Don't abandon financial sense in favour of gold's glitter
LESLEY CAMPBELL
scotlandonsunday.com
I’M NOT saying I always know what markets are going to do, but I know someone who does. I have found a couple of people out there who, over the years, really do seem to get it right. Today, however, I am in the distressing position of watching my two favourite commentators take opposing views.
The issue causing the debate is gold. To me, gold lost its significance a long time ago and fell even further in my estimation when I read about the damage mining had done to the places and people involved in its production.
Gold has been in a chronic bear run for a long time, which I attributed to the long overdue realisation among investors that it does not respond to some mysterious economic force by automatically rising in price when inflation appears. People have to buy it, and these people have simply been buying other things.
But I have to declare an interest. I bought gold on a number of occasions, only to close the positions out before each of the sudden and spectacular rallies that brought the metal back into the headlines.
Often, analysts will give their view on a subject and leave a slightly ambiguous aftertaste. Weighing up the pros and cons can make the picture fuzzy. It may go up, unless this happens, in which case it may well go down. But being vague is not a problem with my favourite bear, Andy Smith - analyst at Mitsui Global Precious Metals - who is both entertaining and perceptive. When I called him earlier this week to ask for his view on gold, I started with a straightforward question.
The outlook for gold is bullish according to the technical analysts, what was his view of the fundamentals? "They’re crap," he answered and left it at that. He tells an interesting story in his regular newsletter concerning the contribution to the recent price rise made by miners, who have stopped selling their gold and even bought back some of the sales they have already made.
This change in practice, according to Smith, is the main reason for today’s higher prices, not reduced production levels or increased, sustainable demand. He estimates that for each 100 tonnes of their gold sales that the miners buy back, the price goes up by $5.
It would be wrong to characterise the debate as being fundamental versus technical. David Fuller, representing technical gold bulls, is a practical analyst who reads everything. He was also my first-ever boss. Straight out of university I got a job as one of his minions, sitting in a large attic room in London, painstakingly drawing and redrawing charts. It put me off for a very long time.
Fuller believes we are at the start of a major bull run. "Gold’s ‘first step above the base’ consolidation is now in its latter stages. I have previously described this as a stealth bull market because most people haven’t noticed - or don’t want to acknowledge that gold is under accumulation. A very large and powerful financial industry is wishing either bond or stock market prices to move higher, or simultaneously.
"In their hearts and minds, gold is the uninvited guest at the party - a spoiler. This is a fantasy of course, encouraged by some frustrated gold bugs who have long predicted disaster for everything but the yellow metal. Today, gold is slowly working its way back into the investment community’s consciousness. Knowledgeable investors want a hedge against credit creation and the bubbles it continues to create."
Smith concedes there is a slim chance for higher prices. "If we slip back into a nanny state, a capital-controlled environment like the ones we saw in the 1950s and 1960s; if we have big government capping interest rates and making it impossible for investors to get their money overseas, we have a better chance of seeing gold go up," he says.
For Smith there are more effective hedges against inflation than gold. "Buy equities, something straightforward like Marks & Spencer. Over time, equities will do the job," he argues. Fuller believes the market may be set for a pullback, but is optimistic in the longer term. "I maintain that gold bullion is in the early stages of a secular bull market. Gold is currently ranging in the first step above its base formation. These patterns can take many months to form and we have seen seven and counting," he says.
"Nevertheless, the overall pattern of rising lows since 2001, and with gold continuing to rally more quickly than it falls since December 2002, the present consolidation may be only weeks from completion. My strategy is to hold a core position in gold shares and funds, adding on weakness and lightening on strength."
Smith’s outlook is uncompromising and will shock many gold producers and investors. "I can’t see it going much higher. The first possible trigger of lower prices will be the expectation of higher interest rates - not the actual changes, note, but expectation of them. Longer term I can see the gold price in two digits."
I asked Willie McLucas, chief executive of Thistle Mining for his opinion, since he is a home-grown gold producer - but he rather disappointingly started off with what sounded like a classic shilly-shally, "It’s not as simple as the gold price going up or down," he began. I concede that it’s not. For him, what matters is the gold price in rands, since his mines are in South Africa. His overheads are in rands, but because gold is a dollar commodity, his revenues are in dollars.
But what about the price? He’s bang in the middle. "My personal view is that it’s OK where it is. We have a very simple approach - we are unhedged when possible. When we do hedge it’s to keep the bank happy, and not because we think the gold price is going down. We are optimistic, but less so than most commentators. The price is not going to crash and we may see higher prices because some mines will be closing at this low price in rand."
There are a couple of interesting plays for gold enthusiasts in the new gold indices - the HUI and the XAU - which reflect the share prices of unhedged producers and remove the inconvenience of buying gold bars or ingots.
But they are not a perfect investment for gold bulls. Fuller explains: "There is an obvious logic in holding the unhedged mines if you think the gold price is going higher. However, relative performance inevitably varies, even in a popular sector." Plotting these two indices against the major stock markets is interesting, depending on where you start your comparison.
Wall Street is up around 10% on the year, while the HUI is up 17% on the year. Impressive, unless you take a look further back. Had you put your money into the index in 1996, you’d be 20% worse off.
The jury is out on gold, and I have seldom seen such a divergence of opinion - if you cut out the World Gold Council, that is. Run by the world’s gold producers, the organisation tends to be bullish. But the independent analysts are split and I will take note of the price at six monthly intervals and see whether we should all be locking away an ingot or two.
Final word to Smith, who advises us not to get carried away with the mystical allure of the yellow metal. "It’s all about eggs and baskets. Don’t get Cherie Blair about it." |
