Gold prices have been on a roll over the past few years. A quick look at this page would tell you that had you invested in the precious metal 5 years back, it would've given you a return of about 160%.
Even after a steady rise, gold prices are likely to remain high and here are some of the reasons:
1. Central Banks, who have been net sellers for a very long period, turned net buyers in 2010. They bought nearly 76 tonnes of gold. This trend further accentuated in the first quarter of 2011, when Central Banks were net buyers of gold to the extent of 129 tonnes. Turns out, the rise in gold prices has caught the eye of various Central Banks who believe it is a welcome addition to their reserves given its status as 'store of wealth' even during the periods of crisis.
2. Analysis shows existing gold mines across the world are aging and output is falling. A study (titled 'In gold we trust') of 375 gold projects by Standard Chartered Research team suggests a very limited production growth profile for the next 5 years. A 10-year bull market in gold has done little to drive production. A lack of funding from equity markets and shortage of large gold mines makes it difficult for the industry to compensate for the depletion caused by aging mines and falling grades. As a result, there are very few large gold mines commencing operations in the next 5 years. Only 7 gold mines and one copper/gold mine are capable of adding a total of 500 koz gold production over 2011-15.
3. Standard Chartered's analysis of IRR (internal rate of return) for major gold projects under construction (for which the acquisition cost of gold reserves has already been spent) shows the gold price would need to be $1,400 /oz to generate a 20% IRR, usually the minimum return requirement. It's from this point of view that analysts have been saying gold will touch $2,000/oz, since new projects would need that price realization to produce an IRR of 20%. Till then, gold production will face delays.
4. The above study also shows that currently, 1.8% of China's forex reserves is in gold; if China were to bring this percentage in line with the global average of 11%, it would have to buy another 6,000 tonnes of gold, or more than two year's global mine production. Imagine what that would do to the price of gold. This is also true of other major holders of foreign exchange reserves like Japan as well as India. Japan's gold reserves stand at a minuscule 3.2% of its total foreign exchange reserves of $1.14 trillion. India's gold reserves at 8.2% are much closer to the world average of 11%.
5. The rise in the price of gold is also due to the rising per capita incomes in China and India. While Indians have been traditional gold buyers, the Chinese are getting there as well.
The gold run is here to stay. Perhaps it's time to consider those gold ETF's (exchange traded funds) which are fast catching on.
[With inputs from The Economic Times]
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