TELLING THE FUTURE BY "GOLD BUBBLES"

Recently, one of the key subjects of discussion for the global economic media and analysts has been the unprecedented rise in gold prices for the first time in the past eight decades. The cause is associated with the departure of investors from weakening dollar assets and economic problems that have yet to be resolved in Europe and the USA. At the same time, it is clear that the rise in the prices of precious metals is speculative in nature, and it is possible that in the near future, the "golden bubble" may burst as the mortgage and oil markets did two years ago.

There is also interest in the dynamics of gold prices in Azerbaijan, where the development of gold deposits began in the middle of last year. And, beginning this year, the Central Bank included the metal in the structure of its reserves.

Stimulation or speculation?

Since the beginning of this year, gold prices have risen by 269 dollars, or 24 per cent. Prices for the metal have risen for five years in a row, which is the longest period of growth since at least 1920.

Analysts attribute the causes of the October jump in prices for precious metals and oil to the fall in the rate of the dollar against major world currencies; this was the result of a report about US Federal Reserve System (FRS) plans to take measures to stimulate the economy. We are talking about the readiness of the FRS leadership to flood the market with additional amounts of cash, as well as the departure of the US president's main economic adviser from his team. Some experts believe that the US is deliberately reducing the dollar's exchange rate, primarily against the major currencies of its competitors - the Chinese yuan and the euro, thereby ensuring greater competitiveness for American exports.

It is notable that the previous wave of rises in gold prices, from August-September this year, was also linked to information from the US - negative forecasts for the US labour market; the unemployment rate has now reached 10 per cent. Earlier this year, the debt crisis in Europe acted as a catalyst for a lengthy growth in precious metal prices. Droves of European investors transformed their capital into gold assets, seeing gold as a more reliable alternative to the unstable euro and company stocks prone to major fluctuations.

But the main reason for the rise in gold prices is the fact that the global market remains uncertain about prospects for the recovery of the global economy. In fact, there are practically no consistently growing assets on the market today, and this alone serves to promote the purchase of gold, reinforcing its role as an investment asset. Moreover, gold has almost zero correlation with other investment assets, i.e. it is a great tool for diversification, not only for central banks and large companies, but also for ordinary investors.

At the same time, such a rampant rise in gold prices alarms experts, who believe that investor interest is fuelled to a large extent by the actions of stock speculators. According to New York University Professor Nouriel Roubini, there is no fundamental reason in the global economy, such as hyperinflation, for such a rise. In fact, the current increases in the prices of precious metals are due to a fear of investing in debt assets because of the risk of default and fears of recession in the economy. A psychological stereotype is triggered - most people believe that gold is the safest asset, just as they believed two years ago that oil prices would never fall and real estate prices would always rise.

However, experience shows that any speculative growth in prices for a particular commodity or stock assets ends sooner or later and, often, it ends with the bubble bursting unexpectedly. Most of the world's experts are convinced that the same will happen to gold - any divergence of views is only about the maximum price level for the metal and when the gold rush will end. For example, analysts at the largest French corporate and investment bank Natixis believe that by the end of the year the price of gold may reach a threshold level of 1,500 dollars per ounce and will subsequently fall. Indeed, in response to the rising prices of precious metals, the volume of supply also increases - both from mining companies and from secondary sources, balancing the demand. It should be borne in mind that sustained high prices will continue to have a negative impact on demand from jewellery manufacturers and other end users. Finally, the positive changes in the economies of Indochina and Southeast Asia give hope that traditional investments will yield more attractive earnings and thus the limited yield from precious metals and the uncertain prospects for future growth in gold prices, will lead to a loss of investor interest in these assets.

There are other opinions. For example, experts from the consulting and intermediary company, US Gold Corp and Xiamen International Trade Futures Co, believe that gold is regaining its function as a global reserve currency for the first time since the abolition of compulsory "gold" backing for the world's currencies. These processes are irreversible and, according to analysts, the gold bubble "has not yet reached its limit, which they estimate to be in the range of 2,000 to 5,000 dollars per troy ounce.

Most experts consider that investors' departure from traditional assets - securities, hydrocarbons and other raw materials - indicates a deepening of the global economic crisis and the complete exhaustion of the world economic model that developed after the collapse of the USSR. Thus, the causes of the mass conversion of capital into treasure have not been eliminated, and the final bursting of the bubble will only happen when the bulk of the population of developed countries, the so-called "golden billion", reaches a critical level of poverty. However, this process has already begun: half the EU governments are already deliberately reducing the living standards of their citizens, raising the age of retirement and the length of the working week and reducing holidays and various benefits.

