May 21, 2001 – I have received many interesting questions from readers about my article Behind Closed Doors, the apparent swap of Gold from West Point with the Bundesbank, and other matters. I’d like to share with you these questions, and my answers.
Q. Do you believe that the GATA summit was successful?
A. Yes, without any doubt. I was privileged to speak at the GATA Summit in Durban, South Africa on May 10th, so I saw first hand the publicity it garnered. The hard evidence that I have presented in these letters that government actions are depressing the gold price is starting to be widely recognized. As we have seen in the past with attempts by governments to manipulate the value of national currencies, the free-market is bigger than all of the governments put together. This reality will soon become apparent in the gold market as the price of gold returns to a more normal level, which as I have discussed in these letters, is something around $500 per ounce. If you are not familiar with GATA or their aim to disclose that government actions are depressing the gold price, then I encourage you to visit their site,by clicking here.
Q. What are the chances the government and the big banks will indeed break the gold industry with low gold prices?
A. In “Behind Closed Doors” I made the point that the free-market gives gold its value, not governments. So it is impossible for governments to destroy the gold mining industry by trying to lower the Gold price or by keeping the Gold price artificially low. There is no doubt that the industry is hurting, but in reality, it was also hurting just as badly in the late 1960’s when the Gold price was also being suppressed at the artificially low price of $35 per ounce. Governments could destroy the gold mining industry, but it would have to be done in a different way than by trying to lower the Gold price. They would have to confiscate the mines, but that approach would have to be a worldwide effort, which is unlikely and in any case, would probably be impossible to implement/achieve anyway.
Q. Back in 1993 the Clinton/Gore/Babbitt team had tried to shut down gold mines with costly claim fees, impossibly strict regulations, and several attempts to subvert the 1872 Mining Law. None of these attempts were effective, so did they pursue a policy of depressing the gold price in order to “starve” gold miners into submission?
A. I had actually forgotten about what Commerce Secretary Babbitt tried to do to Barrick and others in Nevada back then, but your point is well taken. It could be another motivating factor of the anti-gold Clinton team I had not previously considered.
Q. At maturity, will the gold at West Point be shipped to Germany or will the Treasury be forced to buy gold with Dollars to unwind the swap? Will Germany extend the term?
A. These swaps no doubt have a maturity date, but they will probably just be rolled over. But if Germany doesn’t extend the term and the US defaults, Germany could start shipping the gold out of West Point back to Germany – assuming the US government lets them. Germany may own the Gold in West Point, but sometimes possession is 9/10ths of the law.
Q. Will the huge short position in the gold market lead to a delivery default in the near horizon?
A. I don’t see how this short position can be unwound in an orderly fashion. I only see two alternatives. First, the price rises setting off a lot of defaults among the bullion banks and probably the big hedgers as well. Two, the central banks acknowledge that their gold deposits at the bullion banks will not be repaid, so they willingly allow those gold deposits to be turned into dollar deposits – the only question is what Dollar/Gold rate. My guess is that the central banks will try the second alternative, but there will be such a big outcry, their citizens won’t let them do it. There should be some interesting times ahead.
Q. I have been told that the gold in Fort Knox was given to the Federal Reserve Bank and is not in the US Treasury’s accounts. Is this true?
A. The US Gold Reserve is doubled counted – both the Federal Reserve and the Treasury claim ownership of it. The Treasury stores the physical metal, but it has issued Gold Certificates to the Fed. These Gold Certificates mean that the Treasury owes the gold to the Fed, but neither of them are testing this relationship by defining who really CONTROLS the gold, which is the important issue. Right now they both pretend to own it, but who really controls it is much harder to decipher, and I don’t have the answer to that question.
Q. What would be the repercussion of finding out there is no gold in Fort Knox? Would the nation be in upheaval? Would it affect money or inflation at all?
A. No one knows the answer to your questions because it is impossible to predict the future. However, I would be very surprised if there wasn’t some serious monetary upheaval if the gold in Fort Knox is being dishoarded, or for that matter, if any of the US Gold Reserve has been dissipated. Today’s situation is very similar to the late 1960’s, early 1970’s, except that back then the intervention in the gold market was very transparent. Today there are interventions. Some are transparent (e.g., the Bank of England dishoarding), but some are not (e.g., gold being loaned by central banks to borrowers who then sell that gold in the market). Everyone knew that some 300 million ounces of gold from Fort Knox were being dishoarded in the 1960’s. When Nixon finally threw in the towel on August 15, 1971, we began a decade of monetary turmoil. When governments throw in the towel this time, I expect new monetary turmoil as well, but with one difference. Last time the US Dollar survived. Because history shows that all fiat currency eventually is destroyed and ceases to circulate, readers of these letters know my basic view that the Dollar at some future date (which we cannot predict) will cease circulating as currency. A rising Gold price will hasten the Dollar’s demise.
