Bullion's breather discounted in shares
By: Barry Sergeant
Posted: '11-JUN-06 08:18' GMT © Mineweb 1997-2004
JOHANNESBURG (Mineweb.com) -- Fresh analysis of gold markets and stocks is seldom a one-way story. At this juncture, the good news is that gold stocks are now pricing in a $550 to $570 an ounce long-term gold price, according to Stephen D. Walker, director of global mining research at RBC Capital Markets.
The bad news, though not so bad after Walker’s comments, is that according to the Bank Credit Analyst, there is more downside for gold prices in the near term. Developing an optimised theme going forward presents investors with a quandary; Walker, for one, argues that gold stocks offer attractive risk reward upside.
Gold bullion prices have fallen by more than 10% in the past month, even, as BCA Research puts it “as investor concerns about inflation have escalated.” Gold bullion is normally seen as a hedge against inflation; this time around, far from this theme not working out, the inverse has occurred. Analysts at BCA Research argue that investors’ recent counter-intuitive reaction underscores the fact that the earlier rally in gold bullion reflected to a large extent a liquidity boom that investors now fear is being unwound.
On May 10, in the hours ahead of an interest rate hike by the Federal Reserve, the US central bank, gold futures rushed to fresh 26-year highs, nudging $700 an ounce. A broad number of other metals and commodities also touched fresh multi-decade highs. At this point, investor interest in metals and commodities, already heavily fanned by the hunt for safe, alternative assets, remained underpinned by robust global economic growth. On the supply side, there were increasing constraints on expansion, not least due to rising skills shortages.
Metals and commodities continued to draw new investor participants. In a report in early May out of Sydney, Citigroup Smith Barney analyst Alan Heap said investors of all kinds held at least $120 billion in US commodity markets in April. Investors held some $30 billion in natural gas contracts, about the same in crude oil, with the two comprising about half the total of 36 metals and commodities surveyed. Natural gas and crude oil were followed by gold contracts with $13 billion invested.
Citigroup said that investments in global commodity funds were around $200 billion in February. For some time, Heap had made out a case that speculators, not least hedge funds, had been key drivers in pushing metal and commodity prices to multi decade highs. Crude oil had increased some 15% from the onset of the calendar year, but gold had rocketed by 31% and copper by a massive 72%.
In a cautionary note in early May, BCA Research warned that “rampant bullishness in the commodity pits has bolstered the materials sector but the case for a near-term relative performance correction continues to build.” Warning signals were flashing all around, but there was hardly anything new in that.
At the end of January this year, Citigroup warned loudly that “a flood of investment funds is driving base metal prices much higher than can be supported by fundamental analysis of supply and demand. It’s a bubble which could grow a lot bigger before bursting”. Noting that fund investments began to surge in early 2004, Citigroup illustrated how commodity markets “have always been strongly influenced by speculation”.
It was, for example, surging investor demand that had contributed to the 1994-95 boom. In the current cycle, Citigroup noted, however, that funds deployed were perhaps double the previous high, and that since early 2004, when the current cycle started, funds invested had tripled. The interest in the current cycle extended far beyond base metals; “all commodities are involved,” said Citigroup, reiterating that “all classes of commodities – base and precious metals, energy and softs (agricultural goods), have enjoyed substantial price gains”.
While every man, his cousin and his dog was taking tips on metals and commodities and the relevant stocks, fundamental supply and demand indeed remained supportive. But it was increasingly clear that commodities, metals and the broader materials sector had become seriously overheated.
BCA Research’s outlook for global economic growth remained “constructive,” but analysts there maintained “a cautious near-term view toward the overheated materials sector”. The scales dipped decisively in favour of the sceptics and cynics when the Federal Reserve made its hawkish comments on May 10 this year. The world’s most powerful central bank judged that “some further policy firming may yet be needed to address inflation risks”. The core US interest rate has risen incrementally from 1% in mid-2004 to 5% after the latest hike.
BCA Research reckons that in the near term, hawkish talk from the Federal Reserve and other central banks “will weigh on gold prices, which still look overvalued.” Moreover, the argument continues, gold bullion will lose some lustre if inflation fears fade as global growth decelerates. That would be ironic indeed, and would emphasise the risks, known and unknown, of investing in gold bullion, perceived as one of the safest of all investments.
For BCA Research, the bottom line is that while a “soggy” dollar will provide support, there is more downside for gold prices in the near term. This view would accord with Walker’s analysis finding that gold stocks are already looking for gold bullion to fall by up to another $65 an ounce from trading levels around $615 an ounce seen on Friday.
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Originally posted by LesterYoung here:
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