Gold reasserting role as a monetary asset

June 1, 2010

The gold price's recent price behaviour suggests that it is reasserting its historical role as a monetary asset and is increasingly being viewed as a viable currency alternative, Sanlam Investment Management (SIM) said on Monday.

The past month has seen investors take shelter in gold as sovereign debt crises and uncertainty in the financial markets dampened hopes of a robust global economic recovery.

As a result, the price of gold per ounce has soared above US$1 200/oz, with the precious yellow metal last quoted at $1 217.55/oz.

A retrospective look at the gold price in real terms suggests that the price is still 40 percent below the peak it reached at the beginning of 1980.

So the gold price could continue to rise by another 67 percent before it surpasses its historical peak in real terms but when it reaches that peak, the reversal from those levels is likely to be quite swift and dramatic.

Market watchers have, therefore, questioned whether this level is sustainable.

SIM believes that in the short term, gold will be able to hold on to these levels as investors continue to seek shelter from uncertainty in financial markets in gold.

However, in the long term, it warned that prices are not sustainable.

"The gold price exhibits duality where it behaves either like a commodity or a currency and I believe that it is currently behaving like the latter," said Sanlam Investment Management equity analyst Shoaib Vayej.

"However in the fullness of time we don't expect a return to "gold standard", and resumption of commodity type behaviour points to lower prices considering the current costs of production," Vayej said.

In a research note on gold, SIM pointed out that the gold price has been in a steady, unbroken bull trend over the past decade.

However the price has not yet spiked which typifies the mania at the end of bull markets, SIM noted.


The current sovereign debt crisis and the uncertainty in the market are supportive of the current gold price; investors view gold bullion as a safe haven in uncertainty.

But the rise in the gold price has created a dislocation between the price and production costs and the expectation is that the costs of production will eventually reassert themselves in the future when these financial worries disappear.

"Our analysis of price and cost trends shows that since 1980 the gold price has traded at an average 70 percent premium to median industry mine cash costs. In real terms this would indicate a price of close to US$800/oz," said Vayej.

"This number is reconciled with "all-in" industry costs indicating that most miners would continue investing and make an adequate return on capital at those levels."

"Given that more than 40 years of demand is held above ground in relatively liquid form, the downside could be much greater," Vayej said.

The current gold price promise has little impact on South African gold miners except to incentivise them to produce more gold and improve their profitability.

In South African terms, production has been declining since 1970, and is now only 22 percent of that peak level.

Vayej said given this backdrop, when an opportunity like this arises, and the margin widens between the price of gold and costs of production, miners have typically re-invested the resulting cash flow in projects and also adjust their cut-off grades to extend the life of their operations.

This prolongs the mine's production capability but also increases the cost of production.

"Therefore there is no huge expectation of large free cash generation from SA gold companies," Vayej said. - I-Net Bridge