GOLD-THE CLOSEST THING TO A SURE BET FOR 2003
By Chris Temple
Jan 10, 2003
Leading the investment pack in 2002 was the gold sector. The metal itself posted gains of some 27% on the year, as a host of factors strengthened the bull market that began back in mid-2001. Gold mining stocks also surged; and though they ended the year off their best levels reached in June, the group still beat all other stock market sectors, rising by nearly 60%.
Of all the markets/asset classes out there, the closest one to a sure thing for a profitable 2003 is gold. In fact—though I’ve been dead on where my beginning-of-the-year forecast for the broad stock market is concerned now for six years running—I am not even making a call on stocks for 2003 in my January newsletter. The reason is simple: though the Fed’s monetary stimulus should turn 2003 into a modestly positive year for the market and give us a pleasant—but deceptive—interlude in what REMAINS a multi-year, secular bear market—NOBODY can know what will happen until we know whether we’re going to be in a war or not. Maybe things will turn out all right, maybe they won’t. But there are far too many "maybes" this year to make a stock market prediction. If you’re listening to anyone who is doing so under such completely uncertain circumstances, you deserve what you get if their predictions go awry.
But gold should, at least, grind ahead in almost any scenario. It’s been nearly a generation since so many factors have combined to push gold steadily upward, in spite of economic weakness that has already hit jewelry demand somewhat. Jewelry demand will still be an element to watch closely in 2003; after all, this accounts for three-fourths of all physical gold demand. Without investors taking over for lower fabrication use of the metal, prices could get hit still.
However—though I’ll mention here a few things to watch that might give us warning of a nasty correction in this sector—too many things are still in gold’s favor longer term. Last Spring, when I wrote at length about why gold had broken out of its multi-year bearish trend, I spoke of factors that you now know well; among them, reduced central bank selling, the virtual end to the so-called "carry trade," greatly reduced forward selling by producers and other "demand-side" issues.
The last of these—reduced hedging by producers, which included some aggressive repurchases of existing hedges—has already contributed most of the "oomph" it’s going to. However, some factors that were not as important when the new gold bull was born have asserted themselves increasingly of late, perhaps more than compensating.
They are:
Negative real interest rates: There has seldom been an extended time when the nominal federal funds rate (now 1.25% and still headed lower) has been below the Consumer Price Index where gold did not move higher. Currently, if we buy the Bureau of Labor Statistics’ CPI numbers (and you know that I don’t) negative real rates are around 2.0%. As this situation endures, the economy enjoys substantial monetary stimulus, which is positive for gold.
Low long-term rates: Though corporate bonds have been a much different story, rates on long-term Treasury debt remain near historic lows. The new "bellwether" 10-year note (which I predict will be replaced in 2003 by the return of the 30-year bond or some similar device) is still yielding in the 4.0% area. As long as rates on Treasuries do not go up too dramatically, the carry trade game (where speculators, hedge funds and others borrow gold at current low lease rates, sell it and invest the proceeds in Treasuries or similar items) really won’t get off the ground again. This is especially true (and recent gold market behavior seems to confirm this) when most players are stepping up to BUY on price dips, and otherwise seem afraid of either being on the short side of the market or of missing out on further moves higher. Isn’t that a switch!
Re-monetization of gold: Much has been made by some gold bugs of the new gold-backed "dinar" and some other moves by sovereign governments to re-introduce gold as a basis, at least in part, of national currencies. In my opinion—while interesting and worth following—these initiatives do not represent a significant amount of the world’s monetary pool, for lack of a better term. As a percentage of major nations’ potential foreign exchange reserves, the money involved in these new currencies barely registers.
However, given the fact that Russia and China may be strengthening their own embracing of gold for monetary purposes, this subject is one which bears further exploration. Make no mistake: virtually everyone, given their druthers, would like things to remain as they’ve been for several years now. And, that is with the U.S. dollar as the currency of choice for just about everyone and everything. But if 2003 also goes badly for the greenback, look for the rats to start leaving the sinking ship faster. And they’ll do so, at least some, by moving into gold and new, national gold-based currencies.
The declining dollar: Throughout 2002, I seldom mentioned gold’s rally in the context of a declining U.S. dollar. Actually, for the first 12 months of the last 18 months’ move, the dollar stayed either even or, in fact, was strengthening against other currencies. That did not stop gold from rising steadily, as the other factors I mentioned above were sufficient to move gold higher even as the dollar was also rising.
