EDITORIAL Narrower trading range for gold likely

Since Aug. 2 when Iraq invaded Kuwait, gold investors seem to have had a permanent look of puzzlement etched on their faces. Increasing political tensions and the threat of a major military confrontation are generally seen as bullish for gold, but Saddam Hussein’s brinkmanship has barely affected market prices. Gold did rise from a 4-year low in June of US$345.50 to US$413, but now it’s back to US$366 — hardly the skyrocketing price an impending world war is expected to bring. As American Barrick Chairman Peter Munk said at a recent Financial Post conference, the traditional link between gold and fear is no longer in place. Nor, it would seem, is the link between oil and gold as strong as it was once thought to be. Oil prices have doubled since Aug. 2 while gold is virtually unchanged.

It’s not exactly a gloomy situation for gold producers — at least for those who can produce it near the average Canadian operating costs of about US$250 an oz. Gold at US$350 still allows for a 40% markup, as they say in the retail trade, sufficient for a good profit margin. After all, gold producers have no need for advertising or marketing, they do not have to carry any unsold inventory, there is always a ready market for their product and there are no packaging or distribution costs.

About half of Canada’s gold output comes from 10 mines and most of that is produced at well below the average price. Unfortunately, the remaining 58 mines generally operate at costs above average — sometimes well above average — and don’t enjoy that same margin.

Yet despite the unfathomable lethargy in gold prices, some very astute observers of gold markets remain optimistic. American Barrick, to be sure, has somewhat of a vested interest in believing gold prices will go up, not down. But it has to be realistic, too. And Barrick is not alone. For example, another successful player in the gold mining game, Ned Goodman, holds similarly optimistic views to Munk, although for somewhat different reasons.

“The investment case for gold . . . is the best I have seen since the mid-1970s when gold was around US$100 per oz.,” says Goodman, looking at gold from an investor’s point of view. He says gold is still in a bull market phase and does not expect it to fall to its June lows.

And Munk believes there is also a big impact from the trend among senior gold producers to lock in guaranteed prices by contracting to sell future production at set prices. Millions of ounces are being sold forward in this way, but Munk says that tends to narrow the trading range of gold.

For example, when gold manages to struggle over US$400 to US$410 or US$420, many producers will jump in to sell future production at those prices. That flood of sell orders puts a break on rising prices.

But similarly, when prices fall to where they are now, producers will hold back on sales. With forward sales possible, producers aren’t likely to sell when gold is down because they don’t need to, and that tends to put a floor on how low the gold price will fall.

All this is by way of saying that gold and the markets for gold are going through some extraordinary times. Kuwait is merely the crisis that has shown that gold is entering a new era. It does not react the way it has in the past and will not likely do so again. There will be volatility, but the range of prices will be narrower. Profitable gold mining, in effect, will become much more like any other business — less dependent on emotion and more dependent on good management.