Resurgent gold price may stir bull market

GOLD shares exploded this week, starting with a 12.6% gain on Monday and extending further through the week. Was this just a last kick from a dying donkey or a signal that this part of the market is bottoming out and preparing for a longer-term bull market?

Certainly, this sector has been bombed out over the past two years. The gold price topped out in September 2011 at just more than $1 900 an ounce and has been in a downtrend to June this year, when the price dipped briefly below $1 200 an ounce.

The chorus of “gold is going lower” predictions had reached a crescendo by then, and the bearish sentiment has been crushing.

The gold-mining companies fared even worse than the price. They curiously underperformed in the run-up of the gold price to $1 900 and were sold down even more aggressively once it started to decline.

The industry is clearly in bad shape. Production has dropped steeply, and South Africa is now in sixth place in the global gold production rankings.

This is not for lack of gold to mine — South Africa still holds the top spot in gold reserves, by a long shot — but through operational difficulties and rising costs. Depth, labour, electricity and regulatory hostility have all had their impact on the local industry.

The labour unrest that hit the platinum sector last year spilt over into the gold-mining industry, and Harmony Gold had to take the drastic step of closing one of its mines until it could be assured of some semblance of labour stability.

Even now, the industry is locked into a wage dispute over annual increases and the entrenched positions appear to be unbridgeable. This is despite the industry being in a precarious state.

With that backdrop, why would any investor be interested in this sector? Yet bull markets always start by climbing a wall of worry. This is where worry comes in in abundance.

Despite the pessimism, the gold price is probably lagging behind the underlying conditions within that market. The physical demand has soared after the huge drop in the gold price earlier this year.

In many ways, the takedown of the gold price had an artificial quality to it — huge amounts of paper gold were dumped onto the market over short intervals, which helped shatter sentiment among the traders and more speculative funds.

In their place has been soaring physical demand from the east. Imports of gold into China and India have increased despite the Indian government’s attempts to stem the purchases.

At the same time, lease rates for gold have risen — yes, gold does pay interest when leased! — and the forward rates have turned negative. This suggests that within the London and New York trading systems, a tightness of physical supply has developed. Comex inventories have plunged and the gold exchange traded funds have also been sold off with their holdings depleted. Speculative shorts have skyrocketed to record levels. All this has taken place against the acceleration of buying by physical hoarders in the east. In addition, physical purchases of gold coins across the world have also been on a tear.

Essentially, it is becoming increasingly apparent that gold has been shifting from weak hands to strong hands. This has been a twoyear process. It seems gold might have bottomed and be preparing to resume its longer-term bull market that began in 2000 when the price languished at $250 an ounce.

Despite the pull-back of the past two years, the underlying bullish drivers have not diminished. Central banks have been accelerating quantitative easing and have been extending the time frame for keeping zero interest rates in place. Debt levels continue to climb and the systemic risk of default or higher inflation remains.

At this point, the resurgence of the gold price and mining companies may well be an indication of what lies ahead. The deep pervasive pessimism would be a contrarian’s delight, setting up a great opportunity. The big question is whether the contrarians or the bears are right. Time will tell, but it looks as if the odds are stacked in favour of the contrarians.

Hart is chief strategist for Investment Solutions