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Low Risk, But Not Many Thrills In Gold

Cover Story: Where To Invest '96: The Investment Spectrum: Commodities


Someday, gold will shine again--but probably not during 1996. Locked in a narrow price range for two years, the gold market remains lusterless. It wheezed through 1995, shrugging off opportunities to rally past $400 an ounce, which is believed to be a key psychological barrier. In 1996, some analysts say, nothing short of a global financial meltdown could goose the yellow metal over that hurdle. Yet with inflation fears tamed, world economies on track, and peace afoot in the Middle East and the Balkans, a global crisis seems increasingly less likely.

Still, gold bugs have some cause to be bullish. There is little downside risk in the metal below $375 an ounce: Dealers as well as investors have proved to be ready buyers when prices fall to that level. And if gold should move convincingly past $400, a sudden surge of investor interest could provide some surprising momentum. "The seeds of increased volatility are there," says commodity analyst Andy Smith at Union Bank of Switzerland. "When something moves sideways for two years, it will probably move [up or down] sharply."

KILLING RALLIES. But even beyond these technical factors, the fundamentals of supply and demand are providing a subtle upward bias. Smith and other bulls believe that producer forward-selling is finally losing its grip on the market. Throughout 1995, mining companies were selling borrowed gold to lock in prices as much as 10 years ahead. That practice squelched any rallies: "The gold market has been depressed by an unprecedented, unsustainable flow of borrowed gold," explains Caesar Bryan, manager of the $15 million Gabelli Gold Fund. Recently, however, producers have had to pay much more to borrow the metal for forward-selling. Gold "lease rates" spiked up from the usual 1% to as much as 6%. As higher costs discourage forward-selling, the gold bugs reason, a key drag on the market could be greatly reduced.

At the same time, gold supplies are shrinking, and the demand for the metal, particularly from Asia, is surging. World gold demand in the first half of 1995 soared 21%, according to Gold Fields Mineral Services Ltd. The buying was led by Japanese investors who were accumulating the metal at historic lows in terms of yen. Demand for investment as well as jewelry fabrication boomed in India, China, and elsewhere in Asia. Robust demand is far outpacing new mine supply, which declined by 1.4% in the first half of '95. "The market is getting tighter," says Gold Fields analyst Philip Klapwijk.

A LONG SLIDE. There is, in short, a legitimate case for higher prices. But for investors, golden opportunities have never been a simple matter of supply and demand. Gold has made its mark on the investment psyche as a storehouse of value, a hedge against disaster, and a concrete physical holding in a financial world of paper and bytes. Over the past decade, though, gold's importance has diminished. Investors worldwide have access to a vastly increased array of financial products to hedge risks. Technological advances allow the rapid shift of funds into different currencies. So a flight to quality these days often means a move into a financial instrument rather than into gold. The metal has failed to respond to disquieting global events ranging from the Persian Gulf war to the 1994 dollar collapse.

Perhaps gold will revert to its traditional role if many events occur at once: surging inflation, currency devaluations, financial illiquidity, oil crises. "It would take a confluence of a lot of those factors," says J. Clarence Morrison of Prudential Securities Inc. For all but doomsday investors, though, many other markets beckon more persuasively.By Greg Burns in Chicago

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