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AGE Gold Commentary is our regular report analyzing trends in precious metals and rare coins. We monitor domestic and international markets and extrapolate from our 30 years in metals to place current events into a hard asset perspective. View archives.


8/23/2000: Gold at cyclical low

Source:

Gold at cyclical low
European gold sales
Stealth inflation and expensive oil
Record trade gap
Be prepared!

Gold at Cyclical Low

Inflationary pressures, quietly, are continuing to build. Energy prices are up 22.6% so far this year and climbing. With U.S. oil inventories approaching a 24-year low and natural gas reserves perilously depleted, we might well have a winter energy crisis waiting to happen. The U.S. trade deficit is growing to unsustainable levels and could derail the economy. Gold is lingering at a cyclical low, offering a low-risk hedge against economic uncertainty.

With the summer doldrums firmly upon us, gold continues to trade in narrow range between $271 and $276 per ounce.

The strength of the dollar continues to be the primary factor suppressing gold prices this summer. The Euro, Yen, and Aussie all lost ground to the dollar in recent weeks, pushing gold down into the mid and low $270s. Similarly, this week's decision by the Federal Reserve to hold interest rates is solidifying the dollar's near-term position and holding gold near its current bottom.

The unprecedented U.S. trade deficit, however, promises to create an abrupt shift in the relative strength of the major currencies, and not in the dollar's favor. Please see "Record Trade Gap" below for details.

The current seasonal dip in the gold price creates a terrific buying opportunity. Worldwide demand typically increases substantially in autumn, as the gold jewelry trade acquires inventory for the approaching holiday seasons, driving prices higher. A spot price dip like we have seen this week is the perfect time to build core holdings in preparation for the autumn boon. Remember, last year gold dropped to the low $250s in July and August, and then rocketed to $330 in September. Market fundamentals indicate that a similar or stronger run is likely this year.

In the words of David Meger, Metals Analyst at Alaron: "Remember the old adage: never sell a quiet market. We typically look for dips in the July to August time-frame to put on long positions in gold going into year-end demand periods. Over the next two months, dips are a buy!" We couldn't agree more! July and August are typically the most opportune months of the year for accumulating precious metals. We urge you to take advantage of a low-entry point, low-risk moment in the gold market.

European Gold Sales

News about the Swiss National Bank gold sales, which disposed around 7 tonnes of its gold reserves in mid-August, also weighed on the market. Also keeping temporary pressure on gold are concerns about the upcoming September U.K. auction, at which the Bank of England is expected to offer another 25 tonnes of gold.

Chris Thompson, CEO of Gold Fields, Ltd., the world's second largest gold producer, believes these central bank gold sales will soon come back to haunt the Swiss and British. "The world is running out of gold reserves, and faster than you think," he said recently at the World Gold Conference in Paris. "Reserves are drying up at an increasing rate and demand is increasing. Central banks will soon realize it's not smart to either sell gold or lend it, because they may have trouble getting it back in a gold-scarce market."

Stealth inflation and expensive oil

Last week the Labor Department reported that consumer prices rose at a 4% annual rate through the first seven months of the year, compared to 2.7% last year. These figures were higher than expected and hardly indicative of the "no inflation" assurances we keep hearing in the media. Energy prices are up a whopping 22.6% through July and even food, at 2.9%, is doubling last year's figures. And while the Fed elected to hold the overnight rate at 6.5%, it warned that the economy still faces the threat of inflation and that additional rate increases are quite possible. Once record-setting energy cost percolate through the economy, the true threat of inflation will become obvious.

Even though the government assures us that inflation is "under control," oil prices keep rising almost unchecked, and are now uncomfortably over $32 a barrel. Crude jumped 5 percent last week alone, the biggest gain since June. Refiners are already struggling to make enough heating fuel oil for the winter. "It's scary to think what's going to happen if a cold snap hits the U.S. this winter," said Tsutomu Toichi, director at the Institute of Energy Economics in Japan.

