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| Fool's Gold is the Motley Fool's version of the newspaper "Weekend" insert.
Named for the glittery sulfide "pyrite," often mistaken for gold throughout
the centuries, Fool's Gold squarely addresses the difficulties that arise
when attempting to discern what is ersatz and what is real. Separating the
gold from the pyrite is a difficult task without the proper tools, implements
that Fool's Gold attempts to provide.
Alchemy was born from a desire to transmute "inferior metals" into gold. Investors today engage in a similarly hopeless endeavor, buying inferior businesses in the hopes that they will be transformed and yield blue-chip returns. In a similar vein, perhaps no other business wields the power of "speculative appeal" more adeptly than the gold industry. The promise of spectacular returns from "junior" exploration companies that hit the mother lode can be too much for some investors to resist. |
Definitions
Freeport-McMoRan Copper
& Gold
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Why not? If speculation is your game then steel yourself and roll the dice, but if you're inclined to believe that a measure of certainty can be achieved by evaluating a business properly then read on. So what could be more apropos for the golden anniversary of Fool's Gold than a Sector Snapshot on the gold industry? The business model that drives the production segment of the gold industry is very similar to those in more staid industries like oil production. In today's market environment, however, the more mundane business of mining the gold that has already been discovered has been overtaken by the speculative rush to find the next "explorer" that will hit golden ground. Gold Bug Traditionally, small-cap exploration outfits have been afforded premium multiples in today's marketplace, in some instances matching their larger "production" brethren in market capitalization. However, the heavily publicized collapse of Bre-X Minerals has put a damper on investor's enthusiasm for these more speculative stocks and has prompted a valuation correction as well. As with any other business that is centered on a single substance, the actual market price of that commodity will largely determine short-term fortunes. Everyone knows that gold has historically been used as a hedge against inflation due to the relative constancy in its value. Doomsayers throughout the history of the financial markets have preached the gold gospel as the investor's only saving grace in the event of a world economic collapse. Central banks store gold bars weighing 400 troy ounces (gold unit of measurement) in vaults for just such an eventuality. In the past, gold directly backed U.S. currency, but now it serves a more symbolic function as it sits in storage in a few Federal Reserve banks and at Fort Knox. This week's benign inflation report prompted a drop in gold prices, breaking out of its one month trading range of $345 to $355 per ounce to $343.90. This present price is about $75 off of the high achieved in 1996. As with other industries that are beholden to the price of their chief commodity, the successful companies attempt to insulate themselves as much as possible from the vagaries of price fluctuation. Supply & Demand Demand for gold can be segmented into fabrication demand and investment demand. Gold used in the manufacture of value-added product is qualified as fabrication demand, while gold that is used for inventory accumulation is categorized as investment demand. Gold bullion is gold in its purest form and can be smelted into gold coin. Bullion coins are minted by governments and traded mostly on the value of their gold content. Gold bullion coins are a subset of investment demand in that they entail a low value-added manufacturing process and are left in bullion-like form to the market. Pure measures of physical supply exclude paper transactions. Turnover of gold in the marketplace due to forward contracts is rarely accounted for in measures of supply. On the supply side, most market analysis centers on capacity as measured in mine production due to the fact that these are the most readily available figures. However, mine production constitutes only 64% of the total gold supply according to CPM Research. It is the least dynamic sector of the market and is the least influential on prices on an ounce for ounce basis. Central bank activity and investment demand trends have the most affect on prices. Of the two, large scale forward selling by producers and central bank dumping of gold are the twin specters that haunt gold prices. Despite this, it is almost universally acknowledged that the demand side of the equation has the most affect on prices. Historically when net investment demand has been above 529 mt (17 million ounces) in any given year, it has resulted in an upward push on gold prices. Gold prices had been slowly marching upward until recently -- in 1994 demand was at 5.9 million ounces, in 1995 it was at 6.6 million, and in 1996 demand stood at 7.5 million ounces. Overall, it appears that the long-term trends will be favorable for gold as long as the Indian subcontinent, Southeast Asia, and China continue to grow their economies at 5-10% per year. As an example of this furious demand, India is one of the highest consumers of gold in the hemisphere, despite a meager GDP per capita of roughly $400 per year. As the common investment thesis goes, the middle class in these countries continues to grow and so too will demand for gold. Next: More Gold Unearthed -Alex Schay (TMF Nexus6) (c) Copyright 1997, The Motley Fool. All rights reserved. This material is for personal use only. Republication and redissemination, including posting to news groups, is expressly prohibited without the prior written consent of The Motley Fool. |
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