Gold's fortunes of course are tied to the US Dollar and for the past couple of months the US Dollar has been trying to bounce after a sharp drop through 2003. Indeed gold stopped rising before the US$ bottomed and therefore it should be no surprise that gold once again has started to rise even as the US$ tries to maintain a firmer stance. Indeed gold made its most recent bottom in early March 2004 and since then is up about $20 and is not far off the highs seen in early January.

Gold prices could be leading the market. In the latter part of 2003 as the US$ continued to fall and gold stocks started their period of softness, physical gold prices continued to rise into early 2004. This divergence was eventually realized when gold prices fell bottoming just below $400 in early March. At the same time the gold stocks failed to put in new bottoms a potential positive divergence.

But since then gold has broken out of a triangle pattern while the stocks are still struggling to catch up. The breakout has targets of up to $450. Further gold has, as our chart shows below, broken out against other currencies including the Euro and the Canadian Dollar. Gold in Yen is in a steady uptrend. This is a very positive sign as while Gold in US$ has been rising since the lows in 2001 the gains in other major currencies had been muted. We have long suspected that in a world of ongoing currency devaluation that gold would eventually begin to rise against all currencies and not just the US$. That process may be getting under way.

There are numerous reasons that gold's fortune is going to continue to rise. Many of them are found in a recent article in Financial Sense (www.financialsense.com) by Jim Puplava entitled "Super Bull". The reasons are well worth repeating.

• Producer hedge books continue to be reduced. None is more notable than Barrick Gold (ABX-TSX, NYSE) (www.barrick.com, 416-307-7470).
• Central Bank sales have been declining. While there are still central bank sales particular from the European Central Banks, there has also been ongoing buying particularly from the Asian Central Banks (China and Japan).
• Reflation, led by the Federal Reserve, and Central Banks, not only in the USA, have been fighting deflation through a program of massive monetary and fiscal stimulus. This has resulted in huge budget deficits in the US and a feeling that the Fed will in any economic slowdown or market meltdown they will come to the rescue. This has resulted in a massive increase in debt over the past year particularly from the consumer who has reached record levels of debt to income and has encouraged spending growth, which continues to outpace income growth. The massive monetary and debt stimulus has contributed to a new mini bubble in the stock market and a housing market bubble.
• The falling US Dollar. Despite a sharp drop in the US$ against major world currencies in the past year the US trade and current account deficits continue unabated. The trade deficit has reached over 5% of GDP, levels higher than in 1987 when the growing trade deficit caused a stock market crash. Charts point to the US$ going considerably lower before it bottoms. The ongoing fall in the US$ has caused Japan and Europe in particular to take unproductive measures to protect their rising currencies setting off a potential round of competitive currency devaluations and trade wars.
• Global gold demand (up 4% in the past year) continues to rise particularly for de-hedging and for investment purposes even as jewellery demand falls. At the same time mine supply (up 1% in the past year) is not keeping up with the increased demand.
• Low negative interest rates (to inflation) have forced investors', particularly institutional investors, to seek out riskier forms of investment in junk bonds, stocks, emerging market debt and through derivative instruments. Derivatives in particular could be an Achilles heal where one-third of global derivatives lie with one institution J.P. Morgan Chase (JPM-NYSE). Rumours persist that there is a potential huge derivatives problem at Fannie Mae (FNM-NYSE) the world's largest mortgage holder.
• The geopolitical scene remains potentially very volatile and dangerous. Unrest has broken out once again in the volatile Balkans area particularly in Kosovo where NATO was involved in a war in 1999. Unrest continues in Iraq where there is little guaranty of security for Iraqis and particularly for Westerners. The Palestinian/Israeli conflict has potentially been raised to a dangerous new level with the assassination of Sheikh Ahmed Yassin of Hamas. Dangerous conflicts continue in Afghanistan and along the Pakistani/Afghanistan border and as well in the Nepal area. The potential for conflicts out of Iran or North Korea remains high.
• There is a limited supply of physical bullion. The gold market remains small compared to paper assets. With global paper assets of some $50 trillion all the gold in the world has a value of about $1.7 trillion. All the bullion companies in the world are still worth under $100 billion with just 4 companies (Barrick Gold, Placer Dome, Anglo Gold, Newmont Mining) making up a good half of that value. If investment demand not only for physical bullion were to increase coupled with an increase in demand for the bullion stocks there is insufficient supply to absorb any large influx of purchasing.

As Puplava points out the current global situation is very reminiscent of the 1930's where dangerous conflicts and trade wars were a norm. Only this time the stakes are larger because the amount of outstanding debt is considerably higher.

Many believe that if there is a market meltdown that the gold stocks could fall with them. While initially there might be some sell-off history suggests otherwise. In the 1930's the few gold companies around did fall with the market in the Crash of '29. By the time the bottom came around in 1932 and the Dow Jones Industrials fell 89% with the revaluation of gold upward from $20.67 to $35 companies such as Homestake Mining surged 10 fold.

Dr. Richard Appel presented this argument in a recent article entitled "Will gold shares follow common stocks lower? An historical perspective". Historically the best argument against this happening is the bear market of 1973/1974 whose chart is presented below. While the Dow Jones Industrials was losing some 46% in 1973/1974, Gold soared from the $60 area to over $200. Homestake Mining rose from about $2 to almost $10.

The chart of the 1970's, a period of the last great gold boom, is quite interesting. With the markets down in 73/74 and gold and gold stocks up during the same period they switched places in 1975 when the DJI regained its two years of losses while both gold and the gold stocks fell. From 1977 to 1979, the period of the great bull market in gold, both the DJI and Homestake languished in a general downtrend/flat. Note then the unfolding huge divergence between gold and Homestake in 1980 when Gold collapsed then tried to rally back while Homestake and the gold stocks came to life and soared to new highs, a significant major negative divergence which presaged the 20 year bear market in gold and gold stocks.

We leave you with a small group of gold mining producers, which are forming interesting bullish technical patterns for the next leg up in the gold bull market of the first decade of the new century.

26 March 2004

David Chapman is a director of the Millennium Bullion Fund

The opinions, estimates and projections stated are those of David Chapman as of the date hereof and are subject to change without notice. David Chapman, as a registered representative of Union Securities Ltd. makes every effort to ensure that the contents have been compiled or derived from sources believed reliable and contain information and opinions, which are accurate and complete. Neither David Chapman nor Union Securities Ltd. take responsibility for errors or omissions which may be contained therein, nor accept responsibility for losses arising from any use or reliance on this report or its contents. Neither the information nor any opinion expressed constitutes a solicitation for the sale or purchase of securities. Union Securities Ltd. may act as a financial advisor and/or underwriter for certain of the corporations mentioned and may receive remuneration from them. David Chapman and Union Securities Ltd. and its respective officers or directors may acquire from time to time the securities mentioned herein as principal or agent. Union Securities Ltd. is an independent investment dealer and is a member of the Toronto Stock Exchange, the Canadian Venture Exchange, the Investment Dealers Association and the Canadian Investor Protection Fund.