Why Gold Is Rising

Source: Thinkstock

Source: Thinkstock

The price of gold has risen this year by about 5.5 percent, which is more than the S&P 500 and the Dow Jones Industrial Average. After spiking at the beginning of the year from $1,200/ounce to nearly $1,400/ounce, gold corrected to under $1,250/ounce where it was met with buying. Now the yellow metal appears to be on the rise again.

I expect it to continue to do so, as there are several catalysts driving the price.

First, there is interest from central banks, who have been net buyers of gold since 2010. In particular we have been seeing interest from Russia, which sold Treasury Bonds in April in order to accumulate 30 tonnes of gold, or more than 1 percent of annual mine supply. We have also been seeing interest from Turkey, Kazakhstan, and South Korea. It is widely believed that the People’s Bank of China has been buying a tremendous amount of gold, and this belief is backed up by the incredible amount of buying that we have seen in China over the past two years or so. However, there is no formal statement from the PBoC that this is the case, and so this claim is speculative, at best.

Second, we should expect to see a decline in gold supply over the next couple of years. Lower prices plus higher production costs have made it very difficult for many mining companies to find funding for their projects. This has impacted some very large projects from Seabridge Gold’s (NYSE:SA) KSM project to Chesapeake Gold’s (OTCMKTS:CHPGF) Metates project, each of which would add nearly a million ounces of gold to the world supply per year.

Third, we are seeing continued stimulus coming out of central banks. Despite the fact that the Federal Reserve is tapering its bond buying program it has been pumping money into the economy. The ECB recently lowered interest rates below zero, which means that there is a carrying cost for Euros. This means that Europeans have an incentive to sell Euros and to buy an asset whose supply isn’t rising rapidly, one of which is gold.

Fourth, economic data both in the United States and at the global level has been relatively weak. The World Bank recently reported that it is reducing its forecast for global growth this year from 3.2 percent to 2.8 percent. Furthermore, we saw GDP decline in the U.S. in the first quarter by 1 percent, which means that the U.S. is at risk of entering a recession. Retail sales numbers have also been coming in weak, and they would be considerably weaker if it weren’t for inflation and the fact that people are borrowing money in order to buy cars. A weak economy is bad for global stock markets, and when people sell their stocks they need to put their money somewhere. Bonds are overvalued, and there are large institutions selling bonds such as the Central Bank of Russia. Furthermore the Federal Reserve is buying fewer bonds, which means that there is less demand in the market. This leaves gold as the best option for many investors.

Longer term investors interested in owning gold should consider buying the Sprott Physical Gold ETF (NYSEARCA:PHYS), which is taxed like a stock. This means that your gains are taxed at the capital gains rate as opposed to the more popular SPDR Gold Trust (NYSEARCA:GLD), which is taxed as a collectible at 28 percent.

More aggressive investors who want to put in the effort should research individual gold miners. Generally there is far more value in small, undiscovered names and so this is where I focus my efforts and my investing dollars. I would avoid ETFs such as the Market Vectors Gold Miners ETF (GDX), which owns several poor performing companies as well as companies that produce a lot of base metals.

Disclosure: Ben Kramer-Miller owns gold coins and shares in select gold mining companies.

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