Part 2....................
So where has the CB gold gone?
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We have a total aboveground gold supply of about 137,000 tonnes. What I don't know (and would love to know) is the proportions which are London Good Delivery bars, bullion coins, numismatic coins, and jewelry/other.
My guess is that LGDs outweigh bullion coins by at least 4 to 1. Central banks and their close kindred officially hold 31,400 tonnes (perhaps much less, and I should think 90% of whatever they hold is in the form of LGDs.
In the absence of firmer numbers, then, I make wild assumptions:
15% CBs/Governments
10% private citizens holding bullion
40% private citizens holding numis/jewelry/other
35% ?
So who's holding the final 35% (or similarly significant chunk) of aboveground tonnage? My guess is super-citizens. That is, people like Warren Buffett (although probably Not Warren because he's keener on silver), drug lords and other highly successful entrepreneurs, distaff cousins of ruling families, etc. They most likely hold their gold as LGDs, for pretty much the same reason that you prefer not to receive your salary in tuppences or nickels.
As long as these super-citizens sit on their bars of gold for generations, they have no effect on the POG.
But those privately held LGDs do change hands, and it would seem there's been an increase in swapping recently. As in all acquisition games, someone wants to own more and someone wants to reduce holdings.
Why does the POG panic when a CB sells? After all, the CB is most likely selling either to other CBs or to a super-citizen. Besides, it's just as valid to say that the selling CB is caving in to a sufficiently attractive bid from a buyer who wants to own more LGDs. Why should that be interpreted as bad for POG?
I think a lot of it has to do with proportion. A few years ago, some nature show interviewed a scuba diver who'd recently been floating at the surface when a blue whale had cruised alongside him, its back arching like a mountain only a few feet in front of his face. Describing it after the fact, the diver said that only one thought had gone through his mind as it happened... BIG. Very BIG. Really Really BIG.
When BoE announces that it's going to sell enough LGDs to mint 54.6 million Sovereigns, the average holder of a dozen or so Sovereigns understands how the diver felt. This sensation is made dramatically worse by inept reporting by journalists who haven't got their numbers straight. Never assume conspiracy where stupidity can explain something: the press prints nonsense implications (like IMF having enough gold to cover all of its lending) simply because the journalists and the editors don't care enough to research beyond this evening's deadline.
Looked at rationally, you'd expect POG to go Up with the announcement of a CB sale (or, more accurately, for the CB's pet fiat currency to go down against gold), since POG reveals the difference between faith in gold and faith in fiat. After all, the CB is in reality damaging the faithfulness of its fiat by divesting gold. Worse for humanity as a whole, the gold that had been held for a nation's public good is now held solely for the benefit of a few private super-citizens.
Thankfully a few of us see through the misconception and welcome the bargain, but it's a testament to gullibility that the masses do not see.
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Who's acquiring?
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Previous discussions here have convincingly divided the CBs into acquirers (China, etc.) and divestors (UK, Korea, etc.). But if CBs only account for 25% of official above ground, and perhaps in reality only 15% of unfettered gold, who are the private super-citizen holders of the rest?
I wonder if someone is planning to institute a new form of gold coinage. Perhaps it'll be a dinar, perhaps it'll be a 10 gram round ingot issued by someone like Anglo or Newmont or WGC... someone who wants to become a CB for gold's sake (that stance would certainly be an improvement over their having to accept the slings and arrows of fiat CBs).
Be clear on this: I have no idea whether someone is contemplating creating such a new gold standard currency, and I have a sad suspicion that in fact no one is, but I can't help wishing someone would.
The debut of the Euro required lots of public groundlaying because a fiat currency gains its value solely from faith. Inevitability tends to increase faith in fiat (you may not like what's coming, but you can count on it coming), while abrupt surprises tend to damage faith in fiat (if they did this today, who knows what they'll do tomorrow).
The development of a 21st century gold standard, however, would best be served by precisely the opposite approach: lay the groundwork in secret, then drop it as a bombshell on the world before fiat powerhouses have a chance to intervene. Once random smeltings of sample coins confirm they're good because they're gold, they'd be accepted just as readily as are today's Krugerrands.
Bigger isn't better, however. One ounce is too big for everyday citizen-sized transactions, but 10 grams would be in the Sovereign ballpark. That size served Europe well for over a century of exponential economic growth. Being a basic metric weight would be even better, for precisely the same reason that the UK finally caved into decimalisation rather than four pounds two shillings and tenpence. One of the biggest obstacles to gold as a currency today is the question, "What is 4 times .2354 plus .1866?"