Reasonable sufficiency

Yet it is precisely from this year that there have been interesting changes in the issue of gold reserves in Azerbaijan. For example, the Central Bank included a new asset - gold - in its currency basket. "Gold is a universal currency, is freely convertible, bought and sold, and what's more, gold prices have been increasing recently," says the CBA head, Elman Rustamov. However, for the time being, our country is not buying gold on the world market, but is only storing some of the precious metals extracted in Azerbaijan. In particular, we are talking about the gold mined in Gadabay - since the middle of last year, the Anglo-Asian Mining PLC operating company has been engaged in commercial development there; the gold produced has been sent to Switzerland for refining since the second half of last year. This is one of the six gold fields granted to the American company RV Investment Group as a concession in accordance with the 1997 contract signed with the government.

According to the State Statistics Committee, from July 2009 to August this year, 1,533 kilograms of pure gold were produced at the Gadabay deposit, and 1.2 tons were received in eight months of this year. "In the next four years, the volume of gold production in Azerbaijan will increase six-fold, due to the expansion of gold mining at the Gadabay field," Azerbaijan's Minister of Economic Development Sahin Mustafayev said recently. In general, by 2015 it is planned to produce more than 300,000 ounces of gold from this field. And after investors recoup their costs (about $70 million) the government of Azerbaijan will receive 51 per cent of revenues from gold exports. The development of other fields included in the contract with RV Investment Group will begin soon. Among these fields are the Qosa and Maarif deposits, where exploration work is being completed. The potential reserves at Qosa in Tovuz District alone are estimated at 5 million tonnes of copper and 400,000 ounces of gold.

Government coffers are expected to receive gold under a contract the government concluded with five foreign companies in 2006. It is planned that the consortium created by the agreement - Azerbaijan International Mineral Resources Operating Company - will begin developing the Covdar field in a year or two. Our country's share in this project will be 30 per cent and, according to experts, one ton of ore from the mine will provide up to four grams of gold. The consortium will also develop gold deposits such as Karabakh, Qeydag, Dag Kasaman and sites such as Kohnamadan and Kurakcay.

"A promising new gold deposit has been discovered by Azerbaijani geologists in Goygol District and, apparently, it will be even richer than Covdar," said Huseyn Bagirov, Minister of the Environment and Natural Resources. Exact reserves are still being clarified. An exploration of gold deposits is also under way in the Naxcivan Autonomous Republic and Daskasan.

Thus, Azerbaijan will begin developing several gold deposits in the next few years, and some of the precious metals mined there will be made available to the government. This process has already begun and, according to Finance Minister Samir Sarifov, the Central Bank of Azerbaijan is keeping in reserve some of the gold mined under PSA contracts to develop gold deposits. "Today we are in talks to buy another batch, an amount exceeding 100 kilograms. In view of the first batch held in reserve - 99.5 kg - the country's gold reserves could exceed 200 kg and by early next year, with subsequent purchase, they will have increased significantly," said Sarifov.

Apparently, in this respect, the country's leadership intends to adhere to the principle of reasonable sufficiency and has no desire to radically diversify foreign currency reserves. After three quarters of 2010, the joint strategic currency reserves of the Central Bank and the State Oil Fund of Azerbaijan (SOFAR) exceeded $28 billion; more than half of the country's currency portfolio was in US dollars, while another 40 per cent are held in euros and the rest in British pounds or other stable world currencies. That is to say, in monetary terms, the gold in the total foreign exchange reserves of the country amounts to around 0.003 per cent and is unlikely to reach 0.1 per cent any time soon.

In recent years, the practice of including gold in central bank reserves has become widespread. Indochina plays first fiddle here: by the beginning of this year, India's gold reserves exceeded 550 tons and account for approximately 1.5 per cent of its GDP, while China almost doubled its gold reserves and brought them up to 1,054 tons. These transactions are becoming a trend in South-East Asia and other developing countries which plan to further increase their gold stocks. According to the World Gold Council, this year the central banks of leading nations will become net buyers of precious metals. However, in this case, Azerbaijan does not intend to blindly follow the global trend - the CBA and SOFAR do not really gamble on gold, and our country is unlikely to begin to buy gold on world markets on a mass scale, changing the structure of its foreign exchange reserves. This is correct, because the "gold bubble" will burst sooner or later, and it would be unwise to get involved in the game of buying precious metals which are rising in price and risk losing billions at a time of inevitable decline.