A DIFFERENT KIND OF RALLY

In the fall of 1999, a surprise announcement from 15 central bankers that they would, for the next five years, limit the amounts of gold they sold or leased into the public markets was the main catalyst for a sharp--but brief--price in the spike of gold. The so-called "Washington Agreement" among these (primarily) European banks was universally welcomed by a shell-shocked gold market that never knew which central banks were next to depress gold’s price. Now, with a definable limit to what these banks could do until 2004, one of the two most significant weights holding gold down had been removed; and the yellow metal went on a three week tear that scared the daylights out of policy makers the world over.

As I wrote at the time (and have recounted often since) the Federal Reserve was not a party to the Washington Agreement. Seeing the strong possibility that a runaway bull market in gold could devastate other capital and financial markets, the New York Fed--in conjunction, as it turns out, with J.P. Morgan Bank--aggressively added gold reserves to the market through various derivative-related machinations. The spike peaked on October 5, as gold reached an intra-day high of $340 per ounce. On that very day--confirming the Fed’s activities--I recommended selling the mining shares and call options on them I had recommended a few weeks before (and at VERY nice profits approaching 300% in the latter case, as many of you will recall.) For the time being, the party was over.

It’s important to keep in mind that the brief 1999 move was never really anything resembling a fundamental one for gold. As I’ll recount in a moment, that spike was actually a classic "short squeeze," fed by hedge funds, banks, and other parties both known and unknown scrambling to cover short positions in gold that were quickly slipping under water as the price rose. Apart from this, there was little investment demand for gold at the time. Technology stocks were still rising. The so-called New Economy had not yet been revealed to be more fantasy than fact. The dollar’s hegemony as the world’s reserve, and strongest, currency was not being questioned. In short, gold looked at the time to be every bit the "barbaric relic" it had been notoriously labeled as by John Maynard Keynes.

Recent months, however, have witnessed the strengthening of a much different kind of "rally" for gold--and, of course, gold shares. Far from being a reaction to essentially one isolated event as was the 1999 move, the steady move upward for months now belies something more significant. You already know that I some time ago called this a new bull market for gold;  and as you’ll be reading further along, it is a bull market whose case is being made stronger by the week. Yet one thing we need to guard against here is getting too emotionally attached to gold. Instead, we must coolly analyze both the real and perceived reasons for its move, handicap the likelihood of those factors continuing to act in gold’s favor and--finally--ask ourselves what could go wrong, and look out for those factors.

It regularly amuses me--especially as gold’s move has strengthened, without so much as a few days’ worth of an overdue correction--to listen to various pundits trying to explain why gold is rising. With a handful of exceptions, your regular, everyday economists and TV talking heads have pointed recently to a few fairly obvious (?) reasons for gold’s relentless ascent; this is while, it must be noted, they often couch their commentary in some disdain for the yellow metal. After all, the memories and longing for a Nasdaq at 5000 still preoccupy most of these folks; and, in their minds, gold will get its just desserts and this latest move will be revealed as yet another death pang as soon as investors come back to their senses and push techs back into the stratosphere.

Right.

In reluctantly "covering" a move in gold which they understand no more than they do the economy and markets in general, these folks have recently pointed to the following (in no particular order of importance) as the reasons why investors are moving toward gold:

* Saber-rattling over Kashmir--Sure, this adds to the overall uneasiness and desire for a safe haven; but how do you explain gold’s rise before the prospect of India and Pakistan lobbing nukes at each other was in the news?

* Inflation fears--This, as you’ll see farther along, is a fun one to talk about. If anything (and as I suggested in the last issue) the economy still has more to fear where deflation is concerned, at last for the time being.

* The Middle East--Tensions have flared up in that area of the world on and off before, including during gold’s long bear market. Why are things different this time?

* Distrust over Wall Street--Now we’re getting a little warmer. However, if you have closely watched gold’s behavior even during occasional broad Wall Street rallies in recent months, the yellow metal--and mining stocks--have remained solidly in up trends.

* A declining dollar--Warm again--but only a little. While the greenback has indeed been hit in recent weeks, how do these guys explain the fact that gold’s bull market began over a year ago--and kept going--when the dollar was still strengthening?

