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Wednesday, June 5, 2013

Betting against Roubini

Nouriel Roubini recently came out with an article predicting gold prices to reach $1000/oz by 2015. He is not the only one being bearish. As a matter of fact, his views seem to be shared by an overwhelming majority of opinion leaders and investment banks.

For example:

Desjardins Economic Studies - target $1200
Commerzbank  - target $1227
Bank of America Merrill Lynch - target $1200
Goldman Sachs - $1270

As mentioned in a previous post, even notorious gold bulls, like Jim Rogers and Marc Faber, have mentioned $1200/oz as a possible floor for the drop in the gold price.

So, will Nouriel "I predicted the financial crisis" Roubini be correct about his gold price predictions? The arguments he is providing can be interpreted as follows:

1. The serious geopolitical risk has subsided and Gold as a "fear trade" is loosing triggers
2. Inflation has remained low in spite of massive monetary easing
3. Gold earns no income
4. Interest rates will rise (increasing the alternative cost of holding no-income assets)
5. Central banks of more indebted nations (such as Italy) may need to liquidate their gold holdings
6. Gold has been over-hyped by conservative US politicians

Just like everything else coming out of Roubini, his analysis is highly superficial, and just in line with US mainstream view (sorry Nouriel, you were not the only one, and definitely not the first one "predicting the financial crisis").

That does not necessarily mean he is wrong about his prediction, though his arguments certainly are flawed (as I will elaborate on below). Price formation for investment assets (gold, stocks or real estate) is largely determined by mainstream's expectations about future prices. If a majority of market players expect the price to go to $1200/oz, then the price will go to $1200/oz, as buyers will stop buying anticipating the price decline, and sellers will continue selling as long as the current price is above the expected future price.

As expectations are concerned, the US and European public go in tandem, with Europe usually lagging US consensus views.

What US and European public opinion leaders seem to have ignored, is that the market for gold has undergone massive structural shifts in demand over the last 12 years, dramatically changing the dynamics of the market. In q1 2013 the US accounted for a measly 4% of global gold demand, and Europe for only 6%. China accounted for a whopping 33% of global gold demand, and India for 28% according to the World Gold Council, with other mostly emerging economies accounting for the rest. Furthermore, ETF demand was only 6% of total demand.

Do US commentators still think we are in the 1980s, when the US and Europe accounted for nearly 80% of global gold demand? Roubini certainly seems to think so; all of his arguments would hold true if that was the case.

But the fact still remains that with new supply of gold increasing only a few percentage points per year, the price of gold is overwhelmingly determined by Asian buyers. It is highly questionable how much they worry about US recession risk, US inflation- and interest rate expectations, and how much they listen to Ron Paul and other ultra-conservative US politicians. They are likely to be much more preoccupied with the preservation of their domestic purchasing power, local traditions, and increases in the price of gold in their domestic currencies (which, for example in Iran, has been astronomical due to hyperinflation, contributing to Turkey becoming the third largest gold buyer in q1 2013, as Iranians cannot buy directly due to the international trade embargo).

It is the Asian buyers who predominantly have driven a five-fold increase in the gold price since 2001. And they have bought more gold because they could afford to do so. For example, average dollar wages in China doubled from 2008 to 2013. And official inflation numbers in India averaged nearly 10%, unofficially estimated by some to be at least 5% points above that. As the informed reader will know, the gold price doubled over the same period. With the recent price decline, gold has never been cheaper for the Chinese and Indian public as measured by how much gold they are able to buy. Get it? The implication of this is so important that I will repeat it: For more than 2 BILLION PEOPLE, the price of gold is at an ALL TIME LOW!

And, unless prices resume their ascent, gold will become cheaper still. McKinsey and the Boston Consulting Group have both published reports projecting Chinese wages to reach close to $20,000 by 2030.

In the near term, with central banks in the US, Europe and Japan printing money like mad to stimulate their economies in response to economic declines primarily caused by increased competition from the emerging world, domestic spending and consumption is set to increase. This is likely to result in even more imports from Asia, further fueling wages in export oriented economies.

And the gold price? Once the sell-offs by the American and European public have subsided (perhaps in a few more months), gold will resume its long term surge. At end of this blog, I allow myself to express how thankful I am for the contributions of Roubini and other egocentric imbeciles addicted to media attention (Henry Blodget of CNBC - a big thank you to you as well!). They are helping to create a major sell-off in gold when the fundamentals for owning gold are the best in 30 years. Thank you. Thank you. Thank you.

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