Market Update

September 14, 1999 – There have been several important events in the Gold market in recent days. Do not be misled by the lackluster Gold price, which has remained fairly tame and within a narrow $253-$258 trading range.

I will provide a brief update in this interim report, and I will probably have more to say about some of these points in the newsletter to be emailed this Sunday. Some of these important events include:

1) The potential sale of Gold by the IMF appears to be dead once again. Too much opposition to the sale developed in the US Congress and in other countries, so the IMF backed down. The plan now is to revalue a portion of the IMF’s Gold reserve to a market related price, from the current SDR 35 carrying price (about $46 per ounce). The net result is that no new metal will be coming into the market from the IMF, which is a bullish development for the Gold price.

2) It is appearing more likely with each passing week that the Dollar has topped out. I am watching the Dollar here mainly against the European currencies because I think the Dollar/Yen relationship is about to change from a strong Yen to a weak one. In any case, it seems that every attempt by the Dollar to rally is met with good selling, a sure sign that holders of Dollars are getting nervous. A weak Dollar is bullish for Gold.

3) The Producer Price Index has jumped to a 6% annual rate of increase. Commodity prices continue to move higher. Oil is now well established above $20 per barrel. The grains appear to have bottomed. Base metals are in uptrends. And this week, platinum and palladium have broken out of trading ranges to the upside. Can Silver and Gold be far behind? Usually Silver moves first, and then Gold follows.

4) Short-term Gold interest rates are surging. The interest rate to borrow Gold for one month is 4.3%, up 75 basis points over the last two days. Everyone short Gold who has not locked in a fixed rate (most companies borrow Gold on a floating rate basis, i.e., they renew the rate at which they borrow every three or six months) must no doubt be feeling the pain in their borrowing costs from having to pay these higher rates. As the three or six month notes of more companies come due in the days and weeks ahead, the incentive to cover their short Gold position will increase.

5) One of the market’s leading precious metal bears, Martin Armstrong, has been arrested and charged with securities fraud. It has been rumored for some time that his company, Princeton Economics, has amassed a huge short Gold position. If so, expect a big short covering rally.

All of the above points are interconnected in one way or another, but points #4 and #5 are of greatest interest to me at the moment. It seems likely that the rise in Gold’s interest rate is linked to the troubles of Princeton Economics.

Readers will recall that since June I have been repeatedly making the point that Gold’s interest rates are rising because deposits of Gold are being withdrawn from the market. Central banks, the major source of the Gold that is borrowed by bullion banks and then loaned by them to their clients, have become concerned about counter-party risk. Consequently, rather than take any risk, the central banks are pulling back the Gold that they have heretofore routinely made available.

However, there is no lender of last resort in the bullion market. The Gold loans made by the bullion banks must therefore be funded, or called in (i.e., canceled).

The continued funding of these loans requires the bullion banks to borrow Gold at whatever rate is prevailing. The bullion banks have no option but to keep the loans funded, unless the loans can be called in. Many of these loans, however, cannot be called in because of loan agreements requiring the bullion bank to keep lending as long as certain financial criteria are met by the borrower.

There is another and more important reason some loans cannot be called in – they are hopelessly uncollectible. It has been known that some banks avoid calling in the loan as long as possible, therefore enabling them to postpone the inevitable day of reckoning, which is a bad debt that must be written off. Some of these issues relate to Princeton Economics, which is essentially a hedge fund that reportedly has been making hedge fund type of bets.

The biggest trading and banking relationship of Princeton Economics is with Republic National Bank of New York. It is well known within the bullion community that Republic has been one of the major borrowers of Gold recently, particularly over the last few days as the Martin Armstrong troubles have been building. The important questions then become: (1) Has Republic been lending Gold to Princeton Economics? (2) If so, has this Gold disappeared along with the other assets of Princeton Economics, making the Gold loan uncollectible? (3) Are central banks pulling Gold deposits out of Republic? (4) And if so, is Republic having difficulty in funding its Gold loans to Martin Armstrong?

Republic was set to be taken over by HSBC, the parent of Hong Kong Shanghai Bank, one of the world’s largest. The shareholder vote on that merger has been postponed, pending the outcome of the investigation of Republic’s involvement and probable losses on loans made to Princeton Economics.

To put this matter into perspective, HSBC was to pay $72 per share for Republic, valuing the take-over around $10 billion. Republic closed today at $59, an 18% decline from the take-over price. The market is therefore discounting a $1.8 billion loss on Republic’s involvement with Princeton Economics – so far.

I say “so far” because the total losses at Princeton Economics have not yet been determined. And how big will the losses be if Princeton Economics has a huge short-Gold position and Republic must cover those shorts, which will no doubt drive the Gold price considerably higher, increasing the size of their loss? The market is out-of-whack. Gold interest rates are too high, and the flip side of this coin is that the Gold price is too low. It is possible (maybe even probable) that the Princeton Economics debacle may be the trigger that finally gets the Gold price moving higher.