A steady rise in the gold price is more durable Back to earth

The gold price is back where it was last September, around the time that Barbra Streisand started quoting fake verses from Julius Caesar as a prop for her political leanings. Mind you, for all that “banging the drums of war,” nobody was banging hard enough to bounce gold out of the US$320-per-ounce neighbourhood until December. Still, we’ll take any bounces we can get.

Events in-theatre can now put an end to macabre speculation on what a Middle East war might do to the gold price. It seems fairly certain that if there are many buyers left who turn to gold during periods of insecurity, then they feel a whole lot more secure today than they did at that top of US$385 an ounce on Feb. 5. And perhaps a whole lot poorer, a pessimist might say — but as mineral economist David Gulley has pointed out a number of times, people don’t buy gold hoping it will go up, they buy gold fearing it will go up. Those people have now paid for their insurance policy.

Gold equities, too, have done a complete climb-and-descent. We will resist the temptation to call it a head-and-shoulders pattern, mainly because we’re not smart enough to be technical analysts, but partly out of skepticism that the gold-equity indices are giving any sort of technical signal at all.

What ought to be remembered is that US$320 is a great deal more comfortable for most gold producers than US$250, and that the market fundamentals that drove that price increase are still in place. The United States dollar has plenty of room to fall, other major currencies show no sign of taking up the monetary slack, and end-use of gold still outstrips mine production by about three to two. And producer de-hedging, which has done much to send the gold price back up, is probably not over even now.

So the world will want gold, and probably be willing to pay a higher price for it. Naturally that will translate into a boost for gold shares, at least for junior gold explorers and the small and mid-tier producers.

One other consideration is whether large gold companies are likely to be a good investment even in a rising gold market. On the surface, the relationship looks nice: when bullion prices go up, profit margins and (usually) earnings go up with them, making gold producers a more attractive investment. That relationship, though, is not the whole story.

The Big Five gold producers mainly have reserves for ten to fifteen years of production. If they want even to maintain reserves at those levels, they will need 5 million to 8 million new ounces to go into reserves each year. On the strength of recent statements, they will explore for them. But on their record, they will acquire them, and often with punitive takeover premiums.

No matter how well the gold price does, no shareholder will make money in companies that destroy capital. The lesson of the consolidation spree holds — when it’s a seller’s market for gold projects or gold companies, there is more money to be made in selling. That means the juniors, once again.

As long as the junior sector can provide discoveries, there will be value found in junior gold equities. That kind of money can be made just as readily from a durable price rise as it can from a sudden spike.

It’s always nice when metal markets burn bright, not least for companies that can pounce on the opportunity to raise some new money. But a nice slow smouldering lights our fire just fine.