Price of Gold

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Yesterday’s downgrade of the United States long-term outlook from Standard & Poor’s to “negative” from “stable” sent investors scurrying into gold. As confidence in the ability of policy makers to address the dire fiscal outlook has waned, gold and investments tied to the gold price have benefitted. Concerns over the integrity of fiat currencies is a theme that has gained momentum in recent quarters.

Sovereign debt issues in Europe may have been relegated to the backburner thus far in 2011. However, the problem has not been solved. Over the past few days, the euro has weakened, and the euro-denominated gold price has surged, as investors ponder the impact of a possible debt re-structuring in Greece. Bart Melek, analyst at TD Securties noted, “While the various economic indicators will play a role in moving markets around, news flow surrounding European and US sovereign debt will likely have the most impact on the markets. We expect more headlines reporting record-high Greek and Portuguese yields in the days to come and increasing chatter pertaining to record-setting US debt levels.”

Melek highlighted that “Greece is under tremendous pressure, with the 2-year bond well north of 20% now. Portuguese 2-year yields have reached 10% for the first time in the euro era.” Investors have turned to gold as a store of value. Gold prices have advanced as the purchasing power of paper money has diminished. Over the past year, the dollar-denominated gold price has gained 31% while in terms of the euro and yen, gold has advanced 25% and 17.8%, respectively.

Also helping to provide a spark for the gold price was news that The University of Texas Investment Management Co. took delivery of 6,643 gold bars, worth nearly $1 billion on April 15. The endowment was advised by hedge-fund manager and long-time gold bull Kyle Bass, managing partner at Hayman Capital Management LP, who noted in an e-mail that while “the decision to purchase and take delivery of the physical gold” was made by employees of the endowment fund, “I helped where I could.”

Bass went on to say that “If you own a paper contract where they can only deliver you 10 cents on the dollar or less, you should probably convert it to physical.” He also noted that he prefers holding gold bullion over cash because the rate of inflation exceeds money-market rates by 2.5-3%. The presence of negative real interest rates has been fueled by the easy monetary policies of the Federal Reserve and has also helped power the gold price to a series of record highs.

In a telephone interview, Bass commented that “Central banks are printing more money than they ever have, so what’s the value of money in terms of purchases of goods and services. I look at gold as just another currency that they can’t print any more of.”

Kyle Bass, who at age 28 became one of the youngest managing directors in the history of Bear Stearns, also gained notoriety by making $500 million last decade shorting securities tied to the subprime housing market. He stated that approximately 5% of his hedge fund is currently invested in gold.

Open interest in gold futures and options traded on the COMEX generally surpasses supplies held in its warehouses. Bass contended that if the holders of just 5% of those contracts chose to take delivery of the metal, there wouldn’t be enough to meet demand.

Extorre Gold Mines (XG.TSX, XG: AMEX) announced what analysts are calling a “major new discovery” at its Cerro Moro gold-silver project, located in the Santa Cruz Province of Argentina. It appears that drilling has just entered the mineralized zone and that this mineralization continues at depth. Further assays are pending. The discovery of a new ore shoot, Zoe, along the company’s Escondida structure is prompting talk that Extorre could be the next small-cap mining company to be taken out by its larger peers.

Mr. Mathew Williams, Extorre Exploration Manager, noted, “We have made another blind discovery of spectacular mineralization… Every effort will be made to ensure that this new discovery will be included in the revised resource scheduled for Q3 this year.”

“The discovery is in our view quite similar to the Marianna discoveries made by Andean Resources, both in terms of the grade-thickness encountered and in the potential for the zone to be developed as a source of incremental feed for the mill. We believe that the Marianna discoveries ultimately prompted Eldorado Gold and Goldcorp to bid for Andean Resources because they saw potential to dramatically expand production.”