Seeking alpha

by Brian Rezny

Over the course of human history, some 5.3 billion ounces of gold have been mined. And gold has been many things over time. It is currency, jewelry, industrial metal, a store of value, an investment. And yet, China doesn't seem to like it all that much. SAFE (the State Administration of Foreign Exchange) announced recently that China won't be buying too much gold in the future. And considering that China is the world's second largest gold market, that matters.

Gold prices are too volatile, and the size of the market is too limited, so as far as SAFE is concerned "it cannot become a main channel for investing our foreign exchange reserves" (which total $2.45 trillion). Besides, purchasing more gold wouldn't really diversify the country's reserves all that much;doubling gold holdings (currently 1,054 tons) would increase gold's portfolio weight by 1 or 2%.

And China isn't alone. India (the largest gold market) has reacted to higher gold prices. They are still buying, but a lot less. Last year, India's purchases totaled 480 tons; that's 200 tons less than 2008. It's not so much that India doesn't want to buy gold; they just want to sell it even more. Just how much have the tides turned? Jewelers in the district of Lajpat Nagar say sales are down 40% on a yearly basis, according to The Economist. At this point, "there are only sellers in the market at these prices and most jewelers are buying back only old jewelry", according to president of the Bombay Bullion Association, Suresh Hundia; and by his estimation gold imports could fall 40% this year. That's huge, considering that India consumes 25% of the world's mined gold.

The bottom line: demand for gold as an investment has increased, and demand for gold as jewelry has decreased.

Now, gold is an interesting thing, because it has no intrinsic value. It's a commodity;but unlike others, such as gas or oil, its entire value lies in the assumption that it will increase in price. It doesn't have many uses other than adornment (though it has industrial uses like wire circuits for semiconductors and cables, and use in dentistry). It is an investment, but unlike a bond it has no coupon and unlike a stock it has no dividend.

The bottom line: the fact that gold is a safe haven during a global financial crisis is based on perception. And if you ask Citigroup's chief economist Willem Buiter, gold is "something whose positive value is based on nothing more than a set of self-confirming beliefs".

Gold reached a record high of $1,266.50 on June 21.

And on the other hand, maybe gold's good times are coming to an end. So will gold continue to fall? I wouldn't be surprised. The concern is widespread. Citigroup's Buiter believes gold is "the longest lasting bubble in human history". And if you ask Richard Wiggins of Barron's, "Gold is just another fiat currency. The only reason gold is valuable is that we believe it is valuable. Ultimately, this gold bubble ends in tears. When and how far gold's price will decline is anyone's guess, but a smart bet is, sooner rather than later". Well, sooner might be here right now. And later could get even worse. Let's remember, gold has seen steep declines in the past. Back in 1980, gold was used as an inflation hedge, and peaked at $850 an ounce;but adjusted for inflation, that $850 was equal to $2300. And then it tanked, falling to $253 by 1999.

So what's going to happen to gold in the future?

Well, opinions abound. Some would say that this is a correction, and there is future upside potential. That could be. There are plenty of risks to the global recovery, and gold is perceived as a crisis hedge. And down the road, gold can be used as an inflation hedge once we see upward pressure on prices. So sure, gold
might see further gains.

http://seekingalpha.com/article/216623-is-gold-losing-its-luster