Where is this stuff going????
PORTFOLIO POINT: Having briefly topped $US1000 an ounce, the gold price appears to be following a familiar pattern.
Too far, too fast. That’s what hurt gold this week after its moment at a price above $US1000 an ounce, and then a fast retreat as demand dried up and sellers quit investment positions. Moreover, gold scrap, old jewellery and even old gold teeth had started to hit the market in volume in recent weeks, a sure sign of a “top”.
Will gold run up again? “Probably” is the only safe answer because gold is an extremely price-sensitive commodity with thousands of tonnes available every time the price rises too quickly.
For investors with an interest in gold (and that ought to be everyone) now might be a good time to sit on the sidelines or even trim their exposure because last week’s surge in the gold price changed the dynamics of the market.
Once the $US1000 mark was breached, gold investors, many simply active in the exchange-trade fund (ETF) market, were swamped by sellers of physical gold keen to cash out of surplus gold assets.
In one case, according to a US television report on Tuesday, the president of Gold and Jewelry Buyers of America, Jim Mataich, said he had even bought gold teeth last weekend at his store in Parma, Ohio.
“People were coming out of the woodwork to unload stuff just to get them through another month or two,” Mataich said. “Coins, rings, jewellery, heirlooms … even the gold teeth they had sitting in a drawer.”
That dramatic description, from a regional US pawn broker operating a shop called Cash-4-Gold, highlights the two-faced nature of gold, which is both a form of money and just another commodity used as a body adornment, by some industries, and in dentistry.
Until the $US1000 mark was cracked, gold was in its monetary mood, acting as a safe haven for investors fleeing most other investment classes. Over the weekend gold put on its commodity face with recession-hit households around the world cashing in everything from old bracelets to Granny’s teeth.
It was the high of $US1007.70 in New York last Friday that spooked the gold market, in a precise re-run of what happened 11 months ago.
On March 14 last year gold closed in London at $US1003.50 an ounce, peaked the next day at $US1011.25, then started a slow decline that took the price back to $US712 by October – a 29.9% slide.
That downward move was broken by the global financial crisis which followed the collapse of Lehman Brothers in the US, and “runs” on other US banks as the financial system teetered on collapse.
Between October and last Friday, as stockmarkets crashed around the world, the gold price soared by 41% in US dollar terms, and even more in other currencies. In Australia, the gold price passed the $1500 mark last week, but is now back around $1490.
It is reasonable to assume – unless you are a one-eyed gold addict who believes the end of the world is nigh – that the flood of gold scrap will continue to hit the market over the next few months thanks, in part, to the very reason it rose so quickly: fear of recession.
Investors controlled the leg up as they shifted cash out of banks and shares into gold. Households desperate to raise cash as the recession bites are now in control of the market – a classic tug of war between buyers and sellers.
To put the gold market into clearer focus consider what happened over the past two weeks to one of the world’s top gold analysts, Bart Melek, from the Canadian investment bank, BMO Capital Markets.
On February 9, as a preparatory document before BMO’s annual Global Metals and Mining investment conference in Florida, Melek published a report titled: A perfect storm brewing for gold.
No one who has followed the gold sector for many years, including me, could fault anything in that report, which concluded that gold should be “a strong performer for at least the next three years”.
But, in the detail of Melek’s report was this comment: “Gold appears to have run ahead of its main drivers; the US dollar is strengthening and disinflationary risks are growing in the short run.”
In other words, two critically important factors that underpin the gold price – fear of inflation eroding the value of paper (fiat) money, and a decline in the value of the US dollar – are missing in the latest speculative rush into gold, and away from other asset classes.
Melek added: “It is possible that gold will retrench below $US850, before trending up toward $US1000 later in the year.”
He was right. Just early, and it was the dash up (and over) the $US1000 mark that has caused gold advocates to draw back and for gold sellers to take control of the market, at least in the short term.
No one is tipping that gold will retreat back to $US712 as it did last year, but it would be reasonable to believe that a period of price contraction has started as surplus gold is absorbed by the market.
A table and a graph in Melek’s February 9 gold analysis are useful tools in understanding the dynamics of the gold market.
In the table (A), which is a gold supply and demand model, it can be seen that primary gold production (new gold from mines) has been in decline since hitting a peak of 2621 tonnes in 2003, and falling by 9% to 2385 tonnes (and perhaps rising slightly this year thanks to the lure of a high price).
Sticking with 2008 it can be seen that primary gold production was boosted by official sector (government) sales of 279 tonnes and 1108 tonnes of scrap to lift total gold supply of 3772 tonnes.
The importance of scrap in the equation (including Granny’s teeth) is shown by the fact that it represented 29.4% of total supply last year – and the higher the price rises the more scrap makes it to market.
On the demand side, equally interesting things have been happening. As the gold price has risen jewellery and industrial/dental demand has dropped, a classic example of price sensitivity.
Taking up the slack in demand has been investment, especially bars, coins and the new boy on the block, exchange-traded funds.
The importance of ETFs, products that hold gold in precise proportion to cash invested, is shown in the rise from just three tonnes in 2002 to 308 tonnes last year, a rise tracked in a separate graph (B) which, unfortunately uses troy ounces as its demand measure. Australia's biggest ETF is the ASX listed Gold Bullion Securities (GOLD).
Useful as the BMO graphics are to understanding what drives the gold market (up and down) there is a third illustration that highlights why gold should be part of a balanced investment portfolio.
Governments, the same people flooding the world with paper money as a means of beating back recession, remain true believers in gold.
According to the BMO table (using data provided by the World Gold Council, Bloomberg and other sources) governments around the world, despite some high profile sales, retain 26,354 tonnes of gold.
Interesting as that number is there are two other numbers that catch the eye. The US, with its 8133.5 tonnes of gold stuffed into Fort Knox, owns gold that represents 577% of its reserves – in other words, it’s the only positive asset on the US balance sheet.
But, the really important number for investors is at the bottom of the table – the 11.3% gold occupies as the total of all government reserves.
There’s a message in that percentage and one that I’ve written about before. Gold is an important part of any investment portfolio, private or public, with 10% being a rough guide to how much exposure you should have.
The tricky questions are how to buy gold (shares, bullion, ETFs) and when?
For purists, you cannot beat taking physical possession of gold, complete with the cost of safely storing it. However, well-run ETFs are a reasonable substitute though in truth they do carry an implied trust because all you are actually getting is a piece of paper, which says you’re entitled to a certain amount of gold – just don’t expect to be able to ever see it.
Gold shares come in all shapes and sizes, from the well-run and profitable producers such as Newcrest and Lihir, to the re-emerging producers such as Kingsgate and Resolute, and the new boys on the block, such as Centamin.
Interestingly, the new float game is not (yet) being played with gold despite the high price. There are no new floats listed with the ASX, just Ballarat South which tried (but failed) to float last year.
Most recent raisings have been for recapitalisation of existing gold miners such as Newmont and Newcrest, both of which attracted a flood of money. In the case of Newcrest, it asked for $500 million and took in $750 million, virtually overnight.
But, that was last week, before gold’s mad dash through the $US1000 mark with the next few months likely to see a retreat.
BMO’s Melek reckons the average price in the first half of this year will be about $US850 an ounce, a tip that implies a substantial fall. In the second half, the average is forecast to be $US925, with the same price tip applying to 2010.
Those prices are, obviously, one man’s view of the gold market. But it is a well-informed view that should not be ignored.
From Tim Teadgold.