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Comments on the Gold Market
by Professor von Braun

January 15th, 2000

The last several years, certainly since early 1996, have not been kind to bullish supporters (sometimes referred to as gold "bugs") of precious metals, depending of course as to whether ones support had resulted in writing a check.

What a year 1997 was, what with the Bre-X debacle, the announcement by the Australian government that it had sold 2/3's of its gold reserves, and the ongoing decline in the price of gold. 1998 saw silver get off to a good start, then it to joined the precious metal price decline. 1999 saw the long awaited and frequently called for rally, which was of course quickly capped. Moving too soon on that rally also turned out to be painful for some. Y2K also came and went without any major glitches resulting in no joy there either.

Now as we begin the "new" millennium, what is the outlook for precious metals? Perhaps we should begin with what exactly today is the precious metals market? What has become apparent to gold investors is that all is not well in the world of gold trading. Something is amiss here as, despite fundamentals, supply deficits, statements by central banks that they will cease their leasing activities and limit their sales, falling production figures, etc, etc, gold still languishes under $300 per ounce. (For what it's worth we don't believe that CB's can cease their leasing activities. One needs to continue to borrow from Peter to pay Paul so he can repay Peter me thinks).

There are three ways to play this market; physical metal, gold mining stocks and futures contracts. As most of us know, the theory is that as the price of gold rises, stocks and options provide the best leverage and, potentially, the greatest return. However being sentimentally long in this market has been for most a painful experience. Just ask any holder of Ashanti, or Cambior, or Alta Gold stock to name a few.

Physical Gold

Buying physical gold at these levels and taking delivery is a very effective way of hedging against future turmoil, including delivery problems that must occur in the gold futures markets, as well as ludicrous stock market valuations that cannot go on forever. It's safe, convenient, won't evaporate and it's yours. Even if further declines in the gold price occur, still a real possibility, it is likely that they will be short lived.

Taking delivery now provides more leverage than most people believe. You own the gold and as this market eventually returns to something that reflects the reality of the supply and demand situation, the premium will be on physical metal. Given the nature of the markets at present, the amount of paper currencies in the system, the potential for all sorts of "corrections" and the fact that paper promises are at the end of the day worthless, holding physical metal as a percentage of ones assets, is definitely prudent.

There is no speculation involved in deciding the actual content of either a gold coin or a 10 ounce bar. The content is what it is, 99%+ pure gold, and as such is not dependant upon dubious market perceptions, management accounting practices, or the greater fool theory. Nor does it need to be watched every day. (As an aside, I have not heard of too many bullion dealers receiving daily phone calls asking for quotes on the current purity of their clients gold bullion).

Gold Mining Stocks

In a previous article we stated that not all gold stocks are created equal. This was evidenced by the now well-reported problems associated with both Ashanti and Cambior. It's a statement that is more relevant today than it was then. The potential for serious problems associated with hedge programs and a rising gold price were clearly demonstrated. Margin calls became the phrase of the day. The reverberations died down as the gold price declined back to the $280 level. Somebody was breathing a sigh of relief.

Needless to say, the problem has not gone away. Selective purchases of gold stocks that have no hedging programs and enough staying power to survive at these price levels (an important qualification) is a better strategy than buying those that have medium to large forward sales in place. One needs to remember that most hedge programs contain the potential for a margin call, which could require cash to cover it. It is also difficult to get accurate information from some companies re what their liability actually is. Given the speed of the rise from $255 to $340 last year, followed by the rapid decline back to under $300, which was reflected in the XAU as well, the word nimble comes to mind. Any adverse market conditions will be reflected very quickly in the quoted prices of all mining stocks.

