A decade ago, Ian McAvity was in high demand in investment circles. The price of gold had soared to its all-time high of $850 (U.S.) an ounce in 1980, and McAvity, one of Canada’s best known “gold bugs,” was offering ultra| conservative advice on storing the precious metal. Since gold becomes most valuable when society is in chaos, he argued that investors should keep their stash easily accessible-hidden in a comer of their basements or buried under their rose bushes. McAvity, who manages a collection of small gold mines and writes an investment newsletter from his Toronto office, says that he should not have been surprised by what happened next. “In 1983, I had a wonderful garden,” he said. “Then one morning, I woke up and discovered that someone had dug up all my roses.” With no luck, he hastened to add. Now, as gold prices climb and investors pour into the market, McAvity says that he would like all potential thieves to know that the garden is the last place he would plant his hoard.

After more than a decade of decline, gold prices are soaring. Since March, when the

price of gold touched a seven-year low of $325 an ounce, it has climbed sharply to a 16month high of $382 last week. The price of stock in gold mining companies has climbed even faster. Although gold watchers differ about the reasons for the sudden change in direction, a growing number are citing its underlying use as a commodity for jewelry making—rather than its traditional investment role as an inflation hedge—for the price surge. Whatever the reason for the

increase, however, mainstream investment advisers are hopping on the gold bandwagon. A report from Salomon Brothers Inc., an investment firm based in New York City, declared in April, ‘We believe that the price of gold is near a longterm trough and that the metal is poised for a significant rally over the next several years.” That enthusiasm is not universal, however. For his part, McAvity, who remained resolutely opti-

mistic about gold’s revival during a decade of falling prices, is cautious about the recent price surge. “It is too early to declare the beginning of a long-term bull market,” he said, “but there are encouraging signs.” Still, he is not as wary as Montreal investment adviser Stephen Jarislowsky, who says that he may use the current price rise as an opportunity to sell all the gold in his personal portfolio. “There is some kind of buying frenzy going on,” he said, “but it’s all just follow the leader, like a buffalo stampede. Maybe they’re all going over the cliff. I’d like someone to tell me what gold is worth. I just don’t see what it does for you.”

Although the last bull market in gold was driven by double-digit inflation rates, at the moment it is gold’s role as a commodity—its use for industrial and dental purposes, and, primarily, jewelry—that appears to be the driving force behind its upward thrust. The London-based Gold Fields Mineral Services Ltd. report, a comprehensive analysis of the supply and demand factors affecting the world’s gold market, states that the Western world’s consumption of gold for jewelry and other non-investment purposes amounted to 2,859 tons in 1992. At the same time, mine production of 1,841 tons and sales of 66 tons from Communist countries totalled just 1,907 tons. That gap, which in 1992 was largely filled by the sale of gold by central governments, is encouraging some investors to bet that the price of gold will continue to rise.

Although North Americans are still mired in recession and are more concerned with paying off debt than buying baubles, the demand for gold jewelry is strong in such countries as China and India. There, strong economic growth, less developed banking and financial systems, as well as concerns about inflation

and currency devaluation, have converged to create a healthy appetite for gold jewelry. In Asia, many people buy jewelry as an investment. It acts as a kind of portable savings account that does not devalue with inflation like currency or other hard assets. Gold Fields reports that China is now the largest consumer of gold jewelry in the world.

According to Peter Cavelti, a Torontobased investment adviser who manages three precious-metal funds, the recent surge in the price of gold is noticeably different than in past cycles. Historically, Cavelti noted, the price of gold would go up towards the end of an economic boom, as demand for jewelry and anticipated inflation mounted simultaneously. Towards the end of a recession, the phase that North America and Europe are now experiencing, the price of gold is usually low and falling. The current surge suggests a new dynamic in the world’s economy, said Cavelti: “It represents a transfer of economic power that’s moving away from the industrialized world towards the developing countries.” However, he warned that the Asian market for gold is highly price-sensitive: if the price rises too high, investors will stop buying it.

Inflation, which has often been cited as the underlying reason for the price increases over the past 20 years, is considered to be a less important factor in this rally. Peter Munk, chairman of American Barrick Resources Corp. in Toronto, told Maclean’s that supply and demand factors are driving gold prices more than inflation fears now. By using sophisticated hedging strategies and by increasing its mine’s production, American Barrick has steadily improved its profits since 1986—even though the price of gold has declined to $380 from $500 during the same period. “I’m not a gold bug, I don’t like gold,” said Munk, turning his wrist to display an understated black leather watch band. “But when I look at the economic fundamentals of gold, it seems to me that prices are heading up.”

