A little help from our friends:
Gold Watch
Veneroso Associates
June 4,1998 Issue 06.01
John Brimelow William J. Murphy III Frank Veneroso
The Gold Market
· Down Nine Days In a Row (through Monday)…Why?
We are of the opinion that undisclosed EMU related selling has capped the gold market over the last two months. We predicted a $290-$315 range for gold as long as the ongoing undisclosed selling continued. We did not expect to see the late 1997/early 1998's lows, largely because of an abatement in Far East household and commercial liquidations and an improvement in the sentiments of producers and funds who are becoming aware of a likely abatement in official sales.
Through Monday, old declined nine days in a row and broke slightly below the lower $290 limit of our forecasted range. Why? We present several possibilities.
1) Official selling has followed the market down, rather than waiting for stable to rising prices.
2) Two factors---future Swiss sales and fears of global deflation---have deteriorated fund sentiment toward gold, thereby encouraging short sales.
The following analysis leads us to conclude that we should not change the positive position we set forth at $300 gold.
Official Sales
Regarding official sales, we thought that any ongoing undisclosed European official sales would wait for stable to rising prices because of pressure by "Europe" (France, Germany, and Italy) to avoid "counter productive" gold sales. We remain confident that there have been undisclosed official sales, probably by the Dutch. It is possible the selling central bank has accelerated its sales to complete its program before key meetings in early June or early July on the ECB. If this is so, the market is at the mercy of the central bank seller until he is done.
It is possible that Russia has been a seller of reserve gold, but we doubt it. Russia has been losing foreign exchange reserves. However, she has the option to sell currency since currency reserves were $19 billion two months ago while gold reserves were worth $5 billion. Also, she can swap as well as sell gold. The 1989-92 balance of payments crisis in Russia provides some precedent. Then, faced with yet lower currency reserves than now, Russia sold gold, reducing its gold reserves by 550 tonnes to a low of 250 tonnes. Russia swapped the remaining 250 tonnes. In a swap, the physical gold is sold but the sale is offset by a long forward position. Reserve currency obligations (or outflows) are met but there is no net negative sale of gold on the spot and forward markets combined.
Russia has been building her gold reserves. We do not believe that holding gold versus dollars or D Marks in a country's central bank strengthens its currency, but many people do. Russia may have been raising her gold reserves to increase public confidence in the ruble. With roughly 500 tonnes of gold reserves, it is probable that she would swap rather than sell if forced to have recourse to her gold reserves.
Russia has a surplus of gold mine supply over domestic consumption and sells its mine supply from time to time. Rumored Russian sales may be occurring, but they may be sales of mine output.
Fund Sentiment
Regarding fears of Swiss sales, a recent announcement by the Swiss Finance Ministry that they plan to sell 1300 tonnes of gold beginning in late 1999 or early 2000 over a five to seven year period has damaged sentiment. This is the most negative statement made to date by the Swiss authorities. In the past, an outside panel of experts recommended that the Swiss sell 1400 tonnes. At the time the Swiss authorities noted that it was a recommendation of an outside panel only. Swiss official statements suggested sales of 400 to 700 tonnes over perhaps a decade if the required constitutional referendum passes. Peter Munk was told in January by the Swiss authorities that, if there were any sales, they would be on the order of 300 tonnes. Another negative is the position of Christian Blocher's opposition party. Initially, Blocher came out against the proposed referendum. He now appears to be focusing on using the proceeds from planned gold sales to meet the needs of the Swiss social security system.
Quite frankly, we are not worried about Swiss gold sales. First, the referendum has been postponed from early 1999 to late 1999. We still doubt that the required cantonal majority will be achieved. We believe that, with some recovery in South East Asia, a flow of more than 1000 tonnes of official gold (both sales and loans) are consistent with $370 to $400 gold. By the early 2000's demand will grow relative to supply at this price range. The Belgians, Dutch and Canadians will be done selling. The gold market should be able to easily absorb such sales.
We might add that it is still not clear that the Swiss intend to sell 1300 tonnes. Monday the Swiss Finance Ministry made a statement that opens the possibility that any gold sales might be capped at 500 tonnes.
ZURICH, June 2 (Reuters) - A Swiss newspaper reported that the Berne government planned to cap official gold sales for financing a proposed humanitarian fund at 500 tonnes rather than sell what is needed to raise seven billion Swiss francs. …the plan would probably be approved by the cabinet on June 22 and limit the amount of gold Berne would gradually sell to finance the solidarity Foundation. "We need some sort of security," he (Ulrich Gygi, Finance Ministry Director) was quoted as saying. Daniel Eckmann, aide to Minister Kaspar Villiger, confirmed the report was accurate, but said the plan still had to be approved by the cabinet and by parliament.
