another gold article - by chris temple

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    Chris Temple

    The still-young bull market in gold which got under way early last year has owed its health to a number of factors. For the most part, it has been improving supply-demand fundamentals that have done the trick; after all, any commodity will rise in price when its supply is shrinking faster than demand is consuming the product.

    In gold's case, as I and many others have written, we have a combination of declining mine production, reduced producer hedges and-more recently-increasing investment demand outside the United States. These things have all given the gold price some tail wind, even as jewelry demand has softened in 2002.

    Since mid-year and until gold's sudden spike here in December, the metal's advance had taken somewhat of a pause. Gold mining shares were actually ratcheting downward from their June highs. Far from being a cause for alarm, this showed both order in gold's advance, as well as continuing skepticism on the part of many investors still feeling that gold was irrelevant; or, perhaps, that their hero Alan Greenspan would soon make things right with the stock market again.

    Now, however, we are seeing in the last few days activity reminiscent of the scary short squeeze of late September-early October 1999. Having finally broken above the $330 per ounce level, gold surprisingly made short work of piercing Greenspan's old target of $340. Indeed, in Asian trading overnight, gold traded at one point well above $350 per ounce. Most interesting to Yours Truly is that-so far-there have been no apparent "official sector" attempts to push gold down.

    That the metal so easily pushed above $340 per ounce without intervention (so far) requires us to re-think both our near and longer-term expectations. In addition, we need to go back and put additional weight on a couple of the factors, at least, that have helped to fuel the most recent move.

    Over the last couple days I've conversed with a few different people who, in my view, are the more learned (and less emotional) watchers of the gold market. In particular, I spent nearly an hour chatting with Tom MacNeill of BEC Corporation in Saskatoon, Saskatchewan, a successful private investment firm. Some of you reading this know that his Dad Bill is chairman of Claude Resources (TSE-CRJ) and brother Ken is chairman of Shore Gold (CDNX-SGF), two of my recommended stocks. Tom, Bill and I in particular often visit about the goings-on in the markets; Tom in particular really likes to roll up his sleeves, put on his thinking cap and look for factors that others are ignoring.

    When we spoke yesterday he, too, expressed some surprise at the ease with which gold ran over $340 per ounce. We both wondered aloud whether investment funds might be in the process of "setting up" gold bulls again, as they did in early 1996. Back then, gold sliced rather quickly through previous resistance levels; first $380, then $400. As retail investors became convinced that the move was "for real," they started buying; but, into that strength, the speculators began to take short positions. The rest is history.

    While this is a possible explanation for gold's sudden spike, it is far less likely this time around. Those hedge funds and commodity traders who often do run gold (and other commodities) around for their own short-term gain have too many factors arguing against their taking short positions in gold; world tensions, spiking oil prices, Iraq, revived nuclear reactors in Iran and North Korea, and more. Take your pick. Nobody in their right mind would short gold under such circumstances; further, as with any market move, it is just plain dangerous to "fight the tape."

    What seemed most apparent to Tom when we spoke is that-in stark contrast to the years-long speculation many of us engaged in as to who was forcing gold down-somebody is instead putting pressure on the physical market. Many have documented well the fact that gold's physical market is very thinly traded, particularly in comparison to other financial markets. In such an environment, if you have one or more big players on one particular "side of the boat", it shows. Recently, Goldcorp (TSE-G; NYSE-GG) head Rob McEwen reported how much difficulty he had in getting orders filled for 40,000 ounces of the metal. Apparently, someone else may be having some trouble now, as the spike in the physical market price belies some heavy buy orders. And keep in mind, folks-the buying so far has largely been devoid of retail buying from investors here in the U.S. Were even a modest number of Americans convinced that it was finally time to join in the gold rush, prices might really rise!

    Keep in mind here something I wrote back in the Spring, also; and, that is, that the Fed was ready to accept at least a modestly higher gold price. As I wrote back then-and is even more apparent in light of the Fed's November interest rate cut and the comments from Federal reserve officials including Greenspan himself-the central bank has declared war on deflation. As I'll be writing in my 2003 outlook shortly, it will not have as much success as it would like in that war. But part of any war is propaganda; and the Fed wants it to at least look like the market place is starting to accept the notion that mild inflation is in the future.

