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Finding currency in gold price
Forecast sees looming rally in metal, mining stocks

By Thom Calandra, CBS.MarketWatch.com
Last Update: 11:30 AM ET Jun 18, 2003
SAN FRANCISCO (CBS.MW) - Gold's price is on the verge of staging a powerful summer rally in all currencies, boosting bullion producers and their more risky counterparts, exploration companies.

At a $360 U.S. dollar gold price, the metal, since hitting a February high of almost $390, has disappointed investors the world over. What's more, most gold mining stocks have failed to match their formidable gains of 2002.

That's all about to change. "I think if you look around, all of a sudden, you're seeing more than a few mining stocks hit new highs," said Richard Sacks of Phoenix Advisory Management in Chicago. Sacks is a large shareholder in a number of mining companies, both explorers and producers.

This week's money flow into gold companies has taken large and small companies near their highest values since February 1998. These include the largest, Newmont Mining (NEM), and the smallest, virtually unknown exploration companies such as Radius Explorations (RDU), which trades only in Canada.

On May 28, in subscription service The Calandra Report, I detailed exactly why gold is headed for a stunning summer and autumn rally, one that could double the level of the most widely followed gold index, the so-called XAU (XAU), to 140 or more. Such a gain for mining stocks would go hand in hand with a roughly 20 percent to 25 percent gain in the gold price.

I won't give away the store to non-subscribers of The Calandra Report, but here is how I worked through part of my bullion forecast:

I never read Arthur Conan Doyle as a child. The only room I had for Sherlock Holmes was Basil Rathbone on the boob tube. These days, after spending a lot of the past two years mixing it up with the gold crowd, I have a lot more respect for Holmes and the art of ferreting out plausible scenarios. I'm not talking about conspiracy theories, derivatives, short sales, lawsuits or central banks. I'll leave that, for now, in the capable hands of those with far more insight. My sherlocking has to do with gold and its relationship with currencies. Here's what's been getting under my skin. The spot gold price, since early February, has sunk in dollars. Combined with the strength of the euro, rand, Swiss franc, Aussie dollar and so on, unhedged non-dollar buyers of gold have gotten crushed this spring. So what's going on there? The way I see it -- and I'll state this right up front -- gold's price will soon revisit its pre-February trend of rising against most, if not all, of the world's currencies. But the way I want to take you through this is the same way I got through it: by putting on my Sherlock hat, asking some questions, then throwing my biases (far higher gold, the XAU doubling in the next four months) against a group of people I consider among the best gold thinkers in the business.
Let's start here. I am trying to get a sense of what it takes for a rand buyer of gold, or an Aussie dollar, Canadian dollar, Swiss franc or euro buyer of gold, to do the deed. What goes through those heads on the value proposition of owning gold, either physically or through a closed-end fund or via one of the exchange-traded funds headed our way? After all, I hear so much about the purchasing power of gold, how the benefit of gold is increased purchasing power for those who prefer not to own a given currency, or at least prefer to keep some of their wealth unlinked to a currency. Let's say gold sold for about $380 an ounce on Feb. 5, which it did. (As high as $389 spot). Now, the euro was worth about $1.08 U.S. that day. Someone not living in the United States, someone looking for greater purchasing power, goes out and buys an ounce of gold using, let's say, euros. So that investor has to pay $380 divided by 1.08, or 352 euros. Since then, the euro has kept piling on the gains, to $1.18-plus against the dollar. Gold, alas, has declined to $370 spot on the dollar (that was in late May - it's now $360 an ounce). So now, that investor, shall we call him Watson, sells the ounce of gold, gets $370 worth of American dollars, but that's worth just 313 euros. The European buyer of gold (or anyone not on American shores) lost on the value proposition, right?
This means that gold right now -- at least since early February -- is not rising in all currencies, which is what ordinary folks are told is the sign of a bull market for bullion. (And to be fair, during that span, the gold price was not rising in dollars, either. But the losses for non-dollar buyers of gold have far outpaced those who used dollars for their gold purchases.) So what happens to the euro or Australian dollar or rand buyer of gold? When will a gold purchase give them the greater purchasing power they desire, especially presuming the dollar keeps slipping? (Feel free to substitute the Federal Reserve's dollar index for more of a basket-of-currencies approach to this model.) My answer, simply, is only when gold really makes big moves. The $1.18 euro buyer of gold today pays 313 euros for an ounce, of gold. So let's say six months from now, we get the all-currency gold rally, and an ounce of gold is worth 10 percent more in euros, or about 345 euros an ounce . . . and the euro itself has gained another, let's say, 5 percent against the dollar in that span, to $1.24. Gold then, in that scenario, will have risen in euros and presumably most currencies. A 345-euro price of gold, multiplied by the projected $1.24 worth of a euro, translates into $427 an ounce in U.S. dollars. My point here is that gold must rise everywhere, and not just at Wal-Mart in the states, to make it a true generator of greater purchasing power. In my six-month scenario, another 5 percent drop for the dollar is reasonable, given the state of America's trade gap and government spending deficit. Gold must rise significantly, or at least outpace by a decent margin the dollar decline, for the euro (or Canadian, Australian, Swiss) buyer to have had a "winning" trade.
I think that winning trade is just around the corner, and helping it along will be the North American introduction of new trading vehicles for gold, including a New York Stock Exchange-traded fund (expected in July) that will allow investors ownership of physical gold via a real-time electronic trade. See: Paper gold to spark demand.