Just as gold bugs for years have often been unrealistic--and irrational--in their predictions for gold so, too, are some of the pundits’ current explanations based more on their preconceived notions and heartfelt desires. None of these clods want to see the New Economy dead and buried forever; and all of them yearn for a resumption of the kind of 1990's style growth that will resurrect their kind of world. One night recently, Messrs. Jim Cramer and Larry Kudlow--who, combined, probably haven’t lost people as much money as the infamous Gruntal "strategist" Joe Battipaglia, though they’ve probably come close--reached a new level of anti-gold propaganda. As you may know, these two co-host a new evening program on CNBC (I didn’t think the talent pool had dried up that badly!) In the estimation of these esteemed sages, the act of buying gold and not putting money back into beaten-down technology stocks--and thus showing your faith in America--was downright unpatriotic. The nerve! Of course, these two generally don’t talk about their advice over the last couple years, and how abysmal it’s been. They are simply frantic over the prospect of their kind of world really being gone for a good long time.

REMEMBER--GOLD IS STILL PRIMARILY A COMMODITY

I highlight the word "primarily" because--contrary to all the "safe haven" and similar talk you may be hearing elsewhere--gold’s bull market at least began due to the most basic supply/demand factors that determine the price of any commodity. This is not to say that some of gold’s move recently does not owe to some of the factors I listed above; it certainly does. But, as I like to do, we must start with some of the basic reasons underpinning gold’s changed environment.

To help explain my point here, let’s talk for a moment about the oil market. Oil has been incredibly volatile in recent years, and for reasons I should not have to recap (though, most likely in my July issue, I’ll be providing a comprehensive assessment on the energy markets.) Suffice it to say for now that, when oil prices have weakened at various times, new exploration and production--especially in relatively high-cost U.S. fields--usually came to a screeching halt. Companies will simply not go out on a limb and spend money on new projects--in spite of what they think the price should be for their product--when they will lose money doing so. Some of you who live in areas like Texas have seen over the years what has happened to activity in the oil patch when prices plunged to $10 per barrel or so on a few occasions.

Likewise, the chronically weak gold prices experienced during the latter half of the 1990's have laid the groundwork for actual declines in current gold production. According to my friend Barry Cooper of CIBC World Markets in Toronto--arguably, one of the better gold analysts anywhere--2001 was the peak year for gold production in the world. He estimates that some 2600 metric tons of new production came to market in 2001, added to some 1,000 metric tons of scrap reclamation and about 400 metric tons from the central banks. In this environment, the gold price rose modestly, even given the shock to the economy and deflationary fears engendered by September 11.

In 2002, according to Cooper, the production of the largest producers--in spite of the higher price now--will be off by as much as 10 per cent. It is important to note that, during gold’s long bear market, more companies than not engaged in the practice of "high-grading" some of their properties. This means that, in order to keep their heads above water at least on a cash flow basis, miners were milling their best, richest ores in order to keep mines operating. For many, the point has arrived where gold production going forward will be more difficult, since they must now begin milling lower-grade ores, having at least partly exhausted the "easy pickings." Thus, whereas some skeptics claim that the industry will now be bringing lots of new gold to market due to higher prices and, therefore, acting in a sense to cap the price increase, many can’t do so even if they wanted to.

This is the most under-reported element of gold’s new bull market.

For those who have gone underneath the surface of the typical CNBC "coverage" on gold, this looming supply deficit is major news. Though Barry Cooper’s numbers could end up being a bit too pessimistic in this regard, many industry insiders generally agree that levels of gold available to the market will not be increasing due to mine output. The latest producer to sound the alarm bell that the industry was running out of gold faster than it could replace it was world number two miner (behind Newmont Mining) AngloGold. "Over the next 10 to 15 years, new mine supply is (more) likely to be neutral or negative than it is to increase as it did in the past 15 years," that company’s C.E.O. Bobby Godsell said on the sidelines of a recent mining conference in Australia. This is in an environment where, though it has generally softened some in recent months, jewelry demand alone consumes 3,000 metric tons per year.

