THE MINING INVESTMENT COLLEGE
Moderator: Adrian Day
Taped on January 13, 1998
8:00 pm CT
Part III of III
Operator: Of course Mr. Day. It looks like Stan Potter has our next question.
Stan Potter: Hi I'm from Carmacks, Yukon in Canada. And I was just wondering what you thought the price range for gold might be this September and December? And if you were looking to buy junior mining stocks what months you'd be looking at you know just looking ahead from now? And would that be exploration or producer type companies?
Frank Veneroso: You know we actually don't make short run forecasts like everyone else does because we only make forecasts about things that we think we can forecast.
If there is a pick up in central bank sales and producer volumes or funds shorts, if the flow from central banks increases for whatever reason the gold price will go down. And if it abates dramatically the gold price will go up a hell of a lot.
Now probabilistically what I would say is that there has been one or more large EMU related central bank sales that will end probably before the end of April and possibly have already ended as of the end of last year. That means that the price will tend to go up.
There will be other central bank sales. They probably will not be as large. And overall there will- probably will not be as many once this EMU related selling is over if that's in fact what's happened.
Two, the Asian currency crisis' negative impact on gold will abate as I said. We think it's chopped about 400 tons of demand off the market at an annual rate. It has generated some distress central bank selling.
And we think that the total supplies and loss of demand associated with the Asian currency crisis will be reduced by perhaps 75 percent, even if these exchange rates remain very depressed, (until) sometime in the second half of the year.
So those two things which we can sort of assess tell us that in the second half of the year the gold price will be higher than it is in the first half of the year and possibly by a reasonable amount.
And so I would say if you were going to buy you should buy in the first half of the year. And the lower the price is the better to buy.
The price has just gone to a 13 year low. And maybe tomorrow it will all be washed away. But it has managed to come back above the low of 1985 or at least around the low of 1985. And that's sort of a positive price action and would suggest maybe that this is a decent buying opportunity.
I think the risks are higher in the juniors. But the rewards are far greater in the juniors. If I was going to lay a bet I would certainly lay a bet in a diversified basket of juniors. The overall reward risk is much better in the juniors than it is in the seniors.
Adrian Day: Okay Lisa.
Operator: Next we go to Benno Schoenborn.
Benno Schoenborn: I'm from Santa Fe, New Mexico. Recently we heard that a group of Swiss economists recommended that the Swiss sell 50 percent of their gold. What is the reason behind this? And Switzerland doesn't belong to the or will not belong to the EU. And how much gold would be involved if they would sell?
Frank Veneroso: Okay, it started out with a proposal to sell 400 tons of gold for a special holocaust fund. Let me tell you what happened here.
The decision has been made by bureaucrats in the central bank I believe. It is not all of the senior staff at the central bank. One of my friends knows one of them. It's not everyone at that level in Switzerland. Leutwiler, who was the former head of the central bank, has opposed very strongly this policy.
But these are younger central banks who feel that Switzerland has too much gold per capita, too much gold as a share of its central bank reserves and that this gold doesn't yield a return. I think they used this holocaust fund as an opportunity to try and reduce some of their gold holdings.
You know this may have actually backfired. Because as you know to change the central bank to allow gold sales requires a constitutional referendum. And the people are more opposed to a tax that you know for abroad that they have some guilt associated with the holocaust then they are about gold sales. So when they have this referendum people are not just going to be voting on the sale of gold. They're going to be voting on the whole holocaust issue.
Now a lot of conservative people or very nationalist people in Switzerland are very worked up about this whole holocaust issue and are likely to vote against the referendum, even if they don't have a strong feeling about gold sales. So the polls have shown a lot of public opposition.
Christoff Blocher, who is the head of the opposition party, has come out very much against this whole proposal and has vowed to make it a major political issue. He has campaigned for and against referendums in the past and has tended to win.
I myself believe that the odds are not good that the referendum will pass because you need both a Canton and a public majority.
It's easy enough to get a majority of all the voters- well I shouldn't say it's easy enough. It's possible to get a majority of all the voters. But it's much harder to get a majority of the Cantons. Because the populations in the Cantons are very skewed.
You know most of the liberal people there are likely to vote for this referendum are in the cities. And the rural people who are more conservative are in the country. And the country population is less- constitutes more of the Cantons.
So I think the Swiss authorities realized once they proposed this that is was going to be tough sailing. It was going to be difficult to get this referendum to pass. It would take a lot of selling effort on their part. So they have turned to independent authorities- you know independent opinions. That's why they had this panel take a look at it. Well the panel came out and said, well you should sell 1,400 tons of your gold. That then created a lot of bad vibes in the gold market. Created quite a bit of controversy.
