The Gold Market and Precious Metals Commentary

October 23, 1998

Technicals -

Row, row, row your boat. It is an upstream row for us bulls. We are fighting the tide of government cajoled, and supported selling. First, let me make a correction. In the last Midas I inadvertently said a break below $296 basis Dec. would put the bull case on hold for the short term. It was a typo and should have read below $290. That is where our heroes took out the Guns of Navarone. A closing move below that support level would make the recent action look like topping activity instead of the basing activity that we suggest it is.

The price of gold tumbled yesterday as the moving average around $295 was taken out. The liquidation on Comex was fairly small as there was only a 1481 contract open interest reduction to 184,276 contracts on the sell off. The bullish consensus is a low 30% and the commitment of traders report released after the close showed a modest reduction in large and small spec longs ( about 13,000 contracts in total ) as of last Tuesday. $300 spot resistance is formidable now and causing buyers to back a way a bit until new reasons surface to assault the $300 area come into play. We still look for the market to hold under the recent bear assault and resume its up trend in the near future.

Silver is acting like it usually does after a breakdown and is preparing itself to move forward again, in our opinion. This is gain composure time for silver. The Indian premiums are 11.4 % over the U.S. which are important for silver imports ( a healthy sign for the market ). The silver bullish consensus is also a low 35%.

Fundamentals -

Bullish news from Russia:

Bloomberg, Oct 23, - "The Russian government likely won't export any gold next year as the central bank stockpiles the metal to support plans to print money. " I don't think it makes sense to export gold next year if the central bank is trying to increase its reserves," said German Kuznetsov, head of the State Precious Metals Reserves, known as Gokhran. COLOR="#FF0000""Gold is the last safe haven if we have oil prices falling, a poor harvest, and a financial crises."

Russia's government and central bank are also considering a plan to mint gold coins to prop up the ruble and create an alternative to the U. S. dollar as a safe haven. " It's better to issue gold rubles rather than have unguaranteed paper money, ''Kuznetsov said."

The gold premium in Tokyo continues to be the strongest in years hitting $1.30 to London spot. This confirms our information that the largest bullion dealers are months behind in delivering gold to a clamoring Japanese public.

One month lease rates popped up from about 45 basis points to 75 basis points which indicates a pick up in demand on this price break.

Potpourri and the Gold Shares -

The XAU closed at 69.74 down 1.18

Bankers Trust lived up (down) to our expectations with a much worse than expected, $5 per share loss and who knows what other debacles they are still facing. Our "toast" prediction looking better and better.

The theatre of the absurd. Fed Governor Fred Meyer commenting on another central bank investing in LTCM. Bloomberg, Oct. 23 - " He did say the unnamed central bank (Italy) defended its investment by saying it didn't know Long Term Capital was a hedge fund." This is a big league banker talking about another. Talk about not telling it like it is. And, some due diligence crew Italy has!

A Café member and friend of mine, is one of the better thinkers in the gold industry. I will share his provocative and perceptive thoughts about the gold market with you.

The Ongoing Gold Price Decline

October 23rd, 1998.

The gold price began a decline in February of 1996 after peaking at $412 per ounce. This decline has been relentless, with a few very minor rallies on the way down. But the decline has continued and continued, exceeding all gold "bugs" expectations and in some cases created a sense (perhaps very valid) of disbelief.

The fundamentals of the gold mining industry in terms of supply and demand, are very much in favor of higher prices with demand exceeding supply by on average since 1995, 40%. And as the gold price heads lower it is now estimated that the cash cost of as much as 50% of all production is above the current gold price. New projects are being put on hold and money for exploration and ongoing reserve delineation has completely dried up. Mining company shares are at an all time low and it seems that there is no light at the end of the tunnel.

The shortfall in production has been met by sales into the market from Central Banks selling down and from gold leased to mining companies and sold to raise capital for development purposes. Regardless of what the critics say this has to be regarded as part of the supply side of the equation.

Known gold i.e.: all gold in existence, is believed to be about 120,000 tonnes and of this figure (a best guess estimate) 30% is believed to be held by various central banks as part of their "official" reserves.

Annual consumption, gold used for industrial and decorative purposes is 4000 tonnes per annum with new supply (mined and recycled scrap) believed to be about 2400 tonnes. But a good percentage of that supply is already spoken for by way of the repayment of borrowed gold. As time goes by this could reach a level of 40%, thereby reducing the supply/demand deficit even more.

Over time (20 -30 years) a case could be made that the supply/ demand situation would eventually consume all gold in existence - which makes no sense at all.

The problem with the gold market today is lack of transparency in terms of what is going on. The London Metals & Bullion Exchange handles on average 35 million ounces a day, which is about 1000 tonnes. In other words the entire known world gold supply changes hands three times a year. And that's just one exchange. There are others. (New York, Hong Kong, Sydney). As well there are smaller exchanges in many countries that trade gold. And other over the counter markets for gold futures.

We are currently in a period of major Central Bank manipulation of financial dealings and reporting of these dealings. The current asset bubble of stock market values is at an historic level as is debt levels associated with the worlds number one reserve currency, the US dollar. The largest player in this manipulation game is the United States itself with Japan not far behind. The object of the game is to cover up the fact that fiat money has no real value and to ensure that people forget about the fact that these paper currencies are not redeemable for anything of value. They are at best redeemable for more IOU's and the most popular form of these is US treasuries which are debt instruments issued by the US to fund its deficit. The estimated total value of the amount on issue of these is $5 trillion dollars.

