Gold sails into horse latitudes

So far, this has been a somewhat nervous year for the gold-mining industry and its investors. Most North American gold stocks have been chopping sideways or declining on shrinking trading volumes since December, when gold prices finished their big US$80 run-up to US$454.20 per oz., a 16-year high, before retreating.

When a gold bug’s faith gets a little shaky, it’s a good time to step back and listen to two of the world’s best gold-price prognosticators: Victoria, B.C.-based economist Martin Murenbeeld of M. Murenbeeld & Associates (now owned by Dundee Wealth Management) and London-based GFMS, compiler of the annual Gold Survey, a must-read.

But first, let’s take a quick look at the raw numbers for gold in 2004: the average price in 2004 rose 13% to US$409.17 per oz., closing out the year at US$438 per oz. It was the third year in a row that a double-digit percentage gain was recorded.

The 2004 average was more than 50% higher than the low of recent years: the US$271.04-per-oz. average recorded in 2001. As well, last year’s high, US$454.20 per oz., was almost US$200 more than the trough of the summer of 2001: US$255.95 per oz.

Non-dollar gold prices saw more modest gains in 2004, and even some losses: in Canada, gold prices averaged C$532.33 per oz. in 2004, up from C$509.03 in 2003 and C$485.98 in 2002; the average euro price for gold in 2004 was only 9% higher than in 2001; and the average rand price in 2004 was 19% lower than in 2002.

Speaking at the PDAC in Toronto in March, Murenbeeld outlined a macro-economic argument for gold’s continued rise in U.S. dollars that would be familiar to gold investors everywhere.

While Murenbeeld said there are about a thousand variables that can affect the gold price, he sees the U.S. dollar as “the key variable,” since gold and the U.S. dollar are so highly, negatively correlated. Thus, to determine the outlook for gold, you need to ask: what is the outlook for the U.S. dollar?

Simply put, Murenbeeld believes the U.S. dollar has further to fall, though it did not fall as far or as fast as he expected in 2004.

Joining a chorus of people worried about the U.S. balance sheet, Murenbeeld warns that America’s debt is a “serious, long-term problem, and a potential long-term driver of the gold price.”

The total, outstanding U.S. domestic debt is now 200% of gross domestic product, an all-time high. Thus, it’s not in the U.S. interest to move interest rates up quickly, because there’s some slack in the U.S. economy both in terms of capacity utilization and employment figures.

Furthermore, as Alan Greenspan said last year, the U.S. budget position “will almost assuredly deteriorate substantially” as baby boomers retire.

On top of the budget problems, the U.S. current account is now 3% of GDP. The last time it reached levels that high, in the mid-1980s, the U.S. dollar dropped harder and faster than it is sinking today.

Just in purely technical terms, Murenbeeld said, the dollar “should” probably drop another 15-25%, so the question becomes, What’s keeping the dollar up?

As people who follow gold know, the answer to that question is the central banks of East Asia, especially Japan and China.

The Asian currencies are, by and large, fixed to the U.S. dollar, and in order to keep those currencies fixed, the Asian central banks have been going into the foreign-exchange market and buying U.S. dollars. Then they turn around and put those dollars into the U.S. bond market.

Japanese and Chinese buying of U.S. dollars has been so heavy that half of America’s US$600-billion current-account deficit is now being financed by foreign central banks.

“This is not going to go on forever,” said Murenbeeld.

China has become critical to the world economy, and that brings renewed scrutiny of the Chinese renmimbi, which has not risen in some 20 years.

Significantly, the renmimbi was devalued at the end of 1993 by 34% against the U.S. dollar, and as of that devaluation, China started to build its foreign exchange reserves.

Today, the Chinese currency is seriously undervalued, and even a 5% rise — which could be undertaken as a political concession to the U.S. government — would only be a nice token and do little to change economic events.

“Cracks are starting to occur in this Asian system,” said Murenbeeld, “and most definitely, the U.S. dollar has to come down against the Asian currencies.”

It is likely a sign of things to come that in February South Korea said it was considering diversifying its reserve assets out of the U.S. dollar.

Meanwhile, Murenbeeld sees gold’s supply-and-demand issues as “not that critical at the moment” but points out three gold-positive developments in the past year: the renewal of the Central Bank Gold Agreement; declining mine output; and the launch of several exchange-traded gold funds, such as streetTRACKS in New York.

Equally, he sees hedging and de-hedging as “not that big an issue” and estimates that hedging has hurt gold prices by about US$5 per oz. for every 100 tonnes (3.2 million oz.) sold.

“Gold is cheap by a number of measures,” concluded Murenbeeld, who predicts the precious metal will average US$458 per oz. in 2005, US$479 per oz. in 2006, and US$491 per oz. in 2007.

GFMS, on the other hand, is not nearly so keen on pushing the relationship between the gold price and the U.S. dollar, and describes it as being “to a large extent a self-fulfilling relationship,” fuelled by speculative investors who are trading on the back of it.

At a presentation hosted by the Toronto CFA Society in late April, Bruce Alway, a senior metals analyst with GFMS, attributed gold’s price rise in 2004 to several factors: sustained investment interest; major cuts in above- and below-ground supply; record levels of de-hedging; and fabrication performing well as price-sensitive markets began to accept higher prices.

He described gold’s 13% rally in 2004 as “distinctly ordinary” in comparison with most other commodities. For example, the other precious metals all enjoyed much stronger rallies, with silver up 36%, platinum rising 22%, and even palladium up 15%. Copper, tin and lead likewise registered gains of 61-74%, while Brent crude rose 33%.

Moreover, states GFMS in its Gold Survey 2005, “with gold prices in many other currencies also showing limited or smaller increases, whether we can truly call the last three years a bull market for gold is open to question. The dollar is, after all, a somewhat elastic ruler.”

On the plus side, though, GFMS says there is now more of a consensus that prices a little over US$400 per oz. are sustainable, and believes it’s now “quite reasonable” to call levels heading towards US$400 per oz. a good buying opportunity.

Placing the gold price of 2004 in its historical context, GFMS notes that the nominal level reached was seemingly strong at more than US$55 per oz. higher than the average of the previous 20 years. In real terms, however, the 2004 average could still be viewed as weak, at more than US$70 under the average of the prior 20 years.

While GFMS sees a possibility that the gold price will chop sideways between US$420 and US$440 per oz. for the rest of the year, the company still sees further downside on the U.S. dollar and wouldn’t be surprised by an investor-led rally in gold prices this year toward the US$500-per-oz. mark.

In the end, GFMS predicts gold will trade in a range of US$410-480 per oz. for the rest of 2005.

So, some comforting words from the experts for gold bugs who are getting a bit antsy waiting for gold to resume its upwards march!