If someone were to try establishing a new gold standard, though, where would the founder of such a coinage get his gold from? If miners were to pursue it, their gold would come new from the ground (possibly augmented by gold borrowed long ago from CBs as if for forward sales yet not in fact turned out to the market but instead hoarded). If non-miners were to pursue it, their gold would have to come from CBs or super-citizens. The other two categories are just too illiquid to contribute. Korea tried liquidating its Gold M3 and only got a few hundred tonnes. A new world gold currency would need tens of thousands of tonnes. Gold M2, in both public and private hands, is the only source of that magnitude available.
Okay, enough dreaming for one post. Let's get back to the numbers.
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Whither POG? Up or down?
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As I said above, no one can reliably forecast the future. Having said that, I'll give it a try anyway <grin>.
I agree with Kaplan's Gold Mining Outlook goldminingoutlook.com that the nearly unanimous consensus is almost always wrong, but there's more than one way to be wrong.
Gold may rebound in the mid term rather than in the near term. Here now in June 99, I find little likelihood of Y2K lifting spot gold during the rest of 99 or early 00, since at this stage I tend to think Y2K will be an annoyance, maybe even a year-long hindrance to business as usual, but probably not a single abrupt disaster. Going back to that business of inevitability, the guardians of fiat have gone to great lengths to reassure the population. In fact, they've said Y2K so often that Joe American will numbly tolerate a dud ATM or a day's power outage here and there. I presume Europeans are getting a similar lecture, though frankly they're more concerned over the already present problem of a descending euro.
Expected result: the U.S. dollar will probably continue to grow stronger at the expense of POG, the Euro, the Yen, and pretty much everything on the planet with the exception of the price of oil. It will continue to strengthen until it begins to weaken. Glib but realistic. Since I can't time the sea change, I have to trade in anticipation of it, gently moving from U.S. dollar-denominated wealth to something else... or several somethings else.
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POG and Gold Mining Stock Analysis
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A Reuters article dated Tuesday 25 May 99 entitled "Gold output seen lower in Q1 1999" finally provided some useful numbers:
70% of world production = 12.23 million ounces 1Q99
divided by .7 implies
100% of world production = 17.47 million ounces 1Q99
divided by 32,151 ounces/ton implies
100% of world production = 543 metric tonnes 1Q99
times 4 implies
100% of world production = 2173 metric tonnes -- total year '99 expected --
70% of world production = average CASH cost near $199 per ounce
70% of world production = average TOTAL cost near $249 per ounce
Since this is the 70% that includes all of the significant miners, it's near certain the other 30% are the small miners that cannot benefit from economies of scale. Hence, they have higher cash costs and total costs. Now, cash cost means Variable Cost. A going concern will carry on manufacturing and selling product at prices all the way down to Variable Cost even when running at a loss on Total Costs because the Fixed Cost component can be at least partially defrayed.
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Translation for non-CPAs
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A restaurant owner pays both for food (variable cost) and for mortgage (fixed cost). Say a meal sells to the public for $3. Say also that the food itself costs the restaurant owner $2. He distributes the mortgage cost across each meal, say at $0.50 a meal. In other words, his cash cost is $2, his total cost is $2.50, and the current price of a meal (POM) is $3, so he makes a clear profit of $0.50.
Now say competition drives down the POM to $2.60. He's making barely 4% profit, too close for comfort.
It gets worse. Competition drives down the POM to $2.25. Now he's losing money overall, but he doesn't dare stop selling meals. After all, it costs $2 to produce the next meal, so he can get $0.25 to at least partially pay for the mortgage rather than dip into savings for all of the mortgage (or declare bankruptcy). He may even try to sell more meals: if he can find a way to sell twice as many meals, he'll break even again and cover the mortgage.
Unfortunately for him, it's not to be. The POM goes under $2, under cash cost. Then he has no alternative but to shut down. Any further meal sold would simply make things worse.
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And then there's hedging
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Here's a very important number I still don't know: the fraction of anticipated mine production 1999 to 2002 which has already been sold at well above $260 POG.
Let's assume 50/50 in the absence of real data. Assume 15% of current active mining capacity (half the smallfry 30%) has total costs higher than current Spot POG but has already been sold at sufficiently higher futures prices. Assume a further 35% (half the big-boy 70%) is hedged at similarly higher futures prices.