This 500 tonne cap may refer only to gold sales for the humanitarian fund, with another 800 tonnes earmarked for other uses. The diverse statements made by the Swiss authorities over the last year make Swiss intentions unclear. In any case, the issue right now is not the impact of such sales on the market, but the impact of talk about official sales on fund sentiment. The Swiss issue has deteriorated sentiment and encouraged short sales.
Regarding fears of global deflation, the combination of financial and economic deterioration in Asia, a new and very severe crisis in Russia, and severe weakness in US high tech have fostered a deflation theme in financial markets. This change in market sentiment is very pervasive. It is adversely affecting the cyclically sensitive sectors of global stock markets, it is buoying the US bond market, and it is depressing commodity prices. We believe that receding prospects for European official sales led the hedge funds to significantly reduce their short positions in gold in the early months of this year. This new deflation theme has offset the earlier positive sentiment toward gold that had developed as fears of EMU related official sales ebbed. Hedge funds who trade on the OTC (as opposed to computer funds who dominate Comex) are greatly influenced by these major trading themes.
Economic sanctions against the Indian subcontinent with it's high level of gold consumption has further eroded fund sentiment toward gold. We believe that the economic sanctions imposed on India and Pakistan will not have a great adverse impact on these economies. The US must impose sanctions by law. The other major industrialized countries are not imposing such sanctions and the US is not urging them to do so.
WASHINGTON, June 1 (REUTERS) - …the United States will not press for sanctions, a U.S. official said on Monday. "This…is not an attempt to gather support from China, France and Russia and the United Kingdom for the draconian sanctions the United States has imposed." (State Department spokesman) James Rubin said.
We believe there has been very substantial hedge fund short selling of gold over the last several weeks. Our biggest error in judging the gold market recently has been failing to predict the emergence of this deflation theme, its adverse impact on fund sentiment, and the short selling it probably has set in motion. This deflation theme has substance. Volatile global capital flows in late 1997 and early 1998 have destroyed the economies of emerging South East Asia. We predicted in a long note on Asia last January that the real economies of emerging Asia would weaken into the third quarter of this year and that the crisis would spread to Latin America and Europe. However, we thought this prolonged and deepening crisis would provoke a stronger social response and a drive for less restrictive policies in emerging Asia. Noted economists like Martin Feldstein and Joseph Stiglitz have spoken out for reflationary policies, but the authorities in the most affected countries have turned silent. The IMF and the US Treasury have continued to demand deflationary policies in these countries. This has increased the risk of further erosion in the Asian economies and more deflationary pressures. Of course, such pressures will spread to Eastern Europe, Latin America, and eventually the US.
Despite this clearly deflationary shock to the emerging world, we have been of the opinion that the worst had passed for gold, since it is unlikely that anything comparable to the liquidations of South East Asia will recur and that they are largely over. We adhere to this position. Of course, the issue in the market today is more one of perception, investment theme, fund sentiment and fund selling, and the latter has become a major new adverse short-term factor in the market.
Conclusion
The gold market has fallen further than we had expected because of fund short selling encouraged above all by the spectre of global deflation. It is possible that there has been a last round of official selling which has followed the market down. We still believe that undisclosed EMU related selling and Asian liquidations have seriously depressed the gold market over the last eight months and that both have abated or will abate shortly. We attribute recent weakness primarily to fund short selling that is out of proportion to the actual deflationary pressures that presently exist in the world economy.
It is our view that the U.S. and European stock markets are dangerous financial bubbles that will eventually burst. If they burst soon, global deflationary pressures will build and the recent deflation theme that has inspired fund short selling in all commodities will prove justified. However, if these stock markets do not fall precipitously in coming months, these short positions will not be validated and there will be a scramble to cover. If the authorities in Japan and South East Asia move decisively to reflate, the scramble to cover will come sooner and will be more dramatic.
In any case, we stick with our positive position set out over the last month. The gold bear market of 1997-98 resulted from a set of exogenous shocks: EMU related official sales, which have not yet been fully disclosed; producer and fund short sales resulting from fears of such sales; and household and commercial dishoarding in South East Asia. These sources of supply have abated or will soon abate. Accelerated EMU related official selling or fund short selling does not change this basic dynamic. If these several supply shocks abate, the gold price will rise, and recent speculative shorts will cover, contributing to that rise in price. ¨
Veneroso Associates:
All portions of this work, copyright 1998, all rights reserved.
|