And they've backed off a bit from that. They've come out now and said, look we're not going to sell 1400 tons of gold. We're only going to sell 800 or 700 tons of gold. And we're going to do it very carefully. And we're not going to do it in a way to disturb the gold market. We'll be very sensitive about that.
So that panel of experts, their assessment was an extreme. I think they turned to that panel in order to build their case. Because they know they have a lot of opposition, that it's not going to be easy to get this referendum to pass.
And if you look at what they're saying it sounds as though even if the referendum does pass that they'll sell 700 tons of gold or something over quite a few years beginning I guess in the year 2000 or the end of 1999.
Adrian Day: Okay, next question.
Operator: Next, we go to Samuel Robbins.
Samuel Robbins: Frank, would you explain in more detail how you arrived at this real rate of return of gold of 3 percent? We all can understand that bonds should yield a real return over the years of 3 percent and bills 1 percent.
But it wasn't clear to me. And I was wondering if you would do it kind of slowly and thoroughly to show us how you figured out that 3 percent?
Because that's such a key figure, if it's true somebody maybe you is going to wake these central banks up to realize how stupid they are to be selling a high yield securities and buying- replacing with a low yield security.
Frank Veneroso: How do I get there? First of all there are two studies that I have that give me some data on what's happened to the real price of gold over a very long time period.
Professor Jamie Segal at Pennsylvania has tried to calculate what the long run real returns have been for all kinds of assets since the year 1800. And I think he concludes that the real price of gold has risen by 3/10 of 1 percent since 1800.
In Sherman's book on gold there is another compilation. And he actually shows a somewhat higher real return to gold.
Okay I then analyzed this in more detail. And I tried to determine what the microeconomic dynamics were that determined long run changes in the real gold price. And basically what I have concluded is as follows- I mentioned earlier.
There is a trend rate of growth of gold demand that exceeds global GDP. It has been 5 or 6 percent real over the last 25 years.
And if I go back over a very long period I can infer that if there was no monetary flows of gold -- this is very important. If there were no monetary flows of gold that the rate of growth of demand would have been not quite that high but quite significant.
Now let me try and explain to you why I say this. If you go back 150 years about half of the demand for gold was for monetary use. If you look at the current situation where central banks are selling 1,000 tons of gold or 1,500 tons of gold monetary demands are actually negative, okay.
Now you can ask yourself what has happened to fabrication demand over a very long period of time. And the data that I have suggest it has grown about 4 percent. But what would have happened to fabrication demand had there been a- how can I explain this?
Samuel Robbins: Had there been no central bank sales.
Frank Veneroso: Well, yes, what I basically did was I adjusted the data 170 years ago using certain assumptions about price elasticities for no gold- monetary gold demand. And I made the same assumption now.
And what that basically showed me was that had there been no monetary demands for gold a long time ago, 170 years ago, therefore the price would have been lower. Because half of the demand wouldn't have existed. And had there been no monetary dishoarding today the price would be higher.
And then I went and I took a look at what the real price of gold would have been based on pure commodity fundamentals. The same- no monetary demand absorbing half of all gold supplies 170 years or 150 years, or actually it doesn't matter much whether you use 170 or 100 years ago but back in the nineteenth century. And if there was no monetary supplies- monetary dishoarding- negative monetary demand depressing the price of gold today.
And what I found out when I made those adjustments was that based on pure commodity fundamentals with no monetary dynamics the price of gold in real terms wouldn't have grown by .3 percent per annum or a little more than that. But it would have grown by about 2 percent or 3 percent per annum over that time period, okay.
Then I asked myself well, why does that happen okay? Now I told you that for a constant real gold price the trend rate of demand has been 5 or 6 percent over the last 25 years. And if I go back further in time it's somewhat less.
If I take a look at the historical data on mine supply I find out that mine supply grew at about 1.7 percent per annum over the last 25 years. Even though the real gold price tripled and you would have thought that would have stimulated mine supply. But you still had only 1.7 percent per annum mine supply growth. It was a very low growth rate.
If I went back all the way to the year 1820 -- and I calculated a somewhat higher rate of growth of mine supply, something more like 2.4 percent.
In any case it's very, very clear that gold is a scarce commodity. That it's hard to find the stuff. That when the real price of gold is constant the growth in mine supply is less than global GDP. And the growth of fabrication demand is in excess of GDP. That for a constant real price of gold there is a tendency for demand to grow a couple of percentage points in a given year than the supply- the mine supply.
