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hot metal by bxl82158


									             cover story

       hot metal
         With the price of the                              pale into relative insignificance compared with
                                                            other demand drivers. Independent precious

         yellow metal in the region                         metals researchers and consultants GFMS
                                                            Ltd calculate that in the period 2001 to 2005

         of $580 an ounce, can                              77% of demand came from the jewellery sector
                                                            while 12% was for investment purposes.

         gold still be considered a                         Governments came in third place with 11%.
                                                                 Moreover, gold is a diminishing, non-

         reservoir of value or is it                        renewable commodity. Not only is the planet
                                                            not making any more of it but reserves tend to

         too hot to handle, asks                            occur in inhospitable, difficult to get at locations.
                                                            Where they have been accessible previously –

         Richard Willsher?                                  such as in some of the large, well-known South
                                                            African mines – often the deposits have been
                                                            exhausted or have become uneconomic to
            In May this year the middle spot price for      produce; although, with the gold price currently
         a troy ounce set a 26 year record of $730.         at such high levels some marginal reserves
         Gold could do no wrong, apparently having          have become more worthwhile to work.
         risen over 30% in the previous year.
               Since May, however, it has fallen by 20%     demand
         from its top. From a longer-term perspective,      By far the largest demand for gold jewellery
         in early 1980 it reached the $700 mark while       derives from the Indian market where it is
         in 1999 the price slumped to a low of $252.        driven by traditional gift-giving for weddings
              Gold buffs will tell you that its pricing     and festivals such as Diwali. But in this vast,
         cycle is characterised by long swings and that     populous country the amount of disposable
         short-term fluctuations are common but not         income is increasing across the board with an
         necessarily significant. The basic drivers, they   ever-larger middle class purchasing jewellery
         say, are as solid as a gold bar.                   in larger quantities. The same is true, though
              Investors from the largest central banks      to a lesser degree, in China.
         down to private individuals believe in gold as          However, the most rapidly growing demand
         a reservoir of value, a safe haven. For example,   is from investors – both retail and wholesales
         according to the World Gold Council, in June       – who are investing in various gold-related
         this year 75% of the total foreign reserves of     instruments. While equities in the form of gold
         the United States were held in gold as were        mining stocks have attracted interest, exchange
         63% of Germany’s, 65% of France’s and 67%          traded funds (ETFs) that track the gold price
         of Italy’s. Some countries are keener on gold      and are backed by gold have quickly become
         than others. The UK for example had only           popular. Despite having been launched in 2003
         12.5% of its reserves in gold – Chancellor         they accounted for around 200 tonnes of
         Brown having made a policy decision to sell.       gold demand in 2005. The steadily growing
              Meanwhile, central bank gold requirements     surge of wholesale investor money is likely to

         10                                                                                                               financial services review November 2006

FSR 80.pmd                           10                                                                      16/11/2006, 14:28
                                                                                                                                       cover story
                                                   force further demand for ETFs. The drive behind         will return strongly, pushing the gold price to
                                                   these products is for portfolio diversification         fresh highs. Given the US dollar’s poor
                                                   as well as for return.                                  fundamentals, rising energy and commodity
                                                        In addition, recent research by J.P Morgan         prices in general and increasing geopolitical
                                                   Securities1 has shown that there has been a             tensions, the investment case for gold remains
                                                   substantial influx of investment into commodity         powerful… Furthermore, higher short-term
                                                   funds although the most popular of these has            interest rates and the generous contango3 on
                                                   been energy commodities rather than gold.               gold are unlikely to prove sufficient incentives
                                                   They note, however, that compared with other            to entice many short-sellers or producer
                                                   asset classes, commodities may not in fact be           hedgers. Finally, given the ever-widening
                                                   a ‘bubble’ waiting to happen. Moreover, in the          investor base for commodities, the potential
                                                   current investment climate where equities and           “weight” of money that could enter the gold
                                                   fixed interest are in general failing to provide        market is immense. To date this rally has
                                                   adequate levels of yield for wholesale funds,           only involved a small minority of institutional
                                                   it is likely that pension funds and insurance           and private investors. Indeed, should the
                                                   companies may increase their exposure to                inflow of new money into gold prove sufficient,
                                                   commodities.                                            there is even a good chance that the 1980
                                                        However, such demand drivers and                   nominal high of $850/oz will eventually be
                                                   investment strategies should not be taken as an         taken out.’
                                                   indication of whether gold is a good reservoir                So the experts’ view is that the gold price
                                                   of value or whether its current price level is          still has gas in the tank. Whether the commodity
                                                   sustainable. Common sense might argue that              is a strong store of value in the long term
                                                   if the physical price has fallen so far since May       remains to be seen. At present the drivers do
                                                   this year there could be a fundamental instability      look strong and sustainable but how much
                                                   to it. Moreover, a cynic might say – based upon         value gold will be able to retain over the long
                                                   observation of wholesale investment behaviour           run is still anyone’s guess.
                                                   over time – that when stolid, slow moving,
                                                   Johnny-come-lately institutions such as pension         endnotes
                                                   funds start to move into an asset class in any          1
                                                                                                             Are Alternatives the Next Bubble? Global
                                                   major way the smart money has probably                                      .
                                                                                                           Market Strategy J.P Morgan Securities Ltd
                                                   already bailed out. Nonetheless, they can               London by Jan Loeys and Nikolaos
                                                   create their own momentum and force pricing;            Panigirtzoglou 8 September 2006
                                                   however, at present funds do not carry that             2
                                                                                                             Gold Market Review and Outlook prepared
                                                   much clout in proportion to the major jewellery         by GFMS Ltd on behalf of the Chicago Board
                                                   gold price driver.                                      of Trade. June 2006
                                                                                                             Contango: ‘A contango between two dates
                                                   forecasts                                               exists where the price of the asset for a
                                                   As we approach the fourth quarter of the year           forward date exceeds the price of the nearer
                                                   it could be useful to consider a forecast among         date. This is the usual situation in gold and if
                                                   25 analysts collated by the London Bullion              there is no constraint anywhere along the
                                                   Market Association as to how they thought gold          supply pipeline then the contango will reflect
                                                   would perform in 2006. The forecast estimated           prevailing interest rates and storage charges’
                                                   that the average high price would be $607,              The World Gold Council
                                                   their average lowest price estimate was $476
                                                   and the middle was $535. That looks pretty              Richard Willsher is a freelance journalist.
                                                   accurate from where we are at the moment.
                                                        Looking further into the future GFMS2 view
                                                   is as follows: ‘In the latter part of the year and
                                                   through to 2007, we expect investment demand

         financial services review November 2006                                                                                                         11

FSR 80.pmd                       11                                                              16/11/2006, 14:29

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