Instability should augur well for the price of gold

Noted in a parking garage, appropriately mounted on a gold-colored car, was this personalized license plate: DIG4 AU.

In these times of a depressed gold price battling to hold US$350 per oz., it is refreshing to run across an optimist on the future of this precious metal.

The bears on gold have dominated for about a dozen years. The voices of the optimists have been weakened by the battering, by the inability of the gold price to move decisively higher even under conditions of world crisis such as the Iraq-Kuwait war and the collapse of the Soviet empire.

Gold was supposed to be the ultimate haven in such chaotic times yet the sellers dominate. Even the Bank of Canada has been selling large chunks of its gold reserves, employing the logic that by investing the proceeds, it would earn interest.

And not so incidentally, the Bank’s John Crow, et al, could point to a fat profit since those gold reserves probably flowed to the Bank many years ago at prices very far below today’s levels. Once upon a time, some 20 years ago, gold made up 80% of the gold and foreign exchange reserves. These days the yellow metal is reported to account for something around 24%. Then there are the gold miners, who should be true believers yet they’ve been putting heavy downward pressure on the gold price by selling large shares of their production before the gold has been mined. This selling forward and other related preproduction dumping seems to hit when gold reaches US$400. The result is inevitable. Just as a rising gold market starts to attract attention, the hedges pour in and the price drops.

Talk about killing the goose that lays the golden egg. If ever there was a nation where self-interest argued for higher gold prices, it has to be Canada. What sane investor would acquire gold under such market conditions with so little opportunity to profit, especially when there are many other financial products and markets, even currencies, where activity and price movements provide opportunities to make money.

It is generally agreed that in the final analysis, investor and speculator interest is at the heart of gold’s future price. Attract investor interest and the gold price will climb. Thus the key questions for the future relate to whether and when the right conditions will occur to attract that interest. For gold followers, there isn’t any doubt that gold is destined for higher prices. Their problem is determining timing. I lost a $5 bet on a prediction a year ago that gold would hit US$400 by the end of 1991.

The auguries, the underlying conditions, for a higher gold price look favorable.

Consider the supply-demand equation. The amount of gold used to make jewelry exceeds western mine production and that source of buying continues to increase. The growing economies of the “emerging” nations of Asia are generating the discretionary funds for people to use to purchase gold items. In the first six weeks of this year, sales of the Maple Leaf coin were equivalent to 17% of total 1991 sales, the Mint has reported. Asian demand was the key factor.

The supply side of the equation indicates future tightening. The big growth cycle with mines opening everywhere is history. World production probably has peaked and could start slipping. A major rush of new mine development is unlikely unless the gold price rises substantially and stays up. With the exception of unusually rich deposits, gold mining has become something of a matter of high-grading. These are not the good times of 1980 when gold traded at what today would be an inflation-adjusted gold price of more than US$2,000 per oz. and the profits rolled in.

The “old” Russia was the big mystery influence. Now the truth is coming out. Russia’s gold cupboard is bare. It didn’t have the quantities the rest of the world thought it had and eye-witness accounts of its mining areas point to far less annual production than predicted.

South Africa has its gold problems of rising costs, declining grades and a turndown in production. It has been estimated that more than half of South African gold production is uneconomic at current prices.

The key question for any big upward push in the price of gold revolves around the conditions that might bring back the long-term investors and the kind of speculative attention which more than a decade ago led to lineups outside banks of eager gold buyers.

Looking at the possibilities leads to consideration of gold as a financial instrument, as a store of value and not as a commodity. Any argument falls into two opposing camps — financial and economic experts such as those in the Bank of Canada selling gold reserves who want to end any role for gold in the international financial system, and the now relative handful of voices maintaining gold will again become a major force in world finance. With much of the world balanced on a knife edge of economic and financial difficulties on a scale not seen in 60 years, those arguments on the future of gold take on considerable meaning.

Governments in Canada, the U.S. and most other major countries have been cutting interest rates drastically. By itself, this is favorable for gold markets. If low interest rates don’t work, desperate governments, primarily the U.S., in an effort to reverse the recession/depression, could reinflate massively, a potentially explosive positive factor for a higher gold price. For the months immediately ahead, possibly the clearest way of thinking about gold is to be aware that historically the metal is a refuge in chaotic times. Our times are threatening to become increasingly chaotic as the major nations fail to solve the serious problems crystallized in a persistent and worldwide economic slump.

For gold, maybe this is the year to place a bet on higher prices, at least cutting well through that US$400 ceiling which has held for the last three years.