How far can the gold price go?

The theme of the past two essays was that it would appear from the behaviour of the gold price that the vaults from where the gold had come to satisfy the excess demand and keep the gold price under pressure are running empty.

A combination of gradually increasing demand and depletion of gold reserves night well be the reason why the gold price has been in a bull market since March 2001. For six months from May 2002 the price was kept below $325/oz, establishing in the process a large triangle on the gold chart – a kind of pattern that in about 80% of cases acts as a continuation formation. When a price breaks out of a triangle, as gold has recently done, it extends the original trend, which in this case is the bull market. T

There is an old rule of thumb that says the extent of the move out of a triangle is equal to the length of the ‘flag pole’ on which the triangle is suspended, i.e. the extent of the trend that leads into the triangle. In the case of gold, the flag pole ended on 4th June at a price of $328 for the PM fix. There are however two possibilities for the base of the flag pole – it could be the start of the bull market after the price bottomed at $256 on 2nd April 2001, or, more conservatively, the start of the steep part of the bull market on 29th January last year, at a price of $278. The two possible values for the flap pole are $72 and $50.

Then there also two possibilities for where the move out of the triangle should begin: some say it should be taken from the point of the break out of the triangle, while others believe the count begins from the start of the leg leading into the break. In the case of the gold triangle, the difference is not large, only $6, between $317,30 and $323,40. So one could use $320 as a compromise level to deliver targets of $370 and $392 respectively.

Projecting from the triangle on the daily chart gives results that fall far short from the $400+ that many believe is possible. Analysts who work with estimates of supply and demand arrive at a level somewhere between $600 and $700 for equilibrium. Others, who proceed from the premise that the price will rise to where sufficient gold can be brought into the market through dishoarding and ‘scrap’ – i.e. sales of jewelry to cash in on the increase in value – to cover the 10-15000 ton short position, think that the price will have to rise to well over a $100/oz before this will happen.

There is yet another school who think that when the dollar really ends up in trouble, the US will have to use its gold to back all cash dollars outside the US or even all of the M1 money supply. Estimates of the price then run up to as much as $18 000/oz, which would make a marriage much more expensive than it is today, unless another material is used for the rings. One problem with this kind of estimate is that many people believe the US authorities no longer have much gold left in the vaults at Fort Knox and elsewhere, which of course makes this calculation meaningless.

With gold having been in a bear market since early 1996 and in a sideways market for some years before that, one has to go to a monthly chart that includes the 1972-1981 bull market to get the kind of complete overview needed to enable a technical estimate of the longer term target. Treating the 1981-2001 pattern as a very large consolidation within a long term bull channel provides two values for the gold price say 15 months from now. An upper boundary for a channel that originates off the top of the 1980 bull market – on the monthly close – sets a target of $850, while a slightly more conservative view has $700 as the level where major resistance can be encountered.

Where would the prices of gold shares be if these projections come to pass? Well, firstly the rand becomes a factor to consider as well, with the possibility that the rand would continue to firm as the gold price moves higher. The last time the rand was at its current level was in July 2001. At that time the rand price of gold was say R2200 compared to the R3000 of today. A mine like Durban Deep was barely breaking even in mid-2001 and is now making R800/oz more than then. Its price has gone from 740cps then to 3500 cps now, with the increase of about 2800 cps in response to an R800 increase in income/oz.

Assume the rand firms to R8,00 and the gold price goes to $400, for a rand price of gold equal to R3200, one can then expect that Durban Deep should add one quarter of 2800 cps to its price, to reach 4200 cps. If gold should go to $500 with the rand still at R8,00, the rand price of gold would be R4000/oz adding another R800 to the projected price at $400. That should take the price higher by another 2800 cps above the estimated 4200 cps to give a price of 7000 cps for the shares – just about double the ruling price.

Similar estimates can be made for shares of other gold mines, taking into regard what their estimated cost of production is. It is of course clear that the lower the cost of production, i.e. the higher the previous or current profit margin, the smaller will be the effect on the share price of an increase in the (rand) gold price .

Of course, these estimates do not take into regard the kind of buying frenzy that may well erupt if the price of gold breaks above say $400/oz. The market value of all gold shares is likely to fall far short of the money heading their way when (if?) that should happen. One can foresee that even the mania would pale by comparison to what will happen to gold shares with the price of gold at $500/oz!.