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PRUDENTIAL SECURITIES, INC.
One New York Plaza, New York, New York
(August 18, 1997) METALS: GOLD “PUT INTO PLAY” AS ALTERNATIVE INVESTMENT–Gold prices initially firmed last week on mounting concerns that an overheating U.S. economy would raise inflation fears and result in higher domestic interest rates. While the stock and bond markets declined sharply in response to the news, gold followed its typical contrary pattern by rallying as a safety asset and/or an alternative investment. The potential for higher inflation was bullish for precious metals. In subsequent sessions, silver followed gold higher, while gold price fluctuations moved nearly tick for tick with stocks and bonds. Gold gave up some of its gains late in the week. after inflation concerns abated (momentarily, we believe) in response to moderate July data for the Producer and Consumer Price Indexes.
Given the rising volatility and uncertainty surrounding the equities markets, investor interest in gold has intensified as hedge funds have expanded their search for alternative investments. Gold company stocks have moved higher, as has the Gold/Silver Index (XAU) at the Philadelphia Stock Exchange. We believe that precious metals have now been “put into play,” regardless of the direction of the financial markets, as market participants are becoming increasingly aware of the precious metal's role in a portfolio.
Australian miners remain at odds with their government for its sale of 167 tonnes of gold from its reserves in the first six months of the year, news that sent prices sharply lower when it was revealed on July 4. Australia is a large gold producer, and had been targeting an output of 356 tonnes this year. However, the recent decline in gold prices to under $320 per ounce makes higher- cost deposits unprofitable. Australia's gold production costs are among the highest in the world, and 26% of gold mines there have cash costs that exceed $318. Amortization, depreciation and other expenses must then be added to obtain total production costs.
The Australian Reserve Bank sold the gold in efforts to prop up the country's faltering currency. This underscores gold's significant role in an investment portfolio: It is a defensive market sector in times of instability and distress. Incidentally, it can also be immensely profitable to own gold on such expectations.
SILVER–Silver resumed its role as a gold follower and thin market conditions caused relatively broader price moves. Funds resumed their buying with the September contract, but kept hitting resistance between $4.53 per ounce and $4.55. Meantime, COMEX silver warehouse stocks continued to decline moderately, lending sporadic, modest support.
We continue to expect silver to outperform gold when the yellow metal stabilizes because silver does not carry the burden of potential producer or central bank selling.
PLATINUM AND PALLADIUM–The end of the strike at South Africa's Impala platinum refinery put pressure on platinum prices. However, as we expected, the downside drift has been moderate so far because supplies of these metals remain tight. Russia has shipped some modest-sized quantities to Japan, but traders report an acute shortage of both metals. That realization may impact favorably on these markets once the prevailing concerns over the stock market and gold prices stabilize somewhat.
PRICE OUTLOOK–We remain constructive on gold and would recommend adding on to long positions at $327, risking $8, with an initial objective of $345. We would buy December silver near the lows of our range of $4.40-$4.80. We remain sidelined in platinum and palladium, anticipating continued broad volatility. Our ranges for these metals are: October platinum, $410-$460 per ounce; and September palladium, $185-$240 per ounce.
COPPER–Copper prices have moved sideways during recent weeks despite pressure stemming from continued increases in London Metal Exchange (LME) and COMEX warehouse stocks, a seasonal lull in demand and uncertainties surrounding Chinese demand. The Chinese situation is two-pronged. One report suggests that China is delivering stocks to LME warehouses and may continue to do so for the balance of the year. Another analysis points to a likely rise in China's purchases of copper from the West once prices reach their perceived low. This latter view indicates that China must continue to import large quantities of copper and copper concentrates to meet that nation's expanding economy.
Supply constraints continue to act as supportive factors. They include:
1. The large OK Tedi copper mine in Papua, New Guinea, has had to stop shipments of its copper concentrates due to drought conditions that have lowered water levels along the Fly River. The river is used to transport copper shipments to smelters and refineries in Japan and Europe that process the concentrates into refined copper. Additionally, the low river levels have hindered getting supplies, including maintenance parts, to the mine.
2. A labor strike continues at Canada's Falconbridge Sudbury nickel-copper complex, which produces 50,000 tons of copper annually. Renewed talks are scheduled this week.
Last week's economic indicators, including the July Producer and Consumer Price Indexes, quelled fears of inflation and hence, abated concerns over higher U.S. interest rates. Because rising interest rates have bearish implications for copper prices. the latest reports could be viewed as constructive.
The supply/demand outlook suggests higher prices in the months ahead as fall demand resurfaces, the U.S. economy remains expansionary and inevitable supply constraints likely resurface. However, we expect copper to trade sideways in the interim, in a range of 96.00 cents per pound to 106.00 cents, basis December. We recommend long positions near the lows of this range, risking 3.00 cents.
Bette Raptopoulos
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