Prior to a decade ago gold hovered interminably in the $250-$300 range, suggesting that at today’s gold price of about $1 750 (at year end) all the easy money had already been made.
Not so. While the perception might be that gold is at the end of a decade long bull run, Standard Bank head of commodity research, Walter de Wet points out that in real terms it has yet to regain the level of 1980, when it reached $900/oz.
“Gold’s strength is that it has historically been a dependable hedge against inflation and a good alternative asset class having performed well during several recessions. It has kept its value even during recent economic slowdowns when equities and other assets tumbled in unison,” says De Wet.
In reality, behind this apparent conformity to trend, the fundamentals of gold have altered substantially. “Gold used to follow the trade-weighted dollar closely until July 2002, at which time the synchronisation broke down. A number of factors brought about this delinking: China’s economic rise and consequent trade surpluses; the establishment of the Eurozone which enabled countries which otherwise could not do so to issue debt at very low rates; and the development of exchange traded funds (ETFs) in gold which meant instruments did not have to be directly backed by hard assets,” explains De Wet.
Government bailouts supporting gold price
“Today, what is supporting the gold price is the fact that it now tracks global liquidity rather than the US dollar.” It is widely expected that current economic conditions support a continuation of the sharp rise in global liquidity for at least the next three to four years, through mechanisms such as quantitative easing. “In this scenario, what then is a fair value for gold? We believe global liquidity issues alone will justify an average gold price around $1 600/oz, on top of which is physical demand.” Standard Bank expects gold to average $1 895/oz during 2012 and peak at $2 200/oz during the first quarter of 2012 if expectations of a recession materialise.
“We foresee growing global liquidity until such time as China stops being the ‘debt buyer of last resort’ which it effectively has been by running massive trade surpluses — something which will continue until at least 2014/15.
“Even when real interest rates begin to rise globally, we still see the gold price continue increasing. In addition, we expect physical demand to remain strong, as it did during the fourth quarter of 2011,” says De Wet.
In fact, the price of gold needs to remain at least at the level of $1 600/oz because Standard Bank expects costs of production to rise from their current level of $1 150/oz to about $1 600/oz by 2015.
“The short-term risks to the global economy are credit risks and this is also positive for gold which carries no credit risk. In addition, we expect the European Central Bank to embark on some form of liquidity support (quantitative easing) which will underpin gold.”
Central banks are today’s major buyers of gold. De Wet explains that the graphs of most hard currencies showed a gradual debasing over time, so that gold was seen both as a more attractive reserve currency and as an important component of currency diversification for central banks.
Gold ETF is safe investment, but equities are interesting too
Having made the decision to buy gold in order to diversify one’s portfolio, Daniel Sacks, a fund manager at Investec Asset Management, thereafter recommends the simple expedient of buying the gold ETF – it’s the same as having physical gold without having to get your fingernails dirty.
However, gold equities also currently offer exceptional value. “Gold shares traditionally have a gearing to the gold price, whereas over the past quarter they have lagged the gold price increase, creating an arbitrage opportunity,” says Sacks.
Whereas the gold price has surged 20% and earnings have gone up by three times that amount, the price of listed gold companies has not budged. This places them on a favourable valuation of eight to nine times forward price/earnings ratios, well below the average of the JSE.
“This is a very low forward valuation,” says Sacks.
Investec favours AngloGold and Goldfields over Harmony – the JSE’s remaining three listed stocks. While Standard Bank projects rising costs of global production, Investec believes this is less the case among South African miners as production is falling, which tends to aid cost containment.
“In South Africa, most of the cost rises are behind us, and the inflationary costs such as labour and electricity are quantifiable.” As to why the cost of gold equities has not risen in tandem with the gold price, Sacks says it may reflect a market fear that the gold price will collapse.
“We don’t think that’s a likely scenario. We see the factors that have driven the gold price continuing into the future. So there is a strong case for holding gold: at a minimum we see a continuation of the trend that gold has increased by an average of 15% a year,” adds Sacks.