To:John Barendrecht who wrote (475)
From: Stephen D. French Saturday, Jul 12, 1997 12:43 PM
Respond to of 80072
Precious Little Upside - (via this week's Barrons)
Why gold's price has plunged -- and could tumble lower still
Michael Santoli
Table: Central Banks Take Dim View Of Gold
he gold market, desperate to account for the metal's tumbling price this year,
found a villain this month in the unlikely form of Australia's central bank. The bank's
announcement July 3 that it had sold two-thirds of its gold reserves in recent months
knocked the wind from the market, sending prices down violently to 12-year lows of
$314 a troy ounce, 14% below where the metal started the year. For gold holders, it
was bad enough that the consuming fear of central-bank sales was affirmed. Even
worse for market sentiment was that the culprit was Australia, one of the world's
biggest gold producers. What's next, Saudi Arabia switching its government limos
from gasoline to electric power?
But Australia's actions are more a symptom than a cause of gold's problems, and
outright sales by central banks in general have been overdramatized as a looming
supply overhang.
In the first four months of 1997, the period when Australia was apparently unloading
much of its cache, the change in central-bank reserves of the metal was small.
According to the International Monetary Fund, central-bank reserves had ebbed to
897.5 million ounces by April 30 from 906.1 at the start of the year. (In addition, the
IMF, European Monetary Institute and Bank for International Settlements hold a bit
more than 200 million ounces among them, bringing total official reserves to 1.1 billion
ounces - about 30% of all the gold believed to ever have been taken from the
ground.)
And, of course, the market absorbed Australia's dumping of 5.3 million ounces
without even knowing it - not surprising, given that 30 million ounces of gold pass
through the London Bullion Market each day.
The damage from Australia's decision isn't so much in the actual weight of metal
hitting the market, but in reinforcing what the declining gold price was already
suggesting: Gold's role as the ultimate store of value, as a key monetary instrument, is
withering in the current economic climate, making the yellow metal more and more
like any other commodity.
The sales ``call into question the fundamentality of gold,'' says Peter Munk, chairman
of Barrick Gold. ``The allure of gold as the automatic safe haven in a crisis is gone.
It is gone not because of Australia's sales, but Australia sold because it is gone.''
Current prices are below the average global cost of producing gold, making more
than half of the world's mines unable to book a profit on the next ounce they gather.
This surely will lead to production halts among high-cost producers, such as South
African companies. In fact, to gold boosters, this suggests that the recent price action
was a ``selling climax,'' a piling-on by short sellers that will quickly be rectified by the
forces of supply and demand.
But unlike in many other commodities markets, where prices below the cost of
production tend to right themselves once stockpiles are depleted, gold can wallow
below production costs because of the massive inventory stored around the globe.
Virtually no gold, after all, has ever been consumed or destroyed, creating a huge
latent supply that is sent to the market largely through the back door as central banks
lend out their gold to gold producers, which sell it forward. Munk, whose company is
an exception in having locked in an average price of $420 an ounce for its production
through 2000, thus sees no reason gold can't decline below $300 and then stay there
for some time.
Some other producers are at least partially hedged, such as Royal Oak Mines,
which has locked in at $395 an ounce, while Coeur d'Alene stopped hedging as gold
fell. Most North American producers, though, have costs well below $300 an ounce,
giving them some remaining cushion. Newmont Mining, for one, says 1997 cash
costs will be less than $200 an ounce.
Wayne Angell, the former Fed governor and now chief economist at Bear Stearns,
forecast this year's drop in gold prices in a December 1996 Wall Street Journal
article. He now sees the price slipping toward a once unimaginable level near the
$230-$250 it costs the more efficient North American producers to mine an ounce of
the metal.
``The main message of the price of gold,'' Angell contends, ``is that the world's
central bankers are increasingly prone to increase their holdings of U.S. Treasury
notes, relative to their holdings of gold.'' And that is because under the
Volcker-Greenspan regime at the Federal Reserve, ``people have come to see the
dollar as a very stable currency relative to world wholesale prices.'' So, gold is
moving toward an equilibrium point with the low end of world production costs, ``a
process that I presume is already three-quarters done.'' That suggests the price
would fall below $300, as average production costs rise somewhat to meet it, owing
to the need to spend more to tap into increasingly scarce deposits, Angell predicts.
