Gold's Bull Market

"I don't think we're half way through the game yet. I think we're around the fourth inning..."

JOE FOSTER is the Gold Strategist at Van Eck Global, the US investment team now managing some $7 billion in assets. Traveling the globe to study new mining operations, as well as the state of demand in growing economies such as China, he brings a real-world perspective to his Gold Market analysis.

Foster spoke recently with Mike Norman, anchor of
HardAssetsInvestor.com and founder of the Economic Contrarian Update, about the outlook for gold...

Mike Norman: We've seen Gold Prices recently move back to the high that we saw in 1980 at $850 an ounce. There seems to be a lot of momentum and a lot of people wanting to own gold now. What do you think is driving this move and what has pushed it so far to this level?

Joe Foster, Gold Strategist, Van Eck Global: We've been in a bull market since 2001. Gold started down around $250 per ounce at that time, and it has more than tripled since then. The big driver has been the falling US Dollar. Investors are losing faith in the US currency, and that's been causing them to move to gold.

More recently, the credit turmoil, high oil prices and the whiff of inflation have been additional factors causing people to invest in gold.

Norman: Even though gold is above $850 per ounce, a historic high, if you look at it in constant dollars it is actually far below the level we hit in 1980. Right?

Foster: Actually, if you take the high of 1980, which in itself was a bit of a bubble, that high was over $2,000 an ounce in 2007 money.

Norman: I personally got involved in gold in 2001 and 2002, when gold seemed like a no-brainer to me at that time. It was trading far below the cost of production. Do you get a feeling at all that now there is somewhat of a speculative aspect to the market? Has the gold market gotten ahead of itself?

Foster: It goes in short-term cycles. Gold does get overbought and it has been overbought in various periods in this cycle. But when you look at what's driving it, what's going on in the credit markets right now is unprecedented.

We have the Fed easing at a time when we're seeing inflationary pressures in many countries around the world. So I think you can justify these high Gold Prices. In my mind, I think we can target higher prices going forward.

Norman: How much of current gold demand is due to real industrial demand like jewelry fabrication, and how much of it is due to speculative or investment demand?

Foster: Most of it is demand for jewelry and fabrication, roughly 70%-75%. The other 25%-30% would be investment demand. I would add that when you get into bull markets like we are experiencing now, it is the investment demand that drives the Gold Price.

Norman: You mentioned central banks and I know that central banks still own a lot of gold. Do they have the power to stop this rally at any time they want? And would they do something like that?

Foster: Well, the attitude is changing among central banks. The European banks have been the big sellers and they have an agreement in place not to sell more than 500 tonnes per year. They failed to meet that quota last year, and the year before. So the central banks are net sellers, but they're less willing to sell than they have been in the past.

Norman: Tell me a little bit about gold stocks, because some of the gold stocks, at least until recently, haven't kept pace with the price of the metal. What's the disconnect there?

Foster: When you say the gold stocks have lagged behind, it's mainly a few companies that are having difficulties with cost and difficulties growing productions...that haven't invested enough in new developments...those are the companies that are underperforming in this cycle.

Norman: Oil...We take it out of the ground; we burn it; it's gone. Gold is mined. Every ounce of gold that was ever mined since the beginning of time still exists. I mean, that supply is still out there. Why is it going up?

Foster: Well, it goes back to the fundamentals of why people invest in gold. Gold is not a commodity like oil, or copper, or other metals, or wheat or other soft commodities. Gold is a hard asset. It's hoarded, just like stocks are hoarded or bonds are hoarded. It's a financial asset, and the role of gold in the financial system is to act as a hedge against financial stress.

Norman: Who are the main consumers of gold right now? Are we talking about the Chinese? Are we talking about India?

Foster: Yes, we're seeing strong emerging economies around the world that have an affinity for gold; places like India, China, Turkey, and the Middle Eastern countries. We're seeing strong demand out of those areas, and that's a function of their strong economies.

Norman: In your opinion, do you think gold could ever fall back again to the mid-$200 range, or is that like saying, hey we're not going to see a $5 per barrel oil again?

Foster: It's similar to that, although even more so in gold. Because of the rising commodity crisis, the costs of fuel, steel and chemicals have all gone up. So the cost to produce an ounce of gold is getting close to $400 per ounce. At $250 per ounce, if we were to ever go back to those levels, you'd see the gold industry virtually disappear.

Norman: Historically, gold has underperformed stocks as an asset class. But do you think that's now at the point of changing?

Foster: These things go on very long-term cycles and yes, gold has a lot of catching up to do. We're in the midst of that catch up right now. The last big cycle like this that we saw was back in the 1970s. Prior to that, you have to go back to the 1930s. These are very long-term cycles and gold is playing catch-up right now.

Norman: In this current run that we've seen so far – let's date it going back to 2002 – where are we in terms of this run? To use a baseball analogy, is this the eighth inning, the ninth inning, or what do you say?

Foster: I don't think we're half way through the game yet. I think we're around the fourth inning, and the reason I say that is there are still tremendous imbalances in the world global economy that need to correct back to normal levels.

You know, the trade deficit, the level of debt, the imbalances in the housing market, and the credit market bubble...There are so many imbalances that are going to take a long time to get back to normal levels.

Norman: The Fed right now is in a rate-cutting mold, so that's supportive of the gold market, correct?

Foster: What that does is bring an inflationary element into the Gold Market with high commodities prices. With the Fed easing, there is a real threat of inflation around the corner now.

Norman: So put a number on it: Do you think we can see the $1,600 per ounce level in this leg of the bull market?

Foster: I think so. If you give me, say, a three-to-five year time frame, then yes – if some of these imbalances don't come back to more normal levels, I think we can see those types of numbers.

Norman: And especially if we use oil as a bellwether that has hit its all-time high on an inflation-adjusted basis. Is there a linkage between oil and gold?

Foster: Fundamentally, there really is no reason for gold to correlate with oil. It had a strong correlation in the 1970s because oil was creating inflation and inflation drives gold. So again, in this cycle, I think if inflation comes into the picture, you'll see that correlation come back.

Norman: Right now, clearly this is on the minds of investors, and as I said, there seems to be a lot of momentum. You definitely don't want to stand in front of a market that has a lot of momentum.

Foster: That's right. And, yes, especially at this time of year, gold has a seasonal pattern and we are in gold's strong season now, so we should see continued strength.