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Gold Market Update

June 13, 2001

Gold finished the week at $273.40, declining $5.70 since our last update two weeks ago. Following the mid-May price spike, bullion has consolidated, bouncing along the 45-day moving trend line. Daily gyrations aside, the positive momentum that began at the end of March remains intact and, more significantly, this two-month up-trend is occurring at the same time that the U.S. Dollar Index is making new long-term highs. Comex commitment of traders data released Friday shows that despite the consolidation, traders remain net long gold.

Earlier this year many tech companies were stricken with severe cases of myopia. A lack of visibility is what they called it, referring to their newfound inability to forecast business trends. Such trends are derived from order books, which tend to start filling a couple of quarters in advance of manufacture and delivery of whatever product the company happens to produce. Without the orders in hand, CEO's become reluctant to offer any guidance. Recent comments on the future are now becoming clearer. Hewlett Packard's CEO Carly Fiorina stated on June 6th: "we are now addressing what is clearly becoming a global slowdown." However, apparently vision is still somewhat impaired, as H-P could not offer any forecasts as to when revenues will start to grow again. Attempting to put a positive spin on negative news, the press reports that chipmaker Broadcom says that order cancellations are slowing. Last week's Sanford C. Bernstein Strategic Decisions Conference at the Plaza Hotel gives us insight to the basic materials sector. It seems the views from Silicon Valley to the Rust Belt are one and the same. Commenting on the aluminum and steel producers presenting at the conference, Sanford C, Bernstein analyst John Tumazos concludes "little or no sequential pricing or profit improvement has developed in the second quarter or leading into the third quarter – improvements in metals demand are not developing as anticipated". These types of comments suggest that economic weakness will persist across many sectors of the economy, leading to continued Fed easing and an expanding supply of currency. Like gold; computer chips, steel, and money are made from natural resources. Silica is a product of pure white beach sand, steel is made from iron ore, and paper currency comes from wood (or some such organic fiber). Unlike a silicon chip, gold does not crack when stepped on, unlike iron, gold will never tarnish, and unlike dollars, gold cannot be made from trees.

Gold, in its natural form, is found in rare occurrences within the earth. Exploration for such gold deposits started to decline in 1997 following the collapse in bullion prices from the $400 level in early 1996. Around 1998 the gold mining companies essentially abandoned exploration outside of known mining areas. Rather than search for new mining camps, they chose to maximize output at existing facilities. Now that this phase of "headframe exploration" has run its course, production is set to decline. Using Goldfields Mineral Services statistics, the annual increase in world gold mine production has declined steadily from 5.0% per year in 1997 to 0.2% in 2000. According to Standard Equities, gold production could decrease by 35% (or 900 tonnes) over the next eight years. Data presented by Goldman Sachs at the Australian Gold Conference last April leads us to believe that this is a conservative estimate. Goldman analyzed 16 of the core mines held by the major North American producers, which represents around 20% of global production. To cope with low gold prices, producers have been mining their best ores to keep unit costs low, a practice known as "high-grading". According to Goldman, since 1996 the grade of ore mined from these properties has increased by 38%, whereas the grade of ore left in reserves has decreased by 31%. In 1996 the reserve grade was 18% higher than the mined grade. In 2000 the reserve grade was 41% lower than the mined grade. Mined grades will trend towards the lower reserve grades in the future, which means less gold can be gained from the same volumes of rock. This will cause additional downward pressure on production. There are a number of projects currently on the shelf that will be developed, however, these will only partially offset the new trend to lower levels of mined gold. Without any significant outside exploration for three years running, there is nothing in the pipeline to replace production declines. If the gold price should rise to levels sufficient to support renewed exploration, another five to ten years will be needed to explore, drill, and develop new reserves. We are not aware of any broadly traded commodity that has been faced with such a potentially long decline in primary production. The market will increasingly need Central Bank sales to remain in balance. It is unknown as to whether the banks will be willing to supply such quantities, or whether they are even aware of this imminent decline in production. At the same time, the gold industry has finally undertaken a campaign to aggressively market gold jewelry. All this leads us to believe that fundamentals are improving substantially for gold the commodity. As for gold the investment, more on that in the next update.

The Federal Reserve Bank of New York holds the world's largest accumulation of monetary gold.
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