"Midas" commentary for September 30, 2000


12:45a EDT Saturday, September 30, 2000

Dear Friend of GATA and Gold:

The Tocqueville Gold Fund's John Hathaway has produced
another masterpiece, and it largely reflects GATA's view of
the gold and financial markets. Here it is.

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

* * *

The U.S. Dollar: Over-owned and overvalued

By John Hathaway
September 29, 2000

I invest in gold shares for a living. I manage a gold
sector mutual fund. Despite this, I do not long for a
return to the gold standard or wish to prescribe any
particular solution for this or that economic ill. I
am not as captivated as some by geological
speculations. The finer points of mine engineering or
nifty metallurgical nuances disinterest me unless they
pertain directly to value creation in our portfolios.
The painstaking bean counting necessary to construct
supply and demand models for the gold market does not
dazzle me. The promotion of gold as jewelry and the
liberalization of Asian retail markets are
constructive, I suppose, but in the final analysis do
little to form a rationale for investing in the sector.
Finally, I am not caught up in conspiracy theories.
None of the foregoing considerations, it seems to me,
add up to a money making proposition.

Why then, you must be asking, would I be doing this? I
see gold as a way to reap a tidy profit on impending
changes in the financial landscape. It is a
speculation against financial assets, against the
preeminence of the US Dollar, and against the financial
market speculation that has raised dollar to its
untenable, almighty stature.

I am only interested because of the possibility that
gold might, within a reasonable time frame, i.e., in my
lifetime, trade at $500 or even $5000/ounce. A
breakout, to say $325, which we would all enjoy, would
be hardly worth the expenditure, the investment, or the
time it has taken for such a paltry result. Gold is a
potentially huge score. What keeps me interested in
this wasteland barren of investment returns are the
positive macro economic trends for gold. There are
encouraging signs that the high water mark has passed
for the dollar, financial assets, and the credit boom
that has fueled the bull market in paper and the bear
market in gold.

Hedging, Derivatives, The Short Interest,
and Conspiracy

For the most part, these considerations are ancillary
to the main thrust of my investment reasoning.
However, it is worth spending a minute or two to the
extent that they can shed light on the structure of the
gold market. At best, these factors will lead to
periodic short covering rallies. By themselves, their
existence will not attract speculative capital to this

The existence of a large and vulnerable target in the
form of an outsized short interest will help propel the
gold price once the dollar is under attack.
Conspiracy, in my opinion, is too strong a word for
what is going on in the gold market. However, it
should surprise no one that some form of manipulation
is taking place. Governments routinely intervene in
the currency markets. Gold is a form of currency. As
stated by Professor Robert Mundell, Nobel Price Winner,
"gold is subject to a lot of elements of instability,
not the least of which is the attempt on the part of
several big governments to make it unstable." Mundell
made these comments at the World Gold Council's 1999
Fall Symposium in Paris, at which he was the honored

Since World War II, various governments, and especially
the United States, have steadily moved in the direction
of marginalizing gold as a reserve asset. At
different points in time, these efforts have been
coordinated among several governments, although the
motivations among the various participants have not
always been consonant. The first notable example of
such activity was the London Gold Pool, a joint effort
by the United States and several European governments
to depress the free market price of gold to disguise
the growing weakness of the US dollar. This effort
lasted over a decade, from the mid 1950's to 1968. At
no time during the pool's operations was there any
advance official acknowledgement that such operations
were being conducted. Market players were kept in the
dark. However, speculators were able to infer the
pool's existence from the price behavior of gold,
figures on US gold reserve assets, and the balance of
payments. As a result of the pool's activities,
substantial economic interests arose which would win or
lose depending on its success in depressing the gold
price. As time passed, the incentives of all
participants to keep the free market price of gold at
$35/oz diverged, most notably France. Once national
economic interests diverged, increasing flows of
speculative capital mobilized and ultimately defeated
the government scheme. Fortunes were made at the
expense of taxpayers, especially US taxpayers.

