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Gold seems to be in hibernation these days, hovering between US$1,130 and 1,160 per troy ounce. Gold bugs who trace daily price and get worked up by the slightest market noises would certainly disagree. They may also point out that gold price, in Euro terms, has in fact close to its historical high. But I don’t have Euro assets and I’m not concerned about small dollar price fluctuations of such a useless metal. Knowing that gold price is still above US$1,100 is enough to me; the question is: why and what next?
This is actually peculiar—why does gold price still stay above US$1,100, when we seem to believe that recovery is around the corner and inflation is at bay? Where are the fears that support the gold price? Recall that, as we pointed out in “The Gold Report”, gold is all about sentiment—it has virtually no fundamentals to speak of (let’s leave the US dollar question aside for now). Its price is anchored by people’s deep-rooted suspicion (of government and others) and driven by occasional bursts of fear (rational or otherwise). Unfortunately, we don’t have a “fear index”; and how much we fear is a subjective, and often subconscious, matter.
The best explanation is that our fear is still there, hiding behind our brave face and subconsciously preventing us from selling down gold for productive assets. Not much has changed: the liquidity glut is still in the system, albeit depressed by low velocity of money for now; businesses remain fragile; the US deficit is heading towards an even more hopeless level, yet it looks almost sanguine comparing to Europe. What’s new is that China is now panicking over its property price bubble and India already has near double-digit inflation—hardly depressing news for gold price. Yet we have a big bomb coming: RMB appreciation.
It greatly puzzles me why the US is suddenly pressing for an RMB appreciation at this juncture. The simple fact is that the combination of a stable RMB-USD exchange rate and Chinese productivity gains has kept US inflation low. RMB appreciation would directly drive up price level across the board in the US, as there is no immediate replacing supply capacity of this scale in the world, certainly not at the current price level. In fact, many Asian countries, including the most opportunistic of the bunch, Singapore, have been revaluing their currencies even before any move of the RMB. This is imported inflation; and US domestic monetary policy can do little to alleviate it.
Now that RMB appreciation seems inevitable despite Chinese “indignation” over the “interference in Chinese domestic affairs” by the US, it would be interesting to see how gold price (in US dollars, of course) react in the aftermath. Of course, the outcome depends on the degree of RMB appreciation and its effects on the US price level. Allow me to give an update on the scenarios we depicted in “The Gold Report”, but surely you will find your own take:
The Paul Krugman dreamland scenario:
Inflation does what the Fed couldn’t do—send real interest rate into negative zone, and “spur” business and investment activities. Liquidity glut in the banking system is released and velocity of money accelerates. The imported inflation is succeeded by a domestically propelled one; and general price level keeps rising. The Fed will intervene at some stage, but the question is when and whether it is too late. Gold price shoots up toward US$2,000, but may stop before US$1,500 if the Fed is vigilant in clamping down inflation.
The worse-than-1970s scenario:
This is the stagflation case. The economy remains fragile and unemployment sticks, despite 3-5% inflation rate. Gold price is caught in the middle, between fear for inflation and fear for a double-dip, possibly hovering between US$1,200 and 1,300. US politicians and “economic conscience” then drum up their demand for more RMB appreciation. The rest would be a diplomatic and political question: if China obliges, we may see high-single-digit inflation in the US and gold price at US$1,500.
The dead horse scenario:
China allows a token RMB appreciation, which is absorbed by US retailers as consumer demand remains weak. No tangible inflation occurs and we are where we were today. Gold price may get a small boost to close to US$1,200; and we wait for another shoe to drop. The problem is that, even though the US politicians may not know what they are asking for, they are pretty adamant that they want it. The heightened danger of a trade war would only add to fear.
As we suggested in our road-show for “The Gold Report”, investors from high-growth countries with reasonable fiscal balance (such as China and India) would be better off putting their money into productive assets denominated in their home currencies rather than gold. But they should be aware of the complications. China still has foreign-exchange controls. Its property market is taking a beating from the government’s cooling measures. India’s consumer price inflation is a structural, supply-side problem that cannot be done away with monetary measures. If you worry too much about the daily chaos of China, India or the world, gold is a simple asset to hold.
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