The Slanker Report
Metals



Gold
May 2000

Gold:  Leveraged to Fly
      In many prior commentaries I've downplayed the probability of a gold conspiracy.  But that does not mean a lot of central banks have not been lending their gold to eager borrowers.  The central banks have been lending gold to hedge funds, mining companies, major money center banks, and more to earn income on what they view as a “dead” asset.  The borrowers then sell the gold and reinvest the proceeds in assets that are supposed to earn more than it costs to borrow the gold.
      The interest rates on gold loans are very low (less than 2% in many cases), so borrowing the gold is a lot like getting free money.  And free money has always been attractive.  Cheap gold loans are so attractive that some folks estimate that nearly 10,000 tons of gold has been borrowed and sold by aggressive institutions.  In addition, many gold mining companies have sold gold forward in the commodity markets, plus they have sold calls against future production.
      Well, 10,000 tons of gold is 321.5 million ounces.  That is worth $88.4 billion at $275 an ounce.  That total does not include the gold sold forward or the calls gold miners have sold against their production.  And all of this gold, at some point in time, has to be bought back or produced and delivered.  (In the case of the calls, gold only has to be delivered if the gold price exceeds the call price.)
Gold’s Proper Price
      We know that based on the government’s flawed consumer price index (CPI) gold should be $423.94 to be valued on a normal relative basis with all other things.  I calculate that figure by taking the price of gold in 1900, which was $20.67, and adjusting it with the CPI.  The last time gold traded above $424 for any length of time was back in 1987 and 1988 for a period of 18 months.  And before that it traded briefly above $424 in 1982 and 1983.  And, of course, it spent two years above $424 between late 1979 and late 1981.


      Based on gold’s trading record, I think I can safely say that little if any of the gold that has been borrowed from central banks and sold was sold for more than $424.
      Furthermore, I think most of it was borrowed and sold in the past four years while gold slumped from $400 to $250.  Also, I do not know of even one gold mining company that has a hedge in place with an average price that is even close to $424.  They are all less, some much less.  Now this is important.  And it is important because gold will trade at its normal value at some time in the future.  That will happen.  When it happens, all of those who owe gold to others will be a “little nervous.”
      For an example of a tangible item moving from being undervalued up to its normal relative value, let us look at oil.  Let us just say its normal value with all other things in $25 per barrel.  At the end of 1998 oil traded for $11.  Normal looked like it was a long way off.  But today oil is looking down at normal.  And it only took 15 months to go from $11 to $30.


      Another metal, palladium, was $120 in early 1997.  This year it peaked at $825.  It went from below normal to well above normal.
Who’s Doing the Buying?
      If oil can go up like that and palladium can go up like that, why can’t gold just go to normal?  Well, it can and when it does you can bet it will not stop at normal.  We hear a lot of talk about who is selling gold:  central bankers, mining companies, hedged funds, big banks, etc.  But nobody talks about who is buying all the gold.  All of the gold that was borrowed and sold, all of the gold the central banks sold in addition, and all of the gold produced by the mining companies has been purchased.  And yes, the gold price fell, but the gold was purchased nonetheless.
      I do not think the buyers were ignorant.  They bought it because they wanted it.  And they are well aware of the fact that central banks will sell more gold in the months (and years) ahead.  But they are also well aware of the huge, unprecedented short position that exists in the world of gold today.  They also know that the world is awash in paper money to an extent that has never before been seen in the history of man.
      This is why I think the gold move (a six-day, 29% spike up) in September 1999 was just a preview of events to come.  When the main feature opens we will get to see the entire gold move unfold.  It may be mind-boggling, and a lot of financial institutions will be squeezed unmercifully.
      Gold is money.  Paper currencies are IOUs.  That is the way it has been and that is the way it will always be.  It cannot be the other way around.  So, one should be taking advantage of the lull before the storm and stock up on some gold and a lot of gold mining shares.  We have had a miserable three years.  But the next 12 months may be payoff time.
      I keep looking back at the stock market peaks of the past.  In every case they peaked with the gold stocks at a premium.  I still think this granddaddy of all bull markets will also make its final peak with the gold stocks soaring.  And that will usher in a 15-year transition away from intangibles back toward tangibles.
      Our positions look sad now, but at least I am comfortable with them.  Volume in the gold stocks has shrunk dramatically as of late.   This is a good sign.  The big breakaway gap created by the gold launch last September was nearly closed today by the drop in gold.  Technically, that has very positive implications.  When I couple those points with the tremendous value gold represents at today’s price, I think the gold stocks are poised to move higher--soon.


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