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Gold
has appeared to have stabilized at a level above US$1,100, close to a recent
52-week and record high. For those following the price of gold, this is in
line with annual increases over most of the last decade. It also coincides
with seasonal variations in the metal’s price. Typically, due to demand
from metal fabricators in Asia (China, India, and the Middle East) the price
of gold tends to increase from late summer and early fall through the late
winter and early spring months of the following year. This pattern was broken
in 2009, quite possibly due to the unhealthy global economy, when the price
of gold maintained more or less steady rates of appreciation to the
present.
Record
Gold Prices Warrant Concern, Not Fear for Gold Bugs
The
record prices for gold have given rise to concerns of a bubble forming in
gold by observers relying on charts and technical analysis. Certainly we
become quite nervous when expectations for appreciation are met, but we see
no signs of a bubble forming similar to other recent financial bubbles,
including excessive use or margin, an appearance of insatiable demand, or
universal euphoria over the commodity.
Recent
premiums have increased for purchasing physical gold. These can be met as
gold may become available for commercial interests whenever gold may be sold
above the spot price. Certainly there is room in 2010 for a seasonal
correction, with even more volatility relative to prior years due to
potential increased interest and ability of momentum traders. In any
event, we suspect general continuation of prior annual trends.
Thesis
for Long-Term Gold Appreciation Still in Force
We
believe gold has performed well as an investment, commencing the current run
with the terrorist attacks on the World Trade Center in New York City, due to
supply and demand fundamentals. Prior to 9-11 the industry had
languished due to two decade of low metal prices. Major operators closed
mines and suspended exploration activities. Most sold off projects to
generate cash, and optimized mining operations in order to remain viable.
There were reduced levels of investment in all areas of critical
infrastructure, including equipment, and skilled labor such as geologists and
engineers.
The
flat to declining expectations for production were eventually offset by an
increase in the money supply (excess reserves in a fractional banking system)
which has persisted since 9-11 with the belief that increased liquidity would
sustain economic growth. While this did occur to some degree, with increased
leverage afforded by the shadow banking system, an increase in the money
supply fueled an increase in housing prices. Defaults of subprime mortgages
eventually led to a collapsing real estate market and rapid deleveraging of
the banking system and near global financial collapse.
Deleveraging
Brought out the Yellow Flag
Deleveraging
of the global banking system did, by definition, reduces the supply of U.S.
dollars to gold and led to a correction for gold in the Spring of 2009. We
believe the easing of mark-to-market accounting led to a bottoming of anxiety
by bankers no longer forced to write down performing asset for which there
was no identifiable market. This eased concerns by regulators and bankers
over capital adequacy and bankers were obliged to become more comfortable
with their viability. In the meanwhile, banks looked to U.S. Treasuries
for risk-free rates of return. In addition, as the Fed and foreign banks
continued to buy U.S Treasuries issued to finance deficits in the U.S.,
interest rates remained low and the U.S. Dollar continued to slide.
Presently,
the most likely threat to sustained gold price appreciation would be comments
or actions by the U.S. Federal Reserve that they intend to increase interest
rates. It would appear that with division among Federal Reserve
presidents, interest rate increases would be more likely to follow
significant signs of inflation (including higher gold prices) rather than
risking stalling an economic recovery.
Gold
Bears Counting on Deleveraging or Responsible Fiscal and Monetary Policy
The
greatest threat to the price of gold would be if the U.S. Administration and
the U.S. Congress embarked upon the unpopular course of fiscal austerity.
This could be accompanied by higher interest rates forced on the U.S. by
foreign investors, or by increasing levels of taxation. The latter appears
more or less certain with the expiration of Bush tax cuts and initiatives to
reform health care and carbon reduction tax initiatives. While there is
certainly significant uncertainty for any of these outcomes, it can be
counted on that increased uncertainty is unfavorable for the business sector
to invest. Without investment, job growth will likely languish and without
bank lending and increased commercial activity, gold may remain at current
levels.
We
believe it is unlikely that gold will move much lower in 2010. The political
will and mindset as well as the ideology of the Federal Reserve runs counter
to monetary stability coincident with economic growth. We can count on
reduced economic activity with higher tax rates reducing total tax revenues,
especially if inflation pushes wage earners into higher tax brackets.
Following the global financial system’s near brush with death, economic
stagnation or stagflation will be given high marks (possibly as high as a B+)
for progress by the political and economic elite. Considering the permanence
of death they may be correct, but in reality, the middle and dependent
classes may remain unsatisfied and aspire for more.
Our
Opinion and Outlook for Gold in 2010
Our
outlook anticipates a price for gold between US$900 and US$1,200 per ounce,
although we would not be surprised if gold increased to US$1,500 per ounce in
2010, as part of an extension of the current long-term trend. Yet it might
still avoid classification as a “bubble” relative to the
inflation of technology stocks at the turn of the century, and of the housing
market more recently.
There
are scenarios which could precipitate acceleration of appreciation of gold
prices including the monetization of debt, increase in bank lending without
increases in interest rates, and consistent and unimpeded international
purchases of gold by central banks. Without real economic growth in the U.S.,
the U.S. dollar would certainly come under pressure and gold would likely
appreciate.
Sadly,
an apparent bubble from the gold perspective, rather than an appreciation of
gold, may be categorized as a collapse of U.S. dollar-denominated financial
instruments. We are not expecting this extreme case in 2010 but this is the
direction. With gold at US$1,100 per ounce, gold companies advancing assets
to production should do well, assuming a relatively stable economic
environment.
Mike Niehuser
Beacon Rock Research.com
Mike Niehuser is the founder of Beacon
Rock Research, LLC which produces research for an institutional audience and
focuses on precious, base and industrial metals, and substitutes, oil and gas,
alternative energy, as well as communications and human resources. Mr.
Niehuser was nominated to BrainstormNW magazine's list of the region's top
financial professionals in 2007.
Mr. Niehuser was
previously a senior equity analyst with the Robins Group where he was a
generalist and focused on special situations. Previously he was an equity
analyst with The RedChip Review where he initially followed bank stocks but
expanded to a diverse industry range from heavy industry to Internet and
technology companies.
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