Since the early days of the Clinton administration, the
tradition of manipulating the free market gold price
has been honored. As with the gold pool, the actual
origins are probably obscure. While far more complex,
current Anglo-American led efforts to depress the price
have one very important similarity to the gold pool.
The financial stakes of public and private market
participants are huge. These interests extend well
beyond the immediate gold market.

There is no better illustration than the panic in
government and private circles that was touched off by
the Washington Agreement. Central bank officials
appeared to be clueless as to the structure of the gold
market, especially as to the size and location of the
short position that had been required to keep the gold
price locked in a downtrend. They were horrified by the
volatility of the gold price in the following days, and
of the potential damage to bullion dealers, many of
whom were also major international banks (see "J.P.
Morgan To The Rescue?" for more detail). The crisis
galvanized the central banking community into quick
action to provide liquidity for the gold market, which
was about to vaporize. The provision of liquidity in
the moment of crisis emboldened dealers to expand

As noted by Reginald Howe (www.GoldenSextant.com), the
mysterious Exchange Stabilization Fund, managed by the
U.S. Treasury, lost $1.6 billion during the fourth
calendar quarter, more than it earned in all of 1999.
After this near death experience, it is likely the
official sector's resolve to keep gold in the deep
freeze was reinforced. The continuing expansion of
dealer derivative positions despite declining producer
hedging, and especially the lengthening of maturities
reported in the BIS and OCC numbers, suggest renewed
conviction among dealers that divine assistance will
never be too far away in time or price.

At the same time, the Washington Agreement marks a
watershed for the gold market. Even though central
bankers worked together to end the crisis, the
interests of the Europeans and the Anglo/American camps
with respect to gold may have started to diverge. This
is despite the fact that Europeans bankers continue to
be persuaded by bullion dealers into "active"
management of their gold reserves, (i.e., leasing and
dispositions to invest in interest bearing securities
including, Euro denominated.) It is also despite the
fact the United States and Britain were signatories to
the agreement, an act they may have found distasteful.

The agreement marks the first step towards the
reinstatement of gold as a monetary reserve asset. If
the Euro continues to have problems, the Europeans will
figure out that there is little advantage to trashing
their largest reserve asset other than dollars.
Professor Mundell has suggested that the European
Central Banks issue gold coins as part of this current
intervention: "The production of a gold currency would
heighten general interest in the euro and at the same
time put the EU's excess gold reserves to good use."

At the end of the day, these structural considerations
are interesting for two reasons. First, they are
necessary to understand what has already transpired in
the gold market. More important, they shed light on the
massive misallocation of investment capital. The
continued existence of a large short interest, which is
impossible to cover other than from longer term
deliveries from new mine production or official sector
sales, increases the potential upside move in gold.

The Clinton Dollar

The case for renewed investment interest in gold
centers on the proposition that the U.S. dollar is at
or near its peak. Should this be the case, investment
flows will seek out alternatives, including gold. The
dollar is the unrivaled instrument of international
credit and capital flows. It is the foundation for
most commercial and financial market transactions. The
perception that the dollar is a store of value as well
as a medium of exchange explains the willingness of
governments, businesses and individuals worldwide to
hold dollar instruments to the near exclusion of
alternatives. However, it was not always so.

During the early 1960s, 1970s, and 1980s, the U.S.
dollar was suspect. In the 1960s, the most obvious flaw
was a deteriorating balance of payments position.
Other indicators such as inflation, interest rates, and
equity markets were favorable or benign. The
geopolitical situation, however, was dicey. It was not
entirely clear that capitalism and the U.S. would
ultimately prevail over the competing forces of
communism and the Soviet bloc. The gold pool attempted
to disguise the dollar's chronic weakness by depressing
the free market price of gold.

In complete contrast, the Clinton/Rubin/Summers dollar
is beyond reproach and is almost universally admired.
At the Financial Times gold conference in June, central
bankers openly worried about the future of gold, but
never voiced concern as to their potentially imprudent
concentration in U.S. dollars. The possibility that US
budget surpluses would shrink the supply of government
debt was openly mourned, despite the fact that OMB
projections show no such shrinkage. These projections,
found on the OMB web site, show government debt
increasing in every year through 2012, as far out as
the projections go. Still, the rage among these
seemingly ill informed central bankers is a pronounced
preference for interest earning paper assets to
stagnant bars of bullion. And the preferred paper asset
by far is the U.S. dollar, which represents 77.7
percent of world central bank reserves, according to
the latest BIS annual report. The percentage is
certainly disproportionate to the U.S. share of world
trade and economic activity.

