Second Quarter Volatility

Volatility was the outstanding feature of the gold market in the second quarter of this year. After barely nudging through $500 at year-end, gold sprinted into the $730 area in May on perceptions that global liquidity would continue to expand rapidly. These perceptions quickly did an about face, led by the Bank of Japan’s move to withdraw substantial liquidity from its banking system. Gold fell precipitously, hitting a low of $541 in overnight markets before bouncing off its 200-day moving average, just as it has done in every other major correction since 2001. Recovery has been uncharacteristically swift with gold trading around the $650 mark as this is written.

A chart of the gold price over the past year now looks strangely like that of many of the world’s equity markets and rather similar to industrial commodities. From this it is clear to us at Seabridge that gold has still not entered its most powerful phase when its counter-cyclical character is emphasized. In the past, gold has always enjoyed its best performance when other asset classes are weakening.

Gold strength over the past year seems to be related more to swings in speculative flows in and out of commodities and currencies based upon anticipated shifts in liquidity and inflationary pressures. Thus we have the conundrum that rising inflationary expectations trigger concern that the US Federal Reserve will raise interest rates, which strengthens the dollar and weakens gold. Therefore, rising inflation means a lower gold price - a perverse logic to say the least. And conversely, a poor job creation number means slower growth, a less aggressive Federal Reserve, a weaker dollar and a stronger gold price as well as rising equity and commodity markets. This pattern amounts to nothing more than continuing confidence in central banking.

In our view, gold will return to its historic anti-cyclical trading pattern and take its place alone at centre stage when confidence in the Fed is broken. This is a development we expect to occur in the months ahead as it becomes clear that the Fed is unwilling to impose the higher interest rates and economic pain required to quell inflation. A slowing economy and growing weakness in the all important housing sector may indeed lead to policy easing by the Federal Reserve just as price inflation is rising, unleashing inflationary expectations which de-link gold from other asset classes, especially equities and commodities. This de-linking may involve painful dislocations as it occurs but the result will, in our view, be most rewarding for Seabridge shareholders.