What next for gold?

published 22 June 2006

If the global economy is slowing, then most commodities are likely to suffer price falls. However, we expect the long-term commodity bull market to resume in due course, and continue for years yet. Obviously, different commodities will be affected differently, dependent upon other factors.

So far, the oil price remains close to $70 a barrel and the bull market is undisturbed. The demand for energy might abate, although supply interruptions could be a balancing factor. For the time being we consider it correct to retain energy holdings, but under close watch. On further adverse price action we might decide to close those positions, although the plan would be to re-purchase them at a lower price at some future date.

In the longer term we don't doubt that China and India, in particular, will become the centre of the economic world. Their growing demand for energy will be a major factor in the price of oil, as will the continuing problem of supply, with or without hurricanes and geopolitical issues.

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Investing in gold: a turning-point in the market

Long-term readers of the Onassis Newsletter know of our strongly held belief in gold-based investments. The story is quite special. Gold is not an industrial commodity - it's the unique residue of wealth, indestructible and infinitely divisible in a way that nothing else can quite match.

On Tuesday last week the gold price fell by $45/oz, the biggest one-day fall for 15 years. That sort of dramatic event quite often marks an important turning point, probably representing a last moment of panic. Action since has been very good, indicative of strong hands taking advantage of a wonderful opportunity.

In 1975, early in the previous gold bull market that ended in January 1980, the price of gold fell 40%, following which it rose seven-fold. Today the fundamentals haven't changed, the global economy is unchanged, the plight of the dollar is unchanged - only the price of gold has temporarily changed.

As we have reported more than once recently, the relationship between the price of gold mining shares and gold bullion is at an extreme level. The ratio is obtained by dividing the gold bullion price by the price of the Philadelphia Gold & Silver Index - today it is 4.6.

A ratio of 5 is normally the extreme ratio when gold shares are priced least favourably relative to the price of gold bullion. So, going forwards, gold shares should benefit very considerably. If gold bullion rises and simultaneously the ratio moves towards 3, the outcome would be just fine.

Investing in gold: an established bull market

The gold story is a long-term story - the bull market is established and nothing that has happened recently changes that. At this stage, it is quite clear that only a minority of investors own gold. We would only worry greatly if a decline in the price occurred at a time when everybody and his brother owned gold.

If you want to test that one, talk to all the people you know and see how many of them are significant owners of gold as an investment or own gold mining shares hardly any, we would guess. This pull-back in an unfinished bull market is clearly an investment opportunity in the making.

And it isn't necessarily the case that a bear market for equities is bad for gold mining shares. Looking back at 2000, the period 1st January 2000 to 31st March 2003, whilst FTSE 100 was falling 50%, ML G&G rose 104%.

By John Robson & Andrew Selsby at RH Asset Management Limited, as published in the Onassis Newsletter, a fortnightly newsletter that gives insight into the investment markets.