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Gold Market Update

July 26, 2001

The gold price began a renewed trend higher after registering a two-month low of $265.35 on July 5th, the same day the U.S. Dollar Index recorded a new long-term high. The dollar has since weakened and gold moved higher to close Friday at $269.90. One of the dollar's steepest two-day declines in the past year occurred last Tuesday-Wednesday, coinciding with Alan Greenspan's semiannual monetary policy outlook presented to the House Financial Services Committee on Wednesday morning. The Swiss Franc was favored by traders seeking the safest non-U.S. dollar currency, rising 2.8% against the dollar over the two-day period.

Market forces have driven gold lease rates back to normal levels. Central Banks that had formerly lent gold for a year or less began lending longer-term in February, which put the squeeze on short-dated lease rates. The three-month rate peaked around four percent in March, but started to decline in May at the same time the Comex specs went long and stayed long. Gold that had been earmarked for speculative short sales found its way to the short-term lease market. Additionally, the attractive lease rates may have enticed some banks to return to the short-dated market. The three-month rate is currently at the one- percent level. Even with the recent fall in lease rates, the three month U.S. dollar gold contango is still 33.5% below its average of the past five years, which continues to dampen demand for producer hedging.

It has become clear that the fate of the global economy now rests squarely on the shoulders of the U.S. consumer. Jobs, re-election prospects, legacies, TV ratings, and numerous emerging economies are at stake. Will the Fed rate cuts and Bush tax rebates encourage consumers to prolong their appetite to buy houses, lease SUV's, travel, shop, eat out, or hire help? Until recently, most of the jobs lost in the current economic downturn have been among the lower income workers. A recent Wall Street Journal article on the Manufactured-Housing Sector provides a stark look at the impact of job cuts among wage earners over the past year. Manufactured homes (formerly called mobile homes or house trailers) cater to lower income families. Booming sales through the mid- to late- nineties were accentuated by easy credit when lenders reduced down payment requirements and increased loan duration. Then, in 2000, shipments of manufactured homes collapsed to 1993 levels as reductions in overtime and job losses impacted the bottom of the work force. In the first quarter of 2001 shipments were down 41% versus a year ago, while major lenders have stopped making loans to manufactured home buyers. The speed with which the manufactured housing industry declined has sobering implications for the general housing market, which has been a bright spot in the struggling economy. As pointed out in our last update, the latest figures indicate that the propensity of the U.S. consumer to borrow, dissave, and spend remains intact. How much longer this phenomenon remains depends on how deeply the job cutting penetrates the salaried work force. A Federal Reserve study released in May shows that the richest 20% of Americans account for most of the consumer spending. According to Morgan Stanley Dean Witter, labor compensation accounts for approximately 70% of overall business expense. On June 25th, International Paper announced it will eliminate ten percent of the company's salaried workers. On July 17th, Boise Cascade attributed a surprising drop in its office products distribution business to rising white-collar unemployment. On July 18th, American Express announced its second round of layoffs this year. As profits continue to erode in the face of increasing unit labor costs, companies come under pressure to let go of their more highly paid employees - the real consumers.

Take a look at the weekly charts for gold and the DOW. The 45-week trend line bottomed in September 1999 for gold. Then, in February 2000, the long-term weekly trend line for the DOW reached a top. Both trends have since moved sideways in an unusually long period of consolidation around the $275 level for gold and 10,750 for the DOW. Logic and history tells us that gold and the DOW will eventually move in opposing directions. When a decisive break occurs, we wager that the behavior of the U.S. consumer will have played a dominant roll. For investors who aren't sure of trends to come, a little insurance in the form of gold or gold shares could go a long way.

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