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Gold Market Update

December 18, 2002

The dollar price of gold broke out on the upside last week from the consolidation since May of its move from $278.70 an ounce at the end of 2001 to $ 330 an ounce in May. It closed at $ 333.20 an ounce last Friday. This move coincided with a rise in the Euro to a three year high. Investment and speculative demand plus some short covering drove the rise. The Commodity Futures Trading Commission reported that net large-scale speculator long positions climbed from 48 metric tons at the end of October to a record 160 metric tons on December 10th.

Japanese investment demand was reported to have been stimulated by North Korea's decision to reactivate a nuclear power plant. The ratio of the Dow Jones Industrial Average to the price of gold resumed its downtrend, falling from 28 at the end of November to 25.3 last Friday. Gold's price has maintained an approximate 17 % a year uptrend rate this year. Looking at the broad picture, it is close to breaking out of its 5 year "bottom" trading range of $ 252 to $ 340 an ounce. Whether it continues this year's uptrend depends upon sustained future investment demand based on a growing decline of confidence in financial and economic conditions.

Creditors and Investors: Beware a prolonged period of negative real returns - Gold Vigilantes to the rescue!

  1. Creditors may face a prolonged period of financial stress. The leveraging of the U. S. since World War II has led to a record high business and household debt of $ 15.3 trillion (144 % of GDP) at the end of September. This debt rests upon the maintenance of a prosperous overall economy's rate of return and "full employment". The ability to service the debt is weakened by the soft economy and compounding interest costs. Credit rating downgrades, deteriorating equity values, a record number of loans in foreclosure and climbing delinquencies are weighing on the market. The junk bond yield spread over Treasuries recently resumed its upward widening, rising from 690 basis points on December 3rd to 723 basis points last week.
  2. Investors who put their savings in T-Bills are being impoverished. Three-month Treasury Bills yield 1.2 %. The Labor Department's Consumer Price Index year to year increase for October was 2.0 %. The Federal Reserve Bank of Cleveland's 12-month median consumer price index in October rose 3.2 %. Core services prices rose at an annualized rate during the past 12 months of about 3-3/4 %.
  3. The present "soft" economic period may be prolonged: Some imbalances from the 1990s boom may remain to be corrected. Capacity utilization for total industry was75.2 % in October. Chapter 11 proceedings reduce creditors claims but are biased toward saving failing companies rather than liquidating their assets and reducing over-capacity. The negative output gap between actual economic growth and trend potential could grow further if the trend potential grows faster than actual growth. Fiercer foreign and domestic competition could then put more pressure on business pricing power and lead to falling prices. Households could reduce their spending and increase their savings to more normal rates. The housing boom and record current-account deficits may not be sustainable.

Business sector hourly compensation (including benefits) increased at an annual rate of 5.3 % from the second quarter to third quarter of this year, up from 4.2 % in the previous quarter. Productivity increases at a high annual rate of 5.4 % in the third quarter saved unit labor costs. However, if productivity falls in the future to a more historic rate, unit labor costs would rise and squeeze unit profits.

The U. S. Administration's anxiety about the economy and its new "robust jobs and growth" plan may turn out to be counter-productive. If it results in higher deficits, its consequences may include rising interest rates and labor compensation costs. This could put further pressure on profit margins. According to many economists, higher profits and profit margins, which would stimulate dynamic capital expenditures, are what are needed to increase "aggregate demand".

Gold is still being mined and refined at the rate of almost 2,600 tonnes per year.
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