Gold sparkles as demand soars

SOMETHING weird is going on in the bullion markets. The price of gold has jumped US$10 in a week to US$271. Rumours that the central banks were curtailing the amount of gold they were prepared to lend to the market sent one-month gold lease rates soaring to nearly 7 per cent.

Lease rates are what the central banks charge when they lend gold to speculators who sell the precious metal short. Mining companies also sell borrowed gold forward to “hedge” the value of their future production. Both practices automatically hurts the price.

Less than a month ago, gold was languishing just above a 22-year low at $253 an ounce. Now the shorts are beginning to perspire. What started out as a technical squeeze has sprouted legs. A confluence of factors seems to be responsible.

l The Turkish lira was recently incinerated in an economic crisis. Turkey is a major jewellery centre and its traders are big borrowers of gold.

l The meltdown on the Nasdaq exchange is spreading to other areas of the stock market, prompting concern there will be less demand for US dollars.

l With the euro flat, and the yen in tatters, some people are asking what do you buy when you sell greenbacks?

l The Bank of England said last week it would only sell 20 tonnes of gold at its next six auctions starting in May, down from the 25 tonnes sold on the previous 10 occasions.

Gold as an investment went out with flared trousers and the hoola-hoop. The yellow metal has been on a downward death march for decades.

In recent years it has come under increasing pressure from heavy sales by state-owned banks which seem to want to turn their bullion vaults into discos. Our own Reserve Bank was in the vanguard dumping 169 tonnes, or two thirds of Australia’s gold reserves. The Bank of England followed suit with a program to sell 425 tonnes and the other EC banks joined in. They collectively reached a view that paper money offered far superior returns.

The gold lending caper is much harder to grasp. What it effectively means is that almost anyone with a suit and tie and a couple of million dollars has been able to rock up to the national bank in Brussels or the Hague and borrow a leveraged $20 million worth of gold at next to no interest. They then sell the gold forward for cash and pop the proceeds into US Treasuries. Bingo, a year later you have made $800,000 and you buy your mistress a Lamborghini. The cheery hedge funds call this the “gold carry.”

Ever so slowly, it dawned on central banks that what they are doing made about as much sense as putting a live grenade down their trouser legs. Sure, most of them believe gold has had it as a reserve asset, but they still hold over 33,000 tonnes of the stuff and their policies guarantee a fall in the value.

So, in September 1999 European Central Bank boss Wim Duisenberg and the 15 EU banks hastily cobbled together a five-year moratorium on collective sales of over 400 tonnes a year, and promised to cap the amount of gold they would lease. For good measure they issued a communiqué saying gold was not just coal painted yellow but: “remains an important element in global monetary reserves.” The gold price promptly jumped US$55 to US$320 and the market smelled barbecued bear as all those short sellers were turned on the spit.

The last time leasing rates were anywhere near the current sky-high rates was just before that EU bankers meeting. There is speculation they might be planning an encore.

We have seen the gold price shoot out of the starting gates umpteen times before, only to watch it fade on the first bend. Sceptics see no reason why it should be different this time. With gold bouncing, and US interest rates falling, the carry trade does not work. The lease rate is now above the LIBOR and US Treasuries rate. Shorts are being obliged to protect themselves. According to Andy Smith of Mitsui Metals in London, more than 100 tonnes of Comex call options have been bought in recent weeks.

Annual consumption of gold jewellery is running at a record 2,900 tonnes. World production is put at 2,550 tonnes and falling.

Salomon Smith Barney remarked recently there is a “massive deficit” in the market. Some sources have put the shortfall as high as 7,000 tonnes. All that is needed is a spark to ignite a brush fire of short covering.

With the Australian dollar in the basement, the gold price for local producers is a dizzy A$540 an ounce. They stand to make heaps if the bullion bulls are right. Or have they already hedged their advantage away in the time-honoured fashion of Australian miners?

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