Weekly Gold Update

January 25, 2002

January 2002 surely will be known as "The Month That Was." This month encompassed the denouement of the Enron saga, as well as the anticlimax of the Argentine peso and the disparagement of the absurd currency board concept which had anchored the peso to a ship adrift. Then came Kmart, followed by Ford's $10 billion shelf registration on top of a $9.5 billion debt offering courtesy of Moody's. Internationally, Japan's second largest retailer is begging banks for mercy, while Hyundai's merger plans have gone awry - in each case due to revealed or hidden debts. Through all this, the Dow has defied the January effect, becoming more volatile and declining 2.5% through the 18th, while gold has risen 2% and the XAU gold mining index gained 7.5%. According to Barron's, gold share performance has been second only to tobacco so far this year.

The purpose of the forgoing litany is to show that Nobel Prize winning Milton Friedman's observation that "Inflation is always and everywhere a monetary phenomenon" applies equally to the gold price, as the gold price measures confidence in the value of paper money, as well as confidence in the viability of credit instruments denominated in that paper. The enormity of corporate debt outstanding and today's extreme corporate leverage means the perceived value of corporate debt has become just as important to monetary stability as confidence in the government itself, because a broad failure of corporate debt would impinge on the creditworthiness of lending institutions and the government itself as the lender of last resort.

Gold has been in a narrow range for the past three years, as the U.S. attracted a huge amount of foreign portfolio investment. Equally important, however, is that gold has risen almost 20% against commodities as measured by the CRB index over the past twelve months. Economic historian Robert Hoye concludes that this is normal in early post-bubble recessions. Later, as credit problems broaden in a widening and deepening recession, gold also rises against the world's dominant currency.

Confidence in credit instruments is derived not only from balance sheet analysis, but is also determined by the trustworthiness of the credit issuers. Former chairman of the SEC, Arthur Levitt, has warned repeatedly about lax corporate governance and the need for board of director and auditor vigilance. During the manic phase of speculative booms and bubbles, however, self- serving corporate activity may be tolerated by investors and employees who themselves are prospering. But when someone lowers the boom, corporate chicanery becomes intolerable. Recessions and bankruptcies are the usual catalysts.

In the wake of Enron, Mr. Levitt has taken a tougher line, suggesting that corporate malfeasance may be endemic. He and others have indicted corporate managers, boards of directors, investment bankers' analysts and especially auditors for not preventing or unearthing unethical behavior. Sweeping legislation affecting these entities is in the cards, but when and how effective?

The vast expansion of corporate debt and reports of lax corporate integrity has made corporate debt a possible causation of monetary instability. From 1994 through the third quarter of 2001, real GDP in the U.S. increased 24.7% while corporate debt rose 84.7% and financial debt soared 139.2%. Creditors, highly leveraged themselves, have funded speculative corporate acquisitions and share buy backs as well as the stock and real estate bubbles. Corporate debt is now 48% of GDP and debt ratios of 70% of capitalization are common. Too big to be ignored!

In a January speech Alan Greenspan cited risks to the economy, but he failed to include the greatest risk of all, namely what the Wall Street Journal described as "disintegrating corporate credit quality." There are many more risks, including potential monetary turmoil in Asia should Japanese currency depreciation go too far.

So, our advice is to be wary about meretricious forecasts of a rebounding economy based on minor improvements in standard economic statistics.

Meanwhile Newmont Mining's acquisition of Normandy Mines has converted a large hedger to a supporter of the gold market. Now all Newmont needs to do is follow Goldcorp's and IAMGOLD's policy of converting cash balances to gold.

The first use of gold as money occurred around 700 B.C., when Lydian merchants (western Turkey) produced the first coins