However, given the trading volatility of Gold futures, we may begin to retrade gold astrotechnically and geopolitically in the near future.  Primarily we own ABX and HM and would trade PDG.  ABX is a blue chip and is the best to own until everyone wants Gold.  Then a less hedged alternative is preferable.   In 2000, we avoid South African mines having too much country risk. We prefer Australian and to a lesser extent Canadian companies.  They are more desirable for their currency appreciation versus the US Dollar.

READER: Do you anticipate gold stocks going up in July, as the market goes down? Also do you think once they move up sharply, that they stay up for the rest of the year?

HW: We issued a Gold trading buy last week. [See below] This is being played with tight stops. On Tuesday Gold dropped $4 on opening, then started to slowly recover but then again dropped dangerously at the end of the week and again a mild recovery. I do realize it may take until the fall of the US dollar for a great gold move, so act/react accordingly

May 27  TRADING BUY   Markers:  GOQ 270; XAU 60; ABX 17

Our long term recommendations remains the same: just continue to accumulate GOLD as time goes by.  Gold is super cheap insurance against both inflation AND a future declining US Dollar!
Currently star picks are the majors: ABX, NEM and HM.
Excellent Risk/Reward to buying Gold and Gold stocks over the intermediate and long term.
We see GOLD above $300 and the XAU above 100 by the Fall 1999.

Good morning, ladies and gentlemen.  With gold currently trading below $300 per ounce and an upcoming favorable summer period astrologically according to the Astrologer’s Fund, Henry Weingarten thought it would be useful for me to comment on gold’s fundamental outlook for the balance of 1999.

I will open by commenting just how rapidly gold’s fundamentals have changed in recent years.  For who could have forecast even two years ago that the Swiss would decide to abandon the link of their currency to gold, mining company production costs would plummet over 25%, and that gold would rise only $30 during one of the world’s worst financial crises since the Great Depression in the fall of 1998?  These events underscore the importance of understanding gold’s new fundamentals and their impact on future investment performance.

As a setting for today’s presentation, I will take you back to last fall, during the height of financial turmoil and present “24 Reasons to Buy Gold Now,” written by the late Jim Blanchard, one of this country’s most devoted advocates of precious metals as alternative investments.  Taking 20 of Mr. Blanchard’s examples, I will briefly explain both pros and cons of each point without taking an official stance on each topic.   To make this more interesting, the audience is asked to vote pro or con for each of the 20 reasons on a voting form that has just been distributed.  I will give you advance warning that due to time constraints I will address the pros and cons of the 20 points in a rapid fire manner leaving little time for decision making.  I encourage each of you not to think to hard and let your first gut reaction guide your voting.  Remember you will not be graded on your results.

Pro. The fact that gold demand quickly recovered after the serious debacle of Southeastern Asian dishoarding is somewhat amazing.  Less than 7 months after a television image showed Korean women taking off their gold rings and throwing them into a bucket to help the government, the Koreans were back on the buy side in the latter half of 1998.  The resurgence in demand bodes well for gold’s long term-outlook.

Con. Even though gold functioned well as a currency hedge for Asian consumers, dollars would have performed even better.  This is a lesson not unlearned by the Japanese who in recent months have created long lines in Tokyo, wrapping around the block of Citibank’s branch office waiting to open a US dollar bank account.  As we move forward in history, the availability of multi-currency accounts in many parts of Asia will present serious competition from gold, especially after Asian consumers learn that dollar accounts pay interest and gold doesn’t.

Please cast your votes.

Pro.   Following Southeast Asia’s dishoarding during 1998-Q1, investment demand has returned to the region, averaging 52 tonnes per quarter albeit at about half the quarterly levels observed since 1993.  As Asian economies have rebounded more quickly so far in 1999 than most pundits forecast even three months ago, gold demand may continue rising as Asian consumers reflect on the value of gold as a capital preservation asset which served them so well in the 1997 financial panic.  Another pro for gold is that its demand is a global one, and that for every country whose gold demand falters, there is seemingly another one to take up its slack.  For example, during 1998-Q1 when Asian demand slumped, a surge in Indian demand provided a partial offset.

