Gold Market Update

March 14, 2001

Gold closed the week at $270.80, it's highest close in just over two months. Gold lease rates have continued to move higher. On Friday the one-month rate peaked at over 6%, sending bullion into backwardation for the first time since the fall of 1999. The unique aspect of this squeeze is that there is no consensus as to the source. Buyers, sellers, lenders, and borrowers are all suspects. This brief discussion will be limited to what we believe are the most likely causes. The first possibility is that the signatories of the Washington Agreement have started adjusting their lending patterns to be more supportive of the gold price, rather than leaving their vaults open to the carry trade. It may not be a coincidence that lease rates started their slow climb in early February, just after the World Economic Summit in Davos and just in time to arrest the speculative assault on gold that was driving it to new lows in mid-February. There have also been rumors in the market that some of the gold lent in the past by non-ECB banks is being taken out of circulation. This especially makes sense for a country such as Turkey, which is in dire need of hard currency to bail itself out of financial crisis. Finally, Centaur Mining, a relatively small Australian producer, is currently in technical default on their debt, has a hedge book with negative present value, and has committed to deliver more ounces than it produces. No doubt that there are some counterparties down under looking for their gold! While lease rates that are higher than normal can be expected if large market participants alter their habits, rates high enough to create backwardation have never been sustainable in the past. Regardless of the cause, once the market compensates for the current imbalance, we will look for gold to find a more respectable trading range going forward.

The market will receive some additional liquidity this Wednesday when the U.K. Treasury holds another of its 25 tonne gold auctions for the Bank of England. The price and level of interest in this auction will be closely watched. Regarding future BOE sales, it was announced last week that the six remaining auctions will be reduced to 20 tonnes each. Of the original 415 tonnes slated to be sold, 395 tonnes will have been auctioned by the end of this series, leaving a balance of 20 tonnes for which no plans have been announced.

Turning to the economy, much has been made of the letters V-U-L lately. These letters represent the possible forecast shapes of a chart of the economy, and hence, the stock market. The consensus is for a V-shaped recovery and it is getting close to crunch time if this V is going to materialize. The key to the V argument is inventories. In the world of commodities and basic providers that we follow closely, we hear a chorus from CEO's and Street Analysts telling investors that the inventories built during the overproduction binge of 2000 is about to be worked off, leaving a somewhat weaker, but nonetheless growing economy to look forward to. A leveling off in the most recent inventory-to-sales ratio, as well as the NAPM Index are being hailed as possibly the very first signs of an improving economy. However, we don't think that V is the appropriate letter to use here. Longer-term charts show that inventories are not out of line. While the inventory ratio has moved up in the past year, it is still within trendlines and well below levels of the past 10 years. This suggests that the current economic slowdown is more than an inventory correction. Further deterioration in the inventory ratio will be possible due to declines in the sales side of the equation. A continuation of profit warnings and downgrades through the first quarter are symptoms of weakening demand. As the wealth effect of the 90's reverses itself, retailers and manufacturers must reduce margins to maintain volume.

While bullion has outperformed the general stock markets thus far in 2001, leaving the current squeeze aside, gold has not reacted to stock market gyrations and has not generated meaningful investment demand. While the Nasdaq crash has been spectacular, it is still in essence a single sector. Gold has not reacted because the dollar continues to stay strong, the DOW has remained upon a plateau above 10,000 for nearly two years running, the S&P Money Center Bank Index has been range-bound for over a year, and while inflation has shown signs of resurgence, it is not yet onerous. Current market psychology believes that investors who have lost money in tech and telecom will be made whole once the economy reaches the other side of the V. If the V should turn to a U or L, we anticipate that there will be a monumental shift in investor psychology away from borrowing and stocks and into debt repayment and wealth preservation.

The volume of all the gold ever mined can occupy a cube 63 feet on each side.

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