YOUR MONEY: Weak equity market sees investors making a new gold rush
Sun 5 May 2002
IAN WILLIAMS
THE price of gold rose last week to $309 an ounce - and at one point was $312, its highest for two years, a period during which the FTSE gold mines index gained 55%.
This highlights the counter-cyclical nature of gold relative to bonds and equities. A multitude of factors - technical, fundamental and cyclical - are responsible. But one thing seems certain: the price can go considerably higher, outperforming even the previous peak of $850 an ounce in January 1980.
Analysis points to a multi-year bull market developing for both gold and gold stocks, supported by such diverse factors as a 900% increase in Japanese gold imports this year, China’s desire to increase the percentage of its reserves held in gold and changes in forward selling by major gold-mining companies.
Probably the most important factor, highlighted by Durlacher in February, has been the emergence of private Japanese investors. Faced with the imminent curtailment (and eventual abolition in 2003) of Japan’s state-backed, guarantee bank deposit scheme, the Japanese have treated gold as a safe haven.
Examination of supply and demand in the bullion market also reveals a bullish picture. Last year, total worldwide demand for gold was 3,800 tonnes, of which jewellery accounted for 2,995 tonnes. Total fabrication demand was 3,483 tonnes against total global mine output of 2,595 tonnes. The supply/demand imbalance was met by a combination of melting down scrap gold (695 tonnes) and sales by central banks (468 tonnes).
Sceptics believe that gold has a natural cap. In their view, rising prices encourage hedging and central bank sales, and gains in mining stocks are geared to weaknesses in the Australian dollar and the rand. But where many investors have been wide of the mark in underestimating demand is in assuming that investment demand for gold will be zero and that central banks will carry on selling.
Viewed in isolation the figure for central bank sales can be misleading. The fact that some central banks now buy gold puts further pressure on supply.
China’s central bank is the most interesting example. China has foreign exchange reserves of $700bn, of which about 2% is in gold. Last year, the Chinese declared their intention to increase this to between 10% and 15% of total reserves but were "persuaded" by the Americans to keep their reserves in dollars and treasury bills in return for American support for China’s application to join the World Trade Organisation. Now that China is a member, it can change its reserve mix to whatever it wants.
Meanwhile, in Europe central banks which are selling, such as Switzerland, are subject to a self-imposed limit of 400 tonnes a year until October 2004.
Another factor that has depressed gold prices has been the practice of forward selling by the big mining companies. As the bullion price rises, more companies buy back their forward sales and push the price even higher. Accordingly, investors have shunned the hedged companies and concentrated on unhedged shares such as Harmony and Goldfields.
A striking example is the relative performance of AngloGold (a hedger), which is number one in South Africa - and the world - and Goldfields (a non-hedger), the number two and third in the world. In 2001, AngloGold tried to buy Goldfields when its market value was more than double that of its smaller rival. Today, Goldfields’ market cap is almost equal to AngloGold’s, making a takeover impossible.
Gold prices run in 40 cycles - 20 years up and 20 years down - and we are currently in the early stages of an upward surge.
One great attraction for investors is the counter-cyclical properties of gold. Gold has a tendency to rise when bonds and equities are falling and vice-versa. The last decade saw a fall in nominal and "real" (inflation-adjusted) yields; bonds and equities rose as gold faltered.
I believe the great fall in real yields is over and that a multi-year bear market in bonds has begun, fuelled by the avalanche of newly-created dollars and now yen. The increase in the wider measures of US money supply has been out of control for the past five years as the Fed has injected liquidity into the system to avoid recession. In the US, this is now manifesting itself in asset-price inflation.
This was not too bad while Japan was deflating but now the Japanese are printing money like confetti. The Japanese monetary base has risen 25% in the past 12 months, so we now have our two biggest economies printing their way out of slump.
Investors wishing to become goldbugs should concentrate on unhedged mining companies in the global top 12, particularly Goldfields, Harmony and Durban Deep. Ian Williams is head of Durlacher’s fixed-interest and commodities team
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