The Coming Gold Rush?

Recently gold has been in correction mode and may continue for a good deal of 2009 because of supposed "green shoots" sprouting within the economy.

$GOLD 4 year chart:


I have not been charting $GOLD in terms of Elliott Wave myself, but some charts I've seen from others indicate that we're possibly in a primary wave 4 down correction. This actually corresponds to my $SPX analysis, which could promise to be a long drawn out triangle of some sort, or possibly a combination. Technical divergence measures have not yet indicated a change in the current downtrend in $GOLD. Currently, $GOLD/$SPX is at 1, an interesting phenomenon.

More importantly though are the fundamentals in gold via supply and demand for 2008 from The World Gold Council:

Sustained investor interest in gold over the course of 2008 against a backdrop of the worst year on record for global stock markets and many other asset classes, helped push dollar demand for the safe haven asset to $102bn, a 29% increase on year earlier levels. Identifiable gold demand in tonnage terms rose 4% on previous year levels to 3,659 tonnes.

As shares on stock markets around the world lost an estimated $14 trillion in value, identifiable investment demand for gold, which incorporates exchange traded funds (ETFs) and bars and coins, was 64% higher in 2008 than in 2007, equivalent to an additional inflow of $US15bn. Over the year as a whole, the gold price averaged $872, up 25% from $695 in 2007.

Jewelry consumption is the largest driver in total for gold demand. This has decreased significantly in 2008. However, demand for gold increased over the year by 133 tonnes as a result of retail demand, mainly for bars and coins. 2009 Q1 statistics have not been updated as of yet.

What of the supply side?

Here is a note from Barrick Gold Corp's (ABX) most recent annual filing:

We believe the outlook for mine production from all gold mining companies over the next 5 to 10 years, which currently represents over 60% of total global supply, is one of gradual decline. The primary drivers for the global decline are a trend of lower grade production by many producers; increasing delays and impediments in bringing projects – especially large-scale projects – to the production stage; inflationary pressures on capital costs which have subsequently eased, but have been replaced by global financing conditions that constrain the ability of mining companies to finance projects; a lack of global exploration success in recent years; and a dearth of new, promising regions for gold exploration and production. A decrease in global industry production increases the potential for increases in the sustainable long term gold price.

In terms of production, the outlook is of gradual industry decline. In times of increasing demand, this should put long term upward pressure on price. Those claiming IMF meddling in the gold market should look to their balance sheet year over year. Gold holdings at the IMF have changed very little and compared to the overall gold market are small.

What Does This Mean To Investors?

Unless you have a considerably large pool of savings and income, gold can be difficult to store and acquire because of costs. Gold mining stocks have historically been a cost efficient means of having investment in gold.

Is Now The Time To Invest In Gold Mining Stocks?

It may be a bit premature; to see why consider the following charts and then another reference from the ABX annual filing:



Gold miners typically experience higher margins when gold in relation to other commodities is high, as is occurring now. This chart suggests gold mining operations should be highly profitable. However, in 2008 all time high prices and volatility in commodities prices triggered miners to hedge those prices. In 2009 for many miners this will result in hedging losses:

In 2008, we realized benefits in the form of fuel hedge gains on those contracts totaling $33 million (2007: $29 million; 2006: $16 million), when contract prices were compared to market prices. At a price of $42 per barrel, we expect to realize opportunity losses of approximately $100 million in 2009 from our financial contracts.

Miners also have old commodity inventory to work through:

The trend to lower prices for commodities and other consumables seen in the latter half of 2008 is expected to provide some eventual relief from the extraordinary rate of cost escalation the industry has witnessed over the last few years if prices remain at these lower levels. However, these lower prices will not significantly benefit our operating costs in 2009 due to the impact of existing inventory supplies, committed purchase contracts and commodity hedge contracts.

Therefore I conclude gold miners will disappoint expectations due to these setbacks, instead of realizing record profits from high gold prices. This has been the trend since the beginning of the financial crisis and the $HUI (Gold Bugs Index) has been more in line with the S&P instead of diverging. I expect this trend to change towards the end of 2009 as cost benefits start to realize their way into the operations of gold miners and hence their performance should diverge and outperform the S&P.

I reiterate my long standing position, that demand for gold should remain high maintinaing inflation and/or deflation fears since gold has historically been the most trustworthy and honest form of money.