Gold call options may sniff competitive devaluations ahead

Even the Sophisticated
Are Attracted
by the Lure of Autumn Gold

By Ambrose Evans-Pritchard 
The Telegraph, London
Monday, September 4, 2006

http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2006/09/04/ccview...

Gold almost always rises in the autumn, sometimes a little, lately by leaps and bounds.

Even when it churned ever-down from a peak of $850 an ounce in 1980 to $255 in March 2001, it usually managed to eke out a meagre counter-rally each September.

The seasonal cycle is anchored in the ancient habits of the Orient, where buying picks up after the Indian monsoon and reaches a climax with the Chinese New Year.

Speculators have noticed this, of course, so it has become self-fulfilling. Hedge funds programme their black boxes with triggers to catch the anticipated rally, giving the seasonal effect ever-more leverage.

Be careful, however. Gold tends to catch a nasty cold in mid-October before resuming its upwards march towards a New Year peak.

Gold took a battering in May, crashing 26 percent from its quarter-century high of $730. It was scary for newcomers but not enough to reverse the five-year bull market. Gold bounced straight off the crucial 200-day moving average watched by chartists and is now forming a base around $620 -- technically undamaged.

Goldcorp's chief Ian Telfer predicts a surge to over $800 an ounce over the next two years, though perhaps he would say that to justify the outlandish premium offered in last week's $8.6 billion bid for rival Glamis.

Yet there are sophisticated investors who seem to agree. UBS has seen growing demand for gold "call options" dated December 2006 at strike prices of over $1,000, and up to $2,500 by late 2007. The options expire worthless if the price falls short.

John Reade, UBS's precious metals strategist, said gold may churn sideways until a deadline passes on September 26 for European central banks to sell their annual quota of 500 tonnes.

"There is a lot of talk about selling, and where there is smoke there may be fire. But it will be a bullish signal if they fail to take up their quota," he said. "We think gold could go up a lot this quarter if the dollar starts to fall fast."

So far the banks have sold just 340 tonnes, chiefly because the Bundesbank has clung to its bullion. "It's not a good idea to touch the stuff. Gold is an important factor for confidence in the euro," said Buba chief Axel Weber.

Quietly, Moscow is buying and Russia's foreign reserves ($258 billion and rising at $12 billion a month) will soon match those of the entire euro-zone.

And yet, and yet, I fret about those black clouds gathering over the United States, threatening to douse the world commodity boom with an icy downpour.

The resources cycle has been correlated for half a century with U.S. monetary policy, peaking as the Fed funds rate peaks. That bell rang in July.

There can no longer be much doubt that the U.S. housing market is crumbling. New home sales fell 21.6 percent in July from a year earlier and average prices are following, down from $250,000 in February to $230,000 in July.

What will happen to the global economy when Americans stop drawing $600 billion a year in pocket money from home equity, or when $2,700 billion of floating rate mortgages come up for adjustment at much higher interest rates?

Gold will soon have to make up its mind whether it is a commodity like the rest of them or whether it is a safe-haven "currency" that shines in bad times -- a sort of AC/DC asset to hedge against both inflation and deflation.

The jury is still out on that big question. Gold passed the test in the dot-com recession when it parted company with its base cousins in the spring of 2001, pushing upwards as the Goldman Sachs index of industrial metals fell off a cliff. But it failed in the U.S. recessions of 1975 and 1991, holding hands with copper and zinc all the way down.

Contrary to belief, gold is not always a good hedge against trouble. It fell during the French Revolution, again during the Napoleonic Wars, and in the First World War. But then it was the world's currency. Now it is the counter-currency, waiting in the wings to challenge an ever-more deformed and fragile dollar system.

I suspect that gold was already starting to explore this new role in 2001.

Which is not to say that the dollar will crash. It ought to fall, perhaps, to correct the world's vast imbalances but it cannot easily do so because there is no credible currency for it to fall against -- except gold.

America has only just started to slow, yet Japan is already showing ominous signs of stalling -- yet again -- with vehicle sales down 5.9 percent in August and construction orders down 20.1 percent.

China remains a small economy (one ninth of U.S. consumption), over-dependent on exports for 35 percent of GDP.

The eurozone's short-lived expansion has already peaked, with German retail sales dropping 1.5 percent in July. Lehman Brothers is predicting an outright recession early next year.

Paris and Berlin both insist that the euro must not rise above $1.30. Should it do so, we can expect finance ministers to start threatening use of their Maastricht powers to dictate exchange policy to the European Central Bank.

No, the dollar cannot collapse because the Japanese and European governments will not let it happen, while the Chinese yuan is pegged in any case.

They will counter U.S. devaluation with devaluation of their own, setting off a fresh cycle of negative real interest rates. Is that what gold is sniffing as a few very rich men and women buy their call options at $2,500 an ounce?

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