The price of gold has recovered

The price of gold has recovered somewhat so far in 2016. While you might hold a little gold for diversification purposes, remember its disadvantages.

Gold has been trading above US$1,250 an ounce. But this is far below the peak price of $1,908 an ounce on August 22, 2011. Then again, the price has recovered somewhat and is expected to average $1,225 an ounce in 2016.

One factor working against gold is low inflation and deflation in many countries, such as Japan. This reduces gold’s appeal as a hedge against inflation.

A second factor is better government finances in Canada and the U.S. This lessens the risk of debasement of both dollars and the need for gold.

A third factor is that gold produces no income. Worse, one must pay for safe keeping.

A fourth factor working against gold is sales by the International Monetary Fund. Selling gold enables the IMF to raise cash and assist countries.

The price of gold is notoriously cyclical and unpredictable. The industry itself didn’t foresee the most recent plunge in the price of gold.

Factors that influence higher gold prices

There are other factors that raise the demand for gold. One is that the U.S. dollar has paused. The price of gold usually moves in the opposite direction of the dollar.

A second is the popularity of gold jewelry–especially in China and India which account for 63 per cent of global demand. As middle classes in emerging markets grow, so will the demand for gold as an alternative asset.

Third, low interest rates cut the ‘opportunity cost’ of gold—interest that cash would’ve produced.

Fourth, some investors distrust paper currencies and prefer to hold gold. Poor finances in Europe raise the risk of debasement of the Euro.

Fifth is higher demand by the ‘official sector’. That is, many central banks would rather hold gold reserves instead of dollar or euro reserves.

Sixth, moderate gold prices make it less profitable to produce. It can lead to a shutdown of marginal mines and depress gold scrap recoveries. Lower supply is supportive of gold prices in the long run.

Seventh, there are fewer short sales. Short sellers borrow gold, sell it and hope to replace it if prices are lower. They pocket or lose the difference between the price at which they sell and buy back. With the price of gold rising, short sales lose appeal.

We recently surveyed 15 gold producers and recommend seven of them as buys:

Senior producers Agnico-Eagle Mines (TSX─AEM), Barrick Gold (TSX─ABX), Goldcorp (TSX─G), Kinross Gold (TSX─K) and Newmont Mining (TSX─NEM) and intermediate producers Iamgold (TSX─IMG) and Semafo (TSX─SMF).

Alternatives to gold stocks include gold exchange-traded funds or gold bullion. Just remember that given gold’s disadvantages, it’s best to hold only a little.

 

The Investment Reporter, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846