Still, others insist that the inflation factor is also at play.

McAvity noted that gold prices

began rising just as Germany’s benchmark interest rates began falling this spring. The decline in those rates signalled that other countries could begin lowering their rates. That, in turn, increased speculation that lower rates would lead to an upturn in economic activity and,

eventually, to higher inflation

rates. In addition, McAvity said

that the new administration in Washington is likely to introduce economic policies that could encourage a rebound in inflation. “The President and her husband are going to burMcAvity added. den the United States in a major way,”

In a climate of low interest rates, gold provides an attractive alternative investment for people who believe that inflation will pick up.

If the pessimistic view prevails, and the industrialized world comes to the brink of collapse because of the dual burdens of heavy government debt and the need for massive economic restructuring to become competitive with developing countries, gold might be the ultimate insurance policy. Said McAvity: “If we were to go into some kind of financial meltdown, it’s not too hard to make the case that gold could be $7,000 an ounce by the end of the century.”

Counterbalancing the case for higher gold prices are two primary factors. Many investors are reluctant to hold onto gold since it does not pay interest. But an even more important issue now is whether central banks will follow a pattern set by three governments last year and continue to sell their gold reserves. In the last year, Canada,

Belgium and the Netherlands sold a total of 700 tons of gold. Many analysts say that dumping the gold—and thereby increasing the supply—resulted in depressed prices.

Some of that gold was purchased by central banks in Asia, which are now building their reserves. By selling part of their gold,

fañada and the other two countries made nassive paper profits: the gold was valued n their books at $35 an ounce, its purchase »rice when the price of gold was fixed by nternational agreement. In addition, the »roceeds from the sales are put into inter■st-bearing investments. The Bank of fañada has earned $3 billion in interest from the investments made with the proceeds of its sales, which began in 1980.

Canada, the only major industrialized country following a formal policy of gradually selling all of its gold reserves, sold 94 tons last year. If it continues at that pace, it will have sold all of its remaining reserves, 318 tons, by the end of 1996. “We are selling our gold for reasons of financial management,” said a Bank of Canada official, who spoke on condition of anonymity. He added: “In today’s world, it doesn’t make a lot of sense to have a lot of gold in reserves. We need a fairly liquid portfolio because we use it primarily for currency intervention.” Such activity includes stabilizing the movement of the Canadian dollar in global currency markets. If the dollar rises too quickly, the bank sells Canadian dollars and buys other currencies. If the dollar is falling too fast, the bank reverses the process.

Central governments around the world hold a total of 29,000 tons of gold reserves, or 15 times the amount of gold mined in 1992. If other governments were to follow Canada’s example, the price of gold could be depressed for a long time. Concluded the Gold Fields report: “It may already be a cliché to suggest that the course of the gold market will depend on decisions to be taken with the world’s central banks about the future composition of their reserves. However, even if the heavy net official sales of last year were to be repeated, there is every reason to believe that they could once again be absorbed without further damaging the world market.” It would, however, increase the global supply of gold and put a downward pressure on the price.

Despite that uncertainty, stock market optimism about gold prices has pushed the prices of shares in gold mining companies even higher—and faster than the price of

gold itself. From its low of $325 an ounce in March, gold has since risen by 17 per cent. By contrast, the Toronto Stock Exchange’s index of gold and silver mining stocks has gained 65 per cent from its low for the year.

Gold share prices usually move in advance of the actual price of gold, whether prices are rising or falling. John Ing, president of the investment firm Maison Placements Canada Inc. in Toronto, says that there are several reasons why many investors opt for shares instead of the metal itself. The prime reason is that an increase in gold prices goes directly to a mining company’s bottom line. As a result, investors can benefit from the investment principle known as leverage— dollar for dollar, investors get higher returns buying shares than they do buying gold when gold prices are rising. Leverage, however, works in reverse when prices are falling. As a result, share owners suffer. In addition to leverage, gold shares are popular with institutional investors, many of whom are prohibited by the terms of their investment guidelines from owning gold bullion. Ing says that U.S. institutional investors have led the current rally in gold share prices. “The Americans were early buyers this time because they were reacting to the election of the new President and the belief that his policies would lead to higher spending, higher taxes and higher deficits,” he said.

Despite the differential between the two types of gold investment, gold shares might still be considered a good buy if, as Ing forecasts, the price of bullion continues to rise. In fact, Ing is bullishly predicting that gold will reach $500 an ounce in the next 18 months. With such glittering prices on the horizon, Ian McAvity will soon be back on the seminar circuit—a little bit wiser and a little bit richer.