Why Emerging Markets Love Gold

On the surface, our favorite yellow metal isn’t doing much this week. The spot price has moved within a tight range around $1,380. But just below…we sense something lurking.

Retail buyers in China can’t get their hands on gold bars fast enough. The premium in Hong Kong, for example, has reached $3 an ounce over the spot price, a level last seen during the Panic of ’08.

“I don’t have any gold,” one dealer told Reuters yesterday. “Premiums are very high. Some say they have no stocks on hand.”

Chalk it up to inflation – officially at 5.1%, but probably double that – and the run-up to the Lunar New Year. “The jewelry sector is gearing up,” another expert tells Reuters, “and giving gold bars as a gift has been getting very popular.”

Likewise, the first gold-oriented fund in China has had no trouble meeting its goal of raising $500 million. Lion Fund Management hung out its gold shingle barely six weeks ago, giving ordinary Chinese access to overseas gold ETFs for the first time.

In the limited space of funds allowing Chinese to invest overseas, this was the biggest offering in three years. Perhaps not a surprise for the world’s No. 2 consumer of gold.

Meanwhile, the world’s No. 1 consumer of gold likely set a record for imports last year. Final figures aren’t in yet, but Indian purchases totaled roughly 800 metric tons – a massive increase from the previous year’s 557 tons, according to the World Gold Council.

Investment demand for bullion surged 73% in the year ended Sept. 30, says the Council’s Ajay Mitra. “Price is no longer a factor,” he adds, reinforcing a point we made here last week: Indian buyers no longer wait for a 10% pullback before backing up the truck.

We have visited gold markets in Mumbai and Beijing over the past year and can attest to the irrational desire buyers have when they get near the stuff.

“There are two main drivers of gold demand,” says US Global Investors chief and Vancouver favorite Frank Holmes, helping put the demand in perspective: “The Fear Trade and the Love Trade.”

The Fear Trade is what we have in the West, “driven by negative real interest rates – where inflation is greater than the nominal interest rate – and deficit spending. Whenever you have negative real interest rates coupled with increased deficit spending, gold tends to rise in that country’s currency.

“In the US, we’re in the middle of an extended period of negative real interest rates that will likely last through the year.”

By contrast, “The love trade is significant and unique to gold,” Frank continues. “People buy gold out of love and those in emerging markets are especially amorous of the metal. It is customary in most emerging countries to give gold as a gift to friends and relatives for birthdays, weddings, and to celebrate religious holidays.

“What is important to remember when looking at the history of gold is that in the 1970s, China, India and Russia were isolationists with no significant global economic footprint. The world’s population was 3 billion, and today we have witnessed an awakening of epic proportions.

“These countries are growing with free market policies and massive infrastructure spending. In the 1970s, gold rose on the fear trade and the Cold War. Today, the world is significantly different and the love trade drives gold.

“It’s impossible to predict where gold prices will be 12 months from now,” Frank concludes, “but we think gold prices could double over the next five years. This would mean roughly a 15% return if you compounded it annually.

Addison Wiggin

for The Daily Reckoning

The Daily Reckoning