U.S. inventory supplies are reaching a crisis point. Crude oil inventories dropped 2.7 percent last week and are down 15 percent since May. The 24-year record low for crude stocks is 282.1 million barrels and as of the week ended August 4, supplies were at 282.6 million, according to the American Petroleum Institute.

OPEC has resisted calls for more oil until its members meet Sept. 10, and even Saudi Arabia, which urged a boost in output, has been reluctant to pump more.

With oil inventories in the U.S. approaching a 24-year low, an OPEC production increase, even if it happens, is likely to have little effect on overall energy prices. Phil Flynn, a senior energy analyst at Chicago brokerage Alaron.com, has said that the market is expecting an increase of about 3 million barrels in crude supplies, but if estimates are wrong, "we might be facing a new record low in 24 years and see panic in the oil market." As we move from the summer season of high demand for gasoline into the fall/winter period of high demand for heating oil, with reserves so low, do not be surprised to see oil at $40 a barrel by Christmas!

Just when gasoline prices seem to be leveling off, get ready for big increases in that other kind of gas. With natural gas supplies at historic lows and demand expected to be strong this winter, analysts expect price spikes to record levels.

"We are looking at the highest natural gas prices in a winter period that we've ever seen," said Paine Webber energy analyst Ron Barone.

Record trade gap

The gap between U.S. imports and exports is reaching dangerous proportions. While it's getting amazingly little press coverage, the deficit has many analysts worried that it could end the U.S. economic boom. According to the Wall Street Journal, during the first three months of 2000, the current-account deficit (the broadest measure of trade imbalance) surpassed 4% of gross domestic product for the first time in U.S. history. Merrill Lynch predicts that the year-end 2000 gap will measure $411 billion, 24% wider than the 1999 deficit and an unprecedented 4.2% of the overall economy.

A trade deficit indicates that a country imports more than it exports, and borrows to cover the difference. At some point, foreign investors begin to wonder whether they'll be paid back. When investors get nervous, they are far more likely to pull their money out of the U.S. economy.

According to Catherine L. Mann of the Institute for International Economics, in economically advanced nations the current-account gap hits its limit at 4.2% of GDP, which is precisely where the U.S. finds itself now.

'Confidence in the U.S.A could abruptly collapse before the rest of the world is firmly back on its feet," warned Norbert Walter, chief economist at Deutsche Bank Research. If that happens, "capital flows into the U.S.A. will dry up and the dollar will take a rapid dive . . . triggering a stock market crisis."

An event like a sustained loss in stock values could easily stimulate foreign investors to start selling their dollar investments, triggering herd instinct and creating a sell cycle that pushes the dollar down far and fast. As money leaves U.S. markets in favor of the yen and euro, stock and bond markets will fall further. The resulting economic landscape would look a lot like the financial stagnation of the early 1990s.

Even Alan Greenspan has admitted his concern. In testimony about the trade gap before the House last month, he acknowledged that "at some point, something has got to give, and we don't know what it's going to be. We don't know whether it'll be protracted over a long period of time or whether it will occur abruptly."

Be prepared!

If Greenspan thinks the record trade deficit has the power to dump ice water on the overheated U.S. economy without warning, maybe you should, too! Factor in the deeply worrisome oil and natural gas inventories and escalating prices as we enter into winter, and our economic picture moves from rosy to gray indeed. It's only prudent to protect your investments in this scenario.

At current prices, gold offers a low-risk hedge against expensive oil, a dangerous trade imbalance, stealth inflation, and precarious stocks. When the unprecedented strength of the dollar weakens — and weaken it will — European and Asian investors always flee to the safe haven offered by gold, bidding up prices. We urge you to take measures now, while gold is cheap.

That's it for now. As always, thanks for your time!

Sincerely,

Dana Samuelson, Owner and President
Dr. Bill Musgrave, Vice President

  

Metal Ask      Change
Gold $1,462.12           $0.77
Silver $16.65           $0.01
Platinum $900.63           $0.08
Palladium $1,881.30           $-6.36
In US Dollars