Con. What the World Gold Council fails to emphasize is that much of the increase in 1998’s investment demand originated from large investment funds that simply covered short positions.  In their most recent Gold 1998  - Update 2, Gold Fields Minerals Services estimates an increase in world investment from 166 tonnes in 1997 to 511 tonnes for 1998.  However, 235 of that increase is attributable to investors which merely covered shorts.  In fact the current skew in over-the-counter put volatility indicates that large investment funds are gearing up for another attack on gold after letting it rest for the last 15 months.

Please cast your votes.

Pro: Those who view gold as a currency alternative join the ranks of the world’s central banks which – even in spite of recent sales – still maintain a sizeable proportion of their reserves in gold bullion.  With the dollar as the world’s primary reserve currency, gold has historically performed well when the dollar has not.  Once foreign money leaves the speculative hotbed of the U.S. share market and U.S. Treasury bonds after inflation begins to rise, all one will hear is the sound of a crashing dollar as the balance of payments turns sharply lower.  Gold will then skyrocket.

Con: Interactions between the current account, capital account, and balance of payment accounts are only partially influenced by financial market returns.  In the Y2K environment, what appears bleak for the US is nothing compared to indescribable conditions for emerging market countries and Europe which have recently devoted their financial resources to mere survival (in the case of the emerging markets) and the Euro currency conversion (for European countries).  The U.S. financial system is the most Y2K compliant internationally and the dollar will attract a flight to quality bid from global investors in an uncertain Y2K environment.  When people realize they can’t spend their American Eagle gold coins at Safeway, gold’s myth as a safe haven will quickly be exposed as a farce.

Please cast your votes.

“The deep Asian currency devaluations are causing ballooning trade surpluses, as exports to U.S. and European markets of now-cheaper Asian products boom.  This fact, along with high savings rates and strong work ethics, will lead to a sharp rebound in the Asian economies in 1999.  In turn this will create a similar recovery in gold demand . . . [On the supply side citing a CPM Group study] ‘The flow of newly refined gold into the international market could decline 3.4% to 98.3 million ounces in 1999.  This would be the first decline in total gold supply since it fell 2.2% in 1987.”

Pro: As stated earlier, gold fabrication demand has showed a sizeable rebound following Asian dishoarding in early 1998.  On the supply side, exploration expenditures for gold mining shares have all but dried up as costs have been cut to the bone in a poor gold price environment.  This will lead to a reduced inventory of gold deposits available for development in the future and bodes well for keeping the lid on annual mine supply.  What’s more, the so-called “declining production cost phenomenon” which in a world of falling production costs keeps mine supply high, is a temporary phenomenon as most North American gold mining companies are now mining the high-grade portions of their deposits.  One high-grade ore is depleted, a surge in production costs will occur as low-grade ore replaces high-grade ore.  Higher production costs will lead to a suspension of mining operations, reduced mine supply, and higher gold prices.

Con:  In fact the declining production cost story is only partly attributable to high-grading.  Weakness of primary gold producer’s currencies, including the Australian dollar, the Canadian dollar, and the South African rand, has widening local operating margins.  As long as these currencies remain weak in a deflationary global economic climate, there is no motivation for a curtailment of supply from producers operating in these countries.  Despite contrary warnings earlier in 1998, annual mine supply showed a year over year increase of 2.3% for 1998.

Please cast your votes.

Pro:  No matter what the fundamentals, technicals, or astrology says, money flows will always win in the end.  For a bull market to continue charging, it needs fuel.  According to Trimtabs Investment Research, since July 1998, stock market mutual fund inflows have failed to match their torrid pace established during 1996 and 1997.  The bull appears to be on a diet and is losing weight fast.  This bodes well for gold investment demand.  As a capital preservation tool and alternative asset, gold requires that returns from competing markets to fall before gold becomes interesting.  Reduced money flows are an important indicator that cracks are indeed spreading.

