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Welcome to USAGOLD's "Gilded Opinion" pages. We invite you to browse our index of outstanding gold-based commentary. Each article or essay is selected on the basis of its long-term relevance for understanding the role gold plays in the individual's portfolio, the overall political economy, or both.
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Treading the foothills of a gold bull
market
By John Dizard
USAGOLD Note: The recent firings of Wall Street bright lights, Stanley O'Neal at Merrill Lynch and Chuck Prince at Citibank, will do little or nothing to alter the plight of those institutions - a futile gesture in the face of a very big problem to which no resolution appears imminent except a bailout in the form of low cost and abundant credit. In previous financial crises, policy makers and Wall Streeters were quick to act, quick to heal the wound and re-establish confidence. Wall Street and the markets moved on. This crisis, which we are being told could stretch well into next year at the minimum, has a completely different feel and that's why gold is above $820 today.
Once again I reflect on the irony that the most severe test of the Federal Reserve in the modern era dates almost 100 years to the day from the Panic of 1907 - the credit crisis that instigated the Fed's founding in the first place. The Panic of 1907 was characterized by bank runs and a stock market crash as investors fled the financial system. The current crisis, though it has produced similar results, is a much more complex and wilder breed of cat. The very reasons why the Federal Reserve was founded in 1913, i.e., to provide liquidity, act as lender of last resort and combat a deflationary crisis, become the arsenal for what appears an unstoppable inflationary crisis in 2007.
Market commentator Henry K. Liu, offers a keen insight: "With the daily volume of transactions in the hundreds of trillions of dollars in notional value of over-the-counter derivatives, the Fed would have to inject funds at a much more massive scale to affect the market. Such massive injection would mean immediate and sharp inflation. Worse yet, it would cause a collapse of the dollar."
In the accompanying article, Dizard quotes a fund manager who points out that the current volatility in the gold market is nowhere near what it was at the top of the gold market in 1980. "Implied volatility for one month gold,' he says, "is around 20 per cent. Back in the real bull market of 1980, it was up to 50 and 60 per cent. Silver vol[atility] was over 100 per cent in 1980. You have this clinical signal that the bull market hasn't started yet."
This implies, as Dizard says, that we are just now "treading the foothills of a gold bull market." --MK
With spot gold now hovering around the $800 an ounce price level, you would think the goldbugs would be joined by a frenzied public snorting up of gold shares and Krugerrands. Volatility should be jumping to record levels, and the long-neglected managers of gold unit trusts and mutual funds should be ushered past the velvet ropes and into the VIP rooms.
No.
If you enter "2007 gold bull market" (without the quotation
marks) in the English Google search box, the algorithm will report
more than 1.9m entries. That is not, however, the same thing as
people buying metal or shares.
John Hathaway, the portfolio manager of the $1.128bn (£541m, ¤ 778m) Tocqueville Gold Fund in New York, had a total return of 38.2 per cent from October of 2006 to September of this year. Not bad, but, as he says, "It's all performance, not money flows." Over that time, new purchases of fund shares were $330m, while withdrawals were $280m, for a net inflow of $50m. If the public had really bought into this bull market story, then we would be looking at something better than annual net inflows of 5-6 per cent.
As a precious metals hedge fund manager points out: "Implied volatility for one month gold is around 20 per cent. Back in the real bull market of 1980, it was up to 50 and 60 per cent. Silver vol was over 100 per cent in 1980. You have this clinical signal that the bull market hasn't started yet."
The relatively subdued interest of the investing public, if not the investment newsletters and columnists, is actually good news for those long the metal. It means there are a lot of people left to buy the stuff, which is not the case at bull market peaks.
In recent weeks, as the gold price has approached the $800 level, the rate of increase in the price, the momentum of buying interest, has slowed, one sign that a correction in the uptrend could be at hand. Even so, the low volatility and low level of public interest both suggest that even with a short or intermediate correction, we are only in the foothills of the gold bull market.
For example, one of the main supports for the gold price in recent years has been the closing out of mining companies' hedge books. Throughout the 1980s and 1990s, the mining companies effectively sold much of their future production using a range of derivatives contracts. This protected their earnings from price declines, at the expense of giving up the cash flow benefits of price increases. In this decade, under pressure from shareholders who wanted leveraged exposure to gold price increases, the mining companies bought back their hedges. In 2001, the gold miners had hedge books totalling some 3,400 tonnes; now they are down to a total of about 1,000 tonnes. This unwinding was a significant part of the total demand for gold in the past several years.
Interestingly, the quarterly reports just out for AngloGold Ashanti and Barrick showed that they were not big buyers of gold in the past quarter. So some other people were supplying the fuel for the summer and early fall rally. "The quality of demand, not just total demand, rose over the quarter just past," as a longtime gold sceptic told me when the third quarter hedge books were disclosed last Thursday.
All this has been going on as many of the "gold" mutual funds available to the public became "hard asset" funds. In recent years, the price of gold has not risen as much as, say, nickel, copper, or lead. To keep the money coming in, most portfolio managers re-positioned themselves as commodities or metals investors. They may want to consider another makeover. From mid-August, when the credit squeeze finally became a headline, to the end of October, the spot gold price was up over 19.3 per cent, while the CRB index, a commodities basket, increased by 12.6 per cent. This makes some macro sense, as the demand for commodities such as copper will be reduced by the US housing slump, not to mention substitution effects, while the hesitant Bernanke reflation is helping gold.
However, the reluctance of the big central banks as a group, not just the Fed, to recognise the hole they are in will stretch out the reflationary process. The Fed's statement after the 25 basis point cut last week was far more "balanced" than it probably should be. It is clear that the board will be reacting to weakness, rather than forestalling it. European central bankers are using even more hawkish language. Both the Americans and Europeans will have to see more real-time, real economy effects before they abandon their models and aggressively reflate. They will.
Gold is both a monetary instrument and a commodity, but the size of its above-ground supply makes the monetary element more significant. That means attempts to estimate its future price track by looking at annual mine supply or jewellery demand will be misleading.
As Mr Hathaway says: "Mervyn King's effective guarantee of the liabilities of the British banking system is much more significant than declining South African gold production."
So, even at about $800 an ounce, the real gold bull market has not begun.
Originally published November 5, 2007
John Dizard has been a financial journalist
for 34 years, writing for The New York Post, The New York Observer,
National Review, Fortune Magazine, Institutional Investor, Fortune,
Forbes, Barrons, and the New York Journal of Commerce. He has
been the London Bureau Chief of Institutional Investor, a correspondent
for the Canadian Broadcasting Corporation, and the managing editor
of Canadian Business Magazine. Since 2001 he has been a weekly
columnist for the FT, writing first for the Global Investing page
and then on Wealth. His columns, which appear in the newspaper
ever Tuesday, cover the full range of subjects that might be of
interest to wealthy investors from complicated hedge fund
strategies and ideas for buying stocks, through aggressive defences
of the consumer against bad behaviour on Wall Street, to articles
on investing in gold, diamonds and contemporary art.
-- johndizard@hotmail.com
This article is reprinted with permission from the author.
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