-- Posted Tuesday, 18 March 2003 | Digg This Article

Since we wrote the article, “Why is the Gold price going up – vigorously – and what makes it do so, it has also gone down , vigorously, almost back to where it started from.   So we have re-written the article because it is important to understand the overall picture of influences, not simply one directional influences.   We hope to help you “feel” the market better, so that what we tell you in our technical services will assist you in getting the most out of the markets.  

Conclusions: -

q       The Speculator, acting on news items, adds the precipitous “Froth” in the runaway Gold prices.   Termed War Premium, it has reached nearly 20% of the price.

q       A lack of liquidity in the markets, due to a small level of market supply, well under natural demand, ensures the continuing volatility in the Gold Price.   Such volatility can only be achieved at very much higher prices, when demand is brought more into balance, through higher prices.

q       Dealer control of the market, permits dealers to act as wholesalers, so dominate the price, and ensure wider swings and spreads, when volatility blazes into the market.

q       Large Investors, including Central Bank, draw supplies off to their reserves from internal supplies, so diminishing the newly mined gold from reaching the open market in sufficient quantities.

q       Producers either acting as buyers in the open market or delivering into their hedges, take supplies away from the “natural” demand forces, which make the price in gold.

q       Skilled buyers outwitting the ‘gold trade’ [Jewellers and the like] ensure the volume flows into their hands, before the trade is satisfied at the level of prices.   Once the prices rise too high and Investment demand has grown sufficiently [which it has not yet done so] the Investment buyer will step into the gap left by the Jewellery trade.    Meanwhile, this can force the conservative trade buyer, to act precipitously to get stock.

q       Structural economic decay will lead more and more into the Gold market, currently, at these prices unable to accommodate rising demand will force an increasing vigour into the gold price until it rises to a level to accommodate such large buyers.

q       Central Bank supplies can add volatility through being insufficient as well as unpredictable in both timings and amounts [except for Switzerland].  

Summary of the article: -

·          Recent Market Action.

·          Why did the gold price go down from nearly $390 to $331, so far?

·          Recent  and present market Forces in statistical terms.

·          Monetary & Investment qualities

We started by saying in the original article that, “ it is the interaction and impact of different factors, as well as the timing and the proportion, relative to the rest of the factors, that will decide the shape of the bull market, the price levels achievable as well as the extent of the bull market, and gold’s future”,   but we would now like to address this in layman’s terms, so you can get a feel of the structural changes taking place there, right now.  We include the bulk of that original article and overlay these recent developments over the top of that.  To begin with we will give you recent reports from the gold markets, as we heard them and understood them.

Recent market Action

Early December: - Many said it will stop rising at $350.   Some have said begin selling at $348.   But others say, there is the potential for it to keep going over $400.  

As you know markets are rather like the sea shore, with the waves lapping in then out, but always dominated by the tide.   This tide is coming in, but we will have a continuous series of waves.   This does not look like a “Rally” [ a wave only?] to us.   No doubt there will be corrections.   We would like there to be plenty of time for us to get out then go back in, during these corrections, but you have only to look at the speed and velocity of these present moves to realise that this sea has an awful lot of power, so could go on for longer than we thought and correct and resume the rise before we know it!   But we do see trading opportunities!

19^th December 2002 - The gold price took off again yesterday, triggered by further fears of war in Iraq, so some say.   We would attribute the rise to the continuing “Breakout” of the gold price from the ever  tightening  trading range it sat in for four months.   Buying sprang in from New York, from the professionals, we gather, which triggered short-covering and computer generated buying , The market had opened easier at $336, before the rush began. Subsequently in Asia, and particularly with TOCOM busy with professional and the public dealing with both fresh interest and short covering.   Prices shot up to $354.50 before settling back to fix in the afternoon in London at $345.75 an ounce. It’s rather like a battle fought to the end, leaving only one side standing, with the “Gold Bulls” running rampant!

24^th December 2002 - Well it hit $354 before it paused.   On Friday, just ahead of the  Holidays appearing and an obvious time for traders to square their books and some to take profits, a street smart, New York dealer appeared and sold the market down from the mid$340’s to between $338.50 to $339, no doubt hoping to shake the market down.  But the market was not to be panicked and the day ended with it at $340.5 to $341.  

31^st December 2002 - As this year comes to a close, gold was trading almost on the $350 level.   As can be expected in the festive season, trade is thin tending to be position squaring.   With spreads in the market at around $1 any trade tends to have an exaggerated impact on the Gold price.

6^th January 2003- The business was clearly done in London, with the first day of trading after a long weekend coming out of Asia, particularly Japan.   They came in strongly taking the price right up to $356 + at the fix in London.  After the fix gold hit $357 / .50 as “Safe Haven” buying and fund buying pushed the price up.  Gold drifted lower over the course of the session as profit taking and long liquidation was seen.   The Dollar is currently the driving force behind the metal’s rise.   This is looking distinctly dangerous, but good for gold!

