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Gold Market Update

July 2, 2002

The first half of the year ended with some curious excitement in the gold market. On Friday (June 28), gold drifted lower, looking to close down about three dollars at the $317 level on the nearest (August) COMEX futures. At seven minutes prior to the close, the gold price plummeted to $310.50, then recovered somewhat in the final five minutes to close at $313.90, down $5.70 for the day. The late selling was not on unusually large volume, but an aggressive sell order caused bullion to drop through several stop levels when many traders were caught off-guard, thinking more of fireworks than of buying gold. This action is reminiscent of June 4th, when gold was driven lower in the thinly traded aftermarket, following a day when bullion touched the critical $330 per ounce level. It seems that bull moves in gold are made on sound fundamentals - political unrest, corporate scandal, declining dollar - whereas bears seem to pound the market when it is most vulnerable, when market participants are trying to relax and enjoy life. We would not be surprised to see further such action in light trading during the holiday week.

The gold market correction is now a month old, as bullion has declined 4.9% from its $330 intraday high. The XAU Gold Index was down 15.2% in June. Meanwhile, in the first half, bullion was up 12.7%, while the XAU was up 31.3%. The disparity in performance between the hedged and non-hedged producers in the XAU is remarkable. The American Stock Exchange Gold Bugs Index includes only companies that do not hedge their gold production beyond 1.5 years. It is up 94.7% in the first half. The message is clear, most investors want more leverage to bullion in a bull market.

As mentioned in our last update, the gold market was in need of a cooling off period. Valuations on gold shares had risen to high levels in a relatively short period. Valuation measures, such price/cash flow and price/NAV, were approaching levels last seen at the peak of the market in 1996. The highs reached in 1996 were at the tail end of a three-year bull market, whereas the current bull market is only 15 months young. The sector has attracted more fresh equity in the past year than in the prior four years combined. Perhaps the summer months will be a good time to relax by the pool, forget the frenzied pace, and recharge some batteries.

Finally, the U.S. dollar and gold have moved in the same downward direction in June for the first time this year. This is a break from the normal inverse movement. The dollar first began to decline in January, falling along a gentle slope until mid June, when it began to fall precipitously. These movements suggest that the dollar has been oversold and that the decline in the June gold price presages a summer correction in the dollar. Ultimately, the still-growing current account deficit, along with the decline in foreign investment in the U.S., indicate that the dollar has not yet reached a bottom.

The purity of gold is measured in carat weight.
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