Eight reasons why gold is still cheap

published 22 June 2006

After a near parabolic move up, gold has fallen from its highs, and many funds have recently mass evacuated from the metals markets.

Why? Fundamentally gold had risen further and faster than many had foreseen. Prices clear markets and gold has a larger component of immediately price-sensitive supply and demand than most other commodities.

But is this the end of the gold bull market? I think not. Yes, the rapid price rise has impacted jewellery demand and is drawing old gold (scrap) into the market at an accelerating rate.

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But the gold price is being driven upwards by fear. Fear of oil-induced inflation, fear of a weaker dollar (the US trade deficit at $805bn is at 6.4% of GDP, with apparently no relief in sight), and fear of geopolitical turmoil (Iran).

Despite the recent price correction, none of these things has changed. US deficits are still a major headache, and oil is still pumping the inflation primer. In the US producer price inflation for finished goods [goods leaving the factory gates] rose substantially (0.9%) in April for the second consecutive month (now at 4% per annum). Who said inflation was dead?

In summary, no matter what price corrections occur in the short term, my eight fundamental reasons for a bullish outlook on gold remain firmly in place.

The gold price is cheap relative to other commodities
The gold Price is cheap relative to equities
Gold is cheap relative to inflation
Gold has value relative to interest rates
Gold is cheap relative to asset-allocation possibilities
Gold is cheap relative to its supply / demand fundamentals
Gold is cheap when considering the China factor
Gold is cheap relative to the volatile geo-political environment

Political and economic upheavals are the meat and drink of gold bull runs. They are difficult to forecast and by their very nature are the stuff of violent volatility. But if gold stays in favour as a risk-diversifying asset class, I believe there could be far more upside, as investors look for safe havens and the market discovers that there is so much money and so little gold supply.

Gold is not done yet!

By Daniel Sacks, Head of Resources, Investec Asset Management