Commodities | Feb 26 2007
By Greg Peel
It is very hard to find an analyst who is not bullish gold. Mind you, a lot of analysts have been bullish for a while and had expected gold to pass through US$700/oz in 2006. It hasn’t yet, but circumstances are conspiring to suggest such a move is almost inevitable.
For some reason, the world had begun to become far comfortable with the situation in Iran, which helped to send the oil price lower, despite little change in the stand-off. Focus has now returned as Iran refuses to give in to UN demands to cease its nuclear program. There is now a real fear the US may decide enough is enough, and look to a military solution.
This seems incongruous given the current opposition to the Bush Administration’s plans to send more troops to Iraq. The Democrat-controlled Congress has already “censured” Bush by disagreeing with an increase in troop numbers. Congress is thus unlikely to approve any pre-emptive move on Iran.
However, the reality is that until there is a Democrat in the Whitehouse there’s very little Congress can achieve. Bush has the mandate to do what he and his administration wants until the end of next year. And he is still the Commander-in-Chief. It remains a question of just how much he would be prepared to go out on a limb against world opinion.
But world opinion also tends to agree Iran ‘s president Mahmoud Ahmadinejad, an Islamic fundamentalist, is a loose cannon and very likely to be enriching uranium to make the bomb rather than for Iranian power needs as offered.
In such times of turmoil, gold becomes a traditional safe haven. However, over the last couple of decades, gold’s safe haven appeal has suffered as investors turned instead to the US dollar. With the dollar’s popularity on the wane, gold has once again come to the fore. And while European central banks are now deciding not to sell their allowed quotas of gold, central banks around the world are looking to diversify out of US dollars and into other currencies such as the euro or pound, and into gold.
The super-cycle that has seen all metal prices trade through the roof has also sparked a mining scramble. But where as base metal production is expected to eventually rise to even out demand imbalance – perhaps by 2008 – world gold production is actually on the decline.
South Africa is the world’s largest producer of gold, but its production level peaked in 1970. ABN Amro reports that at 279t, South Africa ‘s 2006 gold production was 72% below the 1970 peak, and the lowest level since 1922. Gold consultancy GFMS calculates global gold production fell by 2% to 2,467t in 2006 – the lowest level in ten years.
While a rejuvenated gold price has led to a new surge in exploration, and the opportunity to process low-grade ores once considered uneconomic, the reality is there is a global scarcity of major new projects. So much so that the world’s largest producer – Barrick Gold – told a gathering recently it intends to extend its diversification from copper to other base metals, platinum group metals, silver, and maybe even energy.
“So in the face of rapidly depleting resources, flat production, rising costs, and longer approval times to open new mines, [Barrick CEO Greg] Wilkins touted other developments besides gold, including a big nickel project in Tanzania, platinum-palladium projects in Russia and South Africa, along with a copper and gold property in Pakistan”, reports the Toronto Star.
A continuing source of gold over years, outside of new production, has always been central bank selling of reserves. European central banks have always been keen sellers, such that sales were agreed to be limited by the Central Bank Gold Agreement of 1999 to a total of 500t. 2006 saw sales fall short by 104t – the first time there has been in shortfall in the CBGA’s history.
Indications are, notes ABN, that 2007 could even see less selling. France is expected to be the major seller, while at the other end of the scale Germany has indicated it would only sell 10t for coins. The madness that is Italy may yet prove a wildcard. Italy is the world’s fifth largest holder of gold.
But Italy is also a significant consumer of gold, representing 50% of European fabrication offtake in 2006. Europe accounts for 15% of global demand. The World Gold Council reports global jewellery demand has begun briskly in 2007, following a volatile 2006 which saw demand fall 16% by weight despite representing 14% more in dollar terms. The May peak and crash had a lot to do with jewellers giving gold a wide berth for a while.
However, it is volatility more than actual price that undermines jewellery demand, and many Asian market watchers believe demand is returning despite higher prices. Sales of gold trinkets during Chinese New Year celebrations have again been strong.
That only leaves gold’s relationship with the US dollar, which has a tradition of being converse. However, it is not unusual for the gold price to decouple from the US dollar and trade higher as the dollar trades higher. This occurred during the price surge of late 2005/early 2006, and has occurred again as recently as last week.
Nevertheless, ABN notes a growing belief that the US dollar will break down against its trade-weighted index this year. It will not necessarily be sudden, and ABN could see a gradual 10% decline over two years. This can only be positive for gold. With a decline in the dollar, gold once again becomes attractive as a direct investment tool as the world looks for a place to park its surging excess liquidity.
ABN Amro is advocating exposure to gold for its clients – a view backed up today by Citigroup. Says Citigroup:
“We retain our positive view on gold based on global macro/monetary catalysts, the emergence of historically frustrated Chinese buyers and petro-dollar fuelled Middle Eastern consumers and the absence of aggressive shorts. We expect a test of the US$700/oz level in the coming months.”
When it comes to investing in Australia ‘s gold sector, Citigroup notes increased costs, production disappointment and adverse hedge books have led to gold sector underperformance in the past 12 months. As 65% of Australia ‘s gold production is now controlled by offshore companies, Citi advocates sticking to the local majors, and that means Newcrest (NCM) and Lihir (LHG). Beyond these two there is a lack of investment-grade quality and exposures are highly speculative.
However, one mustn’t forget that opportunities lie in the fact that sources of gold are scarce. While Citi does not cover the juniors, the analysts have made comparisons to suggest there is speculative value in Avoca (AVO), Dominion Mining (DOM), Perseverance (PSV), and St Barbara (SBM).
Citi also notes companies with “interesting” offshore exposures, being Allied Gold (ALD), Equigold (EQI), OceanaGold (OGD), Troy Resources (TRY) and Pan Australian (PNA).
Of the above stocks, four attract at least some coverage in the FNArena database. Most popular is Perseverance with a 5/2/0 B/H/S ratio, followed by Oceana (2/3/0), Equigold (2/1/0), Avoca (1/0/0) and Pan Australian (1/0/0).