But as 2002 was concluding, the U.S. dollar’s decline accelerated. In fact, the dollar has now broken its long-term up trend that started in 1995. Accordingly, there is more talk now in the investment community of gold reasserting its traditional role as the dollar’s opposite number.
A dollar alternative/crisis hedge: I don’t know about you, but I have a difficult time remembering the last time that there was serious talk outside of our own "gold bug" circles of gold being a viable asset class/alternative to the U.S. dollar. But suddenly, this reason has emerged as perhaps the leading argument in favor of investors flocking to the sector. Since gold broke the long-impenetrable $330 per once area several weeks ago, it has rallied further based on some professional money (i.e., hedge funds) jumping on board, with these folks viewing gold at last as a reasonable place to, at least, park some money.
While this could dwarf other investment demand that this bull market has seen thus far, such piling on by hedge funds and momentum players must be seen for what the overwhelming majority of it is: short-term, speculative money chasing momentum. Among other things, this virtually guarantees that—in contrast with the fairly methodical nature of gold’s bull market thus far—gold in 2003 will become much more volatile. One minute, we could see gold spike to $380, $400 or higher if we get into a war and it gets ugly, or if there is a more concerted "run" on the U.S. dollar. Just as easily, however, we could see gold plunge back to $325—or even, temporarily, lower—if the stock market rallies, we don’t go to war (or a war goes off swimmingly) and the dollar surges anew.
Though it will be more volatile in 2003, I believe that—at a minimum—gold will this year carve out a new trading range in the $350-380 area. This will be true even if we do not end up with a major war, and the Federal Reserve’s monetary potion starts working better to give us a longer respite in this secular bear market than we really deserve. Though such warm developments would doubtlessly knock 10-15% or so from gold’s price (probably in VERY short order) longer-term positive fundamentals would eventually reassert themselves.
At this point, three factors I can think of have the potential to wreck the longer-term bullish picture. Frankly, I do not see much chance of any of them happening in the near term. However, they must be mentioned. They are:
Rising long term interest rates: If other factors were simultaneously pointing to trouble for gold’s bullish picture, a significant rise in long term interest rates could prove deadly. Without a commensurate rise in gold lease rates (which remain very low right now) a sufficient gap could open again inviting a new round of playing the gold carry trade game. And believe you me, if the world’s major central banks were sufficiently concerned about a rising gold price, they would be very willing enablers of this.
New hedging: For the moment, selling future production is in such disrepute among gold players that—especially given the current momentum in the market—no producer dares announce it is hedging anew to lock in current prices. Among other things, companies that have been high-profile hedgers are trying to rehabilitate themselves with investors who otherwise will flee if they smell trouble (on that score, look at the horrible performance of Barrick shares in recent months, even as the company insists that the Blanchard and Company suit against it is "ludicrous and totally without merit.")
But business is business, whether gold aficionados like it or not; and to some extent, hedging is an entirely reasonable step for a company to take under some circumstances. I’m sure there are at least some mining executives around who are looking at the $350 area and wondering whether they should lock in some of this bull market’s gains by constructing new hedges. I don’t know that a couple players doing this with a percentage of their planned production would be terrible; however, if the bloom came off gold temporarily for some reason and there were a rush to hedge, it’s curtains.
New/increased central bank selling: The Washington Agreement entered into by 15 major central banks (including the European Central Bank) in September, 1999 expires in 2004. Many experts expect these parties—joined, perhaps, by others—to announce well before its expiration that the Washington Agreement will be extended.
The agreement limited new sales/leasing of gold to 400 tons per year for five years; that limit was a combined one, including all the players.
An extension of the agreement as is would be bullish for gold. However, if for some reason the parties either let it expire, announce their intention to do so, or announce significantly higher limits, it would throw a wet blanket onto the market.
In summation, expect gold to continue trending higher under most possible scenarios for 2003. Be prepared, however, for substantially more volatility. This could mean, of course, even greater trading opportunities than we enjoyed in the middle several months of 2002, giving you the potential for trading profits on top of maintaining your core positions in the sector. And be on the lookout for those kinds of developments which—though they seem remote now—could upset the overall bullish picture.
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