With gold currently trading at over $1,500 per ounce, the price of the precious metal has increased by 600% following the peaks of the tech bubble. Despite the recent rise in prices, fundamentals continue to suggest that the trend is unlikely to reverse.
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According to the World Gold Council "gold demand in the first quarter of 2011 totaled 981.3 tonnes" as more of the physical commodity was required for jewelry (primarily in India and China) and gold bars/coins for investment purposes. Bullion ETF holdings have increased from approximately 7 Moz in 2005 to over 60 in 2011. Last year's 11% increase in global demand outpaced the 7% rise in total mine production, forcing the prices to appreciate. As a result of the continuing pattern the SPDR Gold Trust (NYSE:GLD) ETF, which tracks the price of bullion, rose by 23% within the last year.
Low Interest Rates
Interest rates are another primary factor that drive gold prices, as an investor's willingness to hold the commodity depends on the potential rate of return on alternative investments. Although gold is considered a relatively safe asset, holding the commodity does not generate an investment yield. The inverse correlation between interest rates and gold prices has clearly persisted since 2001, reflecting a similar historical pattern to the 1970s. As part of the Quantitative Easing program, interest rates in the United States have remained extremely low at 0.25% and the Federal Reserve has indicated that it does not have any immediate expectations of increasing rates.
Barrick Gold Corporation (NYSE:ABX), the largest international gold producer, sites other major macroeconomic indicators such as sovereign debt concerns and trade imbalances to support a bullish gold outlook. Gross debt as a percentage of GDP has been drastically increasing in the PIIGS nations, leading to foreign bond uncertainty. Spain's debt-to-GDP ratio is expected to increase from 40% in 2008 to 70% in 2012, while the Greek GDP/Debt multiple will be on the verge of 140% next year. Furthermore, with the latest monthly $21.6 billion trade deficit with China, investors are looking for protection against inflationary pressures.
Gold Is Not in a Bubble
Unlike the characteristics of most unsustainable bubbles, the price of gold has been increasing at a relatively slow and stable pace throughout the last decade, suggesting a long term change in fundamentals rather than a case of irrational exuberance.
The initial steps of a bubble include a displacement of an established paradigm followed by a rapid price spike leading to unreasonable valuations. Gold price trends are neither reflective of the Dutch Tulip Mania, the Dot.com bubble, nor United States housing boom, all of which displayed the typical characteristics of an overheated market. (Bubbles are deceptive and unpredictable, but by studying their history we can prepare to our best ability. See 5 Steps Of A Bubble.)
In addition to strong fundamentals driving gold prices, there are other valuable purposes to investing in the commodity. Primarily, gold prices are typically uncorrelated with overall stock and bond market movements. Therefore, ETFs such as GLD, ProShares Ultra Gold (NYSE:UGL) and iShares Gold Trust (NYSE:IAU) offer much needed portfolio diversification benefits.
Major corporations such as Barrick Gold, Goldcorp (NYSE:GG) and Newmont Mining (NYSE:NEM) offer other alternatives to play the industry.
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