by Robert Adair
04:45 AM Aug 27, 2011
Hans Sennholz, the renowned economist, remarked that "No other commodity enjoys as much universal acceptability and marketability as gold." Many investors are again considering gold as a safe haven investment after recent financial market volatility.
Physical gold started this year priced at US$1,415 per ounce. By early this month, it moved above US$1,750 per ounce, on heightened risk aversion. Year-to-date, physical gold has outperformed other asset classes, returning 21.03 per cent against equities' performance of -9.95 per cent and bonds' performance of 6.48 per cent.
We expect the price of physical gold to remain strong based on negative real interest rates, increased central bank buying, buoyant retail investment demand and possible additional monetary stimulus measures.
In recent months, many central banks have kept interest rates below the inflation rates of their respective economies, in order to support economic growth and domestic asset prices. This is despite the fact that inflation rates have been trending upwards. Historical data shows that, when real interest rates are negative (that is, interest rates are below the rate of inflation), the gold price tends to perform strongly. This happens as investors are forced to broaden their investment and currency exposure to protect the value of their savings.
The World Gold Council recently forecast that the world's top gold consuming countries will have negative real rates for the foreseeable future.
In addition, central banks have become net buyers of gold in order to reduce an over-reliance on the United States dollar in their foreign reserve holdings. This marks a major change from the last decade, when central banks had been net sellers of gold. Globally, the percentage of central bank reserves held in gold is approximately 10 per cent. However, countries such as China and India hold less than 5 per cent of their reserves in gold. As the US and Euro currencies weaken, there is pressure on governments to buy more gold.
Renewed buying by central banks has been mirrored by increased demand by both institutional and retail investors. Quarterly supply and demand data published by the World Gold Council has shown surging investment demand over the past year, with Chinese consumers posting the sharpest gains. China is now poised to overtake India as the world's leading gold retail market.
GOLD EQUITIES DESERVE A RE-RATE
Since the start of the year, the physical gold price has risen by more than 20 per cent while gold equities (as measured by the HUI Gold Bugs Index) have fallen by more than 5 per cent. In part, this divergence in performance has been fuelled by concerns over operating costs and royalty payments, even to the point of some gold companies running into cash flow problems.
Historically, gold equities have tended to de-rate in periods of financial market stress. There are concerns that gold equities will again underperform relative to the gold price, as in the October 2008-March 2009 period following the 2008 financial crisis. Since March this year, the ratio of the physical gold price to the HUI gold equity index has widened from 2.5x to 3.2x, with a rising ratio indicating that gold equities have underperformed. Investors are worried that the ratio could increase to the 4.0x levels seen during the 2008 financial crisis and during the '90s.
Such concerns ignore the remarkable change in the profitability of gold companies. As we approach the end of the second quarter financial reporting season, UOB Asset Management calculates that operating profits for gold companies are at record levels in absolute terms, with operating margins only slightly below the record highs set in the first quarter.
Certainly, operating profits and cash flow are far above the levels seen during and before the 2008 financial crisis. Looking forward, the recent gold price strength makes it probable that this year's aggregate third quarter operating profits and margins will again establish new record highs.
We believe that gold equities will start to re-rate relative to the gold price for two main reasons. First, as the physical gold price remains at elevated levels, investment analysts will be forced to make upward revisions to their gold price assumptions and equity target prices. Second, current operating margins are not only above previous years, but may soon reach record levels.
The physical gold price has rallied sharply in recent months, and it is normal for any financial asset to consolidate after making strong gains.
However, all of the structural supports for gold-related assets remain in place and support the gold price's current elevated level. Continuing uncertainty over the finances of the euro zone economies, the US budget deficit and national debt, and the increased potential for a global recession suggest that gold will continue to find favour with investors looking for a safe investment haven in these uncertain times.
Robert Adair is the fund manager of the United Gold & General Fund at UOB Asset Management.
Via: http://www.todayonline.com/Commentary/EDC110827-0000239/Gold-shining-brightly-amid-uncertainty
Physical gold started this year priced at US$1,415 per ounce. By early this month, it moved above US$1,750 per ounce, on heightened risk aversion. Year-to-date, physical gold has outperformed other asset classes, returning 21.03 per cent against equities' performance of -9.95 per cent and bonds' performance of 6.48 per cent.
We expect the price of physical gold to remain strong based on negative real interest rates, increased central bank buying, buoyant retail investment demand and possible additional monetary stimulus measures.
In recent months, many central banks have kept interest rates below the inflation rates of their respective economies, in order to support economic growth and domestic asset prices. This is despite the fact that inflation rates have been trending upwards. Historical data shows that, when real interest rates are negative (that is, interest rates are below the rate of inflation), the gold price tends to perform strongly. This happens as investors are forced to broaden their investment and currency exposure to protect the value of their savings.
The World Gold Council recently forecast that the world's top gold consuming countries will have negative real rates for the foreseeable future.
In addition, central banks have become net buyers of gold in order to reduce an over-reliance on the United States dollar in their foreign reserve holdings. This marks a major change from the last decade, when central banks had been net sellers of gold. Globally, the percentage of central bank reserves held in gold is approximately 10 per cent. However, countries such as China and India hold less than 5 per cent of their reserves in gold. As the US and Euro currencies weaken, there is pressure on governments to buy more gold.
Renewed buying by central banks has been mirrored by increased demand by both institutional and retail investors. Quarterly supply and demand data published by the World Gold Council has shown surging investment demand over the past year, with Chinese consumers posting the sharpest gains. China is now poised to overtake India as the world's leading gold retail market.
GOLD EQUITIES DESERVE A RE-RATE
Since the start of the year, the physical gold price has risen by more than 20 per cent while gold equities (as measured by the HUI Gold Bugs Index) have fallen by more than 5 per cent. In part, this divergence in performance has been fuelled by concerns over operating costs and royalty payments, even to the point of some gold companies running into cash flow problems.
Historically, gold equities have tended to de-rate in periods of financial market stress. There are concerns that gold equities will again underperform relative to the gold price, as in the October 2008-March 2009 period following the 2008 financial crisis. Since March this year, the ratio of the physical gold price to the HUI gold equity index has widened from 2.5x to 3.2x, with a rising ratio indicating that gold equities have underperformed. Investors are worried that the ratio could increase to the 4.0x levels seen during the 2008 financial crisis and during the '90s.
Such concerns ignore the remarkable change in the profitability of gold companies. As we approach the end of the second quarter financial reporting season, UOB Asset Management calculates that operating profits for gold companies are at record levels in absolute terms, with operating margins only slightly below the record highs set in the first quarter.
Certainly, operating profits and cash flow are far above the levels seen during and before the 2008 financial crisis. Looking forward, the recent gold price strength makes it probable that this year's aggregate third quarter operating profits and margins will again establish new record highs.
We believe that gold equities will start to re-rate relative to the gold price for two main reasons. First, as the physical gold price remains at elevated levels, investment analysts will be forced to make upward revisions to their gold price assumptions and equity target prices. Second, current operating margins are not only above previous years, but may soon reach record levels.
The physical gold price has rallied sharply in recent months, and it is normal for any financial asset to consolidate after making strong gains.
However, all of the structural supports for gold-related assets remain in place and support the gold price's current elevated level. Continuing uncertainty over the finances of the euro zone economies, the US budget deficit and national debt, and the increased potential for a global recession suggest that gold will continue to find favour with investors looking for a safe investment haven in these uncertain times.
Robert Adair is the fund manager of the United Gold & General Fund at UOB Asset Management.
Via: http://www.todayonline.com/Commentary/EDC110827-0000239/Gold-shining-brightly-amid-uncertainty
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