Japan scheme isn''t doing much good

Section:

11p EDT Wednesday, July 14, 1999

Dear Friend of GATA and Gold:

Reg Howe, author of the recent post here, "War Against
Gold is to Rescue Japan," offers this reply to Vincent
Cook's essay disputing him.

Please post this as seems useful.

With good wishes.

CHRIS POWELL, Secretary
Gold Anti-Trust Action Committee Inc.

* * *

REPLY TO VINCENT COOK

July 14, 1999

By Reg Howe

Basically Vincent Cook says that in my example of the
Japanese investor, there will be no effect in the spot
market for gold because the net short on the TOCOM
(e.g., Mitsui) will hedge elsewhere. Two basic points:

First, Mitsui's hedge as postulated by Vincent cannot
be profitable unless Mitsui earns a rate on its gold
loan higher than the rate implied in my hypothetical
investor's futures contract, which was 2.3 percent.
That is, if Mitsui borrows yen at half a percent and
honors the futures contract that calls for a discount
of 1.8 percent, it must earn in excess of 2.3 percent
to make any money. And if this daisy chain of hedging
continues, each successive player will have to earn a
higher gold lease rate than it pays to make money on
its hedge. Ultimately, it seems to me, there will have
to be a naked net short.

Second, Mitsui's hedge will not effectively transfer my
hypothetical investor's demand for gold to the spot
market. In Vincent's hedge, Mitsui is buying gold at
spot immediately to loan it out again. The party to
whom Mitsui loans the gold will either sell it right
back into the spot market or deliver it against an
existing unhedged obligation in that market. In the
former case, Mitsui's purchase creates an offsetting
sale; in the latter, Mitsui's purchase substitutes for
what would have been a purchase by its borrower, not my
hypothetical investor. His demand is still out of the
spot market.

To me, a general rise in lease rates across the
maturity spectrum is consistent with the sort of
hedging activities Vincent postulates. But a sharpening
inversion in lease rates is consistent with increased
borrowing to meet existing unhedged delivery
obligations. Inverted interest rates are almost always
a sign of stress, and playing the lender of last resort
to gold banks is more like Russian roulette than
hardball.

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