Gold mining stocks, then, fall into four categories:
A) 15% Unhedged, high-cost, in the red or breaking even at $260 POG, bleeding now
B) 35% Unhedged, low-cost, making 4% profit at $260 POG, bleeding if POG below $249
C) 15% Hedged, high-cost, sufficiently profitable until the futures contracts die
D) 35% Hedged, low-cost, making HUGE profit until the futures contracts die
Group A will very soon go bankrupt. Their contribution to annual production will most likely cease until POG recovers. As Texas wildcat wells died when the price of oil collapsed, so will this group of mines. From POG's point of view, it's a pity they only account for 15% of the total, but my sympathies to their shareholders. I truly do know how you feel.
Group B will at first close its eyes and hold still in hopes they can ride out the storm, but then will panic in coming months. With production dropping no more than 15% (and quite possibly Rising), it's highly likely POG will fall through $249. Indeed, Group B will contribute to its own demise by being the biggest overproducers. Picture a man with a shovel trying to dig himself out of a pit of quicksand. His own struggles drive him further down.
Group C will close its eyes and hold still in hopes they can ride out the storm, and they very likely will survive with that strategy.
Group D will likely go on a spending binge, acquiring weaker rivals' veins. They'll buy both the low-cost veins of precarious Group B and the high-cost veins of mortally wounded Group A. Group B veins will be kept online under new management. Group A veins will be mothballed for the time, perhaps a decade from now, when POG will rise to again justify them. Of course, Group A veins will be bought at pennyweights on the ounce because they hold so little present value.
Stockwise,
Group A will follow Royal Oak and Bre-X right out of existence
Group B will be dangerous to buy but those still alive at POG nadir will be excellent bargains
Group C will be low risk but will underperform because there's little opportunity for growth
Group D will rise in share price (they'll acquire Group B by stock swaps and Group A at asset auctions)
Meanwhile, a low POG for a significant number of months (or years) should so demoralize the industry that future planning and exploration will be abandoned unless well in progress. It may be that the nadir for POG in true terms hits around 2002-2003. Aboveground sources (Central Banks) will be largely depleted thanks to the concerted efforts of BoE, the Swiss, the LBMA, et al. Few if any newly prospected underground sources will exist. After all, why waste money exploring when you can go to a bankruptcy sale and buy a known vein with a known (but currently too expensive) cash cost?
Consolidation will ultimately increase POG. When an industry moves from many to few producers, the price rises because of oligarchy. So there's hope. But if it happens too soon, it won't be good for gold long-term.
If POG surges above $300 prior to Y2K, I plan to sell at least some of my holdings into it. Probably the Krugerrands. They're cheap but my they're ugly. A surge in POG now would mean a reprieve for high-cost miners who will keep digging, and an opportunity for low-cost miners to increase production and exploration. Both will lower long-term potential for POG by, say, 2008.
However, if POG fails to surge and instead plunges towards average cash cost of $199 or lower in 1999-2002, I'll continue buying steadily all the way, averaging down my fiat cost of investment.
If POG simply wallows at $260 until 2002, I still think there's an excellent chance of seeing POG rise from there, so I'll still be buying a little as opportunities present themselves.
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My suit for an ounce
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There's a recurring notion that gold maintains a constant value over the centuries, that a good man's suit equals an ounce of gold and so forth.
Well, that's Newton talking. Einstein is closer to the truth: everything is relative, and the relative relationships are constantly changing. A European gentleman's suit in 1350, made of steel, was a purchase on level with today's executive Learjet. In the 1930s, any man who wasn't a farmer was expected to wear a suit 7 days a week, and labor was cheap. Today, formal dress often means we actually put on socks, so suits are less ubiquitous and therefore command a higher price today in any reference currency, fiat or gold.
Insert the word Yen in place of gold and then say it: for century upon century, the price of a good suit in Yen has held steady. See how wrong that sounds? Gold is just another currency.
In the mid 1400s, according to a Forbes 22 May 1998 article by Peter Brimelow (http://www.forbes.com/forbes/98/0504/6109050a.htm), POG in isolated Europe was the equivalent of $2400 current dollars. After the Spaniards discovered and robbed the Americas, POG in Europe plummeted to $500 where it stayed, with brief excursions, for the next three hundred years. That sort of massive sea change was the result of the European money supply of gold being quadrupled over only a few decades.
The quiet fear I can't completely drive out of my head is that we may be in the midst of a similar sea change in POG today. New mining technology and new undersea discoveries, and new attitudes to money, may devalue gold versus the rest of the economy and leave it at a lower price for centuries to come. That's why I don't believe a word of it when I hear someone say that gold's "natural" price is $500 to $600. That may be its historical price, but century-steady prices have changed permanently before (both down and up) and they are likely to change permanently again. The worst case, of course, is the Star Trek scenario: with transporter technology, a substance as elementary as gold is nearly cost-free to replicate by the ton (on the upside, it would be kinda neat to have a ton of gold lying about even if it weren't all that valuable anymore <grin>).
