Frank Holmes: What’s Driving Gold?

The Gold Report    January 4, 2006         www.theaureport.com

These are good times for gold investors, according Frank Holmes, Chief Investment Officer for U.S. Global Investors. In a recent webcast, Holmes told listeners: “We have a unique situation where all critical drivers for gold are pointing in the same direction.” Holmes identified six key drivers and talked about why they are all pointing to higher gold prices.

”There are many components here that are driving gold, and they sort of rotate around,” says Holmes. “It’s not linear.”

Currently, we are in a secular bull market in commodities because gold is the ultimate money, says Holmes, and because demand is now exceeding supply. “When paper money is being printed at an extreme rate, gold becomes more significant as a reserve currency,” says Holmes. “It starts to show up in people’s portfolios, and in governments.”

According to Holmes, gold prices are currently being driven higher by:

- Fear of a slowing GDP, which leads to negative real interest rates. Gold is attractive when real interest rates are negative. Currently, there is a global wide fear of a slowing GDP. Historically, when Americans have been concerned about inflation, the price of gold has surged.

- Oil exporting countries are increasing their percentage of gold reserves. There has always been a strong interrelationship between gold and oil, and historically, gold and oil have always moved in the same direction. “With 3 billion people consuming 20 million barrels of oil per day . . . it is more likely that gold will rise before oil falls, because oil won’t fall much,” says Holmes. Russia announced in November plans to double gold reserves as a portion of all of its reserves, from 5% to 10%.

- China, which now has a trade surplus, is increasing its foreign reserve gold exposure. Incomes are increasing dramatically in China, and citizens are becoming big consumers of American and Chinese goods. The new Shanghai Gold Exchange, combined with the liberalization of citizens to freely buy gold and the culture’s affinity toward gold, make gold an attractive asset.

- Low gold prices in the 1990s led to cuts in exploration and falling production – which has ultimately led to a decrease in supply.

- Lower interest rates have curtailed hedging – which also has led to diminished supply.

- The War on Terrorism has resulted in deficit spending and a weaker U.S. economy. The cost of war is hard on a country’s currency, and a weaker U.S. currency always results in higher gold prices.

According to Holmes, the supply side of gold is running at a significant deficit to demand. South Africa, the U.S. and Australia – which combined represent 36% of gold mining supply – have all seen declines in gold production. The world’s largest gold companies can’t find large deposits, and rising energy prices have hurt the cash flow margins of most large producers.

With the key drivers all pointing toward higher prices, Holmes says a gold price of $600 to $650 over the next 12 months is a “high possibility.” (January 3, 2006)

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