Musings on the gold price from Denver

DENVER, COLO. — Gold prices are going to remain quite volatile in the short term but in the long run, the yellow metal will set new records, Martin Murenbeeld of Dundee Wealth Economics, told investors and analysts at the Denver Gold Forum in September.

When it comes to forecasting gold prices for 2008 and 2009, Dundee’s chief economist admitted he was “sitting on the fence,” with probability-weighted averages ranging from US$860-897 per oz. for 2008 and US$686-1,002 per oz. for 2009.

But Murenbeeld said there are some very good reasons why gold can only move higher further down the road.

“I’m not particularly bullish on gold these days but I do believe over the long term we can reach US$2,300 per ounce,” he told his audience at the prestigious, invitation- only gold conference.

Among the reasons for Murenbeeld’s optimism is his conviction that the U. S. — and later other governments — are certain to ease monetary policy. And we’ll see that happen, he argued, because of shrinking savings rates and rising debt levels. The budget deficit, at US$350 billion, is “the worst we’ve ever seen –and rising sharply. “When we see debts rising and commitments of government increasing, you wonder how the government is going to get out of this,” he said during his presentation on the second day of the conference. “It can renege on promises, it can cut other services it provides, it can raise taxes, or it can print more money.

“I am very gung-ho on monetary easing,” he said. And if the Federal Reserve or central bank is printing money, “that’s good for the gold price. . . You are going to see more easing of monetary policy outside the U. S. It’s going to happen — it’s just a matter of time.”

Moreover, if the Federal Reserve is put under pressure to buy debt, that will also be good for gold. “We are some way from that, but if it happens, gold is going straight up,” Murenbeeld asserted.

The U. S. dollar has also been a wonderful factor for gold, he said. But he argued that he wants to know what the U. S. dollar is doing against the Indian rupee and Korean won more than how it compares with the euro.

As the dollar declines against those Asian currencies, you have an impact on gold, he explained.

On that front, U. S. trade numbers with China are a “disaster” and none of the governments in Asia want their currencies to rise against the dollar.

The world is awash in currency reserves. China has about US$1.8 billion in U. S. dollar reserves, and 18 countries have more than US$50 billion in U. S. dollar currency reserves.

“These are obscene numbers of reserves and it’s sloshing around credit markets,” Murenbeeld said. “Some of this money, in my thesis, gets recycled into gold — either directly or indirectly.”

Is it possible that some of this wealth gets leaked off under the table into gold? “We do know there is heavy trading in the Middle East and it has picked up over recent years,” he said.

And as oil prices trend skyward, these countries have even more money to throw around and can affect gold prices through the wealth effect.

“If I were sitting in the Middle East taking in this revenue, I would definitely be interested in allocating some of it to gold. . . (and) if you live there, you might be very happy to have some of your money in gold rather than in U. S. dollars.”

Gold is also quite cheap as a financial asset when you compare it to the S&P 500, he said.

In terms of supply, Murenbeeld said he wouldn’t be surprised if it fell. As for consumer demand, it remained solid last year.

“The picture is fairly clear — (consumers) are spending more money on gold product. So I feel pretty good about consumer demand.”

Investment demand is also fairly strong he said, pointing to the “phenomenal increase” in demand for gold underlying the exchange-traded funds, or ETFs.

“Investment demand has a long way to grow,” he argued. “Over time, that’s what I believe is going to happen.

“We’re only in the seventh or eight year of this cycle and I believe it is going to last longer than some of the other shorter cycles we have seen,” he asserted. The shortest copper cycle lasted 16 years and the shortest wheat cycle 13 years, Murenbeeld pointed out.

Of course, there are bearish arguments too. When the euro gets stronger, gold gets weaker or remains constant and this is likely to happen, he noted. De-hedging will also end and gold will lose this “demand” component. And gold has a record of declining during U. S. recessions and thereafter, he said.

Other speakers at the conference weighing in on the future of gold prices included John Hathaway, senior portfolio manager at Tocqueville Asset Management in New York, and Paul Walker, chief executive of GFMS in London.

Hathaway, a veteran of countless gold cycles, noted that the U. S. government’s bailout on Sept. 7 of Fannie Mae and Freddie Mac, the country’s two largest mortgage finance companies, should have sent the gold price higher than it did.

“This is a really desperate situation and I would have thought gold would have responded very positively. . . Why haven’t these events supported gold prices?This is a mystery and a puzzle I’m not sure I can answer today.”

