The Gold Market and Precious Metals Commentary

October 21, 1998

Technicals -

Purgatory. Not heaven and not hell. Just listless trading. Gold continues to meet resistance as it approaches the $300 wall and finds support in this area on set backs. The trading is lackluster and uninspiring. The bullish consensus is still a very low 33% ( especially from a historical perspective ). The open interest is a modest 184,842 contracts. While the base continues to build, gold needs two closes over $300 to be convincingly bullish. A close above $305 would be all she wrote for the bears. A close below $290 basis Dec would put our bullish case on hold. Our objective is still $335.

Silver continues to gain internal strength. Most of the time silver, after a liquidation like we have had, takes a couple of weeks to regain its footing. This has been no exception. A close above $5 is needed to turn the technicals bullish. India was closed today ( also tomorrow ) for a holiday, but the silver premiums are high indicating robust demand in that country. The Comex silver stocks (73,450,573 million oz.) are very low and we think a big silver move to the upside is still in the works.

Fundamentals -

There is a natural supply demand deficit in the gold market - which might be in the neighborhood of 800 tonnes at this point in time. This natural deficit ( world demand for gold over mine supply output) has been met the past number of years by central bank sales and from borrowed gold that has hit the market. In fact, it has been more than met and driven down the price by about $100 per oz.

We believe much of the central bank selling has been due to certain European countries selling gold ahead of the EMU. Individual countries will lose the autonomy to sell their gold after Jan.1 1999. That selling should be over soon or should have ended by now. By all accounts there will be no EMU gold sales after Jan 1, 1999 for a couple of years, while the Euro is developing as a currency. There is talk by the gold bears that the IMF will dump some of its gold, but official circles have repeatedly denied any such intentions.

The gold borrowing supply has come mainly from producers who sold their forward production and from speculators who borrowed gold at low interest rates from bullion banks, sold the gold in the market place, and used the proceeds for various investments. Much of the borrowing was done by hedge funds with Long Term Capital Management being a notable example.

Since the dramatic central bank selling is, or has, ended, the only way for the gold price not to go up is for the borrowings to continue (actually they need to increase). Otherwise, the natural deficit will kick in and the price of gold will have to go up to ration the supply coming on stream. We have been reporting about the arm twisting and cajoling going on to producers to sell gold. They have been offered gold on terms that have not been seen in the past.

We also know that those dealers that have written massive amounts of calls and do not want gold to close over the $300 to $305 range. They pull out all the stops (sell gold) when gold rallies to that level. As a result, spot gold has not been able to close over $300 two days in a row.

We have also heard the Fed has gone to the banks and asked them in a nice way, not to put pressure on the hedge funds. That would include not scrutinizing their gold loans very carefully or calling them in altogether (which would reduce the gold supply). In toto, this pressure has been enough to hold the price of gold in check.

But gold has been put in a pressure cooker and, in our opinion, it is only a matter of time before the price really takes off. We have been telling you the Chinese, Japanese and Taiwanese governments have been buying gold (and asked by our government not to push up the price with their buying). This buying has been supporting the market and keeping gold from tanking. We also hear that the Asian bullion banks are buying gold to sell to the public. Demand is so robust that they are months behind in filling their orders.

Gold demand is robust all over. It has been a decade since US coin dealers saw such surges of buying. The People's Bank of China had to raise its official gold purchase price because gold was fleeing the mainland. Russia is planning to mint 10-30 tonnes of gold and silver coins. If this plan goes through, they will eventually need to mint something like 100 tonnes of gold.

Gold demand has picked up again sharply in Asia and is only 9% below the all-time high second quarter of 1997 according to the World Gold Council. The demand for gold rose 50% this past quarter over the first quarter.

Pension funds in the U. S. have invested in gold in the biggest way in over 10 years. And on and on.

With pre-EMU selling abating, Asian official sector buying a reality, Asian public demand coming back to life, and demand surging around the world, the pressure on the shorts is growing and growing. The gold bears need to round up more shorts just to tread water. The problem is the water is going into a pressure cooker. In time the pressure will become too great and the price of gold will explode.

Potpourri and the Gold Shares -

The XAU closed at 72.62 down 1.92.

The news has been sparse. The U.S. trade deficit was about $17 billion which does not bode well for the dollar. The deficit just gets worse and worse.

A new hedge fund worry cropped up. Paloma Partners Management, with $4 billion under management, is reported to be in trouble and keeps the general concern about how big the hedge fund problem is in the limelight.

News was sparse. Finally buttonholed a Prudential spokesman about new disclaimers appearing on the Prudential Securities Consolidated Statements that was sent to us by Café member, Stephen O. The Prudential spokesman would not call me back, but when confronted, did confirm these quotes were true.

"The majority of the Company's derivative transactions are short-term in duration, with approximately $67.1 Billion of notional or contract amounts maturing within one year of which approximately $64 Billion mature within three months."

".....which may impair the counterparties' ability to satisfy their obligations to the company"

"...may require the Company to pledge client securities as collateral in support of various secured financing sources such as bank loans, securities loaned and..."

"..these activities may expose the Company to off-balance sheet risk in the event a client is unable to fulfill its contractual obligations."

Nobody really knows how bad the derivative problem is. But it is bad enough for Fed Chairman Alan Greenspan to uncharacteristically push down interest rates in an accelerated manner and it is bad enough for Prudential to put these disclaimers on their official statements.

This is rather shocking news and if this news circulates and more serious derivative problems surface, Prudential could have a run. Does that sound excessive? Well, you tell me. It now says in their statements that they can pledge client securities to support a derivative bailout. Is Prudential your brokerage house? Do you want them pledging your securities? I bet only a small percentage of investors at Prudential even realize that Prudential can do this.

I think this sort of maneuver by Prudential is outrageous. If this is not a good reason to put a little of your money into gold bullion, I do not know what would be one.

In the Aztec language the name for gold is teocuitlatl which means "excrement of the gods."

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