Barring any major new additions to market supply from the central banks (which is possible even before the Washington Agreement expires in 2004, as I’ll discuss in a bit) gold’s price will enjoy some strong support due to all this.

Right now, gold’s move--impressive though it has been--has not been sufficient (particularly in its duration) to change this equation very much. It can often take several years for new mines to come on line and produce after they are discovered. Even reserves in the ground which are now becoming economical to mine with the higher gold price will not immediately make a dent in this supply deficit. After all, it’s not as though a company can simply "flip a switch" and start milling ore they’ve been sitting on. Preparation even needs to be done in these cases. Properties may need to be newly permitted. The same is true with mills. A lot of preliminary work needs to be undertaken.

And--none will be until the company in question is sufficiently convinced that gold will stabilize at prices sufficiently high to be worth all the trouble of increasing production.

Perhaps helping the positive supply/demand fundamentals for gold down the road is an industry-wide effort to sell more of its product. The World Gold Council was charged over a year ago with developing a massive new public relations campaign designed--much as De Beers has done with the diamond market--to increase consumption. Additionally, work continues on possible new industrial uses for gold, most notably based on gold’s catalytic properties, which could one of these days make cheaper gold an alternative to platinum in catalytic converters, and in other applications.

So, again--as a commodity--gold’s fundamentals are the best they have been in many a year. On the strength of this factor alone (and the related one I discuss next) gold should easily be able to consolidate its gains in the weeks and months ahead, and enjoy a new trading range around current levels. And, this is even if all the other worries which have more recently added to the yellow metal’s move subside.

THE INDUSTRY ABANDONS "HEDGING"

You know from my past commentaries and reporting on gold that the practice of central banks’ selling or leasing gold to various parties--who, in the case of leased gold, then sell it in the hopes of buying it back at a lower price later--was the chief factor in gold’s bear market declines. A close second, however, was the somewhat similar practice on the part of major gold producers to sell gold still in the ground, in order to lock in a certain price. Generally, the practice known as "hedging"--which took a few different forms, some of which were highly speculative--served to short-circuit any rallies in the gold price. It seemed that any time gold would get some traction, one or more big producers would "forward sell" large amounts of gold. In effect, this was their own vote of "no confidence" in gold’s ability to move higher, and their way of trying to keep cash flow and earnings afloat. In one sense, these companies could hardly be blamed for trying to do the best for their shareholders, given gold’s generally bearish environment for so long. Many, however, considered the hedgers--chief among them Barrick Gold and the above-mentioned Anglo Gold--as pariahs.

A "shot across the bow" for these larger concerns and others came in the spike in late 1999. To a certain extent--and without confusing you unduly in explaining it--the practice of hedging on the part of miners acts much the same way as does a short sale. For as long as the gold price stays at or below the price at which future production was sold, all is well. However, if the current, spot price rises much above that same level, the value of having made those hedges is diminished. Further, in the cases where miners themselves have actually borrowed gold outright (or entered into some kind of derivative contract) they can be faced with margin calls, negative values in their "hedge books," or both.

This happened during the 1999 spike to two companies. Ashanti Goldfields of Ghana racked up enormous paper losses on its derivative portfolio (i.e.--hedge book) and for a while teetered on the brink of bankruptcy. Its banking counterparts who had "dibs" on these hedges had the ability to demand substantial cash payments from Ashanti, in order to cover the amounts by which the hedges were now in the red. At the eleventh hour--and assisted by the ultimately successful efforts to rein in gold’s advance--Ashanti managed to barely stay in business. Similarly, Canadian producer Cambior got into trouble with its hedge book.

Though these were the two most publicized examples, you’d better believe that hearts were suddenly pounding fast in other gold mining board rooms. All of a sudden, companies deemed by many (including themselves) as geniuses were being looked at with a jaundiced eye. Maybe it wouldn’t be good after all for some companies if gold did finally go up--and all of a sudden, those few investors interested at the time in gold demanded some answers as to how individual companies would fare if gold finally did turn around.