Q. Are the economic and financial problems in Argentina serious?
A. It’s amazing how these problems (like Argentina) that were supposedly solved just keep re-appearing. Indonesia/Mexico are more good examples. These problems just keep re-appearing if you wait long enough. Yes, the Argentina problems are severe, and it could have a knock-on effect throughout the second-tier credits. If it does, it could lead to a banking crisis because of the banks’ exposure to these bad debts.
Q. I have invested a large portion of my hard earned savings in the gold mining sector for about 16 years now, using a buy and hold approach with several precious metal mutual funds and individual stocks more recently. I am wondering, will gold ever be allowed to recover and should I stay the course?
A. I would stay the course. Gold is undervalued, and I do expect this value to be unlocked. No one of course can predict when the next bull move in gold will begin, but see my comments on Page 3 about the possibility that a new bull market has indeed begun. So all I’m saying is that I would advise being patient awhile longer.
Q. When the gold price begins rising, I expect that the stocks of the marginal mining companies, those that are losing money or barely making a profit at current prices, will do better than others. Do you agree?
A. Yes I do, and you have raised a good point. The marginal mining companies are indeed leveraged to the gold price, meaning the percentage increase in earnings for these companies will be more significant than for those companies still making a profit. But there is a more important issue to consider when choosing a mining company stock – its hedge position and policy. A full-hedged position can completely eliminate a mine’s leverage to the Gold price. For this reason, I have been advising in these letters to focus on the mining companies with little or no forward sales, i.e., companies that use little or no hedging (see most recently my recommendations in Letter No. 283).
Q. Are there any gold mutual funds that you recommend?
A. I don’t follow all of the individual mutual funds that closely, so I don’t have names to recommend. But the objective is to choose good stocks with leverage to the gold price, whether you own these stocks individually or through a mutual fund. I would therefore avoid those funds heavily invested in the companies that hedge and instead focus on funds that have most of their assets in companies with little or no hedging, like the companies I have been recommending. Therefore, review the portfolios of the different funds to see which ones have a heavy investment in companies with big-hedged positions. Telephone the customer support of the various gold funds to see if the fund has a policy about investing in mining companies that are hedged.
Q. Did Centaur Mining in Australia declare bankruptcy because of its hedge position? What about the other hedgers? What will a rising gold price do to their hedge books and the price of their shares?
A. I understand that their hedge book, which went well underwater, killed Centaur. The problem for the Aussies and their hedges is that they lost money as the Australian Dollar declined, causing the Gold price to rise in A$ terms. The recent rise in the Dollar price of Gold will only put more pressure on these companies. They should cover these hedges now to close them out completely. But because their hedge books are under water in most cases, they do not have the cash needed to buy back these hedges. Therefore, the plight of the Australian mines should worsen, and I would avoid all of the mines there except Normandy, which is one of my recommended mining stocks.
Q. What is the significance of the recent drawdown in Comex stocks?
A. Comex stocks have fallen to 832,027 ounces, nearly one-half the level from only a few months ago. I’ve been following these numbers closely because I do believe this drawdown is significant for the gold price – read that to mean bullish. You may recall that there was a big drawdown in Comex stocks in July-August 1999 before the big rally that begin after the September 21, 1999 Bank of England sale. As readers know, I think $380 is a realistic target for this year, and this Comex activity just re-confirms my expectations for higher gold prices. Now that we have taken out $272, I believe that a big rally has begun.
Q. I hear that the gold flowing out of the Comex stocks is going to London. Any reason why?
A. The gold is going to London because that is where the shortage of metal is. The bullion banks are starved for liquidity, which explains why gold interest rates have remained so high for such an usually long time. So the bullion banks are trying to get their hands on whatever metal they can. I do not think that the metal is going to London for any US-specific reasons (like a closing of the gold markets here).
Q. Can you explain relative strength in the gold mining stocks over the past few months?
A. No indicator is infallible, but I consider activity like this to be reliable because my experience has proven to me that relative strength in the mining stocks is a sign that the smart money is accumulating these stocks. In a bull market, the percentage gains in the mining stocks as the gold price rises will be higher than the percentage gains in bullion itself. This reality attracts smart money to the stocks, and because the stocks are less liquid than bullion itself, this accumulation by smart money becomes readily apparent – the stocks outperform the price of bullion, just as we have seen.
Q. How does one buy gold bullion?
A. I could take days to answer this question, there are so many different alternatives. My rule of thumb though is to buy the largest bars/coins possible, given the amount of money that you want to exchange for gold. The reason is that with the larger bars you get more metal for your money (i.e., the fabrication costs are smaller as a percentage of value on a larger bar). One of the cheapest ways to buy gold is to take delivery of a Comex spot contract, but you have to come up with around $28,700 at current gold prices. If you want an inexpensive way to purchase a small amount of metal, then check the Cambios listed on GoldMoney, my Internet venture.