By Kash J. Pashootan
Whether you’re an investor or on the sidelines watching the markets, Canadians want to know, seemingly more than ever, how global financial events impact their financial security. The underlying desire to understand the impact stems from the transition of our country’s demographics. Baby boomers, people born between 1946 to 1965, are entering, thinking about, or rapidly approaching retirement. While there are many events to address, the steep and continuous rise in the price of gold, regularly reaching new all-time highs, has been one of the stories grabbing both financial and world news headlines. As a result of the increased attention in the media and the rapid increase in price, many investors want to know if there is still an investment opportunity, if they’ve missed the opportunity, or if there is a speculative gold bubble that will soon burst.
When investors evaluate whether gold should be part of their portfolio, and if so, what percentage, there are several market trends and developments they should keep in mind, which include the devaluation of fiat currencies and the increasing demand for gold from China.
Devaluation of Fiat Currencies
Governments around the world are devaluing fiat currencies by increasing supply, i.e., printing more paper money. They are turning to this strategy to intervene in foreign exchange markets and to deal with severe economic slowdowns and mounting liabilities. The United States, in particular, has pursued aggressive strategies and policies to increase the supply of money to deal with its government debt, budget deficits, and unfunded future liabilities. Consequently, there is now global concern about a potential U.S. dollar crisis and ultimately, its status as the world reserve currency.
The monetary policy actions taken by world governments combined with the uncertainty surrounding the U.S. dollar has forced investors to seriously question the ability of fiat currencies and government bonds to hold value. Therefore, investors are now seen looking to gold as a safe harbour, store of value and alternative monetary asset.
Increasing Demand for Gold from China
China, the second largest gold consuming market in the world, has a historical and cultural affinity for gold. It’s considered the colour of the emperors, viewed as a symbol of status, and given as a traditional gift for birthdays, Chinese New Year and weddings. And, as income and wealth levels have increased in China, the effect has been a rising demand for gold jewelry. In fact, the demand for it has more than doubled in the last seven years, from 224.1 tonnes in 2004 to 451.8 tonnes in 2010.
Jewelry, however, is only part of the story. The increasing demand for gold in China is also due to the lifting of gold ownership restrictions and opening of the Shanghai Gold Exchange in 2001, which have resulted in increased investment demand for gold and the creation of gold savings accounts in China. Recently, the investment demand has been further stimulated by the global devaluation of currencies and the use of gold investment as a hedge against fear of inflation in China.
The figure (left) shows that since 2001, despite the rising price of gold, demand has increased by an average of 14 per cent per annum. From 2006 to 2010, the increase was even more dramatic and based on current data, this trend has continued in 2011.
As global financial events continue to shift markets and dominate headlines, investors, especially those from baby boomer generation, will want to know how they impact their financial security and retirement. The extraordinary rise in the price of gold is part of the complex web
of events that shape the market, and the devaluation of fiat currencies and increased demand for gold from China are two of the underlying market trends and developments affecting the price of gold. While investors may be hesitant to invest in gold given the current price, the analysis presented above shows that it still makes sense to evaluate whether it should be part of your investment strategy and portfolio.
Kash J. Pashootan is a Financial Advisor with Raymond James Ltd. Information provided is not a solicitation and although obtained from sources considered reliable, is not guaranteed. The view and opinions contained in the article are those of Kash J. Pashootan not Raymond James Ltd. Raymond James Ltd. Member- Canadian Investor Protection Fund.
