IS GOLD STILL A GOOD BET?

Alfred Wong, fund manager for the UOB United Gold and General Fund and the United Optimix Gold & Resources Fund shares his views on the outlook for gold price.

The meteoric rise in gold prices have left many wondering if the precious metal will head further north?

In the short term, a lot will depend on how the Iraqi deadlock unravels. If a war breaks out, gold prices could head towards the US$400/oz mark after the first salvo is fired. A quick 5-10% retraction could follow once fighting gets underway, based on what happened in 1990 when Iraq invaded Kuwait.

In the event of a quick and decisive victory by the US, we could see gold pulling back to US$330-350/oz with good support seen at US$300-320/oz.

On the contrary, a prolonged and demoralising war, (which some estimate may cost up to US$1 billion a day), could take a toll on US external and fiscal balances. More significantly, it could have adverse repercussions on consumer/business confidence and spending. The consequent weakness in the US dollar could push gold higher towards the US$400-420/oz mark. Historically gold is a beneficiary of US$ weakness.

Even if there is no war or a quick and peaceful resolution, the underlying fundamentals for gold are still positive.

In the past, speculative short selling had depressed prices. Speculators could borrow gold at low lease rates, sell them and lend out the proceeds for a good profit. But this is no longer the case because interest rates have come off sharply, making it unattractive for speculators to short sell gold. With deflation looming in the horizon, it is unlikely that interest rates will rise sharply anytime soon. Rates are currently at 20-year lows and in such an environment of low to negative short term US real rates, gold has done well.

Despite the high gold prices, it is encouraging to note that we are not seeing evidence of producers taking the opportunity to sell forward or hedge their production (which would usually be the case). Producers have either been delivering into their hedges or reducing it to leave more of their reserves unhedged and exposed to reflating gold prices. This is evidence of their conviction that higher gold prices are here to stay.

Central bankers have also been changing their attitude towards gold. Since the September 1999 Washington Agreement on Gold (WAG), central banks have been orderly in their disposal of gold. With the gold industry emerging steadily from its trough, central banks may become more reluctant to dispose their reserves as gold is no longer seen as a depreciating asset but one that's desirable for the keeps.

Gold is also enjoying strong investment demand which goes beyond its traditional use as jewellery. Sales of gold coins - American Eagle, Canadian Maple Leaf, Vienna Harmonic etc, are at record highs. Interest in gold related assets e.g. futures, is also showing strong momentum. Tunover on the Tokyo Commodity Exchange is at a 10-year high while net open non-commerical interest positions on the Commodity Futures Trading Commission is at a 6-year high.

More significantly, three consecutive down years for equities has accentuated gold's allure. We believe gold will regain its asset allocation role alongside traditional asset classes such as equities, bonds, currencies and properties.

Last year, the major currencies also staged a dismal performance against gold. Year-on-year, gold outperformed the US dollar by 25%, the Japanese yen by 14%, the Pound by 13% and the Euro by 9%. As gold is negatively correlated to most traditional asset classes, it has an important role to play in diversification and enhancing portfolio efficiency.

Currently, large institutional investors like pension funds with trillions in assets have limited exposure to gold. If these funds have a shift in mentality and commit some monies to the gold sector once again, this will result in explosive price action for the US$55 billion gold industry which is still consolidating.

One good way to participate in gold is through gold equities. Historically, gold equities have offered a leverage of up to three times that of gold bullion. The UOB United Gold and General Fund is largely invested in gold equities. This award-winning fund has outperformed its benchmark for three consecutive year.

Gold equities currently lag gold bullion and they are still trading at fair valuations relative to their historical bands. So I believe that they have room for more upside if gold prices stay firm.