The one consolation I take in entertaining these notions is that POG can't stay for very long below the average cash cost (variable cost) of mining the next ounce from the ground. Today that's $199. And it can't stay below the average total cost (variable plus fixed) indefinitely without shutting down production. Today that's $249. You see now why I welcome a plummeting POG in the short term even if it stays down for several years (in fact, especially if it does). Assuming transporter technology is centuries away, a low POG today lays the foundation for an inflation-free gold currency supply for many years thereafter.
>From Napoleon until World War 1, POG held at about $600 modern dollars. Why? Best guess: the gold standard. Modern commerce was first standardized in the early 1800s. Prior to that, commerce was a very inefficient affair. But with British Sovereigns, French Francs, and American gold dollars in every businessman's pocket, world trade finally became normal rather than exotic.
One of the central reasons for that efficient market was that nearly all above ground gold available to Europe was in the form of coins in people's pockets, not in CB bank vaults. There was practically no Gold M2. Private banks held some gold in their vaults, of course, but little more than the proportion of paper bills held in today's bank branches. Fractional reserves were just as basic a tenet of banking under the 1800s gold standard as they are today under the fiat standard. This made the money supply many times larger than the gold coin supply, to the benefit of commerce overall.
The only difference between their fractional system and ours is that, when the public began a run on a bank, it was nearly impossible for a government to divert enough real gold to the problem bank in time to quell the panic. Today's FDIC and friends do a surprisingly good job of quelling such things. The Savings & Loan debacle a decade ago would have produced an unavoidable meltdown had the U.S. been on an 1800s European gold standard. As it was, the panic was headed off and the losses quietly distributed across the taxpayers… at least, across taxpayers who held their wealth in U.S. dollars. Owners of gold weren't taxed on their gold at all.
World War 1, by the way, is the most interesting thing in Forbes' gold chart. In 1919, POG spiked like a needle down to $196 modern dollars then rebounded within the same decade or so to $600 modern dollars. I've yet to figure out why it did that. Suggestions?
It's that single event which gives me the greatest hope for today's POG. Rather than a permanent devaluation as a repeat of 1492, we may well be watching a momentary downspike as a repeat of 1919, in which case POG is unlikely to reach the stars but is likely to make itself (and its admirers) proud again in, say, the high $300s low $400s.
My apologies in advance to those who anticipate POG of $10,000, but the only way I can see that happening is if, at the same time, the dollar and the rupiah reach 1:1 parity. Gold is Undervalued against commodities and other currencies, but not by that much. The Dollar is Overvalued against commodities and other currencies, but again not by that much. Even when the Nikkei Dow was wallowing at its post-bubble nadir, by what magnitude was the dollar/yen exchange rate different from the exchange rate in 1989? Only by twofold or thereabouts, not by a hundredfold.
On the other hand, fiat currencies have devalued by that sort of magnitude before. But in each case, the afflicted currency was issued by a government whose economic capacity had all but died: Germany after WW1, Russia after WW3, etc. The last time North America suffered such an infrastructure collapse was when the Confederate States were burned to the ground in the 1860s. Even the transfer of the imperial throne from House Windsor to House Washington after WW2 didn't cause the pound sterling to crash that dramatically against the dollar. It seems to me a transfer from House Dollar to House Euro would be no more jarring than its predecessor, though probably no less damaging over many years.
Assuming something short of apocalypse is in store, I plan to steadily acquire more gold as POG descends, and steadily divest as POG rises above my average purchase cost, but physical gold will simply be one of a dozen or so asset classes I own. I'll keep steadily investing in gold stocks of companies likely to survive the next few years, since the market will toss out the good alongside the bad with each headline about the newest Bre-X or RYO. And I expect that someday, sooner or later, we'll have a repeat of the farmer comparing the tulip to an onion and people will stampede out of Wall Street. It's happened before. It'll happen again. But as 1919 and the last two decades show, people can stampede out of gold, too. The nice thing is that gold appears to be a less risky investment today than is Proctor & Gamble stock. Even if soap has more intrinsic value than does gold <grin>.
Well, the sunlight is fading from my solar cells so I'll have to sign off.
Yours,
I.V. Holtzman
usagold.com |
