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Gold Bulls Unite!
21 May 2002
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If it's a bull, prices of the asset, currency, or commodity always rise further than most people expect; in a bear market they always fall further… in the late stages of a bull market all of the nonsense comes from the bulls, but during the late stages of a bear, the nonsense is all bearish. So if the nonsense is densely bullish, but prices of the asset continue surprising on the downside, the bear market is young - on picking tops and bottoms (Ed Bugos)

I could not be more ecstatic about the nature of the rising gold tide. The corrections in the price of gold continue to shorten in duration as well as extent, resulting in an increasing momentum for the Golden Bull that even Mr. Magoo could see.

It's time it appears, for this market to head for primary bear market control at $328 to $338 per ounce, and then beyond. We estimate that a break in the dollar index below 112 will be enough to get gold there, but to propel gold prices into a primary bullish sequence, the dollar has to fall through 108, the last highest low in the primary bullish sequence that began in 1995. Do yourself a favor; don't take your eye off that ball.

So it's not quite time to break out the champagne and caviar. On the way to 108 the mainstream analyst and broadcasting community is going to bring up the idea that a concerted intervention is on its way to support the US dollar. The Japanese would be glad to help, it is likely to be reported, because their reformist government wants a weak yen. In fact, I'd bet Bloomberg writes it first, despite the increasing correlation between a rising yen and rising Nikkei.

But boy would that help the dollar get there faster. One of Rubin's shrewdest tools in managing the dollar is probably the knowledge that "intervention talk" aimed in support of other currencies over the years has been an important psychological factor in support of the strong dollar. "Sure, we'll help you guys out and tell the world we're doing it." What would the layperson make of that? That the dollar is superior.

Thus, any kind of intervention favoring the dollar could be seen as a sign of weakness not leadership, for the intervention would arise as a defensive policy for a currency the whole world perceives to be sound.

Besides, there are other reasons, more economic, that interventions don't work, and the governors of dollar policy know them all. Nonetheless, we can't predict what the humans in charge of these policies are actually going to do. We can imagine, however, there will be pressure by many market participants to move in the direction of interventions... based on other recent policy transgressions.

There is good reason to be bullish on gold, and bearish on the dollar today.

However, there is one exceptional reason to get bullish on gold in my own view from the penalty box. And it is ironic, so ironic. Are you ready?

The Meaning of IT
The biggest contribution of the IT (information technology) revolution is not a ramp up in technological innovation for our society, or in the productivity of our machines.

Rather, it's most important contribution is in the potential for an unprecedented knowledge advance for all of society, which should appear as though a large sledge hammer was thrust through the thick veil of contemporary ignorance in all subjects. The Internet has destroyed many information monopolies as a result of the favorable economics arising from the break down in any knowledge advantage previously enjoyed by either the buyer or seller in a transaction, provided of course that buyers and sellers take advantage of them. The most guarded of all these information monopolies is that which is presided over by Fed Chairman Greenspan and the global banking community, whose main business is inflation.

At any rate, this process has been developing slower than some might expect because there still is only a fraction of the population who are efficient end-users of the IT.

Generic economic experts might point to today's declining profits on Wall Street and quote you the efficient market hypothesis as having been accelerated with the benefit of the Internet. But you already know the real reasons for falling profits (…inflation breakdown, shhh).

Nevertheless, the contribution of IT as we see it will probably become more manifest and easier to perceive when the Internet's capacity as a near perfect medium of "information" exchange is optimized by the market economy. What we mean is that as buyers and sellers learn to use the IT we're counting on the process to organize the world's information and knowledge in a way that best suits society in its aims.

The economic benefit may be restricted to helping the freer exchange of goods and services within an economy, which means that it promises to aid the role of money in any market system. But right there is our gold coup. Can the Fed be to the dollar what the Internet will be to money? Absolutely not.

The Internet is a powerful breakthrough for the knowledge field and for freedom, if it is left alone. Thus to the extent that institutions like the Fed, IMF, BIS, or nearly any public authority depends on ignorance or illiteracy, the information revolution is bullish for gold prices, not technology stocks. The latter was transitory speculation and euphoria.

