Anatomy of a gold mar­ket

How the golden bull got his horns

Finweek English Edition - - Cover - DAVID MCKAY

TWO YEARS ago David Davis, a gold an­a­lyst for Credit Suisse Stan­dard Se­cu­ri­ties (then Andisa Se­cu­ri­ties) wrote a 55page re­port called The Fu­ture of Gold. At the time, the gold price had staged a promis­ing re­cov­ery from a low of $255/oz to around $430/oz. The gains rep­re­sented a re­cov­ery but there was scep­ti­cism that the gold price could travel much fur­ther. Op­ti­mists were smok­ing their socks.

Ac­cord­ing to Davis’s re­port, how­ever, the gold price would be $700/oz by 31 De­cem­ber 2008, in­creas­ing to $1 200/oz in 2015. Given that he was too con­ser­va­tive for 2008 (gold breached $700/oz last year and is tipped to do so again in 2007), can we sup­pose $1 200/oz is too timid a sug­ges­tion as well?

“Putting all the fac­tors to­gether, we’ve got an in­ex­tri­ca­ble change that only a col­lapse in the jew­ellery mar­ket can stop,” says Davis. Jew­ellery de­mand ac­counts for just over 2 000 tons/year of the 2 600 tons an­nual pro­duc­tion.

But the as­tound­ing fact is that the world’s pri­mary pro­duc­tion of gold has been in sup­ply deficit, with mi­nor ex­cep­tions, for the last 15 to 20 years. That means not enough new gold is be­ing mined to feed de­mand. Take 1997, which recorded a pri­mary gold sup­ply deficit of 1 000 tons, says Davis. Why then the 20year-long gold bear

slide?

Ac­cord­ing to Davis, sec­ondary sup­ply of gold from cen­tral banks filled the sup­ply deficit. To­day, this is chang­ing as the dif­fi­culty of find­ing new pri­mary sup­ply in­creases. Geopo­lit­i­cal disor­ders and US dol­lar dis­tress are other fac­tors chang­ing the play­ing field. For years, hope­lessly con­verted gold bulls have been talk­ing (rav­ing) about a run­away gold price. They could be right.

Says Cock­er­ill: “Ex­ist­ing mines are ma­ture. The rate of newly dis­cov­ered gold is in­ad­e­quate, and gold pro­duc­ers have been steadily de-hedg­ing.” He also be­lieves US in­fla­tion is “be­gin­ning to rear its head”.

Per­fectly re­spectable pro­fes­sion­als, be­com­ing emo­tional about the in­fa­mously fickle gold price, may ap­pear un­seemly, but the change in sen­ti­ment to­wards gold is broader than that. It’s also be­ing re­flected in the sud­den pop­u­lar­i­sa­tion of the gold-backed ex­change traded funds (ETF), one of which trades on the JSE as New­gold.

Th­ese are shares backed by ac­tual gold but with­out the cost and has­sle of ac­tu­ally hold­ing the metal. In­stead, it’s held on be­half of the scrip owner in a bank vault. There’s also less of a bid/ask spread than in gold coins, where it is around 15%. The spread be­tween buy­ers and sell­ers in ETFs is only 1%.

In ad­di­tion, the share can be re­deemed. In­ter­est­ingly, how­ever, it sel­dom is, says Cock­er­ill. “When gold fell from $725 to $600/oz last year, the re­demp­tions on the ETFs were min­i­mal. This is sticky money and new money.” Moms and pops can own the ETF be­cause it trades like a share and tends to re­act with less volatil­ity than the ac­tual dol­lar price of gold.

Mean­while, Cock­er­ill sees the hand of pro­fes­sional in­vestors in the gold price. “You can see it hap­pen­ing. The gold price goes up and then cor­rects but never to the level from which it came.

“Per­son­ally, I can see the gold price go­ing sig­nif­i­cantly higher.”

David Davis, gold an­a­lyst, Credit Suisse Stan­dard Se­cu­ri­ties

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