Now obviously you can't have that. The market must clear. Demand must be equal to supply at the end of the year. How does the market clear? The way the market clears is that the price of gold in real terms or in relative terms must rise enough to ration price elastic demand down to the level of price inelastic mine supply.
That means given the price elasticity that we have- long run price elasticity that we have for gold demand that for every 1 percentage point differential between demand and supply you need about a 1-1/2 percent increase in the real or the relative price.
So if you have a 2 percentage point differential between ex ante mine supply and fabrication demand -- fabrication demand being 2 percentage points higher ex ante than mine supply -- that you would need a 3 percent rise in the real gold price to ration demand down to the level of inelastic mine supply. So we did these long historical studies to try and understand what commodity dynamics do to the real gold price. That's in fact what we think has occurred.
Then we went and we looked at the microeconomics of the gold market- of gold supply demand in order to understand the mechanism whereby this occurred, the dynamics that generated this. What I just described to you is that dynamic.
So it's sort of interesting that the historical record and the analysis of the microeconomic dynamics of gold supply demand concern one another. They're mutually consistent.
I hope that's clear.
Samuel Robbins: Yes, very good.
Adrian Day: Okay, let's take- Lisa we have time for one last question if you don't mind.
Operator: Sure, that's fine. Our final question this evening comes from Jim Mecom. Mr. Mecom please go ahead.
Jim Mecom: Good evening, gentlemen, I'm from near Dallas. Two questions. One, I was speaking with a knowledgeable gold broker in Canada this week. And he indicated he expected a further dip in the price of gold this spring due to mutual fund sales. And I wonder if you or Adrian have heard anything about that?
And also you said something about the tenbagger gold, the $600 gold. Could address the time frames a little more. I know that's a difficult question but you're much more qualified to answer it than we are.
Frank Veneroso: Well, on funds selling I think we have a lot of funds selling recently.
I don't think funds selling alone is likely to send the gold price significantly lower. I think the key is really central bank sales. If central bank sales persist at very, very high rates the funds will stay short and they may be encouraged to go more short. If the central banks sales abate there will be a tendency for the price to rise. These shorts tend to be very price sensitive. They are very trend oriented. These central bank sales if they abate will tend to lift the gold price. And that will tend to cause the funds to cover those shorts. The key is less the funds although I will admit that maybe the funds have been more instrumental than anything else in the price decline over the last 11 days. It's much more the pace of central bank sales.
Now on $600 gold I can't tell you what the behavior of the central banks will be. My own view is that it's become quite fashionable for central banks to sell gold now. I think that we will continue to have central bank gold sales. I think that a lot of the bigger central banks that might have sold gold have sold -- the Belgians, the Dutch, the Canadians, the Australians. And that we are now looking at a world with fewer large candidates for- fewer large holders who might be sellers as long as the US, Britain, Japan and the principal European countries don't sell.
The- I think the odds are that they will not. That means that there will be official sector sales but that they will be less. Now there's going to be another problem with the gold price. Producers are going to hedge. They have been terrified by this break. It has rewarded those people who have hedged hugely and imperiled those who have not hedged.
So there will be a shift in the demand hedge as a result of this experience by producers. So there will also be a lot of producer selling- forward selling on any rallies.
So I think it will take years before the flow of central bank gold abates. I don't think it will take forever. I mean there are a lot of people that are likening the gold situation to silver in the late nineteenth century where silver was demonetized. And the silver price fell to 1/3 of its value. And it took decades in order to be able to make the adjustment.
No I don't think there's anything like that. I think that the amount of gold- physical gold in central bank coffers that can be forthcoming is far more finite, that the very sort of positive trends in gold demand and gold supply forward to the gold price will result in a widening deficit, and that the 26,500 tons or whatever it is that's in central bank coffers will get eaten into at quite a rapid rate.
And since they all will not sell that you know when- or even the time arrives in let's say 5 years the odds are that this flow will abate significantly and possibly may be zero.
And when that happens in today's prices -- whatever the inflation rate is forward you can make calculations for future prices. In today's prices- the gold price would clear at about $600 an ounce without significant Western investment demand when that flow abates.
Adrian Day: Okay well that's probably a good note for us to end on. I'd like to thank everybody very much for attending and listening and thank in particular Mr. Frank Veneroso for his insights and some rather unusual and thought provoking ideas. So once again ladies and gentlemen thank you very much for attending.
Frank Veneroso: Thank you Adrian.
Adrian Day: Thank you.
Operator: That concludes today's conference. Thank you for your participation.
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