Investors wanting to store gold bullion in Swiss bank vaults can forget it. They've been full from July. Since the metal's price started running early this year, there has been a frenzied rush of investors buying gold, pushing it to record highs above US$1 200/ oz. But usually when investors get caught up in the fever of the gold run, it ends in tears.
A decade ago, the UK government announced plans to sell 400 t of gold, or about half its holdings in the metal. It was not alone in that decision. Central banks in many other countries, including Switzerland, Argentina, Australia, Canada and India, did the same.
After a near 20-year bear market (a general decline in the stock market), gold was out of favour. At the same time, public finances in many countries were stressed after the emerging markets crisis.
Mark Cutifani
Bullion (gold bars) sales were seen as an easy way to raise cash.Central bank selling helped push the price down to $252/oz in July 1999. Some Asian countries, particularly China, were buyers of gold at these prices, which were far below the metal's previous peak of more than $850/oz in January 1980.
The gold market looks very different now. After a recession and financial crisis, there is great uncertainty about public finances, paper currencies and future inflation. Investment demand has lifted the bullion price to historic highs above $1 200/oz. China has remained a strong buyer of bullion, adding 454 t to its reserves since 2003 (though it expressed caution about the market this week), but now other central banks are buying too.
When the International Monetary Fund said recently it would sell 403,3 t of its large gold holdings to strengthen its lending capacity, India quickly bought 200 t and Sri Lanka and Mauritius bought smaller amounts. The price surged on the news.
In the commodities world, gold is always a special case. It's partly an industrial metal and is also used in jewellery. Demand from that sector has fallen sharply. But many investors see gold as a store of value - and investment demand is driving up the price.
Marius Kloppers
Other commodities have also had a good run this year. After falling below $35/barrel last December, the oil price has more than doubled to around $80. Copper, the benchmark industrial metal, is close to its trading range of 2006-2007, at $7 025/t. Platinum has recovered to almost $1 500/oz, from below $800 in October last year.
Does this suggest the commodities boom is back? The outlook for this sector is important for investors and SA's exports, capital inflows, growth and, possibly, inflation.
Prices are rising for different reasons. Increased confidence about global growth, and a quick rebound in countries such as China, India and Brazil, has fuelled the recovery of some commodities, including oil and copper. Other positive factors include restocking, US dollar weakness and low interest rates in the developed world.
Uncertainty about the economic outlook and the financial system means prices could retreat quickly if the more positive assumptions about a global recovery turn out to be wrong.
"It would be dangerous to say the higher prices are wrong," says Investec Asset Management (IAM) portfolio manager George Cheveley. "The prices reflect fundamentals as people are seeing them now. But growth forecasts for next year could be too optimistic."
The larger miners are cautious on the near-term commodities outlook. At the BHP Billiton AGM last month, CE Marius Kloppers said the group still believed "we will come out of this recession less strongly than in previous cycles". But he believes Chinese growth will continue and be resource-intensive.
Producers are also focusing on efficiencies and restructuring. Anglo American CE Cynthia Carroll recently announced more asset sales and job cuts, including a layer of senior management.
In some sectors - such as aluminium, nickel and zinc - the hangover from the previous commodities boom continues. Overcapacity created in the good years is still depressing prices. Prospects for the different commodity sectors are mixed.
"There was a high correlation between commodity prices when they collapsed last year. Some of them have moved up together," says Cheveley. "As market conditions normalise, each product's supply and demand fundamentals will be more important to its price."
What's driving this good run? The US dollar weakness and low interest rates in Europe, Japan and the US have played a big part in the commodities recovery so far.
Commodities are mostly priced in US dollars, so the increases reflect adjustments for changes in exchange rates. Another aspect is many commodities are produced in developing economies, whose currencies, like the rand, have rallied against the dollar. This raises producers' costs in dollar terms and pares their margins. It should in theory lead to higher prices over time, depending on industry capacity and competition.
Low interest rates affect capital flows and prices in other markets, as investors may move money into any market that's rising. For now, that includes some commodity sectors.
The dollar, and investors' views on its prospects, only partly explains the recovery this year. Since March, the dollar has weakened by about 20% against the euro. Some commodities have shown greater increases from their lows. Oil, copper and palladium have more than doubled.
