Wednesday, September 3, 2008

A day in History: January 14 1980 "Gold and Silver Go Bonkers "

Monday, Jan. 14, 1980

Gold and Silver Go Bonkers

More Middle East jitters send precious metals leaping into orbit

In one hectic week, the long surge in gold, silver and other precious metals crested into a wild pay-any-price frenzy. While bullion traders from Hong Kong to Zurich to Kansas City gaped in amazement, panicky investors big and small reacted to the worsening turmoil in the Middle East and the increasingly troubled world economy. They sent precious metal bars, coins and trinkets on the most dizzying roller-coaster ride in memory. Prices touched levels that were inconceivable a few months ago. Said a New York commodities expert, George Clarke, in a revealing if overwrought explanation of the market's extreme volatility and nervousness: "In my opinion what is happening is that the world is looking at World War III."

On a single day, gold climbed $74.50 per oz., or more than twice its total value as late as 1971. During the week, it climbed an incredible $148, to hit $660 per oz. before slipping back suddenly at week's end to a still dazzling $603, or an overall gain of 18% in only five days.

The sell-off was spurred partly by rumors that the U.S. was planning a surprise gold auction of as much as 6 million oz. in an effort to break the price runup. Though the Administration denied the rumors, the U.S. could well afford such an auction. The nation's gold reserves are still far and away the largest on earth, totaling some 276 million oz. At last week's closing price, the reserves were worth some $165 billion, or more than twice as much as those of second-ranked West Germany. By comparison, the Soviet Union's official reserves, though never disclosed, are estimated by the U.S. Central Intelligence Agency to be less than 45 million oz.

Silver, which had climbed more sharply than gold during 1979, leaped by $7 per oz., to a peak of $41.50, or a rise of 20%. Then it, too, fell back, with equally extreme gyrations, to some $36.10. Even at that figure, silver was trading for more than gold had been worth at the start of the 1970s.

Other metals also rocketed. Platinum, which is used for jewelry and manufacturing of such products as jet engines and high octane gasoline, soared from $693 to a record $870 per oz. before settling down to $767.

Titanium, which is used in the manufacture of aircraft and was trading for as little as $3.98 per Ib. earlier in 1979, has been climbing steadily, in part be cause of a cut in world exports by the Soviet Union, the leading titanium producer, which needs it for domestic consumption. By last week, New York dealers were selling the metal for as much as $25 per Ib. Even copper climbed nearly 10% as speculators pushed it to a record $1.11 per lb.

The explosion in metals prices fuels inflation psychology by undermining confidence in money itself and making it seem smarter to spend the currency on almost anything rather than save it. Metals mania also vindicates such economic Cassandras as James Dines and Franz Pick, who for years have urged investment in gold as a safe hedge in an in flation-weary world economy. As gold soared, the dollar continued its plunge against foreign currencies, hitting an all-time low of 1.70 deutsche marks, and sinking against the Swiss franc, Japanese yen and British pound, though it recovered somewhat at week's end.

Each of the speculative metals is reacting to special supply-and-demand pressures. Gold remains the premier refuge of moneyed Europeans, Asians, Latin Americans and, especially, the oil sheiks of the Middle East. Since 1973, Saudi Arabia, Kuwait and the other members of OPEC have accumulated more than $250 billion in dollar surpluses. The states literally do not know what to do with this money, and it has been losing value in bank accounts as inflation goes up and the dollar slides. Troubled by the U.S. seizure of Tehran's American bank deposits, fearful of war in Iran or Afghanistan, petrosheiks are becoming jumpy about holding dollars. More and more of them are using the brokerage services of institutions such as Geneva's Credit Suisse Bank and Frankfurt's Commerzbank to buy gold on the London and Zurich markets. The more they buy, the higher goes the price of the metal and the further slips the dollar against it.

The dollar's slide gives oil-exporting nations an excuse to raise prices, even though the slowing world economy is helping to cut demand for oil. Last week Mexico lifted its price from $24.50 per bbl. to $32, and other OPEC members are angling for steeper increases.

Saudi Arabia, which has more than $60 billion in official reserves, is by far the largest foreign-dollar holder and stands to lose the most as gold prices climb. Yet top Saudi businessmen and members of the Croesus-rich royal family have been among the biggest gold buyers. They are nervously fleeing to precious metals as reports persist of increasing tension and violence within faction-ridden Saudi Arabia and splits in the royal family.

The Saudis and most other gold hoarders are not looking for quick profits but for long-term security. They probably would be inclined to hold on if the price fell $25 or $50. Even then a sell-off might generate a new wave of buying from investors who felt they had missed a golden opportunity earlier.

The only nations that are unmistakably benefiting from the surge in gold are the two that produce the most of it, South Africa and the Soviet Union. For the apartheid regime of South Africa, which last year dug 700 tons, or fully half the world's production, the price explosion has been a bonanza. Each $10-per-oz. jump swells the country's foreign exchange earnings by $200 million annually. South Africa's official reserves have jumped in the past year from $2.5 billion to some $7 billion, making the nation one of the world's richest per capita. The government is weighing a 10% tax cut for 1981 to spread the wealth around a bit. One group not likely to benefit much is the black laborers who dig the ore for $40 per week and help to hold down the cost of producing gold to a fraction of its market value.