Of course the ongoing revolution in IT will draw out new and exciting discoveries, but they will have nothing to do with the impact of the revolution on the business of money. In fact, they will have nothing "on" that impact either.

The Fed, for its part, is going to have to figure out how it can continue to fool most of us into believing that the dollar is as sound as gold in its economic role as money.

The US Treasury department shares in this responsibility, but after all, the US dollar is just a Federal Reserve Note today.

So if you're a gold bull today, you probably believe in the government's capacity for manipulation, past, present, and future. But if you also happen to be bullish on the human capacity for knowledge and advance, as we are, then you must be able to see how the Internet has become a grave threat to the opponents of gold & free market capitalism. The rising price of gold is then a bullish indication of capitalism's return.

Though, it is a bearish indication for the global banking establishment that controls so much with so little.

Hedge or Liability?
Even Freeport made fresh intermediate highs on Monday and Tuesday morning. All US gold bourses made new 30-month highs this week, except for the HUI (Amex Gold Bugs index), which went off to new four-year highs. That index is in a primary bull market due to its weighting in non-hedged production.

The other indexes are only marginally short of making bullish primary trend reversals themselves.

There has been a lot of good commentary from the independent analyst community that has highlighted the vagaries of hedging in a bull market for the commodity in question; specifically, over-hedging in the gold industry. Of course, this is a relative concept and it is a difficult one. It's not black and white. Indeed, not much of anything is.

In some cases, the criticism of a company's hedging practices is warranted. In other cases, it isn't. Within a particular industry, and while prices are falling, the market is likely to place a higher risk premium on the producers that aren't hedged. In other words, the shares of the hedged producer should fall less. If prices are rising, as in a bull market where they always rise more than people expect, the market is going to put the higher risk premium on the hedger, meaning the hedged producers will gain less quickly, and depending on the extent of their prior hedging, may not gain at all.

We can't know the proper amount of appropriate hedging, only the market can. The hedger can only know to the extent of his or her ability to figure out what the market may do.

There are two ways to enter into most derivatives transactions. One is through exchange standardized futures contracts with the least amount of counterparty risk and the other is through OTC forward contracts, which features are normally custom tailored for the specific transaction between the hedger and dealer. This is where most of the counterparty risk you hear of shows up, and what prompted Mr. Sinclair (Chairman of Tan Range Exploration; TNX, a TSE listed gold company) to write to Newmont as a shareholder and publish the letter at Le Metropole. If you'd like a copy of the letter please mail us at: mailto:gold@goldenbar.com

It was very good. Since we haven't seen Newmont's replies, we don't know the answers to the questions that were raised by the ex operator of metals trading for the Sinclair Group prior to 1989. And since most of the gold industry uses the less liquid OTC instruments for their hedging, the questions are important.

Yet any heavy criticism of Newmont is probably unwarranted for a few reasons. First, the overall hedge is much smaller than any other producer, particularly in Newmont's blue chip league. Only 8% of their total reserves are hedged. Second, most of the contracts are denominated in Australian currency and so long as the AD can keep up with the price of gold against the dollar then the value of their hedges should stay intact. Third, many of these hedges are put option contracts that were purchased, so the liability is probably limited. Fourth, the contracts are financial liabilities only to the extent that the company can't deliver the actual gold into them. Otherwise they are mainly a drag on earnings when prices are going up and a buffer when they're going down. Fifth, they plan to unwind at least a third of those acquired hedges over the next few years.

What I'm trying to say is that we have to give Newmont some credit for its acquisition of Normandy's hedge book as ushering in one of the events that began to separate the performance within the sector between hedgers and non-hedgers. Newmont's success was a vote by the market, which had become increasingly bullish on gold prices, and which is why Anglogold heeded the signal later.

