Strong dollar behind gold’s slide

Gold prices continued their slow decline in early February.

The London afternoon fix was US$343.40 per oz. on Feb. 5, down $7.70 from the previous Wednesday’s close, and down a stinging $26 from Dec. 27, 1996.

Prices are now $44.60 below the 1996 average of US$388 per oz. but have yet to hit the lows suffered in the first three months of 1993, when they hovered around US$330 per oz.

Gold prices have suffered recently from a combination of two factors: the unusual strength shown by the U.S. dollar against most major currencies, and continued gold sales by European central banks.

The U.S. dollar, with the stock and bond markets in-step, kept soaring as economic figures issued by the U.S. Commerce Department showed that the U.S.

gross domestic product grew in the fourth quarter at an impressive annual rate of 4.7%, with an annual inflation rate of just 1.4% — the lowest since the 1960s.

Gold sales by European central banks remain an unpredictable market force. In mid-January, the Dutch central bank announced it had recently sold 300 tonnes (9.6 million oz.) of gold on the world market. The Dutch say the sale was intended to increase the bank’s foreign exchange reserves and generate yield on its currency reserves, and was not related to the move towards a common European currency. The Dutch made similar sales totalling 285 tonnes at the end of 1992.

While many analysts are speculating that more European central banks will sell gold this year, it is unlikely they will sell below US$350 per oz. A new ruling states that central banks in the European Monetary Union may not reduce deficits via gold sales but that they may sell gold to reduce debts.

Theoretically, the fundamentals for gold remain strong, with a continuing shortfall between traditional supply and demand. Over the past two years, this shortfall has been made up by central bank sales, producer hedging and short sales. Some bullish observers think the lid on the market may soon be lifted.

Henry Roy, senior vice-president of finance at mid-tier gold producer Cambior (CBJ-T), thinks gold prices will “return to a more reasonable level”, averaging between US$375 and US$400 per oz. for 1997.

He says these kinds of price drops do not seriously harm a mid-size producer in the shortterm but that they do affect its hedging strategies. For example, Cambior ended 1996 with about 400,000 oz. gold covered by hedging, a relatively low figure for the company. Over the past eight years, Cambior hedged an average of two years of production, usually about 1 million oz.

“We’re obviously positioning ourselves for an uptick in the gold price,” says Roy.

With overall cash costs at the US$250-per-oz. level, Cambior stills retains its flexibility in the industry. Its new Gross Rosebel gold project in Suriname has cash costs in the range of US$230-240 and will proceed even if prices drop further.

If gold prices remain low, those most hurt will be junior gold producers, who have often highly leveraged themselves in order to manage a project. They may find it harder to finance marginal projects, as the market’s fickle appetite turns away from gold producers.

Bearish outlook

Decidedly bearish on gold is Fergus Prentice, a researcher with the Montreal publication International Bank Credit Analyst, who says a price of US$325 per oz. is not unreasonable. He adds that the real price for gold will continue to erode over the long term, and will consistently underperform financial assets in our currently stable economic and political climate.

His publication points to many factors pushing down gold prices over the long term, including: low inflation rates; lower public deficits and debts; high-performing financial assets; increased availability of alternative inflation hedges; increased gold production from emerging countries; and increased gold production due to technological innovation. The publication notes that gold is still above its 130-year historical average.

Robert Buchan, president of mid-tier gold producer Kinross Gold (K-T), refused to comment at all on the gold market, saying simply, “We produce it, and that’s hard enough.”