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Gold Market Update

May 25, 2001

Last week gold broke through two technical resistance prices, and today fell back, as might be expected, after piercing the $292 an ounce resistance point. Last week gold rose $19.60 an ounce to close at $287.40 an ounce. Virtually all of the gain occurred during the last three days and 70% of it on Friday.

Reasons given for the rise include:

l) Speculative short covering and some net buying. As of Tuesday the large speculators were in a small net long position, and open interest has recently risen.

2) A low contango for gold which has discouraged mine forward selling and perhaps speculative "carry trade" activities.

3) Increasing reluctance of central banks to lend, possibly because of the bankruptcy of a borrower with as much as a million ounces of gold derivatives position. Gold lease rates, though down from the recent peak, remain historically high. In this environment any attempt at significant gold borrowing could cause skyrocketing lease rates to drive gold into backwardation and incite panic in both lenders and borrowers.

All of the above, however, are not necessarily causes of the gold price. They are more likely the effects of a preceding gradual change in the perception of gold's value in the developing economic environment. Since early April gold, after a double bottom, had been slowly creeping up against the dollar, and more quickly and for longer against other currencies. The catalyst seems to have been the major central banks' capitulation in the war on inflation so as to direct all forces to the war of economic growth – a scenario for unknown and unintended monetary and inflationary consequences.

The potential for accelerating inflation or speculative excess in the United States has been the explosive 12.6% and 24.7% annualized growth rates of M2 and Money with Zero Maturity respectively this year. These are increases from huge bases, totaling around $5 trillion. Money growth is being fueled by the return flow of credit from private foreign interests, accentuated by the Federal Reserve's easy money policy. Confirmation that gold is cheap was an observation in Saturday's New York Times that the best grade of marijuana sells for more than an ounce of gold. Not too long ago only elite cocaine held that honor.

Perhaps this year's Dow Jones and gold performance will finally dispel the myth that gold and the stock market never rise together. While it may be that during broad economic sweeps gold and equities are reciprocals they have often risen in tandem. Examples include segments of 1995-1996, 1993, 1989, and very important, 1985-1987 despite rapidly rising interest rates in 1987.

The two most notable periods, however, were 1982-1983 and 1972. The l982-1983 market ended in a parting of the ways as the Dow forged an 18 years bull market and gold generally languished, though with huge intermediate rallies. The 1972 market ended with gold surging from a starting point of $35 an ounce to nearly $200 in 1974, while the Dow fell nearly in half.

In l982, when the Dow began its bull run, equities were thought to have died. Few expected a resurrection. Valuations were among the lowest of the century. Conversely in l973, when the parting of company favored gold, the Dow's valuation was near the extreme upper end of the century' scale.

Today the Dow's valuation resembles that of early 1973 and is exacerbated by the high debt levels of its components. Barring a new paradigm, the next parting may again be sweet for gold.

A long held conviction of gold enthusiasts was perhaps best said by Oliver Wendell Holmes: "Prophesy as much as you like, but always hedge." In a world of undisciplined monetary systems with no standard of value anywhere, Mr. Holmes words may be more cogent today than in 1861 when he penned them.

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