[Editor's Note: This look at gold prices is the first in a series of Money Morning quarterly reports that will examine such topics as housing, U.S. stocks and oil. These reports will now be a regular feature at the end of each quarter.]
By Mike Caggeso
Gold surged a solid 4.3% in the first quarter, with falling stock prices and rising inflationary fears providing much of the fuel.
The so-called "yellow metal" has seen its price advance for eight straight years, and most economists and "gold bugs" believe the catalysts are in place to extend that streak to nine this year. To such experts the question isn't whether gold will eclipse the $1,000-an-ounce level (or its all-time high of $1,033.90, set last March).
The real question is when gold will eclipse one or both of those price points.
And why not? The money being pumped into the U.S. financial system as part of the economic stimulus and bank-bailout initiatives is fueling inflationary worries, while the 11.67% decline of the Standard & Poor's 500 Index during the first quarter (not withstanding the recent rally) has many investors seeking profit alternatives.
Gold closed the first quarter at $918 an ounce. By late morning yesterday (Monday), however, gold had fallen in price for its third straight session, and was trading at less than $870 an ounce – enough of a drop to wipe out the yellow metal's year-to-date gains.
But don't be fooled by what's merely a temporary reversal. Instead, look at what happened during the first quarter, and consider that a rehearsal for what's to come.
In addition to the $789 billion stimulus bill passed in mid-February, U.S. Treasury Secretary Timothy F. Geithner has said he is ready to commit as much as $1 trillion to initiatives that are aimed at strengthening the nation's banks in order to jumpstart lending.
That's on top of the $1.8 trillion deficit for the current budget year forecasted in U.S. President Barack Obama's fiscal 2010 budget plan.
The basic logic – which Money Morning's Martin Hutchinson outlined as far back as November – is that with the government pumping so much money into the economy, there's bound to be an inflationary fallout.
And that fallout would include gold prices reaching as high as $1,500 an ounce by the end of the year, Hutchinson said.
"Indeed, both the unprecedented budget deficits and the very rapid money supply growth point to an inflation rate of perhaps 10% per annum by the middle of 2010," Hutchinson said. "The latest price-and-output figures suggest that any contrary tendency has disappeared. And that points to a strong likelihood that gold may be due for an additional upward run, which may be quite sharp and happen quite quickly."
Sure enough, gold rose nearly $70 an ounce – its biggest gain in six months – after the U.S. Federal Reserve's plan to buy debt hammered the U.S. dollar and reignited inflationary fears.
A week later, on March 25, the U.S. Department of Commerce announced the consumer price index (CPI) rose for the second consecutive month. That morning, gold rose as much as $22 dollars an ounce in trading in New York.
Higher Commodity Price Targets
Gold has long been used as a hedge against inflation, but by the time inflationary figures actually show that pricing pressures are a real problem, it's usually too late to buy gold.
One way to gauge inflationary expectations is to track the futures for staple commodities – the goods and resources whose prices are directly affected by inflation.
When inflation began soaring in late 2007, commodities prices across the board skyrocketed – especially oil, which hit a record high of $147 a barrel last July.
That tightened household and corporate budgets, and helped topple the U.S. into the recession that started in December 2007. As falling consumer confidence and demand sapped spending, commodity prices backtracked from their record highs in a near-lockstep pattern.
By the close of this year's first quarter, commodity prices rebounded from their low levels. Copper prices gained 32%, crude oil rose 11% and gasoline futures jumped 39%, The Wall Street Journal reported.
Inflation has risen at a relatively gentle pace so far in 2009 – 0.3% in January and 0.4% in February, an annualized rate of 1.8% that is well within the central bank's acceptable range.
Theresa Gusman, head of global commodities at DB Advisors, the asset-management arm of Deutsche Bank AG (DB), believes the run-up in commodity prices we've seen so far this year is a preview of coming events – namely a more powerful recovery.
"Stimulus spending will eventually lead to a rebound in commodities," Gusman told The Journal. "We think 2009 will be a mirror image of 2008."
According to New York-based commodity- researcher CPM Group, investor demand for gold will increase 21% this year – from 43.3 million ounces in 2008 to 56.5 million ounces this year.
CPM's report differentiates between investor demand and consumer demand, as it projects demand for gold to make jewelry will fall 7.1% to 56.5 million ounces because of weakening consumer spending, Bloomberg reported.
CPM's report also notes that – despite many signs the economy is nearing a bottom – "continued volatility and weak financial and economic conditions are expected."
That will have a direct impact on gold prices, the research firm concluded.
"Investors are concerned about the preservation of the value of their assets amid the massive destruction of wealth over the past year," CPM said. Gold will rise "as investors look toward safe-haven assets in these volatile times."
The Yellow Metal Hat Trick: Three Ways to Score From Gold's Gains
With inflation on the horizon and an economy that may be in recovery mode, gold is clearly a "must-have" investment for the months to come. The question, of course, is how to play it. Our research has identified three solid strategies. Let's take a look:
- SPDR Gold Shares (GLD): Of the three ways to play gold, the first is to buy gold outright, either in bars, or though the gold-linked, exchange-traded fund (ETF) SPDR Gold Shares. Today, GLD itself holds more than 1,000 ounces of gold, and has a market capitalization of $31 billion. The fund's share price fluctuates in concert with the price of gold, which adds a small mount of risk. On the other hand, however, buying this ETF is more convenient than buying gold bars directly, because the fund dispenses with the accompanying storage problems that comes with actually owning physical gold.
- Barrick Gold Corp. (ABX) is the largest and financially strongest gold producer, with a market capitalization of $29 billion, reserves of 124.6 million ounces of gold (plus copper and silver), and operations in North America, South America, Australasia and Africa. It took a fourth-quarter charge of $779 million – because of its copper operations – but was otherwise profitable in 2008, with revenue rising 10%. For 2009, it should see a double-barrel benefit from rising gold prices and declining costs; it currently sells on a forward Price/Earnings (P/E) ratio of 19.1, but of course as gold prices rise, earnings will rise on a leveraged basis.
- Yamana Gold Inc. (AUY) is a growing gold producer with a $6.8 billion market capitalization that made an unexpectedly good profit in the fourth quarter of 2008, and that is expanding both production and reserves (currently 19.4 million ounces) with operations in Canada and Latin America. Its expansion magnifies the likely potential benefit from an increase in gold prices. Yamana's shares currently trade at a forward P/E of about 17.6, but earnings should rise sharply if gold prices rise.
News and Related Story Links:
Obama's Stimulus Plan: When is There "Too Much" Stimulus?
Inflation Gently Rises in February, Offering Analysts a Sign the Economy Isn't Collapsing
Wall Street Journal:
Gold Retains Its Allure.
- The Vancouver Sun:
Gold falls below $870 on possible IMF gold sales, rising dollar.