So much 4 Barron's Einhorn bias: OPEN QUOTES: Monday, April 20, 1998
New E-bullion-ence? Gold's slump may be over
By Cheryl Strauss Einhorn
Despite the rise in the equities market and the U.S. dollar, gold prices have begun to move higher. In fact, while gold prices are up nearly 7% this year, they've gained 5% in just the past month.
Is the slump over? Yes, says Frank Veneroso, a gold consultant who runs a co by his own name in Summit, New Jersey. "We're basing now. I'd recommend buying the dips." He expects gold to trade between $290 and $315 this year. It currently commands $308 an ounce.
Even gold producers are turning less bearish. Whereas they had been active buyers of put options, that market has nearly dried up, meaning producers are no longer afraid of downside risk. Now traders
say producers have been active sellers of calls, implying they believe the market is stabilizing here.
Too, in an unusual move, producers have been aggressively selling long-term -- say, 2, 5- 10-year -- volatility by writing calls, which produces premium income that helps offset production costs. Should gold surge, the downside pressure that typically results from producers seeking to lock in prices with forward sales may be limited if they have already hedged via this call writing.
Why is sentiment changing? Because many of the pressures that plagued gold prices in 1997 have dissipated. Specifically, the gold market was hit last year by three adverse shocks: ongoing central-bank
gold sales as European nations readied their economies to meet the entry requirements for economic and monetary union (EMU); forward sales by gold producers and short sales by speculators who anticipated continued central-bank gold sales; and the Asian financial crisis. The latter hurt gold in three ways: It depressed jewelry demand, caused commercial inventories to be liquidated and forced investors to sell to obtain liquidity.
Now, however, much of the official gold sales by CBs could be ending. In May, the new European Central Bank is expected to set the level of gold reserves when the composition of the euro is formally
announced. In fact, two major European CBers, one from Belgium and one from Italy, recently indicated the ECB could hold 30% of its reserves in the yellow metal.
Moreover, while EMU will not formally start until next year, the French and Germans have indicated that a high level of reserves will be needed to maintain confidence in the EU. Comments from these two
nations are particularly important to the gold market, in part because both the French and German central banks hold significant gold reserves but neither has been among the banks that have sold gold
in the past.
Thus, once the reserve level is set in May, although European CB gold sales may continue by law, they may stop as these nations try to avoid disruptions to the mkt. This is an important point; gold sales
after May could cause political problems by undermining confidence in the euro. Upshot? Sentiment should be less bearish and reduce producer and speculative short sales.
"There have been so many false starts in this market," says Jean-Marie Eveillard, manager of the SoGen Gold Fund. "But a month from now, CB selling cld be over 4 the next few yrs & the fear
associated with such sales will subside."
As for the Asian crisis, two of its three depressants on the market are ending. For instance, analysts estimate that Asian jewelry fabricators keep twice the amount of gold in inventory than they sell. This is done in part because of the way gold items are sold, namely by display. That is much higher than the average 0.6:1 inventory-to-sales ratio of all goods sold in the U.S. economy. Hence, as Asian sales fell, these commercial gold users cut their inventory to keep this 2:1 ratio constant, resulting in huge liquidations.
This is largely over.
Further, as the Asian crisis worsened, there were large government-led campaigns encouraging patriotic gold sales by citizens to obtain needed foreign exchange. The Koreans, in particular, led such an effort. This ended in March.
The last leg of the Asian depressants-end-use demand for jewelry and coins -- remains grim. In 96, Indonesia, Korea, Malaysia and Thailand represented 10% of global demand. Now, however, it will take
time for these important consumers to return to gold.
In total, though, these three adverse shocks to the gold market are nearly over. With fewer Euro CB gold sales, producers and speculators will have less incentive to sell too. And if much of the Asian shock has indeed run its course, the mkt outlook is improving. Says Veneroso: "We expect the gold market to move sideways until this last tranche of EMU-related selling is over. After that the market
should significantly rally."
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