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Harry Koza

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Yellow brick crossroads

Harry Koza

TORONTO (GlobeinvestorGOLD)—I love gold (or as they say in the gold camps of northwestern Quebec, "J'adore l'or"). It is really the most marvelous metal. It's the most ductile of all metals, capable of being drawn into wires finer than frog's hair. It is singularly malleable, and can be hammered into sheets so thin they're translucent. It is impervious to rust or corrosion, and immune to most acids. It is among the best conductors of electricity. It is a truly rare element; the amount of gold in the earth's crust being only two parts per billion. It has been a medium of exchange and a recognized store of value since the dawn of civilization.

And, perhaps most importantly, gold has the power to cloud men's minds. Oh, the northern lights have seen queer sights, indeed, among the men who moil for gold, as the poet Robert W. Service might have said.

For a mining promoter or a geologist, there's no easier way to convince a skeptical investor than to show him how to pan a handful of fines, swirling it around to reveal that siren smile of gold dust at the bottom of the pan. Suddenly the punter's eyes are afire with the flame that launched hundreds of gold rushes, and many an armada, too.

Anyway, before I get swept away on that tide, too, let me tell you, I'm trying to keep this whole gold bull market in perspective. It's been a long time since anyone has been so excited about gold. I remember walking through the main banking hall of one of the big banks on Bay Street back in 1980. There were hundreds of people lined up at the counter: I'd never seen the place so busy. What's this, I thought, a run on the bank? So I asked a security guard what was happening. He told me that all these people were lined up to buy gold. I found it a little odd that so many people wanted to buy gold when it was trading at its all-time high, when so few of them had been interested only a few years earlier when it could have been had for $65 (all prices in U.S. dollars) an ounce. I immediately went and sold all my gold. Of course, it wasn't that long before the golden balloon burst.

Through the rest of the 1980s and into the 1990s, gold languished, while every gold analyst at every dealer I ever worked for, year in and year out, predicted that gold prices would average $450 an once next year. We used to call them Godot Analysts, since they were always waiting for something that never came.

But gold is back. Geopolitical tensions, a weakening U.S. greenback, the debt bomb, stocks already trashed—and still expensive—gee, maybe it's time for a little of that old-time hard currency in the old portfolio. Why, unless I was hallucinating at the time, I was sure I even heard Federal Reserve Chairman Alan Greenspan waxing somewhat wistfully on the subject of gold-backed currencies the other day. Ok, sure, maybe he was having an irrationally exuberant moment—gold can do that to a person.

Gold has been enjoying a nice upward run, and the gold bugs have all, and I mean all, come out of their bunkers. Maybe some of them were running out of freeze-dried food, but many of them had seen the signs in the charts, and the golden goose was on the loose.

Hard-core skeptic and market semiotician that I am, I looked at the charts, too. The omens were indeed propitious, and I didn't need to scry too deeply. So in a Dec. 16 column for GlobeinvestorGOLD.com, I suggested that buying long-dated options on gold might be an interesting way to go along for the ride, for example by buying a Dec 2004 $340 call option. At the time, that option would have cost $28, or $2,800, one contract representing 100 ounces. On Monday, that option closed at $49.90. Of course, if I had had the presence of mind—or the tolerance for risk—to have actually followed my own advice, I would have sold the thing there and then for a quick profit of $2,190 (less brokerage). But I didn't.

Not to worry, though, I thought. Let's have another look at the charts and portents. The price chart has made an important technical pattern, having gone steeply up and to the right. Extrapolating that trend line with a handy ruler, why, the price goes to infinity, and beyond—it's a Buzz Lightyear Formation! (Skip chart.)

Seriously, though, gold is looking like it might take a little pause for consolidation here. For one thing, every time gold reaches an important psychological level—and let's face it, when you're dealing with the naked lust for the yellow metal, you're dealing with psychology—some sweaty-palmed central banker is going to be tempted to dump a hundred tons of reserves onto the market, which tends to flatten the chart out for a while. And producers will be tempted to hedge again. Then too, while the Iraq situation has been helping gold, if the Americans actually carry out a military-powered regime change in Iraq, some of the current attraction of gold as a ''strategic'' hedge against Armageddon will fade, and more importantly, the U.S. dollar will rise and gold will fall.

I attached even more semiotic significance to an item I noticed in recent days about how some 90 per cent of the loons in the online stock-touting chatrooms are bullish on gold. To paraphrase an old Bay Street axiom, when the wind blows, the turkeys get their feathers ruffled. When everybody is jumping on the bandwagon, it's time to get off it, I reckon.

Pick your price

But then, I'm a bond guy now—bland is good and boring is better. Maybe gold will get back to its old highs, but I doubt it. There are plenty of optimistic forecasts about. How high do you want it to go? $400? $500? $800? $1,500? There's a gold bug out there with a chart that predicts it. One of them could well be right.

I remember the Aden Sisters, the gold analysts who worked from Costa Rica, so that their prognostications would not be affected by any perturbations in the Force caused by undue proximity to actual markets. At the height of their fame, at the height of the last gold boom, they were predicting gold would reach $2,500 an ounce. Punters were literally lined up to hear their pitch—they were bigger on tour than the Grateful Dead, at least until the party ended abruptly.

Not to be outdone, even old-line investment banks began publishing research reports linking the price of gold to increased sunspot activity, predicting that as we were headed into a sunspot maximum, the price of gold was going to even loftier levels than the Aden Sisters had predicted. (I'm not making this up, and I won't name the firm that wrote it, but I still have a copy).

If you insist

We haven't reached that stage of mania yet, but I get a sense that investors really want to believe in gold again. Like gamblers in Las Vegas, all that glitter has them convinced that this time it will be different, that chasing gold prices up the chart won't end in tears like putting their nest egg into StupidIdea.com shares did. Whatever.

Take a flutter if you must. Just don't bet the mortgage money.

So, bottom line, much as I love the yellow metal, bullion is a speculation, not an investment. It pays no interest or dividend, and costs money to store. It's more useful as a hedge than as an outright investment. And while it's had a great run recently, having risen $58 since Dec. 1, I think it's going to go sideways for a while here. Speculate if you must, but consider waiting for a pullback to establish any new longs. With the low cost of carry on long-dated gold options (about 1.2 per cent), I still like them as a vehicle for a small portion of your portfolio. If you must have gold, whether as an inflation hedge or an outright speculation, options may still be the way to go.

The current new fervour about gold reminded me of the late Otto Eckstein, formerly on the President's Council of Economic Advisors (1964/66), and the man who introduced the concept of ''core'' inflation. Back in the early 1970s, at an annual Institutional Investor Conference in New York, the crowd gasped when one of the panelists predicted a gold price of $100/ounce.

Someone asked Mr. Eckstein what he thought about the future direction of gold prices, and he leaned forward to the microphone and replied "I don't know and I don't care. I'm not a dentist."

Harry Koza is Senior Analyst in Canadian markets for Thomson Financial/IFR. At various times in his career, Mr. Koza has been a prospector, metallurgist, project manager, engineer, as well as an institutional bond salesman for 15 years. His current area of expertise is in high-yield distressed securities and corporate bonds in general.

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