Falling market opportunity 1: Gold investments in $AU

This does not happen very often: Gold prices are surging. The metal, the ETFs and the shareprices of gold stocks are bouncing higher. Moreover, it's in non-US dollar regions where the upside is kicking in most usefully. In South Africa, rand gold just beat its all time high of 19,000 rand and in Australia we are getting very close to a breakout.

Yesterday (Tuesday February 9), as most share prices tumbled, the Australian dollar gold price came with $12 an ounce of setting a new record when it reached $A1712/oz, seemingly on the way to topping the $A1724/oz reached in October, 2011.

The South African experience is more dramatic than Australia's because it has a much weaker economy which is reflected in a 40 per cent collapse in the value of the rand over the past 12 months, whereas the Australian dollar has fallen by 9 per cent over the same time.

The effect of the local gold price rising yesterday to within sight of a record had a significant effect on Australian gold mining companies.

*Newcrest, the local leader, rose by 8.2 per cent to close at $16.80, down slightly on a 12 month high of $16.83 reached in early trade.

*Northern Star, another favorite, performed a similar trick, setting a new 12 month high of $3.71 before closing at $3.63, up 7.7 per cent on the day.

*St Barbara added 10 per cent to close at a 12 month high of $1.76,

*Regis did best of all, rocketing up by 12.3 per cent to $2.83.

Share prices: Regis Resources, Northern Star and St Barbara Ltd., YTD.

Overall, the ASX gold index was the only index in green, rising by 7.8 per cent as stocks in every other sector fell, dragging the all ordinaries index down by 2.3 per cent. The gold index was down today (Wednesday February 10) but the lion's share of the 7.8 per cent rise has stuck.

Over the past 12 months, as interest in gold has been slowly returning, the ASX gold index has risen by 28 per cent, a dramatically better result than every other major index such as the all ordinaries (down 15 per cent), the financials index (down 20 per cent) and the energy index (down 37 per cent).

Much of the local increase in gold and gold stocks is a result of the currency effect, something I have been following closely, most recently on January 20 (click here: read Gold shines through in tough markets).

Interestingly, the Australian gold price in that story of just three weeks ago was $A1587/oz, the best part of $A100 less than the latest price of $A1681/oz, a rise of 6 per cent.

All investors know that historic performance is not necessarily a guide to future performance but the appeal of gold as part of a portfolio is the way it acts as a sheet anchor, and a buffer against local economic and political events.

Back in 2011, there was a worldwide rush for investment safe havens with investors shifting funds into gold lifting the price as high as $US1895/oz on the London bullion market.

Locally, that record US dollar price was offset an exchange rate at the time which was close to $US1.10.

Today, it's currency doing most of the driving (but not all) in the Australian gold market with the exchange rate sitting at around US70c and the US dollar gold price bouncing off last year's low of $US1049/oz to trade earlier today at $US1189/oz, down from a peak of more than $US1200/oz yesterday.

What happens next is the question which every investor asks of every asset class and with gold the answer is never clear because of those twin drivers – demand for gold in the international market where it is traded in US dollars, and currency movements which could either be the US dollar rising or the Australian dollar falling. (To read more on the technical aspects of the gold pric,e which is showing support but no clear signal of a break out, click here for Michael Kahn's view in Barron's this week).

In the US dollar market for gold, it is uncertainty about global growth, the economic slowdown in China, and fear of a recession in the US, which has investors on the run.

Just how fast they're running can be seen in the rush back into gold with an estimated $US4 billion invested in exchange-traded gold funds over the past three months, bringing to an abrupt end the exodus from gold-backed ETFs over the past three years.

Last week alone there was a 4 per cent increase in the funds invested in the world's biggest gold fund the SPDR Gold Trust, the fastest rate of inflow since 2009, lifting gold under its management to more than 500 tonnes.

What's more, those gold-backed ETFs are rising quickly: The Market Vectors Gold Miners ETF is up 40 per cent since the start of this year.

For Australian investors with an interest in gold it is important to separate out the driving forces of the gold price itself and the value of the local dollar.

A test of that situation is to consider the gloomy view of gold held by one of the world's leading investment banks, Goldman Sachs.

Despite the recent rise in the gold price to almost $US1200/oz the Goldman Sachs view is that gold will retreat back to $US1100/oz in three months, $US1050/oz in six months and $US1000/oz by this time next year with each step down matched by three upward moves in official US interest rates.

Needless to say this negativity on gold is offset by relative optimism on the global economy, with Goldman Sachs suggesting the world is not heading for a recession: The investment bank's chief economist Jan Hatzius has just issued a core prediction that the risk of global recession is just 25 per cent over the next year – that's less than the historical average of 28 per cent.

Meanwhile, US interest rate rises are expected to be 0.25 per cent at a time, which means the US could end the year with an official rate of 1.3 per cent, and each step up making gold less attractive as an investment because in its physical form it does not generate income.

If Goldman Sachs is right with its interest rate prediction, which is based on an assumption of continued strength in the US economy and a rising value of the US dollar, then it is possible that the Australian dollar will come under fresh pressure, underpinning the local gold price.

If, for example, the Australian dollar ever re-tests the low of less than US50c reached before the resources boom, then the effect on the local gold price could be substantial.

Tipping what might happen with gold or the dollar is not the way to treat exposure to gold which is best seen as an insurance policy against government policies and, in the case of Australia, as an investment to offset the country's deteriorating terms of trade and weakening budget outlook.

For Australian goldmining stocks, 2016 should be an interesting year as can already be seen in the sharp upward price moves of the sector leaders and the trickle-down effect to mid-tier and emerging gold producers such as Gold Road Resources, which has moved to within sight of developing its first mine.

Despite an estimated capital cost of $A455m and an extremely remote location in central WA, Gold Road's Gruyere project has strong financial fundamentals which include a forecast average cash cost of $A912/oz, implying a handsome profit margin of more than $A700/oz at the current gold price.

What's happening with gold is an interesting turn of sentiment. Having been off most investment radar screens for at least three years there are signs of gold making a return, at all levels of the industry from exploration through to production.

Whether investment banks are ready for the revival is another question because most have downsized their resources research desks – which, in turn, means clients are not being told about the gold revival.