The Bull Market For Bullion
Even Peter Munk Believes Gold Has a Bright Future

By Drew Hasselback, Financial Post
December, 2003

One of the most solid examples of gold's rising tide came late last week when Peter Munk, chairman of Barrick Gold Corp., said the company is eliminating its hedge book.

Mr. Munk, for those less familiar with the gold business, spent decades as hedging's poster boy. Hedging is a risk management tool that uses contracts to lock in future prices. Miners hedge future production to protect themselves from falling gold prices.

Gold spent much of the 1980s and 1990s in a bear market, and Barrick's gamble on falling gold prices helped the company generate US$2-billion in cash.

Mr. Munk's decision to move away from hedging indicates that even he believes gold has a bright future. Barrick need not protect itself using hedging contracts if gold has entered a bull market.

The spot price is indeed hot. For the first time in more than seven years, last week gold briefly popped through the US$400 an ounce barrier. Gold closed the week at US$396 an ounce. Given the current mix of economic fundamentals -- a whopping U.S. budget deficit, lingering violence in Iraq and the Middle East, rising oil prices -- there's a lot of reason to believe gold will yet again crack the US$400 barrier.

"Our six-month target is around US$440. I wouldn't be surprised if we were at US$440 by the second half of next year," said Katherine Beattie, technical analyst at MMS International in Toronto.

That's in line with the forecast from Pierre Lassonde, president of the world's largest gold miner, Denver-based Newmont Mining Corp. "Gold at around US$400 an ounce is probably fairly valued right now. You are very likely to see its price trade around that for the next while, with a US$50 an ounce band on either side of it," he said. But, he added, that's just the beginning.

Gold has entered a long-run bull market, the likes of which we haven't seen in three decades, when it rose more than 2,200% from US$35 an ounce in 1971 to a peak of more than US$800 in the early 1980s, Mr. Lassonde noted.

"Since it hit US$250 an ounce in 2001, gold is up 55%. We still have a long way to go. This is chapter two of a 20-chapter book."

For North America's four biggest gold producers, Newmont, Barrick, Vancouver-based Placer Dome Inc., or Toronto-based Kinross Gold Corp., the rising gold price should result in some interesting changes for their 2003 annual reports.

A higher gold price should obviously translate into higher cash flows, with the caveat that mines in Canada, Australia and South Africa will see profits squeezed as local currencies become more expensive relative to the dropping U.S. dollar.

But the gold price will have a more subtle, but equally dramatic impact on the financial health of big gold producers.

The big panic over the past few years has been replacing reserves. Every time a gold miner digs up and sells some of its gold, it obviously must subtract this gold from its statement of reserves. There are two obvious ways to replace them: Buy another company that has some, or send out some geologists to find some.

Yet in the 2003 annual reports, you may well see reserves rise through a third, less obvious way.

Gold miners base their proven and probable reserves on their ability to mine the ore profitably. So if the company figures it would cost US$500 an ounce to mine a specific deposit, the company won't bother including that deposit in its stated reserve calculation. There's no point in claiming to have gold if you can't afford to dig it out of the ground.

According to their 2002 annual reports, Newmont, Barrick, Placer and Kinross each based their Dec. 31, 2002, reserve estimates on a long-term average gold price of US$300.

When you get their 2003 reports, check the footnotes to see whether they've boosted the long-term average gold price used in the reserve estimates. One of the miracles of mineral economics is that the higher the gold price, the more gold you find in the ground.

"When you raise the bar, some of those reserves become much more valuable. Particularly if you use US$350 or US$375 as a long-run average price, which I think some companies will do. So there will be a bump up in valuations from that stand point," explained John Ing, gold analyst at Maison Placements Canada Inc. in Toronto.

That's fine if you track the financial fates of the big gold producers. What about the little guy? If the experts think gold will rise by 10% in the next six months, is it time to buy your own private hoard of bullion?

Ray Nessim, managing director of bullion merchant Manfra, Tordella and Brookes Inc. in New York, wishes you would. His company buys, sells and stores gold bars to investors keen on profiting from swings in the gold price.

Earlier this year, Mr. Nessim thought the buzz around gold would generate a substantial number of sales. But sales volumes have been slower than he thought. The price has risen so fast that a lot of investors think it would be too late to join the party.

"The volume would have been much higher but for the fact that gold has zoomed up. People are somewhat reluctant to invest as much in gold as they would have," Mr. Nessim said.

You could call it the cab driver theory. If you hop in a taxi and find the driver explaining why you should buy gold, you might want to question whether it's the right time to buy.

Indeed, Frank Holmes, chief executive of San Antonio-based US Global Investors Inc., cautions against immediately jumping on gold bandwagon. "The biggest worry we have is that people run in and chase performance," Mr. Holmes said.

There is a case for including gold in your portfolio, and there is a lot of reason to think gold has entered a long-run bull market, Mr. Holmes added. But if you want to balance your portfolio properly, wait until gold underperforms other assets before you jump in.

Courtesy of: www.nationalpost.com