What is going on with the bailout ultimately attacks the standing of the dollar as the reserve currency and the whole credit structure this world has operated on since the Second World War, he pointed out. “That’s why I think there’s a heck of a lot of upside for gold.”

The fact that news of the bailout didn’t push gold higher was particularly surprising given that physical gold is so short, Hathaway added. “I was talking to someone in Dubai this morning who said, ‘Send us all the gold you have because it’s running out the door here.'”

Gold closed at US$775 per oz. in London at presstime. It reached an all-time record earlier this year when it vaulted to US$1,033.90 per oz. on March 17.

For now, all the macroeconomic indicators are making Hathaway very bullish on the yellow metal.

“If you think, as I think, that this (bailout) is just another milepost along the way in the financial crisis, then it seems to me that there is substantial room for the price of gold to go up,” he claimed.

With the value of paper disappearing in front of everyone’s eyes, he added, “people don’t trust anything” and they “distrust currencies.” And if the euro “comes apart at the seams,” he continued, “there’s a lot of safe haven money that was parked in the euro as an anti-dollar trade, so where does that money go? . . . There are very few places where they can go.”

Arguing that the price of gold “still hasn’t done anything” yet, Hathaway pointed to negative real rates in the U. S. and noted that the U. S. Federal Reserve and other central banks can create liquidity but not an appetite for risk.

Banks have lost US$500 billion and only raised US$350 billion. Lending is way down, credit standards are very tight, capital is short and the willingness of the private sector to provide capital is not there, all part of the reasons why “gold has a long way to go.”

The real turning point will be when the dollar is downgraded and Hathaway argues that the world is beginning to see signs of that.

“The thing for us to watch, and I believe we’ll see it, is the U. S. dollar will be on credit watch,” he said. “If this were Panama and not the U. S., there would have already been a negative rating issued on the currency.”

Hathaway asserted that if market and macroeconomic events make people think they ought to have gold, “the exits are way too narrow and that’s why the price of gold at US$1,000 is not even close to where it can go.”

If Hathaway is proven right, that’s good news for everyone, particularly the juniors.

“As long as people think US$1,000 is the ceiling, we’ll probably have the juniors in the penalty box,” he concluded. “On the other hand, when gold at US$1,000 is seen as the floor — which is coming — I think that whole sector (go
ld juniors) will come back to life.”

Walker of GFMS said he was optimistic on the short-term case for gold.

“You’re starting to see real signs of economic slowdown in India and I don’t think China will be immune from this,” he said. “I think there is real recognition that the backdrop is slowing growth and inflationary pressures. All of these factors conspire to give you a broad macroeconomic backdrop that is positive for gold. We are bullish on gold, we think gold still has legs and will run higher.”

Walker added that when one looks at where the economy stands, it is difficult to believe that the dollar can continue to strengthen as it has over the last few months.

What intrigues Walker is how physical markets for gold have responded to prices over the last 12-18 months.

“Mr. and Mrs. Joe Average in India or the same individuals in Saudi Arabia have taken the view that there is a lot more upside potential for gold and they don’t believe there is a lot of downside risk at the moment so the scrap volumes have come down,” he noted.

Indeed, the physical markets of India and Saudi Arabia have adapted to current prices, he added, “and have decided to come back and buy at price levels I wouldn’t have imagined people buying at even two years ago.”

Describing himself as “bullish on gold” Walker argued that within the next three or four months gold will be pushing well above US$900 per oz. and will push through US$1,000 per oz. in 2009.

But he cautioned it’s not all plain sailing ahead. For every ounce coming out of the ground, there is not enough net fabrication demand to take that gold off the market. “For every ounce of gold, there has to be an investor’shand out willing totake the metal,” he explained.

So is investment going to be a permanent feature in this market? “My view is that the investment case for gold is extremely good. Investment will be a feature of this market.” But the question is for how long.

“For the next six months?Yes. For the next twelve months? Quite possibly.” But Walker said he could not “make an intellectual case for investment to remain a permanent feature of this market.”

If that is true, he added, you are then dependent on the physical market to come in and pick up the pieces. “Physical markets matter,” he said. “They are going to matter tremendously over the next two, three, four, five years.”

The hill that gold has to climb is going to get steeper some time in the future, Walker noted. “I think we’ve got a couple of good months ahead of us, maybe a year, but there will come a time when. . . this metal is going to come back to the market, investors aren’t going to hold it forever. And that’s where the physical markets are critical.”

The downside risks of gold start to look serious when you start to go beyond 2009,Walker concluded.

“There are worrying signs ahead but the investment case is still there. We’ll see US$1,000 but it’s what happens after that that really intrigues me.”