Gold Price Q&A
2008-03-20 10:01
Cape Town - With the gold price smashing the $1 000 barrier in the past week, many News24 Users have been asking why this is important news for the average consumer already struggling with rising interest rates, petrol price hikes and escalating living costs.
We asked David Mckay, Executive Editor of Miningmx and Fin24.co.za, to explain some gold price basics to us.
News24: What factors affect the gold price?
David Mckay: Gold's biggest pull for investors is as an alternative investment to traditional types of investment. For instance, investors flock to the tangible wealth of gold when paper money i.e. the dollar, weakens. Gold's virtue is that it represents physical wealth whereas currencies are paper descriptions of wealth, sometimes referred to as fiat money.
Global finance distress, such as the current subprime crisis, also appears to have sent investors into gold. Equally, political shocks, such as the Iraq invasion, send investors into gold. Once again, the attraction is that gold is physical wealth - notwithstanding fees attached to warehousing and handling of gold in a bank vault.
More recently, under-exploration in the gold mining sector has led to a dearth of new deposits. This has created a fear of a significant and sustained supply deficit of primary metal although this has, in actual fact, been the case for years. What's actually happened is that the supply deficit - supply is less than demand - has been fed from above ground stocks held by central banks and the like. Now, however, central banks are not selling their gold into the market owing to its appreciation.
N24: In turn, how does the gold price effect the South African economy?
DM: A higher gold price boosts foreign exchange reserves and obviously improves the financial performance of companies mining gold from the country, some of which are listed on the JSE Securities Exchange.
But it's not just the dollar gold price that affects the SA economy. The fortunes of the rand against the dollar is equally, in some cases more, important to the SA economy. A weakening in the rand against the dollar is better for SA gold producers because they are paid in more rands for their gold produced.
N24: How important is gold and the gold mining industry to the South African economy?
DM: The gold mining industry is now only a fraction of GDP (gross domestic product). But it does earn valuable foreign exchange e.g. investors and end-users of gold buy the metal in dollars which is converted into rands. It's also a major employer - more than half the 460 000 employed in total in the SA mining sector. This is owing to the labour intensive practice of our gold mining, most of which are predominantly deep level. There's also an entire chain of supply industries that feed into the gold industry such as equipment, refrigeration and power.
N24: How should the man in the street view the gold price? How does a high gold price, for example, translate into real-world examples for the consumer?
DM: Well, apart from the boost it gives the economy, a higher gold price is good for investors in SA gold companies. Such investments can be risky, however, because shareholders are also investing in the capability of company management, not just the gold price. For pure gold price exposure, the man in the street can buy the gold backed ETF (exchange traded fund) which is a share - certificate - equal to a portion of gold. This is a more effective way of owning gold, some say, than a Kruger Rand which has transportation fees attached to it as well as insurance costs for the investor.
A higher gold price means employment is more protected, not to mention the multiplier effect: it's calculated each mine employee supports ten others. Bear in mind, however, that it?s not all a "one-way-street". A higher gold price is part of a general improvement in all metal and raw materials, including the items used to produce gold. That means costs have tended to increase, in some cases outstrip, the improvement in the gold price.
N24: How is the electricity crisis affecting the gold price? Is this adding to our woes?
DM: To some extent, it is. Power shortages are affecting the ability of gold mining companies to maintain production. That?s a short-term worry. But there are long-term concerns as well. Uncertainty as to future supply of power is seeing gold mining companies reassess future gold mining projects which could result in reduced future investment. The prospect of less gold from SA raises the prospect of a greater supply deficit which in turn helps increase the gold price.
The power crisis is more important to the platinum price, however. China has overtaken SA as the largest producer of gold; in fact, SA is not so important in overall gold supply to world markets because it can be mined from many other places. But more than two thirds of all platinum supply is derived from SA. This means any disruption to the SA platinum industry, such as lower power from Eskom, has a marked and immediate effect on the platinum price.
N24: What should South Africans be doing to take advantage of this boom in the gold price? With international markets as unstable as they are, should we all be rushing out to buy Kruger Rands?
DM: See the comments about the ETF above. This financial product generally performs better than investments in gold companies which also take stock of management decisions as well as other exogenous factors that affect gold mining production, such as wage and labour issues, legislation etc. But for more on why ETFs are important, visit ETF best investment option in SA which is an article in Miningmx on why ETFs are the best investment in the SA market.
N24: Which is more important to the South African economy? Gold or platinum?
DM: You'd have to say platinum is the metal of the moment. Better margin, more shallower reserves, not found in great quantities anywhere else in the world. But bear in mind, the gold sector still employs about 250 000 individuals.
N24: Is the current gold price sustainable? Where does the smart money say the gold price will be in 12 months time?
DM: Possibly the most difficult of questions about the gold market/industry. The improvement in the gold price has been rapid in the last two years - up from $650 per ounce at the beginning of 2007 to over, and then back under, $1 000/oz now.
The price of gold has never been higher (though if you allow for inflation it has to go much higher to hit a record) so it?s really in new territory. That's what makes it so difficult to call. Supply and demand considerations aside, the current gold price is a function of world financial distress and the fortunes of the dollar. If you think the US economy will continue to suffer, or there are more financial shocks in the system i.e. the run on Bear Stearns last week, then gold investments might be an option. In general, expert traders play the gold market.
Best always to find a dividend payer in the gold market with a geographically diversified asset base and stay in that counter for a period of time.
Thanks David!
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