Gold Market Update

The price of gold, in our opinion, has finally successfully completed a fourteen month test of the move from its 1999 "bottom" of $ 254 an ounce to $ 324 an ounce in early October 1999. Last week it fought its way above a four week "intermediate bottom" of approximately $ 265 an ounce to over $ 270 an ounce, actually closing on Friday at $ 268.70 an ounce, up 1.0% from the prior week. The extreme bearish sentiment represented by a very high net short "large speculator" C.F.T.C. traders' commitment position of 144.5 metric tons on November 21st was reduced to 112 metric tons as of November 28th.

The prices of gold mining shares performed much better than gold. They have usually led the way in major turnaround moves. The Philadelphia Gold/Silver Stock Index rose 9.1% last week. It was 16.1% above its November 17th record low.

The following warning signs indicate to us that a period of eventual financial "stress" may have begun which could well lead to a "hard landing":

1. Annualized U.S. economic growth fell from 5.6% in the second quarter to 2.4% in the third quarter. Capital spending grew at a 7.8% annualized rate about half its pace in the second quarter. Consumer confidence in November slid to a 13-month low. The growth in U.S. commercial and industrial bank loans have leveled off. It was 15% earlier this year. On Friday a Federal Reserve Governor said the slowdown was broader than when the F.O.M.C. last met in mid-November.
    
2. The dollar's rally during November, excluding Japan, failed to exceed its October 25th high. During the last week the euro climbed 4.8% against the dollar. Sterling also rose. A Middle East central bank was reported to have placed a large order to buy several billion dollars worth of euros, sterling, Swiss francs and yen. Possibly radical rising popular anger against Isreal and the U.S., its ally, for the continued shooting, repression and inhumanity against the Palestinians has put pressure on the moderate Arab governments to reduce the use of dollars in their monetary reserves. The Arab nations together have over $ 36 billion of foreign exchange, probably mostly dollars.
    
3. Corporate profit growth rates are slowing, and stock prices are down. After-tax corporate profits for the third quarter rose at a 0.6% annual rate after a 2.5% pace in the second quarter. Earnings per share growth on the S. & P. Composite has fallen from an annual rate of over 20% earlier this year to an estimated 10% in the fourth quarter and 2001. After surging 40% in 1998 and 86% in 1999, the NASDAQ Composite Index is down almost 50% from its March high.
    
4. The risks of an incipient financial crisis are rising. High-yield corporate bond yields rose to a high of 14.16% last week, and the spread over 30-year Treasuries climbed to a recession level of 857 points from 799 points the previous week and 438 at the end of 1999. Although the Fed is monetizing debt at a higher rate in the last three months than in the previous three months, "free reserves" in the banking system are over $ 1 billion and bond yields have come down, the treasury yield curve is still tightly inverted.
    

The diversification of a portfolio into gold is important during periods of financial "stress" or instability because such diversification may improve performance. During the last 30 years almost one quarter of monthly returns in a study were "stress" periods. A recent World Gold Council study of the behavior of various asset classes during both stress and non-stress periods to determine the optimal mix for "efficient" portfolios concluded that a portfolio for optimal performance during stress periods would contain significant amounts of gold and fixed-income securities. If a non-stress period were expected, the portfolios would emphasize equities and contain little or no gold. However, since most investors cannot accurately forecast the timing of stress periods, a moderate-risk portfolio with 6% gold performs closest to the expected return during both stress and non-stress periods. The portfolio for a stress environment would contain 29% gold and 62% T-bills and bonds. Thus, as investors begin to expect a stress environment, they may well diversify from 6% to 29% of their portfolios into gold depending upon their stress expectation and wish to preserve rather than grow wealth.