8^th January 2003 - the market was thin in a market showing and promising more volatility.   Europe took the price lower.   This was followed by locals [including professional funds] on Comex extending the trend by selling gold at the opening of the market in the States.   But this all seemed to be part of the funds  plan, as moments later, they started buying, but when they came in to buy, they found little gold on offer.   Their buying, consequently, triggered stops, as they caught the market short.  Gold leapt from around $345 to $350.50

By the end of Europe's day, the Dollar had done a U-turn and soon came under heavy pressure, as the Euro spiked from 1.0390 and posted a fresh 3, and a bit, year high at 1.0535.   

Can you believe it, in one minute gold rose from $348 to $351.   The strong Euro kicked into the buying frenzy that had begun with short covering and stop loss orders took gold to a high of $355.25.   News of a European Central Bank selling gold [within the confines of the “Washington Agreement”], most likely the Netherlands, did not deter the one large and obvious speculator from buying to keep the price elevated between $353 - $355.   the inevitable cooling then took place when dealer and fund profit taking took gold back down to the level, at the time of writing this, at $351- $352.20.

15^th January 2003 - The thinness of trading is unnerving.   It seems as if the Traders know that if they make a move, they could be caught the same as last week where the price moved $8 in a minute.   Got to be brave to swim in those waves, could get caught in an undertow going the wrong way!   The trading band seems to be narrowing, which is always a signal to be ready for quite a move!   But it is narrowing to the lower end in the face of a stronger $.   It saw $348 at one point, but this attracted good physical buying a pleasure to see as this confirms acceptance of  just below $350, as a bargain price for physical buyers.

23^rd January 2003 - Gold is benefiting from tension surrounding the planned attack which commentators have ascribed to the increasing political and economic isolation of the US amidst gathering global anxiety that their ambitions are economically rather politically driven.

After hours in New York last night a larger than usual volume deal was done of the order of 100,000 ounces, during a period of very low liquidity.   When Sydney opened, gold jumped $2 immediately, triggering “Buy stops” and prices rose to $365.   London saw the strength and held to it, fixing gold in both sessions of the day above key technical points.

There are now, apparently few shorts in the Option market with one month implied atm volatility increasing by 0.7 vol. To 20.2mid. 

 Physical buyers suddenly reappeared in the market and came for bargains at the $358 level, a welcome sight reinforcing the acceptance of these price levels in gold.   Last night buying from Tocom [Japan] saw short covering push the price up to $365 before retreating to $360.   This morning in London, the price rose strongly to be fixed well in the morning at $363.30, breaching key technical levels and setting course for more rises.

4^th February - Consolidation in the $360’s being complete, gold has soared to a new high, trading at the break of day at $381-60 - $382.90. 

12^th February - After the roller coaster ride of last week, with the froth being blown off our “Cappuccino” of a market, this week began with a high of $365 the night of the 10^th, though and with the opening of TOCOM gold quickly traded lower, as a barrage of long liquidation was seen.  Gold dipped to $359.50 before finding support, as early European bargain hunters took advantage of the low price. 

19^th February - Gold was trading better, at $346, in the middle, having had a better day than for some time.

Spec buying started New York’s day, clearly in the hope that the fall had been completed, but Long liquidation re-appeared.   Gold survived a barrage of fund selling on TOCOM overnight, prompted by a brief test of $342 late on COMEX yesterday.  Long liquidation in Tokyo is now waning.

Gold made several attempts at $342 overnight, but failed to break lower as the Euro recovered from 1.0680 to 1.0720.  Gold jumped from $344.50 to $346 shortly after the London open this morning, as some light short covering was seen.

A pattern in the last few days is emerging: -

Ø       Long liquidation in the U.S. & Asia.

Ø       Some European & physical demand [not large but present].

Yes, indeed, physical demand, the one we have been waiting for all through the fall is here.   Good levels of interest have come from Turkey and the Middle East in the $334 -$335 region, this as we see signs that long liquidation is seemingly.   The Speculators are moving out.

13^th & 14^th  March – Gold has fallen dramatically in the last two days as conflicting stories of surrender, agreements to disarm, a stronger $ and rallying equity markets give a heady feeling to markets, encouraging long liquidation of around quarter of a million ounces of gold form the market.   Is this the speculative “Froth” on the downward slope?  Will it go too far?   What is for sure is that the professionals have played it well with them absorbing the physical offerings well, whilst allowing the fall.   Support around the higher twenties and early thirties region has kicked in, so where next.   The play between the risk aversion Investors trying to hold the price just out of reach of the Jewellery trade must kick in again.   We have seen good physical off-take from India and Turkey, whose presence has been shadowy since November.    Where to now?

18^th March – Gold drifted lower after a brave attempt at staying over $340.   As the “Final” Ultimatum, to Hussein was given by Bush, to flee the country within 48 hours, or face attack”.   The gold markets first reaction has been to seem to want to wait at around $337.   Speculation on whether it will be a “quick” war or will drag out will, no doubt, give speculators a reason to punt one way or the other.    Gold has to find a solid base to give us a convincing reason to take a position.

Why did the gold price go down from nearly $390 to $331, so far and VIGOROUSLY?

