Negative sentiment regarding gold has just reached a new all time low for this 20 year long bear market. At this point it appears as though gold will never again enjoy a meaningful rally. After all, the last time there was any rally in the gold price that lasted longer than the time between two currency crises (a distance that was once measured in years, but is now measured in weeks) was 1993. The depth of the negativism in this market was brought home to me during the last few days when the topic of gold arose on two separate financial news programmes. In both instances the experts being interviewed completely dismissed the topic as being irrelevant in today's world and quickly moved on to more pertinent subjects. In other words, they had gone past being bearish on gold, bearishness having been replaced with total disinterest. In another recent business news programme gold did actually warrant a two-minute discussion. The expert du jour pronounced that the Fed's vigour in jumping on inflation (by tilting towards a tightening stance), even when there are no visible signs of inflation, removes any need to invest in gold. So there you have it – if there is no inflation then there is no reason to invest in gold, but even if there is inflation the Fed will 'kill it' before it becomes a real problem and there is, therefore, no reason to invest in gold.

With bullion prices languishing right at the bottom of their 18 month trading range, the share prices of many important gold mining companies are still in up-trends. Such a divergence occurs because the investors in gold mining company shares are discounting the future. They are, in fact, anticipating a future gold price when valuing the companies. If these investors are correct, then the gold price will rally in the coming months. In addition to the gold mining stocks, there has been a general surge in resource stock prices over the past 2 months. This highlights an expectation, at least amongst some equity investors, that we have seen the bottom for commodity prices.

Although many commodities are still at or near their lows for the current cycle, an impressive rally has occurred in the oil market this year with the oil price leaping by around 60% between mid February and the end of April before easing back slightly during the last 3 weeks. The rally in oil has occurred amidst widespread disbelief – disbelief regarding the commitment of some OPEC members to the agreed supply cutbacks and doubts revolving around the possibility that worldwide demand would increase sufficiently to reduce inventory levels. The fact that such disbelief still exists, despite the substantial price rise to date, indicates that the oil rally has some way to go. It would be unlikely for a rally in oil, the most important and heavily traded of all commodities, to occur in complete isolation.

The rise in the oil price has already had a rather important effect on the CPI, with the April number showing a 0.7% gain and providing the first visible sign of inflation in this 'new era' (the first sign, that is, to those who refuse to recognise the massive increases in money supply over the past 2 years as 'inflation'). The next major effect of this oil price rise will be seen in the US trade deficit to be reported in mid June (for the month of April). February's trade deficit was 19.1 billion (a record) and March's was 19.7 billion (a new record). However, the US is a net importer of oil and, as time goes by, the imported proportion will increase. The combination of higher oil prices and the need to import more barrels will lead to a further blowout in the trade deficit. It is therefore very likely that the April trade deficit will exceed $20B. As the trend towards higher trade deficits continues it should be expected that political pressure would mount to either bring about trade restrictions or to devalue the Dollar. As a minimum, such pressure may encourage the Fed to avoid increasing interest rates in the near term since higher rates would lead to a stronger Dollar, further exacerbating the trade deficit. (Note – this Federal Reserve does not seem to require much encouragement when it comes to pursuing easy monetary policies) In summary, the signs are that we have seen the bottom in commodity prices and a resurgence in 'visible inflation' has begun.

Getting back to the gold market, the Commitment of Traders Report released on 21 May shows that speculators have built up a large short position in gold futures. This suggests, when viewed in isolation, that a near term short covering rally in the gold price is likely. However, the same report shows that speculators have built up a large long position in silver. This is a concern since a sustainable rally in gold will only occur in parallel with a rally in silver, and vice versa. As we have seen a number of times during the 1990s, attempts by speculators to engineer an isolated rally in silver have always failed. The fact that the currently reported Trader's Commitments for gold and silver are diametrically opposite means that the information cannot reliably be used to determine near term direction.

The gold auctions by the British are scheduled to commence on 6th July. Once these sales actually get underway they will cease to exert a negative influence on the market. If gold has not already bottomed, the period between now and July 6th 1999 is the most likely time for an end to the seemingly endless bear market.

In conclusion, we have sentiment in the gold market ranging from extreme negativity to total disinterest, relatively good performance of gold mining shares in the face of declining bullion prices, a strong rally in oil prices, an apparent turnaround in the prices of many commodities, and early signs that the CPI is beginning to reflect the true level of inflation. These factors together suggest that a gold bull market is about to commence.

Milhouse
Hong Kong
26 May 1999

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