The "junior" mining stock market needs even more scrutiny than does it's senior counterpart. This market has been decimated by a lack of capital and many companies have very little cash left. As with "Old Mother Hubbard" the cupboard is bare or it now has dot com attached to it's name. The first criteria should be project location. This should be followed closely by "can it be brought into production" or will it become attractive to a major should the gold price move. Un-hedged projects in good locations that can be turned into producing mines may be at a premium when this market finally moves to the upside. We say finally because we still believe that at least one more rally could be capped. Meanwhile beware of any current blanket recommendations to buy junior gold stocks. They too are not created equal.

The Futures Market

It is important to remember that this market exists because of the physical gold market. It is a bet against future rises or declines in the price of physical metal, not the other way around. As we have commentated on previously, the reported daily turnover of the gold futures markets is a mind-boggling number. The London Bullion Market Association, (LBMA) which is the arena where many of the hedging programs are consummated, trades up to 1000 tonnes per day. Add another 250 tonnes on the NY Comex, and pick a number for the OTC market and you find that the entire estimated above ground gold reserve trades about 4 times per year.

Estimates of physical gold demand on a per annum basis are believed to be 4000 tonnes. Total reported volume traded on a per annum basis exceeds 400,000 tonnes.

Either we have considerably more physical metal in existence than believed or somebody is writing a very large number of paper contracts that can never be delivered against. We suspect the latter is the case and eventually the concept of contract credibility and good delivery will be put to the test. It may already have been put to the test and survived the first tremor. It may survive the second, but the third will cause problems. Which is why caution should be exercised in this market as well. Even the first whiff of good delivery problems will cause reverberations. Watch for nervous bullion dealers to make the first moves.


As the "new" millennium begins to unfold and market volatility increases, the ability of the market makers in the gold futures arenas to keep a lid on this market will decrease. Eventually there will be some very embarrassed participants, including the central banks that have fueled the fire with their gold leasing policies. One day they will realize that a large portion of the gold they have on their books which has been "leased" will have to be written off, since it will not be returned. (There will be surprises here for sure.)

Caught up in the resulting furor will be the bullion banks and the mining companies that have, as a result of their participation in hedging mine production (both current and future), contributed to the farce that currently exists. Clean ownership will be the key to participation, henceforth the recommendation to purchase physical metal, followed by mining stocks that have clearly recognizable un-hedged production (which also means that there are no hidden claims to their producing assets), followed by the "juniors" that have real assets, as in gold reserves that are real (as opposed to the Indonesian variety) coupled with the real potential to produce gold at a profit.

The Prof can be contacted by email at

Copyright by Professor von Braun. All Rights Reserved. Reprinted at USAGOLD by permission.

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The Rocket School of Economics -- The Lecture Series Index

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  • 14 Nov 2008 -- What Exactly is an Asset?
  • 23 Aug 2008 -- Through the Looking Glass?
  • 02 Aug 2008 -- Compounding to the Downside!
  • 26 May 2008 -- Back to Basics Again!
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  • 10 Dec 2007 -- Monetary Systems & Productive Assets.
  • 14 Feb 2007 -- Divorced from Reality
  • 06 Sep 2006 -- Gold, Bankers, the Trade Deficit and Unsettled Transactions
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  • 31 May 2006 -- The significance of August 15, 1971.
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  • 03 Jun 2005 -- Real Money, Funny Money and YOU -- Part 4.
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  • 17 Sep 2002 -- Wishful Thinking!
  • 27 Jul 2002 -- Gold Bugs Beware -- part 2.
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  • 24 Nov 2000 -- The Bubble Has Burst
  • 11 Nov 2000 -- The Media, Bull Markets & the Gold Price
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  • 16 Oct 2000 -- A Peso Here ...and a Few Thousand Pesos There
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  • 15 Sep 2000 -- Time WILL Tell!
  • 27 Aug 2000 -- SS "Paper Assets" Begins to Take on Water
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  • 26 Jun 2000 -- A Yellow Brick Wall
  • 22 May 2000 -- The King IS Naked
  • 30 Apr 2000 -- Goodbye Yellow Brick Road
  • 18 Apr 2000 -- Beware the Ides of March, April and May
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