In the immediate aftermath of this near-disaster, a couple companies came out and announced they were moving away from the practice of hedging. Early on, these announcements--led initially by Placer Dome and Gold Fields--were motivated as much by the companies’ desires to allay fears over their solvency as by any real confidence that gold’s bear market was drawing to a close. Still, there did not seem to be an industry-wide consensus--or motivation--for a practically wholesale abandonment of the practice of hedging.

That changed, however, with the closing in January of Newmont Mining’s acquisition of Canadian-based Franco Nevada, and the Australian miner Normandy. As you’ll remember, I wrote extensively on the months-long struggle between Newmont and Anglo Gold for Normandy in particular; and, far from being your typical battle over an appealing target, this turned into a battle between hedgers (Anglo) and non-hedgers (Newmont.) The non-hedgers won; and both leading up to its acquisition and since, Newmont--now the world’s largest producer--has worn its status on its sleeve.

A number of long-time gold market bulls pointed to Newmont’s victory as the most significant gold market event in decades. And so it was. For, one by one, the most notable hedgers among gold producers have come out and embraced the old-time religion of being bullish for and an advocate of their own product. Before they’d hardly had time to lick their wounds and swallow some pride after losing the battle for Normandy, Anglo Gold came out and said that it would rather switch than fight. In a series of announcements, the big South African miner has said it is "aggressively" unwinding its hedge book.

In a February 5 interview with the Financial Times, Anglo’s Executive Director for Marketing Kelvin Williams indicated that his company would allow its hedge book to "erode" during 2002, while watching for "upside opportunities."

"We think there is a solid floor under the physical gold market," he explained. "And there is no longer a constituency of speculators eager to play the market from the short side. . ."

As gold’s price has continued to rise this Spring, Anglo has occasionally repeated its earlier announcements that it was unwinding its hedges, so as to take better advantage of the rising cash price. Especially conspicuous in recent weeks, though, has been the management of Barrick Gold, the so-called "king" of the hedgers. That company has--similarly to Anglo--been going out of its way at times to assure the market and its own investors that, (1) it, too, is unwinding its hedge book and now selling at least some production into the spot market for the first time in many years, and (2) it has no intention of short-circuiting the rise in gold’s price by adding new hedges.

Except in the most learned gold bug circles and among those who have taken the time to analyze the markets, this story has not received nearly sufficient attention. Coupled with the declining mine supply, the virtual wholesale abandonment of hedging has written the epitaph to the long, nasty bear market endured by gold for so long.

INVESTMENT DEMAND SUDDENLY GROWS

In addition to these supply/demand factors, gold has enjoyed a steadily-broadening level of interest from investors around the world concerned about any number of existing or potential maladies. Most noteworthy early in the year was the heavy demand for gold coming from Japan. As most of you already know, that country’s phasing out of deposit insurance on bank accounts coupled with lingering concerns about Japan’s fiscal and economic stability served to push Japanese citizens into acquiring record amounts of the metal. Japanese investors bought about 45 tons of gold in the first quarter, up from 12.6 tons a year earlier, according to figures published by the World Gold Council. "The Japanese have lost confidence in political leaders to right their economic woes and are buying gold by the bucketload," quipped Tamara Stevens, the Australian Gold Council's chief executive, at an early April mining conference in her country.

Since Japan’s new fiscal year started on April 1--and as that nation’s currency and stock markets have enjoyed another temporary respite from a more than decade-long recession and deflation--some of this gold has been sold by some thinking that the Nikkei might have finally bottomed. It’s important to note, though, that gold’s upward move has actually accelerated during this time frame. Clearly, the Japanese haven’t been the only buyers. Further--once the bloom is again off the Nikkei and more people wake up to the fact that Japan’s problems are not over yet--new net buying could easily emerge.

Lost in the talk about Japan has been the fact that other countries’ investors have been beginning to turn to gold as well. Argentina is mired in an economic and currency crisis which has resulted in banks being closed at times, and over which the current government seems fairly powerless. Initially, some Argentineans seeking to stop the bleeding in their savings’ values turned to the U.S. dollar and dollar assets. But recently, they have been losers as well. Resultingly, more of these folks are redeploying assets into the one asset which has been strong this year: gold.

