Central banks should not be over-rated as to their gold price influence

A key gold market analyst has warned Australian equity markets not to over-rate the role of central banks around the world in influencing or setting a base line on the gold price. Addressing the opening day of the 2008 Paydirt Gold Conference in Perth, Hartleys’ Director – Corporate Finance, Martin Pyle, said central banks contributed to some volatility in world gold prices but in real terms, commanded control over only 25% of world gold reserves.

“Central banks should not be viewed as the be all and end all in influencing the gold price,’ he said. “Their control is further limited in that 50% of their holding at any time is also subject to orderly sale agreements and the banks are not achieving these orderly sales currently. What sales they are securing are in the order of $5-15 billion per annum but that is small in terms of the financial scale of global markets – at a time the gold price has risen by 300%.

“Further diluting the perception of the central banks is the increased availability of gold to the common man. Exchange traded gold funds (which provide a platform for average citizens to hold gold) have grown substantially in the past five years. This amounted to only 80 t in 2004 but has now exploded to more than 700 t, with StreetTracks (the largest of these funds) the eighth largest gold holder in the world.”

Pyle said the short-term outlook for gold probably “has more downside risk” due to the US economy and flat commodities outlook – but the long-term outlook was strong. He said the Australian gold equity sector could expect a substantial re-rating of juniors as the strong gold price meant sustainable margins were opening up and allowing previous non commercial operations to enter the production race. “Even if the equities market does not recognise it, the major gold companies will and this will generate constant consolidation and accelerate the pace of corporate activity among the gold explorers and miners.”

Meanwhile, one of the sector’s lead analysts said gold should be trading around $1,400/oz if it were to be truly performing within current inflationary impacts of the past three decades. Westpac Institutional Bank’s senior economist, Justin Smirk, said that although gold had been visiting record price highs in recent times of around $1,000/oz, this was not a true reflection of its performance.

“If you take away the effect of inflation, the gold sector long-term has shown more evidence of flat or downward trends through the seventies, eighties and nineties,” Smirk said. “We should be benchmarking the sector in real gold terms, which if adjusted for inflation impacts, would have the current gold price much higher at around $1,400/oz.

“Yet it is already easing off its recent highs, although still remaining strong. The real benchmark over the past 80 years can be compared to what an ounce of gold could buy historically and now. In the 1930s, you could get a very good man’s suit for the value of an ounce of gold and that was still true in the 1980s. It has not been true in the 2007. If the implied value of gold had matched the price rises last year in the USA of outer menswear, which accounts for suits, the price of gold should have been around $800/oz, not the $700 levels where it sat for much of the year.”

Smirk said gold remained sensitive to record price ceilings with the key jewellery and bridal market in India already generating easing import demand for the precious metal. This was being offset by continuing strong and increasing investor demand – now seeking around 130 t/y of gold.

He said he expected gold to outperform resources commodities in the near term but would drift back to lower averages in the longer term due to factors such as weakness and uncertainty about the US dollar as gold tended to follow the US dollar pathway.

“I expect gold to average under a $1000 this year – perhaps around $938 – get back to above that next year, possibly averaging around $1,023 an ounce – but then easing by 2010 to levels averaging around $850 for the full 12 months.”