One for the weekend :-)
11:45p EST Thursday, November 18, 1999
Dear Friend of GATA and Gold:
Here's another excellent essay by financial analyst,
Harvard-trained lawyer, and former mining company
executive Reginald H. Howe at his web site,
www.goldensextant.com. Howe describes how gold
interests have failed to handle gold in ways that would
increase its financial utility and general value. Let's
hope that a few take the hint. You might help them by
posting this as seems useful.
CHRIS POWELL, Secretary
Gold Anti-Trust Action Committee Inc.
* * *
Gold Bricks, Glass Houses,
and the Web: Retooling Gold Funds
By Reginald H. Howe
www.goldensextant.com
November 12, 1999
Managers of gold mutual funds have not been reticent in
their criticisms of Ashanti, Cambior, and other heavily
or imprudently hedged mining companies. Granting the
validity of their complaints, they are not without some
responsibility themselves for the problems recently
plaguing gold investors, notably their own shareholders.
As a group, gold fund managers are the principal
professional investors in this sector. They have the
required analytical skills and technical support. What
is more, many of them understand both the monetary role
of gold and the dangers of gold banking far better than
the mining companies or even the bullion bankers. Yet
many gold funds apparently bought the bear case for
gold sufficiently to sprinkle their portfolios with a
significant number of heavily hedged miners while
failing to do very complete investigation or analysis
of their hedge books.
What is more, few gold funds with the authority to
invest in gold bullion actually held any. Seeking the
leverage traditionally associated with shares, they
spurned bullion while failing to appreciate fully just
how quickly ill-advised hedging could turn leverage
against them.
The purpose of this commentary, however, is not to
criticize gold fund managers for falling victim to the
pervasive bearish sentiment that engulfed the gold
market in recent years. Rather, it is to offer some
thoughts on what they might think about now.
1. Requiring Greater Transparency. No group is better
situated than gold fund managers to insist that gold
mining companies make full disclosure of all relevant
information, including their hedge books. Put bluntly,
gold fund managers need to remember their ABC's, which
in this case are Ashanti, Bre-X and Cambior. All these
disasters blindsided more than a few gold fund managers
who were just a little too careless, a little too ready
to follow the crowd, and not demanding enough of the
companies in which they were investing. Gold funds
operate in a quite restricted universe, making it
understandably difficult to avoid investing in a major
company which others seem to like. In the gold sector
particularly, the temptation to lower or waive
established investment criteria because of the actions
of others must be resisted.
2. Participating in Mining Finance. Due principally to
their own greed and self-interest, the bullion bankers
have failed the gold mining industry. With their eyes
set narrowly on earning a spread, whether from mining
finance or the gold carry trade, the bullion banks have
failed to give their mining company customers sound and
prudent financial counsel. This failure now gives gold
funds a good opening to become more active in mining
finance themselves. Gold funds, their shareholders, and
the companies in which the funds invest all have a
community of interest in stronger gold prices. Bullion
banks searching for profit or official favor in
trashing gold are not part of this community.
In this respect it is useful to compare a gold loan to
a mining company with a gold bond or gold preferred
issued by the company. In each case the basic idea is
to repay the obligation out of future gold production.
Interest costs are typically comparable, i.e., based on
gold lease rates rather than ordinary interest rates.
However, in a gold loan, gold is borrowed and
simultaneously sold into the market at spot, putting
immediate pressure on the gold price. With a gold bond
or a gold preferred, the company receives cash but
there is no immediate sale of gold, and the loan
principal when due is paid directly out of production.
While issuing costs for gold bonds or gold preferreds,
particularly those which are publicly traded, generally
exceed gold loan fees, the swift pace of financial
reform could lead to a narrowing of this gap too.
Gold loans and forward sales have a legitimate role to
play in mining finance, but when they are conditioned
on margin requirements or required call/put hedging
that jeopardize a company's financial viability, the
time has arrived to consider other alternatives, e.g.,
debt instruments or preferreds convertible into equity
or with accompanying equity options, gold bonds, gold
preferreds. All these vehicles are appropriate
investments for most gold funds, and to a limited
extent could be bought by many even on a private
placement basis. A portfolio consisting of bullion,
gold bonds or preferreds, established producers who
hedge prudently or not at all, and a few carefully
selected smaller companies should more than hold its
own against a portfolio of all the usual suspects,
i.e., the better known gold equities.
