- 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.
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- 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).
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- 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.
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- 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.
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- 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.
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- 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?
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- Copyright © 2002 Bell Globemedia Interactive
Inc. All Rights Reserved.
- http://www.globeandmail.com/servlet/ArticleNews/printarticle/gam/20021001/RVOXX
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