Gold Market Update

December 13, 2001

The gold bullion price tested its November lows of $272 an ounce last week and closed on Friday at $273.90 an ounce. It is up 6.6 % from its April low of $255 an ounce.

Gold shares continue to perform better than gold bullion. The Philadelphia Gold/Silver Stock Index (XAU) on Friday was 7.4 % above its November low and 14.4 % above its April low.

Here are three reasons why we like gold shares as portfolio diversifiers (more on our next Update):

First, Japan may be on the brink of beginning a sustained wave of gold investment demand, the key to a major rally in its price. GDP contracted 0.5 % in the third quarter of this year, compared to the same quarter last year, and is forecast to decline further next year. Prices have declined, and deflation is in danger of getting out of control. Bankruptcies have grown sharply since the investment bubble in 1990. Bank bad debts are huge. The Keynesian remedies of zero short-term interest rates since 1995 and a string of high government deficits have failed to stimulate the economy. Between 1991 and 2000 the ratio of gross public debt to GDP rose from 61 % to 131 %. The point of no return of these policies may soon be reached. Government intervention has merely delayed market-driven structural reforms which may be needed to reestablish a balanced economy. The three major rating agencies again recently downgraded Japan's sovereign debt. Investors have been penalized by extremely low interest rates and debt defaults. Many have invested in the U. S. The yen hit 125.54 to the dollar on Friday, back to its April and July lows and down from 115.83 in September and 106.97 a year ago. The yen price of gold has climbed steadily from 29,308 an ounce a year ago to 34,385 an ounce last Friday, up 17.3 %. Gold investment demand in the third quarter was 91 % higher than a year ago. As Japanese confidence deteriorates further, a gold investment-led recovery could gain momentum.

Second, the huge U. S. private sector debt may enter a correction period which could last longer than expected. Outstanding domestic financial sectors debt soared from $35 billion (6.4 % of GDP) at the end of 1961 to $8.8 trillion (86 % of GDP) at the end of June 2001, up at an annual average compound rate of 15 % a year, well above the real GDP growth rate averaging 3.2 % annually. The cost of servicing this debt is becoming an unsupportable burden for many corporations and households as corporate cash flow and personal income are squeezed. About 250 public companies, such as Chiquita, Bethlehem Steel, and W.R. Grace & Co., have filed for bankruptcy so far this year. Filings rose 14 % to an all-time high during the year ended September 30th. Last week Enron Corporation, which had a market capitalization of more than $ 60 billion at its peak last year, filed under Chapter 11, the largest bankruptcy in U.S. history. The bankrupt companies immediately reduce their debt burdens, and at the same time creditor and investor income and wealth are destroyed. Under earlier proceedings corporate assets were restructured or liquidated at the time of bankruptcy. The bankruptcy laws were changed in the 1970s. Now, the needed operating problem corrections and restructurings of overcapacity are delayed until well after the bankruptcy filings. This additional time may stretch out the recession.

Third, short-term investors receiving low and even negative real interest rates may become dissatisfied and choose gold as an alternative investment. At the present time Ninety-day T-Bills yield 1.7 %, and the year-to-year October C.P.I. Index increased 2.1 %. There are approximately $2.1 trillion Treasury Bills and Notes outstanding. In the past, to preserve their savings from negative real interest rates investors and creditors have turned to gold. In the 1970s and in 1992 and 1993, nominal interest rates fell below inflation rates, and real interest rates were negative. Creditors, who expected a "fair" real return, were impoverished and unjustly victimized. To protect their wealth they diversified into real assets, including gold bullion and gold mining shares. The resulting investment demand for gold caused its price to soar from $35 an ounce to $850 an ounce during the 1970s. In 1993, gold climbed from $327 an ounce to $410 an ounce.

Seventy-five percent of all gold in circulation has been extracted since 1910