Alex, thanks for all your posts. Thought you and others may enjoy this fro Gold Eagle site.
Is Gold set to rise? A private interview with an anonymous
Swiss banker, a bear of gold since he started following
commodities in the early 1980's says "Maybe". According to him,
the supply vs. demand fundamentals are starting to shift in favour
of the yellow metal. "Many mines are now closed and for a
number of years retail and industrial demand has exceeded new
mine supply." Nevertheless the Gold price has continued to fall
punctuated by very weak rallies for some 18 years. "This is due to
the fact that the Gold Market is far larger than the annual new
production. Almost all of the gold ever mined still exists and is free
to be traded - at the right price. The falling price has been due to
dis-investment by bullion hoarders and central banks. Thirty years
ago the investment choices available to investors and central
banks were very limited. Now there are far more investments
available to both central bank and investors, ranging from to
foreign currencies, international equities and bonds, to futures,
options and guaranteed return products."
"Some of the fundamental reasons why people hold gold have
gone in the world's wealthiest countries - war, confiscation of
assets, inflation, exchange control, absence of alternative
investments".
Almost all of the gold ever mined still exists
and is waiting to be sold - at the right price.
So why should this banker, now be less bearish than before? "I
am not saying that gold is a screaming buy yet, but I think we
have seen the bottom. Some factors which should cause people
to consider gold again may become more important in the coming
months. For example, much of the Gold reaching the market has
come from Central Bank Sales. In particular, the Asian Crisis
created massive gold sales from the distressed countries as they
tried to defend their exchange rates in vain. Hence the recent low
gold price. These countries should now be trying to replenish
their coffers with the help of the IMF, and will probably seek to put
part of their reserves back into Gold. The value of gold became
obvious to the local populations of these countries as the
exchange rate plummeted and prices in the shops rose. The
governments by inviting the local population to hand in their gold
re-inforced its values to a larger population as its price rose."
The Asian crisis made people in the region realise
the value of Gold as their local currencies plummeted
"Another factor which has been depressing gold has been the
Central Bank sales by the European Central Banks. Before the
introduction of the Euro from 1st January 1999, the new
European Central Bank will need to constitute its reserves and it
will decide how much of these should be in gold. At present it is
not clear where this gold will come from, probably the existing
central banks will be asked to hand over all or part of their gold
reserves. This is likely to mean reduced gold sales in the future.
No one yet knows whether the new Euro will be a strong or a
weak currency. In order to give confidence to the world the new
European Central Bankers are likely to want to have a solid
backing to the currency. As far as the public is concerned, they
have no idea whether the Euro will work, or how much it is worth.
After all, paper money is only worth something as long as the
public has confidence in it. This is likely to bring in new Gold
buyers before the Euro arrives."
The new European Central Bank will need to decide
what percentage of it reserves are to be in Gold.
"The Millennium problem is another factor looming on the horizon.
The simple truth is that no one knows whether the US
Government will be able to do its sums on the 1st January 2000. If
it can't, we have meltdown of the world's financial markets, and
investors will flee to the safety of Gold. Many investors are not
going to sit around until then to see what happens. They will
prepare themselves in advance. With stock markets at record
highs, this may be a good time to start making the switch of at
least some of their assets."
The Millennium problem opens the
question of whether the US Government
can do its sums on the 1st January 2000.
How high can gold go? "In theory, there is no top in the short
term. In the long term, say five years or more, the gold price is
unlikely to remain significantly above the marginal cost of
production. At present production levels, this is around the $280
level. If the demand for gold rises and is not met by dis-hoarding,
then the marginal cost of production could easily rise very
significantly, as mines with lower concentrations open to meet the
new demand. Probably, a long-term top would not exceed $1'500,
assuming no inflation. At that price production would be many
times the current production."
"In the short term the price has nothing to do with production
levels, but is driven by the ratio of new gold hoarders versus
dis-investment. We must remember that nearly all the gold ever
mined is waiting to be sold - at a price. And for twenty years that
price has not been seen and hoarders have become disillusioned
with gold as an investment. Virtually no new hoarders have been
created, while many existing hoarders have become forced
sellers."
Many existing gold hoarders
have become forced sellers.