The most “out of control” phase of a market is when the emotional Investor appears, who invests solely on the emotions of fear and greed.    He provides “Froth” to the market.   In addition the gold market is not as liquid a market as most others.  We have seen it on the up, and now we are seeing it on the down!   On the up it was called “War Premium” and was estimated at around $50.   He needs to be separated, at least in our mind, from the underlying gold market, as he can distort the true picture of what is happening.  

As you saw above, the market moved in jumps, with small amounts of consolidation at these price levels.  The professionals attempted to gauge just how much of the price was “Froth” or “War Premium”.   It was felt that this was around $50, but $60 seems closer.   The Gold price almost touched $390 in almost un-tradeable markets, with dealers pushing prices up almost without dealing, to that level.   We were led to believe that one could deal in the seventies, with small opportunities in the low $380’s, so if you did not get out in the $380’s +, don’t be upset, very, very few people did.   Those who did get out then did so in the $370+ area.  

What happened?   The market stopped buying, it became one-way, just as it had been one way on the way up over $350 - $360.   The serious Investor went in to get quantities of gold, not to buy at a particular price.   The market lost its liquidity on the way up, so this type of Investor stayed out of the market.   Once the “selling mood” struck, the buyers realised that they could afford to wait until this extreme mood had settled down and allowed the price to form a firm base.    The ideal indicator for this was to watch the “Physical” buyer, usually the jewellery wholesaler type.   He stood back in the early forties and only appeared sporadically in the fifties.   Now he is very visible in the low thirties.

With the two serious buyers off the scene, the capricious speculator was left in charge like a school of sardines fleeing feeding sharks.   At the top, fear took over and the gold price plummeted, bouncing briefly, before falling again, where, as we write it is now trying to steady.   But as with a rise upwards, so downwards, and we wait to see if this is selling “Froth” taking it below its likely consolidation base.   We will know when this consolidation is complete by, initially the “Technicals”, then by the sure presence of the physical buyer.   The large buyer will continue to drain the market of any reasonable quantities of gold and will encourage conditions that produce that volume [the sharks].   Indeed, he will try to position himself just above the physical buyer, forcing him to take the price higher, to get his stock, so moving that solid base upwards, whilst the Investor takes the volumes.   From time to time the same is achieved by standing back, to let the price fall watching the physical buyer and moving in just before he does.    Who are these large buyers?   They will not let you know and will deal in such a way as to cover their tracks.   The funds and banks that deal for them will ensure confidentiality is maintained.   They could be Central Banks, Institution or even high wealth individuals, powerful enough to buy gold in large volumes.

To be succinct, the market fell because of the capabilities of the physical and the large Investor and his advisor’s ability to know when to buy and when to not buy, in the face of the speculator.   The lack of liquidity in the market acts as an accelerating factor to the price, which dealers do not hesitate to encourage as they profit from the higher price you pay!  

This type of volatility in the gold price will continue to be a feature of the gold price, until the large Investor dominates the market.    As you know this may not ever prove to be a constant feature, unless governments bar their citizens from owning gold, as happened in the U.S. in the 1930’s.

Why will the Gold prices continue to rise and at times vigorously?

Recent  and present market Forces in statistical terms.

Here are the facts of the matter.   On this table are described, what makes the gold price go up and down, succinctly, but bluntly.   Like a photograph, it gives a picture, but no movement or feeling or personality.  

Apart from one key feature, these figures describe a gently changing picture, from the days when gold was  ‘successfully’ treated as a ‘barbarous relic’, to when the restoration of gold’s Monetary role began to be re-established, after the announcement of the “Washington Agreement”.   Then, both the Demand and Supply picture began to change: -

If we are right in our extrapolation for this year [2003], the market cannot bear the extra demand without a substantially increasing average price of gold for the year [to date it is around 20% higher than last year].   We have looked at our own assessment of external factors, such as the gentle, insidious, destabilising of the world economy and politics, as well as the change in factors directly affecting gold [below].   When such an overall decay occurs, such as the one we are witnessing right now, the symptoms of that decay manifest themselves in dramatic ways, as history has shown us: -

·          For example: - In 1933 to 1935, the world was trying to exit from a depression, the clouds of war were looming creating conditions where the U.S. President of the day,  President Roosevelt,  made a decision on gold to ensure U.S. reserves were filled with as much gold as could possibly be acquired, to the end that the gold market was dominated by the U.S. governments rapacious buying of gold, initially from the captive market of U.S. citizens, [which was followed by, the banning of the private ownership of gold by U.S. citizens], to the outbidding the market price of gold, for the gold of other nations and their citizens.  

All other factors were pushed into a minor role, as the U.S. government bought thousands of tonnes to spark the regeneration of the economy, to fill a war chest and subsequently to re-establish post-war growth.  

You may be saying that this is just a piece of obsolescent history, but ‘is it?’.   Could the future hold similar prospects?

Positive steps to moving Gold back into monetary reserves and systems.

