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Feb 2003 - Gold Volatility

Gold returns to volatility

In our opinion the gold price has reverted to what it was like pre-producer hedging, which was not just 5 or 6 years’ ago, but actually more than 15 years’ ago. The GFMS Gold Surveys record the net new forwards as shown in Table 1.

Table 1. Net New Gold Forwards (t) 1986 to 2001GDNfeb03-1

It can be debated as to when the accumulation of forwards began to dampen the gold price, but the sluggishness was definitely in place from 1989 onwards. In contrast, the early 1980’s were noted for the volatility in the gold price, as shown in Table 2.

Table 2. Average Annual Gold Price (US$/oz) 1976 to 1985GDNfeb03-2

Days would occur when the gold price would move up and then down by US$10 to US$20/oz, somewhat similar to the past few weeks of late January and early February 2003.

Gold rallies used to last for 7 to 10 weeks or more (again a recent occurrence) compared to the 3-week rally that we have become accustomed to for the 1990’s and early 2000’s. However, this volatility has resulted in the market not knowing what to do.

While gold has soared the gold shares have largely drifted sideways. The poor performance of some of the Australian gold shares has been attributed to their levels of hedging, but all the gold indices have been behaving the same. Looking at the US Philadelphia Gold and Silver index, the market basically ignored what was happening from mid-Dec 2002, as shown in table 3 where the gold price has risen by more than 10% and the XAU gold index has barely moved.

Table 3. Gold Price and XAU Gold IndexGDNfeb03-3

There are at least two possible reasons, namely that the market was used to 3 week rallies and expected the gold price to fall, or the market did not believe what the gold price was doing and expected it to fall later.

We have seen the market ignore the movement in the gold price before. The classic example was in 1979 to 1980 when as shown in figure 1, the gold price (in blue) rose from about US$500/oz in late 1979 up to its peak of US$850/oz on 21 January 1980 and then dropped back to about US$500/oz in mid-1980, and the gold shares drifted sideways and essentially ignored the move.

However, when the gold price again the South African gold index literally went ballistic and doubled in a matter of months even though the gold price itself did not rise to anything like the lofty US$800/oz or more heights. The gold index also soared beyond all comprehension in 1982 on a relatively minor gold price move too.

Figure 1 Gold Price (US$/oz) and South African Gold Index (Feb 1979 to Mar 1984) Source : Frankel Kruger (which was ultimately taken over by SocGen)GDNfeb03-4

The moving average indicator shown in black in figure 1 is the percentage difference between two moving averages (10-day and 40-day) that was described in the previous (February 2003) issue of Paydirt. It provides an indication of how many weeks rallies used to last for in the early 1980’s.

So fast forward to 2003. It should be recognized that the environment of the early 1980’s has changed due to technological advances and 24-hour gold trading that can be accessed by a home computer, compared to clustering around a Reuters ticker tape or line printer printing each movement in the gold price one line at a time every few minutes, half hour etc.

Consequently when gold does move up again, gold shares could rally materially. The times when it was common to have 5% of a portfolio in gold and or gold shares could be returning again. The market has moved against gold companies that sell gold forward, unless they are forced to by a bank due to taking a loan, so the trend should continue in reducing forwards.

There have been a number of comments that the move in the gold price has mainly been due to a possible war with Iraq, and it should collapse. It seems unlikely that the gold price has risen US$80/oz on a possible war in Iraq. Although there could be some premium in the price, a study by the forerunners of the WGC, namely Intergold in the late 1980s concluded that gold only gains from world strife when it is already rallying. This conclusion resulted from a surprise observation that when the Afghanistan War occurred in the early 1980’s, gold (which was then falling) ignored it and continued to fall.

The gold market appears to be returning to what it was in those largely forgotten pre-hedging days. Once the gold shares can handle the volatility in the gold price, they should react positively to upward movements in the gold price again, because the market has changed.

Disclosure and Disclaimer : This article has been written by Keith Goode, the Managing Director of Eagle Research Advisory Pty Ltd, who has a Proper Authority with State One Equities, and with his associates, either has or expects to have interests in most of the stocks in this article, This e-mail address is being protected from spambots. You need JavaScript enabled to view it . The opinions expressed in this article should not be taken as investment advice, but are based on observations by the author. The author does not warrant the accuracy or completeness of any information and is not liable for any loss or damage suffered through any reliance on its contents.

  • Written by: Keith Goode
  • Saturday, 01 February 2003

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