Investing
Gold, Again, Becomes a Shield Against the Unknown
By CONRAD DE AENLLE Published: September 23, 2007
GOLD
is supposed to be a destination for scared money, but as the
credit crunch intensified last month, this presumed haven
lost value along with many other assets. Only after the worst
of the crisis had passed did traders return to gold, sending
its price sharply higher.
The metal has gained about $80 an ounce, or
12 percent, since mid-August, around the time the stock market
reached a trough. While share prices have since had ups and
downs, gold's ascent has been nearly uninterrupted.
This strength
heralds further gains for physical gold and for shares
of mining companies, many analysts and fund managers
predict. They offer a variety of reasons, ranging from
a desire to hedge against a falling dollar, a weaker
economy or geopolitical instability, to a conventional,
Econ 101 imbalance of supply and demand.
The bullish consensus, and the abundance of factors
invoked in reaching it, result from an oddity of the
gold market: it thrives on uncertainty, and investors,
even authorities on commodities, are uncertain what
makes it tick.
“What is unsatisfying about gold
is that there is no single easy explanation for why
it moves either up or down,” said Fred Sturm,
manager of the Ivy Global Natural Resources fund. “There
are a number of elements that impact the price direction.”
Stuart Schweitzer, global market strategist
at JPMorgan Private Bank, is another who finds gold a head-scratcher.
“If there’s a rule where gold
is concerned, it’s that it doesn’t trade predictably,”
he said.
That was the case last month, when gold failed
to rise along with anxiety about the availability of credit,
as might have been expected. Instead, it fell about $50 an
ounce from late July to mid-August, a result of selling by
hedge fund managers.
Gold is an asset coveted as a hedge against
risk, but these mostly unregulated and highly leveraged funds
acquired large positions, using the substance as a tool for
speculation. When other markets on which they had made big
bets turned bad — subprime mortgages, for instance —
the funds were forced to sell gold, among other holdings,
to raise cash.
“There has been a lot more leveraged
money in gold over the past few years, compared to history,”
Tony Lesiak, a gold analyst for UBS, said in a note to the
bank’s clients. “So when we get financial market
risk aversion, the same investors who are cutting long equity,
long credit and long emerging-market positions also cut back
on gold.”
Now that hedge fund selling has abated, a
serious impediment to higher gold prices has been removed,
advisers contend. Another reason to expect further gains,
even with gold now at $731.50 an ounce, close to its highest
price since 1980, they say, is that little further supply
is likely to come to the market.
Central banks, mainly in Western Europe, have
been selling gold from their reserves as they diversify into
other assets, and are thought to be nearly done with those
sales. Supplies from mines rose a mere 3 percent last year,
while another usual source of supply, scrap, fell 27 percent.
There is plenty of demand, meanwhile, from
the flourishing middle classes in China and India and, says
John Hathaway, manager of the Tocqueville Gold fund, from
central banks in countries that have enjoyed gains from foreign
trade, like Russia, the Persian Gulf states and, again, China.
Then there is the risk-aversion play. Hedge
fund sales masked demand that might have arisen in the subprime
crisis, but analysts expect a demonstrable resumption of flights
to safety if the dollar keeps falling, credit conditions worsen,
political hot spots ignite or if some other bad event occurs
that they can’t yet envision.
Gold is “an asset that people want to
own as protection for risks they can’t really analyze
and get their arms around,” said Mr. Schweitzer at JPMorgan.
“That risk has gone up.”
If investors buy the arguments for gold, they
must then decide how to buy access to it. They can acquire
the physical metal, but that entails costs for storage to
guard against theft and the hidden cost of holding an asset
that does not pay interest or dividends.
A way to mitigate the first expense is to
buy an exchange-traded fund like the StreetTracks Gold Trust,
the largest of several E.T.F.’s on the New York Stock
Exchange that hold bullion in quantity so that storage costs
are spread thin.
The main alternative to physical gold is shares
of mining companies. They have failed to keep pace with bullion
over the last year, and fund managers and analysts have no
trouble explaining why. As Mr. Sturm summarized it, gold mining
“is a pretty lousy business.”
The costs of energy and the chemicals used
in mining tend to rise along with the metal, so company profits
are prone to rise more slowly than the price of gold, he noted.
That makes gold one of the less-rewarding substances to produce
during a commodities boom.
“Very few gold producers are beating
their chests, bragging about how much free cash they’re
generating,” Mr. Sturm said.
Though he finds gold mining “a tough
gig,” his expectation of higher gold prices and lower
input costs has led him to increase holdings of mining stocks.
He tends to favor companies with mines in politically stable
countries and with enough ore in their reserves that it would
take a decade or more to extract it all.
His favorite example is Gold Fields in South
Africa. Its stock became very cheap, in his view, as its price
fell from $26 in the spring of 2006 to $14 last month as the
price of bullion showed little net change.
Mr. Sturm’s eclectic list of choices
includes Agnico-Eagle Mines, a smaller Canadian company that
he expects “will probably have some brand-spanking-new
gold reserves coming at a time of rising prices.” For
investors interested in mixing their metals, he likes Impala
Platinum in South Africa and Silver Wheaton, an American company
that provides financing for silver mines around the world
in exchange for interest and royalty payments.
Echoing Mr. Sturm’s thinking, Mr. Lesiak
at UBS has buy ratings on Agnico-Eagle and another Canadian
company, Goldcorp, in part because the bulk of their revenue
is generated in placid locales. John Hill, a gold analyst
at Citigroup, advises buying Barrick Gold and Newmont Mining.
Mr. Hathaway of Tocqueville Gold also counts
Goldcorp and Gold Fields among his selections. Others include
Ivanhoe Mines, a Canadian company developing a large mine
in Mongolia, and Randgold Resources, which he said is “run
by a very smart group of people in West Africa.”
But he sees many mining companies as poor
investments. “Their main product is going up in price,
and they can’t transfer it to the bottom line,”
he said.
He said he was “beginning to see signs
of intelligence” from a variety of companies on allocating
capital, and predicted that profit margins “should come
out of this funk they’ve been in.” That may make
it more worthwhile to own the stocks than the metal now, but
he stressed that investors should buy mining shares in spite
of what happens in the boardroom, not because of it.
“There is only one reason to buy gold
stocks, and that’s because you think the gold price
is going up,” he said. “It’s not a growth
industry.”