We have heard many commentators implying that a U.S. economic recovery that leads to the sort of growth that was seen before 2008 will give investors reasons to divest from gold. As the year end approaches and another year is on us, it seems wise to us to look at this carefully. All of us would dearly love to see a real recovery, with rising housing prices moving back to levels seen in 2008, strong employment data and consumers with plenty of disposable income to make life stress free again. In such a climate, one can understand that these desires would be accompanied by a fall in the gold price, which to many is a thermometer measuring the ailments of the developed world economies. But is that the reason that gold is at current levels?

The developed world economy grows as the gold price rose

Let's take a look back to the year when the gold price started to rise, back in 2,000. What was the economic climate of the developed world like then? When the Volker hiked interest rates in the early eighties,, confidence in the dollar grew and world growth took off. As the turn of the century approached, developed world economies looked good. The euro made its entrance onto the world monetary stage and the Eurozone grew steadily. By 2008, life was even better. The bulk of the world's executives had only seen these good times. There appeared no unmanageable reason for not expecting the future to be more of the same. During the days from 1999 to 2008, the gold price rose nearly five times. Could we relate this to the economic state of the developed world? No, of course not! In fact it would almost be wrong to say that the gold price rose. At $275, it was very undervalued.

Why was it at $275 and rose from 2,000 onwards?

The $275 price of gold was a result of the long-term central bank campaign to 'discredit' gold in favor of the dollar then the euro. Britain sold half of its gold in 1999 at that price. The fact that European central banks decided to limit their sales of gold to amounts that the gold market could handle without taking the gold price down was the key factor.

The arrival of the gold Exchange Traded Funds unleashed pent-up U.S. institutional demand and brought gold back to the investment world.

The realization by gold mining companies that the profits from hedge positions in a gold market, where the price was persistently falling were disappearing caused them to re-think their policies. The profitable hedge positions, which so many of them had, could limit their income to prices lower than the rising gold price. These positions had to be closed to increase profits. Shareholders demanded that they were. Around 400 tonnes of these hedge positions were bought back annually. A combination of the above factors ensured that the gold price would drift upwards towards a level it should have been in 1985.

The came the 'credit crunch'

When the growth of the east met growth in the West, the oil price took off and nearly doubled in price. This was the pinnacle of world growth. It was a time when the worry was, could the resources of the world accommodate global growth? It was also the zenith of U.S. economic power. Then came the unexpected credit crunch as the property bubble burst. All markets fell, including the gold and silver markets, but for different reasons.

Why did they fall when the hope in the future was so strong? We would favor calling this an investor meltdown. There appeared every reason to expect companies to continue to perform well in the future, when the investment was looked at, but the change had hit investor's capacities to invest. Too many investors has leveraged their positions so that when house prices fell then equity and other markets fell, there was a need to liquidate holdings and find cash to cover the margin and other calls. So markets, such as gold and silver, which should have risen in that economic climate, fell as investor investment capacities shrank.

History shows that when such breakdowns in prices happens, gold and silver act as 'safe havens', but they weren't between mid-2008 and most of 2009. Right now, U.S. investor capacities remain well below what they were before then. Markets in general have stabilized, but not grown, in an investment climate that has been marked by falling confidence in the monetary system and the rising fear of instability and uncertainty.

The gold and silver markets also stabilized. With the Fed's policy of QE, the developed world's economies have not spiraled down into deflation nor have they promised a real recovery. What has happened is that in this fearful financial climate, business goes on as usual, but with little hope of seeing the pre-credit crunch days.

As the credit crunch crossed the Atlantic and morphed into the sovereign debt crisis fears of a systemic collapse have heightened. The attention has swung to a falling confidence in the currency system itself as far too much debt is being carried by nations responsible for confidence in the paper currency systems. The expectation is for the sovereign debt crisis to worsen in the future.

The Gold market changes structure

The change in the gold and silver markets has been structural. It has become global and embraced peoples from diverse cultures, nations and stations in life.

• From the limitation of gold sales by European central banks, to the cessation of those sales, to central banks becoming buyers of gold the 'official' gold market has changed direction completely.

• U.S. institutional investors have joined the line of investors holding for the long-term [not trading for profits], a change from past attitudes. The advent of the gold E.T.F.'s have drawn new large investors to the gold market [the same has happened in silver].

• As Europe's sovereign debt crisis brings the Euro into question, Europeans, who have experienced many currency collapses in the last hundred years are turning to physical gold held out of reach [they hope] of their governments.

• In India as that country's middle classes go global and enlarge locally, gold demand is overcoming rising prices in line with growing disposable income. This year should see them buy close to record levels of bullion. As always they do not buy for profit, but because they see gold as money and to ensure financial security.

• In China the last decade has seen that country turn into the world's second largest economy and headed to be the largest, with more than four times as many people as the U.S. From a tiny gold market at the turn of the century, it is growing phenomenally with the support of its government. With its people new to wealth, their propensity to save is unwavering [saving around 40% of income]. The Chinese, from the government down, favors gold as both money and a means of saving. With inflation running ahead of interest rates there, gold is proving itself a leading investment medium. The potential gold demand from China is many times the level it is and was in the developed world.

Will gold fall in a real recovery?

Against the background painted above, it is clear that the gold price is independent of the state of the U.S. economy. Mr Ravi Kumar in Mumbai does not understand the implications of U.S. house prices rising or falling. Mr. Wang Ho of Shanghai is not overly worried about U.S. Treasury Yields. They are driven to buy gold by completely different forces, as old as man himself. He wants to protect himself and his future with it. This won't change if U.S. growth were to jump to 10%, let alone 3%.

The reasons why gold rose [pre-2008] had very little to do with U.S. economic growth. Those reasons will continue to take gold higher in 2011 and onwards, because they have to do with the monetary system not economic growth or the lack thereof. Where U.S. economic growth will affect the gold price in a recovering investment climate, is that U.S. investors will be financially more able to invest in gold and silver. The rise of gold is about the state of the developed world's money is!

But far more importantly the gold market has moved primarily out of the developed world and India to encompass the entire global economy. As money, as a reserve asset and as an international measure of value there are considerably more ramifications of far greater importance to gold investors than a recovering U.S. economy. What are they?

Will gold rise in a recovery? What role will it take in a future global money system?
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