Harmony joins AngloGold and Gold Fields on New York Stock Exchange this month

Drawing gold lines in the sand;
Futures sellers at heart of bullion collapse, some say

By Thom Calandra, Editor
CBS.MarketWatch.com
Friday, November 15, 2002
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SAN FRANCISCO -- This is smack-down city.

For more than a year now, each time the price of gold has
flirted with $325 an ounce, New York-traded futures contracts
for the metal get dumped. That depresses bullion's spot
price and the values of publicly traded gold mining
companies, among them Newmont Mining and Barrick
Gold, the two largest producers.

The failed bullion rallies also lead gold's believers to
wonder if large banks and governments use the price to
manage interest rates and ameliorate the quot;fear factorquot; that
higher gold prices bring to the market.

This week, gold staged yet another run at $325 as
investors interpreted reports coming from Iraq and the
U.S. about weapons inspectors and the lifespan of
militant Osama Bin-Laden. The rally pooped out
mid-week, ending in a dramatic, $7 decline in the
gold price.

On Friday, a whiff of inflation in U.S. producer prices
boosted the price of gold. Gold almost always benefits
from inflation, the scourge of stock and bond market
investors. Wholesale prices in everything except food
and energy rose 0.5 percent. That was enough send the
spot gold price up $2.10 to $320 an ounce by 9:15 a.m.
ET Friday. The Comex-traded December futures
contract in New York, which expires Nov. 22, rose almost
an equal amount.

As for conspiracy, one longtime gold banker in New
York told me the bad price behavior of the metal almost
always centers on manipulation of the gold futures pits.
Several organizations, including the Gold Anti-Trust
Action Committee, routinely point to manipulated bullion
markets and the suspected activities of large banks such
as derivatives-giant J.P. Morgan Chase as the reason
for gold's many failed coups. It's a claim J.P. Morgan
Chase denies.

The truth lies somewhere other than in the conspiracy
belt, say several economists, metal analysts, and
derivative experts.

Andy Smith, precious metals analyst at Mitsui Global in
London, notes that total Comex open interest on its
gold futures quot;leapt 10,000 lots Tuesday, when Iraq
parliament said 'no' to inspection. The price only
rose $3 that day.quot;

A day later, Iraq opened the gates, so to speak, to
the inspectors. quot;So a Saddam qualified 'yes' would
easily be enough to kick Johnny-come-latelies out
(of gold),quot; Smith, one of the most circumspect metals
analysts in the world, told me Friday.

Open interest is the total number of commodity
contracts that have yet to be exercised, closed or
allowed to expire. Some two-thirds of the total,
sometimes more, is in the quot;nearby contract,quot; in this
case the December futures.

Smith acknowledges the Comex open interest in
gold futures didn't fall in Wednesday's sharp gold
decline, when Iraq seemed to open its borders to
the inspectors. quot;Maybe those new longs left,quot; Smith
says about those betting the metal would rise, quot;but
there were new shorts too, leaving open interest a
bit higher.quot;

UBS Warburg, in its daily metals analysis Friday,
called the open interest figures for Wednesday
quot;rather perplexing.quot; The investment bank's researchers
noted how gold fell in price, quot;yet open interest barely
changed, indicating perhaps that as many new shorts
as long liquidation was seen. This action leaves the
market vulnerable to further long liquidation but also
short covering, so gold is likely to be volatile.quot;

Smith at Mitsui conjectures that gold, after more than
a year of price gains following the New York City and
Pentagon terrorist attacks and volatile stock markets
worldwide, quot;is showing event fatigue.quot;

Michael T. Darda, economist at researcher
Polyconomics Inc., also examines gold's price against
the Iraqi landscape.

quot;I think most of the drop can be explained by firming
expectations that the Iraq problem will be solved with
inspectors instead of bombs,' Darda said Friday. quot;The
recent inverse relationship between equity prices and
gold is a function of the war-risk premium, which influences
expectations of growth and hence the market demand for
dollar liquidity.quot;

Darda notes the world community is now behind the U.S.
after a unanimous United Nations vote, so quot;the negative
fallout of a war should inspections fail would be much
less than if the U.S. would go it alone, the world community
be damned.quot; In financial markets, expectations -- of
inflation, political consequences, currency
strength/weakness, earnings and so on -- are
three-quarters of the reason for any price activity.

quot;Those expectations and calculations are all captured by
the dollar price of gold, the most monetary commodity in
the dollar universe,quot; says Darda. (It's a pity most financial
broadcasters and writers rarely use the gold price when
reporting on inflation, Iraq, currencies, interest rates, and
so on. But that's another story for another day.)

James Turk, editor of Freemarket Money Report, pins
gold's activity on the dollar. Turk and some economists
see a direct relationship between dollar strength and
gold weakness, or vice-versa. quot;After Saddam agreed
to the inspectors, the dollar rallied, and gold and oil got
hit hard,quot; Turk said Friday. quot;Importantly, gold has held
support -- so far at least at the $318 area. Saddam has
a history of changing his mind. The interesting thing now
will be to see whether gold goes up $6 if he does.quot;

Bernie Schaeffer, chairman of Schaeffer's Investment
Research and an options and derivatives expert, sees
a quot;more straightforward explanation to the question of
who wants to keep December gold below $320, and
below $330 for that matter.quot; Gold's highest spot price
this year was $329 an ounce, making that level a line
in the sand for bullion believers.

Schaeffer looks at the open interest of the options
contracts that represent the December futures. As of
the latest report, December $320 call open interest
was 11,673 contracts; put open interest at $320 was
4,050 contracts. In the options world, calls are bets
on a price rise, and puts are bets on a decline.

quot;It is an open secret that when there is heavy open interest
at a futures options strike, the option sellers will try to keep
the contract from attaining value in order to maximize their
profit and perhaps most importantly control their huge
exposure to a move in the wrong direction,quot; says
Schaeffer. quot;This is particularly true as option expiration
crunch time approaches.quot;

Options sellers are the folks who take the opposite side
of the trade from a buyer. A seller of call options collects
a premium from a buyer of call options, and prays the
call contract does not surge past its strike price.

For those in equity land, Schaeffer draws a parallel with
shares of KLA-Tencor. quot;There was a big buildup of
November 30 put open interest ahead of their Oct. 22
earnings report,quot; he says. After dipping briefly below
$30 on the lousy earnings news, quot;the stock put on a
huge rally to just shy of $40 that had the fundamental
people scratching their heads. It then experienced a
major put buildup at the $35 strike, and sure enough
its recent dip below $35 ended abruptly and was
followed by another big rally (Thursday).quot;

Back in gold territory, with heavy call activity in the
$320-$330 an ounce area, quot;it makes sense that the
call sellers (the investors who benefit as long as gold
does not surpass $320, or $330) will use every
opportunity to beat down the price of the December
gold futures so the options they've sold will have the
maximum opportunity to expire worthless.quot;

So, can things change before next Friday, the expiration
date for the futures and the options on these gold
contracts? quot;Sure,quot; says Schaeffer from New York. quot;But it
will require some massive buying demand to break the
will (and the capital) of the call sellers. Would such a rally
be explosive as the floor capitulates and is forced to
cover their shorts? Yes.quot;