The markets stand corrected

The shock in the bullion markets at the end of January left some people wondering if the long-awaited gold bull had met a sudden end.

What caused the US$10 drop was an announcement from the Federal Open Market Committee, the board that decides the monetary policy of the United States Federal Reserve, that it would maintain the current “accommodative” monetary policy, but that it would, if necessary, raise interest rates once circumstances dictated a change.

That was widely read as a change in attitude, if not policy, from the Fed. The Open Market Committee said it “believes that it can be patient” about tighter money, but patience may not be quite measurable enough for the markets; low U.S. interest rates were no longer a sure thing.

Bull markets do, indeed, climb a wall of worry. A little bad news and there is an instant and adverse reaction. But the noises from the Fed weren’t even bad news — they were musings. Musings are the grains that form the rock of uncertainty, which came through the window in late January.

Balance that uncertainty against a few fundamentals. Gold production still makes up only 80% of fabrication demand — it is likely that 500 to 600 tonnes of gold had to be sold out of above-ground stocks in 2003 to meet industrial demand. We know the gold bugs don’t like to think of gold as a commodity, but as a commodity, it is in relatively heavy demand.

It can be said that even in gold’s darkest days, mine production came nowhere close to meeting industrial demand, and that bars had to be melted every year in the 1990s. That’s all true, but in the gold market’s infuriating fashion, the years of the gold slump were precisely the time that gold behaved more like a currency and less like a commodity — and its decline mirrored the rising fortunes of the U.S. dollar.

Then, on the rare occasions U.S. Fed officials tipped their hand about raising interest rates, it was never in support of the dollar. There was plenty of talk about reining in the stock market, but nothing about the exchange rate. The world simply continued to buy dollars.

Things are very different in the present gold market. Faced with the need to bring the U.S. dollar down, the Fed has played the decline with all the patience and nerve of a really good salt-water fisherman: it has let the currency market run with the dollar, knowing that it can reel in the quarry when it needs to. And it hasn’t yet needed to; there remains an easy-money, low-dollar bias at the Fed even when the bank finds it necessary to say it will adjust policy to circumstances.

Even though U.S. economic growth warmed up in the later part of 2003, many conditions are still bearish for the U.S. dollar, including the country’s trade balance and its net savings rate.

As reassuring as most of the indicators are, there are still reasons for a note of caution about gold. A correction of a few dollars now — like the one we saw in late January — is vastly better than seeing a seriously overbought market develop, then crash in months or years.

One weakness is a decline in the amount of gold going into jewelry: a fall of 7% in the past year and 25% over the last four years. GFMS (the former Gold Fields Mineral Services) expects jewelry fabrication is at its lowest level since 1991.

A large part of the decline came from Asia, where higher gold prices damped down discretionary gold purchases. That is not necessarily bad news: recovering economies will make a big difference to the demand for jewelry, and fabrication offtake will inevitably follow.

Still, the slower jewelry market points up the need for the gold industry to think about promoting end uses like jewelry.

They also need to promote gold as an investment. Many market pundits now see gold, rather than gold equities, as the better investment buy, overturning the conventional wisdom that shares are leveraged to the price of gold. Certainly the strong recovery in gold equities over the last couple of years supports that view, and therein lies an opportunity for investment in gold. It’s unfortunate that new tradable gold investments such as the Equity Gold Trust have not had a smooth a roll-out, but there is still time to make these investments attractive in countries where gold-backed securities are not yet easily available.

So we’re still sanguine about gold’s prospects, and even more optimistic if prosperity is on the way. Nothing benefits gold quite like a Gilded Age.