Con: No matter what the money flows do, as long as the narrow indexes retain their health investors are unlikely to jump into capital preservation tools like gold.  What’s particular healthy about the market at this phase is the broadening of the rally since April 7, 1999 which marked lows in the US broad market.   As investors finally see most of their mutual funds go up which have lagged index funds since the broad market top in April 1998, money flows are likely to return to the stock market and drive the indexes to sharply new highs.

Please cast your votes.

Pro:  The period of imminent stock market weakness is resoundingly bearish for the dollar.  While one could invest in overseas investments, if the US economy goes into recession, so likely will the rest of the word.  Gold becomes the only rational alternative investment to US financial assets and global currencies.

Con: As a percent of total Gross Domestic Product, the total federal budget debt has shrunk to miniscule proportions as the Clinton administration as done a superb job in creating annual budget surpluses recently.  The resiliency of the US economy that has confounded doomsayers ever since 1987 is a testament to the creative power of Americans and the capitalistic system.  In this environment, it does not pay to buy gold as a portfolio insurance asset in a continued era of capital growth.

Please cast your votes.

Pro: The biggest pool of bad debt in the world remains hidden in the Japanese banking system.  The only way to out of the Japanese deflationary spiral is either  (1) let the entire house of cards fall to the ground and wait for a genuine resumption of demand and growth or (2) act preemptively and inject large monetary reserves to offset the effects of a deflationary monetary contraction.  Japan’s low interest rate policy and aggressive approaches to banking reform are in fact a desperate signal from a central bank which has lost control of the economy.  Printing money has always been the easiest political route and Japan is playing out a textbook example of procedure.  Reckless monetary expansion has always been bullish for gold.

Con: While aggressive monetary expansion of the yen may be bullish for gold in yen terms, what is means for gold in dollar terms is anything but clear.  Especially when US banks continue to generate record profits and do not show the same symptoms of bad loans as in Japan.  To paint the global banking system with the same brush as Japan is a misguided generalization.

Please cast your votes.

Pro:  Begining in 1992, European Central Banks were large sellers of gold reserves prior to entry into the European Monetary Union.   Sales were not encouraged but nevertheless tolerated until the launch of the Euro in 1999.  The key question is what happens to excess gold held by EMU member central banks held above and beyond what was transferred to the European Central Bank.  The market’s understanding is the ECB now has effective veto power of any gold sales, even from reserves held outside the ECB by member countries.  With a desire of the ECB to conduct its policies very conservatively in order to uphold the value of a brand new world currency, it is unlikely that they will allow any gold sales which may unintentionally call into question their motives.

Con: Europe includes more countries than just EMU members, as the U.K’s recent surprise gold auction announcement reminded us.  And don’t forget all the non-ECB gold held by EMU member nations.  While this gold may be under lock and key for another year or so, don’t be surprised in the year 2000 or 2001 that 5 to 10 years of equivalent annual mine supply will suddenly be added to the auction block still warm from the blows of the U.K.

Please cast your votes.

Pro:  It was under Wayne Angel’s leadership at the Fed when commodity prices took a more prominent role as an indicator of the stance of monetary policy.  Certainly the 1997 collapse in commodity prices, a symptom of slackening global growth, was one factor behind coordinated central bank rates cuts last fall.  And look what’s happened since: though the CRB took out the 200 support level, the index has stabilized after reaching the low 180s this past February.  More importantly, the energy dominated Goldman Sachs Commodity Spot Index rallied 27.2% from its December 21, 1998 low on the heels of a strong crude oil rally.  With economic growth recovering this year, monetary stimulus appears to be working and inflationary pressures have started to rise again.  Gold has historically done well during periods of high inflation.

Con: The commodity rally has been dominated by crude oil and a careful look at its supply and demand factors reveals an important point.  Crude rallied not because monetary policy stimulated large incremental demands for crude oil; crude oil rallied because OPEC decided to make a supply side response by cutting production.  This destroys the link between last fall’s ease in monetary policy and commodity demand.  Furthermore, if inflation were to rear its ugly head, surely Alan Greenspan would raise rates in a pre-emptive strike.  One of the benefits of his tenure is avoiding monetary policy mistakes of the 1970s that included negative real interest rates.  Why buy gold when Greenspan is at the helm?

Please cast your votes.