    What better way to do that than by having gold go up? On cue, the talking heads on CNBC are pointing to a rising gold price as some kind of "proof" that the Fed's policy of throwing dollars around like a drunken sailor is finally "taking hold." Keep in mind that some leading figures such as Steve Forbes, Jack Kemp, Larry Kudrow and others have all been clamoring for higher gold to demonstrate that the U.S. is not following Japan after all into a multi-year deflationary period. Now they have their evidence; or so they think.

    This notion, of course, is utter nonsense. Adjusted for inflation, gold should be double its current level just to get back to a fair price. How one looks at even $350 gold here in late 2002 as proof of inflationary expectations alone is beyond me. For the most part, the move over the last year and a half or so has merely corrected some of the gross depression of gold's price due to the carry trades and hedging of, in particular, the last half of the 1990's. If gold were to ever really start acting like an inflation (or, more correctly, a monetary) hedge again, watch out.

    It might be starting to do that; at least in the sense that gold is one area responding to the flood of new dollars being pumped into the system by the Fed. Look also if you will at the oil price. Yes, there are troubles in Venezuela; but when you consider that OPEC members have already been producing well above their quotas, the market is really not missing Venezuela's oil. There have been no reports of supply constraints, except for in Venezuela itself. Yet oil prices have moved up considerably in recent weeks.

    Don't blame it all on Iraq, either. On and off for months now, we've witnessed threats, saber-rattling and all the rest. Yet it's only now that oil prices have jumped some 20% in fairly short order.

    Paradoxically, look also at the bond market. Even with the dollar cracking its eight year up trend line, Treasury securities still enjoy robust demand. This shouldn't be happening-but it is.

    I submit to you that all three of these asset classes are performing as they are because there has to be some place to sop up the zillions of extra dollars the Fed is cranking out. These developments where gold is concerned are noteworthy; to the extent that some of these players have moved into gold even temporarily with their dollar holdings, it begins to ratify CIBC World Markets analyst Barry Cooper's thesis of Spring, 2001. Back then, Cooper-in a cleverly-written take-off on the television show "Survivor"-predicted that, eventually, gold would be the only currency left on the monetary island, once even the dollar itself fell under a big enough cloud. It looks to me as though both this commodity and oil have not gone up due only to the fears most evident in the press, but also because some global investors have moved into them in lieu of paper currencies.

    Let's talk about a possible intervention. To the extent that the Fed or other central banks would seek to "cap" gold's price anew, they are now dealing with a much different situation than they were during 1999's short squeeze. Then, they were able to work in a relative vacuum, as gold was not really on the table as a viable investment alternative. Now, though, that sentiment has begun to change. And-just as currency interventions usually fail if they are attempted against the market-so, too, might the Fed be "pissing into the wind" if it tries to counter the kind of strong physical demand clearly evident. However, if the Fed becomes sufficiently nervous over the health of those still deeply on the short side of gold, watch for it to "pile on" to a correction.

    This, folks, is still the one big part of gold's equation that is a relative unknown. We all know that gold's fundamentals as a commodity have improved, and appear to be continuing to do so. Now, we see gold's allure as both a monetary and crisis hedge joining the mix, making an already-bullish picture even more so. Were there no other issues involved, gold would be a "no-brainer"; and long term, it truly is. But-if all the talk of thousands of tons of uncovered short positions is still true-the Fed might move to suppress the rally at some point.

    That's a development that will bear watching. For example, if you were to see still-low lease rates suddenly move higher, that would likely mean that someone is borrowing more gold than normal in order to short it. Such a development would drive down the price short-term. However, given that gold has now demonstrated that $330 and even $340 are not perpetually insurmountable after all, few investors are going to dare to join the short side-and that's especially true now given all the concerns of the world. Thus, even though it served for so long as a ceiling, the $325-330 level will probably now develop as a reliable support level once any meaningful correction materializes.

