Timing the next rush to gold


By Conrad de Aenlle
International Herald Tribune, Paris
Friday, November 7, 2008


When there seems to be nowhere to turn, investors often turn to gold. The unprecedented volatility in stocks and uncertainty about the world economy and financial system should make this an ideal time to own gold.

Conditions apparently are so tough, however, that the value of this traditional refuge has been sinking along with everything else.

From Oct. 8 to Oct. 22, a period when markets in many assets went haywire, gold fell about $260 an ounce, or close to 30 percent, to $680. After a mild recovery, gold for current delivery closed at $731.20 on Thursday on the New York Mercantile Exchange.

The relationship between gold and calamity was intact earlier in the year as the bear market gathered force. Investors liked gold well enough when the investment bank Bear Stearns collapsed in mid-March to send the price of the metal to an all-time high -- near $1,050.

The repeated failures of financial institutions during the past couple of months, along with other distressing events, have produced gold price rallies, often sharp ones, but they have quickly fizzled out. The decline last month has left gold trading with a loss of about 10 percent for the year.

Shareholders in mining companies would gladly take that. The PHLX Gold/Silver Sector Index, a benchmark for the sector, lost nearly two-thirds of its value this year before rebounding slightly in the past couple of weeks. As seems to be the case with stocks of all sorts, investors sold mining shares with little regard for corporate fundamentals.

One reason for the decline in all things gilded may be the gloom engulfing emerging economies. Demand for gold from Chinese and Indian consumers soared during the boom times, but as forecasts for economic growth are ratcheted down, so are price targets for gold. Inflation expectations have diminished markedly, too, as prices of other commodities, mainly crude oil and related products, have plummeted even more than the price of gold.

A more significant source of weakness, in the opinion of analysts and strategists, is forced selling of the metal by hedge fund managers. These investors travel in packs, piling into many of the same trades and using borrowed money to do it. Gold, other commodities and foreign currencies have been favorite investments of theirs, but with markets volatile and access to credit severely curtailed, the funds have had to reduce their exposure.

"What is dominating gold right now is not fundamentals but position liquidation," said Rebecca Patterson, global head of foreign exchange and commodities for J.P. Morgan Private Bank. "People who desperately need cash are selling whatever they can to get it. That's dwarfing buying interest."

There is still plenty of that, even if the wave of selling is greater. People who have cash -- the wealthy private clients that use her bank's services -- have shown "an incredible amount of buying interest in gold" during the past couple of months, she said.

One sign of the nervousness is that the typical client does not just want to hold gold on paper but instead "wants to see a numbered gold bar in his or her name," Patterson said. "That usually only happens when investors are really frightened about the world."

That such palpable fear is unable to overcome the effect that the forced selling is having on the price of gold is causing exasperation for bulls. As John Hathaway, senior managing director of Tocqueville Asset Management, said in a recent report, "If these horrific financial market developments have been insufficient to drive gold to new highs, what will it take?"

He answered his question by fast-forwarding to the post-credit crunch world and enumerating the consequences of the various emergency measures taken by policy makers to try to minimize the damage. "The socialization of credit in the U.S." could result in higher inflation, a weaker dollar and even a downgrading of Treasury debt, he warned. Those developments would probably push gold higher eventually.

What Hathaway finds more imminently bullish is a supply shortage in gold that is being obscured by a glut of paper equivalents, like futures contracts, which hedge fund managers and other speculators have dumped on the market.

"Gold trading steadily at $2,500 is not unthinkable," he said.

Maybe not to him, but Patterson is not giving serious thought to gold at any quadruple-digit price for the time being.

"It's not going to go back up to $1,000 easily," she said. But she does not expect the decline to continue much longer, either. The next significant move will be higher, she predicted.

"We're starting to get to levels where, even if we have some down-side risk, prices are attractive enough to consider starting to build long positions," Patterson advised. She finds it more likely that gold will be higher a year from now than lower.

Many gold bulls prefer to invest in the metal through shares of mining companies. The bulls reason that shares have fallen so far this year that they stand to benefit from a recovery more than if they bought the commodity itself.

One indication that mining stocks have borne the brunt of the aversion to gold is the ratio of the value of the PHLX index to the price of an ounce of gold. At one point last month, the index fell to less than 10 percent of the gold price, an all-time low by far. The previous low until the past few weeks, around 15 percent, occurred in 2000 when gold traded at just $250 or so.

The decline in mining shares has been so severe that even managers of diversified equity funds are moving gold miners to the top of their shopping lists.

"Gold is my favorite sector," said Josephine Jimenez, chief investment officer for Victoria 1522 Investments, a specialist in emerging and frontier markets. Echoing Hathaway's thinking, she added: "Can you imagine all these governments pledging these hundreds of billions of dollars" to bail out their economies and financial systems? "We might get an economic decline with inflation."

Her fund is new and she is still filling it, so she did not want to discuss individual holdings. But she offered Buenaventura, a Peruvian mining company, as the kind of stock that she expects to benefit from such a development.

Hathaway finds the stocks so cheap compared with gold that he "would throw darts at my top 20 names" to build a portfolio. Some of those names are Randgold in South Africa, Goldcorp, Kinross Gold and Agnico-Eagle Mines in Canada and Newmont Mining in the United States.

"The whole sector is ready to take off," he declared.

Vahid Fathi, a commodities industry analyst for the research firm Morningstar, also considers mining stocks the better bet, but he would make it a small one. Gold, however it is owned, should be 3 percent to 5 percent of a portfolio, in his view.

He advised investors to hold gold shares through a mutual fund or exchange-traded fund. When pressed, he said his selections included Newmont, the South African miner AngloGold Ashanti and two Canadians, Barrick Gold and Yamana Gold.

One reason that gold stocks are so cheap, Fathi said, is that investors are underestimating the impact of lower commodity prices on the companies' earnings. Declines in "oil, copper, cement, everything used to extract gold from the ground are not discounted in the marketplace," he said. "As we begin to see margin improvement, we will see significant room for upward movement."

A healthier earnings backdrop for the sector certainly couldn't hurt, but for Jimenez, the bigger point in favor of gold stocks is the shaky outlook for everything else.

"Gold stocks should do well until the world comes out of this mess," she said.

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