Con: The reason why stocks have outperformed gold is arguably the success of capitalistic progress, corporate profits, and the power of capital appreciation over gold as a capital preservation tool.  As Wall Street often says: “Cash is Trash.”  Further, microeconomic theory predicts that prices under competition will converge to average cash production costs in the short run and average total production costs in the long run.  With cash costs of gold production falling to $191/ounce in the third quarter of 1998 [Gold Fields Mineral Services], microeconomics theory predicts that gold can fall to $191 in the short run.  Total costs, which include overhead and other expenses that must be covered in the long run for mining companies to stay in business, were tallied at $289 during the same period.  Last quoted at $278.80, gold’s decline has simply followed the laws of microeconomics.

Please cast your votes.

Pro:  Many derivative models assume a normal distribution of price returns.  Periods of unusual volatility can easily blow out the assumptions of derivative pricing models and pose greater profit and loss risk to financial institutions that manage derivative books.  This in fact happened last fall when the yen had its explosive move on October 7, which was calculated to be a 5 standard deviation move by a currency risk manager at Tiger, who conceivably lost more money that day than anyone else in the entire world.  Gold did rise on the heels of that event, but it was at the very tail end of last fall’s panic.

Con:  The problem with this argument is that it depends on where the derivative risk is.  Regarding gold’s behavior under deflation, my research says that for gold to rise under a deflation-induced derivative blowout, there must be a sufficient reduction in bank capital to require a large injection of capital by monetary authorities which must be judged a reckless inflationary overkill in monetary stimulus.  Turning to last fall’s problem, Tiger’s losses in yen (which can be considered a derivative as much of their position was leveraged) were born by private investors and did not require a public bailout.  Moreover, nearly all of Tiger’s investors have made so much money over the years that a flat return for one year was considered a hiccup in the bigger picture:  “shaken not stirred.”  The final problem is with the derivative argument is that no one person can tell you how many of the derivatives are vanilla currency forwards versus the more toxic positions.  So maybe the derivative problem is overstated.

Please cast your votes.

Pro:  As the collapse of Asian currencies in 1997 was triggered by capital outflows which had up to that time supported deteriorating current accounts, it’s easy to apply the same model to the U.S.  It’s only a matter of time until capital flows dry up and the dollar collapses.

Con: Japan’s large trade surplus with the U.S. generates billions of dollars which the Japanese must either invest in US$ based assets or swap for foreign currencies.  As long as attractive investment opportunities remain in the US, then those dollars will end up in the land of the free and the brave and the US trade deficit will be funded for longer than anyone cares to image.  Perhaps the best argument for a collapse in the dollar is a genuine Japanese economic recovery which will cause the Japanese to sell their dollars for yen and invest back home.  [This is the point made by Chih Kwan Chen in his internet posted article:  http://pages.prodigy.net/ashino4112/articl01.htm  ]

Please cast your votes.

Pro:  Prior to 1997, strong economic growth from Asian and other emerging market regions powered the strong commodity boom from 1993 to 1997.  Gold was a major beneficiary of this strong trend.  Supporting this pro argument is that the Southeast Asian populace just lived through a very devastating economic collapse during which gold correctly functioned as a hedge against currency depreciation.  People will be quick to save gold once their income stabilizes.

Con: But incomes haven’t stabilized in many cases despite the illusion of prosperity garnered by the explosive advance in Asian emerging market equities in 1999.  In the last part of 1998, Southeast Asian demand was running at about one-half of its pre-1997 levels.  One also has to be concerned about potential currency devaluations in China and India, as each of these events could cause after-the-fact gold sales as people cash in their gold once its purpose as a currency hedge is achieved.

Please cast your votes.

Pro:  In a speech delivered at the World Gold Council’s annual Central Bank forum last summer, I discussed the behavior of gold under deflation and proposed an optimal central bank reserve policy under deflationary conditions.  My conclusion was simple: if deflation spreads to the United States, the US dollar may become at risk.  My recommendation is that central banks should consider gold as a part of reserves, principally as a hedge against an overweight dollar position.  Any purchase of central bank gold is positive for gold whether the demand originates from Asia or other geographic regions.

