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Gold Market Update

November 22, 2000

Over the last two weeks, gold has traded sideways in a narrow range between $264 and $267, closing at $265.70 on Friday. On an intraday basis, bullion reached a low of $263.25 on November 7, the day of the Bank of England auction. The intraday high occurred on November 16, when gold rose to $268.25 on short-covering in Asia. Gold shares have drifted sideways to slightly lower, at levels well below the 45-day moving average. A look at the past twenty-one year history of the Philadelphia Gold and Silver Index (XAU) reveals an average gain of 27.07% from the November/December lows to the January/February highs. Only five of these years (1980, '81, '94, '96, and '99) turned in low-to-high gains of less than 15%.

The U.S. dollar has resumed its upward trend, appreciating against most other currencies following the brief, sharp correction from historic highs reported in the last (November 6) Gold Market Update. The European Central Bank intervened three times in the past two weeks, but failed to gain support for the euro. The annual European inflation rate, at 2.8%, has exceeded the ECB's 2% limit for the fourth month running. Conventional thought says that this is a situation that calls for higher interest rates to defend the euro and simultaneously cool inflation. However, rather than rattling a weakening economy by raising rates, ECB vice president Christian Noyer initiated a deceptive policy he must have learned from his peers across the pond. Mr. Noyer said in an interview that the ECB is now focusing on an inflation rate that excludes energy costs, which was only 1.6% in September. How can monetary policy ignore oil, a commodity that currently costs the world $1.13 billion per day more than it did just one year ago? That's an annualized cost increase of $410 billion per year! Two months ago the Clinton Administration intervened in the oil markets with an ill-fated attempt to drive oil prices below $30, as WTI crude closed Friday at $35.48. Supply/demand fundamentals within the oil patch indicate that these high prices cannot be ignored or manipulated downward.

Sources tell us that the Saudis are buying 100 ounce gold bars for the first time in years. Newly mined gold bars that typically weigh 1000 ounces are gradually becoming harder to come by. Newcrest, Glamis, Homestake, Dayton, and Kinross have all announced premature mine closures in the past six months that total around 700,000 ounces (22 tonnes) of annual production. These closures will take effect over the next six to twelve months. Mining executives are extremely reluctant to close operations because: 1) mines represent a substantial capital and social commitment, 2) closures reduces the production profile in a sector that has traditionally been viewed as a growth industry, and 3) associated write downs temporarily reduce earnings and permanently increase debt ratios. The decision to shut down is a process that can take years as companies struggle to revive high-cost operations. With hindsight in a low gold price environment, each of these closures should have occurred months, or even years ago. Moving forward, companies that bite the bullet and cut production will become more profitable and management will not have the distraction of problem operations to deal with.

We expect to see more such closures in the coming year. A look at Nevada, globally the number three gold producing region behind South Africa and Australia, illustrates this coming trend. An analysis of 1999 production by Dr. John Dobra of the University of Nevada shows that 58% of Nevada's gold production comes from 9 mines with cash costs below $200 per ounce. Twenty-three high-cost mines produce the remaining 42%, with 10 of these having cash costs above the 1999 average price of $272 per ounce. Using another calculation based on the discounted net present value of future gold production, a recent Brook Hunt study shows 10.7 million ounces (335 tonnes) of world-wide production does not break even at a gold price of $270 per ounce. While much of this is cash-positive, steadily declining ore grades and ongoing capital expenditures make it increasingly difficult to maintain this marginal production. At prices below $300, this is not a growth industry and the sooner unprofitable ounces are removed from the market, the sooner market forces can work to move the price higher.

The next Gold Market Update is scheduled for Monday, December 4. Thank you for tuning in and have a happy Thanksgiving.

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