Jerusalem and Gold

July 30, 2000

Now that the Camp David talks have failed over the status of Jerusalem, it's time to look at the effect on the Precious Metals markets this fall. First, there is likely to be a pronounced effect if there is MidEast political instability, especially if it lasts a while. The Stock Market detests uncertainty and political chaos. September 13th will shake the foundation of the bull market and consumer confidence violently. I don't believe either would survive without a sharp decline. So much for the so called bull market, a little old fashioned political chaos and it chokes like the Portland Trailblazers.

My interests lie more in the area of precious metals and the broader economy for this essay. Assuming there is no political settlement over Jerusalem, gold bugs have to ask some hard questions. The first question is would the Arabs use their economic neutron bomb, an oil embargo, to wring concessions from the West over Jerusalem's status? It's obvious that if they do, the energy price increases would stick. In other words, we would have an energy crisis, circa 1973/74, all over again. Goldbugs should certainly be aware of the possibility beginning in mid September. The United States has already sustained across the board price increases of three to five percent since January. Energy prices have gone up fifty to seventy five percent since last summer. Oil supplies would be disrupted, just as people were preparing for winter heating. Prices would go up and spot shortages would appear without a doubt. Whether the West would go into recession remains to be seen. Since the economy is already slowing, it's an open question if further oil price increases would push us over the edge.

Precious Metals have historically done well during periods of political instability. They do even better when inflation is added to the picture. I've shown we are entering a period likely to be high with both factors. What is unique to the current precious metals market, as it enters a bullish scenario, are the fundamentals of supply and demand. I accept as a matter of common sense gold demand will increase starting in August and September. I see no reason to question that assumption at all. If you do, then the rest of this essay will make little sense to you. I believe the key to the coming precious metals market lies on the demand side. Here's why.

Sidestepping the controversial subject of whether the ESF and other entities have conspired to control gold's price, I want to focus on pure economic supply. I firmly believe current events are creating a situation where the ownership of physical gold and silver will become desired by more people. Since this is the case, the obvious question becomes: Is there enough physical precious metals to meet this demand? The answer to that question is the key to the coming bull market in precious metals.

Without going into a lengthy discussion of gold hedging and gold leasing, which candidly I'm not an expert on, there are a few facts pertinent to gold and silver supply. The United States admits it will exhaust its silver stockpile next year. Austria has largely depleted it gold reserves by issuing gold ounces. Holland, England and Kuwait, among other countries, have reduced their gold reserves. The list goes on. The point being, Central Banks and Governments won't be their usual market smashing selves this time around. Either they won't have the gold at all, or they can't mint it fast enough to impact a demand spike. Y2K's spot gold shortages from last year will be magnified by the large public demand for physical gold during the fall. Honestly, if that was the only supply issue I wouldn't be so bullish on precious metals. A few million extra ounces from a Central Bank could probably crush the market yet again, if it was only private demand that needed to be sated. Unfortunately for the current elite, a golden sword of Damocles hangs over the precious metals market.

An example may make this clearer to you. Imagine you're an ice cream shop owner on a 100 degree summer day. Your demand is way up; so, you call your supplier and ask for more ice cream. Under normal circumstances, your supplier and the factory can easily accommodate your increased need. Everyone would make some extra money and be happy. I think this is the precious metals markets in mid September. The public demand could possibly be met, although there could be spot shortages and price increases. Except for one thing.

Many pundits have commented on the large, both in terms of multiyear production and actual tonnage, gold short position. Here is the core reason for my belief in an explosive gold rally. There isn't enough physical gold or silver to meet total likely demand. Our ice cream shop owner calls his supplier and is told that there are only a few fudge cicles in the warehouse. Worse, fudge cicle production has been bought out for several years. "Call us back in summer 2002", he is told. This is called Gold Hedging. Further, the ice cream factory has "leased" past and current production, as well as any warehouse inventory, onto the market over the past several years. Fudge cicles have glutted the market and been very cheap. Of course, the factory owners got a guarantee the fudge cicles would be returned at the end of the lease. This is called Gold Leasing. What happens when the increased demand works it way up the supply chain? What happens when the factory owners calls the people they leased their fudge cicles to and ask for them back? "But we ate them, or sold them and people ate them" comes the frantic reply.

Likewise, at a time when private demand is increasing, production is unable to increase and warehouses are virtually empty, our pitiful lessor must go out onto the open market and buy the fudge cicles needed to repay the loan. Bankruptcy, Loan Default or Market Manipulation are his only options. It's more complicated than that I'm sure, but you get the general idea. Once the market starts to "unravel" as they put it, there is risk to entire banking system. Just ask Alan about it.

The gold "short" position is variously estimated at between 2,000 and 12,000 tons. Tons and not ounces in case it hasn't begun to dawn on you. Several years of world gold production depending on which figure you believe. Once the gold price breaks above $350 an ounce, the entire banking system will be shaken to its rotten core. "My fellow Americans, we have a fudgecicle crisis. There are none to be had."

Well, Mr. GreenSpan, where will the physical gold come from to meet both increased private demand and cover the shorts? What will happen to the banking system, Chase Manhattan, City Bank and the others, when the billions in gold shorts must be covered? I'm waiting for an answer.

Bullish doesn't begin to describe the type of precious metals market this fall could bring. With Jerusalem as the trigger event, and thousands of tons of gold to be bought to cover short positions, the sky is the limit. Once the gold price barrier is breached, there will be no holding back the tide.

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

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