Gold: Third time lucky?

Moments after the price of gold broke through US$1,000 an ounce (again) I received a call from my broker. Would I like to buy more? I told him to get back to me after the price corrected. The tone of his voice made it clear he didn’t expect that to happen. It did, although it bounced back over the $1,000 level again on Friday. The question is: can it stick? Is this a case of third time lucky?

Twice before the price of bullion has topped $1,000: in March 2008 and in February of this year. On the two previous occasions, investors seemed to be frightened by the rarefied atmosphere and sold. Why? Some pundits put it down to “profit-taking”. That’s what they always say when they can’t come up with a more plausible reason for a market turn. Conspiracy-theory types whisper that a secretive cartel, perhaps involving the central banks, is manipulating the gold price and doesn’t want to see it move much beyond $1,000 because of the inflationary psychology that would create. Maybe they’re right. Certainly, the dynamics of the world economy and the gold market suggest that the price of bullion should be even higher than it is now.

Barrick Gold is making a multi-billion bet that’s what will eventually happen. The world’s largest gold miner made headlines recently with an announcement that it will issue up to 94.8 million new common shares to raise US$3.5 billion which it will use to eliminate virtually all of its hedge positions. Hedges are an insurance policy against falling prices but they are a two-edged sword. When bullion is on the rise, a company like Barrick doesn’t reap the full benefits because of the contracts it has in place to sell at a lower level.

In announcing what amounts to a radical change in direction, Barrick said that it plans to use US$1.9 billion to eliminate all of its fixed priced (non-participating) gold contracts within the next year and approximately US$1.5 billion to eliminate a portion of its floating spot price (fully participating) gold contracts. The company also said it will take a charge of US$5.6 billion in the third quarter as a result of a change in accounting treatment for the contracts.

Clearly, Barrick would not be making such a dramatic move unless management strongly believed that the price of bullion is heading much higher. There are good reasons to think they are right. Start with the United States, which has been quietly devaluing its currency for several years (that’s the main reason the loonie has soared). Gold has long been seen as a way for people to protect themselves against a weak U.S. dollar and as a result the price of bullion tends to move inversely to the value of the greenback.

Washington is staring at ever-increasing fiscal deficits as it continues to pour billions of dollars into stimulus programs. President Obama’s health care reforms, if they ever clear Congress, will add billions more. Americans are notoriously reluctant to pay higher taxes to cover these mounting costs. So what’s the solution? Inflation, which will debase the currency and make debt repayment cheaper.

There are reports that foreign governments, including China and India, clearly see what is happening and have started quietly buying gold for their reserves as a substitute for U.S. dollars. If so, and it makes sense, that will increase the upward pressure on bullion.

Well-connected British journalist Ambrose Evans-Pritchard of The Telegraph published a column recently in which he quoted Cheng Siwei, a former senior official in the Chinese government who continues to represent the country at international events, as suggesting that his country has lost faith in the U.S. dollar and is gradually moving towards a partial gold standard. But they’re proceeding with caution.

“Gold is definitely an alternative, but when we buy, the price goes up. We have to do it carefully so as not to stimulate the market,” Cheng Siwei was quoted as saying.

Does this mean that China is trying to manipulate the international gold price? Perhaps. Certainly, it’s one more tidbit for the conspiracy theorists to chew on.

So what does all this mean for investors? Is bullion finally poised to permanently crack through the $1,000 barrier, as the gold bugs have been predicting it would for decades? (I mean decades literally; I can remember attending a conference in Montreal in the 1980s at which several speakers predicted that $2,000 gold was less than a year away.) Or will we see yet another retreat?

Frankly, I don’t know and I doubt anyone else does. I understand the case for higher bullion prices but I also know the history. At this stage, I have to be skeptical. When gold stays over $1,000 for several months, I’ll be convinced. Not before.

If you want to invest in gold at this point, my advice is to buy on the pullbacks. I expect we’ll see a lot of volatility in the next month or so as bullion continues to flirt with the $1,000 mark. So wait for the dips and then take action.

Adapted from an article that originally appeared in Gordon Pape’s weekly newsletter, the
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