk of inflation or of depression? And could gold prices rapidly rise towards $2000?
On the one hand, the Doctor does see the pro-gold argument, which he highlights in five main points:
There are several reasons why gold prices are gradually rising, but they do not suggest a rapid rise toward $2000; at most they suggest a gradual rise with significant risks of downward correction.
- First, while we are still experiencing global deflation, there are rising concerns that inflation may reemerge forcefully in the medium term because of large monetized fiscal deficits.
- Second, a massive wall of liquidity—borne of easy monetary policy—is chasing assets. Some of those assets include commodities like oil and base metals—the rise of which could eventually become inflationary.
- Third, dollar funded carry trades and a more generalized portfolio allocation to non-dollar assets (especially EM assets) are pushing the U.S. dollar sharply down. There is an inverse relation between the value of the dollar and the dollar price of commodities: the lower the dollar the higher the dollar price of oil and other commodities, including gold. The rise of gold in euros has been much more muted.
- Fourth, the global supply of gold—both existing and newly produced—is limited, and demand is rising faster than supply over the medium term. The recovery of the global economy has started a revival of retail gold demand especially in India. Central banks looking to diversify their portfolios account for further demand—see for instance, the recent increase in gold holdings by emerging market central banks. Most of the increase in demand comes from private investors using gold as a hedge against low probability tail risks of high inflation and another near depression caused by a double dip recession. Inflation risk and the risk of a double-dip are both low, suggesting lower gold prices, but increasingly investors want to hedge against such risks early on. And given the inelastic supply of gold, it only takes a small shift in the portfolios of central banks and private investors to boost increase the price of gold significantly.
- Finally, as sovereign risk is rising—see Dubai, Greece and other emerging markets and advanced economies—the concern about sovereigns not being able to back stop too-big-to-save financial system could rise again.
This article was posted: Wednesday, December 16, 2009 at 4:59 am