Con:  Despite the sound reasons behind the diversification benefits of gold in an overweight dollar reserve portfolio, there has been little movement among the Asian central banks to buy gold.  Even last year’s rumors of China’s gold purchases were not confirmed by official statistics released during early 1999 which confirmed that not one ounce of gold was purchased by China during 1998.  Also against this point is the modern portfolio approach increasingly taken by more central banks whose focus on total return hurts gold against other currency choices that can be invested in government paper with higher yields than can be obtained from gold lending.

Please cast your votes.

Pro:   Producer forward sales have been increasingly replaced by the purchase of put options as many producers don’t feel comfortable hedging at such low gold prices.  The problem with this strategy is that producers are so stingy in doling out the dollars for option premium that the put option’s price is normally paid for by the sale of out-of-the money call options.  Were a sharp rise in the gold price to occur, producers would have to buy large quantities of gold to cover their short gold call option positions.  This situation could create an explosive gold rally of $50 to $100 dollars simply because of the delta hedging required to hedge the rising value of short call option positions.
Con:  As long as the gold market stays in contango, it pays to be short.  Earning that contango every day builds up a large reserve of accumulated profits which can withstand sustained gold rallies of 20 to 40 dollars without making longer term traders nervous.  And for some smart producers like Barrick Resources who employ spot deferred contracts in their hedge books, were gold to rise suddenly, they can sell their current production at the current spot price and roll their existing forward sales out to future years, because of the dual nature of the spot-deferred contract’s terms.  Barrick has no reason to panic and buy gold to cover forward sale contracts were gold to rise suddenly.

Please cast your votes.

Pro:  In 1997, the London Bullion Market Association started the release of monthly trading volume in an effort to improve transparency in the gold market.  Prior to 1997, the sole source of gold trading volume was futures volume data provided by the COMEX and Tocom exchanges.  The first release of the LBMA’s volume data met with some surprise and was higher than most participants expected.  The figures do suggest that bullion trades in a quantity required to meet the liquidity requirements of many institutional investors, who have shied away from gold in the past due to gold’s perception as a relative illiquid investment.

Con:  It’s common knowledge among bullion participants that trading volume in the upstairs spot market exceeds futures volume by several times.  During 1994 and 1995 I conducted verbal surveys with the largest bullion dealers who indicated that upstairs liquidity exceeded the floor’s liquidity by a factor of 3x to 5x for COMEX and 1x to 2x for Tocom.  As a caveat, the dealers noted these liquidity factors were subject to substantial fluctuations on a day-to-day basis.  I suspect these factors are lower in 1999.  The primary problem with the LBMA numbers is that they include transfers of gold which may occur because of swap rollovers, collateral exchanges, and other activities which do not require a spot dealer to register a bid or offer.  The LBMA numbers overstate gold’s true liquidity and should be interpreted with caution.

Please cast your votes.

Pro:  Certainly gold has outperformed T-bill returns during some historical periods.  Central to the late 1970s gold bull market was the negative real rate of return experienced by T-bill holders whose nominal rate was more than wiped away by CPI increases.  These types of inflationary macroeconomic episodes are generally favorable for gold or other physical commodities that can be hoarded as capital preservation tools.

Con: Veneroso’s analysis is time dependent and many other time periods produce different results.  Veneroso’s results merely demonstrate that sometime in the past gold outperformed Treasury bills.  Long periods of over/underperformance of asset classes is a common fact of modern investing.  To imply that investors will suddenly buy gold because gold outperformed T-bills during a prior historical episode is a hollow argument if other more powerful reasons are not included in the proposition.

Please cast your votes.

Pro:  Playing the contrarian investor role is often an edge in investing and sentiment data can provide a quantitative measure of when to step in front of the crowd.  Citing Market Vane’s Bullish Consensus, gold analyst John Brimelow noted that gold’s Bullish Consensus reading had sunk to a low of 16% during August 1988.  “Two days at 15% marked the bottom this January [of 1998].  On March 5, 1985, a low of 16% also marked the end of the 1983-1985 bear market.  Between 1985-1987, no other readings in the teens occurred.  During the 1992-1993 base, the Bullish Consensus never fell below 31%.  Readings this low have always been followed by violent rallies.”  In fact a violent rally did occur between August 31 and October 8, 1998.  The conclusion is it always pays to fade the crowd when sentiment is at an extreme.  With current sentiment at historical lows, gold is a safe bet.