Institutional investors in the Middle East and Asia--and most particularly, in India--are also moving into gold. The Financial Times contained an interesting story recently about how some of India’s citizens were actually selling gold of late in order to take advantage of higher prices than they’ve seen in some time. However, that gold was being gobbled up by large investors and institutions just as quickly, as Indian family jewelry was melted down to form ingots. Sooner or later, the piece suggested, India’s citizens--worried about war, and the possibility of losses in their holdings due to the dollar’s swoon--might stop their short-sided profit taking, and make the gold market tighter in that nation.

One of the things that remains quite incredible about gold’s move so far is that, for the most part, the developed nations outside of Japan have not yet seen a significant investment demand for gold manifested. But that could change; and, if it does, gold could really be off to the races.

GOLD AND THE U.S. DOLLAR--AND THE "SURVIVOR CHALLENGE"

Earlier in this piece, I mentioned that the recent weakness in the dollar had been mentioned as one reason for gold’s upward move. Without a doubt, that has been true. Yet, keep in mind that most of gold’s move since re-testing its lows early last year has occurred in a different environment; one in which the dollar continued to strengthen against most other currencies.

Some of the pundits pointing to dollar weakness now can be forgiven. After all, even Yours Truly has said on prior occasions that a reversal of the dollar’s bullish run since 1995 was a prerequisite to a sustained bull market for gold. It is still an important ingredient.

However, there have been times in the past where weakness in the dollar did not directly relate to strength for gold--provided that some other currency is sufficiently attractive to be viewed as a "safe haven." I have often cited the example of the Gulf War over a decade ago as proof of this. At the time, the dollar AND gold briefly rallied at the start of hostilities. Within just a few days, however, both lost ground to the German mark, which at the time was already viewed with the same comfort level as the dollar has been in recent years.

Exactly a year ago, CIBC’s Barry Cooper and Ayesha Hira wrote a lengthy research report entitled, "Gold Versus The Dollar--Our Choice for the Survivor Challenge." To my knowledge, they were the first to ask the rhetorical question (in my paraphrase), "What happens if there is NO currency that can be turned to as a refuge one day?" Writing a take-off of sorts on the TV show "Survivor," they started with the premise that neither the Euro nor the Yen were anywhere near the point where global investors would take them seriously as a replacement for the dollar (I invite you to refer back to my January issue, where I gave some of the reasons for this myself.) The question then remained whether the dollar or gold would ultimately win out over the other as a safe haven, as economic and political woes intensified.

One by one, Cooper and Hira "kick off the island" those factors which have combined to give the dollar virtually unchallenged hegemony for the last seven years. Productivity gains reported by the government were coming into further question. The low wage concessions exacted of laborers in America in recent years will become a thing of the past as basic living costs begin to rise further. Oil prices--though they have come off their peaks--remain higher than their average of the last few years, constituting a "tax" on incomes and a drain on savings.

As I have myself pointed out, they also discuss how real interest rates have turned negative, with the cost of living rising above the Fed’s key short-term interest rates. Virtually every other time this has happened, gold has risen and the value of the dollar has declined.

The big one that everyone is talking about, of course, is America’s current account deficit; that difference between our imports and exports of both goods and capital. Cooper and Hira can’t help but mention this. The deficit--which requires the U.S. to import $2 billion a day in foreign capital simply to maintain equilibrium--has long been viewed as the Achilles’ heel of the great U.S. growth story. Much the same as the Nasdaq ran on to greater--and more unsustainable--heights due simply to the sheer volume of money pouring into technology stocks so, too, has the dollar become a "momentum play," especially given the lack of a more inviting playground elsewhere in the world.

But that is changing. Over the last few months, while they have still shown net inflows, foreign investments into dollar-denominated assets have been conspicuously declining. Keep in mind that--in order for the dollar to go into a steady decline of some magnitude--it is not necessary for foreign money to be yanked willy-nilly from the U.S. All that is necessary is for new money to start drying up--and it is. This does not yet mean that the most dire predictions of the dollar’s demise and implosion will imminently come true. In fact, I’ll address this issue in June’s newsletter in much greater detail. What it does mean, at the least, is that the dollar’s reign as King of the Hill has now been called into more serious question than at any time during its reign.