There is certainly a strong move towards gold by certain important Central Banks of the World: -

q       Russia’s Central Bank – “Our U.S. $ reserves are now in excess of 50% of holdings”.   They have confirmed a desire to diversify away from this position.  Previously they had confirmed they would be increasing their gold reserves and have slowly done so, adding in excess of 100 tonnes in the last year or so.   We expect this process to continue, if not accelerate.   Subsequently, the first Deputy Chairman of Russia’s Central Bank announced that Russia, “would hold a minimum of 10% of its reserves in gold”.   Not only did that imply they were in the process of acquiring another 80-100 tonnes of gold right now, but said this level could increase.   However, it is most likely that they would add to their reserves only by the acquisition of local Russian production rather than going into the open market to acquire it.

q       China – The Chinese Central Bank announced their current policy was to ‘diversify away from excessive dollar holdings’ It has increased its reserve holdings of gold by 200 tonnes, or 50% in just over the last year.   They have liberalised the ownership of gold for individuals and continue to open up the gold market to itself and its citizens.   It currently hold 2.4% of its reserves in Gold, a figure 12.6% below that of the generally, conservative views of the European Central Bank.   It is clear that the process of increasing gold’s content in both the hands of its Central Bank and its citizens will be an on-going, if not accelerating process.   Please note that simply to catch up with other developed countries levels of gold in their reserves, China has to buy 3,150 tonnes more of gold  [to raise the gold content of their reserves to 15%].   Prior to the “Year of the Ram” having started recently, the Chinese public, who for the first time were allowed to buy retail gold, bought so much that the People’s Bank of China had to release some of its own gold into the Shanghai Gold Exchange to cool down prices which had risen above international prices.   The 190 tonnes of local Chinese production one expects to be the primary source of the increase in Chinese Gold Reserves, but with the granting of Import and export Licences already, the people of China will enter the open market via Shanghai.   With their historical inscrutability, the Chinese will no doubt take every opportunity to increase their holdings of gold, without moving the gold price, or being seen to do so, whilst always maintaining their control of the situation.

q       In North Korea lately, the private gold holdings of Korean citizens were handed over to the government in a show of Patriotism, to restock the nation’s reserves.  Again, gold found a critical role in times of distress!

q       Iran has reported to the World Gold Council that they hold reserves of 500 tonnes, a figure not previously known.

q       Malaysia, alongside Iran have formulated plans for trading on the basis of gold exchange values and periodic settlement, thus bringing gold, in place of the $,  into International trade dealings.

We are absolutely certain that the present world situation is ripe for a positive move to gold, in the eyes of both individuals and governments.   This has to be positive for the gold price.

 Supply

Mine Production - Because the gold price has been so low for so long, the profitability of gold mining has diminished considerably.   We are, here, talking of prices that produce a profit for the Shareholders being too low to warrant expenditure on exploration.   As a consequence the likelihood of the discovery of a low cost deposit [making a sufficient profit below $300] has diminished considerably.   This in turn has discouraged expenditure on exploration.  From exploration to gold production takes 5 years, usually.   It has already been so long since the prices established these low levels, that we are now seeing mine production drop, and will continue to see it drop this year.   The pace of this drop will pick up from this year onwards and for the next few years.   This is the natural demand / supply formula, we all know so well.  

But shouldn’t this work on exploration blossom quickly?   A responsible miner needs to be convinced that the high gold price will still be there, when the gold starts coming out of the ground.   It takes a steady average gold price to convince him of that, not what could be seen as a short term spike in the price.

So, dropping volumes of newly mined gold will contribute to the rise in the gold price, more significantly from this year onwards and for some time to come, until new production is established, as it pulls supply further away from demand.

Old Gold Scrap –  Unlike other commodities, gold is not consumed, it can be returned to the market.   This source of supply is price sensitive, but not always, obviously so.   As owners of the cheaper types of jewellery see prices rise, so they sometimes realise profits by turning in their gold for re-smelting.   We say cheaper gold, for the jewellery costs can be in excess of 50% of the costs of good jewellery.   Few wives are impressed by husbands selling their jewellery, it could prove a once in a marriage event – the last one?

Whilst gold is hoarded in a pre-war climate, escape is oft provided by sales of  scrap.   However, as you can see from the above figures, prices do not have to rise for scrap gold to be sold.   Perhaps the increase in sales from 2000 to 2001, was due to a fear that the gold price was still on a downward slope.   The gold price during 2001 saw the solid base in the gold price being built, which may have deterred sales as expectations of higher prices were factored in. The increase in scrap sales came mainly in the last quarter of the year [primarily from the Middle East], as the increase in price was absorbed and as prices rose.  

We do expect the supply from this source to rise in line with movements in the gold price, as this is a form of gold price speculation too.  So long as this sector perceive a gold price rise is on the way, they will buy or hold gold.   If they perceive a fall is due, they will sell.

Producer Hedging – It seems the days of selling gold forward to finance the development of a mine have gone, certainly until interest rates rise to provide the large contangos which add the cream on the forward sales of gold.   We cannot see interest rates rising for some time to come and find it difficult to see such a scene in the near to medium term.

