gold: the barbaric relic shines

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    Like us all I try to get all sides of the picture re Gold but Trevor Sykes in todays AFR doesn't do his reputation any credit with the following journalistic lowpoint.

    The research with JP Morgan is a classic...

    Gold: the barbaric relic shines again but the glow may not last
    Feb 8
    Trevor Sykes

    It's been lovely watching the gold price soar, but it may have gone too far too fast. Several of the factors that drove gold to a peak of $US387 an ounce on Wednesday night appear to be running out of steam and it was already back to $US370 the following night.

    War. The looming Iraq war is the biggest short-term factor. Rather surprising, because for a long time gold seemed to have lost its traditional role as a safety investment during times of crisis.

    Of course, there must be many Iraqis who believe that a bar of gold is a better asset than Baghdad real estate, but one would not have thought they amounted to a large factor in the international gold market.

    Iraq's neighbours may have bought some gold, though. One of the least commented aspects of the likely war is the relatively mild objections by other Middle East nations. There have been more reports of protests in Sydney against an Iraqi war than there have been from places such as Egypt or Syria. They know Saddam and don't mind if he cops a hiding. And once again, Australia's soft left are, effectively, supporting a dictatorship against a democracy.

    The impact of the probable war upon gold are essentially psychological and therefore unmeasurable. But if a war is short and sharp (the possibility everyone's praying for) then the impact on gold might be the same.

    Interestingly, the gold price dropped $US10 an ounce immediately after the US Secretary of State, Colin Powell, spoke to the UN Security Council on Wednesday night - a speech that seemed to make war more likely rather than less.

    Devaluation of the $US. The rise in the gold price is partly linked to the devaluation of the $US. Analysts who decry gold as a barbaric relic hate this argument, but it seems to work.

    Taking January 2002 as a starting point, gold was then $US276.60 and the $US was trading at 0.886. On Thursday night gold closed on Comex at $US370.70 and the $US was trading at 1.084.

    So over the past year the $US has devalued by 22 per cent against the euro and by 34 per cent against gold. So there is a rough symmetry between the $US, the euro and gold as the world's major currencies. Assuming that the relationships were right at the start of 2002 (an assumption that is almost certainly wrong), that would argue gold has overshot and its right price should be somewhere around $US335 ex-war panic. Incidentally, at $A626 gold is at its highest in $A terms since the start of 1988.

    Hedge book rundowns. A large reason for the rise in gold price in the second half of calendar 2002 was the fact that producers were running down their hedge books.

    They were led by the US gold miner Barrack, the world's largest hedger. Barrack had decided to reduce its book by some 1.25 million ounces to 12 million, which effectively took the equivalent amount of gold out of the market.

    Deutsche Bank's global gold analyst, Peter Rose, says the gold price has now risen so far that producers can make more money delivering into the spot market and so are not delivering against their hedge books.

    Rose says Placer is marginal with an average hedge price around $US370, but that most other majors are delivering into the market. Barrack's hedge book is based in Bermuda so that profits don't attract tax, but the corollary is that losses don't get tax relief so Barrack seems to have stopped reducing its hedge book.

    Short covering. Gold conspiracists keep saying Wall Street has an enormous gold short position which it has to cover - particularly JP Morgan. When this writer checked that with JP Morgan in New York a few months ago, the response was, "bullsh!t". Not a technically detailed response, but one which accords with the market gossip that the big short positions in the US were largely run down some time ago.

    More important might be the call options sold by some of the big producers. Many of those are reported to be out of the money, so it could be that the fundies are covered but the miners aren't.

    Lacklustre markets. As Stephen Wyatt reported in The Australian Financial Review on Thursday, the equity and fixed interest markets have been so uninspiring that fund managers have been switching into commodities. This has undoubtedly happened but a few of them must be pausing now that gold has enjoyed a 75 per cent rise in 13 months.

    Central bank sales. One of the great bogeys of the gold market in the 1990s was the sales by central banks, including the Reserve Bank of Australia. Last calendar year the banks dumped 430 tonnes on the market, but more than one-third (about 150 tonnes) was mopped up by other central banks in China, the Philippines and Venezuela.

    Central bank sales are continuing but seem a muted force as far as the gold price is concerned. Apart from anything else, those selling gold can't have a lot left.

    India. The black spot of the gold market. We are now in the Indian wedding season which traditionally is a great demand period for gold, but this year the demand is restrained. The rupee has devalued slightly against the $US over the past year so the rupee price of gold has risen by nearly 40 per cent over the past year.

    Japan. The great bull market. The reason gold took off early this week was heavy buying in the Asia-Pacific market, out of New York time. The big buyers were the Japanese and nobody really knows why.

    Rose says his personal theory (not Deutsche's) is that there are two war prices for gold. The first is Iraq, but the second one is a fear by the Japanese that war may be looming in North Korea.

    This is the real wild card: not a one-war panic on gold, but a two-war. On the present scenario, North Korea will have to stand in the queue behind Iraq, but someone in Japan thinks it's going to happen anyway. Even when gold was having its overdue correction on Thursday, Japanese support was still strong around $370.

    So while gold is likely to retrace a bit, the downside looks limited.
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