GOLD AGAIN FIRMLY IN LIMBO
Some of you will remember as fondly as I do one of the most spectacular calls on the market--and trades--that I've made in a long time. I had been making the case for a big move in the price of gold for many weeks prior to last September's issue. In there, I stressed ". . .my growing belief that the gold market is not only grossly oversold, but has the potential literally at any moment to spike so dramatically to the upside as to not only make those who anticipate the move much wealthier, but quite possibly roil all other world markets in the process."
It was soon after that gold's run from its low of around $252 per ounce received a boost from a favorable auction result out of the United Kingdom. The yellow metal really took off next after the so-called Washington Agreement, where 15 European central banks--including the European Central Bank itself--agreed to a cap for the ensuing five years on official gold sales and leasing activity. With the most substantial weight having thereby been removed from its shoulders, gold prices were off to the races.
Quickly, hedge funds, bullion banks and at least two major mining companies--Cambior and Ashanti Goldfields--were drowning in an ocean of paper losses. These and other players were so heavily on the short side of gold that the sudden price surge was moving increasing numbers of bettors into having to sell other positions in stocks, bonds, currencies, interest rate bets and the like in order to cover their derrieres where gold was concerned. The miners had sold forward substantial production in the $275 per ounce area; the higher gold rose, the more their hedge books were a drag, threatening insolvency for both companies. The investment speculators had invested the proceeds of gold sold short in various other contracts which were now being broken. The world’s financial mechanism and most markets were a few days from implosion.
On October 5th--for the second time--the New York Fed added massive liquidity to the market in the form of physical gold and gold loans. Seeing that the Fed itself understood the urgency of the situation and simply could not allow gold to go any higher, I recommended that day that you sell the various options contracts on gold mining shares that I had recommended a scant three weeks earlier. The result was that we more than tripled our money by getting out on the day that gold hit its intra day high of $340 per ounce.
As we were safely on the sidelines again, the usual suspects were simultaneously hysterically promoting gold in various forms to their victims. Of course, Y2K fears were adding to the alleged "case" for gold which had seemingly been bolstered by the sudden volatility. While conceding that a modest amount of physical gold bullion (not to mention silver, tobacco, food, booze and toilet paper) might be okay to hold in case the world did come unhinged significantly, I nevertheless cautioned against putting too much faith in gold. In fact, I warned often that gold would be in renewed trouble once we entered the year 2000 if I was correct in my belief that the financial markets and economy would still be functional. Sure enough, many of the people who in the many months prior to the end of the year who had bought physical gold as insurance, turned around and started selling it as unnecessary.
Gold did manage a brief spike in February when a few major producers, led by Placer Dome, announced that they were cutting back on their hedging programs. But with that exception, gold has relentlessly trended downward all this year. As I expected some time ago, the $280 per ounce level refused to hold--and at this point a break below $270 would not surprise me.
It goes without saying that this shabby performance during a year which has seen oil prices soar, inflation expectations rise, and the stock market suffer its first significant, prolonged interruption in recent memory, is an enigma to gold bugs. However, it should not be. The very same indicators I relied on a year ago that suggested a big (though ultimately temporary) upswing was in the cards, now reveal that gold will not be moving significantly one way or the other any time soon.
CENTRAL BANKS TO BECOME AN EVEN BIGGER GOLD SOURCE?
Paradoxically, the very same central bank agreement which last year caused temporary joy for gold investors, is now looked at just as much as a new weight itself. With trading and investing activity in gold--while still stretched and vulnerable--having slowed down throughout this year relative to the pace of 1999, the average of better than one ton of gold per day coming to the market looms large. Many in finance are now viewing last year's agreement as having more overtly institutionalized the central bank selling of--or "disinvestment" from--gold, which could continue for several more years. In this thinner trading environment, the bi-monthly sales of gold by the UK in particular have become an easy mark for traders who can safely take short positions on any strength prior to the sale, knowing that a trend has emerged where the price at auction is almost never more than the current London fix.
With the abetted failure of gold to mount any sustainable rally on top of either of the two significant blips of the last twelve months, the debate has once again begun over just how much gold central banks want to hold onto. The fact that there is renewed talk as well about the United States possibly selling off some of its reserves is that much more unsettling. At the least, policy makers here are beginning to encouraged faster central bank gold sales than even those announced last year.
At an International Precious Metals Institute conference in Williamsburg, Virginia in June, an economist with the Fed unveiled a report that served as the most serious jolt yet for gold bugs.
It stated that a "speed-up" of central bank bullion sales and a slowdown of mining by gold companies would benefit both individual countries as well as users of the metal, such as jewelers.
"The role of central bank gold is diminishing," Dale Henderson, an international economist at the Fed, told the gathering in making the case for, ultimately, a complete divestiture of gold, much the same as the western nations years ago sold off their "strategic" stockpiles of silver. He said that banks should sell gold reserves, because "the benefits outweigh the costs of selling."
This is a familiar refrain, of course--and is not helped by gold’s inability to attract support.