The market's preference for Newmont over Anglogold in its bid for Normandy sent Anglo a strong signal. After all, Newmont just became the world's largest gold producer. It subsequently announced that it too would change course on its hedging practices. The rally in gold shares following this industry consolidation was increasingly concentrated toward the unhedged producers. Shareholders of the gold companies with the least amount of their future gold production hedged have done the best since the event.

When today's analysts write that unhedged producers are rising faster than the hedged ones they're saying that the market is placing a higher risk premium on the hedgers, which as we've noted before, means the market is pressuring today's hedgers to reverse their hedges in order eliminate this risk premium so that they too do not become the target of a hostile takeover by the unhedged producer whose shares are trading at a discernible valuation premium - ie. stronger currency.

But to criticize Newmont for catalyzing this market process, for gaining significant global market share at the same time, and for holding a bag full of dynamite that when it explodes will have a much more bullish affect on its bottom line overall anyhow, is something that might create a buying opportunity. And it comes as the consequence of a first quarter earnings report that probably disappointed investors.

Newmont lost $0.04 per share, which compares with a $0.20 loss in the same quarter one year back. Management blamed rising production costs in its Nevada operations for the shortfall, and warned that this year's profits will fall short of analyst's expectations.

It received an average realized gold price of $291 in the quarter compared with $264 in the year ago quarter, while its total production costs rose to $262 from $220; only half of that rise is due to rising cash costs. The non-cash rise is the consequence of a $30 million increase in the expensing of the "Depreciation, Depletion, and Amortization" account to $113 million from $85 million in 2001. That's about $0.10 per share right there.

Cash on hand, however, grew from $47.2 million a year ago to $511 million at the end of the first quarter 2002 due to a big increase in cashflow from operations during the quarter. The company's operating loss fell to $13.2 million from $31.1 million before gains on derivative instruments reported to be $19 million in this quarter compared with $16 million in the year ago quarter.

Newmont's management also said it plans to reduce its debt down to 10% of total capitalization, as well as reduce the hedges it inherited from its Normandy acquisition over the next three years. In a recent press release, Pierre Lassonde, the President, said:

"With our non-hedging philosophy, we continue our proactive program to reduce and simplify the hedge book we inherited from Normandy. During the quarter, the acquired hedge book was reduced by approximately 250,000 ounces to 7.3 million committed ounces. In addition, the floating gold lease rate exposure was reduced to 55 percent of committed ounces. Our ultimate goal is the closeout of the hedge positions in an orderly and timely manner, while looking for opportunities to accelerate delivery into or closure of the book." For the balance of 2002, Newmont expects to deliver a minimum of 1.0 million committed ounces at an average gross gold price of approximately $303 per ounce, which will net to an estimated $286 per ounce after accounting for associated gold borrowing costs. This price will improve if the Australian dollar continues to strengthen against the US dollar - Newmont Press Release

Our criticism of hedgers stems largely from the fact that we are bullish on gold prices. If we weren't the criticism would have a less important place, and in fact, if we were to be bearish on gold, the more hedging the company did the more we would see it as the sound choice, so long as the counterparty risk is properly accounted for, and of course, so long as the hedging doesn't become the company's main line of business. I hope that Mr. Sinclair's letter prompts Newmont to review its disclosure guidelines and lead the industry in publishing such details to shareholders so that the market can do its job and value their shares accordingly.

It could be to their benefit if their competitors hedge books are far worse off than theirs.

In any case, the higher the price of gold goes, the more pressure there will be for companies to stop hedging or close down their hedge books altogether. We've said that before, many times over, as have many of the gold analysts we follow.

In such an environment all (short) hedges become a potential liability. But in responding to the pressures by shareholders (with respect to their action in the market), one by one, the excess hedgers are going to fuel this bull market or risk being eaten up by a competitor with a stronger currency.

Ed Bugos

The Goldenbar Report: is not a registered advisory service and does not give investment advice. Our comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other financial instrument at any time. While we believe our statements to be true, they always depend on the reliability of our own credible sources. Of course, we recommend that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction, before making any investment decisions, and barring that, we encourage you to confirm the facts on your own before making important investment commitments.