Quarterly Review of Gold:
Editor's Comment: Following is a gold report by Mr. Harry Bingham - internationally acclaimed gold expert, who is President of Van Eck Institutional Advisors and Manager of PIMCO Precious Metals Fund among other accounts . Furthermore, he is a well-known speaker of frequent Gold Conferences in the U.S. and Canada - and is often interviewed on nationally syndicated TV programs.
Quarterly Gold Review
Henry J. Bingham, Van Eck Associates Corporation
During the quarter ended June 30, 1999 the Gold mining shares on average declined about 4%. Gold, itself began the quarter at $279 an ounce, having been affected by proposals that the International Monetary Fund Sell up to 10% of its holdings over several years. Gold then recovered to $289.70 an ounce in early May. Gold mining shares, demonstrating their leverage to gold, rallied more sharply and by May 6th, were up approxiametly19% from their March 31st closing prices.
On May 7th the Bank of England announced that it would conduct a series of bi-monthly auctions to dispose of 415 tonnes of gold. Britain, the founder of the gold standard, is not a major gold holder and, unlike most large European holders and the United States, has never disavowed an intention to reduce its gold holdings. Nevertheless, Britain's announcement had a disproportionate affect on the market, and gold closed on June 30th at $262.50 an ounce.
The speculative short interest in gold on the Comex, instead of falling as the price declined, rose to a record 264 tonnes. Including the much larger over the counter market the total speculative short position probably exceeds 2000 tonnes.
The demand for fabricated gold remains brisk, exceeding mine supply and scrap recoveries by about 500 tonnes annually. In the United States gold eagle coin sales totaled 1.25 million ounces in the first half of the year, a rate that exceeded record coin sales at the height of the 1980 gold boom.
Gold Shares declined with gold but on June 30th were approximately 18 % above their August 31, 1998 low when gold was $274 an ounce. Historically the out-performance of gold shares in a declining market has had favorable implications for both gold and the shares.
During this period of low gold prices the gold mining industry is maximizing efforts to reduce costs and to consolidate operations. The Placer Dome-Getchell Gold merger was the most prominent this year.
Outlook
Currently attention is concentrated on central bank and other official sector gold activities, despite denials by the French, German and Italian central banks of any intention to reduce their gold holdings. The German Finance Minister stated that the new government envisions no change in the policy that gold is held for emergency use only.
In the United States both Robert Rubin and Alan Greenspan testified in opposition to gold sales before the House Banking Committee in May. Mr. Greenspan said "Gold still represents the ultimate form of payment in the world. Fiat money in extremis is accepted by nobody. Gold is always accepted and is perceived to be an element of stability in the currency and in the ultimate value of a currency."
Social and political pressure is also building against official gold sales. International Monetary Fund sales require U.S. Congressional authorization. Five Democratic Senators, including minority leader Thomas Daschle, as well as five Republican senators have written Secretary Rubin objecting to the sale. Subsequently other Congressional leaders have announced their opposition.
In June the Chairman of Anglogold and the President of South Africa's National Union of Mine workers met with various Congressional groups. On June 30th twenty six members of the Congressional Black Caucus wrote to President Clinton opposing both IMF and central bank gold sales.
Political leaders in South Africa and Ghana have expressed opposition to the British auctions. In the British House of Commons the British sale was denounced as "a reckless act which goes against Britain's national interest". Surveys in Britain and Europe have revealed overwhelming public opinion that gold provides value and stability to currencies and economies. A British poll registered 5-2 disapproval of gold sales.
During the 1970's, in a period of inflation and low confidence in central banks, efforts by the United States and the IMF to suppress gold failed. Today, in a period of prosperity, official sellers of gold may be over playing their hand. Their policies are being perceived as threatening employment in Africa and other poorer areas as well as investment in those regions as their economies sink into recession.
The halting of official sector gold sales may lessen the speculative inclination to short gold and could lead to a classic short squeeze. During the recent Financial Times Gold Conference, Robert Sleeper of the Bank for International Settlements, an organization not known for flamboyance, said a gold rebound "will take no prisoners."
