Year End 2003 Gold Review
The past year marked the
fourth in the secular bull market in gold, which commenced August 1999. The milestone passed with little fanfare as
the recovery in global equity markets transfixed investors. The persistent decline in the US dollar also
received little attention, as did the growing US Federal budget and trade
balance deficits. The crossing of the
$400/oz. price threshold by the metal in December merited no special news
coverage. Gold is in the early stages of
a stealth bull market. Stealth augurs
well for potential longevity and magnitude.
There are two reasons to
invest in gold. First, there is the
simple and obvious prospect that it may rise in price and thereby create
positive returns for those of us who hold it or gold mining shares. The second reason is not quite so obvious,
but it is more powerful. It is the fact
that gold’s behavior is uncorrelated to other financial assets including bonds,
stocks and currencies. When expected returns
on financial assets are low, money flows in the direction of gold. It is also true that gold, being uncorrelated
as opposed to inversely correlated, can rise while financial asset prices are
also rising. It is these characteristics
that qualify gold as a form of financial insurance.
One might speculate that
with lofty valuations, investors ought to worry that future returns on
financial assets might be sub par.
However, that does not appear to be the case. Even though the S&P is trading at more
than 30x trailing 12-month earnings, ten-year bonds at 4.2%, and Federal Funds
at 1.00%, investor expectations remain high.
Beneath the complacent
surface of the financial markets at year-end, those investors who are thinking
beyond the next six months are detecting reasons for concern. Awareness is spreading that the Fed’s
excursion into extreme liquidity has been little more than a band-aid to deal
with the aftermath of the bubble. The
Fed has purchased near term euphoria with a flood of debt issuance and
unsustainably low interest rates. Those
who can see through the fog are beginning to exit the dollar and look to safe
havens such as the Euro, gold or tangible assets. Despite record low inflation readings, the
future purchasing power of the dollar has never been in greater jeopardy. The Fed’s barrage of liquidity is nothing
less than an attack on savings. For
those who wish to preserve the value of their liquid assets over the next
decade or more, and do not wish to speculate in overvalued financial assets,
recourse to gold is inescapable.
Gold at $400 is one of the
few remaining bargains in a financial world that is a minefield of risk. Investors owe thanks to the central
banks. Their repeated sales of the metal
have kept a lid on the price. Without
such sales, the price would already be several hundred dollars higher. Those with vast pools of wealth to protect,
including institutional and private investors, can only hope that these
outdated bureaucracies, managed by financially ignorant civil servants,
continue their divestment process to facilitate acquisition of meaningful gold
positions at attractive prices.
An important milestone for
the gold market was the 2003 launch of gold exchange traded funds (ETF’s). These instruments link physical gold to the
financial markets for the first time in history. Two versions trade in
Despite gold’s 20.8% rise in
2003, and more than 60% rise since 1999, professional sentiment is
negative. The Hulbert Digest of gold
timing newsletters recorded extremely low sentiment readings at the end of
December. According to Hulbert, “You
will rarely see a more perfect textbook illustration of a bull market climbing
a wall of worry…” Consider also the January 6th comments of a
well-known market strategist: “Gold is
‘blowing off’ on the upside right here, just as the U.S. Dollar is ‘blowing
out’ to the downside. I’m expecting a
reversal imminently...” In December,
Barron’s carried an article titled “Gold’s Bugs: If you’re a fan of the precious metal, buy
it, not the stocks.” Bull markets are
born in skepticism and die in euphoria.
Based on this current survey of sentiment, the gold bull market is alive
and well.
Along the same line, we were
most encouraged by the January 4th comments of Federal Reserve Governor, Ben Bernanke stating that “gold prices … respond to
geopolitical tensions; these tensions have certainly heightened since 2001 and,
in my view, can account for the bulk of the recent increase in the real price
of gold.” These comments were included
in a lengthy defense of the Fed’s very accommodative monetary stance. The speech by this highly influential Fed
governor suggests that the Fed is unconcerned about the rise in the gold price
and rules out the possibility that it is discounting a renewal of inflation, a
dollar crisis, or the bursting of the most recent equity market bubble that the
Fed has engineered.
Pullbacks and corrections
are a fact of life for any bull market and in this respect, gold is not
exempt. We will take advantage of such
opportunities to add to positions. While
we will attempt to defend against them, we do not want to find ourselves in the
position of the sold-out bull who, having grasped the
opportunity, missed out because of hyperactive trading strategies and other
sins of micromanagement.
Since the gold bull market
commenced in August, 1999, gold has increased 66%, while the euro has increased
19% against the US dollar. However, over
the past year, they have increased by roughly the same amount, leading many to
think that gold is just another play on the weak dollar. Once the weak dollar creates sufficient
stress among our trading partners in
The bull market in gold is
well underway. While it will suffer
periodic setbacks, it will not reach its completion until world governments
restore integrity to financial instruments beginning with paper money. There is little to suggest that such a moment
is within view.
John Hathaway
January 8, 2004
© Tocqueville Asset Management L.P.
New York, NY 10019