Bundesbank''s board is said to oppose Welteke on gold sales

From Investor's Digest of Canada
January 2, 2004

By John Embry

Gold's fundamentals may be even better than they were
at the outset of the 1970s, a decade that saw a 20-fold
increase in the price

The gold picture in a word: explosive

I had the opportunity recently to meet the renowned
Ferdinand Lips, the former Swiss banker who wrote a
seminal book on the management of the gold price
entitled quot;Gold Wars.quot;

This brilliant work caused me to reflect on the lengths
to which the financial establishment is prepared to go
to discredit gold and champion paper money, which
they are systematically debasing.

There is no better example than what is now going on
as gold struggles to break away from the
US$400-per-ounce area. With the fundamentals looking
superb and the technical position shaping up even better,
any free market would be exploding to the upside.

However, whenever gold begins to surge, the usual
suspects -- Morgan Chase, Goldman Sachs, Morgan
Stanley et al. -- show up on the floor of the Comex and
sell until the upward momentum has been reversed.
They did it aggressively prior to the December options
expiry to keep gold under US$400 so the December
$400 call options would expire worthless. And then,
when gold moved through US$400 subsequently, they
sold aggressively again to prevent the price from
accelerating upward.

Certainly, one of the primary reasons for this behavior
is the existence of an enormous short position, which is
going further and further off-side. The entities that are
short gold are feeling the pain, and it is requiring an
immense amount of capital to sustain their positions.
So just who are those entities that are on the wrong
side of the market?

To begin with, the so-called commercials, the
aforementioned bullion banks that have capped the
market, no doubt with the acquiescence and
assistance of their central bank associates, are the
principal culprits. They increased their shorts by
23,000 contracts in the successful effort to hold
gold under US$400 prior to the December options
expiry. That's not chicken feed as it represents 2.3
million ounces, worth more than US$900 million.
They are now hugely off-side on a substantial short
position.

Secondly, we have the remnants of the carry trade,
all the quot;smart guysquot; who thought they couldn't lose
by borrowing gold from the central banks through
their bullion-bank friends, selling it in the spot market,
and reinvesting the proceeds in a financial instrument
to secure a large spread.

For the longest time they were right because gold
always went down, and when they had to repurchase
the gold to collapse the trade, they did so at a lower
price and made even more money. However, these
transactions were done in such size that, when the
gold market turned, they couldn't get off them and
were trapped.

The next group is the gold-mining companies that
hedged aggressively and didn't implement risk-control
programs as the price began to rise. The poster boy
for this category is Barrick Gold, which is short roughly
16 million ounces, or three years of production. After
bragging for years about how much money it made
with its premium hedging program, Barrick now stands
to lose far more than it ever made if the gold price
continues to rise. Barrick may have finally come to
its senses, as both the chairman, Peter Munk, and
the CEO, Greg Wilkins, have now renounced hedging.

Lastly, there are the gold-derivative dealers, led once
again by Morgan Chase, which has a ridiculously high
gold-derivative exposure, particularly when viewed in
the overall context of the physical gold market.

The one thing that has become abundantly clear is that
this is the largest short position that has ever existed in
gold, and when measured in terms of annual production
levels, it might best be described as ludicrous.

When one realizes that, without even considering the
short position, the current gold market fundamentals
may be even better than they were at the outset of the
'70s, a decade that saw a 20-fold increase in the price,
one can garner some insight into the potential for the
yellow metal.

With the short position this time, the gold picture is, in
a word, explosive, and to quote my friend Bill Murphy,
the head of Gold Anti-Trust Action Committee:

quot;You gotta be in it to win it.quot;

An emerging parallel with the '70s is the energy situation.
The dramatic inflation in energy prices in that era was one
of the contributing factors to gold's enormous price rise.

Today conventional wisdom seems to think that energy
prices are ahead of themselves. I beg to differ. Three
factors in particular will have a major impact in driving
the price higher.

The industrialization of China and India, the two most
highly populated countries on the planet, and the
astounding growth in car ownership in China and other
places in the Far East ensure a stronger demand
picture, almost irrespective of what happens in the
West.

At the same time, the endemic weakness of the U.S.
dollar in which oil is denominated will be a very
positive influence on oil prices. The Saudis are already
complaining and talking about denominating their oil
sales in euros.

Lastly, Saudi Arabia will remain the swing producer
for the foreseeable future, and the country is anything
but stable. The rising influence of the Islamic
fundamentalist movement could destabilize the country
at any moment. If this were to happen, oil prices could
double overnight.

Unless there is a deep world recession, the oil price is
heading higher along with most other commodities,
and that will be very gold-friendly.

With respect to gold stocks, I have been enamored with
China since I went there in March, and some very
interesting Chinese gold vehicles are now emerging in
the Canadian market.

Everyone is probably familiar with the remarkable success
of Southwestern Resources, whose Boka project in
Yunnan province is shaping up as a potential monster
deposit.

However, there are a number of other companies that
deserve consideration, including Mundoro Mining Inc.,
Minco Mining and Metals Corp., and Afcan Mining
Corp.

There have been numerous locally operated small gold
mines in China, but they tend to be hand-to-mouth
operations that have not had the benefit of either modern
mining or exploration expertise.

The Chinese, in need of both capital and said expertise,
have opened the country up to foreigners, and
Southwestern is just the first of what I expect to be a
number of successful ventures.

The geological potential is truly exciting, and if you have
the right Chinese partners and solid connections in the
country, the prospects for success are good. Those who
worry about the political risk in the country should be
considerably more concerned about places like Eritrea
and Russia. With China now in the World Trade
Organization and hosting the summer Olympics in 2008
and a World's Fair in 2010, it is unlikely to do anything
unfriendly to foreign capital.

* * *

John Embry is president of Sprott Asset Management and
manages the Sprott Gold and Precious Minerals Fund.

----------------------------------------------------

Reproduced by permission of Investor's Digest of Canada
133 Richmond St. W., Toronto, Ontario M5H 3M8.

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