Next, Cooper and Hira turn their attention to gold; and, one by one, they "vote off" those factors which had contributed to the metal’s long bear market. Much of this, I have already addressed, so I wont repeat it all here. In the end, as you may have already guessed, these folks predicted that this game of Survivor would ultimately see gold as the last man on the island.

(NOTE: Always wanting to pat someone deserving on the back--besides myself, of course--these good folks at CIBC were almost alone a year ago in forecasting a longer-term price of $325 per ounce by as early as this year. However, they added that, "We stand ready to move these figures up." Hopefully in the near future, I’ll be able to share with you their latest gold price forecast.)

In one of his recent CBS Market Watch columns appearing daily on the Internet, Thom Calandra suggested that--even if the euro and yen do appreciate significantly against it--a falling dollar would, in the end, translate into a much higher gold price. "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," he writes. "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. . .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.)

"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. . .

"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. . ."

Now, you might not get quite that bearish a prognostication from me on the greenback in June’s issue. After all, most all other central banks are loathe to see their own currencies appreciate very much against the dollar; most recently, in fact, Japan and Switzerland have been aggressively trying to cap their own currencies’ rallies against the buck. However, and not to beat a dead horse (and needing to move along) it’s safe to say that the dollar may have seen its best days even if it doesn’t go into a free fall quite yet. And, all this can’t be anything but bullish for gold.

"POLITICAL" SUPPORT FOR A HIGHER GOLD PRICE

A continuing "wild card" in the whole equation for gold has been the central banks. Specifically, we have the promise--still officially on the table--by Federal Reserve Chairman Alan Greenspan that the Fed itself, if necessary, would act to cap any rise in gold’s price that took it above $340 per ounce. This promise was kept in 1999; but, again, that was in an environment where the actions of the Fed (or any central bank, for that matter) carried a much greater ability to influence prices. Now, we must ask whether or not the Fed has either the ability or will to act similarly in 2002.

A number of supply-side and libertarian-oriented economists and pundits have been loudly castigating ongoing Fed monetary policy; and they have been specifically pointing to the still-low (in their view) price of gold as "proof" that the Fed remains too restrictive of the money supply. Men such as the previously-mentioned Kudlow, publisher Steve Forbes, politician Jack Kemp and others are universally beating Greenspan over the head with his own previous pronouncements that a $340 per ounce level for gold was the desired "equilibrium." Such a level, the central banker said a few years back, indicated the proper balance between inflationary and deflationary fears.

These commentators--still appropriately concerned about the U.S. economy’s ability to mount a sustained recovery--feel that gold must rise in order to show that the Fed is being accomodative enough. Now, I have previously suggested that almost no amount of Fed-induced monetary inflation will do the trick in the end, as the economy still has a heck of a lot of unwinding to do after the massive debt and asset bubbles of the last two decades. However, the debate over the gold price is one the Fed can’t ignore.

Further, if we adjust Greenspan’s target gold price of several years ago for "inflation" (and I can’t help but do so) shouldn’t we now see an equilibrium price of $360-380 per ounce? Perhaps. The question is whether or not the Fed can allow it. A corollary question is whether--in the end--the Fed can prevent it.

THE LEASE RATE ISSUE

I am glad to be vindicated in my call a little over a year ago that the bearish environment for gold was unraveling, and that a new bull market had apparently started. Yet, as you know, I have been a bit reserved in my expectations. Were the price of gold to do no more than settle in a new range around $325 per ounce, many mining companies would enjoy healthier cash flows and profits, and would remain worthwhile investments (some more than others, as I’ll explain shortly.) As gold has steadily moved to this level during the month of May, however, one element has had me puzzled--at least, until recently. And that is the element of lease rates for gold.