The really mesmerizing gains have come in the silver market. Silver has more than quintupled in value in the past year, with much of the gain coming in the past three months. Last January, silver was selling for $6.25 per oz., and anyone astute or lucky enough to have bought a typical 5,000-oz. contract for a twelve-month future delivery would have made a killing. For a $2,000 margin payment to his broker, the canny investor today would hold the rights to $127,500 worth of silver, a profit of some 6000% on his investment. What is more, people who hold commodities futures contracts for more than six months have their profits treated as capital gains, taxable at a maximum 28%.

Investors in shares of silver-mining companies have also done well. Stocks listed on the red-hot Spokane regional exchange, which deals mainly in mining firms, are up 60% since mid-November. Last Wednesday, an avalanche of buy orders forced the New York Stock Exchange to halt trading for several hours in the shares of Hecla Mining, which since early 1979 has climbed from $5.25 per share to $47.50.

World production of silver in 1979 was about 334 million Troy oz. (a pound has 12 Troy oz.). Mexico was the largest single supplier (18%), followed by the Soviet Union, Canada and the U.S. But, as has been the case for years, demand surpassed supply, by perhaps as much as 90 to 100 million oz., in part because of industrial demand. Silver is a basic ingredient in photo film, electronic components, metal brazings, batteries and, of course, jewelry and tableware.

The U.S. imported nearly 75% of the 160 million oz. that it used last year, but the price rise has led to a surge of new investment in domestic mines, notably in Western states. Production in the Coeur d'Alene district in the rugged northern panhandle of Idaho, which is the richest silver region on earth, has held steady at about 18.5 million oz. annually over the past five years, but is expected to rise to 20 million oz. during 1980. Still, shortages will persist, and that suggests rising prices.

There are signs that a small group of unknown investors, which rumormongers in the futures market variously identify as shady Middle Easterners, tricky Europeans and even sinister folk from Staten Island, are plotting an unscrupulous investment maneuver known as a squeeze play. If they are, the price of silver could go far higher, then plunge as breathlessly as it climbed if and when the investors bailed out. One speculator widely mentioned in these stories is Bunker Hunt (see box page 61), but he insists that he has no plans except to hold on and watch his hoard grow.

Any small group of ultrarich investors could pull a squeeze. They would simply buy up so many outstanding futures contracts that there would not be enough metal available to meet demand if the contract holders insisted upon delivery of real silver, rather than being willing to turn their paper profits into cash, when their contracts expired. That would push prices into outer space on the spot market, as unfortunate speculators who had contracted to deliver silver scrambled to buy the limited supply to meet their legal commitments.

Most of the action in silver futures seems to be focused on two commodities exchanges, the Chicago Board of Trade and the New York Commodity Exchange. The New York exchange alone currently has futures contracts outstanding for 155 million oz. of silver, but its warehouses contain only about 70 million oz. Warns Jack Boyd, vice president of New York's Drexel Burnham Lambert brokerage firm: "The ownership of the contracts is concentrated in only a very few hands, and there seems to be a definite indication on the part of the contract holders to want actual delivery."

Both the Commodity Exchange and the Chicago Board of Trade have been slow to awaken to the disruptive potential of a silver price explosion. To limit speculation in the metal, the New York market belatedly has sharply increased the margin requirement for investors. Since November, the Chicago market has limited to 600 per day the number of futures contracts that any individual can hold at one time.

The slowest off the mark has been the federal Commodity Futures Trading Commission, which is responsible for maintaining orderly markets. To learn the identities of the big silver players, CFTC staff members have been talking to bankers and brokers who have been doing much of the buying and selling for clients. So far, the commission's main accomplishment has been to file suit against the Banque Suisse Populaire, headquartered in Bern, Switzerland, for failing to divulge its list of silver clients.

The most effective, quick step that the U.S. could take to pop the bubble would be to auction off a chunk of its 180-million-oz. silver stockpile, the only substantial official reserve of the metal left in the world. An auction would help cool down the markets for all precious metals, including gold. Some lower Treasury officials last week discussed how to stem the gold and silver stampede, but decided to hold back when rumors of a gold auction alone were enough to cahn the markets. Said one Treasury official to TIME Washington Economic Correspondent William Blaylock at week's end: "We are not going to do a darned thing today. Our attitude on gold and silver continues to be to sit back, watch and do nothing."

That policy could be risky. Rising metals prices feed inflation by pushing up costs for a range of products and processes. Last week, for example, Kodak (1978 sales: $7.1 billion) announced a 7.5% jump in its retail film prices to help offset the rise in the cost of silver, which could add nearly $1.5 billion to the company's overhead this year. The largest users of industrial silver are hospitals, which require vast quantities for X-ray film. When the prices go up, hospital costs rise, insurance premiums climb, and federal Medicare and Medicaid outlays, already among the biggest items in the federal budget, also increase. That means steeper Social Security taxes, larger employer contributions to payroll deductions and ultimately fractionally higher prices throughout the entire economy.

The graver peril is that the precious-metals fever will sap more and more confidence in paper money, debauching its value. Says London Bullion Dealer Jack Spall: "At these prices, gold must already represent 60% to 65% of the world's monetary reserves, and the increases are worrisome because of their possible disruptive impact on the world monetary system and trade itself." Gold is, after all, a sterile investment that does not produce anything. It diverts funds from investments that would create jobs and wealth in economies everywhere.

Political crises come and go, but inflation is the obvious long-term reason why gold glows, silver surges and platinum hits the moon. Until the U.S. conquers that problem, every other economic palliative the nation resorts to in order to prop up the dollar or press down gold will amount to nothing more than a quick fix.

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