Producer hedging is ideal for a market where one expects a neutral, to dropping, gold price, Those who followed the ‘hedged’ road secured prices  [in 1998 you could sell forward at just below $300 and achieve a net income of $355] below the current market levels, thereby denying the shareholders the opportunity of a rising income, from a rising gold price.   We do not expect to see this type of operation resurrected, until the general perception in the market place, as reflected in lease rates, the contango and the gold price, is for a fall over time, with no prospect of a medium term rise, in the price.   As you can see not only has supply from this source has dried up [see Net Producer Hedging as a source of Demand – below] but the producers have been turned into buyers of gold, in a rush to unwind these hedges.

Producer hedging produced accelerated production  and subsequent accelerated sales of gold, at a time when the price was falling, over the long term.   It was a useful tool to produce a growing supply of new gold at a time when the U.S. $ was in the ascendancy, and the U.S. in particular, supported by the developed countries, wanted no challenge from gold.   The $ had to grow in use until it was by far the most used and plausible of the world’s reserve currencies.   Now that it is in a hegemonic position, this objective has now been achieved, so the Monetary Authorities have no more need to suppress this judgemental challenge form Gold.   Consequently, they have no interest in encouraging an accelerated supply of gold.   This is now being reflected in gold being withdrawn from the gold lending scene, by Central Banks, as well as the limitation of gold sales by 15 of the key developed countries, as reflected in the Central Bank Gold Agreement.

Dis-Investment – In the year 2000 the market mind set was still for falling gold prices as reflected by the figures for that year.   As the change in direction of the gold price became apparent so dis-investment fell.   In 2002 it ceased, as the destabilisation of the investment scene set in.  

 With this set to continue, as gold forms a solid asset class in the minds of Investors, outperforming other asset classes, we expect to see Investment from “Safe Haven” or Long term Investors rise considerably, keeping Dis-Investment at zero.   

This could prove the most dramatically growing gold demand factor, as this investor buys solely to get away from other decaying assets.   When the dis-investor becomes the Investor, gold is performing its most valued function of providing “safe havens and wealth preservation”, for the large investors.

Demand

Jewellery- Jewellery is price sensitive, but also reflects the general level of wealth.   The healthier the purses of the affluent, the more is spent on gold jewellery.   In India the demand pattern is linked to religion as well as culture, so the level of demand is dominated by the amount of funds to be spent on jewellery, which varies only with the success of the agricultural season.   One would therefore expect the demand from India [855 tonnes in 2001] to vary with the cost of that gold. i.e. if the gold price rises 10% so the volume of purchases will drop 10% as the funds available remain the same.   But the religious connotations and sentimental values reduce the amount of gold treated as a speculation.   This being said, we do expect Jewellery demand to reduce by around 400 tonnes worldwide, this year at the most in line with the price increases.

Electronics

Generally a relative constant, driven by technological demand, not price, we would expect this source of demand to maintain its level in the foreseeable future.   The demand for items consuming gold will dominate this side to gold.   This is strictly a commodity use of gold.   The figures again demonstrated a dropping demand in 2001, when the average price dropped somewhat [$279 down to $271], then a further drop of 10%, in the 2002 year when the average price rose 20%.   In this sector gold reacts as a commodity would, but because of its unique qualities, is not easily replaced by a poorer quality metal.  We do not see a large change in the amount of gold bought for industrial reasons.  

Official Coin

Difficult to gauge, as this reflects a certain patriotic demand, and other factors not related to the usual picture of demand and supply.   Germany, Malaysia and other countries are issuing gold coins for commemorative reasons.  

China on the other hand wants it citizens to own gold.   The Banking system in China is fragile and not near the levels of sophistication of the West.   Gold is seen in China as a traditional place to place savings.   Coins will be a place where the small investor can place his savings.

This market, particularly in the Far East, is not so price sensitive.  We have no doubt that the Chinese government appreciates the strategic wisdom of the nation’s individuals buying gold through the markets.  That one’s citizens have gold “under the mattress” proved useful in the U.S. when Roosevelt forced Americans to hand over their gold to the government, in 1934.   Should China continue this route, with Coins supplied from Switzerland as well, the net Chinese holdings of Gold Coins, will continue to rise strongly.

Official coin has risen ahead of the gold price in 2001 then fallen 10% in 2002.   We do not believe this is due to the rise in price.   Indeed we believe 2003 will see demand from this source rise significantly.

Dentistry – Another relatively non price sensitive, commodity use of Gold and one that will not vary so much with a rising price until it rises too much.   The fashion of Dentistry will have a far greater impact than the price of gold.

Difficult to get one’s teeth around the price at which demand will change, one can only tell the story of an unfortunate fellow, with very golden teeth in his smile, sitting on top of a load of timber travelling to the mill in Malaysia, who was decapitated when passing under a bridge.   The driver realised something had happened further down the road, came back found the head, but the gold had gone.

What can one say?

