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Last Updated: Sep 25th, 2006 - 11:36:04 |
Gold at US$1,000?
The spot price of gold in New York has soared 15% in six weeks, hitting a quarter-century high on Friday.
David Berman
Financial Post / National Post, Toronto
Monday, December 12, 2005
Soon after the price of gold broke the US$500-an-ounce barrier
earlier this month, a number of gold-loving investors began mulling
over the next big hurdle.
Could it top US$600 an ounce within a year? Dare they dream beyond
US$1,000 an ounce?
Thanks to gold's meteoric rise, it may seem as though anything is
possible now. The spot price in New York has soared 15% in just six
weeks, hitting a new 24-year high of US$530.75 an ounce in intraday
trading on Friday.
Perhaps more important, gold has broken out of its recent pattern of
rising only when the U.S. dollar falls and remaining relatively flat
in other major currencies. Now, the price of gold has been rising
with the U.S. dollar and in virtually all other major currencies as
well.
In Canadian dollars, gold traded in a $20 band in 2004 and most of
2005, rarely poking above $540 an ounce. But since the beginning of
November, it has shot up to a high of $614, a 14% bounce that has
certainly outdone the return from the stock market.
In euros, the change has been even more dramatic. Gold was stuck
between 320 and 340 an ounce for most of the past three years. Since
June, though, it has jumped to 445 -- an amazing 30% pop in just six
months, which has made gold the hottest investing trend going.
For the gold bugs, those enthusiastic investors who believe that
bullion's best days are still to come, the reasons for these eye-
popping moves are obvious.
Inflation is on the rise, they argue, and gold has historically
proved the best hedge against it. As well, many investors believe
the U.S. dollar is doomed because of massive deficits in the United
States, while the euro can't pick up the slack because of its short
track record -- all of which makes gold an ideal substitute currency.
Wait, there's more to the bullish argument: Living standards are
rising in China and India, where people love gold. According to the
World Gold Council, demand for gold-based jewelry in India rose 42%
in the first half of 2005 over the previous year.
Finally, some of the world's central banks, once big sellers of
gold, may now be stocking up on it as a diversification strategy and
a hedge against a declining U.S. dollar.
For example, some gold investors note that Russia's central bank has
said it would like to double its exposure to gold, to 10% of its
assets.
Since the gold market is minuscule compared with financial assets,
all it takes is a relatively small diversion from stocks or bonds
into gold to make the metal's price shoot up.
John Hathaway, manager of the Tocqueville Gold Fund in the United
States and one of the most outspoken gold investors, believes gold
has been in a quiet "stealth" bull market for the past five years.
It still is, and the price of gold will eventually trade into the
four digits. "The bull market in gold, which commenced in August,
1999, will shed its stealth mode. Its pace will quicken and become
difficult to ignore," he said in a note to clients earlier this
year. "We stand at the end of the beginning of the first leg in a
multi-year bull market in the metal."
Trouble is, gold must overcome a couple of big obstacles before its
allure can become truly widespread.
For example, doubters point to the fact that the inflation-savvy
bond market in the United States does not appear to be showing much
concern about rising prices. After all, the yield on the U.S. 10-
year Treasury bond has been under 5% for more than three years. Bond
yields in Canada and Europe also remain low.
"The bond market is not worried about inflation particularly," said
Martin Barnes, managing editor of The Bank Credit Analyst. "If you
look at the inflation expectations that are embedded in bond yields,
they don't seem to have spiked up to confirm gold's rise."
As well, gold isn't rising on a weak U.S. dollar, since the
greenback has proven resilient against the euro and yen recently.
Indeed, money is flowing into U.S. assets right now.
Rather, Mr. Barnes believes the stronger gold price may simply be a
byproduct of rising liquidity: The world is awash with money right
now and it's looking for places to go.
"Whenever anything looks a little bit hot, the money just piles in,"
Mr. Barnes said.
This raises the possibility among some observers that gold has
attracted a speculative fervour, meaning the price is rising simply
because, well, the price is rising.
The Economist noted last week that gold remains "fundamentally
unattractive," given that it has no yield. They also believe that
most central banks around the world still want to unload their
vaults of bullion eventually.
The influential magazine also noted that gold has vastly
underperformed other base metals. While gold, in U.S. dollars, has
gained 26% since the start of 2004, copper has doubled over the same
period and silver has increased 47%. Meanwhile, crude oil has risen
74% and natural gas is up a stunning 186%.
In other words, gold is something of a laggard as a commodity -- and
this has created some big headaches for gold producers, which have
been popular vehicles for riding the rising price of gold.
Strong commodity prices have led to soaring production costs at many
gold mines. According to Mr. Hathaway, the cost of starting up a new
mine has increased about 30% over the past five years. These rising
costs have undercut profits and depressed share prices in many cases.
"All mining companies are facing increased input costs on everything
from fuel, labour, rubber and carbon," said analysts at BMO Nesbitt
Burns in a recent research note. "Combined with ageing mines, start-
ups or otherwise marginal operations, rising costs can prove lethal
for a junior company with limited financial resources."
They noted at the end of November that the 13 junior gold producers
they follow have seen their share prices plummet an average of 21%
this year.
Senior gold producers have fared better, but still lag their
underlying commodity. The shares of Barrick Gold Corp. are up a
lacklustre 13.4% this year.
The shares of Placer Dome Inc. are up a healthier 20% this year, but
most of this return has occurred since the end of October, when
Barrick announced its intention to acquire its rival.
Some observers blame the gap between the rising price of gold and
relatively unspectacular share appreciation on the fact that some
companies dilute their earnings by issuing more shares.
"I'm very vocal about how investor-unfriendly the success of share
issuance is," said Mr. Hathaway in a Barron's interview last
month. "I'm particularly upset with the Canadian investment banks
that do these deals."
Indeed, it is through share issues that the current mergers and
acquisition frenzy in gold is being funded. Last week, Goldcorp Inc.
grabbed a property from Virginia Gold Mines Inc., Iamgold Corp. said
it is acquiring Gallery Gold Ltd. and Yamana Gold Inc. said it is
buying RNC Gold Inc. The market doesn't expect it to end there, but
as Desjardins Securities noted last week, a lack of cash in the
sector means that most of these acquisitions will be funded with
shares.
This merger frenzy is being driven largely by the gold price, but
how long it can last is still a big question. "Really, at these
levels we're in unchartered territory and all bets are off," Sean
Russo, a director of Sydney-based risk advisory and funds management
firm Noah's Rule, told Dow Jones on Friday. "Anything could happen."
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