Walloped dollar to accelerate gold
Toronto veteran explains the de-hedging scenario
By Thom Calandra, CBS.MarketWatch.com
marketwatch.com
SAN FRANCISCO (CBS.MW) - The possession of gold, Thomas Bailey Aldridge once said, has ruined fewer men than the lack of it.
This column isn't about Aldridge, the American short-story writer who quit school at age 13 to write for 19th century magazines. I just put it there so you can turn away from this column now if you don't want to hear my view of markets in coming years - a view that essentially is the gold story with some dollar-trimming and a swollen current account deficit for good measure.
A month from now, a year from now, five years from now - you choose the timing, because I won't - the price of an ounce of gold will be three to six times what it is now. By then, the world's money flows will have stopped way short of the fiber-optic fork in the ocean that leads to New York.
By then, the euro will be worth a ton more than 91 cents. So will the Canadian dollar and the Australian dollar. By then, overseas investors long will have stopped hoarding U.S. securities in their digitized central banks or their frosted chalets. (As I write this, the flow of fur-ner money into dollar-denominated assets is falling sharply, to well less than half the average monthly flow of $44 billion we saw last year.)
The world's battered economies, the ones that rely on metals and other natural resources for their livelihoods, like Ghana, Australia, South Africa, Chile, Canada, even Russia, will be less battered. We'll be seeing more folk heroes from the top bullion producers, like South Africa's Nelson Mandela this week, ringing the bell at the New York Stock Exchange, or listing on the Toronto Stock Exchange. Gold Fields' Chris Thompson presents the bullish story for bullion.
By then, the paper wealth that is the industrialized world's stock and trade will be more paper and less wealth. America's current account deficit, the best way to judge this country's money flows, already will have surpassed an annualized $450 billion. (See definition below of the ticking time bomb called the current account deficit.)
Hard landing ahead
There are some who believe that when the red ink in the U.S. current account surpasses 5 percent of gross domestic product, all heck will break loose in financial markets. Stephen Roach at Morgan Stanley is on record saying a "hard landing" for the dollar, and with it the boatloads of U.S.-linked securities in foreign portfolios, may be inevitable. "A crisis of confidence is not inconceivable," Roach writes. (Six or nine months from now, you can go back to Roach's report and long for the good old days, when a euro was worth just 91 cents.)
I submit that with that swollen account deficit and the dollar's decline will come (has come and is coming) an explosive move up in the price of gold. The $310 metal, up almost 20 percent this year, one day will sell for a price that reflects a cascading American balance sheet. With U.S. households living off their spree of credit-card and mortgage debt, the perpetual stock and housing market bubbles in this country (and in most of the world's major cities) will hiss, hiss, hiss.
In coming weeks, I hope to bring you several high-profile money managers and (of course) mining executives who state better than I do the case for, as Tocqueville Gold Fund (TGLDX: news, chart, profile) manager John Hathaway put it to me, "a big number" for the gold price. Whether that big number comes from a sinking dollar, or the $63 billion of gold derivatives on the books of U.S. banks and trust companies (as of Dec. 31), or creeping inflation, shocking deflation or, Lord help us, bigger and more deadly exploding mailboxes, remains to be seen.
Ian McAvity, the longtime newsletter editor whose Deliberation on World Markets provides in my view some of the hardest-to-find historical charts, money flows and hard data on international gold mining equities and gold and silver bullion, says the gold-price trigger may be days or weeks away.
McAvity, who keeps paper files of every chart, stat and mining press release, stretching back 25 years, points to a pending rush by hedged gold miners to reduce the amount of gold they are forward-selling. As Gold Fields Ltd.'s (GFI: news, chart, profile) top executives, Chris Thompson and Ian Cockerill, put it this week from New York, the forward-sale of gold is a source of supply in a falling gold market, spurred by bullion banks and central banks that lend their gold reserves in search of incremental income. But in the current market, where gold relentlessly sets new highs, the scramble to close forward-sale contracts - to de-hedge and return to the spot market for bullion - is a source of potent demand in a rising gold market.
South Africa's Gold Fields and several other large miners, such as Newmont Mining (NEM: news, chart, profile), have virtually no hedged sales of gold. In other words, the miners who don't cross-dress their portfolios with frilly futures contracts, options and other derivatives, sell an ounce of gold for whatever it sells for in the spot market.
Andy Smith, the London-based precious metals analyst at Mitsui & Co. whose work in this field sets him apart from most Wall Street gold analysts, estimates there are 3,000 tonnes of gold on mining companies' hedge books. "In Q1 2002, (South African) Anglogold (AU: news, chart, profile) disarmed its hedge book by 1.7 million ounces, some 20 percent more than quarterly output, implying about 0.3 million ounces of buy backs on top of deliveries into hedge positions," Smith notes. "Anglogold's hedge was defused another 0.65 million ounces in April. In fact, this de-hedging in Q1 exceeded (gold) imports into Japan . . . by almost 30 percent."
McAvity up there in Toronto on Friday told me a story, complete with charts and press releases from long ago, to illustrate how powerful the rush to de-hedge can be in a rising gold market. In May 1993, a company called Lac Minerals, now operated by Barrick Gold (ABX: news, chart, profile), announced they had decreased their hedge book to 85,000 ounces from 585,000 ounces. The company said it was doing so "to take advantage of rising gold prices." The average price they achieved on their remaining 85,000 ounces of hedged gold was $333 an ounce.
When the announcement hit the wires that day in May 1993, McAvity coined what came to be known as the "Lac gap." The price of gold gapped up to first $363 an ounce, then higher and higher. By summer, the price would reach $407 an ounce, not bad for a metal that began the year at $328.
"History certainly won't repeat itself precisely, but a look back at the surge in 1993 may add some perspective to what I believe is going on now," says McAvity.
On Friday spot gold's price just after midday was up $2 to $311.30. Gold mining equities in Canada and New York were trading erratically, approaching their highest points since October 1999. Gold mining indexes, as measured by the Amex Gold Bugs Index (HUI: news, chart, profile) and the Philadelphia XAU (XAU: news, chart, profile), were last up 1.2 percent for the day.
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