Gold Regroups

Gold has taken a step back in the past week, but don’t lose heart. The factors that caused its slip '” a stronger US dollar, a falling oil price and the largest speculative long gold futures position since 1983 '” will prove short-term distractions, and a buying opportunity. The price of the yellow metal will go significantly higher, pushed by rising inflation, strong demand/supply fundamentals and a falling US dollar.
Last week there were more hawkish comments from the US Federal Reserve on interest rates after a key regional inflation measure, the Philadelphia Fed index, revealed that the prices paid by manufacturers for materials and prices received for finished goods rose at their fastest pace since November 1980, which just happened to be the same year as the gold price reached $US850 ounce.

Last month's producer price index rise of 1.9% (for the prices paid by producers) represented the biggest gain in 31 years. It is not just the strong oil price that is fuelling inflation; it is record commodity prices, resulting in rising raw material costs, due to the unprecedented demand from China.

Gold is also underpinned by very strong demand/supply fundamentals. Gold demand for the September quarter was up 21%, with jewellery demand up by a strong 17%. Investment demand was the highlight, however, up a massive 66% on a year previously. Mine production is also stagnating due to the lack of new discoveries. Last year, global production fell 5% due to an 18% decline in South African production. Australian gold production for 2004-05 was 265 tonnes, 2.9% down on the previous year and the recent quarterly reports for Newcrest Mining, Lihir Gold and Oxiana all indicating similar trends. Central bank agreements are also substantially capping official sales, with net gold sales last year 478 tonnes versus 617tonnes in 2002-03.

The massive US trade and budget deficits show no sign of any meaningful recovery; in fact Congress has just revised up the 2005-06 budget deficit due to the $US62 billion allocated to the aid recovery program in the wake of Hurricane Katrina. I believe a highly stimulatory monetary policy and the fiscal irresponsibility of the Bush Government, combined with the structural imbalances of the US economy, will result in the resumption of the long-term bear market for the US dollar after the Federal Reserve is finished tightening interest rates.

Gold has recently broken the nexus with the US dollar and is now not only rising in $US terms, but it is making new Euro and Yen currency highs. The first stage of secular bull markets for gold is a rise against the dominant currency; we are now entering a powerful second stage, where gold rises in all currencies. The revaluation of the Yuan is also the first sign of a longer-term move of lower Chinese and Asian demand for the $US as those countries reweight into a basket of currencies.

The current rise in the gold price reminds me of the early stages of the massive upside move in the oil price, when the market was in denial about the fundamentals and dismissive of the potential upside. International gold funds are starting to get big inflows. I believe the Australian market is underweight in the gold sector, and there will be a river of funds going down a very narrow stream. I urge investors to use the pull-back in the gold price and in gold equities to significantly increase their weightings.

OIL’S OPPORTUNITY

My most reliable contacts in the oil industry assure me the price of the benchmark West Texas Intermediate (WTI) crude oil will stabilise in a $60–65 range for the rest of the year. They say that my comments of a month ago, that WTI would trade down to $55, was "too bearish" so I reviewed the situation taking their opinion into account. They believed WTI would hold the $60 level and they were right, as the spot price only ever traded 30¢ below that level on a "tick".

With oil stabilising inside this $60–65 range, it's blatantly clear that the right course is to wade through the trading damage in leading Australian energy stocks and selectively increase exposure.

CEO’S SPRING SALE

I recently wrote at length about the dangers of not having your investing interests aligned with directors’ interests. Many readers replied that they "detested" directors selling, and couldn't understand why any serving director, chairman, or senior executive had grounds for a large-scale share sale.

As a couple of investors pointed out, "any margin lender will lend you 80% of the value of your shareholding for other purposes, so to say you needed to sell stock to diversify your portfolio is a fallacy". I think that's a fair comment, and it's hard to stray from the conclusion that the basic reason for any insider sale is the belief that the stock is "expensive".

Changes in directors’ interests from the "sell" side are generally a better development to follow than changes in directors’ interests from the "buy" side. Investors must take notice of any large-scale selling by directors, and they should not believe any director who says they are selling to diversify their portfolio.

It's on this basis that I believe the market is paying too little attention to a recent option exercise and significant share sale (825,000) by Coles Myer (CML) chief executive John Fletcher.

Fletcher was well within his rights to exercise his options and sell the stock, but I just think the timing is a little odd. It's widely reported in the press that CML is in the process of selling the Myer division, and I think it's strange that the CEO would alter his personal shareholding during that process. I also think it's strange that the CEO would alter his personal shareholder so close to the AGM, to be held on 17 November.