Gold Market Update

The prices of gold mining shares and gold during the third quarter of the year corrected their first half rises, but they continued to outperform the New York stock markets, as they did in 2001. The Financial Times Gold Mines Index climbed 78 % from the end of 2001 to its May high, fell to the end of July, then rose to close up 40 % for the year to September 30th. Gold rose 18 % from $ 278.95 an ounce at the end of 2001 to its high of $ 330. an ounce, corrected to the end of July and then resumed its uptrend to close at $ 323.90 an ounce on September 30th, up 16 % from the end of 2001. The Dow Jones Industrial Average fell 24 % during the first nine months of the year. The ratio of the Dow Jones Industrial Average to the price of gold fell from 36 at the end of 2001 to 23.4 last Friday. This ratio reached a peak of 44 in 1999 from a low of 1 in 1980.

The higher gold prices reflected an increase in investment demand arising from a growth in risk-averse sentiment and a reduction in net producer hedging (which increased demand). The higher demand more than offset a lower fabrication demand. In our opinion, a probable further deterioration in the global financial, economic and political situation will lead to the continued growth of risk-averse diversification of investment portfolios into gold-oriented assets.

The managing director of the International Monetary Fund warned last month that there were increased risks to the global economic outlook. He concluded that the global current account imbalances could not be sustained indefinitely and that the world should worry about a rapid correction. He suggested that a likely scenario would be that revised expectations of U. S. growth prospects would cause lower U. S. consumption, imports and growth. A sharply lower dollar would export some of the pain to Europe and Japan. The U. S. second quarter current account deficit reached a record 5 % of GDP. The dollar has already declined approximately 15 % in terms of the yen and the euro from January to August.

The risk of more financial distress is rising. The value of corporate bond defaults in the year to date hit a record $ 140 billion, surpassing last year's record $ 135 billion. Record-high debt levels, credit rating downgrades, deteriorating equity values, economic weakness, a record number of loans in foreclosure and climbing homeowner delinquencies are weighing on the market. Yield spreads between corporate and government bonds are widening. The junk bond spread over Treasuries climbed from 535 basis points in mid-May to 865 points last Friday. The ratio of the price of gold to the price of silver, a characteristic of the credit spread anticipating developing distress (Institutional Advisers), rose from a low of 62.5 in July to 72 last Friday.

The risk is rising that optimistic expectations of a stock market rebound may be delayed. Assumptions of future long-term equity returns may be scaled down. Profit warnings and forecasts continue to disappoint. The 42 % fall in profits in the non-financial sector from 1997 to the first quarter of 2002 has been unique in history. The squeeze on profits may continue. Despite the Fed's interest rate cuts, business interest expenses continued to rise in 2001. Employment compensation in private industry rose 4 % in the year to June 2002, while finished goods producer prices in the year to August, 2002, fell 1.6 %. Under-funded pension plans and rising insurance premiums may put added pressure on profits. The correction of the remaining imbalances from the "bubble" years may be prolonged. An equally destabilizing burst of the housing "bubble" could be added to the collapsing stock market "bubble".