A primer on gold from Hathaway...
William, thanks for the Gold-Eagle index...I had some good reads by dipping my pole into that well of knowledge, but had never seen this index of analysts. gold-eagle.com
For the thread:
Reading from John Hathaway's 1998 treatise on the inner workings and hidden mechanisms of the gold swap business gives me a better understanding of how and why the CBs and the Fed got into the gold derivative mess. Hathaway's historical perspective puts a footing under the factual picture Jim paints for us today.....jj gold-eagle.com
Extracts:
Gold: A Pot Worth Watching
Basic economics teaches that manipulating a commodity price must lead to distortions
in supply and demand. Price supports create oversupply; price ceilings create
shortages. While this lesson has been learned through the years in too many cases to
mention, it appears that world central banks and finance ministries are attempting the
impossible once again, this time with gold. They are screwing the lid tight on gold
prices at $300 per oz. At the same time, they are firing up the burners with a volatile
brew of anti-deflationary policies. An explosion in the gold price is inevitable.....
World central banks are suppressing the gold price, not through outright sales, but via
gold leasing activities.....
For the purpose of market manipulation, lending is more attractive than outright sale
because such transactions go unreported and are harder to detect. Reserve positions
remain unchanged, unlike outright sales. Nobody knows the size, location, or cost
basis of borrowed gold positions on a global basis....
And a recent writing from June 2002...more details to support what Jim has been posting here...[I feel like I'm reading JW's mail! ]...jj... gold-eagle.com
Extracts:
O Brother Homestake, Where Art Thou?
“If I buy a gold stock, it’s because I expect the gold price to go up. Why then would I buy
shares of a company that hedges the gold price?”....
At the end of the day, hedging was nothing more than a devious and complicated way to
finance a declining business. Complexity in monetary matters, in the words of John
Kenneth Galbraith, ” is used to disguise truth or to evade truth, not to reveal it.” The truth
about gold hedging is that it is a short sale, which can be covered in only two ways. First,
it can be covered as gold produced by mines is repaid to the bullion dealers, who in turn
repay the original central bank lenders. However, this method of repayment takes time,
often years. Such a delay might be excruciating in a rapidly rising price trend. What is
also interesting about this method of repayment is that it actually reduces the supply of
gold because gold earmarked for repayment never hits the market. The second method
of repayment is outright purchase of physical gold on the open market. If done in an
orderly, measured fashion, open market purchases are probably feasible. However, if all
the shorts get the idea at the same time, it would be very difficult to cover because the
amount of this short interest is at the very least 4,000 tonnes, or more than 1.5 years of
new mine supply.
What is happening in the gold market currently is that the hedged mining companies,
after having taken a pasting in the form of share underperformance and vocal criticism
from the investment community, are beginning to capitulate. Recently, Durban
Roodeport, a South African mining company, raised cash through a new share issue.
The use of proceeds was to purchase gold on the open market in order to close out its
hedge book. Other miners have been quietly writing puts at strike prices below the
market, in the hopes that they will become long gold on pullbacks. However, the
proliferation of puts only serves to put a floor beneath the market. Several prominent
hedgers, including Anglogold, have reduced their hedge books and numerous others
have stated that, at the very least, they will not increase their hedge books and are in the
process of reviewing their hedge exposure. The intellectual case for hedging appears to
be in tatters and there appear to be very few who would advocate it vociferously. The
recent rise in the gold price has all the appearance of a slow motion short squeeze,
which could well get out of hand if too many rush for the exits....
What about the central banks who in the past were famous for their willingness to stuff
any significant price rally with an “injection of liquidity?” Central bankers are only human.
Once, they were only too happy to pile on to the downtrend in the dollar gold price by
outright selling and lending of gold reserves in order to accumulate more paper assets.
Now, they find themselves in the position where their principal reserve asset, the US
dollar (representing 76% of world central bank reserves) is declining in value against the
gold they were dumping as well as their holdings of other paper currencies. What they
are loaded with is their worst asset. Since they are only human, it would be most
surprising if they decided to sell what little (proportionately) remains of their best asset
into a rising market. It would not be surprising if net sales of central bank gold have
already seen their high water mark. The discussions between bullion dealers and central
bankers on rollover of existing loans should become extremely interesting following a
sharp rise in the gold price.
It has been about a year since Homestake management agreed to be taken over by
Barrick Gold. Since then, much has happened in the gold world, most of it good. As
candidate Ronald Reagan once asked rhetorically, are the shareholders better or worse
off today given what has happened? Homestake, once a household name in the gold
sector, was the purist’s gold stock. It was a refuge for assorted curmudgeons such as
myself who had no desire to view the world through the rose colored lens of CNBC.
Staunchly conservative accounting, a strong balance sheet, and a perceived antipathy to
hedging created the sort of mystique appealing to gold investors. It is ironic that Barrick,
the gold stock for agnostics, became its merger partner. According to Barry Cooper’s
analysis, Homestake shareholders are about as well off as part of Barrick as they might
have been had the company remained independent. However, that is not the real issue.
How will they fare once gold exceeds $400? In that instance, it seems fair to say that
they will have lost out.
Running the shorts is only a small aspect of the investment case for gold. Much more
important are the overvaluation of the over-owned US dollar and the prospect for a
continuation of poor returns on financial assets. Wherever the gold price settles after this
current squeeze remains to be seen. In my estimate, however, it will be at levels high
enough to make the remaining shorts uncomfortable. It will not retreat to a level where
they can make good on their bad bets. Undoubtedly, there will be bone-rattling
corrections designed to shake out latecomers, momentum investors, and other weak
holders. The gold sector is notorious for volatility and huge swings in sentiment. On the
other hand, will mining companies attempt to rebuild their hedge books and once again
try to outsmart the gold market? I suspect that such a prospect will require a new
generation of management.
John Hathaway
June 6, 2002
© Tocqueville Asset Management L.P.
They are squeezing us again today...jj kitco.com |
