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Gold Market Update

June 27, 2001

The prices of gold mining shares and gold have been consolidating their rapid end-March to mid-May upward moves. They were little changed as of last Friday from our June 11th Update. The Financial Times Gold Mining Index rose 16.2 % since the end of 2000 while the S. & P. 500 Index is down 7.2 %.

Negative Real Interest Rates May Stimulate Gold Investment Demand

Creditors in the U. S. a week ago faced a new era of negative real interest rates. Inflation had edged upward, and interest rates have been sharply reduced. The first quarter GDP price index showed inflation accelerating from a 1.9 % rate in the fourth quarter, 2000, to a one-year high of 2.8 %. The consumer price index for May was 3.6 % above a year ago. The Treasury yield curve steepened with the 30-year bond yield rising from a low of 5.25 % in March to a high of 5.90 % in May. The spread between rates on nominal ten-year Treasury notes and inflation-indexed ten-year maturities rose from 1.3 % in early 2001 to almost 2 % recently. The Fed's easier money policy has encouraged money stock (M-2) to grow from an annual 5.5 % rate last year to a 10.8 % rate to mid-June. The trouble with inflation is that by the time it shows up, it is often deeply entrenched and is very hard to bring down again. The Fed's interest rate cuts since January have lowered nominal 3-month Treasury Bill yields from 6 ½ % last November to 3.5 %. Six-month C. D. rates are down to 3.6 % from 6.2 % a year ago. Real 12-month Treasury Note yields and real returns on Treasury Bills are currently negative. If negative and unrewarding real yields continue or are worsened, frustrated creditors may seek freedom from the Fed's discrimination against their desire for a real positive return and look for alternative investments. They may remember that in the 1970s and in 1992 and 1993 short-term interest rates were also held below inflation rates, and real short-term interest rates became negative. Creditors, who expected a "fair" return, were impoverished and unjustly punished. To protect their wealth they diversified into real assets. The price of gold soared from $ 35 an ounce to $ 850 an ounce during the 1970s. In 1993 gold climbed from $ 327 an ounce to $ 410 an ounce. Business and household debt has climbed an average 9.5 % a year from $ 9.6 trillion (125 % of GDP) in 1996 to $ 13.8 trillion (135 % of GDP) at the end of March, 2001. Will this debt be "inflated away" or paid? To preserve their savings and obtain a return in real terms, creditors may seek riskier investments or again turn to gold. With a rising investment demand, the price of gold could climb from recent 21-year lows and rise faster than the rate of inflation and thus provide a better real return than Treasury Bills.

Financial News

Fresh concerns about overcapacity, bad debts and lower profits in the information-technology and telecom sectors have further eroded high-yield corporate bond prices. Their average yields have increased from 12.22 % two weeks ago to 12.67 %. Their spread against long-term Treasuries rose from 6.49 % to 7.10 %. (More about growing financial risks in our July 9, 2001 Update).

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