My good friend KY asked me the other day about my thoughts on gold as potential investment.  He really got my intellectual engine running.  I took the time to do a little bit of research on gold, analyzed the current economic conditions, and I must say that I learned a thing or two about gold that I didn’t know before from this exercise.  KY, thanks for your question.  Talking to you is always a pleasure.

Here is a snapshot of some key information on the demand for gold in 2008:

·         Consumption of gold related to jewellery was about 58%   (2137.5 tonnes)

·         Industrial use made up about 25% (860.8 tonnes)

·         Various investments made up about 17% (660.3 tonnes)

Starting with the largest user, jewellery made up more than half of the demand for the world’s yellow metal last year.  We are not even through the first quarter of 2009 and worldwide consumer confidence seems to be still heading south.  When times are bad, it makes perfect sense for people to cut back on major purchases that are unnecessary.  Two years ago, you could’ve gotten away telling people that you had bought that gold bracelet because you needed it.  No one will buy that story today.  Today’s consumer mentality is to buy what you need and put everything else aside for that rainy day.  Things are not looking for the jewellery business.  As of February, India, one of the world largest markets for gold, has yet to import any gold. 

The industrial sector made up the second largest demand group for gold.  There are so many uses for gold in industrial production; I cannot cover every single one of them.  For simplicity’s sake, let’s look at electronic products.  Japan, the world’s second largest economy, relies heavily on exports for economic growth.  Sony, Panasonic, you name it, are key to Japan’s economy.  Japan’s exports fell by over 40%, a sign that manufacturers are cutting back on the consumption of gold. 

Finally, there is investor demand for gold.  While gold has many practical uses such as those mentioned above, gold also has a unique function and that is it can act as store of value.  Over the history of mankind, many empires have risen to power and later crumbled to pieces, taking their currencies with them.  Gold can act as store of value no matter what happens.  People have managed to protect themselves while fleeing their home country from war and from hyperinflation. 

Given that demand is weak in the first two groups, the price of gold could only continue to rise if there is sufficient investor demand.   Investors that look far into the future realize that 1970’s style inflation may be ahead of us and have already flocked to gold to hedge their risk.  (I will write about inflation in my next article, too much information to cram everything here)  This is the last pillar standing to support gold price in the foreseeable future.   If you are considering holding positions in gold to hedge inflation risk, keep in mind that:

·         Many investors have already jumped in the game ahead of you.  This means that the price of gold has already factored in anticipated inflation after the economy recovers.

·         If inflation doesn’t turn out to be as bad as we anticipate, this will put further pressure on the price of gold.

I also learned that the supply of gold is rather rigid.  In other words, you cannot just come up with new supply on demand.  The process of finding gold mines, setting up the equipment needed to mine the gold ore and refining, are projects that are both capital and time intensive.  If mining companies continue to expand their mining operations, the outlook on gold is sliding demand with more than ample supply. 

Personally, I believe that it is still better off staying on the sideline observing the market than jumping into it at this time.    If you still want to invest in gold, there are plenty of ETFs out there so gaining exposure is easy.  (You can go long or short on gold with these ETFs, it’s up to you)   We are amidst one of the greatest financial crises, meaning that great investment opportunities are in the making.  Patience will pay off. 

Hello!  Thanks for reading my first article and your feedback.  Some of you raised interesting questions (I appreciate your email.  It is also possible to post comments on my blog directly) and I'm combining them here so I can respond to them all at once:

The current economic crisis has been on headlines every single day. From the stimulus package, news of layoffs to discussions about when to expect a recovery, economics has become the new topic of interest amongst people of all ages. I would like to use this blog as a platform to share my views on world issues with everybody. I welcome your feedback.

I am certain that the words “Buy American” have been ringing in all of our ears. There is probably much confusion in the air on this topic. Should you support protectionism? Is it a blessing or a curse if your government chooses to “protect” its industries and citizens?

First of all, what is protectionism? My definition of protectionism is “artificial measures taken to direct economic activities to one’s home country where such activities would have taken place in a foreign economy under free market conditions.” Governments can impose tariffs on imports, come up with regulations that only domestic industries can comply with, or devalue their currencies. The main concern is not how governments promote protectionism, but the harms that protectionism will do to every single one of us.

Here is a simple example to illustrate what I mean (without resorting to graphs and equations) with a fictional world consisting of only two countries where each country has two industries; textiles and cars. As businessmen and government officials pay visits to each other, they realize that country A was better at manufacturing cars and B at textiles. What would happen if country A specialized in manufacturing cars and B in textile? At an aggregate level, there would be more cars and more textiles available for consumption in both countries. Country A can import textiles from B in exchange for cars and vice versa. This is a happy scenario, is it not? Consumers win by having more selection of both products at lower prices. What is wrong with improving everyone’s standard of living?

If you were a textiles worker in country A or a factory worker that assembled cars in country B, you would probably be out of a job while the rest the world enjoyed cheaper goods and better pay. Free trade created a bigger economic pie for everyone, but it also cut the pie into uneven slices. Those that got the smaller slices would be the groups that cry for protectionism. Going back to the original question, should you be cheering for or spurning protectionism?

Yes, there are winners and losers under free trade and no, free trade is not perfect. Regardless of free trade or protectionism, a choice needs to be made and free trade is the choice that will produce more winners and fewer losers.

The optimum solution to the world’s problem is to overcome the shortcoming of free trade while pursuing it. Abolishing free trade will only make the problem worse in the long run. Using our example, both countries could convert their productive resources into their area of expertise. Country A could convert its textile plants into car manufacturing plants and train their textiles workers to install wheels and bumpers. Alternatively, textile businesses in country A could move over to country B should they decide not to convert. Vtech, a manufacturer of communication devices, had been a company located in Hong Kong in its early stages. Hong Kong is one of the world’s most important financial centres, but its strength is not in Information Technology. The company moved its operations to Taiwan, where Information Technology is the pillar of its economy. Free trade needs to be coupled with the free flow of labour and capital in order to do what it is intended to do.

There will always be protectionism in the real world. Policy makers have a lot to consider. To revive a slumping economy, protectionism can generate instant results albeit at the expense of future wellbeing. Unfortunately, it is human nature to be short sighted and we will pursue actions that will bring us instant gratification and have the problem fall squarely on the shoulders of our children. The picture is gloomy, but this does not mean that the feeling of despair needs to be in the air. There are things that you can do as a citizen of the earth.

Start with your daily activities. There is no reason to feel guilty when you purchase goods or services that are imported. Protectionists will attempt to convince you that buying homemade goods is how you can show your patriotism. This is a wicked idea.

Depending on what your line of work is and where you live, your next opportunity could be anywhere in the world. My best friend is an animator and he has relocated to Los Angeles to pursue his career. I also know a lady who made a career shift from a secretarial assistant to a healthcare worker. She is very successful and is living happily with her two lovely daughters. You either move yourself or learn a new skill if the situation demands it.

I cannot tell you when the economy will rebound nor can I predict to what extent protectionism will prevail. One thing is for sure; very rarely can anybody smooth sail all her life. We will look back one day and be glad that we had the opportunity to make ourselves stronger individuals and not to take what we have for granted.

See you next time.