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The Barbarous Relic – Relegated to the Fanatics?
The price of gold has fallen around 35% from its all-time current-dollar peak of $1,921 in September 2011, and gold stocks are mostly trading at about half their 52-week peaks. There are several reasons for the yellow metal’s decline. Traditionally, gold has been viewed as a hedge against inflation, a protection against currency devaluation due to excess money creation, and a port in a storm of world troubles. These considerations helped boost the price of John Maynard Keynes’s “barbarous relic’’ fairly steadily from the early 2000s to 2011. The creation of the first gold bullion exchange traded fund, SPDR GOLD SHARES (GLD), in 2004 made it much easier to hold the metal itself, as opposed to coins, bullion, or shares of gold mining stocks. This helped lift gold to its current dollar record. (The peak in ‘’real’’, or inflation-adjusted money, was back in January 1980, when gold touched $850 an ounce for about a day, which would be worth around $2,200 in 2013 dollars.)
As you will have already concluded, gold is suffering from a lack of almost everything that has supported it recently. Although the United States and other countries are vigorously pursuing easy money policies and interest rates are at a post-Depression low in the U.S., the dollar has strengthened and inflation is not even hull-down on the horizon. Europe appears to be dealing with its problems, though gold prices may reflect a little fear that several peripheral European countries will have to sell gold. China’s economy has slowed, easing inflation pressures in that huge country. All this has led to large fold sales by the ETFs, chiefly GLD, which has about half that market, but also by iShares Gold Trust (IAU). In the first quarter of 2013, total demand for gold was down 13% from the prior-year period, to 963 tons, which was also 5.7% below the five-year average. But the main reason was a 49% plunge in gold demand for investment, and that was due to a 230 ton drop in ETF actions, from purchases of 53 tons in the 2012 quarter to sales of 177 tons in the 2013 period. Meanwhile, gold demand for jewelry, by far the biggest category, rose over 12% this year, while net purchases for industry and by central banks eased a few percentage points. In short, if ETFs had neither bought nor sold an ounce in this year’s first quarter, total demand would have risen 2.8%, an entirely unexceptional figure.
While gold prices were falling around 35% from the 2011 high, gold stocks have fared much worse. Of the 10 issues in Value Line’s precious metals industry, seven are less than 12% above their 52-week lows, which were, for the most part, about 50% of the last year’s highs. This is actually reasonable, since the companies have quite limited ability to cut operating costs, even in the longer term. Moreover, most gold producers now do very limited or no hedging, which helped them benefit from peak gold prices but is hurting them now.
Total mine production will probably grow very slowly over the next few years, provided prices cooperate, though some high-cost mines have already been put on hold. On the cost front, the industry is planning to publish what it calls all-in sustaining costs, which includes not only direct mine cash operating expenses, but also replacement capital outlays, exploration, and some sales, general, and other items. AISC for the industry is around $1,200 an ounce now, not much below gold’s recent quote of $1,380 an ounce, and the figure was $1,295 for Newmont Mining (NEM) in the fourth quarter of 2012. That suggests that more mines will be furloughed, and mining of lower-grade ores curtailed, by later this year, which should cause mine output to fall a bit.
While gold prices could ease further in response to good news and investors’ shifting money from gold to the stock market, we think that this is unlikely. The present price should be low enough to boost gold demand for jewelry, and several countries ought to buy more of the yellow metal. Lower mine output should support prices, too, though it does not help the mining companies much, as their fixed costs will be spread across lower volumes.
At present gold and stock prices, we think it makes sense to invest a bit in gold. The stock market will probably take a breather as companies, finally, are forced to hire. And strong gold demand for jewelry, combined with lower mine output should lift gold prices a bit. More adventurous accounts should consider buying gold stocks, given the leverage inherent in their cost structures. And several, such as Agnico-Eagle (AEM), Barrick Gold (ABX), Newmont, and small-cap Pan American Silver (PAAS), have above-average dividend yields. More growth-oriented investors might look at Goldcorp (GG), which has an average yield but the best output growth outlook in the industry.
At the time of this article’s writing, the author did not hold positions in any of the companies mentioned.