Morgan Chase gold derivative department loses control, threatens banking house


By Thom Calandra
May 7, 2002

SAN FRANCISCO (CBS.MW) -- Where is the QQQ
for gold?

Mining executives are probing demand for an
electronic proxy for gold, in theory similar
to the so-called Nasdaq 100 cubes (QQQ). With
gold-mining shares at three-year highs in
North America and other markets around the
world, individual interest in the metal is

Small-lot traders on New York's Comex, the
futures exchange, are net long more than 100
tonnes of gold for just the fifth time ever,
says precious-metals analyst Andy Smith at
Mitsui and Co. in London. Demand for gold in
Japan, where bank depositors are losing some
of their government insurance on cash
holdings, is soaring. The deflated nation's
gold imports have risen more than 600 percent
from a year ago.

Another dramatic sign of gold's lure for
ordinary investors comes in the form of a
$110 million closed-end fund that holds gold
and silver bars in Canadian vaults. Traded in
Toronto and on New York's Amex, the security,
Central Fund of Canada Ltd. (CEF), has, in
two days, risen to a 23 percent premium to
the net asset value of its holdings. The
average premium for the fund, until gold
prices surpassed $312 an ounce last week, was
more like 6 percent.

"This is the only way to achieve a cash
equivalent for gold in clients' accounts,
quickly," says Eric S. Sprott of Sprott Asset
Management in Toronto. Sprott, one of
Canada's most active gold-fund managers, owns
about $20 million worth of Central Fund
shares on behalf of clients and participated
in a private placement of the fund's shares
in early April.

Trading in Central Fund had averaged about
20,000 shares a day before 1.4 million shares
exchanged hands Monday. The closed-end fund's
23 percent premium is near or at an all-time

Chief Executive Stefan Spicer said he was
taken by surprise by the ferocity of the move
into the 19-year-old Central Fund, which he
says is the only investment vehicle backed by
physical gold and silver in the world. The
fund holds 163,000 ounces of gold, 8.1
million ounces of silver, and about $2
million of cash.

"Right now, there is a lack of a way to buy
gold bullion," Spicer says, speaking from his
office in Ontario. "Investors seem to want
fast access to the metal in their accounts."
Spicer says that in an extended gold rally,
or a panicked rush to gold, he could envision
the premium to own the metal rising sharply.

To be sure, there are other ways to own gold
without schlepping off to buy gold bars or
coins, then carting, insuring, and storing
the bullion. One or two countries have gold-
backed bank deposits, says Mitsui's Smith.

Plus, there are so-called gold tracers in
Germany and other markets, such as
Luxembourg. These derivative devices are
similar to warrants that track a commodity
but settle in cash on certain, usually
quarterly, dates. Mostly, they are for large
investors who use the tracers to represent
gold in institutional portfolios, without
having to locate and store the metal.

In Germany, so-called Zertifikate are
derivative products of the large banks --
Deutsche Banc, UBS, Commerzbank. The
certificates trade much like securities.
Still, they are not backed by a physical
asset -- in this case, gold. "Most people buy
the tracers directly over the quote systems
of Deutsche, UBS, etc., with their German
discount brokers, who are often connected to
the quote systems of the major banks," says
Josef Reinthaler, a money manager in Germany.

Via the Internet, the
( site offers
depositors electronic accounts and a secure
payment system based on physical grams of
gold deposited in an actual vault. The
attraction, says Gold Money founder James
Turk, is the avoidance of the baggage that
comes with owning bulky gold bars and coins.

"It is easy for individuals to buy and store
coins, but efficiently is another matter,"
says Turk, who's based in New Hampshire.
"Though they worked well in the 19th century,
coins are not efficient by modern-day
standards. Fabrication and shipping costs can
be expensive. Secure storage can be
expensive, too. Safe-deposit boxes are not

Buyers of gold coins such as the U.S. Mint's
American Eagle or Canada's Maple Leaf also
pay sales tax in some states, and they face
wide bid-and-ask spreads plus sales

The World Gold Council, a trade group for the
metal, is fashioning a $200 million
advertising campaign that will try to add to
gold's lure as an investment. Gold jewelry,
design, and fabrication account for about 80
to 85 percent of the metal's demand, with the
rest coming from investment.

The Gold Council this year is led by Gold
Fields' chairman and outgoing chief executive
Chris Thompson, who has pushed for easier
ways to buy actual gold. The Sunday Times in
Johannesburg just reported the Gold Council
hopes to unveil a "securitised bullion
instrument, tradeable through the regular
channels, which will make it possible for
investors to buy and hold physical gold."

Gold Fields, South Africa's second-largest
producer, will list on the New York Stock
Exchange this week. South Africa, one of the
world's five largest gold-producing nations,
prohibits the ownership of gold as an

All the U.S. stock market's current exchange-
traded funds are based on underlying indexes,
such as the QQQ's Nasdaq 100 Index. Asset
managers, if they can gain approvals from the
U.S. Securities and Exchange Commission,
would like to offer actively managed
exchange-traded funds that trade as a real-
time security and are subject to a money
manager's many daily decisions.

Smith, the Mitsui analyst in London, says it
might not be long before the world's big
banks jump on the gold-instrument bandwagon.
"Any bank worth its salt will design any
investor who asks -- and often those who
don't ask -- any goldlike instrument they
wish," Smith said Tuesday. "If the gold is
allocated, this involves dollar-for-dollar
accumulation of physical gold."

Such a vehicle could boost physical demand
for gold, unlike the speculative trading of
gold for future delivery in futures-trading
pits. In this country, mutual funds must
obtain approvals to own actual gold in their
portfolios. The process is a lengthy one, and
few mutual funds own bullion.

Thompson, the Gold Fields executive who is
headed to New York for his company's NYSE
listing, is quoted on news service The
Bullion Desk (
with some of the potential specifics of a
possible exchange-traded fund for gold. "Most
portfolios, equity managers' portfolios, are,
by mandate, not allowed to own gold,"
Thompson said in the interview. See:


"Most of the mandates around the world
dictate you can own equities, bonds,
tradeable instruments, but physical bullion
you can't own -- so that a huge part of the
investment universe is actually denied the
opportunity to do so. We need to make it
possible for them to own gold."

John C. Doody, editor of Gold Stock Analyst
newsletter, says time will tell whether
individuals are interested in an asset-backed
gold security. Doody, whose top 10 gold-
company stocks are up a combined 80 percent
since Jan. 2, says there probably is a lack
of interest in such a security, even amid the
gold rally that has lifted mining equities an
average of 55 percent this year.

"The market capitalization of the 45 stocks
we cover is $57 billion. Where's the
industry's rank among the S&P 500 stocks?" he
asks. "Way down the list."

Gold mining shares, as measured by the AMEX
Gold Bugs Index (HUI), were up 1.7 percent at
midday Tuesday. Spot gold's price was up 80
cents to $312 an ounce.