The Take

FOOL’S GOLD: VOLATILE 2016 FORECAST FOR A COMMODITY LOSING RELEVANCE04/03/16

Newly-minted Business Correspondent Jack Nolan discusses the yearly outlook for gold as a tradeable commodity – for what is historically considered to be an enormously safe investment, the commodity is shaping up to be in for a rough 2016. Our Chief Business Editor, Jackson Barton, welcomes Jack to the Business team.

Pundits, analysts, and news outlets alike have forecast a volatile and unstable 2016 for gold prices. The purpose of this article is not to join the growing chorus of self-proclaimed experts preaching for either a bullish or bearish year via newsletter or blog. Instead, the question to ask is why anyone still invests in gold. It is losing relevance as a pseudo-currency, only 7% of global demand is for functional purposes, and there are less risky assets that perform well when the stock market is doing poorly.

Gold as an investment is the epitome of “castles in the air” based thinking from investors. As an asset, its underlying value based on its functional use is far below the price it trades for. Investors buy gold purely because they believe the price will go up, and that someone else will want to buy that gold for more money at a later date.

This irrational behaviour has stemmed from the fact that for so long gold has been viewed as something that will always hold value because of its scarcity. In 2016 this logic simply doesn’t stand up. The most common and accepted reason for investing in gold in recent times has been to hedge against a declining stock market, giving it a reputation as a crisis commodity. Gold prices have been shown to spike whenever instability threatens a market or region. For example, gold spiked when Iraq invaded Kuwait, when the GFC began, and when Russia moved in to Ukraine. Earlier in February when the S&P 500 was sitting at a 15% year-to-date loss, Gold was sporting an almost 20% gain.

The logic of seeking a stable and safe asset during volatile periods is smart. Choosing gold as this asset is not. The issue with gold is that it has no value beyond what people assign to it based on ‘castle in the air’ logic revolving around the idea someone will buy that gold from them in the future.

At the end of 2015 gold demand was at $39.761 million USD. Only 7% of this demand was for industrial use. The remaining 93% of the demand comes from speculators, jewellery manufacturers, and central banks. This means that the majority of demand for gold is based not on people wanting to actually use the metal, but is instead based on the archaic idea of gold as a universal store of value.

The rise of fiat currencies and the advance of technology raises the question of whether people will continue to assign value to gold. Information flow is no longer restricted by borders, and a small piece of plastic can reveal how much currency you hold anywhere with internet or phone lines.

Of the global demand for gold jewellery, more than half comes from India and China. Countries that have on average extremely limited internet and information access. As these countries continue to develop citizens will gain access to banks and to cheap data transfer services. They will follow the trend already seen in developed western nations and move to rely on electronic and virtual stores of money.

Once people stop assigning value to gold, central banks will have no reason to hold it. The current agreements on releasing gold will expire and the estimated 166,000 tonnes of gold in storage will be released to people who have no need or desire to use the metal. With global gold demand for industrial use last year being only 84 tonnes, current reserves could genuinely last for well over a thousand years. While speculators and institutions can keep gold afloat in the short term by betting on each other’s demand, eventually the bubble must pop.