This argument makes gold the flip side of the vaunted ``New Era'' in the financial
markets, in which gradual economic growth and modest inflation foster low interest
rates and rising liquidity.
It's just such an environment that has made investors chase capital appreciation at
increasingly higher prices in the stock market, at the expense of dividend income or
general safety. If current income is disparaged by today's investor, certainly the
concept of preserving principal can only fare worse.
Michael Kosares, president of Centennial Precious Metals in Denver and author of a
book on investing in gold, says he has seen an uptick in demand at his firm from those
relatively few individuals who view gold as ``an asset-preservation instrument.'' Not
surprisingly, ``we have yet to see demand from people who want to buy gold because
they think it will go way up.''
Today's financial markets also have found a way to supersede another of gold's
historical roles, that of inflation hedge.
Smith Barney investment strategist John L. Manley notes that, in the Greenspan era,
the bond market is acting as a high-precision thermostat, attuned to inflation and
expectations thereof. Bond prices drop violently at the mere hint of incipient inflation,
raising interest rates and acting as a governor on the pace of
economic activity. This kind of bond market has helped bring the inflation-adjusted
gold price to the levels of the early 1970s, before investors were trained to expect
ever-accelerating price increases. And it has intercepted the ripples of inflation fears
before they get to the gold market.
One harbinger of the prospects for the yellow metal's price comes from central
banks that aren't selling, but instead are active in making gold loans. To glean an
interest rate of 1%-2% on an otherwise inert asset, central banks lend their gold to
middlemen, who then provide it to gold producers, which generally sell the metal
forward to lock in a price. Angell says: ``Central banks wouldn't be willing to lend
gold out if they thought the price were going to rise.''
Investment demand, or the lack of it, has been gold's key vulnerability in recent
years. Demand from jewelry fabricators and industrial users has been steady, if not
fast-growing, of late. But investment demand in 1995 and 1996 came to only a
combined 3.7 million ounces. This was far below historic levels and wasn't even
equal to the four million ounces of a weak year like 1994, according to CPM Group.
Encouraged by the long bull market in equities, investors today need no new reason
to buy stocks. But with inflation in check, many see no compelling reason at all to
purchase gold.
If gold has lost much of its potency and appears to have no impetus to rise in the near
term, it need not be permanently on the outs - as even the bears will admit. A major
factor in its slippage has been the impressive strength of the U.S. dollar. Any
sustained weakness in the dollar would help gold. One precious-metals trader says he
took to heart the recent comment by the Japanese finance minister - since disclaimed
- that continued strengthening of the dollar might tempt Japan to sell U.S. Treasuries
and perhaps buy gold.
The remark was important, the trader says, ``simply because it put bonds and gold
into the same sentence.''
Make a Clear Statement
Barrick Gold's Munk believes in the eventual success of European monetary union,
which would create a single central bank on the Continent before the turn of the
century and would free the gold market from its current state of confusion. Upon
unifying, the one bank will have to, in Munk's view, make a clear statement on its
gold-reserves policy or forfeit any legitimacy. A hopeful sign, but one that means
perhaps another two years of gold investors looking over their shoulders for the next
central-bank sale.
Certainly, if Greenspan or a successor at the Fed were to lose the zeal for pursuing
price stability, it could give gold a good excuse to rally.
And if much of gold's monetary mystique is gone, making it a truer commodity -
subject most of all to real supply and demand - that may not be all bad over the
longer term. Commodities of all types today are in large part a way to follow the
broad, powerful theme of Asian wealth generation. And gold holds a valued cultural
place through much of East Asia and India as a vehicle of individual savings and
prestige.
Then there is always, when speaking of gold, the force majeure clause, under which unforeseen disaster can provide a great lift to the market. But the historic value of gold as a haven amid global emergencies - as a sort of call option on calamity - seems to have been diluted.
Gold prices, for instance, got only a fleeting boost from the stock market crash of 1987, the Persian Gulf War and other disruptive events of the past decade.
This puts the gold bull in the odd fix of perhaps wishing that things will be different - and worse - next time. And if they aren't, he'll be in an even odder - and more painful - fix.
To:John Barendrecht who wrote (471)
From: Bill Jackson Saturday, Jul 12, 1997 9:56 PM
Respond to of 80072
upwards momentum is seen, at last. Barrick shares went up.
Bill
http://www.siliconinvestor.com/stocktalk/msg.gsp?msgid=1751152
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