Gold Investment

Milwaukee, WI

By A.B. Dada
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MineWeb carried a great little article today titled Global gold dehedging slows down¹. The article talks about how the major gold producers have slowed down their gold dehedging in the third quarter of 2006. While this may not seem like major news considering that it appears that a lot of goldbugs have expected this to occur, it will be interesting to see what the short term effect is on gold’s price in dollars.

When someone hedges gold, it comes out a bit different than other investment hedging. The typical investment hedge will purchase a specific investment but short-sell an equal amount in a competitive product. You might buy 100 shares of XYZ stock, but short sell an equal dollar amount in XYZ’s competitor. If XYZ goes up and the competitor goes down, you limit your risk in that industry. It is a form of risk insurance, and it does seem to work for some investors and investment houses.

With gold’s price fluctuating versus many currencies, the gold producers felt the need to hedge against the change in gold’s price (both upwards and downwards) so they felt secure in what they could sell the gold for that they’re in the process of mining and processing. As gold rocketed up in dollar value in 2006, up to US$725, many producers started dehedging as they saw a huge upside potential in the future price of gold — which allowed them to reap bigger profits as gold went up (rather than capping their upside by taking advantage of the downside also).

Yet gold dropped significantly after the run up, and is now sitting somewhere in the middle of the peak and the valley of recent prices. It is odd to me to see producers continue to de-hedge, as the upside potential price of gold seems to be larger today that many would have expected a few months ago.

If you look at my most recent gold versus barrel of goods chart, you see some significant recent swings in certain prices — notably an opposite relationship between oil’s price and the DJIA price. Considering how many investment banks are currently locked into very scary mortgage numbers, the DJIA doesn’t show a realistic figure to actual risk in the stock market for many of these hard hitters. The price of oil’s fall is also unusual considering that many oil producers are talking about cutting their supply in order to keep oil from falling — but it still is falling. If there is collusion in any industry, it seems to be in the oil industry the most. And throughout all this, the chart shows that gold has been fairly stable, even with the major upswings and downswings versus the dollar. It is important to see that the chart reflects the other goods in terms of gold’s buying power, not necessarily in terms of dollar value. This gives us some unique insight in seeing that the DJIA has held the most stable in gold value, and silver has seen the most movement in the same value terms.

The de-hedging that is occuring seems to me to indicate two possibilities: that gold producers are expecting a large increase in the new supply of gold, or they expect a large increase in the supply of available gold from other resources.

MineWeb’s article talks about the additional demand from the EFTs. My gold museum website hasn’t been updated in months, but it is receiving more traffic than ever with people searching for gold coins — to me that seems to signify an increased demand in gold coin investment (but it could also mean that Google likes the site more). If the EFTs have more demand, but the producers seem to think that supply will outstrip demand, we may see gold fall versus the dollar or versus the barrel of goods.

Personally, I am still buying more silver than gold, only because it seems that silver’s supply seems to be have more potential of a shortage than gold. I’m not selling gold, but I am buying less unless I can get a great deal on it. Silver is always cheap, for me, versus the time I spend working. If I can buy 10 ounces of silver for one billable hour, that is still a steal.

If you’re watching the barrel of goods versus gold chart, I’d love to know what your opinion is on silver’s recent peak against the barrel of goods, as well as what you think is happening with crude oil. While we can’t expect anything to be solid in the future, it does seem that we have to start considering what the investors see — disregarding real supply issues. From an investor’s perspective, oil seems like a steal, silver seems like a risk. From a supply perspective, silver still seems like a steal, and oil will likely not stay at the level it is at, especially considering the producers who want to cut back. Or do the local US producers know of a new supply that will offset a reduced OPEC supply?

Discuss this article at the gold investment forum.