Tuesday, March 16, 1999
Goldbugs may have their day
Old safe haven is cheap while stocks are
at record highs
Jonathan Chevreau
National Post
With global deflation threatening and financial markets euphoric but
jittery, goldbugs are creeping out of the woodwork. Given the
battering the yellow metal's enthusiasts have been subjected to in
recent years, any view that bullion or precious metals mutual funds
are set to leave the bear lair would seem the triumph of hope over
experience.
Gold and silver prices are at 20-year lows, according to Nick
Barisheff, president of Toronto-based Bullion Management Services
Inc., which is setting up a fund to hold gold and silver bullion.
Gold is trading at less than half its peak of $800 (US) reached in
1980. A historically unprecedented short position exists.
While the celebration over the Dow Jones passing 10,000 has been
deferred a day or two, gold yesterday plummeted $5.80 (US).
While a vulnerable asset class, these conditions also present a
unique buying opportunity, according to several observers. (Note: I
own some precious metals mutual funds, and a modest holding in
Barrick Gold Corp. stock).
It's worth noting the striking contrast between the high level of
North American stocks and the low price of gold.
"Regardless of whether you are a bull or a bear, the mere threat of a
severe correction should alert you to consider the advantages of the
gold sector," investment advisor Hans Merkelbach writes in a recent
advisory (see www.strategicsector.com). "I believe it prudent for
contrarian investors to accumulate gold investments through
participation in gold-sector mutual funds, and that gold investments
are due to start rising considerably during the next two years."
Mr. Merkelbach, who is based in Vancouver, figures the beginning
of a surge of as much as 25% in the Philadelphia Gold Index
commenced this month.
While gold passed the $420 level in 1989, 1990, and 1991, it failed
to break through $425 an ounce in those years. (Gold and silver are
priced in U.S. dollars.) Once it breaks that barrier, an "upside
breakout" could accelerate it quickly to the $500 level, Mr.
Merkelbach predicts.
Similar breakouts happened in 1997 in palladium, platinum, and,
finally, silver.
Mr. Barisheff argues the news media has exaggerated the magnitude
of recent central bank gold bullion sales. They have been under
pressure to obtain interest on their holdings and gold bullion does
not provide a source of earnings. Therefore they have adopted the
tactic of loaning gold reserves out -- not necessarily selling it --
thereby switching their gold reserves into interest bearing assets.
Mr. Barisheff argues the gold price is being artificially depressed, as
the central bankers worry that a sudden increase would "send the
message that there is a crisis of confidence in the paper money
system."
Central banks are leasing gold and by doing so are creating an
artificial supply. If removed, the gold price, in order to eliminate the
demand, would have to go up. Annual mine supply is 2,300 tons a
year, worldwide. Demand is 4,000 tons. Part of the difference is
made up by net central bank sales, which was about 400 tons in
1998. The rest is made up by leasing. The equilibrium price would
be $700 if the artificial leasing factor were removed.
If the price of bullion goes up, leasing it could become expensive,
since it would have to be replaced at a higher price. If lenders get
concerned about the credit worthiness of the repayment, they'll stop
leasing or increase the lease rate, Mr. Barisheff says. There was a
close call with Long-Term Capital Management, which had 400
tons of gold leased.
The cumulative short position is about 8,000 tons at the end of
1996 and it may be as high as 14,000 tons now, Mr. Barisheff says.
There is a huge potential for a squeeze: If the gold price goes up, the
borrowers have to scramble to buy it to repay loans. Also, if gold
rose close to the price at which big miners like Barrick sold
forward, they would likely go to the market and buy back those
positions, thereby becoming buyers and putting more upward
pressure on the price.
Traditionally, gold has been seen as a small part of a diversified
portfolio and a hedge against inflation or economic chaos. Under
normal economic conditions, a small 5% weighting might be the
typical allocation in a well-balanced portfolio, and 10% would be
be considered aggressive. Given the unique fin de cycle Mr.
Barisheff suggests a far bigger bet for aggressive investors.
Despite the recent "all-clear" issued by Year 2000 experts including
Canadian Peter de Jager, Mr. Barisheff continues to view Y2K as
the trigger to an "end of millennium financial upheaval," during which
precious metals will emerge as the safe haven for wealth
preservation. "A number of investors have cited the Y2K problem
as a reason for increasing their holding of bullion. Bullion is an
effective hedge against uncertainty. And Y2K-driven uncertainty
abounds."
A wide range of current market players, from Warren Buffett,
Nicky Oppenheimer, and George Soros to coin holders and
mining-company insiders, have shown through their actions that
they, too, believe a reversal in the price of gold and silver is
imminent, Mr. Barisheff argues.
If gold were to return to its average value over the past 200 years,
its price would need to double from current levels. Such a doubling
is well within reach, given the global monetary problems and the
unsustainable short position in the market.
In his 1998 Gold Book Annual, Frank Veneroso said the
equilibrium price for gold could approach $700 as early as 1999 if
the artificial supply created by lending were removed. By the middle
part of the next decade, gold could reach $1,100 to $1,400 as a
reflection of the imbalance between annual demand and supply.
Even removing Y2K from the equation, Mr. Barisheff expects gold
to rise because of the precarious and overvalued stock market, the
default problems in Russia and other debtor nations, the U.S. debt,
and what he terms "bubbles on top of bubbles," which will
eventually impact the still vibrant U.S. economy.
Gold mutual fund managers also see some upside, but nothing as
explosive as the superbugs. Bill Belovay of Jones Heward
Investment Counsel, which manages First Canadian Precious
Metals Fund, believes the price of gold could strengthen because of
stronger demand as the year end approaches. He suggests sticking
to gold mining companies with strong balance sheets and those that
can produce free cash flow at the current gold price, examples of
which are "few and far between."
Mr. Belovay notes demand for gold and silver coins is at record
levels, not so much fuelled by Y2K hoarding as by individual
investors who believe we have seen the lows in precious metals.
So far, the demand of a few million ounces has not translated in a
big way to higher bullion prices. If Y2K panic sets in, it could raise
gold-stock prices -- but, he stresses, "only if panic sets in. It will be
a short term phenomenon. If everything works on Jan. 1, then
people will be selling [again]."
Demand for silver coins is exceeding the speed at which
manufacturers can stamp them, he said. The two Canadian pure
silver plays are Pan American Resources Inc. (PAN/ME) and First
Silver Reserve Inc. (FSR/TSE).
There also are several mixed producers of both silver and gold.
With silver bullion trading at $5.30 an ounce, a move to $6 would
result in considerable appreciation in the pure silver stock prices,
Mr. Belovay says. |
