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How to PROFIT in GOLD
Professional Tips and Strategies for Today's Ultimate Safe Haven Investment
By JONATHAN SPALL
The McGraw-Hill Companies, Inc.Copyright © 2011Jonathan Spall
All rights reserved.
Gold at Record Highs
In 1999 gold was friendless. Having reached its then all-time high of $850 some 19 years earlier, it instead languished at $250 and looked almost certain to break lower. Indeed, in a world where clicks were more important than bricks, gold symbolized everything that many of the dot-coms turned out not to be. It had a long track record, it physically existed, and if dropped on your foot, it most definitely hurt. However, this counted for nothing where all the talk was of derivatization and highly structured products.
Even central banks, whose mandate is normally preservation of wealth, had decided to abandon this traditional element of their reserves in favor of assets that yielded a return. In 1997 Australia sold gold, and two years later both Switzerland and the United Kingdom announced that they too were going to be drastically reducing the percentage of precious metals held in their reserves.
The market's shock and dismay was not just that three nations had decided to curtail their investments in gold but that it was those three countries that had been assumed to be favorably disposed to gold. Previously the market had endured selling from Belgium, the Netherlands, Malaysia, Brazil, and others, but these were the then third largest gold producer (Australia), the country where the benchmark for gold is set twice each day (the United Kingdom), and the home of conservative banking and discreet private wealth (Switzerland). The logic ran that if these central banks were selling their gold reserves, then clearly the entire holdings of the official sector were at imminent risk of being liquidated.
It was against this background of extreme pessimism that 15 central banks announced the first European central bank Gold Agreement (EcbGA) in September 1999—covered in depth in Chapter 3. This agreement crystallized their intentions for gold and timetabled sales to minimize market disruption. Ultimately the U.K. government sold 395 tonnes of gold at an average of around $275. As an aside, it is worth noting that the United Kingdom differs from other countries in that the U.K. government owns the nation's reserves rather than the central bank, which is more normally the case. The media's opprobrium for these sales at near 30-year lows is generally laid firmly at the feet of the then chancellor of the exchequer (finance minister), and later prime minister, Gordon Brown.
It was the announcement on November 2, 2009, that the Reserve Bank of India had bought 200 tonnes of gold at an average price of around $1,045 that neatly demonstrated just how much the fortunes of gold had changed over a 10-year period. Indeed, the news of India's paying nearly four times as much per ounce as the United Kingdom had achieved in its sales, plus the much smaller purchases from the International Monetary Fund (IMF) by Sri Lanka (10 tonnes) and Mauritius (2 tonnes), showed that the nature of the debate had changed and it was no longer about which country might be selling its gold but instead which might be buying. China and Russia were the names generally bandied about, but Brazil was seen as another potential candidate to purchase the remaining 191.3 tonnes being offered by the IMF. This debate is covered later.
So what had changed in the intervening period?
In 1980, gold rose to its then heady heights of $850 per troy ounce on a combination of inflationary concerns, the oil price, and the Russians' having marched into Afghanistan (Figure 1-1). Silver price increases were even more rampant, managing to reach some $49 per ounce in nominal terms, a level that it has never seriously challenged since. In that environment of fear, energy rationing, and uncertainty, gold was the natural destination for investors.
However, by the late 1990s, it was clear that gold no longer resonated as a financial investment for the vast majority of people. The Cold War was over, and energy prices were low. In a world dominated by news of technological discoveries, why would anyone have been interested in such a low-tech opportunity? In addition to central bank selling, the market was dominated by the hedging—accelerated selling—of the gold producers and the war of words that raged between the miners and the central banks over who should take the blame for the demise of gold.
Moreover, the stock of central bankers was at its zenith. The actions of Paul Volcker as chairman for the Federal Reserve (from 1979 to 1987) and Karl Otto Poehl as president of Germany's Bundesbank (1980 to 1991) probably exemplified the no-nonsense policies that were, at the time, credited with bringing inflation under control. This was a period when economies could seemingly be directed fairly easily and growth was assured. In turn, this group of central bankers gave way to no lesser reputations than Alan Greenspan in the United States and Schlesinger, Tietmeyer, and Welteke in Germany. Looking at a chart of gold for this period, it is easy to see just how much gold underperformed inflation. So although there were price pressures at this time, it was assumed that a few words, and perhaps an adjustment to interest rates, were all that was needed for matters to resume their course.
The chart in Figure 1-2 illustrates the poor performance of gold at this time, due to what might be characterized as a trust bonanza: a peak in the widely held belief in the efficacy and omnipotence of monetary policy.
Indeed, gold was so marginalized that it seemed little could be done to rescue it. Admittedly the European central banks had done their best to remove uncertainty by timetabling their selling (covered in depth in Chapter 3). Moreover, various mining companies announced their intention not to hedge—thus removing many concerns about an overhang of selling above the market. However, by the time the planes flew into the World Trade Center on 9/11/2001, gold was still languishing. There was some hedge fund buying of gold that day but very little—few people had the appetite for much more than stunned horror anyway—and ultimately gold could not hold its gains.
During George W. Bush's reelection campaign in 2004, AlQaeda released a tape calling for fresh attacks on the United States. Political commentators were divided as to whether this was an election advantage for Bush or John Kerry. Currency markets were similarly split in their interpretation as to who would benefit. In this confusion the dollar did not move. Obviously, though, the market was clearly bullish for gold: uncertainty, elections, attacks. However, the market's lack of confidence was so great that it could not even react to such a significant piece of news, as it was simply wedded to the fate of the U.S. dollar. When that failed to react, gold could not overcome the obstacle.
The chart in Figure 1-3 shows the gold price in euro terms for this period. I have chosen this chart because it strips out the impact of moves in the U.S. dollar—gold tends to run counter to the dollar, and showing price movements in euros is a much better indicator of trends that have taken place in the metal itself rather than external factors.
Apart from the occasional blip, and more significantly toward the end of the period, it is clear that gold generally failed to resonate with investors, with the metal's moving up just 18 percent in five and a half years.
The chart in Figure 1-4 is the same chart as in Figure 1-3 except that it shows the trends for mid-2005 to 2010, and that is a very different picture with the gold price multiplying by some 2.5 times.
So what changed? From being a forgotten asset, why did gold rally nearly threefold in U
Excerpted from How to PROFIT in GOLD by JONATHAN SPALL. Copyright © 2011 by Jonathan Spall. Excerpted by permission of The McGraw-Hill Companies, Inc..
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