Other Ind. Uses –  This again will vary more with the state of the economy, than with the price of gold, so should remain the same for the foreseeable future.   The price pattern is the same as in other areas of Fabrication with demand dropping in 2001 from the year 2000.   the 10% drop in 2002 we do not believe reflects price sensitivity and expect the same level of demand in 2003.

Medals Imitation Coin – This is one area where we could see a rise in demand in a rising gold price environment.    Perhaps the figures showing the same drop in 2001 from 2000, reflected price expectations too.   With the potential for good price rises, 2003 could see a change in this market reflecting the small “safe-haven” buyer entering the market.

Bar Hoarding – Usually the vehicle for high worth individuals, when investing in gold.   We note the change in pattern in the price compared to Fabrication demand.   Perhaps these buyers were more perceptive, understanding the “Washington Agreement” better than most of the market.   We can see this in the pattern of buying as the price changed.   Between 200 and 2001 as the price dropped $8 on average demand for bars grew 7% on the year.  Between 2001 and 2002 this increased by 10%.   We expect it to have risen strongly in 2003, as the structural decay of the world economy and investment instruments is properly assessed by fund Managers.   The only disadvantage of bar hoarding such as the ten-Tola bar, is that in some countries it is treated as solely investment gold and attracts Tax.

Central Bank Buying – We have treated this as a new feature and not shown a net figure, because of its importance.   It is a departure from the policies shown by Central Banks in the past.   Central Banks have for so many years encouraged gold sales, given the impression they were about to sell gold and generally been anti gold, that when we see Central Banks talk of buying gold or actually doing so in quantity, it is of vital significance to the gold price and its future levels.   The actions of China and Russia, according to them, will continue to be to acquire Official Gold for their reserves.   We have no doubt that many Central Banks are reflecting on the future for gold reserves, in the light of the falling $, and will either not sell gold, or not sell gold but buy gold.   This and the large scale buying of gold by Investment buyers will create new and sustainable price levels of which we have no doubt.

Net Producer Hedging [De-Hedging] – Perhaps the main drive behind the gold price last year, with the normal suppliers of gold becoming buyers  the unwinding of hedge positions became a dramatic feature of demand.    352 tonnes of gold were bought in the market by Producers clearing their books to some extent and putting them in a position to  profit from a rising gold price.   With gold currently in the middle $340’s, these hedges are still just profitable as unhedged positions selling into the market, but possible not for long.   It is clear that the risk of disappointing shareholders and losing out on the higher gold prices is inspiring gold producers to maintain the policy of unwinding these hedges, as a matter of haste.   Gold above $400 would paint a poor picture of management getting $350 or so for their gold.

We expect the demand from the market for gold to cover these hedged positions to be the same, if not more this year.

In the main, the above factors for demand / supply have the picture of a commodity metal, with interesting facets reflecting gold’s ability to out perform other asset classes.   Over the last two decades, barring last year, the price has been in a bear market, which emphasised the commodity aspect, keeping prices where they were.   Jewellery demand kept gently rising as the world’s wealth grew, so eventually the market balance reflected a price in the higher $200’s.  

If we were to strip out the commodity factors of gold and look at the Demand / Supply picture this is what we would see: -

[estimated for this year, based on last year [above in the table].

Supply :                 2,517 tonnes per annum, from mining production.

Demand:               2,932 tonnes per annum, from commodity consumption.

This picture would have, of course put the market in such a “Bull” phase, that the price would have risen to warrant an ongoing increase in supply, so as to increased it to match demand.   That in itself would have place the current gold price above $400.

Monetary & Investment qualities

So far we have presented the picture of basic demand and supply, because it gives the underlying explanation, in terms of how actual volume of demand out weighs the supply.   Again this seems inadequate for our proper understanding of why a vigorous rise in the gold price, insofar as we cannot measure adequately the impact of non-demand / supply factors, on the impetus to the gold price.

So we move on to other market factors that drive the price, which usually, the layman has difficulty in identifying as directly related to a gold price rise.   They are summed up in  the title, Monetary and Investment qualities of gold.   Some of these are,

·          Central Bank ownership and ‘controlled’ selling,

·          Jewellery, coins, etc. which do not ‘consume’ gold.

These facets change gold from a “commodity”, to something of far greater depth and breadth, which mix into the commodity aspect so obtusely as to obscure our ability to forecast its behaviour, reliably, as is the case with pure commodities.   The forces that come to play on gold, sit on top of the commodity aspect of gold and creates a blend that separates it, not only from other commodities, but other investments.  

Like a weathervane, the gold market rises to its greatest potential when other markets are decaying as they are today, with the worldwide decay of financial assets which is far worse than most investors appreciate.   Hence, the gold price is responding as it has in similar times in the past.    Words such as “Trust” in values, “Confidence” in the future, are features of a growth equity market, however today, when the reverse is true, the steady decline of these values is reflected in the present worldwide investment scene.  

Gold Market Dynamics

To demonstrate the dynamics of the gold market: -

q       Look back at our table above and take out the Central Bank sales at 549 tonnes in 2002.

