Bullion Settles Into An Uneasy Equilibrium

Sydney Morning Herald

Monday October 25, 1999

By JANE COUNSEL and BRIAN HALE

Gold's price slide of more than 10 per cent during the past two weeks has taken pressure off hedge funds and other short sellers to cover their positions, boosting doubts that the precious metal will see further quick gains.

Few expect the gold price to give up too much more of its recent gains, but a further decline to just below $US300 an ounce may be in store as the price stabilises after the recent surge.

The European Central Bank's September 26 move to cap gold sales to 2,000 tonnes over the next five years and limit gold lending pulled gold well clear of recent trading levels of about $US255 an ounce, but at the same time, a slowdown in short covering has seen gold pull back from recent highs.

Falling gold lending rates, along with moves by Kuwait last week to lend 79 tonnes of gold through the ECB, have dampened recent investor enthusiasm that gold would extend its recent gains.

Kuwait's move reminded investors there are many gold investors outside of the ECB that may move to take advantage of recent price gains. As a result, Comex's gold contract for December delivery fell 4.1 per cent last week, the largest decline in two years, closing Friday at $US303.30 an ounce on the New York Mercantile Exchange, down another $2.20 an ounce on the day.

Falling lease rates for borrowing gold, which have dropped back from highs of 9.9 percentage points reached when speculators scrambled to cover their short positions after the ECB announcement, indicate there is now more gold available in the market.

Hedge funds had borrowed gold from banks at low lease rates of under 2 per cent then sold it, geared up the proceeds and invested in 5 per cent yielding Treasuries in a bet that gold prices would fall, so they could buy back the borrowed gold at lower prices, repay the loans and pocket the difference as well as the yield and capital gain on the bonds.

But the issue remains whether the scaling down of leverages has stabilised gold prices or whether it still is volatile and could move higher again. If so, the moves could accelerate as short sellers of gold are forced to cover their positions.

As the gold price has eased back from recent levels, this has steadily taken pressure off short sellers, removing buying support from gold and leaving the way open for the gold price to ease further.

``Whether they've [hedge funds] covered all their short positions is not clear," said Mr Mark Freemantle, an associate director at Oakvale Capital, an investment analysis group.

Merrill Lynch said: ``It would not be a surprise to see gold surge to higher levels on the back of further short covering and unwinding of hedging." But it added that in the long term it maintained its ``equilibrium" gold price at somewhere between $US325 and $US350 per ounce.

Oakvale's Mr Freemantle, added that although there was still some volatility in the gold market, he expected gold to settle at about $US300 an ounce, with the downside limited to between $US280 and $US290 per ounce.

Mr Dave Meger, the senior metals analyst at Alaron.com, said he still believed gold prices would rise but he was concerned about the near-term slide. ``With the gold market hovering around $US300, traders are fishing for support and the expected support zone lies in the $US295 to $US302 area," he said.

``Lease rates have weakened. Increased lending has pushed lease rates lower, with one-month lease rates around 1.75 per cent, down from 3 per cent at the beginning of last week. Nevertheless, while lease rates have slipped, they are still at relatively high levels, given that under 1 per cent is more typical for one-month gold," said Mr Meger, who also expects the impact of the weaker US dollar and sharemarket to overflow into gold.

Mr Caesar Bryan, the portfolio manager for the Gabelli Gold Fund, is also a believer. ``There have been a lot of other price spikes for gold but this one is different," said Mr Bryan who also predicts gold will not give up all of its recent gains.

Gold companies hedge their gold production by locking it into a future price before it is mined. Hedging can help companies stabilise profits and get a return on their investment by guaranteeing a steady income.

But hedging can also backfire on companies if they speculate wrongly in a firming gold price environment.

Ghana-based gold producer Ashanti Goldfields was one company caught out by the recent rally, revealing the firming gold price had resulted in an unrealised hedge book loss of $450 million. How it manages this loss is in turn affecting gold price prospects.

On Friday, as the gold price dipped to about $US303 an ounce, Ashanti won a third margin call postponement (until late today) with the fall in gold in the past few weeks reducing losses on its hedge book to a more manageable level.

If the gold price holds at about $US305, Ashanti will not face margin calls, since its losses are covered by an existing revolving credit facility and it will not face enforced short covering, thus removing a major source of buying from the market.

Other investors who are still short gold are in a similar position, with the pressure on them to do something diminishing with every dip in the gold price.

It is estimated that Ashanti alone faces margin calls of $US270 million ($415 million) at a $US325 an ounce gold price, increasing to about $US500 million at $US350 an ounce.

Despite the concerns over the near-term outlook for the gold price, Merrill Lynch argues that fundamentals supporting a firming gold price had been improving in the six months before the ECB announcement.

Merrill Lynch said the prolonged period of a low gold price had limited new mine production, cut funding available for new projects, restricted exploration funding and caused many projects to be closed or deferred.

© 1999 Sydney Morning Herald

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