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Sep 2009 - The Last Shoe

The Last Shoe to Fall

Its finally happening, the “last shoe” appears to be falling, the IMF are going to sell 403t of gold. The IMF have been threatening to sell gold for many years. Maybe it will be the last major “central bank” sale, but this time round, it may be taken up by other central banks (that have previously sold gold), or China or other Asian banks seeking to diversify their US$ currency.

Interestingly the US has never sold any gold despite its holdings, probably because historically any country that has done so, has seen their currency weaken afterwards (there are many examples, eg Australia, Canada, the UK, France etc).

We once overlaid a chart of the gold price over a year, for 15 consecutive years on top of each other and for 14 out of the 15 years, gold and gold shares ran in August/September, especially the last week of August and the first week of September. The reasons are mainly ascribed as being due mainly to the marriages following one of the Indian monsoons (there are 2 or 3 per year, from different directions), and jewellers re-stocking for Christmas.

There were quite a few reports stating that the gold price should have been weak because of the poor monsoon in India, yet it still managed to break through US$1000/oz. A few brokers are currently stating that gold has to weaken because of the relatively poor monsoon, combined with India apparently becoming price sensitive because it is trading about US$1000/oz, and consequently they are producing forecasts predicting that the gold price has to fall to US$900/oz or less, within the coming year.

What ever happened to that comment that one of the biggest difficulties about forecasting the gold price is that most people get it wrong.

Why the perceptions of gold price levels have not changed with time, is to some degree inexplicable. Even at the recent Excellence in Mining Conference in Sydney (21/22 September 2009), a gold “bear” (CBA) showed that on an inflation adjusted price, the ~US$660/oz average price for January 1980 (it peaked at US$850/oz on the 20 January 1980), was equivalent to US$1850/oz in real August 2009 terms (so the 1980 peak is equivalent to a gold price of ~US$2380/oz in August 2009 terms, or nearly 3 times).

In response to a question, the CBA bear did not expect the US to ever sell gold, if anything they thought the central banks appeared likely to become net buyers, a view recently echoed by the GFMS.

Of course measuring gold in real terms is somewhat simplistic. We can recall buying a small house in Parkhurst, Jo’burg about that time for ~ZAR28,000. Now that house costs ~ZAR1.2m (being ~43 times).

We have been tracking gold and gold shares for over 30 years (since 1977). Normally gold is weak in October, again on that yearly comparison, however, this time it may not be that simple. Because the Chinese middle class along with

Asia are becoming increasingly wealthy as shown in Figure 1, of a gold jewellery shop in Little India, Singapore that we walked past in early July 2009 (when gold was ~US$930/oz) – packed with mostly men buying gold chains for investment. The other gold shops along the street were also fairly well attended too.

It was also commented at the Sydney conference by basemetals.com in reference to current metals demand from China, that the consumption of cars was up 20% on last year, and demand for fridges was up 30% y-o-y. However, as we have stated before, once you have bought a car or a fridge, are you going to but another one – no you are more likely to save the money and/or buy gold – especially as the Chinese have historically had an affinity for gold.

For many years one of the arguments in favour of gold appreciating was “what if the Chinese decide to buy gold and match even a fraction of the per capita holdings of some western countries for only part of their population?”. Well it looks like its gradually happening, and the Chinese Central Bank appears to be buying gold too (diversify its exposure to the US$).

About 7 years ago in the December 2002 or January 2003 issue of Paydirt, our Goode News column focused on gold price forecasting and a model that we used to predict the gold price in the 1980s, that was based on the South African Chamber of Mines’ model. As we wrote at the time :

“The Chamber’s model was based on a linear regression of 4 parameters being the real US long-term interest rate, the Brent oil price, the DMK/US$ exchange rate and the annual increase in USM1 money supply led by 4 quarters (or one year) to provide inflationary expectations, and a “constant” to balance the equation deriving the US$/oz gold price. The Chamber’s model had the advantage that most of its input data could be sourced from the last page of the UK publication, called “The Economist”.

Although the oil price relationship with the gold price was largely severed some time ago, the inclusion of the oil price in the model gave a better statistical fit than its exclusion……….the model’s predictability began to deteriorate in the 1990s with the increased degree of hedging”.

At that recent Sydney conference, Sean Russo’s Noah’s Rule showed that with the Barrick close out of its hedging (the “last shoe” to fall of the mega gold producers ?), the world gold hedge book is now back to about when it started, in 1991.

Also at the conference, CBA showed that US money supply has almost doubled in the recent stimulus package as the US has printed money to avert a financial crisis. At some stage it should have an impact - the model used to use one year for its correlation, which could infer that the pressure for rising inflation may occur over the coming year, and with it the gold price.

Although the IMF appears to be receiving a good price for the gold they are selling – maybe time will show that it marked the start of a new rising era for the gold price.

It has often been stated that gold vacillates between being a currency and a commodity. This time it appears to be doing both at about the same time, and hence may stay in the vicinity of/or above US$1000/oz longer than a number of people expect it to.

Disclosure and Disclaimer: This article has been written by Keith Goode, the Managing Director of Eagle Research Advisory Pty Ltd, (an independent research company) who is an Authorised Representative with Taylor Collison Ltd, and with his associates, may hold interests in some of the stocks mentioned in this article. 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.

Figure 1. Buying Gold Jewellery in Singapore’s Little India in early July 2009GDNsep09

  • Written by: Keith Goode
  • Tuesday, 01 September 2009

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