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Dog's Breakfast


Glue Factory?

Gold $435 Silver $6.80 Thursday 30 December, 11pm Sydney

G'day. Hope everyone had a happy and safe break and are getting fired up for what will be a monster 2005, IMO. Just a brief one today to slowly ease us back into the games.

The monotonous selling at $445 finally won out and we spat the dummy for about $10 on the day. Plenty sold and plenty bought above $440, and the physical markets are comfy above $440. So what gives? I dunno, but I don't expect we will be down here for very long, unless a stack of physical gold hits the markets. Russia, China, Japan ... you name it will be happy to see such a situation develop, I believe. This is a "paper gold" move only. Furthermore, I hear there was a gold forward sale transacted in the New York session by South African interests which must have increased the selling pressure during a very illiquid timeframe. Some thoughts on that below.

It will be interesting to see where gold is by the end of January. I suspect the downside is very limited but my timing lately has been a lot like the dog's breakfast - all over the place. Let's see what gives.

Indian premiums suggest all is well in gold physical land at levels above $440. They'll be relieved to get some respite from the recent higher prices. Inventory accumulation is on in earnest. The stock market continues to maintain record or near record levels and the currency strength has offset some of the rise in dollar terms.

Some discussion abounds that gold will be more sought after in many Asian countries following the disastrous waves that clobbered a quarter of the world on Boxing Day. I dunno, but this is not a reason that I want to see gold's price rise. Ever.

Forward sales of gold, or hedging as producers like to refer to it, can have significant effect on the spot market, even though the ounces are not due for delivery for 5 or 10 years. For those with little or no knowledge of what is involved in a hedge or forward sale, I will expand a little. Remember too, that we have a significant supply-demand imbalance from mine production.

A typical forward sale will always increase supply in the short term, altering savagely the supply-demand dynamics of the market. The delta of any transaction is sold into the spot market by the hedger's counterparty, usually a bank. This gold that has been sold into the market must be borrowed , usually from a Central Bank. The dollar proceeds from the gold sale are invested at market interest rates, and the dollar proceeds at maturity (minus gold lease costs), are used to calculate the "forward rate". Sure, there are a billion different structures and strategies incorporating all sorts of wonderful options and barriers and whatnot, but they all come back to the spot price, the interest rate to maturity and the gold lease rate. Simple, really.

Basically it is just a couple of interest rate swaps combined with a spot gold sale, but they can evolve to be oh so much sexier! No matter, it effectively supplies the market with gold, now, rather than over the years that it is extracted from the earth. In a perfect world the gold producer will deliver his gold into the forward contract with the bank, who then repays the Central Bank, whose gold loan is then fully repaid with interest in gold, from the mine production. The producer got a very "cheap" financing for his mine. The bank earned its spreads for credit risks, operational risks and suchlike. The Central Bank got his gold back plus a bunch more ounces in interest. Everybody wins.

This holds as long as the banks use this gold to fund their legitimate hedging deals with gold producers. A concern in some quarters is that banks appear to have dipped into the "gold trough" of cheap funding and used it for other internal funding requirements. It is very cheap funding, no doubt. This gold that has been borrowed, has also been sold into the market, and also needs to be repaid, in GOLD - one day. There is no offsetting mine production for the bank to "return" this borrowed gold, so they're gonna have to buy it in the market. This is an A Grade example of a carry trade and we know how they usually end up.

There are also some interesting discrepancies in many hedge books between the duration of their gold lease arrangements and the ultimate delivery date of the gold sales. By that I mean, that gold is borrowed on say, a rolling 90 day, at-market basis, for example, to fund a 10 year forward sale. People get destroyed in the bond markets playing games like this. There is a very big risk should Central Bankers decide that they aren't real comfy lending gold out for a year at 20 basis points or whatever they give it away for. Most long dated hedges have "floating lease" arrangements so as to enjoy the greater contango afforded by such "funding gaps". What would the result be to both banks and hedgers, if gold interest rates go nuts and no one can borrow gold at any rate, let alone at rates that erode their previously "announced" hedge rates? If lease rates were to rise and stay above the nominal yield to maturity, a producer may have his "locked in" forward rates destroyed by backwardation. Lease rate exposure is a big risk, IMO.

Hedging, for some operations, is a prudent and sensible solution to some financial risks. For others, it just opens up more risk to investors, it's a case by case deal but generally, I just leave hedgers alone, there's much fatter fish to fry. Opinion only and not advice.

Silver copped a few around the chops and has headed back to the solid base of $6.60-6.80. It seems that the 200DMA is a bit of a magnet these days, although I suspect $7.22 to print in the short term. Silver really feels good to me down here and I would be surprised if the old "gut" lets me down over the next couple days. Just thinking out loud and remember that timing is nearly everything these days and mine sucks.

I haven't had much of an in-depth look at the metal equities but see the HUI still sub 220. Still, my first aim is for 244 then new high up near 280. If we see sub 180, I will be doing something rarely seen in Walker St, North Sydney that day. A bet is a bet.

I expect that we will one day be talking about how cheap some of these quality producers could be bought for in Jan 05, given the global macro outlook and current economic reality we all face. Time will tell, I'm sure (and it will be just my luck that we'll trade at 179 first!)

Best guess ranges next 24 hrs -
Gold $432-444
Silver $6.65-7.22

I haven't sold my mare. The price hasn't changed. My desire to sell is increasing, though.

Hopefully I will be through with some randoms a bit later in the day.

Some may be pleased to know that Danihilate, the colt we bred and who was sacked by his trainer BEFORE he had his first race, hit the track for the first time in a race yesterday. He ran a very nice 3rd of 14, pleased the new trainer and has delayed his trip to the glue factory, for the time being. If only he performed as good as he looks! Now that's been heard before, somewhere, I'm sure.

Looks like we may be in for a lower kick-off judging by Europe's response to yesterday's downdraft. I fully expected that we'd be back at 440 by NY open and put out the "general alert" to the team. Hmmm. I guess I'm wrong on that one. My timing sucks again. The $430-32 level is a key support level in my eyes. A breach of $430 may start a mild selling scramble and then it's anyone's guess as to where it stops. I still think that the physical market will determine the price; that any dips in gold, or strength in the dollar, will be short in duration but possibly very deep; that buyers who are looking for dips had better have fast feet 'cause I think that it will be a case of the "quick and the dead"; that maybe this year we will see more attention paid to gold and silver by the general public, although that would take some mainstream reporting of the "real" economic stories not "bull market cheerleading" and political pandering. Speaking of media coverage, gold gets very little, even these days as one of, if not the best performing sectors in the market over the last few years. Maybe next year....

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