Gold breaks $1,000 barrier – finally!
Saturday, March 15, 2008
Gordon Pape
TORONTO (GlobeinvestorGOLD) - So it has finally happened. Gold broke through the $1,000 (U.S.)barrier last week, only a mere 25 years or so after it was supposed to. Back in the 1980s, gold bugs were predicting that $1,000 gold was just around the corner, with $2,000 coming soon after. A whole generation has been born and grown to adulthood while we’ve been waiting. But patient – very patient – investors have finally been rewarded.
If you sense a little cynicism in my comments, you’re right. It comes from listening to the same mantra repeated year after year. When bullion failed to respond, the true believers would emulate old Brooklyn Dodger fans, shout “Wait ‘til next year”, and carry on, secure in the belief they would eventually be proven to be right.
Finally their faith has been rewarded, thanks to a juxtaposition of events that set off a rocket under gold prices last fall. I’ll tell you why this has happened in a moment, but first some background.
For decades, the price of gold held steady because it was tied to the U.S. dollar. That stemmed from a post-Civil War decision in 1879 that put the United States on the gold standard by allowing paper currency to be converted into gold on demand.
During the Great Depression, President Franklin D. Roosevelt and Congress made it illegal for American citizens to own gold to prevent hoarding and then devalued the dollar by 65 per cent. This had the effect of raising the official gold price to $35 an ounce, where it stayed through the Second World War and into the post-war era.
In 1971, President Richard Nixon stunned the international financial community by unilaterally pulling the United States out of the Bretton Woods system and ending the direct convertibility of the U.S. dollar into gold. The move, which history has dubbed the “Nixon shock”, had the effect of allowing gold to trade freely on international markets. At the time, gold was trading on the London Bullion Exchange at around $42 an ounce. Nixon’s decision unleashed a wave of speculation in the metal that culminated when gold reached an average monthly price of $673.52 in September, 1980.
Gold bugs proclaimed that $1,000 bullion was just months away but exactly the opposite happened. Gold went into a long decline that saw the average monthly price in London fall all the way to $260.48 in April 2001. At that point, the question was how low bullion could fall.
The metal did not regain its 1980 monthly peak until April, 2007 – almost 27 years later. It then retreated over the summer but in September began an astounding run that propelled it all the way to the magic $1,000 level.
So what happened to cause this meteoric rise? Several things, led by the fall of the U.S. dollar on international currency markets. Ever since the end of the Second World War, the greenback has been the world’s de facto reserve currency. But its dramatic decline in recent years against major currencies like the euro, the yen, and the pound sterling have resulted in a loss of financial credibility and a return to gold as a dependable store of value. The current round of interest rate cuts by the Federal Reserve Board may be necessary to alleviate the credit crunch but it makes the U.S. dollar even less attractive to foreign investors, thereby pushing the gold price even higher.
Inflation is also playing a role in boosting bullion prices. The surging price of oil has hit consumers hard at the gas pumps but there are a lot more sticker shocks to come on everything from food to airline tickets to plastics as the trickle-down effect works its way through the economy.
While demand is growing, supply is tightening. South Africa, one of the world’s major gold producers, has been steadily reducing its output. January production was down 16.5 per cent over the previous year while for all of 2007 output was off 7.4 per cent from 2006. This is part of an on-going pattern. South Africa used to produce over half the world’s gold supply; in 2007 its share dropped to 11.1 per cent, allowing China (surprise!) to edge it out as the globe’s leading gold miner.
Meanwhile, demand continues to increase, especially among investors. According to the CPM Gold Yearbook, investors made net purchases of 43.7 million ounces of gold in 2007, up 11.7 per cent from the year before.
Talk about a perfect congruence of events: growing demand, falling production, a weak U.S. dollar, and fears of inflation. If you’re a gold investor, the world couldn’t look brighter.
What’s next? Experts are divided over where it will go from here in the short term but bullion at $1,200 - $1,300 certainly seems within the realm of possibility within the next 12 months. Clement Gignac of National Bank, who predicted gold at $1,500 an ounce in January, says he has not changed his mind.
The dynamics and the momentum suggest that gold still has a way to run. But I suggest that readers adopt a cautious approach. That may be based on my long, mostly negative experience with bullion but I have seen how quickly it can turn around.
That said, a further 10 per cent gain in the price to the $1,100 range within a relatively short time frame (say three months) appears likely. If you don’t have a position in gold now, you may want to consider putting a little money here, even given the big run-up we have experienced.
The easiest way to do that is by using a precious metals mutual fund. My top choice is the RBC Global Precious Metals Fund. It has consistently been an above-average performer, can be acquired on a no-load basis, and requires a minimum initial investment of $1,000 ($500 for RRSPs).
Just remember that precious metals funds can be volatile so this one is not appropriate for very conservative investors. Talk to your financial advisor.
Gordon Pape is one of Canada's best respected financial authors and the nation's leading expert on mutual funds.
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