Don't say it too loudly, but gold investment in 2007 is starting to look like a buy of the century. Many analysts note that institutions have a “growing love affair with gold”. Expects gold to rise as the US dollar falls further this year. But “now that everyone expects [gold] funds to continue powering ahead, expect a downturn”, warns one fund manager. There’s too much “hot money” in the metal, says another. Could they be right? Take a look at the year ahead and you’ll find it isn’t likely: there are very good reasons to buy and hold gold investments in 2007 and onwards.Demand from India is likely to grow
India leads the world in its love of physical gold. Gold already has “the highest penetration of any other financial product”, says a head of Kotak Mahindra Bank. Private individuals in India own more than 14,000 tonnes of gold necklaces, rings and bracelets – nearly 10% of the world’s above-ground gold stocks, and more than the US, German and French governments put together.
Gold will remains an integral part of Indian culture. As households earning above $80,000 per year set to treble next decade, it seems gold ownership will keep growing – especially considering that, on a per-capita basis, India still lags more developed markets. Per head, Turkey’s jewellery sales in 2006 were six times greater than India’s in volume terms.
Economics 101: mining output fell in 2006
Increased gold mining output would cap any rise in gold prices and basic economics says mining output should now be rising in response to six years of higher prices. Yet gold mining supply fell 2% last year. Gold output slipped 1.5% from 2005. Problems of cost, politics and finance are capping how fast gold mining firms can dig gold ore out of the ground. The “easy gold” in safe regions has already been mined. North American output this year is forecast at just 78% of 2002 levels.
South African output has halved since 1998. Ore grades in both countries are falling fast too, while less stable regions have yet to pick up the pace.
Then there’s cost. In the five years to November, Newmont Mining average production costs rose by two-thirds per ounce. Some forecasts that Newmont’s combined output with Barrick Gold, the world’s largest gold miner, will be 40 or 50 tonnes less than expected in 2007.
Also, as gold miners extract their ore, the value of their balance-sheet assets falls. Replacing gold-in-the-ground with new discoveries is harder than ever. Between 1985 and 2003, new gold ounce discoveries slipped by 30% from the previous 15 years. Each new ounce discovered also cost 2.6 times as much to locate. Large deposits (judged at 2.5 million ounces or more) aren’t enough to replace the major gold miners’ current rate of production. Between 1992 and 2005, world output totalled 1.1 billion ounces. New large reserves were barely half that size.
Risk of government seizures
Gold miners also face populist governments stealing their assets. The government in Fiji last week seized the Vatukoula mine belonging to Australia’s DRDGold. Last year, the Russian environmental agency revoked two mining licenses owned by a London-listed gold producer.
Environmentalism is another issue. The Gabriel Resources’ project at Rosia Montana in Romania may hold the largest undeveloped gold reserves in Europe, but upturning 5 mountains to get at 450 tonnes of gold doesn’t fit with today’s green politics.
De-hedging and prices
By June 2001, the global gold-mining industry had sold forward a massive 3,421 tonnes of production (well over 135% of an entire year’s output) onto the futures market. That “hedging” made short-term sense during gold’s 20-year bear market (from 1980 to 2000). It funded production and locked-in fixed prices for future output. But it also helped drive prices lower. Now that gold has trebled against the US dollar, miners are desperate to buy back their forward sales.
Between April and June last year, gold miners de-hedged 158 tonnes. That helped drive the gold price up to its huge spike above $720 per ounce in mid-May 2006. “The rate of de-hedging was bound to slow afterwards,” says a head of precious metals research at Mitsui.
But data for June to September shows “global mining companies remain committed to reducing their hedge commitments and have very little appetite for new hedging”.
Falling sales by Western governments should also support the gold price. European central banks sold only 396 tonnes of gold last year, against an agreed limit of 500 tonnes. But emerging economy governments are buying gold for their currency reserves. The details are secret, but analysts guess Russia bought 8.7 tonnes of gold between August and October, while Middle Eastern banks may have bought 100 tonnes in 2006. No price for guessing how much China is committing. They are not telling anyway.
The real reason you should buy gold
Why would anyone buy gold in the first place? The metal has few industrial applications. New compounds are replacing it in dentistry, and it will never pay a dividend. Gold costs to own, in storage and insurance fees. Add a minimum 2% surcharge from the gold dealers, or a dealing spread plus stockbroking charges should you trade gold ETFs, and gold soon looks like a losing trade, unless the price rises in terms of your local currency. And that’s where its potential lies today.
