Last night's article from TSC:
thestreet.com
Central Banks' Motives on Gold Move Still a Question Mark
By Aaron L. Task
Senior Writer
10/4/99 10:02 PM ET
Short and Sweet
SAN FRANCISCO -- The price of gold rose $13.70, or 4.5%, to $319 an ounce on the Comex today, which brings us back (as promised) to the issue of why the European central banks did what they did, when they did it. The issue is the subject of ongoing debate, albeit secondary to the one about who was short and who wasn't, concerns which reappeared today as gold jumped.
"I believe central banks discovered they had collectively a gigantic short position" in gold, via exposure to gold producers, said Donald Coxe, chairman of Harris Investment Management and Jones Heward Investments, both of Chicago.
Some mining companies increased their so-called hedging activities in recent years to combat the decline in gold prices. The companies essentially took a loan against their future production and used the cash to maintain current operations. But had the price of gold continued to weaken, it would have further depressed the future value of their assets, potentially forcing some producers into bankruptcy or into the arms of bigger firms, neither situation being particularly palatable to lenders.
"If you're a producer whose cost [of production] is $270 and the price is $250, you're trying to make up the difference in interest income," Coxe said. "But if gold is at $220, you're out of business. Central banks looked into this and said, 'Are these guys good for it?'"
Moreover, the finance officials realized they were putting their own assets at risk -- both in actuality and via their exposure to hedged producers -- because of the uncertainty regarding future gold sales, he said.
West Africa's Ashanti Goldfields (ASL:NYSE) is a name repeatedly mentioned -- although not by Coxe -- as a producer with potentially problematic leverage. (Still, Ashanti outperformed today, rising 12.8% to 9 3/8, while the Philadelphia Stock Exchange Gold & Silver index gained "just" 7.1%.)
As of June 30, Ashanti was hedged 11 million ounces of production -- or roughly 50% of its reserves -- vs. 8.75 million on March 31, according to a report by John Hathaway of the Tocqueville Asset Management. Using "conservative assumptions," the value of the "hedged book" was $290 million, he wrote.
Yet that asset would become worthless "if gold traded at $325; at $350, the company would begin to face margin calls," Hathaway wrote. "The Ashanti hedge book is a bet that the gold market will remain quiescent and trouble-free. Ashanti's sanguine view is not unusual. Few in the industry are prepared for a spike in the gold price, especially one which does not retrace."
The fund manager acknowledged the company could take action in a rising market -- such as buying calls with a higher strike price -- to cover its hedge.
Ashanti's U.S. banker is Goldman Sachs, according to market sources, perhaps explaining why Goldman was rumored to be a big buyer of gold options last Wednesday, following gold's explosive two-day move.
Ashanti executives did not return calls seeking comment. Goldman officials declined to comment.
Oh Yeah
Back to the issue of why the central banks did what they did.
One veteran gold-market watcher said the joint announcement by the European central bankers on Sept. 26 at the International Monetary Fund's meeting was the culmination of a series of similar comments which fell on deaf ears.
To wit, on July 15, USA Today quoted IMF deputy managing director Alassana Outtara as saying the IMF might work with European central banks to limit their gold sales, perhaps via coordination by the Bank for International Settlements. James Cross, a deputy governor in South Africa's central bank, made a similar proposal at a conference hosted by the Financial Times in June.
"There were meetings going on at various different economic forums for some months where topics like this were discussed," the gold-market watcher said. "But the market took no notice."
Wim Duisenberg, president of the European Central Bank, said the joint announcement last Sunday was "a coincidence," according to Reuters.
Uh, sure, Wim. Just like it's a "coincidence" that rock stars of whatever age and character attract supermodels.
Michael Scarlatos, a global strategist at IDEAglobal.com, noted the decision to cap gold sales was made in Washington "while the IMF is in the throes of gold revaluation."
The day of the ECB's announcement, the IMF's policymaking body agreed to revalue 14 million ounces of gold, using the difference between the book value of the metal and the market price to pay for debt relief for poor countries, Reuters reported.
"At the very least, it was an opportunistic decision," Scarlatos said. "Everyone agrees it's extremely advantageous, if the IMF is going to revalue gold, to do it while gold has recovered."
Some "coincidence," huh?
IMF's press contact did not return calls seeking comment.
Quick and Dirty
I don't mean to give short shrift (a phrase with heavy-duty origins, BTW) to tomorrow's Federal Reserve meeting. But judging by the market's attitude today, a rate hike seems highly unlikely and even the distinct possibility of a tightening bias none too troubling.
But if the Fed retains its neutral bias, don't be surprised if that sentiment evaporates. Talk of a November rate hike is quickly gaining momentum and will only accelerate if Friday's employment numbers are robust.
Meanwhile, my colleague James Padhina has laid out a cogent argument for why the Fed should tighten tomorrow, which I'd like to second with a quick anecdote.
Three months ago, I moved to San Francisco; shortly thereafter, I went to Costco (COST:Nasdaq) (if you have the means, I highly recommend it) to stock up on the "basic necessities."
At that time, a 1.75 milliliter bottle of Tanqueray cost about $18. I went back this weekend, and the price had risen to $21 (before tax).
Thus, the TaskMaster Gin Indicator says inflation is here and must be stopped.
I just wonder if Alan Greenspan, reportedly a fan of bourbon, knows or cares.
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Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He welcomes your feedback at taskmaster@thestreet.com .
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