The fundamental case for gold, however remains its long term role as a store and standard of value to measure both the prices of good and the value of other forms of money. During periods of financial tranquility and prosperity gold's value may decline as it did during the 1920s and 1960s, only to rise rapidly in the less tranquil succeeding decades. Today, several risks exist that could further disrupt monetary relationships and financial stability:
While Asian and other emerging market economies have improved, largely because of foreign assistance, soaring American imports and the roll over of international bank credits, the financial structure of these nations remains precarious. In June, Harvard Economics professor and former Chairman of the President's Council of Economic Advisors, Martin Feldstein noted that the improvement in the Japanese economy is due primarily to massive government public works projects at an unsustainable rate. As exports continue to decline, he warned of the likelihood that Japan will "attempt to stimulate export growth by drawing down the value of the yen from120 to the dollar to 150 or even 180. He foresees this causing other Asian currencies to float lower and China to devalue, which would lead Japan to seek an even lower yen. Such developments coinciding with a $300 billion U.S. current account deficit could disrupt both the American economy and the American dollar. U.S. imports now account for 7.5% of world gross domestic product, up from 4% in 1995. The world economy has become increasingly vulnerable to the lessening of an American propensity to consume. Even in Europe devaluation has become acceptable. Both the German and French Finance Ministers have said that a low Euro helps exports. It also has resulted in significant losses to foreign investors, particularly the Japanese.
(1) Credit growth is increasingly exceeding economic growth in the United States. Last year a record $5 of new debt was created for each dollar of additional Gross Domestic Product. During the last twelve months total public and private debt grew 11%. Financial sector debt which finances speculative activities rose 20%. Financial sector debt now accounts for 54% of non-federal debt, up from 38% just five years ago. All this debt, much of it related to rising equity and real estate markets, has contributed to a negative personal and corporate savings rate for the first time since the 1930s depression. An expansionary 9% annual growth of the monetary base and $300 billion flowing into the United States from aboard to finance the current account deficit provided the basis for this credit expansion. The 20% growth of derivatives outstanding last year added to the amount of assets controlled with very little money down. Author and Economics Professor Martin Mayer recently disparaged the hedging attributes of derivatives. He wrote: "One day there will be a day in the market like no other. On that day the greater the presumed mathematical certainty the greater will be the risk of derivatives."
Closely related to credit growth is the increased speculative financing of government debt. It is reliably estimated that 50% of U.S. Treasury bonds are held under repurchase arrangements. A leading bank analyst placed U. S. bank exposure to interest rate swaps alone at $25 trillion and estimated the credit risk of derivatives underwritten by the banks at three times their capital. The Federal Reserve Board is surely cognizant of the banks' exposure as it sets monetary policy.
Excessive credit expansion typically leads to inflation. As David Littman Chief economist of Comerica suggested recently, only the surplus goods coming from abroad prevented prices from accelerating significantly in the face of excessive monetary growth. Recently, however, early warning signs of inflation have appeared. Import prices, even excluding oil, have inched up. The number of purchasing managers reporting higher prices paid rose more than 70% from last December to June. Base metals prices are up from 20% to 55% from recent lows as inventories have been reduced. The Goldman Sachs Commodities Index, A Broad measure of prices with less emphasis on agricultural products is up 15% this year.
Conclusion
In recent months the market has concentrated on prospective official sector gold disposals. The proposed IMF sales are under attack and appear less likely to occur. Britain and Switzerland are also under pressure to review their policies. Meanwhile, a credit induced rise in commodities prices appears to be developing in the midst of fragile financial conditions in much of the world. As this progresses confidence in paper currencies may decline and the demand for gold may rise. At that point Central bank sales are likely to be canceled or become counter productive, much as they did during previous such episodes. In Alan Greenspan's words: "Gold as the ultimate means of payment" provides protection against the destabilizing forces of inflation, deflation and the currency depreciation that often accompanies these occurrences.
Harry Bingham
18 July 1999
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