Has the tarnish come off?

Gold prices have sustained a rally for more than a month now, if you count the fix of US$272.20 per oz. on Dec. 11 as a bottom. And unlike the old days, it is finding buying support on the way down, rather than selling resistance on the way up.

There are persistent rumours that a major hedger (usually said to be AngloGold) is doing the buying. Certainly that has been the trend in AngloGold’s strategy, not least because rand-denominated forward sales were costing the company money. Where, for much of the year, the gold price had stayed essentially level in U.S.-dollar terms, the price in rand has skyrocketed as the rand’s value in U.S. dollars fell.

For AngloGold, the rand hedge has worked in similar fashion to a currency hedge: to hedge gold prices in any currency is effectively a bet on that currency against the U.S. dollar. AngloGold will not be burdened by losing currency hedges, as many Australian producers have been over the past year, but the forgone revenue goes directly to the company’s bottom line. AngloGold has responded by nearly halving its rand-based hedge position.

Couple this with Newmont Mining’s victory in the battle for control of Normandy Mining — a victory that brings together two gold houses that have bet firmly on the spot price, and a third one that is committed to converting to the non-hedging camp — and there seems to have been a shift in the gold market’s momentum.

We have seen these shifts before, notably in the fall of 1999 after the Washington Agreement among the 10 member countries of the European Central Bank, plus the Bank of England, the Swiss National Bank and the Swedish Riksbank. Then, the banks announced a 400-tonne cap on annual gold sales, to extend for five years, and there was an instant short squeeze in the gold market.

Two of that era’s more acrobatic hedgers, Cambior and Ashanti Gold, were caught in liquidity crises by the sudden rise in the price of gold. Cambior divested the greater part of its base metal holdings to meet its obligations, and Ashanti, which sold half of its valuable Geita project in Tanzania to provide cash, is still restructuring.

It’s hard to believe the hedgers took no lessons from what happened to their compatriots: earnings reports over the next several quarters took pains to point out that the subjects were not vulnerable to margin calls. Hedging strategies took on a conservative cast almost overnight.

The adrenaline rush of late 1999 drained away quickly enough, and gold resumed its accustomed downtrend, but the international financial atmosphere has changed substantially since then. The Washington Agreement came before the explosion of the U.S. stock market bubble, when greenbacks were in heavy demand and when “soft” financial assets were both safe and high-reward. Interest rates have plunged in the past six months, and — though the U.S. dollar remains the choice for those looking for a safe haven — nobody seems to want U.S. equities quite as desperately these days.

So far, investors have not piled into assets denominated in other currencies, with the result that gold and the U.S. dollar have both moved up in value together against the other major currencies. That relationship will break off if the dollar is seen to be overvalued: then, there will be reason to get out of the greenback, but not to get out of gold.

Should that happen, hedgers could miss out on a sudden windfall. Even the soundest players, like Barrick Gold, whose hedge positions can be modified to take advantage of increases in the gold price, might find hedging a cost that is not justified by the extra return.

Thus it could be that one or more of the larger hedgers are fashioning more cautious strategies, and if they are, those strategies will find their reflection in smaller hedge books in 2002.

Cutbacks in the hedge books will not solve the gold industry’s main problem, the vast amount of above-ground gold that can be brought into the market, largely at the discretion of central banks. But it will mean that rallies in the gold market will no longer be instantly met with producer selling to take advantage of short-term price spikes, locking in longer-term hedges at better prices.

It looks as though it may be time, at last, for a little cautious optimism about gold.