Gold is often regarded as a currency play, or a safe alternative to paper currencies whose value is eroded over the long term by inflation. That may be true, at times. An interesting aspect about gold now is that it is rising in many currencies, even the stronger ones, such as the euro.
A fundamental supporting factor for gold is central banks and governments are shifting from being net sellers to net buyers of the precious metal. Demand from emerging economy central banks is driving this shift, triggering a reversal in a decades-long trend of central banks selling gold by their developed economy counterparts, says IAM.
The gold bull market of the 1970s was caused in part by central banks hoarding gold. With central banks likely to be net gold purchasers this year for the first time since 1988, a similar scenario appears to be playing out.
The weakness in real interest rates, with the yield on 10-year US inflation-linked bonds below 1,5%, provides strong support for gold prices over the medium term, IAM says. "We believe investment demand will force a peak [for gold] nearer $1 300/oz over the next six months, with $1 000/oz becoming the long-term floor."
Goldman Sachs is also gold bullish, having just raised its 12-month forecast to $1 350/oz versus a previous $960. But it warns that once the US Federal Reserve reins in its unconventional policies and sets on a tightening path, gold prices may come under pressure.
BNP Paribas adds that inflation expectations in the US have risen and there is little upward pressure on nominal US bond yields, lowering the opportunity cost of holding gold relative to bonds.
Years of rising costs, strong local currencies and production constraints have curbed the benefits of higher prices for the gold mining companies. But the producers, including North American producer Barrick Gold and AngloGold Ashanti also seem to have gained confidence and are reducing or closing their hedge books. Hedges provide contractual agreements to sell gold at fixed prices.
"Our decision to move on the hedge book in July has been vindicated by the run in the gold price to record levels," AngloGold Ashanti CE Mark Cutifani said at the company's September quarter results presentation. "We've slashed the book by almost two-thirds in the past two years against the backdrop of a rising price, and that has generated great value for the company and its owners."
Investor interest in gold is likely to be reflected in other commodity sectors. Investment bank Merrill Lynch points to a historic link between gold and oil and says gold could lead oil above $100/bbl in 2010 or early 2011. It says loose monetary policy and a weaker dollar should put upward pressure on the oil price next year. A cyclical rebound in the global economy, which could be stronger than expected, should lead to tighter physical oil supply and demand fundamentals next year. It forecasts long-term oil prices for 2011 averaging $85/bbl.
As in other commodity sectors, spending cuts in the downturn could influence product prices when growth recovers. The International Energy Agency says concerns persist about the adequacy of upstream spending (on exploration and production) in the crude oil industry and project costs remain stubbornly high.
The price of thermal or energy coal should also rise as energy usage recovers. Merrill Lynch says the market is likely to tighten "pretty quickly" in 2010, as Chinese and Indian demand for coal is growing strongly.
Robust global growth will also boost usage of steel and aluminium, but overcapacity and large stocks may keep prices weak for some time. Some of the products used in making steel, particularly iron ore, metallurgical coal and manganese, look considerably more attractive.
WHAT IT MEANS
 Gold has led commodities upwards
Overcapacity is depressing some prices
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These are the "bulk commodities", sold mostly at prices agreed contractually. Higher prices would benefit Anglo American, Kumba Iron Ore, BHP Billiton and African Rainbow Minerals. "We are very positive about the bulk commodities now," says Cheveley.
China has been the main driver of iron ore demand in recent years, influenced by steady growth in its steel-making capacity. Chinese demand for this bulk commodity has remained firm, as the country has closed many of its domestic iron ore mines, which are high cost and lower quality. The iron ore market is moving to spot pricing, and Cheveley says China may agree on a benchmark price early next year, which would be positive for prices in 2010.
Chinese domestic production of metallurgical coal has fallen after extensive consolidation aimed at improving health and safety. This market could also tighten considerably, leading to higher prices over the next year.
In the platinum sector, demand is linked to global growth, confidence and consumer spending. Prices of platinum and palladium (but not yet rhodium) have risen sharply. The question for investors is whether local platinum producers can improve efficiencies enough to make up for high costs and rand strength.
Commodities remain an attractive play on recovery in the world economy and on high long-term growth rates in large developing economies, particularly China, India and Brazil.
Much of the near-term recovery may already be reflected in prices of some commodities. For others, the upturn is yet to come, and may be slow. But the recent price increases show the sector can still produce good returns, despite last year's collapse - but investments must be chosen carefully.
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