    BLANCHARD SUIT-The whole issue of a conspiracy to either drive gold down in recent years or to keep it from rebounding as quickly as it otherwise might just took on an entirely new complexion. Yesterday, the big New Orleans-based precious metals dealer Blanchard and Company filed a $2 billion antitrust-based suit against J.P. Morgan Chase and Barrick Gold (NYSE-ABX) accusing them, among other things, of "unlawfully combining to actively manipulate the price of gold" and making $2 billion in short-selling profits by suppressing the price of gold at the expense of individual investors.

    Some of you remember that the Gold Anti-Trust Action Group (G.A.T.A.) had a somewhat similar suit dismissed earlier this year in U.S. District Court in Boston. However, when the judge dismissed G.A.T.A.'s action, it was chiefly, he wrote at the time, on the grounds that G.A.T.A. did not have standing to sue. Since the organization itself could not prove that it had been damaged by the antics of the "gold conspiracy," it had no claim that could be acted on. The judge said, though, that he might be more amenable to considering a claim if it were brought by one or more parties who could prove that they were indeed damaged.

    Who better than Blanchard? This company has thousands upon thousands of customers who have bought gold in recent years. There could very well be a veritable parade of people brought into court who can claim they lost money by buying gold through Blanchard (or anyone else, for that matter.)

    While it was important for someone to pick up G.A.T.A.'s torch who could demonstrate they have standing, there is another big difference in the Blanchard suit. When G.A.T.A. filed its action, it named everyone and his brother as defendants; the U.S. Treasury, the Fed, the International Monetary Fund, the Bank of International Settlements and many more. Blanchard's suit, by contrast, does not seek to so flamboyantly go after every single party allegedly involved in various aspects of the now-defunct gold carry trade game. Instead, it has narrowed its targets to the two players who, arguably, are going to be most easily proven guilty.

    Barrick, as most of you already know, was the king of the hedgers among major gold producers. And it has primarily been J.P. Morgan Chase which has served as Barrick's enabler, allowing the mining giant to construct elaborate hedges that-until recently-benefited Barrick greatly. The trouble is that, at the same time, these hedging practices have endangered the very health of the venerable House of Morgan, who, according to most observers, will be left holding the bag if and when Barrick (which has conspicuously warned of late of production and earnings troubles) defaults on its obligations. And, these practices have served as one of the chief means of artificially driving down gold's price.

    "Since the end of 1987," according to Blanchard C.E.O. Donald Doyle, Jr., "when the collaboration between Barrick and J.P. Morgan began, the growth of global income and wealth would have lifted the gold price to approximately $740 if the price had been able to respond to the normal laws of supply and demand. If gold had kept pace with inflation, the price today would be approximately $760."

    The lawsuit, according to a Reuters release, claims that in the past five years Barrick and J.P. Morgan Chase injected millions of additional ounces of gold into the market - additions that were several times as great as the annual production of every gold mine in South Africa, the largest gold producing nation in the world. By using privately negotiated derivative contracts and concealing the addition of billions of dollars worth of (physical) gold with off-balance sheet accounting, Barrick was able to make it virtually impossible for gold analysts and investors to determine the size and the market impact of its trading positions.

    "The same type of accounting maze that hid Enron's debts made it possible for Barrick to manipulate the price of gold without the checks and balances that come from public scrutiny. As a percentage of Barrick's total assets, its off-balance sheet assets make Enron look like a champion of full disclosure," quipped Doyle. "Is Barrick a gold mining company, or is it a hedge fund with a mine out back?"

    The suit (continuing with Reuters' characterization) alleges that J.P. Morgan Chase financed Barrick's repeated short selling with remarkably advantageous terms not available to others, including deferred repayments and no margin calls. Doyle said the short-sales scheme between the bank and Barrick appears to be the proverbial "money for nothing."

    Cris Temple, editor
    The National Investor

    December 25, 2002
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