Countdown to Sharia Gold

Sean Brodrick By Sean Brodrick,

Metals

Gold surged higher to test a four-week high above $1,300 last week. That level is key resistance, so it could take a while for gold to hammer through it.

The babbling heads on TV say gold is up because jittery investors are seeking a safe haven ahead of the U.S. election. Maybe a little… but I think there’s something much bigger at work.

I’m talking about Sharia gold.

It’s a huge wave of buying that will enter the gold market in just a few weeks. And I think the smart money is positioning ahead of it.

As a refresher, Sharia law outlaws three things that are part of everyday Western finance: riba (accruing interest), al-maisir (gambling) and al-gharar (uncertainty, or speculation).

Here’s the deal: Much of gold trading – and the financial instruments trading on the gold market – does not presently comply with Sharia law. For observant Muslims, that’s a problem.

Let’s focus on interest: Sharia prohibits acceptance of specific interest rates or fees, including interest, for loans. And that means interest on trading accounts for stocks, currencies or commodities.

In fact, many religiously observant Muslims don’t have bank accounts because they don’t want to collect even small amounts of interest.

Islamic banking has various workarounds to make ordinary business compliant with Sharia law. But gold trading has been tricky so far.

The World Gold Council wants to tap that market. Why? Because if there are Sharia-compliant ways to trade the gold market, the WGC believes that could spark “hundreds of tons” of new demand.

Last month, Natalie Dempster, the WGC’s managing director of Central Banks and Public Policy, put it this way:

Given that Islamic finance is growing, on average, by 16% per year, and Islamic finance assets are projected to reach $2 trillion by 2020, a very conservative allocation to gold would increase gold demand by $20 billion, or around 500 metric tons in 2020.

If anything, the WGC is being conservative. Standard and Poor’s estimates that Islamic financial assets could hit $5 trillion by 2020.

So the London-based WGC and the Accounting and Auditing Organization for Islamic Financial Institutions are working on a draft of a new standard for the finance industry. Some industry analysts are calling it “a game changer.”

The Sharia standard should launch on December 6. According to the WGC, it will offer an internationally recognized consensus on gold savings/accumulation plans, gold certificates, physically backed gold ETFs, gold mining stocks and compliant gold futures.

A Game Changer

Islamic investors will be able to allocate funds through ETFs that hold physical gold (as long as those funds comply with Sharia standards).

Could that make a difference? Yes! Observant Muslims who want to diversify into gold as a way to protect their wealth may find a gold ETF the easiest way to do it.

Let’s use Standard & Poor’s estimate of $5 trillion in Islamic financial assets by 2020. And let’s do a back-of-the-envelope calculation that 1% of that money might go into various gold instruments that were out of reach. That would be $50 billion.

Again, using the back of the envelope, let’s say just 10% of that goes into gold ETFs. That’s still $5 billion!

Last year, total global gold demand was 4,212 metric tons. That was a change of 14.2 tons from 2014’s demand.

Use a $1,400 gold price. Yeah, that’s higher than it is now. But based on current momentum, it’s a totally reasonable figure. Divide that into $5 billion. You get an extra 3.571 million ounces, or 101 metric tons, of gold demand by physical ETFs.

Well, there isn’t an extra 101 metric tons of gold.

What happens when there is way more demand than supply? The only way to fix it is through price. So how high will gold prices go?

We know that this year, gold ETF demand is running 16% ahead of last year’s demand. That’s one of the forces that has pushed gold prices higher. And when Islamic-compliant physical gold funds start opening up, we could see prices go much higher yet.

A Tidal Wave of Opportunity

And that, I believe, is a major reason why gold prices are already heading higher. The smart money can see the demand curve of Islamic-compliant gold financial instruments heading toward the market like a tidal wave.

The babbling heads on CNBC are ignoring this. But that’s okay. That gives us more room to park our own surfboards… and ride that golden wave when it comes.

Personally, I favor select gold miners because, as a group, miners are leveraged to the underlying metal. There’s a good group of them in the Sprott Gold Miners ETF (NYSE: SGDM).

gold-miners-rally

For the year so far, the Sprott Gold Miners ETF is up 75.2%. That’s much better than the 23.4% gain in gold. And it blows away the 2.6% gain in the S&P 500.

That’s just one fund that is solid, well-run and stuffed with stocks leveraged to the gold price. You can play this any way you want to.

Sure, prices don’t go in a straight line. Waves go in and out. But that big wave is coming. Get ready.

Good investing,

Sean