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THE HIGHTOWER REPORT
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(November 12, 1997) METALS: GOLD–The gold bulls continue to use a number of old relationships as reason to buy gold. While they may be right that gold is now historically cheap the holding period and a changing world economic environment make historical comparisons less effective. For instance, free world trade, the International Monetary Fund, the G7 and the EU all serve as stop gap protectors or early warning indicators of conditions that historically have provided gold strength. Also the explosion of financial instruments capable of hedging inflation or providing instant rotation away from negative exposures is an even bigger problem. In the current mode, gold stands above almost all cost of production estimates we have seen. While gold does have solid physical demand and is probably in the process of slowing some mining operations in the year ahead the amount of investment demand more than offsets physical demand in our opinion. Therefore, to assume the downside price progression is over without having prices fall further is premature in our assessment. While stories about reduced output potential have surfaced the real shutdown hasn't been affected yet. In the short run the mere threat of more Central Bank gold sales psychologically gives the appearance of supply. Statistics from the IMF show country holdings of gold have declined from 918-million ounces in 1994 to 897.3-million ounces in mid 1997 with the main point being that a huge sector of gold is available for consumption on the physical side if the central banks and other entities become convinced that gold is not a store of value. The Swiss National Bank actually used the reason that gold was no longer a good long- term investment as reason for the liquidation! Whether or not these institutions are correct in their assessments is irrelevant in the near term as the price factors in the judgement. Therefore, without significant unforeseen financial developments golds eventual bottom might be somewhere below current prices and above the general cost of production estimates of $290 an ounce. Even if gold prices drop sharply other than short covering reactions prices might not instantly repel from those levels. As has been the case for a couple years the attitudes of the commercial gold hedgers will be key in making a bottom in gold and at the current time we would think there remains enough bearish concensus to keep hedging mentality in place. You can buy gold because its cheap but you might want to see what has happened to orange juice prices in their “cheap” state! Look for an exhaustion sell off in gold, a flurry of central bank sales or a slow erosion in price to near cost of production before entertaining the long side of gold. Market sensitivity over the last six months highlights a focus on demand and not on anxiety or inflation. If a sensitivity to financial uncertainty or inflationary stories were to return that might make us more comfortable entering gold on the long side moderately above the cost of production.
SUGGESTED TRADING STRATEGIES–1.) Aggressive traders only: Sell December gold at 323 with an objective of 309. Risk the trade to a close above 331. 2.) Buy April gold at 309 with an objective of 328. Risk the trade to a close below 299.
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