The usual response by the Fed and other central banks to ease the European debt crisis has been to inject more liquidity into the system, printing money one way or another.
This is likely to stoke global inflation as well as devaluing the leading reserve currencies, the US dollar, euro and sterling. The recent plan announced by six central banks to lower interest rates on emergency dollar funding for European banks signals that policymakers have decided to “inflate” their way out of the crisis by printing money. The central banks’ efforts are likely to increase investor demand for physical assets such as gold and silver, as people lose their faith in paper money backed by governments that are not credit-worthy.
The conundrum that has prevailed is the weakness of gold mining stocks in relation to the rising price of gold, which is up 13% for the year to date, while most gold miners have seen their share price fall. Gold shares are equities first and proxies for gold second. In times of market instability investors sell out of smaller, less liquid stocks regardless of fundamentals. There is also an element of disbelief and a lack of trust in the gold price remaining at current high levels after an eleven-year bull market that has seen the price of gold rise six-fold. Nevertheless, most analysts and observers agree that the world is facing debt of unprecedented magnitude, rising unemployment and fiscal imbalances, all of which will support higher gold prices.
Under current circumstances, it is impossible for anyone to predict the future price of gold as a safe haven asset, but most agree that it is likely to go higher. We believe that it is a matter of time before gold shares are re-rated by investors to much higher levels that reflect their thriving profitability and growing cash piles. It is likely that this re-rating will start with those companies currently in production with no hedging and with growing operations.
Angelos Damaskos is chief executive of Sector Investment Managers.