DYNAMICS OF GOLD HAVE SHIFTED, FLORES SAYS
Spike In Bullion Lease Rate Helps Spark Run Above $400
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By Doug Rogers
Investor's Business Daily
Gold remains the hottest performing sector this year, helped by rising
demand and steady supply, many managers say.
The price of gold for near-term delivery jumped $3.20 yesterday to $406.70
an ounce.
Going into yesterday, gold funds tracked by INVESTOR'S BUSINESS DAILY were
up 14% for the year. The sector has switched places with last year's leader,
technology -- at least for now. (See the lower right corner of the mutual fund
index on page B2).
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An element of the gold stocks' rally has been investors taking profits from
areas they made huge gains in last year, some portfolio managers say.
"That would explain a rise in
gold stock prices. But the fact that bullion prices are rising as well indicates
there is something much more fundamental going on," said James Turk, who advises
the MIDAS FUND.
Midas is up more than 17% this year. Portfolio manager Kjeld Thygesen made
a significant shift into South African mining stocks in recent months after
becoming convinced the metal was poised to break out of a narrow two-year range,
partly based on inflationary pressures. South African mining companies are very
sensitive to gold's price.
Victor Flores, chief investment officer of UNITED SERVICES FUNDS and
portfolio manager of the group's GOLD SHARES FUND, has a hard time building a
case for inflation. Instead, he focuses on recent changes in market dynamics.
Gold Shares, almost exclusively in South African miners, is up more than 19%
this year.
Bullion has been trading in a range of $370 to $395 an ounce for the past
two years. Buyers of physical gold -- such as jewelers -- have been stepping up
purchases, driven partly by growing wealth among Asian consumers. They have
helped push annual demand for gold above the annual output by the world's mines.
But while demand outstripped production, supply also came from other
sources. Central banks with huge reserves and gold producers have been putting a
ceiling on gold. Mines, hoping to lock in a decent price for gold, could sell
forward to get around $400 an ounce whenever gold approached $395. This
effectively put a cap on the price, Flores says.
Meanwhile, central banks would sell into the market whenever the price got
attractively high. Confident that central banks and producers would sell at this
upper range, speculators found they could squeeze out a nice profit by selling
short when the price neared its upper range.
But all that has changed, Flores says. It started when central banks, which
have taken to leasing gold at a nominal rate to bullion traders, decided to
curtail the leasing for a couple of days late last year in order to square their
books.
Bullion traders use the leased gold in the forward contracts they set up
for gold producers.
When the leasing stopped, the gold lease rate shot up to 8% from $1.5 to
2%.
"Suddenly a very cozy arrangement in the market was no longer a sure
thing," Flores said. "People didn't want to borrow gold any more to do the
forward contracts."
Also companies that had obligations tied to the lease rates bought gold
when the lease rate spiked in order to repay their obligations, Flores says.
That caused a squeeze on the market, and spot prices briefly rose above
forward prices, which is rare among precious metals.
And suddenly, producers had little incentive to sell forward. They could
get a better price in the physical market.
The central banks quickly returned to leasing out gold, but it was too late
to close the barn door. "The recent blip with the lease rate tells me the two
components of supply -- the central banks and forward selling -- would also
provide instability," Flores said.
With the ceiling no longer a sure thing, speculators and forward sellers
decide to wait before acting.
The floor price also had been creeping higher last year, Flores says. While
it averaged $370 for the full year the buyers of physical gold were coming in at
$385 by the end of the year.
The lifting of the ceiling has allowed gold to pop above $400, making
mining company CFOs very cautious about selling forward. "If they sell forward
when the price is at $395 to get $410 next year, and the price jumps to $415,
their shareholders will crucify them," Flores said.
The price of gold is now in the hands of speculators, Flores says. He sees
strong support for gold in the $400 to $410 range.
Speculators are now looking at the $420 level, which was reached in 1990
when Iraq invaded Kuwait. "Everyone is looking at that level for the market to
run higher," he said.
An intermediate level to breach is $411, which was reached in August 1993
amid the European monetary crisis.