To allow this game to continue the entities responsible for playing it (the worlds banking system, including the Central Banks, major banks and the investment banks) have to make sure that they continue to generate profits anyway they can. The moment the profits stop, this game comes to an end.

The latest addition to this game has been the development of the derivatives industry, complex instruments that ensure that the game goes on by offsetting risk. Risk of course is loss. And losses mean no profits. Which brings the game to a halt.

The source of the capital required to continue this game is the cash flow from the local economy that reaches its end point, the salaries, wages and savings of the working populace that make up the citizens of any given country and who are the ones that the government is relying on to be levied by way of taxes to pay the debt that keeps the game going and maintains the perception of strength in any given piece of paper.

Without their money coming into the markets on a monthly basis (via their 401-K's) the game would end, and should they decide to take it back it will end even quicker.

The mutual funds, the temporary recipients of this cash flow, are really quite powerless here since they are being held to ransom by the Wall Street bankers (who know that mutual funds have to invest, ie: buy more stocks and this requires them to stay fully invested). What a joke that one is.

What the participants don't realize however is that the game they are playing is being played at their expense and could end at anytime with the end result that their savings disappear. There is no fallback position in this game at all. The traditional fallback position has always been gold. Which is why 30% of all known gold is held by central banks who know only too well that the game can end at anytime, and the value of paper currency can diminish overnight - and they would suffer as a result. Central Bankers know that sentiment can change in a flash and that holding worthless pieces of paper doesn't pay the rent to generate the income they need to continue. Paper currencies are only of value while the game continues and the game only continues as long as there is growth (increased profits). The moment it starts to recede the problems begin.

It has always been the role of Central Banks to try and maintain growth while ensuring that certain guide lines are not exceeded as well as maintain sufficient reserves to be able to absorb any downturn expected or otherwise. Booms traditionally are followed by busts. Either man made or of a natural disaster variety. But Central Banks, the managers of the banking system have forgotten their traditional role as the euphoric boom of the nineties has exceeded all expectations and profits have continued to soar. But much of that profit is as a result of capital gains from overinflated stock prices and not from where it should be which is productivity based upon the production of something which as sold at a profit.

We have entered some time ago a period where it is deemed not necessary to do this as we can create some exotic financial instrument that will protect us from risk (the failure to make a profit) and protect us from a slowing down of demand as a result of no growth. The IMF appears to have the attitude that if this happens throw money at the country concerned and reactivate the game. But that only creates more debt which means more liabilities for the participants that are being relied upon for the game to continue. And the problem is that they don't know that yet. But they are about to find out.

The key to this game proceeding is perception. It is critical that the players, the ones who are relied upon to keep it going don't get the idea that something could be wrong here. And the source of these funds, the poor old public, are fueling this "boom" by continuing to fund the activities of the mutual funds with their weekly contributions convinced that this will make then rich, provide for an early retirement and take care of all their anticipated rears. These numbers are known to the Wall Street bankers and they are depending upon them to continue. This dependence allows them to do all sorts of things with a known cash flow that they can depend upon and create more and more exotic instruments that ensure that the game goes on.

As long as the American public (who by the way will bear the brunt of the decline) continue to fund the activities of Wall Street, Wall Street will continue to take the risks that are necessary (but shouldn't be) to ensure the game continues. After all it only continues as long as stock prices rise. When they fall, it ends. That's when Mr. and Mrs. Public want there money back. They want the profits they supposedly have made (their rewards) returned to them in cash.

Corporate profits are declining so Wall Street can't rely on them. And falling prices mean lower stock prices which are injected into peoples lives on a daily basis by the likes of CNBC. And Wall Street doesn't like this. The risks here are real and nobody knows this more than Mr. Greenspan. By all known measures Wall Street has done it this time and what could happen should scare the living hell out of any real Central Banker (and probably already is). But so far fear (which comes from the realization of potential loss) has been conspicuously absent. Conspicuous enough to make a suspicious person take a good look at the activities in the gold market which is the currency of last resort. The one thing to own when paper currencies are in trouble. The only asset that is nobodies liability.

Wall Street knows that it's enemy is gold. Fear of paper currencies would drive people into the traditional safe haven - hard assets such as gold and silver. After all they have worked in the past and will work again. Which is why the older Central Banks such as those of France, Germany and Italy maintain substantial gold reserves. They have seen it all before and have suffered through the results of serious currency debacles. Having your local population decimated by war which had its beginnings in a currency collapse is a painful reminder of what can go wrong. (The US has not learnt this yet).

It is in the interests of Wall Street to maintain the perception that you don't need gold anymore, that money in mutual funds is safe and that all is well. At present Wall Street is hurting as a result of trying to maintain the perception that all is well. They apparently have Alan Greenspan's blessing to continue this perception at all costs. Speculation that his interest rate cut of last week was done from knowledge of something he is not telling us are probably correct. After all economics is not that complicated if you understand the basics of economic growth which as mentioned before is produce something and sell it at a profit. But you do require demand and this is slowing worldwide.

The final battle is being fought. It is called a crisis in confidence and what it is about is confidence in the US dollar, the worlds largest reserve currency, and the perpetrator of the current global meltdown. Should that confidence begin to seriously erode Wall Street has a problem. A big problem.

And Wall Street will go to any, I repeat any, lengths to try and restore that confidence, including trashing the gold market to stop the real flight to quality that will result.

There simply is not enough gold around to go around. Not at current price levels. Neither does Wall Street have access to what is around so they will be precluded from playing anyway. Shut out from their own salvation so to speak.

India and the U.S. trump Italy as top gold jewelry exporters.

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