Thursday, April 18, 2013

Money to be made from the gold rush for the exit?

Shock horror for gold bugs: a two year low and the biggest two day decline in 30 years.

For the first time in more than a decade there is a genuine feeling that the gold price could collapse like it did in 1980 when the dollar price more than halved in a matter of months.

The equivalent today would leave gold south of $1,000 compared to its 2011 high of $1,920.  As of today, the price is hovering uneasily around the $1,375.

Plenty of people will have lost a packet but could now be the time to position yourself for a future profit?

Predicting the gold price short or long term is usually a thankless task.  How do you weigh up an asset class which offers no income and for which the real economy has little use for?

I would offer these observations, which suggest gold may not follow that 1980 trajectory below $1,000:
  • The biggest source of demand for gold is Asian jewelry and Indian orders have apparently spiked upwards in immediate response to the recent falls;
  • Despite all the talk of panic and rushing for the exits, most long term investors (as opposed to speculators) have stayed firm and there has clearly being some bargain hunting in the last couple of days;
  • The main driver of the 1980 crash was a sharp increase in Fed interest rates.  And I mean sharp - up to 20%.  Such monetary tightening is not even the remotest prospect in the current climate;
  • The 12 year bull run has been marked by substantial declines followed by steady recoveries.
  • The underlying conditions that have supported the bull run - negative real interest rates and repeated but failed attempts to spark economic recovery by money printing - are firmly in place.
  • Central bank buying reached a record high last year.  Once the dust settles Asian surplus countries wishing to diversify out of Western currencies will likely buy the dip.
 But these are just straws in the wind and you could probably make a list of bearish points easily enough.  And the short term is even more unpredictable with fear and volatility abounding. I won't be speculating on a gold comeback from these levels.

More interesting are gold mining shares which are unsurprisingly trading at multi-year lows.

Gold producers' profits suffer disproportionately from price falls as their costs do not fall in sympathy. Indeed runaway mining cost inflation, along with a hangover from over investment during the boom years, had already sent gold mining shares tumbling since before the latest crash.

FTSE constituent African Barrick Gold (ABG) has also disappointed the market by missing its stated production targets for three successive years.  In February ABG reported a. 70% profit decline even before the latest slide in the gold price.

But ABG has no debt and plenty of cash, some of which is due to be paid to shareholders in dividends shortly (it goes ex-div on May 1).  It has very large reserves compared to its much-diminished market value.  Its costs of production per ounce are about $975, sharply up over recent years but less than many in the industry.

A buy at today's £1.65 close (it was £4.50 at the start of the year)?

If you believe the gold price will recover at least partially then maybe.  However it had better recover quickly because otherwise ABG will be reporting losses and scrapping the dividend which will no doubt send its shares even lower.

From our website:  Spanish tax advice

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