Gold can’t be made at will, no matter how pricey it gets. This is why it’s been used as a store of value for 5,000 years or more. Gold’s attraction is that it is rare: an attribute of money that no longer holds true for dollars, pounds, euros or yen. Gold is a “global currency", the only one that is freely tradeable and unencumbered by vast quantities of sovereign debt and prior obligations. Royal Bank of Canada now trades gold off its currency desks, rather than viewing it as a commodity.
By June 2001, the global gold-mining industry had sold forward a massive 3,421 tonnes of production (well over 135% of an entire year’s output) onto the futures market. That “hedging” made short-term sense during gold’s 20-year bear market (from 1980 to 2000). It funded production and locked-in fixed prices for future output. But it also helped drive prices lower. Now that gold has trebled against the US dollar, miners are desperate to buy back their forward sales.
Between April and June last year, gold miners de-hedged 158 tonnes. That helped drive the gold price up to its huge spike above $720 per ounce in mid-May 2006. “The rate of de-hedging was bound to slow afterwards,” says a head of precious metals research at Mitsui.
But data for June to September shows “global mining companies remain committed to reducing their hedge commitments and have very little appetite for new hedging”.
Falling sales by Western governments should also support the gold price. European central banks sold only 396 tonnes of gold last year, against an agreed limit of 500 tonnes. But emerging economy governments are buying gold for their currency reserves. The details are secret, but analysts guess Russia bought 8.7 tonnes of gold between August and October, while Middle Eastern banks may have bought 100 tonnes in 2006. No price for guessing how much China is committing. They are not telling anyway.
The real reason you should buy gold
Why would anyone buy gold in the first place? The metal has few industrial applications. New compounds are replacing it in dentistry, and it will never pay a dividend. Gold costs to own, in storage and insurance fees. Add a minimum 2% surcharge from the gold dealers, or a dealing spread plus stockbroking charges should you trade gold ETFs, and gold soon looks like a losing trade, unless the price rises in terms of your local currency. And that’s where its potential lies today.
Gold can’t be made at will, no matter how pricey it gets. This is why it’s been used as a store of value for 5,000 years or more. Gold’s attraction is that it is rare: an attribute of money that no longer holds true for dollars, pounds, euros or yen. Gold is a “global currency", the only one that is freely tradeable and unencumbered by vast quantities of sovereign debt and prior obligations. Royal Bank of Canada now trades gold off its currency desks, rather than viewing it as a commodity.
If you look at the flood of paper assets in global financial markets, you can see why. India’s money supply has surged more than 200 times since 1975, helping to knock the value of the rupee down from eight per US dollar to 48 per dollar. In Britain, the broad money supply is rising at 14% per year, faster than at any time since 1991. But the supply of stockmarket securities, bonds and complex derivative products is rising faster still. “Financial innovation in the last few years has been extremely strong,” says a head of asset management at BNP Paribas. Financial innovation is now so rampant, in fact, that derivatives weigh in at $340trn altogether, more than eight times the value of all goods and services traded in the real global economy last year.
Today’s bubble in novelty and complexity is sure to blow up – if not in 2007, then all in good time. Holding gold acts as insurance. The “barbarous relic”, as it was dubbed by John Maynard Keynes – so beloved of apparently naive investors in the booming economies of India, China and the Middle East – is the ultimate antidote to “financial innovation”. Nobody’s promise, gold is also no one’s to create. And while you’re waiting for the mountain of debt and derivatives to explode, you can own a secure physical asset that’s likely to keep rising in value, thanks to the rules of supply and demand.
Today’s bubble in novelty and complexity is sure to blow up – if not in 2007, then all in good time. Holding gold acts as insurance. The “barbarous relic”, as it was dubbed by John Maynard Keynes – so beloved of apparently naive investors in the booming economies of India, China and the Middle East – is the ultimate antidote to “financial innovation”. Nobody’s promise, gold is also no one’s to create. And while you’re waiting for the mountain of debt and derivatives to explode, you can own a secure physical asset that’s likely to keep rising in value, thanks to the rules of supply and demand.
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