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Gold and silver investing
...Gold and silver will continue rallying until "acted up" by a credible global monetary force. Currently, however, the monetary regime that operates in the US and throughout the world is nothing short of incredible...
Eric Fry - Other articles
Thu 09 Mar, 2006
- Now that commodities in general – and precious metals in particular – are in motion, how much longer might they remain in motion? We have no clairvoyant insight, but we'd side with "Newton's Law" on this one.
- Gold and silver will continue rallying until "acted up" by a credible global monetary force. Currently, however, the monetary regime that operates in the US and throughout the world is nothing short of incredible.
- The world's largest debtor-nation prints without limitation the money that the world's largest creditor-nations lend back to the world's largest debtor-nation. This special currency, called "the dollar", possesses tremendous cache, despite possessing no intrinsic value whatsoever. Pretty incredible, huh?
- Therefore, we wonder, just how high might gold and silver climb before a countervailing force arrests their upward motion? Here again, we possess no clairvoyant capacity, but a doubling of current prices would seem a realistic "base case" scenario.
- As noted in these pages already, Credit Agricole's Cheuvreux analyst Paul Mylchreest predicts the gold price will flirt with $1,000 an ounce by 2008. To lend credence to his prediction, he presents the following analysis:
- "The long-term average in the Gold/Oil ration has been around 16x, but is currently only 8.6x. The argument that oil has experienced a structural price increase due to the difficulty in finding new reserves could equally apply to gold, as production flattens off and reserve lives deteriorate...A 16x multiple on a crude price of $60 would give a gold price of $960 a barrel."
- Applying a similar logic to stock market values, Mylchreest reasons, "The Dow Jones Industrial Average/Gold ratio compares the performance of paper financial assets, in this case equities, with gold (the ultimate store of value)...At its peak in 2000, the Dow traded at more than 40x the gold price. At the bottom of the two major credit cycles in the last 100 years, 1933 and 1980, the Dow/Gold ratio fell to only 1 to 2x."
- "Since the collapse of Bretton Woods in 1971," he adds, "the Dow/gold ratio has averaged 12.5x. Applying a Dow price of 11,000, therefore, would imply a gold price of $880."
- Hmmm...Sounds plausible. But by 2010, 2011 and beyond, a more titillating menu of comparisons and metrics might pertain.
- For example, if the gold price were to return to the PEAK gold/oil ratio of the last 20 years, it would sell for $1,800 an ounce. Or if the gold price were to return to its record high-price of $850 an ounce, adjusted for inflation, it would sell for $2,178. Lastly, if the gold price were to return to the peak Gold/Dow ratio of the last 20 years, it would sell for about $3,000 an ounce.
- Ah, yes...it's fun to daydream! And the case for buying and holding physical gold – as opposed to gold mining shares – would seem to be supported by the risk of such a spike in the price of the metal.
- "Gold's surge to multi-year highs has boosted revenues of mining firms," notes Reuters, "but share prices may disappoint because of poor output, rising costs and concern the gold rally is losing steam. Worries about the outlook for Australia's largest gold miner, Newcrest Mining Ltd, have put a brake on a rally in Asian gold stocks, although the prospect of more gold jewellery demand from India and China may help."
- "I would say that when buying gold shares, additional risk is taken on compared to buying the metal or a derivative thereon," says John Reade, a precious metals analyst with UBS Investment Bank in London. "Gold mining companies have additional leverage which partially offsets these risks but after a four or five year bull market in gold prices, I suspect that leverage in gold companies may be offset by the other risks."
- What could those other risks be? Well, South African gold output last month fell 13.5% in volume terms year-on-year, reports Creamer Media's Mining Weekly Online. Newmont Mining Corp, meantime, saw a drop in fourth-quarter profit in 2005 due to higher energy and raw material costs, legal settlements and asset write-downs. And gold's erratic history of "blow-off" tops might keep a lid on mining stock gains.
- "You know the gold price may run up and [there could be] a sell-off in the shares if the market has a view that the gold price is toppy," reckons Alistair McIntyre Scotia Mocatta in Hong Kong.
- In other words, the right gold mining stock could deliver fantastic returns in this epochal bull market. But every gold investor's portfolio should begin with a position in the physical metal itself.
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