 If that were removed from the market, what would have happened to the price, how high would it have to rise to  encourage sufficient dis-investment of old gold scrap, to compensate for that loss of supply?  Contrary to expectations, Central Bank sales, from the Netherlands, Switzerland and Portugal, have not been sufficient to provide supply to the extent to calm the markets and remove the vigour from price movements, recently.   This has contributed to the volatility, as the supply, with the exception of Switzerland, is not predictable either in terms of timing or amounts.   

As an indication of the availability of gold for hedge operations, it is now known that the Central Banks lending has been withdrawn from the market recently, as the lease rates on gold are so low that they can’t cover their cost of credit reserve. That’s the amount of capital that they have to set aside when lending to any counter-party. This stands at 25% for OECD banks and 100% for all other Lending Central Banks.   Again a negative factor on the supply front, inducing a greater vigour into the price as supplies prove insufficient.   Remember, more gold can’t come from mining!  Will Central Bank sales increase to keep the price down?    – keep your eyes on the next Central Bank Gold Agreement to be signed in Sept 2004!   With the spectre of counter-party default amongst debtors of the Central Banks becoming an increasing danger with so much gold out on loan still, there is likely to be an ongoing withdrawal of gold from the lending market for this reason as well.

q       Look at a price sufficient to reduce the demand for jewellery in the developed world, by 400 tonnes [it would have to be a lot higher than you think] and add the expected 300+tonnes bought by the Chinese [its happening already] this gives only a reduction of 100 tonnes to the expected Jewellery demand in 2003 as we have extrapolated above.  Now - Add to the above demand figures, a Central Bank purchases increase to 500 tonnes – then we have the same problem, a very heavy shortage.   Will dis-hoarding occur from Jewellery and at what price? 

q       We know that Bar hoarding and Investment buying is growing steadily and strongly in terms of the available gold.   This could add a further 200 tonnes or more to the demand, without any leap of the imagination.

Now we are beginning to see the causes behind a vigorous gold price rise.   Turning to other Investment criteria that applies to the gold market: -

q       The professional Investor the measures the total return on capital employed which dictates his decisions.   Translated, this reads, where can I make the most total income from the money I invest.   Note this is not a simple addition, for it must include where can one  minimises losses and preserve what one has already.   So the professional thinking in terms of a falling set of values, not a growth market, makes a review of the available opportunities and selects the best .   This process can follow these lines: -

·          A deposit in $, for instance, has been losing money in terms of inflation, as well as value, compared to other currencies.   Gold has outperformed all key currencies and equity markets for some time now.   Hence Gold is at the top of the performance league over the last year, in terms of total return on capital return.   Will it continue?   If the review shows it will, that is where the investment is made.   .  [ It is interesting to note that a bill has been introduced into both the Senate and the House of Representatives to lower Capital Gains tax on gold from 28% to 20%, giving us cause to believe that the powers that rule in the States, also like the idea of acquiring some of the metal that protects against decaying assets].

·          Interest rates on the dollar are below inflation rates in the States and are expected to fall still [income returns dropping].    What is the future for interest rates and their impact on the different markets.   Currently, they are headed lower in a deflationary climate.   This is not only a danger to future income but to present income, hence the bear equity markets, and the rising prices in the U.S. T-bond markets.

·          The proposed policy of the Fed, should interest  rates fall to zero, will be to buy back long term bonds, local and overseas and possibly to set a ceiling of 2.5% on long term government bonds.    This release of liquidity will ‘under whelm’  overseas Investors in the $ as it is a little like a company being able to issue shares into the market as and when they wish, whilst ignoring the impact on share prices.

·          The external value of the $ is dropping because of a trade deficit to other nations, often, inadequately compensated for by capital inflows, leaving a falling $.   This deficit is likely to continue for the foreseeable future.   Hence the professional non-U.S. citizen has to deduct the assumed future value of the $, from the expected positive return from his U.S. investment.   Currently the result is not a pretty sight.

·          Our professional will logically, turn back to gold and go to the next stage of assessing prospects as accurately as he can.  This means asking the most often asked question in the markets, ‘will the gold price go higher still?’   Our man, if he really wants that professional approach turns to the Technical picture, which describes the most likely shape of future markets.   The measuring of price patterns to highlight future price performances has been refined to extraordinary levels, and has transformed profitability achievements wonderfully.   At Gold-Authentic Money, Tony Henfrey is the expert, who has tracked the gold price for  almost 30 years.   His abilities were aptly demonstrated recently, when he gave the big buy signal at $319 for the short term and $324 for the long term buyers!   Our professional would consult him before acting. [Subscribe through   www.authenticmoney.com ]

q       The gold price is affected on the individual front most heavily by the overall climate in financial markets.   As all the individual features of the weather are important, so it is the final mix of them that permits an accurate forecast.   In times of growth the financial climate is fair to good, as we have seen in the last 20 years and more, but these weather patterns have now changed into a season of storms and is hitting home hard  as well as continuing to be forecast.   Sadly, this is the weather that gold finds best.   It is the port in the storm, the “safe- haven”.   It acts contrary to markets usually, if allowed to do so.    Left alone, it would be an investment  :”for all seasons”, as it was previously.   What makes up the best weather patterns for gold: -

·          Confidence waning in the economy, once it has exhausted its growth potential.   This is reflected in falling equity markets, as is being seen now and falling interest rates in an attempt to stimulate growth, which efforts prove ineffective.

