For what it's worth:
An interesting recent note from people from one of the top funds in the world:
STABILITY SHORTAGES
Is World Stability Taken for Granted?
If you were to write down the names of the most stable countries (politically and economically) in the world your list would almost certainly include the USA, Germany, the UK, Switzerland and France. A list of the least stable countries might currently include the likes of Indonesia, Thailand etc.
Interestingly, the list of "most stable" countries will also tend to be a roll call of the big Central Bank gold holders. The correlation, while not perfect, is so strong that it goes well beyond mere coincidence. The stable countries of the world have a deeply ingrained "culture" of stability which involves a combination of long term and conservative economic policy together with the political will to maintain sensible policies in the face of adversity. In the past, this culture has led, amongst other things, to the accumulation of rationally held gold.
People in the most volatile countries also crave stability. In these countries however the culture is different,and Governments' long term ability to accumulate common wealth is open to question. In such areas of the world, citizens are forced to take matters into their own hands at the personal level. This often involves buying gold and it explains why developing country demand for gold now exceeds developed country
demand. This process is likely to be reinforced by the Asian currency commotion. The front page of Monday's FT showed the disturbing image of an armed policeman outside one of the 16 Indonesian banks that had closed their doors over the weekend. Even if investors do subsequently get their money out, the willingness to reinvest in other financial institutions is diminished. The net result of these factors is the
following simple observation:
In the "stable world" we have little need of gold, unless it is in the form of high premium jewellery. Except during increasingly rare "inflationary events" we trust our governments to do a good job for us. We should be concerned therefore when we find evidence that our political and economic leaders are changing their cultural approach to reserve management. A culture of stability takes decades to establish and the fruits of the policy can endure for decades. However these fruits can be tossed away all too easily. When Central Bankers sell their gold they are effectively demolishing a foundation pillar from their economic policy - a pillar which has stood the test of time. By swapping gold (zero default risk + low volatility + low return) for
interest bearing debt instruments (more volatile + high return) they are increasing the riskiness of reserve management policy. This move from an ultra-low risk policy to a higher risk policy has consequences for Central Bank culture. Gold is a "bottom drawer" asset and having mobilised cash through gold sales and put it in the "top drawer", it will be over-whelmingly tempting for Governments to then raid the piggy bank and spend this money on plugging budget deficit gaps. In the long run this surely undermines a nation's finances and does little good to the citizens. It may be relevant that in the past year the currencies of those countries who have sold (or are about to sell) gold have all been weak (vs US$) for example Canadian dollar -5%, Swiss franc -10%, Australian dollar -12%, Dutch guilder -14%, Austrian schilling -14%, Belgian franc -14%.
What we are really trying to say is that gold's low risk characteristics make it an enduring source of economic stability at both the national level and the personal level. Certain stable Central Banks feel that their economic management is so finely tuned and that they can now do without their gold and are selling it. They may turn out to be right. However the commotion in SE Asia shows that there are plenty of places in the world that are suffering a shortage of stability. While short term patterns might be complex, in the long term,these countries have been and will be the buyers of the Central Bank gold. Looked at in the currencies of these countries, gold has proved to be a superb store of value recently.
Similar returns would have been obtained from an investment in US$ bonds or any other major foreign currency. However, such instruments are not universally available to investors whereas gold is. Furthermore, many investors in this region understand gold and will have owned gold in the past. The same can not be said for foreign bonds.
G15 calls for study of currency markets
One of the most common arguments against gold is that the free convertibility of most major currencies reduces gold's role as a safe haven.
The universal nature of gold means that it can always be swapped for something else, a feature that is not always true for currencies. Indeed the latest comments from the G15 meeting in Kuala Lumpur provide much food for thought. A large number of countries have tried to "import" financial stability by pegging their currencies to the US dollar. These currency pegs have been severely stressed in recent weeks and understandably some of the representatives from countries that have suffered at the hands of speculators would like to tame what they refer to as "unethical" currency trading.
Malaysia's Prime Minister, Dr. Mahathir Mohamad called for new rules to curb the free wheeling nature of the currency markets' and make them more transparent. Any moves to curb speculators though may prove
counterproductive as it is difficult to distinguish between ethical currency speculation and unethical currency speculation. Currencies will become less convertible and riskier so enhancing gold's relevance.
More evidence of the pain
Although gold's reputation as a store of value is more or less intact, it remains the case that it is a very cheap store of value. The gold industry is severely stressed and adding to the list of recent cutbacks and closures, Placer Dome has announced the closure of the Detour Lake mine in Quebec. The mine had budgeted annual production of 125,000oz but expects to cease mining by the end of the year because development of the new ore zone would not be worthwhile at the current gold price. Meanwhile, low gold prices have forced Echo Bay to write off US$309m boosting the company's "deficit" to US$574m and reducing shareholders assets to US$214m. The balance sheet reveals US$710m has flowed in from shareholders and US$574m has flowed out through losses - rather shocking and the reason why we have avoided owning shares in the company.
The longer term picture
On a lighter note, we are indebted to Homestake for providing us with the information to produce the chart below. It shows the Dow Jones Index and Homestake Mining indexed to start at the same level as the Dow Jones. If you had held both assets during the last 100 years you would not only be rather old but, amazingly, your return to date would have been similar on the two. However within the period there would have been times when the performance has been widely divergent.
During the Great Crash of 1929-32, gold shares clearly proved their worth as an insurance policy. More importantly, gold shares have proven themselves to be a useful wealth protecting asset during the prolonged bear market of 1966-82 When the Dow Jones index first broke through the 1,000 barrier in 1966, it was to be another 16 years before it once again commenced on a upward track. During this same period, the capital appreciation on Homestake shares was 466%. It is also interesting to note that during the subsequent bull market for equities, Homestake has only managed to gain 8% while the Dow has soared 645%. It is a useful reminder that gold shares can go up as well as down.
Graham Birch and Geoff Campbell
Mercury Asset Management |
