eat my shorts andy smith..

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    JOHANNESBURG -- After a short stint as a gold bull following the September 11 terrorist attacks, Mitsui Metals analyst Andy Smith has gone back to the dark side, warning of a impending catastrophe for the gold market.
    In an interview with Mineweb, Smith warned that the glut of macroeconomic explanations for gold’s current strength were “utter nonsense”. “Commentators are having to talk sexy about gold. You can’t blame them, otherwise why would you talk about it at all,” said Smith.

    The timing of the bearish remarks may seem odd, coming as they do at a time gold is primed for another tilt at the key $400/oz level, but Smith is unrepentant.

    He argues that the steady stream of bullish commentary from just about every quarter of the market belies a shaky set of fundamentals for the metal. Viewed in isolation, the 12 percent price rise for gold so far this year suggests a flight to its safe haven status in expectation of the macroeconomic Armageddon many bulls are predicting.

    Not so, says Smith. A look at the broader market, and rises in base metals prices in particular, shows a different picture. “Copper has gone up by as much as gold, tin has gone up by more and cocoa and platinum have blitzed it. It’s not a flight to safety, it’s a flight to confusion,” says Smith. “Nickel’s gone up 128 percent since 9-11 and more than 60 percent this year. Is that telling you that the world’s ending?”

    So why the increase in gold? Smith believes it’s a combination of dollar strength and rampant speculation. “The dollar has raised all the boats. If it’s priced in dollars, it’s going to go up, it’s as simple as that,” he said.

    The view is supported by lacklustre inflows into the gold sector. In July of this year only $3 million found its way into US gold mutual funds, in August the inflows leapt to $82 million and in September gold funds recorded $72 million in new investments. The increase is appreciable, but still too low to convince Smith that gold is at the beginning of anything approaching a secular bull market.

    Casino gold

    “Of the $ 6 trillion under management in the US, how much is going into gold? Nothing. Whatever money is going in is going into options and into the Gold Bug Index, the most geared form of gold buying. The money is not going into physical gold, it’s going into casino forms of gold,” said Smith.

    He says the market is now being driven by a worrying amount of speculation, with punters betting on a higher gold price; the next concentration of options at $400/oz.

    Smith says the current option activity, which has quadruped since the beginning of the year, is a sure fire sign of a looming boom-bust scenario; the prognosis is a good short-term outlook for the price, but the spectre of disastrous long-term consequences for the market cannot be ignored.

    “This may be a bull, but now it’s a rogue elephant,” Smith warns.

    Dehedging the risk

    Ironically it is producer de-hedging - the practice of gold producers buying back forward sales contracts and so contributing to gold demand - that has created potential overhang for the gold price.

    Over the past two years, since the buybacks became de rigueur for gold miners, the gold market has had what Smith says is a generously created ‘floor’, supporting all speculative activity.

    Once gold miners stop, or even slow the pace of dehedging, the fallout could be dramatic – unless, of course, investment demand grows sufficiently to fill the gap.

    “Gold has a derivative time bomb sitting on top of mines buying their own output. At 200t a quarter, it’s the equivalent of another India buying every year and that just can’t be sustained. If that slows by half, it has to be filled up with new investment demand. Where is it?” says Smith.

    Collateral Damage

    For the meantime, though, producers continue to buyback gold to wind up their hedges. Their confidence in the long-term price is doing wonders for overall confidence in the metal, while giving speculators some degree of comfort. Smith says it won’t last forever.

    “My worry is that this option machine gets stuck in overdrive; then it’s going to blow up and then it’s going to blow down. There is going to be collateral damage for the professional community. Whatever pleasure there is at $400/oz, of $450/oz or even $500/oz will be balanced by pain. And there’ll be pain at the end of this, that’s for sure. You can’t ride this monster and get away with your body parts intact,” said Smith.

    The collateral damage, he says, could result if the gold market were to suffer another crash, similar to the one that took the price down to the mid $250/oz level in August of 1999. After a second bloodying, he says banks could decide that trading in gold is simply not worth the candle, robbing the market of the crucial elements of liquidity and credibility.

    Central Banks

    But commercial banks are not the only players at risk. Smith says gold price volatility is also likely to scare off Central Banks, the largest group of gold investors – and so also the biggest threat to price - with more than 30,000 tons of bullion in their vaults.

    “Major cross currency rates have volatility of around 10 percent and gold’s is twice that at 20 percent. They can’t realise any capital gain because they’re hooked into the sales quota, so what use is that volatility? It’s no use,” says Smith.
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