What about 1990? The student of the gold market would recognize that gold is a currency, and that it has been one for hundreds of years. But it was disguised, in the 1972-1982 period, under the mask of an inflation hedge, which is nothing more than a currency that maintains its buying power. Others have cast gold as a stateless currency (InterGold) or as a currency of last resort (Placer Dome), both suitable descriptions. More specifically, since 1982 when double digit prime interest rates sounded the death knell of North American inflation, gold clearly has acted in the marketplace as a currency, directionally in line with the West German Deutschemark or the Japanese yen in trading against the U.S. dollar. Gold does retain an element that is characteristic of commodities, which may explain its underperformance relative to other foreign currencies against the dollar, but turning points and direction have been remarkably congruous with foreign exchange market characteristics. When speaking of the gold market, it is the Commodity Exchange of New York (Comex) futures market that has been the price leader for some years (not London or Hong Kong) and that trades sympathetically by and large with foreign exchange (or, in the lingo, forex) markets. The relativity of the Comex and physical markets is discussed later.
In order to follow the track of the U.S. dollar against a basket of currencies, a trade-weighted index of 10 currencies was developed and is called the U. S. Dollar Index. The table below tracks the U.S. dollar index from its historic high in February, 1985, to its low at the end of 1987 and the several subsequent peaks and troughs.
In the past three years, the economic indicators that affect the dollar have been the monthly trade deficit figures, and more uneventfully, the U.S. budget deficit, and latterly, any of a number of statistics which might be seen as affecting the U.S. Federal Reserve Board’s monetary policy. A favorable international interest rate differential attracts dollar buyers, but signs that the U.S. economy may be slowing and that domestic interest rates may ease tend to undermine the dollar. It also has seemed a curious turn that the release of monthly changes in producer and consumer price indices, as measures of inflation, are negative for the gold market (when posting above expected increases), as this supported the federal government’s high interest rate/anti- inflation policy. In the past six months, we seem to have seen a switch in the priorities from inflation- fighting to averting a recession. The key, therefore, to the dollar and to gold pricing will be the trend in employment levels, housing starts, and so on, as measures of economic activity. In contrast with previous cycles, where the physical market was more important to pricing, an economic slowdown in North America, resulting in lower interest rates and a declining U.S. dollar, actually could be moderately bullish for U.S. dollar- denominated gold prices going into 1990. If the U.S. dollar index declined to 95 or lower from 101 or 102, where it stood at the time of writing, a 10% or better rebound in gold prices might be expected, taking the market back above $400. The student of the market should also remember that while lower U.S. interest rates would undermine the dollar and buoy gold, they would also enhance the capability of Comex gold traders to hold contract positions.
The 1982-1989 period of positive economic growth in the U.S. economy has developed a momentum that seems only reluctantly erodable, but a slowing may occur in the next several months with gold prices rising by default. For 1990, the average gold price may reverse its 2-year downtrend and achieve a moderately better level, perhaps in the $390-$410 range, again premised on a lower exchange value for the U.S. dollar.
Since the spring of 1987, when gold prices peaked near $480 per oz (and latterly peaked at $502 on Dec 15, 1987), there has been widely voiced concern about the rapid growth in world mine supply of gold. (We are not sure why this concern was not seen as prices were rising between February, 1985, and April, 1987.) Non-communist world mine production rose 6.8% in 1987 and a further 11% in 1988, and has risen a total of about 60% since 1980. Production in 1989 could be up 12% or more. Those who remember the capacity additions in the molybdenum and nickel industries and the subsequent slump in prices in the early 1980s, would normally be wary of the growth in the production base of gold mining if the metal was considered only a commodity and not a “stateless currency,” which is its dominant role. (This is where gold and silver part company in a fundamental way.)
It generally is accepted that, throughout history, as much as 100,000 tonnes of gold have been mined (the equivalent of about 200 times American Barrick’s Goldstrike reserve) which at a price of $400 per oz could be valued at $1,286,000,000,000. At the 1988 (total) world production rate, it would take about 55 years to produce this amount of metal. About 30% of this 100,000- tonne amount is held by the world’s central banks and official agencies. While $1.29 trillion in North America is a substantial sum (equivalent in value to, say, 4 months of U.S. gross national product), only a fraction of the total amount might be considered liquid and only to a limited extent can we consider gold a secondary reserve currency. This historical perspective does not have much relevance to shorter-term price forecasting but begins to demonstrate the scope of gold as a currency form.
To put the value of “new” gold supply to the market into context, let’s look at Consolidated Gold Fields’ 1988 tonnage figures for gold supply to the private sector, valued at the spot average of $436.83 per oz ($14 million per tonne):
While the tonnage of non-communist gold mined increased 11% in 1988 compared with 1987, its value rose only 8.6%; and the total supply of so-called new gold delivered to the private sector declined by 8.5% in tonnes and 11% in dollar value, again, using spot price averages for the valuations. If non-communist mine production in 1989 rose a further 10% and the other components of supply remained unchanged, the dollar value of the total supply of new gold to the market might be almost 4% lower than last year, if, say, spot gold averaged $385. Others have demonstrated that the rate of growth in world money supply is considerably greater than the annual increase in the value of new gold supplied to the market; and the few rough figures above would seem to imply that, if gold is accepted as a currency form, the new mine supply is a relatively minor consideration in world monetary terms.
So far, this paper has dealt with new gold supply. The subject of the “old” gold trade through the p
rincipal physical markets in London, Zurich and the Far East is difficult to quantify. However as the pricing of this trade seems to have followed New York’s Comex market for some years, its importance has been somewhat mooted in the same sense that of all the dollars in circulation and held by central banks, only a portion is traded in foreign exchange markets. The volume of gold represented by the trade in futures contracts on Comex and other smaller U. S. futures markets in 1988 was 30,000 tonnes (relate this to the historically mined figure]) and the value of this trade would have been somewhere in excess of a $420- billion spot price valuation.
The amounts of gold which have been sold by producers through Comex either for price-hedging purposes or in gold loan transactions seem to be a matter for debate. One source suggests that the total amount of gold represented by gold loans outstanding, forward sales commitments and currency swaps, would be roughly 700 to 900 tonnes. Gold loan- related sales and price hedging have been estimated by another source to have amounted to about 400 tonnes in 1988, but with project financing then in hand, and the decline in gold prices probably close to base levels, gold loan and hedging activity has fallen off and may amount to only 150 tonnes this year. Any of these tonnage figures seems rather insignificant in comparison with, say, 30,000 tonnes of Comex trade and this is why the “paper gold” market dominates the pricing forum. As an example, the 1,050,000-oz (32.7-tonne) American Barrick gold loan completed early in 1989 will be more than sufficient to finance the $365-(us)-million development of the Goldstrike mine. Forward sales by producers probably have been more a psychological negative to the Comex market.
This student’s closing comment should underline that the specific principal factors which affect the gold market do tire and change in time, and those that identified the fading of inflation and renewed currency character of gold as key market elements profited the most: What’s next? David James is a Winnipeg-based gold analyst with Richardson Greenshields of Canada.
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