During September, the JSE/FTSE Gold Index had a tremendous run and appreciated by more than 30%, with some of the more marginal producers doing a lot more than that.

Gold itself moved nearly 10% higher and touched $470/oz. Importantly, the rand price is stronger and touched R3 000/oz for the first time since early 2003. It is now some 20% higher than at the beginning of the year, which means there is some desperately needed breathing space for an industry that has been severely affected by the strong rand.

Why has gold run so strongly? On the demand side, there is evidence of particularly strong jewellery take-off on the Indian subcontinent due to strong economic growth and an acceleration in demand from the Middle East following high oil prices. At the same time, mining output is stagnant and likely to fall in the medium term. There is also increasing interest from investors, even though equity market levels and emerging market debt and corporate bond ratings indicate that global risk appetite is still strong. Technically, the price looks set to rise further to $500/oz by early next year.

The gold sector performed well during the quarter, delivering an 8.6% return and bouncing 30% off its May lows. The key driver was a sharp weakening in the rand and some resilience in the dollar gold price, which drove the rand gold price from R82 000/kg to R94 000/kg.

The weaker rand needs to be seen in the context of a resurging dollar, with the USD/euro rate approaching USD1.20/euro, a level last seen in August 2004. The dollar is benefiting from better newsflow, as well as expectations that there will be further hikes in interest rates in the foreseeable future. The greenback's rebound has also been driven by political uncertainty in the European Union and fears that the strong euro is doing serious damage to the region's economy.

The major news in the gold sector during the quarter was the High Court ruling that Harmony's bid for Goldfields had expired. That effectively put to bed the acrimonious takeover battle for Goldfields before shareholders ever got round to voting on the offer. In the wake of the failed deal, Harmony's share price rose sharply when hedge funds, which had gone short Harmony/long Goldfields, closed their positions. Harmony has since sold a 6.1% stake in Goldfields, leaving it with a 5,4% balance. However, the rating agency Fitch downgraded Harmony's credit rating to BBB+ from A-. Harmony has accommodated those shareholders unable to hold its convertible bond post the rating downgrade by announcing a repurchase of 25% of the issue. Harmony also announced a massive restructuring of their Free State operations, during which it will retrench some 12 000 workers to return the company to profitability.

For Goldfields, the main issue remains addressing the potential overhang of shares, with Norilsk Nickel holding 20% and Harmony 5.4%. However, two Norilsk Nickel directors have been appointed in a non-executive capacity to the Goldfields board.

Notwithstanding the weaker rand, gold shares remain expensive and high wage inflation is still putting pressure on the margins of the gold mining companies. That pressure will continue if the National Union of Mineworkers does ask for 20% wage increases in the forthcoming wage negotiations, as speculated.

We therefore continue to manage the fund cautiously, with the largest exposure to the lower cost and more geographically diversified producers like Anglogold Ashanti.

The gold sector recovered during the quarter, delivering a return of 5% as the rand gold price recovered. This was primarily due to the rand weakening by 10%. The gold price continued to move in line with the USD/EUR exchange rate from $411/oz to $442/oz.
Newsflow in the gold sector continues to be negative, with lacklustre results, potential strike action, more mine closures, and threats of further closures. Meanwhile, the hostile bid by Harmony for Goldfields remains unresolved as Harmony has only gathered some 12% of Goldfields shares in its early settlement offer. At the end of March, the National Union of Mineworkers (NUM) threatened that workers at Harmony and Goldfields would strike due to a dispute on living allowances and other issues. While the threat failed to materialise, the tension between the unions and the gold companies is likely to persist as the time for wage negotiations draws nearer. DRD Gold added to the woes of the industry by putting its North West mines into liquidation.
The fund retains its large exposure to Anglogold Ashanti due to its diversification away from the strong rand and the fact that it is insulated from the acrimonious takeover battle between Harmony and Goldfields. We also retain a large position in Goldfields, which might benefit from a higher offer from Harmony or a rival bidder. We do, however, reiterate our caution that gold shares remain overvalued and that the forthcoming quarterly results are likely to disappoint.

The hostile bid by Harmony for Goldfields grabbed the headlines during the quarter. Harmony gathered some 12% of Goldfields shares in its early settlement offer and successfully campaigned, with the support of largest shareholder Norilsk Nickel, to have the Iamgold transaction voted down by Goldfields shareholders. Goldfields shareholders still need to consider whether to accept the Harmony paper offer, with an improved bid a real possibility.
The high profile takeover battle has diverted attention from the fact that the dollar price of gold has enjoyed another relatively good quarter. On the back of the weaker dollar, strong jewellery demand and lower mine supply, the dollar gold price broke the $450/oz mark during the quarter - above its 16-year highs. Speculators have also been rebuilding long positions in gold. Inversely, the rand gold price only moved sideways as the currency strengthened to six-year highs against the US dollar. At current rand gold price levels, the profitability of the South African gold industry remains depressed. The tragic tsunami that devastated several South Asian countries after Christmas is also likely to negatively impact on a region known for its appetite for gold.
The fund retains its large exposure to Anglogold Ashanti due to its diversification away from the strong rand and the fact that it is insulated from the acrimonious takeover battle between Harmony and Goldfields. We also retain a large position in Goldfields, which might benefit from a higher offer from Harmony or a rival bidder. We do, however, reiterate our caution that gold shares remain under pressure due to a strong local currency and that earnings are likely to remain subdued in the forthcoming quarter.