Gold Market Update

After starting at $262.80 two weeks ago, gold rallied to the $268 level in reaction to the 50 basis point Fed rate cut on January 31, but has since declined to close at $259.90 on Friday. This is the lowest price since just prior to the September 1999 Washington Agreement, which sparked a $70 spike in the gold price. A couple of other recent developments are reminiscent of the market during the lows in August-September of 1999. Analysts from Bay Street to Wall Street have been downgrading their gold price forecasts and net short positions have reached their highest levels since September of 1999. We reported some short covering associated with the Bank of England auction in our last Gold Update, however, Comex Commitment of Traders reports show that the net short positions have remained at high levels, so the buying that occurred was not captured in the Comex statistics.

One difference with the environment surrounding the 1999 gold lows is that producers were lining up en-masse to hedge their production, as their creditors and bullion banks convinced them that sub-$250 gold was a sure bet. We do not currently anticipate such widespread hedging, however reports from the press would have one believe otherwise. News releases from the annual Indaba conference in Cape Town, South Africa, reported that Anglogold announced that they intend to hedge 50% of production for the next five years. Anglogold is already one of the most heavily hedged gold companies. Based on their year-end reporting, they would have to sell an additional 3.5 million ounces (109 tonnes) to reach this level of hedge coverage. In reality, there has been no change in Anglogold's hedging activity. The company says they were merely restating their long established policy of hedging an amount equal to 50% of the next five years of production over ten years. This was misconstrued by the press and analysts to the detriment of the gold price, as short speculators capitalized on the bearish media comments.

Another item talked about at the Indaba conference was Harmony Gold's announcement that it has completed the purchase of put options on one million ounces of production in order to secure financing for recent mine acquisitions. On February 6th, Bloomberg News released an erroneous report saying that Harmony broke with its long-standing policy against hedging by agreeing to sell this gold forward. A forward sale requires borrowing and immediate sale of the full amount of gold that is under contract, as well as a commitment by the producer to deliver the ounces upon maturity. The truth is, Harmony is engaging in put options, which are non-committal. Puts provide a price floor, while leaving the producer free to take full advantage of rising prices. Unlike a forward contract, only a portion of the nominal ounces in a put option are borrowed and sold when the option is written. The remaining ounces become the delta. As gold prices decline toward the strike price, the bullion bank that wrote the option will sell to hedge its exposure. Conversely, as prices rise the bank buys gold to cover its position. So the delta hedge tends to enhance price movements in both directions. Unfortunately, the press is not always adept in the nuance of gold trading, and in this case the ignorance served to fuel the negative sentiment toward gold last week.

Also weighing on gold was the fallout from the tragic earthquake in the Indian State of Gujarat. Gujarat accounts for around 10% of Indian demand. Amedabad, Gujarat's capital, has become the largest importing hub in India for precious metals, so it will take time for bullion trade routes to shift and for Gujarat to recover from the devastation.

Another development involving Harmony Gold was news that private Japanese corporation Jipangu Inc. is set to subscribe to 8% of the outstanding shares of Harmony. Jipangu has made large investments in a couple of Canadian Junior gold companies in the past, so this is not a new sector for the company. Nonetheless, with revised Japanese GDP figures showing negative 2.4% growth in the third quarter and Yen gold trading near its 12 month highs, perhaps others in Japan would be well advised to seek the protection of a gold investment.