Thom Calandra continues reporting on the Denver gold conference

Gold bugs revel in slide of fly-in-ointment Morgan

By Fabrice Taylor
Toronto Globe and Mail
Tuesday, October 1, 2002

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Nothing excites the gold bugs more than to watch J.P.
Morgan Chase shares change hands at a seven-year
low. Yesterday, the company, which is expected to
make $1.71 (U.S.) a share next year and pay out a
dividend of $1.36, was yielding 7 per cent -- which was
enough to tempt a few buyers.

Gold lovers hate J.P. Morgan because it has made
life easy for gold producers who want to hedge their
income and for speculators who want to bet against
bullion. This, gold bugs say, is short-selling (which is
essentially true) and hurts the current price (which is
probably true, although it's not the only factor).

One of the ways gold producers can hedge is by
selling gold forward and hoping they bet right. A
forward sale involves agreeing to deliver to
someone a quantity of gold at a specified time for
a specified price. No money changes hands when
the contract is agreed to but it is nonetheless binding.

Obviously, a gold company that wants the peace of
mind of knowing how much money it's going to make
-- or one that's willing to bet gold doesn't rise -- can
content itself selling gold still under ground for future
delivery. The producer would be long unmined gold
and short future gold.

Whereas it can make sense for commodity producers
to protect part of their future revenues while sacrificing
the upside, they aren't the only ones trading gold
futures. Speculators betting on a drop in bullion could
sell it forward a year at, say, $340 and then, if the price
is say, $290 when the contract is due, buy spot and
deliver or, more likely, settle up in cash, cancelling
the contract. Either way, the profits can be handsome.

The losses, in the event of a bad bet, can be
destructive. That, to return to J.P. Morgan, is what
some gold enthusiasts believe is in store for the bank.
The numbers make for a scary case. J.P. Morgan had
$43-billion in equity and $581-billion in assets at the
end of the second quarter, a little more than Bank of
America. But Morgan's derivatives exposure amounted
to a notional $26-trillion, compared with $10-trillion for its
rival, according to the Office of the Comptroller of the
Currency. In some cases, a bank can also be on the
hook for a derivative trade it engineered, in the event
one party goes bankrupt. This, conspiracy agents
contend, is a great reason to avoid such bank stocks
and buy gold shares.

The point needs a few refinements, however. Notional
values are not equal to the amount of risk the banks
take on. Theoretically, a bank with lower notional
derivative exposure can be much more at risk than one
with greater exposure. Also, most of the bank's
exposure comes from interest rate derivatives, which
shouldn't be as potentially lethal as leveraged
commodity plays.

That said, there's no question that you take on a great
deal of risk investing in shares of a company massively
exposed to the volatility of various markets when those
markets are behaving as no one thought they could.
Derivative bets are only as good as the assumptions
behind them. It doesn't help that the disclosure is so
poor you don't really know what you're buying.

A 7-per-cent yield won't do much if J.P. Morgan ends
up being the bank implosion of the current market
tumble (economic cycles always end with a financial
debacle).

But what about the prescribed alternative? Central
banks are still dumping gold and consumer demand
is weak and getting weaker. Is that a good reason to
buy lousy gold stocks (most of them are; only a few
are gems) that trade as though gold were worth $400
an ounce?

The biggest driver behind gold and especially gold
stocks is a bet that we're on the verge of an economic
calamity. So which is the more speculative of the two
bets -- the bank or the gold stocks?