While inflation risks remain benign in most of the developed world, what happens in the developing world and, in particular China is going to be crucial for commodities prices and gold in particular
But what happens in China is critical. The rise of consumers in that country, as well as costs like wages will be trans-formative, Hale says. This poses tests for commodity markets. But in the long there is a demand for gold and other commodities that is, for now, unstoppable.
Global economist David Hale discusses ‘the state of the world' and theorizes on how global economic conditions will impact inflation and monetary policies and how these will impact the price of commodities, in particular gold.
He is predicting a rise in the price of gold - to as much as $2,000 per ounce by 2015. The factors driving this rise are economic and Geo-political. The biggest driver of gold prices, he says, is China, and to a lesser extent, Africa.
Much depends though on the risk of inflation and its impact on growth in the developed and developing world. In the developed world, he says, inflation risks are benign and most countries are following an expansionary monetary policy to stimulate growth. But, in the faster growing developing world, inflation risks are rising. Monetary policy is tight, with many developing countries, including China, raising interest rates as they try to stave off inflation - how they manage this will impact commodity prices.
In the US the corporate profits are up thanks to unprecedented cost cutting and productivity improvements. US businesses are now hyper competitive and very profitable. But economic growth is likely to remain at a subdued 3,5% for this year. So interest rates, he says, are unlikely to rise in the medium term and the monetary policy is likely to remain expansionary for the next 12 to 18 months.
Similarly, the inflation outlook in Europe is also benign. "People are concerned about food inflation, but that is a transient problem". Instead economists are watching events like the current round of wage negotiations in Germany for signs of an inflation push. So far there are no ominous signs. "The first big agreement, at Volkswagen, was settled at 2,5%."
The European Central bank remains constrained by Greece, Ireland and Portugal and other, as yet unseen, problems. "I don't think Jean-Claude Trichet [the president of the European Central Bank] will want to raise interest rates this year. It is too uncertain."
Japan's export led economy showed initial signs of recovery, but slowed again last year. Interest rates are unlikely to change and the government will support an expansionary fiscal policy. "So the Bank of Japan cannot raise interest rates."
Around the world the possibility of monetary tightening is very slim.
But the picture is quite different in emerging markets - which now account for 50% of global output. "There we may have tightening." China could raise interest rates by another 75 basis points this year. Inflation concerns are growing. A bubble in the property market remains a risk. Wage pressure is another concern. In eastern China there is a labor shortage of 20m workers. "We are talking wage gains of 20% to 30%," Hale says.
China is shifting its strategy of export-led and investment-driven growth to a more balanced pattern of economic development, one more dependent on Chinese consumption. As a result, China's growth rate may be lower - around 6% - but more sustainable.
At the same time the Chinese government is pushing to internationalize the Chinese currency and reduce its reliance on a weakening US dollar. "It is not yet a fully convertible currency, so it's not yet a rival to US dollar." says Hale. But it could be in the near future.
The upshot of this, as well as of the depreciation of the US dollar, is that China will want to increase its gold reserves. The Chinese central bank has been quietly buying gold for the two to three years, but last year it upped its purchases, buying 450 tons. (So too did Russia, India and Mauritius, but in smaller quantities). China now has more than $2400bn of foreign exchange reserves, but a fraction of this is invested in gold. The IMF projects that China will run a current account surplus of $2600bn during the next five years. If it does, Hale says, its forex reserves could rise to the $5000bn-$6000bn range. And even if it keeps the gold share of its reserves constant, it will have to buy another 1000-1500 tons. In fact, some in the Chinese government have suggested that the central bank should increase its gold reserves to 10 000 tons. "This would give China larger gold reserves than Fort Knox."
The massive expansion of China's foreign exchange reserves has resulted in faster monetary growth and helped drive China's inflation rate up. This triggered a rise in the private demand for gold. Private holdings have rocketed from nothing three years ago, to 300 tons now. "This could easily increase to several hundred tons, with China rivaling India as the largest private buyer of gold in the world."