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Posted 1/13/2003
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Gold glitters in '03, but crude may not
The experts can cite plenty of reasons why gold prices will stay strong in 2003, but they see crude oil prices tumbling along with other commodities.
By Mike Robbins
Gold glittered to a six-year high of $348.20 an ounce in the closing days of 2002, up more than 33% from a low of $258 in September 2001. Oil prices surged as well, reaching a two-year high of $33.65 per 42-gallon barrel, more than 50% above the prices of a year earlier. (Both commodities ended the year slightly off these peaks.)
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Most other commodities have failed to match these gains. But while the prices of black gold and solid gold have risen seemingly in tandem, the reasons for their current rallies might just be distinct, say the analysts. In the long-term, only gold might continue to shine.
Oil surges forth
You probably already know what's driving oil's advance. Iraq, home of the world's second most-substantial proven oil reserves after Saudi Arabia, might soon go head-to-head with the United States, home of the world's most substantial military. Meanwhile, Venezuela, home of the western hemisphere's largest oil reserves, has been virtually shut down by strike. The United States is Venezuela's largest oil market by a considerable margin. "It's a combination of both factors," says Chip Hodge, a managing director in John Hancock’s Bond and Corporate Finance Group. "Everyone could see the Middle East situation coming. Venezuela kind of caught us off guard."
Indeed, one of Venezuela's great strengths as an oil exporter always has been its relative stability. The country is located half a world away from the predictably unpredictable Middle East, and had a long history of meeting its international oil commitments.
Of course knowing why oil prices are up doesn't necessarily mean we can predict exactly when they'll subside. There's no telling when a war in the Middle East might begin, much less when it might end or how much damage it might do to supplies. In the first Gulf War, crude oil prices spiked to $40 a barrel (adjusted for today's dollars), says John Tobin, executive director of the non-profit Energy Literacy Project, but quickly returned to the $30 range when it became clear that the war was going well for the West. Within six months, crude was back to $20. But there's no guarantee Gulf War II will be as easily won. Should the Iraq situation disrupt supply from all of the Middle East, crude oil prices could reach unprecedented levels. "Pick a number," says Hodge. "I've heard predictions as high as $100."
The Venezuelan situation is equally difficult to forecast. The strike could be resolved tomorrow. Or foreign workers could be brought in to replace the strikers... Or the country could devolve into chaos.
Yet for all the uncertainty, there are a number of reasons to believe that oil prices soon will slip back into the $20s.
- OPEC has stated that its members will increase production to make up for lost supply. Should we take OPEC at its word? In this case, yes, says Tobin. At current prices, it is in OPEC's interests to increase production. Besides, OPEC's leadership understands that ultra-expensive oil can put the breaks on an already sluggish world economy. That, in turn, would reduce future demand for oil, something OPEC definitely doesn't want.
In fact, while no one's ruling out a short-term spike in oil prices to perhaps $40 or more, there's an outside chance that a second Gulf War could provide a long-term reduction in oil prices. "If (Iraq dictator) Saddam Hussein is replaced with someone friendlier to the West, prices could come down substantially," notes Michael Tucker, a finance professor at Fairfield University in Connecticut.
What does all this mean for investors? Three things, analysts say:
- Don’t overplay the expensive-oil hand.
Can gold retain its recent luster?
It's tempting to attribute climbing gold prices to the same Middle East war concerns that have so roiled oil. Investors frequently turn to the safety of gold when the world begins to seem like dangerous place to live. But most gold analysts believe that this is not the most significant factor in gold's current climb. "There are a lot of issues surrounding this," says John Doody, editor of The Gold Stock Analyst, an investment newsletter. "But the central factor is the weakness of the dollar."
The U.S. dollar recently fell to $1.05 versus the euro, down 20% from $0.84 in May 2001. That’s a three-year low. The dollar is weak because foreign investors are starting to pull their money out of our markets, explains Joseph Foster, portfolio manager of Van Eck International Investors Gold Fund in Kansas City, Mo. "They're losing faith in our ability to turn our economy around quickly, and turning to gold as a more attractive option."
Also intriguing -- yet harder to prove -- is the contention on the part of some gold analysts that the U.S. central bank has intentionally flooded the gold market in recent years as part of an effort to keep the dollar strong. These analysts see the recently weakening dollar as evidence of a quiet policy change that could push bullion prices up substantially. "For quite some time, we've actually had a fundamental shortage of gold," says Jay Taylor, editor of J. Taylor's Gold & Technology Stocks, a newsletter based in Woodside, N.Y. "Only central bank dis-hoarding has kept gold prices from rising."
Meanwhile, demand for gold could get a boost from a pair of disparate sources largely unrelated to the Middle East. Many mining companies essentially must buy their own gold to cover their sizable hedge positions, notes Foster. And China -- population 1.3 billion -- is in the process of removing restrictions on private ownership of gold. "People living in nations with political and economic uncertainty have always liked assets like gold that they can stick in their pockets when it's time to flee," says Patti Harper-Slaboszewicz, a senior analyst with Frost & Sullivan, the global consulting firm.
For any or all of these reasons, many observers believe the gold rally could continue even after the Middle East situation is resolved. How high might gold climb? While no one expects a return to the $800-an-ounce gold prices reached briefly in early 1980, predictions in the $400 to $500 range are common. "Clearly gold has a much higher upside potential (than oil)," says Ned Riley, chief investment officer with State Street Global Advisors. "Gold has broken out of its range." For nearly five years, from 1997 until 2002, gold had made only brief forays outside of the $260-$320 trading range.
What about other commodities? Other precious metals followed gold up for a while in 2002, including silver, platinum and palladium, but all have fallen off their peaks. Copper prices have been falling more or less since 1995. Lumber prices have been falling steadily for the last year -- despite record levels of construction.
How to play gold
For investors, gold mining stocks typically offer more upside potential -- and more downside risk -- than bullion. Doody likes Newmont Mining (NEM, news, msgs) for its anti-hedging policy and high visibility, and AngloGold (AU, news, msgs) for its 3.2% dividend. He also likes IAMGOLD (IAG, news, msgs), a small player set to become a midsize one following a forthcoming acquisition of Repadre Capital. Foster favors Gold Fields (GFI, news, msgs) for the company's non-hedging policy and manageable portfolio of just a handful of large mines, and Glamis Gold (GLG, news, msgs) for its recent history of successful acquisitions. Taylor's top pick is Goldcorp (GG, news, msgs) for its low cost of production, while Ron Nicklas, president of Pennaluna & Co., a brokerage specializing in mining stocks, likes Harmony Gold Mining (HMY, news, msgs) for its 2.8% dividend.
The unpredictability of the mining business means mutual funds are a safer choice for many individual investors. In addition to Foster's Van Eck International Investors Gold Fund (INIVX), other top performers include the First Eagle SoGen Gold (SGGDX), Toqueville Gold (TGLDX) and Gabelli Gold (GOLDX).
"Gold might not be a bad hedge for this market," says Riley. "Though I don't think anyone should bet the house on it."
Don't tell that to Taylor. He and his wife recently invested a sizable sum in gold bullion. They freed up the money by -- you guessed it -- selling their home.
As of the date of publication, Mike Robbins does not own or control shares of any stock mentioned in this article.
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