Opportunities in Gold
27 March 2008As good as gold. If ever there was a time when this saying rang true it is now.
The value of gold has been increasing dramatically. Favourable fundamentals point to this continuing. The major factor is that supply is decreasing at a time when there are structural changes increasing demand for the foreseeable future at least. Gold also performs well in periods of economic and political instability, tends to have a negative correlation to the US dollar and a low correlation to equities*. All of this makes gold an ideal asset for wealth preservation and risk management.
You may have read that gold recently broke through $1,000 an ounce. Record prices are always good for a headline. Yet gold is well positioned to continue its rally and in our opinion is unlikely to repeat its 1980 performance where it underwent a swift correction after hitting new highs. Why is this?
The supply of gold globally is finite with many of the easiest deposits to mine already mined. This leaves in the ground gold that is more expensive to mine. Many of the mines are also approaching the end of their lives. In addition there is a lag time of three to four years for new mines to begin producing. Similar to many mining stories, there has also been a lack of investment in new mines and related infrastructure. This is illustrated by South Africa being unable to supply present power needs to existing mines. The supply story is completed by the reduction in gold supply caused by changes in some mining companies’ policies to hedging gold production.
On the demand side, the increasing wealth of emerging markets, the weakening US dollar and the current financial crisis have contributed to structural changes in demand for gold. The diversification properties of gold to equity markets, especially given the strong growth in equity markets over the last few years, has lead to institutions and individuals increasing their demand for gold as an investment asset. This is reflected in the growth of exchange traded funds linked to gold which provide easy access to physical gold.
In 2006 and 2007 a number of central banks did not meet their 500t sales quotas. In contrast Asian central banks with huge and growing foreign currency reserves have begun to look at switching some of their reserves into gold. Further to this, Russia has purchased 51 tonne of gold since the start of 2006 and is targeting gold to compose 10% of their foreign reserves. Qatar similarly has increased its gold reserves to over 4% of their reserves since the start of 2006, up from below 0.50%*.
Look at all of this together and, in our opinion, you see that gold is well-positioned to continue its current rally. As a result it has the potential to continue to be a great risk management and wealth preservation asset which provides a low correlation to equities.
* BlackRock Merrill Lynch Investment Managers January 2008