3. Buying Gold Bullion. As of August 1999, the U.S.
gold funds covered by Morningstar had total assets of
about $2.5 billion. At $300 gold, 40% of that amount or
$1 billion would buy more than 100 metric tons of gold,
or more than three times the current COMEX stocks, more
than Kuwait recently made available to the Bank of
England, and four full tranches of the current BOE gold
sales. At US$18 per share, the market capitalization of
heavily hedged Barrick Gold is just over $7 billion, of
which more than 75% is public float. Sale of 20% of
Barrick's float at $18 would yield more than a $1
billion. In other words, gold funds have sufficient
resources to be an important factor in a tight physical
market, particularly if they take delivery or insist on
allocated storage. And many if not most have the
ability under their existing charters to substitute
bullion for shares. What is striking in reviewing the
August portfolios of the gold funds covered by
Morningstar is how similar they were and how little
bullion they contained.
Indeed, physical gold can be as or even more useful in
a gold fund portfolio than an individual portfolio. Not
only does it serve as insurance and to reduce risk and
volatility, but also it enables a gold fund to stay
reasonably fully invested in gold even when good mining
investments are hard to find, such as during periods of
low gold prices and excessively hedged mining
companies, or periods of high gold prices and
overvalued mining equities. A gold fund manager who
prefers bullion at low gold prices to the shares of a
mining company that has hedged away much of its upside
does more than just benefit his fund's shareholders. He
acts both to support the gold price and to discourage
new or additional production at low prices.
4. Offering Internet Gold Bullion Accounts. So far as I
am aware, only e-gold (www.e-gold.com) offers bullion
accounts on the internet. My knowledge of e-gold is
limited to what can be observed at its site. I have no
connection with it, and I take no position on whether
one should or should not use it.
An e-gold account, which can hold gold, silver,
platinum or palladium, is fundamentally a storage or
custodial account as opposed to a bank account, meaning
that e-gold promises to hold a 100% metal reserve
against its deposits, which e-gold describes as a
"spendable bailment." Profits come from bid/ask spreads
and certain transaction and storage fees. Through
arrangements with online merchants and other
intermediaries, an e-gold account can be used to make
or receive payments in any of several major currencies
converted to equivalent metal values at current market
rates. Various other features and details of an e-gold
account can be viewed at its website, which is well
worth a visit if only to see the idea in practice.
The concept of online accounts that can be used for
both investing in gold bullion and making or receiving
payments appears not just viable but probably
inevitable. What is surprising is that so far only one
company is offering such an account, and it has no
discernible connection with any of the big names in
gold, be they bullion banks, gold funds or mining
companies, nor with any of the recognized financial
services firms so intent on worldwide growth via the
internet.
The concept itself is really no more than applying in
the internet age pretty much the same basic ideas that
resulted in the development of gold banking by ancient
goldsmiths. While the bailment concept may work best
for a relatively small or unknown entity like e-gold,
there is really no conceptual reason that old-fashioned
retail gold banking could not be practiced on the
internet by a financial or other entity with sufficient
name recognition, reputation and resources to do so
credibly.
Certainly there are numerous legal, tax and other
questions that would have to be addressed, and probably
a gold mutual fund itself could not offer such
accounts. But open-ended gold funds that are tied into
large fund groups or banks have the required electronic
infrastructure and software capabilities largely in
place, not to mention the necessary accounting and
legal resources, regulatory contacts and political
clout. Just as large fund groups offer linked
investment and money market accounts, they could offer
linked gold fund and internet bullion accounts. In the
U.S. internet commerce enjoys various tax advantages,
both existing and proposed, that could be particularly
beneficial to gold. In the arena of international
financial services, an internet bullion account might
in many situations be of far more interest to
prospective customers than retreads of existing
American investment products.
Successful young internet entrepreneurs are driven by
opportunities that the more experienced do not see,
undeterred by obstacles others proclaim insurmountable.
Someday, somehow, someone will offer internet bullion
accounts in an increasingly prosperous India moving
toward fuller and freer integration into the world
economy. At internet speed that day may not be too far
in the future. And most who could have been players
will be spectators.
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