Gold Market Update

September 11, 2001

Gold mainly meandered through a narrow range, but as of today is down $4.00 to $272.10 an ounce since our August 20 update. Generallyspeaking, gold has been tracking the dollar, but at a lesser magnitude than the euro and yen. So far confidence in one or another paper money remains high despite growing credit problems and weakening financial markets and global economies. Nonetheless the operative equation seems to be Stock Prices +dollar = Bonds + Gold. When one side is up the other is down.

Last Friday the head of Foreign Exchange and Gold Reserves of the Bank for International Settlements, perhaps responding to various reports of missing official gold reserves, estimated that 4700 tonnes of gold reserves have been lent to the market, well below some private estimates. Time will tell, but increasing financial stress leading to a covering of short positions may be the impetus the gold market needs. Even 4700 tonnes is a big number, roughly twice annual WORLD gold production.

The strength of the euro and yen can best be described as weakness of the dollar. Other than for speculation, there is little apparent capital movement from the U.S. to Europe and Japan. More likely is a repatriation of foreign held funds by Japanese banks in preparation for the probable shrinking of capital when on October 1st common stock holdings must be priced at market. Japan's rapidly shrinking trade surplus and poor corporate earnings in a weakening economy are powerful disincentives to foreign adventure. A sign of the times is the resort to naming the next Japanese debt issue the Koizumi Bond, for the popular Prime Minister, to garner public demand. But what is the encore to finance a $250 billion deficit?

At home Congress argues incessantly about whether the budget, excluding Social Security, is in a deficit of $9 billion or $15 billion, all in the context of a $2 trillion budget. The Treasury Department's daily statement, however, shows a twelve month $127 billion increase in the gross public debt. A government deficit is not financed by Social Security, it is financed by selling bonds. Social Security acts as middleman for the public when it buys some of the bonds, as it always does when in surplus. Government I.O.U's. are Social Security's sole assets.

Where does all this paper, as well as newly authorized paper credits for Turkey, Brazil, Indonesia and now Argentina come from? When will the first "hot money" follow Secretary O'Neill's dictum to take a bath?

All this paper is beginning to resemble Buenos Aires patacons with which it is paying provincial salaries. Neither official currencies nor patacons are convertible on demand into anything of value. But patacons promise to pay interest and to be convertible into pesos in a year. But patacons, unlike paper money in Marco Polo's time do not have the seal of a sovereign on them. Which is better a seal or patacon interest?

Economic statistics have been mixed with heavy discounting leading to a stabilization of durable goods orders while services industries continue to contract. Sharply lower corporate earnings as reported by Standard and Poor's make a capital goods recovery unlikely any time soon.

More telling for gold, I.M.F. economists warn of a significant danger of global recession similar to the early l980s, which could cause "substantial financial market turbulence including a possible abrupt decline of the dollar".

Confidence is key. Perhaps consummate confidence was Barron's report that Eurodollar futures contracts outstanding have soared 60% this year to $4.8 trillion on a bet that Eurodollar prices will be the same or higher than today. The bet is a highly leveraged gamble on the future general level of interest rates. Other than counter-party solvency, another real risk is that the now paper thin Eurodollar deposit rates over Treasury Bill rates will widen sufficiently to wipe out far more than the down payment on the futures contracts.

An accelerating rise in unemployment may well shake what has been resilient consumer confidence.

All of which makes Alan Greenspan's testimony of earlier this year worth recalling. "One big risk is that consumer confidence could crumble like a dam being breached. The torrent carries with it most of the remnants of certainty and euphoria that built up in earlier periods". That's where gold comes in!

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