Gold Market Update

Gold and gold mining shares have regained their position as an important and accepted asset class and superior safe-haven investment in times of uncertainty and trouble. Weakness of the dollar, mounting tension between India and Pakistan over Kashmir, continued trouble in the Middle East and fears of a new terror attack in the U. S. boosted gold and gold mining shares to new 2 ½ year highs. The price of gold closed at $320.40 an ounce last Friday, up 3% from our last Update and up 15 % from the end of 2001. Although its price is back to its 1999 high, it is well below its 1996 high of $418 an ounce and its 1980 high of $ 850 an ounce. The Philadelphia Gold/Silver Stock Index rose 7% from our last Update and 57 % from the end of 2001. The Financial Times Gold Mines Index climbed 10 % from our last Update and 75% from the end of 2001. The Standard & Poor's 500 Index was down 5.6% from the end of 2001. Gold has outperformed the market averages since the end of 2000.

Rising gold prices have been due to rising investment demand and lower supply. The World Gold Council reported that investment demand rose 36% during the first quarter of this year over the same 2001 quarter. In particular, Japanese investment demand was double the average of the previous two quarters due to fears of banking and economic stability and low interest rates. Elsewhere, the sources of demand were institutional investors, high net-worth individuals and hedge funds. Jewelry demand fell due to the fragile global economy. Gold supply was reduced by mine deliveries into outstanding forward-sold positions.

The probability of a growing investment interest in gold and gold mining shares and a new gold bull market, in our opinion, depends upon an increase in the desire of investors to protect wealth by reducing their risks in owning stocks, bonds and Treasuries. Gold is a primary alternative to these investments. Stocks are vulnerable to earnings disappointments, lower price/earnings ratios, doubts about the strength of the economic recovery and diminished confidence in the integrity of corporate management, auditors and security analysts. Bonds are vulnerable to a steepening of the yield curve. Short-term Treasuries and bank deposits are vulnerable to negative real returns and dollar weakness.

We believe a major threat to the economy and stock market is the risk that continued strong consumer demand may be unsustainable. Household demand has and is being supported by the growth of borrowing stimulated by a very easy monetary policy. Outstanding household debt (largely mortgage) grew from 83% of disposable income ($3.55 trillion) at the end of 1990 to 104% of disposable income ($7.7 trillion) at the end of last year. The aggregate household debt service burden is up from under 12 % of disposable income in the early 1990s to over 14% today, equal to the previous peak in the 1980s. The personal savings ratio has already turned up from its record low of 1% in 2000.

Another major threat is the risk of higher long-term inflation and interest rates. Total outstanding U. S. debt has grown 5.6 fold from $5.3 trillion in 1981 to $29.5 trillion at the end of 2001, compared to a 3.3 fold growth of real GDP from $3.1 trillion to $ 10.2 trillion over the same time. The risk is that the burden of this huge debt may be "inflated away" as in the 1970s rather than "deflated away" as in the 1930s through a serious depression. The world's leading monetary authorities have evidently already adopted the policy of gradually "inflating" the debt away through accepting approximately 2% rates of inflation. The risk is that this rate may be raised as the debt grows.

A third major risk is the possibility of the withdrawal of short-term funds by foreigners from the U. S. and consequent global monetary disorder as happened in Britain in 1931. The U. S. has run large current account deficits since 1990. After rising strongly since 1995, the dollar began to weaken last February.

The probability of these risks becoming real and their eventual consequences are unknown, but we recommend that forward looking investors diversify their portfolios into the gold asset class as a precaution. Gold prices are volatile; so we suggest buying on dips.