"The sixty four thousand dollar question is what will happen when
the price starts rising. Given gold's dismal performance over the
last 20 years, it is reasonable to assume that most of the weak
holders have been shaken out. As the price rises, the demand to
hold it as an asset class increases. In that respect, it is not
dissimilar to the stock market in recent years. What will happen, if
investors believe the stock market has become over-valued and
realise that gold is starting to move upwards? A rise could
become self-fuelling leading to rocketing prices as long and short
term gold bugs fear that they are going to miss out on the next
gold price rise. It is impossible to say how high the top would be,
but certainly it would be significantly higher than today's price of
about $310. The conditions which need to be in place for an
explosive bull market already exist in the gold market - no interest
from speculators, all weak holders shaken out, limited supply and
most of the world's future production for the next few years
already sold forward. All we need is the trigger to start the price
moving. I do not know when that trigger will come. It may start
gradually with the price rising gradually, or there may be some
event such as a war or another financial crisis that starts it. But I
can assure that it will come. I just can not tell you when."
What will happen to demand when the
gold price is perceived to be rising?
Won't the gold mines sell in to any rally? "Yes, but only up to a
point. Most of the World's future gold production, for at least the
next few years, has already been sold forward and thus it exists in
the market place in the form of paper gold. If the gold price is
rising, the ability to sell further gold will be limited, although of
course there will be the possibility of selling future production from
mines which have been closed and will now be re-opened. As to
whether the gold mines will want to sell further production into a
rising price will depend on the attitude of their directors and
shareholders. Certainly there will be some who will question
vociferously the wisdom of having sold tomorrow's gold in the past
at lower prices than now available. Especially if the margin calls
are coming in."
When the gold price is rising, gold mine shareholders
will question the wisdom of forward sales.
Isn't the price of gold dominated by the trade in "paper gold"?
Certainly most of the world's trading in gold is dominated by paper
trading with investors never taking physical delivery. Paper gold is
represented by physical gold held in Banks, warehouses, or still
in the ground and not yet mined (e.g. forward sales by the gold
mines). The interesting feature of paper gold is that like paper
money, its supply can be many times the underlying amount held
in support of the paper. For example, Mr X buys paper gold
through a Bank. The bank credits his account with the gold, but
seeing that he has not taken physical delivery, they can then lend
it out, e.g. to a gold mine that then sells it through the bank to Mr
Y. The bank earns a fee by charging the Gold Mine interest on
the Gold it has borrowed, until the gold is repaid, by fresh
production in say three or four years. Meanwhile, both Mr X and
Mr Y both own gold - the same gold, and since neither has asked
for delivery, the bank can lend it out again to another gold mine, -
who sells it to Mr Z - and so on. The effect of this is that demand
for paper gold has been met by the creation of new paper."
Paper gold is like paper money.
New supply can be created out of thin air.
So what happen if Mr X, Mr Y and Mr Z all demand physical
delivery at the same time? Basically, the price of gold for spot
delivery rises as banks scramble to meet their liabilities to these
investors. Even if only one of them wants his gold, it moves many
times the paper supply off the market. For example fifty investors
or more may effectively own each kilogram of paper gold. If a
trend starts, we will have what is known as "backwardation"
where the price of spot delivery gold is much higher than the price
for delivery in six or twelve months.
What happens to the price if investors make a move into gold? In
the short term the price could go through the roof. We must
remember that the amount of financial assets today is at least ten
times as much as when gold hit $850 some eighteen years ago. If
just two percent of professionally managed assets were to be
moved into gold bullion, the price would be well over $1'000 per
ounce. Of course such a move is not necessarily going to move
into physical gold, but it is more than likely to move into paper
gold and the shares of gold mining companies as the physical
gold price rises. And what of the sellers? If they haven't sold for
eighteen years, when the price was double today's price, they are
not likely to be selling in droves. The only sellers will be those
who bought in the last six months at below $350 an ounce. The
smart investors are the ones who buy at the current price, while
the dumb investors are those who bought in the wake of 1980's
record prices.
Smart investors are buying now.
The dumb ones bought eighteen years ago.
Martin Dixon
20 April 1998
martin_dixon@hotmail.com
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