You know from my early bullishness that I pointed to rising lease rates a year ago as one reason why the so-called "carry trade" in gold couldn’t be safely played any longer. The "carry trade"--known more specifically in gold circles as the "contango"--is where gold could be borrowed from a central bank at low interest, and then invested in higher-yielding government debt. This carry trade was played in a falling gold market by many, and helped to drive the price of gold down to the $250 per ounce level. Accordingly, if one was earning 4-5% more on government debt than what he was paying in interest on the borrowed gold, there was profit in such a move, especially if the price of gold was also falling.

Now, the price of gold is rising. However, it has reached a level where some might suspect that the Fed or some other central bank would come into the market and push the price back down. At the same time, lease rates have fallen steadily; currently, the interest rate to borrow gold for a year is all the way back to 0.9%, its lowest level in recent memory. On the surface, if a hedge fund thought the party was over and that gold was going back down (or, at least, had peaked) it could borrow gold at 0.9%, but intermediate-term government debt at around 4.5%, and pocket the difference. Back a few months ago, I suggested that this development beared watching, as it constituted a threat to the new bull market.

It still could be a threat; however, I have come to a slightly different conclusion as to why lease rates have plunged. Keep in mind that it is normal in a strong gold market for these rates actually to rise. That certainly makes the most sense; when demand for anything goes up, the price for obtaining that asset should go up as well, whether it be to buy or borrow it. Those of you who have played the options market know that, for instance, when a stock is going up, the premium you must pay for a call on that stock rises as well. This is simple supply and demand at work. Why isn’t this the case with gold? After all, when the gold price started moving quickly in 1999 (and on a few occasions since) lease rates appropriately rose, reflecting higher demand for gold and a tighter market. What gives??

I’ll tell you what I think it is that’s given.

I believe that the Fed--and perhaps other central banks--have been feverishly "liquefying" the gold market so as to keep the recent advance a much more orderly one than was 1999's. Don’t forget that there remain massive short positions held by any number of hedge funds, banks and other speculators, still sitting on a few years’ worth of derivative-evidenced "bets" against a rising gold price. Were gold to go up unchecked, many would be in trouble, as were producers Ashanti and Cambior in 1999, and as were an unknown number of institutions.

I believe that the Fed has been "bleeding" large amounts of gold into the market, so that some of these players can steadily cover their short positions. At some point, of course, these loans will also have to be repaid; but the Fed (and any other central banks involved) will, I guarantee you, be very patient creditors. The motive, of course, is to get as many of these institutions as possible out of harm’s way in the event that gold rises far more, and in such a way that the bankers are unable to do anything more than slow it down.

Make no mistake: the central banks have more ability still than anyone to push prices back down. Were this belief to take hold in some circles, the short-selling game would start anew. Who knows--maybe even one or more large producers would once again turn to hedging. However, I am increasingly persuaded that the low lease rates are an indication that the bankers realize, in the end, that they cannot fight the markets where gold is concerned, any more than currency intervention works if the markets are of a mind to do something different. If I’m right--and the low levels of lease rates are, in fact, an admission by the Fed and others that they can’t stop this bullish trend--then perhaps gold in the end will rise even higher than I would have thought earlier this year.

For now, gold is certainly due for a well-deserved consolidation; one which I wouldn’t have been surprised to see before now. Later, though--barring a dramatic change for the better in both economic and geopolitical events--I think we’re on our way at least to the $340-350 per ounce area. Beyond that, we’ll have to see (1) how bad the economy and dollar get, (2) how bad things get in Kashmir, the Middle East and in the co-called war against terrorism and (3) whether the central banks make any bolder attempt to try to slow things down. It will be interesting!

INVESTMENT CONSIDERATIONS

In this move, the spot price of gold has already moved up from the $260 area to around $320 per ounce, for a gain of better than 20%. For those who bought gold bullion at the bottom, you have some decent gains, after paying a commission of some 3-5 percent for your Eagles, Maple Leafs or what have you. If you are still of a mind that you need more physical gold on hand to use as "mad money" if things really went to pot, you probably won’t regret it in the long run if you were buying now, though I might wait, at least for part of your investment, for a correction.