·          Abuse of the management of paper currency.   This can be reflected in inflation getting out of hand or through the over expansion of the money supply to counter Deflation [Deflation is now impacting in Japan and  the U.S. & Europe], or simply in spending more than comes in [Deficit financing] to the nation or government.

·          General confidence in Investment instruments and their management, has to diminish alongside of falling confidence in government financial management.   Like the arrow on a Barometer, confidence is swinging round to bad weather, now, with news of one of the most respected Auditing firms in the world, being indicted of Fraud, following another one months ago [KPMG & A. Andersen], leading to a question mark being raised over accountants in general, as well as losses in their multi billions being made in some sectors of the economy.  

·          The final safe place for paper money is the Bond market or Cash.   Deposit rates having hit negative levels in the States and are expected to fall further still.   The Long Bond market yields are dropping quickly to levels where the risk reward ratio becomes minimally attractive.   With storm clouds gathering on other fronts the small patch left under the sun loses most of its attractiveness as does any residue of confidence!

·         The Financial climate has been so good for so long [the bulk of the life of most financial managers] that the need for a port in a storm is almost forgotten.   As a result the port is in poor condition.   The gold price in 1979 was felt to have a floor of $300.   Even after a spectacular run, the gold price is only 25% up from there, so one can say it is still at low levels.   This bodes well for the extent to which gold could rise.

·         The prospect of war raises risks on so many levels, which hastens the pace of moves into gold..   In the immediate situation, the almost certain war in Iraq spotlights troubling possibilities for the outcome.   If the war is efficient and effective, supplies of oil will increase to the extent that prices could more than halve, so boosting growth in the U.S. and other developed economies and assuring Bush of re-election.   However, if the war protracts, and possibilities of oilfields being set alight, or other Arab states reacting with diminished supplies the oil price could soar to $100 a barrel [as stated by Sheik Yamani, past Saudi Oil Minister].   In this climate, gold becomes the favoured asset class of the individuals and institutions, but unfortunately invites the capricious Investor at first.

·         Central Banks realise that Gold’s place in a nations reserves give confidence to all, both inside and outside a nation, when that confidence is on the wane.   The Washington Agreement was primarily a re-affirmation of key central banks view that gold is a valued part of any nations reserves.   Add to this the acquisition of gold for reserves, by China and Russia, no doubt to be followed by many other Central Banks, the new demand for gold in a monetary role has begun again and will continue.   At current price levels, there is insufficient gold to permit a large scale expansion of gold reserves, but at significantly higher prices, it can be done.   By allowing the market price to rise significantly, a nations reserves of gold, in value terms, will rise, with minimal open market purchases.    Whilst most of the western nations will not be inclined to sell any of their gold from now on, a rise in the gold price of these reserves will go a long way to convince outsiders that sufficient gold is held to back their currency. Those without gold would be horribly exposed.   So the weather conditions ideal to gold would be a cessation of sales of gold by Central Banks and the gentle acquisition of gold by Central Banks presently short of it.

·         The realisation of the impending price rises of large proportions, has been seen by some key players in the market, who have been reacting over the last year.   The Gold Producers have seen it and although they secured profits as their stated motive from Hedging, were aware that if they do not clear them away, they could miss out on a price rise in gold that would all but destroy their credibility and future.   The demand from gold miners for gold,  to remove this possibility prompted a new demand factor  to hit the ,market last year, to the extent of 352 tonnes.   2003 should see a similar demand or higher.   There is a belief amongst many that this type of demand extends to open short positions of huge proportions.   We are not qualified to comment on that, except to say that any massive short covering would accelerate the price rise to destabilising proportions, if it is the case.  This is as major a demand factor as the Central Banks are a supply factor.   Now we can feel the proportions of the market!

·         The final condition that would accelerate the price of gold to the stratosphere would be a degeneration of the financial, economic and political world scene to such an extent, that a repeat of President Roosevelt gold acquisition acts were repeated, by the U.S. or Europe or both, with other power blocks competing for the same gold.   At the moment unlikely, buy technically possible.

In the Gold-Authentic Money series of Publications, we will be keeping up commentary in this burgeoning market.

Producers precipitated the current price rise, with only a small impact from the above other factors, except for the distorting Iraq factor.   As these factors reach maturity, so there will be an acceleration in the gold price rise.   The pace of these upward moves will be like the gear changes. Currently, we are accelerating in first gear, soon we could change to second gear, after that momentary dip of the engine as we change up.

 There are several gears to follow.

In “Gold-Authentic Money” and its sister publications, “Changing Tack”: -

We gave the entry point of gold recently at $320 exit $370+ went short & will re-enter when ready!  

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-- Posted Tuesday, 18 March 2003 | Digg This Article

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