James Turk: A ''waterfall decline'' for the dollar

Section:

Gold Waits as Base Metals Fall;
South African Bid Is Reminder
that the Commodity Has Great Potential

Barry Riley
Financial Times
Monday, October 25, 2004

It has been a frustrating year for gold bugs, who have
been forced to watch the bullion price tracking
sideways while other commodities have been soaring
-- oil by 60 percent and copper by 25 percent.

But Harmony's cheeky bid last week for the somewhat
larger Gold Fields, representing an attempt to create the
world's largest gold producer, is a reminder that the
yellow metal has great potential.

There is a Chinese puzzle here. Soaring demand for
industrial commodities by China, at the forefront of a
global economic boom, has been the key factor in
triggering the price inflation in raw materials, which
has sent the GSCI index up by 36 percent this year.

True, base metals suffered a sharp selloff this month
and the mining sector of the stock market has tumbled
too. There are fears of a Chinese slowdown. But there
are fundamental capacity shortages in the international
mining industry, which will support prices as long as
the Chinese industrial machine continues to prosper.

Gold is different. The bullion mining companies have
had to watch the progress of their base metal peers
with envy.

The FTSE Gold Mines index is down 5 percent since
the end of 2003, and a slightly higher exchange rate
for the rand has put pressure on the profits of South
African producers: Harmony has had to defend its
profits through job cuts, for instance.

Might China come to the rescue here too? The country
has for several years been accumulating a hug hoard
of U.S. dollars, mostly in the form of Treasury bonds.
If it revalues its currency, as is constantly being
rumoured on foreign exchange trading floors, it will
take a hug hit in terms of its own money.

But its options for diversifying the currency risks are
few: euros, certainly, but other currencies are based
on relatively small economies or, like the Japanese
yen, cannot be regarded as reliably independent of
the U.S. dollar.

That leaves gold, traditionally a central banker's
diversifier, but one that has fallen out of favour in
recent years. China has not yet announced an
official gold purchasing strategy but it has opened
the doors for private buying by Chinese citizens.

A weakening U.S. currency, moreover, must be
concentrating the minds of the big dollar hoarders.
As if on cue the bullion price rose last week to $425
an ounce, the highest level since a brief spike to near
$430 in the spring. Meanwhile, the U.S. dollar sank
against the euro and hit and 11-year low against the
Canadian dollar.

The steady drain on gold from sales by central banks
has slowed.

Indeed, Argentina, which has no reason to trust the
dollar, bought 42 tonnes of the metal during the
summer and the new five-year Central Bank Gold
Agreement, signed last month by the European
Central Bank and 14 other institutions, will limit
sales to 500 tonnes a year.

Gold bulls doubt whether sales will even reach those
target levels in the context of a weak dollar and a
rising gold price.

Apart from China, there is also speculation that the
newly oil-rich Russia will diversify its growing
foreign exchange reserves, which are about to exceed
$100 billion, by adding some yellow metal. In fact,
North American gold speculators, led by the Gold
Anti-Trust Action Committee, have for years been
accusing the U.S. Treasury of covertly manipulating
the gold price, starting in 1998, when, allegedly, a
big bullion short position amassed by Long-Term
Capital Management, the failed hedge fund, was
secretly absorbed.

Soon afterwards, in 1999, the Bank of England
launched a highly publicised series of auctions
involving 415 tonnes, sold at sub-$300 prices,
which now look like very poor value for the British
taxpayer.

This summer the gold price suppression allegations
were assembled in a document published by Sprott
Asset Management, which runs hedge funds out of
Toronto. The World Gold Council, the London-based
global mining trade association, refuses to accept
speculators' claims that it is being misled by the
leading central banks about the extent to which they
have lent gold to the markets and capped the price.

Nevertheless, the World Gold Council last month
launched a research study titled "Gold as a Hedge
Against the U.S. Dollar." After statistical tests, as
detailed in the study, gold turns out to have been an
erratic but "remarkably robust" hedge: It cannot be
debased in the way that currencies can.

Past sharp movements in the gold price -- in the
1930s, for example, and the 1970s -- have usually
been associated with currency crises. For periods as
long as several decades, however, gold can be a very
dull investment.

You have to smell trouble ahead for gold to be at all
appealing.

With the U.S. trade deficit spiralling ever higher, there
are plenty of serious dollar bears around at the moment.

Now for an intriguing power struggle among the gold
mining giants. The two combatants are based in South
Africa but have broad international share ownership,
including the 20 percent stake in Gold Fields owned by
the Russian mining group Norilsk Nickel.

The latter has its own agenda, probably involving the
attractions of spinning off its Russian gold interests into
the newly merged group, thus placing assets out of the
easy reach of the Russian government.

Such a combination -- creating the world's biggest gold
producer, though one less valuable in terms of market
capitalisation than Newmont of the United States --
would have the advantage of spreading Harmony's
production risks more widely outside South Africa.

But, for a big payoff, Harmony would need to benefit
from a revival in the bullion price. A rise to above $430
an ounce, a 16-year high, would be a start.

Continued strength in the Chinese and Indian economies
would greatly help demand because gold is a highly
popular commodity in those countries. Above all,
however, central banks will need to take a different
attitude to gold and the dollar.

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