GOLD-THE CLOSEST THING TO A SURE BET FOR 2003
By
Chris Temple
Jan 10, 2003
Leading the investment pack in 2002 was the gold sector. The metal itself posted
gains of some 27% on the year, as a host of factors strengthened the bull market
that began back in mid-2001. Gold mining stocks also surged; and though they
ended the year off their best levels reached in June, the group still beat all
other stock market sectors, rising by nearly 60%.
Of all the
markets/asset classes out there, the closest one to a sure thing for a profitable
2003 is gold. In fact—though I’ve been dead on where my beginning-of-the-year
forecast for the broad stock market is concerned now for six years running—I
am not even making a call on stocks for 2003 in my January newsletter. The reason
is simple: though the Fed’s monetary stimulus should turn 2003 into a
modestly positive year for the market and give us a pleasant—but deceptive—interlude
in what REMAINS a multi-year, secular bear market—NOBODY can know what
will happen until we know whether we’re going to be in a war or not. Maybe
things will turn out all right, maybe they won’t. But there are far too
many "maybes" this year to make a stock market prediction. If you’re
listening to anyone who is doing so under such completely uncertain circumstances,
you deserve what you get if their predictions go awry.
But gold should,
at least, grind ahead in almost any scenario. It’s been nearly a generation
since so many factors have combined to push gold steadily upward, in spite of
economic weakness that has already hit jewelry demand somewhat. Jewelry demand
will still be an element to watch closely in 2003; after all, this accounts
for three-fourths of all physical gold demand. Without investors taking over
for lower fabrication use of the metal, prices could get hit still.
However—though
I’ll mention here a few things to watch that might give us warning of
a nasty correction in this sector—too many things are still in gold’s
favor longer term. Last Spring, when I wrote at length about why gold had broken
out of its multi-year bearish trend, I spoke of factors that you now know well;
among them, reduced central bank selling, the virtual end to the so-called "carry
trade," greatly reduced forward selling by producers and other "demand-side"
issues.
The last of
these—reduced hedging by producers, which included some aggressive repurchases
of existing hedges—has already contributed most of the "oomph"
it’s going to. However, some factors that were not as important when the
new gold bull was born have asserted themselves increasingly of late, perhaps
more than compensating.
They are:
Negative real
interest rates: There has seldom been an extended time when the nominal federal
funds rate (now 1.25% and still headed lower) has been below the Consumer Price
Index where gold did not move higher. Currently, if we buy the Bureau of Labor
Statistics’ CPI numbers (and you know that I don’t) negative real
rates are around 2.0%. As this situation endures, the economy enjoys substantial
monetary stimulus, which is positive for gold.
Low long-term
rates: Though corporate bonds have been a much different story, rates on long-term
Treasury debt remain near historic lows. The new "bellwether" 10-year
note (which I predict will be replaced in 2003 by the return of the 30-year
bond or some similar device) is still yielding in the 4.0% area. As long as
rates on Treasuries do not go up too dramatically, the carry trade game (where
speculators, hedge funds and others borrow gold at current low lease rates,
sell it and invest the proceeds in Treasuries or similar items) really won’t
get off the ground again. This is especially true (and recent gold market behavior
seems to confirm this) when most players are stepping up to BUY on price dips,
and otherwise seem afraid of either being on the short side of the market or
of missing out on further moves higher. Isn’t that a switch!
Re-monetization
of gold: Much has been made by some gold bugs of the new gold-backed "dinar"
and some other moves by sovereign governments to re-introduce gold as a basis,
at least in part, of national currencies. In my opinion—while interesting
and worth following—these initiatives do not represent a significant amount
of the world’s monetary pool, for lack of a better term. As a percentage
of major nations’ potential foreign exchange reserves, the money involved
in these new currencies barely registers.
However, given
the fact that Russia and China may be strengthening their own embracing of gold
for monetary purposes, this subject is one which bears further exploration.
Make no mistake: virtually everyone, given their druthers, would like things
to remain as they’ve been for several years now. And, that is with the
U.S. dollar as the currency of choice for just about everyone and everything.
But if 2003 also goes badly for the greenback, look for the rats to start leaving
the sinking ship faster. And they’ll do so, at least some, by moving into
gold and new, national gold-based currencies.
The declining
dollar: Throughout 2002, I seldom mentioned gold’s rally in the context
of a declining U.S. dollar. Actually, for the first 12 months of the last 18
months’ move, the dollar stayed either even or, in fact, was strengthening
against other currencies. That did not stop gold from rising steadily, as the
other factors I mentioned above were sufficient to move gold higher even as
the dollar was also rising.
