by Frank Holmes
The price of gold has corrected
by close to 20 percent since peaking on March
17. If you have been listening to the popular
press and business TV, you may be convinced that
the gold and commodity “bubbles” have popped.
Once you back away from the day-to-day noise and
put things into perspective, we believe this
correction in gold, while painful in the short
term, is just another pause in a long-term
secular bull market. As it has been said, bull
markets climb a wall of worry.
Over the past year, gold bottomed around $640
per ounce in late June. As the financial crisis
unfolded, it staged a spectacular rally, surging
more than 60 percent to $1,032. Gold has since
pulled back, but given that the long-term
fundamentals remain intact, we believe it is
setting the stage for the next leg up.
Here are some of the reasons why:
Negative real interest rates
The macro environment for gold is still
supportive based on negative real interest
rates. The one-year Treasury bill is offering
just 2 percent, while the official inflation
rate is around 4 percent.
Negative interest rates make gold look more
attractive compared with other safe investment
alternatives, such as T-bills and certificates
We believe the Federal Reserve will keep
interest rates below the rate of nominal
economic growth in order to support a fragile
economy in an election year.
Negative real rates between mid-2001 and spring
2005 powered gold’s biggest bull run in decades,
with prices rising from $255 to $455 per ounce.
Real inflation is underreported
The official inflation rate is around 4 percent,
but when you include the rapidly rising prices
for food and energy and understated housing
costs, the real inflation rate is even higher.
One of the best ways to protect yourself against
inflation is to participate in it by investing
in commodities such as oil and agricultural
products. Historically, gold also has proven to
be a viable hedge against rising inflation
because it maintains its purchasing power.
We agree with those who estimate that the actual
inflation rate is close to double digits due to
the Fed’s massive injection of new money into
the economy to avert a recession. MZM (money
zero maturity), the amount of money in the
economy that’s easily accessible for spending,
is up 15 percent compared with the same time
The current correction in gold has been led by
sizable ETF redemptions.
The StreetTracks Gold Shares ETF (ticker GLD)
lost 1.3 million ounces of gold over the past
two weeks, with nearly a third of that amount
being redeemed this Tuesday alone. This may mark
the first-ever ETF-led gold correction.
This correction is not surprising, given the
strong acceleration in the first quarter of 2008
and typical seasonal trends. Some short-term
profit-taking is likely, along with speculation
that prospects have improved in financials and
But in our opinion, this move out of gold is not
indicative of the smart money, as momentum
investors chased performance on the way up. The
price action appears to be signaling a rotation
from weak gold holders, perhaps back into the
broader equity market.
On top of the factors above, there are other
fundamental factors that we believe will drive
the price of gold higher over the longer term.
Declining output from existing mines,
particularly in South Africa, and a virtual
absence of large new discoveries will reduce the
supply of gold available in the market.
At the same time that gold supply is falling,
demand is increasing due to rising wealth levels
in China, India and other nations with cultural
affinity for gold.
In addition, history suggests that jewelry
demand, which fell off when gold surpassed the
$1,000 mark, is likely to pick up again during a
It’s easy for investors to get swept up in the
emotion of a strong rally or a significant
correction. In these volatile times, we suggest
that investors protect themselves from
suboptimal decision-making by not losing sight
of their long-term asset allocation strategy.
For more insights and perspectives from Frank
Holmes, visit his investment blog “Frank Talk”
Material for this article contributed by John
Derrick, director of research, U.S. Global