The Fed report was surprisingly aggressive, though, in suggesting that increased central bank selling could take the place of new mine production for some time. Central banks at the end of last year reportedly still held about 33,490 tons of gold in their vaults--enough to keep the jewelry industry supplied for 11 years, according to the International Monetary Fund. Jewelers are the biggest users of gold, accounting for more than 80 percent of demand. Some theorize--and the Fed report seems to be lobbying for--a drastic decrease in mine production which will cripple the mining industry throughout the world, all so the banks can get the best price as they finish selling off their gold in the coming years. No doubt environmental issues will be brought to bear as well into this equation to help make this case.
Whether such a bold plot succeeds is dubious; it must be remembered that one key reason for the Washington Agreement a year ago was the plight of African mine workers who were losing jobs left and right due to low prices. In this case, political correctness and such will probably never allow something apparently envisioned by Mr. Henderson to come to pass. Nevertheless, especially with investment demand for gold being all but absent as a demand factor that could tip the scales in the bullish direction, the central banks clearly have the upper hand for the foreseeable future--and gold’s fate, one which will see it mired at present or even slightly lower levels for some time, appears to be sealed.
One wild card here, too--with the obvious willingness of at least some to sacrifice miners--and their employees--anew in order to get the best deal for central banks in selling their gold, don’t think that the banks’ gold hoards would survive a currency crisis. Namely, I have the Euro in mind--if the first round of intervention just taken does not work, you can expect to see gold proceeds from various quarters used to buy Euros, if necessary.
CAN ANYTHING HELP GOLD?
It is obvious to everybody now--or should be--that most of the traditional events that formerly caused gold to go up no longer have an influence. This is chiefly due to the changed perception of gold by the marketplace; a perception that I have been talking about for years, but which the self-serving gold mavens ignore or cover up. So, let me spell it out again. GOLD IS A COMMODITY. PERIOD. In order for gold's fortunes to change, the amount of gold that is consumed must rise more than the available supply, just as with any commodity.
As for that second element, there is some hope in spite of the previously mentioned institutionalization of central bank sales. One benefit of last year's near carnage is that some of the more irresponsible hedging activities received a bad name, and have been curtailed somewhat. At the same time, gold producers appear to be a bit more willing to give rallies a chance before they short circuit them through forward selling. (I am still doing some homework on this area, and I should add that there continue to be significant short positions outstanding.)
As with the diamond situation these days, where DeBeers is attempting to help sagging diamond prices by embarking on a marketing campaign, the gold industry is doing likewise to help its own commodity’s standing. Marketing efforts are currently being led by the World Gold Council, some of which I've discussed previously. The WGC is particularly hard at work to help modernize and streamline the jewelry industry in India--a nation which accounts for better than one quarter of world demand, and will no doubt continue to be a reliable anchor for increasing demand in the future.
Frankly, the best scenario for gold is if the current economic uncertainties and imbalances begin to be conquered by the central planners. If what follows is a more concerted and more organized global expansion where the US can continue to play a leading (if somewhat diminished) role while Europe and Asia catch up, commodities of all kind can benefit, including gold. New wealth will continue to increase, and those "luxury" industries which do the best job at marketing will gain larger shares of people's disposable incomes.
What will certainly not help gold are fears of recession, for with them will come lower prices for commodities. Nevertheless, I continue to read promotional materials from gold peddlers insisting--again--that an end to America’s long bull market and economic expansion just has to translate into higher gold prices. They’ve been wrong on this for so many years now you’d think they’d give up.
About the only bad scenario economically that might help gold would be one that is truly cataclysmic--a Financial Armageddon. If the dollar bubble were to burst spectacularly, other currencies and markets would surely follow--though in the end maybe not in direct proportion. What would have to occur here is a sea change in the public’s very perception of money and trust; an historic shaking of faith in the credit and paper money regimen that had led to a complete annihilation of the world’s economy. As newsletter writer Jim Grant correctly pointed out in an op-ed piece in the July 10 issue of the Financial Times, "The flip side of investors’ persistent lack of interest in gold is an unquestioning faith in (fiat) money." Only when this faith in today’s banking and credit regimen is shaken in an almost unprecedented way will gold have a chance to
stage a comeback as a monetary asset--though at this moment the odds against that are long.
IS THERE ANY HOPE LEFT FOR INVESTORS?
Following my recommendation last October 5 to sell your option positions in gold stocks and half your positions in the equities themselves, the equities--while occasionally bouncing around enough for the traders out there to make some money--have generally languished. Frankly, I have kept these remaining positions recommended as much out of habit as anything; and also because it’s usually proven historically that pops come frequently enough to get back out whole.
At some point, we will probably see a decent rally again; I would first look for this if the actions being taken to bolster the Euro begin to bear some meaningful fruit. As you know, the strong dollar has been as relentless a bane for gold as have central bank sales; a prolonged period of correction in the dollar’s value might give us enough of a rally to profit from.
Apart from this, we must look at gold mining companies in the same way as we would companies in any "Old Economy" industry facing tough times, and stick with the bigger companies whose economies of scale can keep them profitable, and/or whose strong cash flows can enable them to buy smaller competitors on the cheap. At the same time, of course, we’ll want to single out the most likely takeover targets that--even in this dour environment--can fetch a nice premium over their present price (I continue to strongly believe, for example that Claude Resources is one such company.)
If in the near future things don’t look as though they’ll coalesce for a rally before year-end, I will likely recommend some tax selling of our remaining positions, except for Claude.
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