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Update
on Gold
Brian
Trumbore
President/Editor, StocksandNews.com
About twice a year I like to deviate
somewhat from the norm for this space and supply you
with a little update on gold, courtesy of my friends
at Van Eck Global.
As
I noted in my last "Week in Review," gold has been
stuck in a very narrow range for the past 3 months,
really all the way back to April. For the week ending
April 26, gold closed at $311. Just viewing the price
on a weekly basis, it has been below that level only
3 times since then, while also not closing above $326.
I
bring this up because with the recent rumblings on
both the inflation/deflation front, investors are
once again beginning to sniff around in the sector,
particularly after the comments of guru's like PIMCO's
Bill Gross, who has now moved to the "reflation" camp.
What
follows are some comments made by Van Eck portfolio
manager Joe Foster about ten days ago. This is in
no means an investment recommendation on the part
of yours truly and I do NOT personally own any gold
shares myself at this time. But Foster's remarks do
supply you with a good general background on the economy,
as well as some historical context.
---
"Gold
has been in a holding pattern, moving sideways within
the $310 to $325 range. Likewise, the trade weighted
U.S. dollar has drifted sideways?Hopes of near-term
prosperity endure and it looks as though the markets
will need some sort of jolt to give them direction
in one way or the other. Our bet is the other way,
as most of the jolting candidates are negative in
nature, from war to economic collapse, from Iraq to
Japan, from Israel to Brazil. And from the Federal
Reserve to the White House, low interest rates and
ballooning budget deficits have policy makers in a
bind?
"From
a very broad perspective, the global economy is now
suffering through an historic period of post-bubble
economic weakness. During the nineties, speculative
excess infected nearly every aspect of investing by
individuals and corporations. Expectations of a perpetual
rise in the stock market and a seemingly unending
supply of capital caused individuals to pay inflated
prices for stocks and businesses to over-build. Much
of this investing was financed with debt, causing
households and businesses to become more leveraged
than at any time in history. Excessive speculation
and spending creates imbalances in the economy that
can take a very long time to correct?
"?past
post-bubble markets have under-performed over long
periods. As one of the few asset classes that historically
has little or no correlation to either general equities
or bonds, gold and gold shares may outperform during
such periods of general market malaise. Over the past
ten years, the correlation coefficient between gold
and the S&P 500 is a negative 0.11?
"The
Federal Reserve recognized the negative ramifications
of an economic slowdown brought on by the historic
stock market collapse. Shattered investor confidence,
excess manufacturing capacity and foreign competition
has created a potentially deflationary environment.
An economy where business and household debt totals
a staggering 145% of GDP (as of June) cannot afford
an environment of falling prices (and falling profits).
In order to avoid the fate of Japan since 1990 or
the U.S. in the 1930s, the Fed undertook unprecedented
cuts in the Federal Funds rate in 2001, while increasing
the money supply at rates not seen since the inflationary
era of the 1970s. No government in history has been
able to avert a painful post- bubble economic collapse,
and it is by no means certain whether the current
government will be the first.
"It
is likely that the U.S. government will continue its
aggressive easing to reflate the economy. This attempt
to avoid a deflation could be inadvertently sowing
the seeds for onerous levels of inflation in the future.
While it is not clear how the economy will ultimately
respond to government policy, it is clear that we
are currently in a rare and unusual period of monetary
and economic instability. Such periods have been marked
by excessive deflation, as in the 30s, or excessive
inflation, as in the 70s?
"The
geo-political situation that the world has come to
know since 9/11 has inflicted costs and threatened
our sense of security in ways not experienced since
the Cold War. Acts of war typically have a short-lived
impact on the gold price; however, a lasting conflict
can take its toll on the economy and place stress
on government budgets. This, along with low returns
on interest- bearing accounts and stock market losses
have combined to cause investment psychology to change.
Rather than chasing stock market returns, investors
have turned to alternative strategies that include
hedge funds, real estate, and gold. While no one knows
how long such trends will continue, the recent Fed
rate cut indicates that interest rates will remain
low in the foreseeable future. Meanwhile, the Bush
Administration has made it clear that the war on terrorism
is a long-term commitment. Under such circumstances,
rather than a return to the investment attitudes of
the 90s, investors are likely to continue the trend
towards capital preservation and investment alternatives.
"In
addition to a macro-economic and political environment
that is favorable towards gold, fundamentals within
the gold mining industry are also supportive of the
gold price. Gold Fields Mineral Services Ltd. estimates
that newly mined gold production will decline in 2002.
Many analysts agree that this is the start of a trend
that will last through the decade if gold prices remain
in the low-$300s. Companies cut back on exploration
during the late 90s as gold sank to 20-year lows.
The current gold price is not high enough to begin
a new cycle of exploration and discovery and there
is not enough new production coming on-line to replace
the mines that have entered their declining years.
Also, many gold companies are reducing their gold
hedge books, which results in gold production being
returned to central bank vaults, rather than sold
into the market. Both production declines and de-hedging
will restrict the supply of gold in the near-term.
The industry has also come to realize that it must
actively market gold to increase market share. A new,
dynamic management within the industry-sponsored World
Gold Council has begun an exciting program to market
gold both as jewelry and as an alternative financial
asset."
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Wall
Street History returns next week with the tale of
the Erie Lackawanna Railroad.
Brian
Trumbore
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