In contrast to the closing months of 2011, gold has begun the new year on a strong note. Whatever the metal's short-term prospects, we believe 2012 will be another stellar year for gold investors.
Gold topped out at an all-time high just over $1,924 an ounce in early September - a whopping gain of some $600 or about 50% from last January's low point. But as investors know all too well, gold prices can be quite volatile - with big upswings often followed by big downswings, albeit around a rising long-term trend. Such has been the experience of the past four months with gold shedding roughly 30% from its all-time high to its recent late-year low point. But, let's not forget, even allowing for this deep price correction, gold still closed the past year with just about the best annual gain of any asset class.
Looking ahead, 2012 could well turn out looking much like the past year for gold - with sizable gains, possibly as much as 50% (or more) from the recent lows under $1,600 an ounce, but also with big declines that may lead many observers of the gold scene to mistakenly declare an end to the yellow metal's bull market. Just as gold bears have been wrong over and over again in the past decade, so will they continue to be wrong in 2012.
The story of gold in recent years has been a tale of institutional traders and speculators - including hedge funds, commodity funds, and the trading desks at the big banks and financial firms - producing great two-way volatility as they rushed into gold (as we saw last summer) and then, not just unwinding long positions, but shorting the metal in a big way (as we saw this past fall).
Driving these institutional players, in addition to momentum and technical trading indicators, has been the flight from the euro into US dollar assets - and the appearance of dollar strength pushing gold lower, particularly at times of massive euro capital flight.
Importantly, much of this activity has taken place in gold derivative markets - but, all the while, long-term physical demand has remained fairly robust.
Buying from the Asian gold-market giants - China and India - for both jewelry and investment has continued unabated in spite of higher prices that years ago might have discouraged continued accumulation.
Having just returned from two weeks in China and meetings with many players in the country's gold market, I can tell you that gold demand remains strong despite some slowdown in economic activity, thanks to personal income growth, rising wealth, and also inflation fears. Higher gold prices, rather than discouraging demand, have attracted new investors to the market.
Meanwhile, global net central bank gold buying has not just continued but has accelerated as reserve managers look for opportunities to shed US dollars and euros too in favor of something that has a longer track record as a reliable store of value.
Central bank reserve managers, ever sensitive to buying without disrupting the market, have used episodes of price weakness to step up their buying. This behavior now reduces downside risk while it is also helping set the stage for a surprising sizeable snap-back in the metal's price.
What few gold pundits realize is that the amount of physical gold available in the world gold market - the "free float" - is shrinking, thanks not only to Chinese and other Asian buyers, but also due to renewed interest and accumulation of gold by a growing number of central banks. For central banks, the holding period may be measured in decades if not longer. As a consequence, future demand will have a much more high-powered effect on the price of gold - and this is one of the reasons we expect much higher prices in the years ahead.
Short-term trading in derivative markets may, at times, produce a great deal of gold-price volatility but, in my book, it does not affect the long-term price trend. What governs the price of gold over the long term are the market's real-world supply and demand fundamentals - and these have been decidedly bullish and are becoming even more so. Hence, my long-standing long-term forecast of higher gold prices over the next several years.Jeffrey Nichols, managing director of American Precious Metals Advisors and senior economic advisor to Rosland Capital, has been a precious metals economist for over 25 years.