Gold Market Update

The price of gold closed at $ 311 an ounce last Friday, approximately unchanged from our last Update. It has climbed 8 % from its March low of $290 an ounce, partly reflecting dollar foreign exchange weakness and a fall in the stock market (The S. & P. 500 Index is down 10 % from its March highs.) Gold usually has a negative correlation with the stock market and so is a good portfolio diversifier.

Gold mining share prices continue to perform well. The Philadelphia Gold/Silver Stock Index (XAU) made new highs since September 1999. Last Friday it was up 31 % from its March low and up 46 % from the end of 2001. South African shares have been the stars.

Last week the Federal Open Market Committee expressed its opinion that the degree of strengthening in final demand over coming quarters, an essential element in sustained economic expansion, was still uncertain. The Committee evidently is not convinced that its policy of low short-term interest rates and high rate of government debt monetization (monetary base) will be effective enough to stimulate borrowing and spending to achieve its final demand target. Accordingly, we believe that the risks of a double-dip recession and of a traditional post-bubble contraction still exist.

A serious slide in the dollar could result in another period of monetary and economic disorder. The dollar has declined approximately 4 % from its March highs in trade-weighted terms. The U. S. current-account balance, which was in surplus in 1990, fell into a deficit of about 4 % of GDP last year and is expected to hit nearly 5 % of GDP this year. Foreign investors' willingness to fund the deficit at current interest and exchange rates may be waning. Capital inflows in January and February have declined. After its current rebound U. S. growth may be faced with a slowdown. A strong currency may not be in the best interest of the U. S. when demand growth is insufficient to propel a sustainable recovery. If the U. S. needs a weaker dollar to sustain its recovery, the rest of the world may need lower interest rates to sustain theirs. However, in Europe last week the ECB voiced further concern about increasing inflation risks in the euro-zone, where prices rose at an annual rate of 2.2 % in April, due largely to oil prices which have risen sharply due to renewed violence in the Middle East. Excessive wage demands also threaten price stability.

Although the Japanese yen has strengthened since March, the longer term appears more and more uncertain. The growth of Japan's debt and monetary base point, in our opinion, to possible eventual hyperinflation. Japan runs a fiscal deficit of about 6 % of GDP, and its public debt has climbed from approximately 60 % to 140 % of GDP currently to revive its stagnant economy and to tackle deflation. The Bank of Japan increased its monetary base by over 35 % in April, and it has promised to keep zero interest rates and to flood the market with liquidity until prices rise. Japanese debt has been downgraded. Last week the Japanese government said its diffusion index of economic indicators rose above the boom-or-bust mark for the first time in 15 months while an index of leading indicators came in above 50 for the third straight month. Consumer spending rose unexpectedly in the first quarter. When prices turn up, the bad debt problem might ease, but interest rates could rise, lowering the prices of debt issues and raising the government's interest rate burden. A financial crisis and hyperinflation may not be avoided. Japanese investors have been turning to gold as a hedge.