The U.S. trade deficit will reach 4.3 percent of GDP
this year, as noted in a paper ("Perspectives on OECD
Economic Integration: Implications for U.S. Current
Account Adjustment") presented to world central bankers
at the annual Jackson Hole symposium by Professors
Obstfeld and Rogoff. More important is the percentage
of US financial assets held abroad, $1.9 trillion or
nearly 20 percent on a net basis of GDP, the highest
since the 1800s. They argue that only a small
percentage of GDP is "tradable," the remainder being
explained by non-tradable components of GDP such as
rent, transportation, labor, etc. The percentage of GDP
that is internationally traded, or readily redeemable
for dollars held abroad, may only be 20-25 percent of
the total, suggesting a higher rate of borrowing and a
lower degree of national solvency than is generally
perceived. According to the professors, "a critical
issue in determining sustainability is not simply the
rate of borrowing, but accumulated debt." They assess
the risks of a dollar crash as significant. While not
predicting such an outcome, the study suggests that a
sudden depreciation of 24-40 percent could occur if
foreigners moved quickly to exchange their dollars.

The disproportionate ownership of the dollar is
widespread throughout numerous asset classes.
According to Bridgewater Daily Observations, gross
foreign ownership of U.S. assets now measures over $6.4
trillion (66 percent of GDP). Foreigners own a record
38 percent of the U.S. treasury market, and 44 percent
excluding Federal Reserve holdings. They own a record
20 percent of the U.S. corporate bond market and 8
percent of the U.S. equity market. What would a change
of sentiment on the dollar do to U.S. asset prices?

Keep in mind that the dollar's strength is only
relative to the Euro and the Yen, two seemingly
unappealing alternatives. Neither has been regarded as
a serious rival, with their shortcomings widely
publicized. The integration of world financial markets
has eliminated many of the traditional safe havens such
as the d-mark or the Swiss franc. World capital flows
dwarf even the more liquid currencies. It seems as if
it has come down to the dollar or nothing at all.
Nothing at all, except for gold, which stands to become
the protest vote on the monetary ballot, the equivalent
of "none of the above."

The epic strength of the dollar is no longer something
to celebrate. The weakness of the Euro in particular
has created sufficient discomfort to trigger a round of
concerted multinational intervention. The
interdependence of world economies and financial
markets means that the dollar cannot be isolated or
insulated. Whenever the foreign exchange markets force
the hand of central bankers, there is reason for us to
cheer. Interventions rarely work in the long term.
Perhaps the Euro will be viable, but there is no
precedent for a successful multinational currency. It
was the prospect of the Euro in large part that led
European central bankers to view their reserve assets,
especially gold, as redundant.

It is possible that the Euro will turn out to be a
fiasco, notwithstanding the current rescue effort.
Even though the economic fundamentals of Europe are
improving, that does not assure success for this
experimental, peculiar currency. The ECB is issuing
Euros at growth rate of 10 percent on a 12-month basis
and nearly 20 percent in recent months. Banana republic
growth rates may help explain the market's aversion.
An eventual abandonment of the Euro would be bullish
for gold and possibly bearish for the dollar, but the
demise of the Euro is not the only potential source of
renewed investment interest for the metal. Time and
space will not permit me than to do more than merely
mention some others:

* Banking derivatives. The potential miscalculations in
the gold market are minuscule compared to the bets that
have been placed on the foreign exchange and interest
rate markets. According to the Bank for International
Settlements, total derivatives on interest rates and
currencies measure in the hundreds of trillions.

* Under-investment in the commodity sector will lead to
shortages and spiraling prices in certain commodities.
What is happening in oil is a template for nearly all
other basic resources. A softening economy, favored by
the bond vigilantes, will only starve the resource
sector of the necessary capital investment to meet
growing demand. The rise in commodity prices over the
past year is not a fluke.