But as 2002
was concluding, the U.S. dollar’s decline accelerated. In fact, the dollar
has now broken its long-term up trend that started in 1995. Accordingly, there
is more talk now in the investment community of gold reasserting its traditional
role as the dollar’s opposite number.
A dollar alternative/crisis
hedge: I don’t know about you, but I have a difficult time remembering
the last time that there was serious talk outside of our own "gold bug"
circles of gold being a viable asset class/alternative to the U.S. dollar. But
suddenly, this reason has emerged as perhaps the leading argument in favor of
investors flocking to the sector. Since gold broke the long-impenetrable $330
per once area several weeks ago, it has rallied further based on some professional
money (i.e., hedge funds) jumping on board, with these folks viewing gold at
last as a reasonable place to, at least, park some money.
While this
could dwarf other investment demand that this bull market has seen thus far,
such piling on by hedge funds and momentum players must be seen for what the
overwhelming majority of it is: short-term, speculative money chasing momentum.
Among other things, this virtually guarantees that—in contrast with the
fairly methodical nature of gold’s bull market thus far—gold in
2003 will become much more volatile. One minute, we could see gold spike to
$380, $400 or higher if we get into a war and it gets ugly, or if there is a
more concerted "run" on the U.S. dollar. Just as easily, however,
we could see gold plunge back to $325—or even, temporarily, lower—if
the stock market rallies, we don’t go to war (or a war goes off swimmingly)
and the dollar surges anew.
Though
it will be more volatile in 2003, I believe that—at a minimum—gold
will this year carve out a new trading range in the $350-380 area. This will
be true even if we do not end up with a major war, and the Federal Reserve’s
monetary potion starts working better to give us a longer respite in this secular
bear market than we really deserve. Though such warm developments would doubtlessly
knock 10-15% or so from gold’s price (probably in VERY short order) longer-term
positive fundamentals would eventually reassert themselves.
At this point, three factors I can think of have the potential to wreck the
longer-term bullish picture. Frankly, I do not see much chance of any of them
happening in the near term. However, they must be mentioned.
They
are:
Rising
long term interest rates: If other factors were simultaneously pointing to trouble
for gold’s bullish picture, a significant rise in long term interest rates
could prove deadly. Without a commensurate rise in gold lease rates (which remain
very low right now) a sufficient gap could open again inviting a new round of
playing the gold carry trade game. And believe you me, if the world’s
major central banks were sufficiently concerned about a rising gold price, they
would be very willing enablers of this.
New hedging:
For the moment, selling future production is in such disrepute among gold players
that—especially given the current momentum in the market—no producer
dares announce it is hedging anew to lock in current prices. Among other things,
companies that have been high-profile hedgers are trying to rehabilitate themselves
with investors who otherwise will flee if they smell trouble (on that score,
look at the horrible performance of Barrick shares in recent months, even as
the company insists that the Blanchard and Company suit against it is "ludicrous
and totally without merit.")
But business
is business, whether gold aficionados like it or not; and to some extent, hedging
is an entirely reasonable step for a company to take under some circumstances.
I’m sure there are at least some mining executives around who are looking
at the $350 area and wondering whether they should lock in some of this bull
market’s gains by constructing new hedges. I don’t know that a couple
players doing this with a percentage of their planned production would be terrible;
however, if the bloom came off gold temporarily for some reason and there were
a rush to hedge, it’s curtains.
New/increased
central bank selling: The Washington Agreement entered into by 15 major central
banks (including the European Central Bank) in September, 1999 expires in 2004.
Many experts expect these parties—joined, perhaps, by others—to
announce well before its expiration that the Washington Agreement will be extended.
The
agreement limited new sales/leasing of gold to 400 tons per year for five years;
that limit was a combined one, including all the players.
An extension
of the agreement as is would be bullish for gold. However, if for some reason
the parties either let it expire, announce their intention to do so, or announce
significantly higher limits, it would throw a wet blanket onto the market.
In summation, expect gold to continue trending higher under most possible scenarios for 2003. Be prepared, however, for substantially more volatility. This could mean, of course, even greater trading opportunities than we enjoyed in the middle several months of 2002, giving you the potential for trading profits on top of maintaining your core positions in the sector. And be on the lookout for those kinds of developments which—though they seem remote now—could upset the overall bullish picture.