Con:  As a technician, I have learned to appreciate the concept of signal failure.  Simply put, when a market doesn’t do what is should according to a powerful technical setup, it usually does the exact opposite.  This in fact is the problem with low sentiment readings as a gauge of any future gold rally’s magnitude.  If from 1985 to 1987 the price of gold nearly doubled to $502 after a Market Vane reading of 16% in 1985, then surely we must be disappointed by gold’s 1998 respective rallies of just $36 and $30 following sub 20  Market Vane readings at the onset of each rally.  Further, the speed at which sentiment turns bullish after sentiment lows is alarming.  According to Peter Palmedo, of Sun Valley Gold Company, following extremely low sentiment numbers at the April 5, 1999 gold low – this time using MBH Commodities Daily Sentiment Index, sentiment had swung nearly 60 points on a 100 point scale with only a $10 dollar movement in the gold price.  If this is what little is required to swing sentiment from bearish to bullish, then traders shouldn’t become agitated about a $200 gold move in today’s environment whenever Market Vane falls below 20.

Please cast your votes.

Pro:  The pro gold argument concludes that since the experiment of dollar-linked currencies failed, Asian economies will create their own monetary union whose new currency would presumably be backed primarily with yen and gold.  As was prognosticated last year, prior to the Euro’s advent, this new currency would compete against the dollar, reducing its importance as a reserve currency, and gold’s importance as an indirect result.

Con:  Asian monetary union was a pipe dream made during the heat of last year’s turmoil by disenfranchised parties.  At best, this proposal merely vented anger about the financial devastation and at worst was a trial balloon designed to poison the political climate during IMF debt negotiations.  In addition, as much as Southeast Asian economies may have resented the US and IMF for meddling in its economic policies, it hardly pays to pick a fight with the US who is a principal buyer of Southeast Asian exports.

Please cast your votes.

Pro:  The bullish view is that net central bank sales and investor dishoarding are temporary factors which are actually required to fill the ongoing mine supply/jewelry demand deficit for the market to clear.  Any temporary cessation of these sales will release the coiled spring and gold will explode higher.  In fact, gold’s most recent bull market peak in early 1996 was marked by this exact sequence of events.  Because of a large rise in gold lease rates, gold’s forward curve actually fell from contango to backwardation in the last months of 1995, decreasing the incentive of producers to sell gold forward as the forward price of gold fell.  This episode of reduced producer sales allowed a substantial gold rally in the space of about 10 weeks.

Con:  The negative view is simply that there are so many sellers of aboveground gold stocks that these sales have been transformed from a temporary to a permanent factor in the gold market.  And over time the problem only magnifies itself as nearly all fabrication demand can return to the market in the future through sales of scrap jewelry and gold bar sales.  Finally, on the producer side, at the rate production costs have been falling, forward sales at today’s spot prices – which even 2 years ago would have been unthinkable - do make sense for some companies.

Please cast your votes.

Having reached the end of 20 reasons to buy/not buy gold, if you are confused you are not alone.  All attempts at predicting the gold price through fundamentally derived models have failed because gold’s fundamentals are highly complex and change very rapidly.  I hope my presentation has caused each of you to consider gold in ways other than simply an inflation hedge, a libertarian vote against government, or a Y2K financial planning tool.  Gold’s complexity is high and therefore deservedly retains its mystique among many of the worlds investors.  Thank you for your attention.

Sam Hewitt is currently Chief Technical Analyst for Van Eck Global, a privately held money management firm specializing in the management of alternative assets.  Mr. Hewitt’s duties include  co-manager of the firm’s Hard Asset hedge funds as well as a  management role of both International Investors and Gold Resources mutual funds.  Mr. Hewitt is a Duke MBA and earned his Ph.D. in Mineral Economics.

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