Gold's Not Glistening
By TIM WHITEHEAD
A friend of mine is both an underwriter of gold shares and an incorrigible forwarder of e-mail jokes. Over time, I’ve noticed that the frequency of his emails is inversely related to the state of the gold market: when gold is on a rebound, there are fewer jokes because he gets busier with prospective deals. The flow of jokes has been fairly steady for most of the last couple of years, needless to say.
Gold bugs are only too aware of the sad state of the yellow metal. Over the last while, bullion has had a few flurries of interest – the month of May saw one such episode – but its price in U.S. dollars has been less than, well, golden. The accompanying chart shows the monthly average price (London close) for gold in U.S. dollars and in constant 1982-84 U.S. dollars. The annualized return for gold in U.S. dollars was –2.4 per cent from the beginning of the 1980s to now. That almost makes Nortel look good.
Prices are always relative, however, and with an investment like gold it is worthwhile to consider it from a number of different perspectives.
The largest market for gold is India – the country accounted for a quarter of the worldwide demand for bullion from 1996 to 2000. From 1980 to now, the price of gold in rupees rose at an annualized rate of 5.9 per cent. Not sensational, perhaps, but not bad either as a poor man’s hedge against the vagaries of the Indian rupee.
The difference between Sam’s and Rajiv’s experiences with gold is, of course, the relative performance of the U.S. dollar and the Indian rupee. The Indian rupee has lost ground against the greenback at the annualized rate of more than eight per cent over the last two decades. It has, therefore, shrunk faster against the U.S. dollar than gold has.
Now, put the whole equation on its head. We’re accustomed to thinking of gold’s price falling but it would be just as accurate to think of the price of the U.S. dollar rising in terms of gold. (As I said, prices are always relative.) If, as many Americans argue – and manufacturers scream and Treasury Secretary Paul O’Neill mutters – the U.S. dollar is overvalued, then it could be equally said that gold is undervalued. Indeed, over the last five years, the trade-weighted value of the U.S. dollar appreciated by about thirty per cent, while the price of gold in U.S. dollars fell by almost the same amount.
It’s this sort of thinking that has gold bugs watching the U.S. economy. Continued weakness there could mean (a) more interest-rate cuts at the Federal Reserve and (b) a slowing of foreign capital flows into the United States. Either (or both) might weaken the U.S. dollar. And that’s another way of saying that either (or both) could strengthen the price of gold.
That’s why the quarterly analysis from the World Gold Council devotes considerable attention to the state of the U.S. economy in general and Federal-Reserve policy in particular. Gold investors see the best prospects for bullion to lie in the worst prospects for the U.S. dollar.
Even so, expert opinion is not anticipating a surge in bullion prices. At the end of a good review of the factors affecting the gold market, TD Bank economists forecast that ‘gold prices are likely to trend only gradually higher, reaching US$290 at the end of 2002 and rising to US$320 in 2004’.
If true, that wouldn’t make gold an outstanding investment, but it would be an improvement over the experience of the last few years. And it would cut down on the joke-emails coming from my friend on Bay Street.
MINORITY INTEREST
The early betting on next week’s Federal Reserve meeting is that we’ll see another quarter-point cut in rates. Daniel Grombacher of the Chicago Board of Trade has translated the futures’ market for U.S. interest rates into probabilities of a rate cut. The latest result: an 88 per cent chance of a quarter-point cut and a 12 per cent chance of a half-point cut.
Economist/author Tim Whitehead operates a consulting firm, Left Bank Economics Inc., near Paris, Ontario.
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