Gold Rush '99

Dateline: 10/07/99

"The prospectors came first in twos and threes with little more than a rucksack, a gold-pan, a short-stemmed shovel, and a phial of mercury, living on beans and tea and bacon - men fleeing ahead of civilization. Whenever they struck it rich a circus parade of camp-followers crowded in upon them, saloon-keepers and hurdy-gurdy girls, tinhorn gamblers and three card monte men, road agents, prostitutes, vigilantes and tenderfeet."

- Pierre Berton, Klondike: The Last Great Gold Rush

Although the above quote refers to the Gold Rush to the Yukon Klondike area from 1896 to 1899, it seems strangely apropos of today. Substitute goldbugs and hard money enthusiasts, beaten down these last two years, for the prospectors, and Bill Gates, short sellers, Y2K doom and gloomers and the general public for saloon-keepers, gamblers, vigilantes and tenderfeet and there you have it!

A prime example of the tenderfoot is the little old lady in Toronto who cashed in all her mutual funds this past week and bought $200,000 of gold bullion. "Her hands were shaking at the counter. She wants it right now, right now," reported Rana Kazemi, senior operations officer for the Scotiabank's foreign exchange and precious metals desk. The old lady, she said, was convinced the price of gold would double by the end of the year.

The emerging stampede to buy physical gold is reminiscent of 1979 and early 1980. I remember standing in line at the Vancouver Scotiabank precious metals desk on a number of occasions to buy gold or silver bars back then. I bought them steadily on the way up and held onto them all the way down again through 1981 and 1982, convinced we were on the verge of hyper-inflation.

The only difference is, today there is no spectre of inflation, or at least not in its obvious form of rising prices. But there is concern over Y2K. There is concern that the stock markets are over-inflated. And there is an urge to fall in with a trend.

And its not just little old ladies who are developing an interest in hard money. Last week it was revealed that no less a luminary than Bill Gates, chairman of Microsoft, has quietly been buying up shares of Pan American Silver. He now owns 10.3% of the company. Last year it was Warren Buffet, the wizard of Omaha. He revealed that Berkshire Hathaway had bought over 100 million ounces of silver.

If two of the wealthiest individuals in America have a decidedly large scale interest in precious metals, can one blame the general public for sharing that interest? Maybe they're onto something.

Gold hit rock bottom on August 20th, a twenty year low of $252.55. Since then it has risen steadily closing at $326.25 on Oct. 5th, over 30% above its low.

Gold stocks have soared except for a few that were heavily hedged with forward sales. Juniors such as Battle Mountain Gold and Bema Gold jumped over 85%. Majors like Barrick and Placer Dome gained 20-30%. And hedged stocks like Cambior Mines initially jumped, then sank like a stone.

Cambior is forward hedged 2.7 million ounces of gold through 2007 at an average price of $318. It is committed to deliver around 600,000 ounces a year for the next three years at below $300 an ounce. Not surprisingly it lost 40% of its value on Oct. 6th when this stunning news was released.

Another hedger, Ashanti Goldfields, had its trading halted after it plunged from $10 1/8 to $3 on the same day. This was in the wake of announcements that Ashanti was facing margin calls from some hedgees.

Meanwhile, Barrick, while heavily hedged, has maintained that it can make additional profits if the price of gold rises. Its minimum forward selling price is $385 an ounce, far higher than Cambior's. Interestingly, the Barrick website section on its Premium Gold Sales Program as they call it, is "currently being updated". We await the new posting with anticipation.

Gold analyst Steven Jon Kaplan, on the other hand, a fellow who has been mostly bullish on gold for the last couple of years, greeted his readers on Sept. 28th with the information that "I sold out of most of my gold shares a few minutes ago".

Kaplan argues that the XAU is lagging the price of gold and "in the earliest stages of a major bull market, there is almost always a pullback before the next leg upward can begin". He changed his outlook from Moderately Bullish to Significantly Bearish.

Kaplan was absolutely correct as gold then plunged from $328 back below $300. It has since climbed back up again. But it is touch and go. Kaplan is now Modestly Bullish.

The impetus for the sharp rise in the price of gold was the announcement Sept. 26th by 15 European central banks that they would cap their gold sales to 400 tonnes in any single year for the next five years. Further, they said they would limit their gold leasing programs. Then the short sellers got squeezed and further fueled the price rise in their frenzy to unload their positions.

Will the price of gold continue to rise or is it a flash in the pan? (Or should we say "flash in the gold pan"?) As Patrick Bloomfield points out in his Oct. 4th column in the National Post, there has long been a significant supply/demand deficit in gold production, a deficit "largely made up by an ever-expanding supply of gold for leasing." Bloomfield reports that a deficit of 1000 metric tonnes a year is not too wild a guess.

It is the cap on leasing that is significant in the European bank announcement. Producers like Barrick Gold generated generous interest income on the spread (or contango) between the leasing rate and the interest earned on the proceeds of forward sales (called the London Libor rate). This was a steal when leasing rates were around 1-2%. But with the tightening of supply on the leasing end, the lease rate has jumped as high as 11.5%. On Sept. 28th the contango turned negative for the first time in four years as the leasing rate exceeded the interest that could be earned on forward sales.

With the incentive to lease gold in order to profit from the contango removed, producers like Barrick will only hedge forward sales to lock in a price. If they believe the price will rise, then that incentive is gone as well.

The Post reported on October 1st that the estimates of the amount of leased gold varies from 4500 to 13,000 tonnes. This compares to 2500 tonnes of actual new production. This is a huge difference on the supply side of the gold equation.

With the overhang of central bank gold capped and leasing curtailed, the true effects of the supply/demand imbalance will be felt on the price of gold. The long term outlook has to be bullish.

Because of the renewed interest in gold, I have created a new handy GoldWatch page. It includes links to the latest news and commentary on gold, precious metals and mining, graphic displays and graphs of the current gold price from Kitco (near live updates) and other links of interest.

Links of Interest

Bars of gold bullion are selling like hotcakes - October 6th article from the National Post.

Golden tricks lose their lustre - Pat Bloomfield's October 4th column in which he comments on the changing dynamics of the gold market as the incentive for producers to forward hedge has been effectively scuttled.

Huge gold rally sends short sellers, producers' hedgers into frenzy - October 1st article in the Post discusses the diminishing incentive for producers to hedge.

Bill Gates' silver play - Sept. 30th Post article on Gates interest in Pan American Silver.

Gold stocks take off after European deal - Sept. 28th Post report on the European bank announcement and its effects on gold stocks.

Comments? Suggestions? Why not post them on our Bulletin Board or email me.

E-mail me!

ZZZNEWSLETTERSIGNUP1ZZZ


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Investing (Canada) Notes

Disclosure: The author owns shares in Barrick Gold, Placer Dome Gold, Bema Gold and Battle Mountain Gold (the latter two purchased on Oct. 1)

About.com Convention: Yours truly is heading out to Las Vegas this morning for About.com's four day convention. You're invited to join us Saturday at the Luxor Hotel for an open house called The Red Ball if you happen to be there then. Look me up. I'd be pleased to chat with you.

Monday article: My usual Monday Internet Update won't appear until Tuesday at the earliest and maybe as late as Wednesday as I won't get back from Vegas until Monday afternoon.

Currently reading: I plan to review Paul Lermitte's Allowances, Dollars and Sense: A Proven System for Teaching Your Kids About Money upon my return from Vegas. But you may want to check out his new Making Allowances website in the meantime. It is a superb site for kids based on Paul's book.


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