gzip's old way had a security hole. I don't observe any problem with gzip 1.6 on Fedora 20 (see below); maybe there was a bug in gzip 1.3.12 that's been fixed, or maybe your OS has special restrictions, or something. You might try upgrading to 1.6, or if that doesn't work try running 'strace gzip' rather than 'gzip' to see exactly what's failing.

$ ls -ld . passwd
drwxrwxrwx. 2 eggert eggert   60 Aug  7 14:01 .
-rw-rw-r--. 1 eggert news   5400 Aug  7 13:54 passwd
$ sudo -u news gzip passwd
$ ls -ld . passwd.gz
drwxrwxrwx. 2 eggert eggert   60 Aug  7 14:01 .
-rw-rw-r--. 1 news   news   2134 Aug  7 13:54 passwd.gz



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