The two faces of gold

the two prices of gold are also telling investors is that, as a commodity, gold has been relatively stable.

Tim Treadgold  Commodities Journalist 12 Jun 2019 Eureka Report

Tim Treadgold checks out the two faces of gold, which look different in Australia and the US, and explains why central banks have been buying up big.

Gold, for an Australian investor, has been a star over the past 12 months.

It has, however, been quite the opposite for most international investors, and that’s a reason for taking a fresh look at the commodity which doubles as a currency.

Since this time last year, the gold price as measured in Australian dollars has risen by a respectable 11.7 per cent, up from $A1707 an ounce to $A1908/oz, outperforming most other asset classes, especially property.

In US dollar terms, the currency in which gold is traditionally traded, the price increase has been a modest 2.3 per cent, up from $US1298/oz to $US1328/oz.

It’s in those prices that one of the keys to understanding gold becomes clear; it can be a very useful form of currency and investment ‘insurance’.

Gold’s currency tailwind

What the two prices of gold are also telling investors is that, as a commodity, gold has been relatively stable. That means most of the Australian increase is down to the local dollar sliding against its US cousin.

A year ago, the exchange rate was US76.15 cents. Today it’s around US69.6c. That 9.4 per cent currency drop represents much of the increase in the Australian gold price.

It hasn’t been all good news for local investors with a taste for gold because a number of smaller gold mining companies have been performing badly.

But the problems of Gascoyne Resources (collapsed into administration), Dacian Gold (under-performing operations) and St Barbara (botched capital raising) have little to do with gold and a lot to do with the calibre of gold company management, human error and bad luck.

Unfortunately, corporate issues can give gold a bad name, adding to a belief that it is difficult to understand, and unattractive in its physical form because it doesn’t pay interest or generate a dividend.

Some investment advisers tell their clients to steer clear of gold because they don’t understand it.

That’s certainly not the case with the world’s central bankers who also might struggle to explain gold, except for one critically important reason. Gold is a store of value beyond the reach of any government, and that can be an important factor in troubled times – like now!

Central banks buy up big

China, which is locked in a trade war with the US, has been busy buying gold this year as a means of diversifying its reserves (a form of insurance open to all investors) and perhaps because of a belief that recent strength in the value of US dollar is coming to an end.

In May alone the People’s Bank of China, the country’s central bank, quietly acquired 15.6 tonnes of gold, meaning it has acquired 74 tonnes of gold since last November, taking its total holding to 1916 tonnes, a stake just behind Russia’s 2183 tonnes, which has also been a gold buyer this year.

Political factors, especially ongoing disputes with the US, could lie behind the gold buying of Russia and China, but their central banks are not alone in buying gold.

Other countries have also been buying gold as a means of cutting exposure to the US dollar. Overall central bank purchases of gold totalled 145.5 tonnes in the March quarter, the biggest quarterly increase since 2013.

The portfolio positioning evident in central bank activity is sending a powerful message to all investors because of the apparent belief that owning gold will offset a future fall in the US dollar and it’s in that view the next phase in the price of gold might be seen.

If, as seems likely, global economic growth is slowing because of the trade war, the seeds of a crisis have been sown – and gold loves a crisis, especially if it’s one which hits the value of the US dollar, gold’s arch-enemy.

Because it is generally traded in US dollars, a fall in that currency generally flows directly into the price of gold – and the other way in good times.

As was demonstrated at the start of this story, the gold price, in US dollar terms, hasn’t done a lot over the past 12 months. It is up just 2.3 per cent compared with the 11.7 per cent rise in the Australian price.

What some investors expect over the next few years, as do the central bankers of Russia and China (with political guidance) is a decline in the value of the US dollar which has risen strongly in the two years since the election of President Trump.

If the rise of the US dollar has stalled, and it is poised to slide, then gold in US dollars could be set for a rise with a hint of what might be to come seen last week when the price hit a 6-year high of $US1348/t – largely because of weaker-than-expected US job creation in May.

The big question

The next price target for gold, according to Rhona O’Connell, a seasoned gold analyst currently working for the international broking firm INTL FTStone, is $US1400/oz.

She told the Bloomberg news service on Monday that: “All the dominant asset classes have a question mark over them at the moment, which is generally when gold comes into play”.

Assuming O’Connell, and the central banks of Russia and China are right, then a shift in the gold market could have started with the US price rising after several years in the doldrums, rarely falling below $US1100/oz and rarely rising above $US1350/oz.

What a price of $US1400/oz does to the Australian gold price could be quite interesting, assuming there isn’t a corresponding rise in the Aussie currency as the US dollar declines because at $US1400/oz and the current exchange rate of US69.6 the local gold price moves above $A2000/oz.

Whether gold is poised to reach a new record high is a question for speculators. Prudent investors will continue to see gold as a form of insurance against currency moves and as a balancing force in a well-managed portfolio.

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