Interestingly, those kinds of coins sold by promoters and referred to as "rare coins" have in many cases ACTUALLY GONE DOWN in value even as gold has moved up! Back when gold was in the $260 per ounce area, the following were the wholesale prices for some of the mos often sold, common-dated items:

MS-61 MS-62 MS-63 MS-64 MS-65

$20 St. Gaudens $435 $440 $455 $550 $800

$20 Liberty 440 455 540 815 2,100

$10 Indian 380 450 565 1,100 2,750

$10 Liberty 325 365 565 1,225 2,800

The following are wholesale prices for these same coins as of May 20, when the spot price of gold was at $316.20:

MS-61 MS-62 MS-63 MS-64 MS-65

$20 St. Gaudens $352 $375 $410 $485 $785

$20 Liberty 370 380 460 815 1,875

$10 Indian 320 335 475 885 2,250

$10 Liberty 220 235 455 885 2,250

Quite a difference, isn’t it? If you’d bought a basket of these coins at $260 per ounce gold, paid a 20% commission (if you’re lucky; most of these Christian and patriotic coin salesmen charge more) and wanted to "take your profits" now, you’d be under water by some 40% or so. And, to think that one of the firms selling these things (which recently signed on Charlton Heston as its spokesman) refers to these coins as "high-powered gold!"

To an impartial person not selling these things for a living, the reason for the decline is simple: these coins are not as "rare" as they are touted to be. Truly rare gold coins have indeed gone up in value over the last few years, as the strong economy made owning collectibles of any kind a wise investment and status symbol. However, the common-dated varieties usually sold as "crisis" investments have actually suffered. Many people bought these coins over the years, only to see them steadily decline in value along with (or often at a faster pace than) gold itself. Many have tried getting out of these as gold prices have risen in recent months. The problem is, this has translated into a "glut" of these "rare" coins!

Now, if gold were to go up substantially more from current levels, these coins might finally move up in the right direction. However, my long-standing advice remains that--if you think you need physical gold on hand, stick with bullion. Further, if you don’t know where to get the best prices, let me know and I’ll steer you to one or two sources you can trust.

MINING SHARES

Leading the pack on an otherwise gloomy Wall Street have been gold mining shares, which historically have provided the greatest leverage and profit opportunity in a gold bull market. As you already know--and have enjoyed, if you’ve followed my advice--our recommended companies have enjoyed varying degrees of success, with Bema Gold and Claude Resources providing the most explosive gains. I continue to like the long-term prospects of each; Bema as having the greatest leverage to a continued rise in the price of gold, and Claude for its ability to add to its future gold production and for its exploration possibilities. (NOTE: In the Company Updates accompanying this issue, I give more detailed updates on these and others of my recommended holdings.)

As I alluded to earlier, Barrick Gold has been taking some time recently to try and assure investors that its hedge book is not too susceptible to a further move up in gold. At the least, I view ABX as a continuing laggard in this bull market, though I have been pleasantly surprised with its ability recently to move over $22 per share. Those of you who have high hopes longer-term would do well to start moving out of Barrick, and accumulate others of my current recommendations, especially if you can do so following a correction.

Among the majors, Newmont remains the one best poised to take advantage of further price rises for gold. One would think this would make it more volatile (as the smaller, highly-leveraged Bema has been of late.) However, NEM has remained surprisingly resilient even on most weak days, suggesting that a lot of serious money has come into the stock to stay around for a while.

Placer has finally perked up some recently, especially after making a few announcements suggesting it was going to try adding to its reserves through joint projects and acquisitions.

For the most part, though, further life for gold’s bull market will increasingly mean that smaller producers and even pure "exploration plays" will be getting the lion’s share of the attention. In last month’s issue, Keith Barron made the case for why this is so. With gold’s new move, and the increasing confidence that it is not just a 1999-style flash in the pan, money is suddenly more available than ever for promising new prospects. Without a doubt, this will also increase the risk for investors, as you’ll now be bombarded by all kinds of "tips" for some junior mining stock that’s about to hit it big. Careful discernment and lots of homework will be required. I am engaging in both as we speak--and, though I continue to love Claude and Bema--I hope to shortly bring you a couple or more other worthwhile candidates, especially if we can get in on a dip.