December 22, 1997

This edition will cover the period between November 27, the date of the last newsletter, to December 22, 1997. Investment markets were influenced by the following economic events. On November 29, US personal income was reported as rising 0.5%. On this day, long term Canada bonds were trading at a 5.99% yield, US long term treasuries traded at 6.05%. Two year maturing Canada's traded at 4.69%, while US 2-year treasury notes traded at a 5.74% yield. On December 4, the International Monetary Fund bailout package for South Korea was set at $57 billion. The Argentinian Central Bank confirmed that it had sold in the 1st half of the year all of its gold reserves, 4 million ounces. This spooked the gold market and drove the price down to US$289. On Dec 5, US non-farm payroll for November came out as an increase of 404,000 vs. expectations of an increase of 215,000. US unemployment rate for November came in at 4.6%, compared with 4.7% in October, its lowest rate since 1973. November average hourly earnings rose $0.07 compared with expectations of a $0.05 rise. US factory orders rose 0.3% vs an expected 0.1% increase. Time for the bond market to get spooked. US long treasuries traded down to a 6.15% yield. On Dec 11, the South Korean WON currency fell the 10% limit for the 4th consecutive session. The Asian currency crisis appears to be having a more profound & lasting effect than first anticipated. A flight into the US$ is being expressed in long term US treasuries, moving back up to trade at 6.05% yield. From here on, economic stats came out on the positive side for markets. US retail sales for November came out weaker than expected at up 0.2% vs expectations of up 0.4%. US long term bonds went through the 6% barrier to 5.98%, long Canada's went to 6.06% reflecting a strong flight to quality as markets felt uneasy with equity positions. On Dec 12, US Producer Price Index for November came in at down 0.2% vs expected rise of 0.1%. The Bank of Canada raised its Bank rate to 4.5% from 4.0% in order to help strengthen the Cdn $ vis-a-vis the strong US$. This is still below the 5.0% US Federal discount rate. On Dec 16, the US Consumer Price Index for November came in at up 0.1% vs expectations of a 0.2% rise., indicating tame inflation. Housing starts in the US, however, were up 0.8% in November to an annualized basis of 1,531,000. This is much stronger than the expected downturn of 1.2%.

US long term bonds ended December 19 trading at a 5.88% yield a significant improvement from 6.04% on November 26. Long Canada's closed at 5.96% unchanged from November 26. Two year maturing US treasury notes yielded 5.64% on Dec 19 up from the 5.73% yield on Nov 26. while Canadian 2 year bonds yielded 5.20% on December 19 a significant drop from the 4.60% yield on November 26, showing the effect of the increase in the Bank of Canada rate and also reducing in substantial fashion the yield spread with US.

Meanwhile back on the ranch, stock markets continued to behave in very volatile fashion with a great deal of trading volume. The Dow Jones Industrials average stood at 7756 on December 19 not much changed from the 7795 level on November 26. At this level it now trades at 19.9 times trailing earnings compared with 20.1 times on Nov 26 and yields 1.76% on cash dividends, pretty well unchanged from a month ago. The S&P's Composite Index at 947, is also virtually unchanged from the 952 level of Nov 26 and down 4% from all time high of 986 is trading at 23.3 times earnings unchanged from a month ago. Dividend yield is 1.64% compared with 1.60% a month ago. The TSE 300 index closed at 6535 on December 19 unchanged from the 6505 level of a month ago but down 9.4% from the 7210 high of Oct 7, to trade at 22.3 times trailing earnings relatively unchanged from the 22.7 of a month ago. Dividend yield is unchanged at 1.68%. North American stock markets appear to be still reasonably priced in terms of value in a setting of low inflation and moderate growth. Dividend yields are historically low but combined with moderate capital appreciation relating to growth in earnings, stocks still compare favourably with fixed term investments.

What does all this mean? There is a flight into North American investment markets based on the premise that these markets indicate an environment of low inflation combined with moderate growth. There is also the perception of stability. The great unknown factor is how will the drop off in Far East economies affect American economies, since a great deal of the past growth in the Far East benefited North American companies. Canada seems more vulnerable than the US, since an important part of resources were exported into these market, particularly forest products and minerals such as coal.

A word about gold. Supply and demand for gold averages about 3500 metric tonnes per year. Jewellery fabrication takes up about 2700 tonnes, electronics 200 and other fabricating about 280, for a total of 3,180 tonnes on the demand side. On the supply side, mine production averages about 2280 tonnes and scrap gold about 620, for a total of 2900 tonnes. It is difficult to see, from a traditional point of view, less gold being used for jewellery fabrication. On the other hand, with lower gold prices, there could be a fall-off in mine production, particularly from high cost producers. Among the jewellery producing nations, the price of gold has dropped more than the drop in the local currency in the bulk of the countries, Japan, Taiwan, Hong Kong, Singapore. This lower cost component and the resulting profit margin may actually spur on increases in jewellery manufacturing. And, hence, increase demand for gold. The price of gold, as measured in a strong US$, has suffered from forward sales and hedging operations and from the threat of further central bank (official sector) selling. On the negative side of the equation is the possibility of less hoarding, which appears to run at about 180 metric tonnes a year. Hedge trading quite often creates exaggerated swings and, yes, maybe traders did succeed in driving the price down to the 280-285 level. Short sellers may decide that their game is now boring. Taking this scenario into consideration, we may have seen the lows in the price of gold and a return in 1998 to a level of $320-330 could be in the wings. One thing quite certain is that gold producers, particularly those in Australia and South Africa, will sell forward on upward spikes in 1998, thus placing a lid on the price of gold. Because share prices of gold producers have been battered down so much, gold stocks should perform considerably better than bullion. This may prove to be a particularly opportune time for bargain hunters. Among major producers, the following can be considered: Barrick Gold, Teck Corp, Prime Resources, Ashanti Goldfields, Freeport McMoRan Copper & Gold. Among the tier 2: IAMGOLD, Samax Gold, Viceroy Resources, Geomaque Exploration, River Gold. Among the explorers: Golden Knight, Nevsun, Gitennes Exploration, Gold Reserve Corp, Sutton Resources, Etruscan, Pangea, Sulliden Exploration, Trillion Resources, Birim Goldfields.

This month, The Pick takes a look at two companies for the first time. The January edition plans to comment on four companies for the first time.