Gold Market Update

Gold mining share prices continued to charge ahead last week. The Philadelphia Gold/Silver Stock Index (XAU) at 55.76 last Friday rose 7.1% from the prior Friday. It was up 20.7 % since early this month and up 33.2 % since the November 2000 low. The price of gold increased 3.2 % since early April and is at its approximate November 2000 low. The better performance of the shares reflects investment demand and may indicate a major change in gold's intermediate downtrend, as has happened in the past. Investors may be more concerned about economic and financial risks while the gold market may be influenced by other factors.

The economic news last week renewed fears of cost-push stagflation. The employment cost index rose 1.1 % during the first quarter of 2001, the fastest pace in a year, and increased 4.2 % from a year ago, despite a jump in jobless unemployment insurance claims to their highest point in five years. The first quarter GDP price index showed inflation accelerating from a 1.9 % rate to a one-year high of 3.3 %. Gasoline prices made record highs. The Fed's easier money policy has presumably encouraged money stock (M-2) to grow from an annual 5.5 % rate last year to a 15.1 % rate from mid-February to mid-April this year. The Treasury yield curve steepened with the 30-year bond yield rising to 5.80 % from 5.25 % in March. In Europe, the annual German consumer inflation rate rose to 2.9 % in April from 2.5 % in March.

The big question is whether the Fed's recent easy money policy will work in the foreseeable future. The policy of keeping market interest rates below "neutral interest rates" and encouraging debt to grow faster than income may not stimulate greater aggregate demand. Although consumer spending jumped 3.1 % in the first quarter, 2001, consumer demand may weaken in the foreseeable future. Consumer confidence fell 23 % from September to April, the lowest level since 1996. Total household debt has climbed from $ 3.6 trillion (84% of disposable income) in 1990 to $ 7.2 trillion (103% of disposable income) in 2000. The debt represents a liability to pay in the future for wealth consumed in the past. Debt-servicing costs have grown close to 1986 peak levels. Lower interest rates may reduce some of these costs. However, 3-month Treasury Bill yields have declined from 6 ½ % last November to 3.7 % on April 23rd. Lower short-term interest rates directly reduce household interest income from time and savings deposits, money market funds and credit market instruments. U. S. personal interest income in 2000 was approximately $ 1 trillion. Lower short-term interest rates may turn out to be counter-productive by hurting creditors more than they encourage debtors to go further into debt, thus leading to a period of credit contraction.

The costs of servicing the huge accumulated $ 13.7 trillion business and household debt could pose an acute financial risk as profits, cash flow and consumer real income are squeezed. This cost and the risks in the derivatives market were supportable when the economy was growing at a 5 % rate and there were numerous investment and speculative opportunities. At a 2 % growth rate or less, no one knows what bad debt problems might eventually surface or how long it will take to correct them.

If investors lose confidence in developing macroeconomic conditions and in the dollar, diversification of portfolios into gold (or gold mining shares) could accelerate. If short speculative and mining forward sale positions were covered at the same time, there could be a serious shortage of gold supply. In this environment the price of gold could well resume its very long-term secular up-trend and also experience another bull market as in the 1970s.