At one extreme, there are the "Gold Bugs", supposedly constant 'bulls' of the gold price, so not too reliable? At the other end there are those who look at the gold price as "peaking", simply because it has gone up a lot, so it has to come down. And with so many one way or the other, the market is labeled as dangerous or worse. But there is a tendency amongst professionals as well as amateurs, to believe that if it is not measurable, of numerically definable, it is dangerous, speculative or just plain gambling. In this gold market, such views will exact a heavy penalty from those who hold them!

The reasoned reality is so different from the above, leaving the only pertinent question, "Is this gold price rise a 'spike' or something very, very different."

1980 'Spike'.
We now believe that this market has taken the position the gold market was headed to in the '70's and '80's, before "Official Intervention" [Central Bank sales, leasing, accelerated supply, etc] took the gold price down over the next 20 years. Then gold 'spiked' to $875. We call it a 'spike' because the price went quickly down, when new supplies were thrown at the market and demand just was insufficient to take this supply up. Yes, there were other macro-economic features of note that we find similar to today, for sure, but nowhere near as disturbing as they are today!

Reasons why.

Inflation: This roared until in 1979, until Volker drove interest rates up to 25%+ quickly, to cap it and cap it well, but this was seen in the developed world and was initially triggered by oil prices that had jumped from $8 a barrel to $35 a barrel.

Gold rose on the back of that inflation and fell on its fall too. But today is very, very different!

Inflation is not driving prices up as it was then. Inflation is being restrained by deflation caused by cheap imported goods and amongst other reasons, by the realization that wage demands may well not be met, despite higher growth rates. Whilst there is a fear that inflation will rise the numbers on which the inflation levels are based are not showing any danger signals. At all!

The oil price: - is jumping now because the globe is heading irresistibly towards a situation where there will simply not be enough oil to go around, irrespective of the oil price, which is certain to go a great deal higher as those nations caught without sufficient oil bid up the price [which looks like heading through $100 a barrel and higher].

The drive behind oil price rises in the seventies came from O.P.E.C. fed up with being paid inflated $ for their oil, but a whisper from Uncle Sam in their ear [primarily the Saudi government] about their future being reliant on U.S. backing had them towing the line and dropping prices.

The day when supply is just insufficient is likely to appear in 2007 or thereabouts, but could come considerably earlier, if Iran diverts its supply just to China, or supplies are damaged through a sectarian war among Muslim nations. It could come far earlier if we have another Hurricane Rita, hits the Gulf of Mexico, say, Houston? With global warming there could be more than one such hurricane hit.

China and India are likely to be able to maintain growth through such difficult days too so keeping demand for oil rising inexorably. Visions of national "Musical Chairs" around the oil price jump into ones mind with visions of rationing in the worst affected nations.

In the middle sit the Producers of oil, no longer dependent on the U.S. for their demand, but having a choice between East and West, each willing to pay the price. They are already signing deals with China to supply oil. In addition to the dangers to the oil price mentioned above, lies the growing threat of a conflagration in the Middle East between the two main branches of Islam, the Shi'ites and the Sunnis. Oil exports will no doubt be a prime target of both sides. Hence these prices cannot be dropped by political influence. Rather the reverse is true!

"Official" Supplies of Gold.
Perhaps the prime reason the gold price appeared to 'spike' in 1980 was the sudden threat of overwhelming Central Bank sales. The prime Central Banks did so threaten, as well as lend, lease and sell [for extremely low interest rates] gold until it fell to $270. It funded the accelerated supply of gold so that it paid to hedge future gold production earning more than the market paid [the additional 'Contango' made this possible].

This stopped in 1999, when the "Washington Agreement" was signed. This clarified who would sell gold and limited it to 400 tonnes worth a year. The second agreement took its place at the end of the 4-year "Washington Agreement", limiting sales to 500 tonnes a year. Interest rates were at a low, so the "contango' shrank to unattractive levels, reducing leasing and lending. With this threat limited to containable levels the gold price turned around and started to rise.

Not only did this reduce the supply to the market, it made the conservative, profitable, hedging of future gold production unwise as the gold price rose above the levels of the prices earned from the hedging of future gold production. Three years ago the market began to see the 'opportunity cost' of hedged positions against the proceeds of 'spot' [immediate] prices make hedging look unacceptable. The proceeds of de-hedging then appeared and slowly gained momentum. This allowed management to close these hedged positions, once again exposing shareholders to the higher open market prices of gold. With gold accelerating its climb, the potential opportunity costs are now horrendous.

Mines such as Western Areas having to deliver virtually, all available production to those with whom they hedged future production. This means that they are looking to earn $430 and ounce, whereas un-hedged mines are earning $720 and ounce. So Producers are selling very little and buying back hedged positions. If they believed the gold price was at a 'peak', they would not be closing positions, because they would be buying at the top of the market, ahead of a fall. But clearly they do not believe the gold price is at a peak, so they are buying ahead of further rises!

Investment demand.
In the seventies, investment was solely in the form of bullion or coins [excluding India], difficult to ship and to store and expensive to insure. This is still the method very wealthy individuals invest in gold and we are seeing this in growing volumes at the moment. But last year saw new types of investment demand in the developed markets of the world. The World Gold Council wisely launched several gold "Exchange traded Funds", who issued shares against physical holdings of gold in bank vaults. The extent of the demand was not fully gauged!

Many institutions and funds had been restricted to enjoying the benefits of gold through gold mining shares, often disliked, as the attendant risks were higher than they wanted. With the E.T.F.' they are now able to buy shares that move exactly in line with the gold price. Currently moving towards 600 tonnes over the last year and more, demand appears to have no limit. The money under management by these institutions is vast. As the gold price rises, so does the demand for these gold shares. There is no ceiling on this demand. No such demand existed in the seventies!

The Structure of the Gold Market, today!

A market moving like today's has always been a 'spike' or 'bubble', set to burst, because one assumes that those who bought it must sell once the profit is achieved. But today's market has the above ingredients in it, which describe a far broader and deeper market than ever seen before. This market is more a haven from other investments including currencies and fixed interest securities. So the reasons to sell would have to be founded on the fears of such Investors being removed. A cursory glance at the above describes the likelihood of matters worsening across the globe and gold coming into its own as a solid investment when others move out of that particular category.

• We see no small speculators flooding the market, indeed the traders of note the hedge funds are low profile in this market.
• There is no panic in the buying, buying on the dips when possible. The Investors are competent professionals taking a position on a long-term investment.
• This market is not the gold market of a year ago, where the players could move prices either way, where large quick sales from Central Banks would have burst such bubbles.

This is a market that wants to go higher, much higher!

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