* Excessive investment in the high tech and
telecommunications sectors will lead to banking and bad
loan problems reminiscent of tanker loans, S&L
defaults, real estate, and other similar misadventures.

* The doctrine of just in time inventory management has
resulted in a run down of critical stocks of basic
materials. Supply shocks will evoke consumer responses
similar to that recently witnessed in Europe during the
protests over high energy prices. If the markets lose
their confidence in deliverability, there could be a
secular swing towards restocking and hoarding.

* The over-concentration in U.S. financial assets.
Recent acquisitions of behemoth financial institutions
by their foreign counterparts are another sign of a
market peak for financial assets.

* A recession would undoubtedly trigger renewed
monetary ease, including lower interest rates and more
rapid money growth.

* U.S. equity prices seem to have peaked out, with no
new highs in the DJII, S&P, and NASDAQ Composite since
the first quarter of this year. Most stocks peaked out
a year or more before the averages.

* A bear market or a recession would depress tax
revenues and undermine the outlook for a budget

The dollar is vulnerable on these and many other
fronts. It is vulnerable because, like an overvalued
growth stock, it is priced for perfection. It is
vulnerable because, like an overvalued growth stock, it
is over-owned. The inflation news cannot remain rosy

The BLS reports on the CPI and PPI are already viewed
with suspicion. The concept of a core inflation rate
has become laughable. The idea that inflationary
threats can be stifled by high interest rates,
restrictive money growth, and tight fiscal policies
seems questionable against today's political and even
geopolitical realities. The productivity myth rests on
the dubious foundation of hedonic pricing methods, a
methodology applied to the BLS price indices at the
beginning of the Clinton administration.

Even the Deutsche Bundesbank and OECD have recently
challenged the validity of this centerpiece of
financial market lore. Using this methodology, the BLS
has inflated spending of $28 billion by business on
computer hardware, or 3 percent of nominal GDP growth,
to $127 billion or 20 percent (Richebacher Letter,
September 2000). The impact of these adjustments is a
substantial overstatement of productivity figures and
an understatement of consumer price inflation.

The policies and practices of the Clinton
administration's Treasury Department have established
the dollar as the premier currency. This exceptional
high standing is essential to the low inflation rate
enjoyed in the US but not in the rest of the world. A
weaker dollar would hinder the access of the American
consumer to cheap foreign items and therefore lead to
higher inflation.

The dollar is high because of a successful and
widespread campaign across a number of fronts and the
confluence of external events that included:

* Implementation of hedonic pricing methodology to BLS

* Widespread financial market reforms that encouraged
banking industry consolidation and the emergence of
financial institutions of unprecedented scale.

* Removal of trade barriers.

* Curtailment of longer term treasury debt maturities.

* Endless spin on a strong dollar.

* Making sure gold did not establish an uptrend.

* The demise of the Soviet empire.

* The strong fiscal position of the U.S.

There were probably a number of other contributors to
this strong dollar policy. These developments
interacted with the markets in a way that reinforced
the dollar's strength and undermined gold. However
these measures and/or events, like the Clinton
administration, will soon be history. The explanations
are similar to those associated with great growth
stocks at their peak valuations. They are easy to
articulate in retrospect, and there is a tendency by
market participants to extrapolate more of the same.
However, we may have reached the limits of the
desirability of a strong dollar based on the extreme
position of our trade balance and foreign asset
ownership. The euro intervention is a tipoff that there
is sufficient disquiet in the public and private sector
that a change is in the wind.

The real clues to the outlook for gold lie in the
market for the U.S. dollar. The Clinton
administration's strong dollar campaign has enjoyed
wild success, creating an insatiable appetite for the
paper. This success is a principal reason for the
dollar's present vulnerability. When will foreign
holders of U.S. assets begin to suffer from buyer's
remorse and realize that the strong dollar has gone too

The fundamentals supporting a change of opinion have
been in place for some time and without a catalyst
could continue. Identifying a particular catalyst is
very tricky, but there seems little doubt that
prospects for a change of direction are promising.