Oidon Company, Ltd. (OIDN)

[muleofkintire]

And then there is the official sector whose activities are so important to the gold market. The official sector continues to sell physical gold which restrains the gold price. In addition, there has been huge investment and speculative flows into gold derivatives along with such flows into all other metal derivatives. Somehow someone must take the other side in these derivative contracts. In base metals, it is consumers with inventory to hedge and miners and refiners with future production to hedge. But that does not happen in gold. Gold miners hedged in the past to a great degree when miners of other metals barely hedged at all. But now, having experienced losses on those misplaced hedging bets, gold miners, under pressure from share holders, have been reducing their hedges.

If so, who has taken the short side of the investment and speculative longs in gold derivatives in recent years? By process of elimination, I believe it must be, in some way or other, the official sector.

Therefore, I conclude that the price of gold has gone up in percentage terms by less than other metals because it has been restrained by physical and forward sales by the official sector. There are now very large outstanding long positions in gold derivatives by the pensions and the endowments and the private client bankers and the hedge funds. All those investors and speculators will eventually exit the entire metal sector in “revulsion”. Some of these investors and speculators might discriminate; they might regard gold differently than other metals and hold it while they sell the others. But such discriminating investors and speculators will surely be in the minority.

Pensions and endowments have just entered the metal sector for the first time. This sector has never been regarded as a respectable asset class by these investors. It suffers from relative liquidity, high cyclicality, a lack of transparency, poor regulation, and a long history of manipulation. When “revulsion” towards this sector finally occurs these staid institutions will make the same kind of big picture allocation they made when they entered this space in recent years: they will exit simply by reversing those past allocations, by cleaning house of commodities and metal baskets and commodity hedge funds. Gold will not go unscathed.

The same will be true for the hedge funds that have herded into all the metals by way of derivatives. Yes, some will see that gold has different dynamics than the base metals and the white metals. But most of them, caught in the redemption dynamics of “revulsion”, will have no choice but to sell across the board to meet redemptions.

So the odds are that, when the metals liquidation comes, it will adversely impact gold. It is possible that gold will escape such contagion. It is possible to envision a U.S. recession where the Fed panics, the base metals fall, while the gold rises because the dollar crashes. But given the institutional structure and behavior behind the financial inflows into metals in recent years, one has to assume this favorable outcome has a lesser probability, at least initially.

But once the correction in all the metals is well underway, the odds favor an eventual sharp divergence between gold and the other metals. The odds are that, in a price decline in gold, official sector selling will turn to buying as physical liquidations abate, forward short sales are taken in, and some central banks looking to buy will step in.

Nothing like this can be expected in the base metals and even the white metals.

So, after the initial contagion impact gold should diverge from the base metals, driven upward by the eventual abatement in aggregate official supply. While the other metals are buried by the long lagged aftermath of demand rationing and supply encouragement.


http://www.kitco.com/ind/veneroso/feb052007.html

remainder of post at this site... mule