Gold, boosted by inflation and Chinese demand, reached its highest level since 1988

by Pierre-Antoine Delhommais, Le Monde, 20th October, 2005

We are witnessing, these days, a form of gold rush. A week ago, in London, the price of one ounce of gold reached $478,92, that is, its highest price since January 1988. Why such a success ?

As Ixix CIB economists note in a recently published working paper, "gold has a hybrid status : it is used in jewelry, the dental industry, and electronics, therefore it is a primary metal resource ; but it is also used as a reserve of value."

Alan Greenspan, the president of the Federal Reserve System, made the following comment on this special status of gold as a reserve of value : "Gold represents the ultimate means of payment in the world. In the worst case, when fiduciary money is no longer accepted by anybody, gold is still accepted." The yellow metal appears to be the last resort for an investor who no longer trusts the stock market to shelter his funds, nor government bonds, nor real estate, and who has doubts on the value of money.

"Historically, gold has been a way to protect oneself in times of exchange rate crisis, inflationary pressures, oil shocks, wars, etc.", Ixis CIB experts note. In this respect, the deterioration of the world geopolitical environment over the last few years, with the september 11 attacks, the Iraq conflict bogged in quagmire, the Iranian nuclear threat, all contributed to the rise of gold price. The threat of a world epidemic from fowls and birds, may have pushed fund managers into gold as well.

Renewed inflationary pressures, triggered by oil prices, are favorable to gold too. In the United States, the consumer price index (CPI) jumped by 1,2% in September, its greatest monthly jump since 1980. In Germany, inflation is at its highest level out of the last four years, and, in England, out of the last eight years.

Gold is a shield against inflation, which is synonymous with money devaluation, loss of purchasing power. "The acceleration of the general level of prices may induce economic agents, and investors, to quit fiduciary money and go into gold.", Ixis CIB economists say.

To inflationary risks, one must add exchange rates risks, and, in particular, a possible collapse of the value of the dollar - currently the world main reserve currency - because of the imbalance in US external accounts. If this scenario - of a collapse of the dollar - happened, then gold would be an alternative reserve of value, as well as the usual swiss franc.

Beside being a financial tool, gold is also a primary metal resource, the price of which is governed by the law of "physical" supply and demand. It is this rule which seems to be playing a decisive role in today's price rise, according the Ixis CIB analysts, on a market where - here too - China is a perturbing factor.

In 2004, demand for gold increased by 11,4%, to reach 3 595 tonnes, while the jewelry sector, which represents 77% of the global demand, progressed by 10%. The demand is pulled by Asia, most notably India and China (+45%, from 215 tonnes to 314 tonnes). "Compared to the demand, supply does not follow the same growing rythm. World mining production (63% of total demand) decreased substancially in 2004 (-4,6%), while official sales by central banks and the IMF decreased by 19,4%, and the recycling industry decreased by 12,2%", the Ixis CIB paper notes.

Ixis paper also mentions that, paradoxically, the price rise did not induce producers into increasing their supply, or launching new prospection. In 2004, production increased only in China, Russia, and Canada ; everywhere else it decreased. In particular, it decreased in South Africa, which lost its first place, and became second behind the United States.

During the first eight months of 2005, the trend is confirmed again, with a demand increasing by 11% and a supply decreasing by 8%, and South Africa's production still decreasing. "This imbalance should stay for a few years in the future, foresees Ixis CIB. The combination of a sustained physical demand, a risk on the dollar, and an inflationary threat in the United States, suggests that the upward pressure on gold will continue over the next months, with a target price of $500/oz in early 2006."

Pierre-Antoine Delhommais