Looks like a good time to buy Gold. Well, Blanchard does not think so...
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Gold Bullion and the Economy
So far this year, notwithstanding the stock market rally last week, the S&P 500 is down 10% and the Nasdaq has lost 22%. The Fed has cut interest rates on seven different occasions by a total of three full percentage points. Consumers continue to spend, helped by the rate cuts. Housing prices have risen throughout the economic slowdown, keeping family wealth at historically high levels. Retail sales are up, home construction continues to be strong, factory production has stabilized and wages are rising faster than inflation.
The dollar is down 8.3% against the euro in the last month and a half. That should be very bullish for gold bullion, which is historically expected to go up when the dollar goes down. This time around, gold has gone nowhere. In fact, gold is down over $15 from its high in May, and is essentially unchanged from its levels in June.
MESSAGE TO OUR CLIENTS
Sell your gold bullion. Sell it in an orderly fashion, but get rid of it all. Given current economic conditions, we may very well have a period of relative strength for gold. Don’t let that deter you from getting rid of all of the gold that you have. If you find that you miss it in a few years, you’ll be able to buy it all back at a much lower price. If you wait too long to sell, you will be caught in a rush for the exits.
In its Annual Report 2000, the World Gold Council describes itself as “an organization through which producers of gold collectively promote and expand the market for gold and gold products, directly and indirectly.” The Council’s objective is to promote both private and institutional ownership of gold, “through a a research-driven approach.”
Blanchard has been the largest retail dealer in physical gold in the country for at least the past decade, making the World Gold Council and Blanchard natural allies. Blanchard has found that the research offered to it by the Council’s economists and analysts, along with the reports commissioned by the Council, have been an important addition to Blanchard’s own research.
It has long been the position of the Council, and of the independent gold analysts retained by Blanchard, that gold is an excellent source of liquidity and that it provides portfolio insurance without
sacrificing return. The Council has maintained, throughout the long bull market in stocks, that the place of gold in modern portfolio theory is best summed-up by the following quote:
Including gold within an existing portfolio improves investment performance by either increasing returns without increasing risk, or by reducing risk without adversely affecting returns.
Throughout most of the 1990s, the terrible performance of gold could be explained by its negative correlation to financial assets, which have enjoyed a sustained bull market. Gold’s big tests were the Asian Crisis in 1998 and the Nasdaq implosion in 2000. It failed both of them.
Blanchard decided that, if gold didn’t react to crises of that magnitude, it was possible that it couldn’t be counted on as a store of value or as a hedge against anything. We asked the World Gold Council for their input and began our own research. We started with every confidence in gold’s intrinsic value and its long-term effectiveness as financial insurance.
Our research was directed at questioning all of the traditional assumptions about gold:
C Is gold still a reliable store of value?
C Is gold still an effective portfolio diversifier - an effective form of financial insurance?
C Is gold still a good hedge against inflation?
C Is gold still a good hedge against depreciation in the value of the dollar?
C Is gold still an effective hedge against major shocks in the price of oil and other commodities?
C Is gold still an effective hedge against war and international crises?
C Is gold still an effective hedge against international banking and debt crises?
C Is gold still an effective hedge against major declines in the U.S. stock market?
C Does the price of gold still increase at a rate at least as great as the rate of growth of income and wealth?
C Does the price of gold still increase at a rate at least as great as the sum of the rate of inflation and the real rate of interest?
C Are increases in the price of gold still proportional to decreases in the value of the dollar?
C Do the positive correlations between gold and other precious metals still apply?
Our conclusions, particularly those dealing with the potential downside risk involved in gold, have come as something of a surprise to all of us. Every bit as disconcerting as our own conclusions is the fact that the World Gold Council, with a $25.2 million budget and a mandate to do the research necessary to be able to promote and expand the market for gold, has been unable to provide answers to our questions or to rebut our conclusions.
Our requests for information from the Council began in March 2001. When we did not receive responses through the usual channels, we put our requests in writing on July 3rd and then again on July 25. The first meaningful response that we received from the Council was dated August 24. The following are our questions, and the Council’s answers:
1. Question: “Since March, I have been asking representatives of the World Gold Council the same question: Can the council provide me with a reason why Blanchard’s clients and Blanchard should want to buy gold, or to keep the gold that we presently have?”
WGC’s Answer: NONE
2. Question: “I told (a senior member of the World Gold Council) that we would no longer market gold to our clients, or accept co-op marketing funds from the World Gold Council, if we do not want to own gold ourselves. Can you give me a good reason why we should?”
WGC’s Answer: NONE
3. Question: “Why didn’t the price of gold explode when the dollar collapsed between 1988 and 1995? Simply because the Fed reacted to any 10% increase in the price of gold by reducing monetary reserves... and increasing interest rates... What’s to prevent the Fed from doing exactly the same thing the next time the dollar begins to lose strength?”
WGC’s Answer: NONE
4. Question: “The Council’s Annual Report 2000 said that the Council has reconsidered its strategy and is now placing its focus on creating demand through the promotion of gold and jewelry. Can the council provide me with a plausible argument that increasing jewelry demand can materially increase the price of gold? The Council’s change in strategy means that the major producers have resigned themselves to a flat or declining gold price. A declining price might work well for the biggest of the gold mining companies, whose profitability is enhanced by a falling gold price, which also helps them to buy up their competitors. It does nothing for Blanchard’s clients.”
WGC’s Answer: NONE
The following are the conclusions that we reached and which we asked the Council to rebut:
1. Conclusion: “The Federal Reserve Board has an explicit policy of capping any increase in the price of gold by reducing monetary reserves and increasing interest rates.”
WGC’s Rebuttal: NONE
2. Conclusion: “The European central banks have a policy of capping any increase in the price of gold by adding additional liquidity to the gold market, either through sales or leases.”
WGC’s Rebuttal: NONE
3. Conclusion: “...The U.S. Federal Reserve Board and the European central banks... have a bigger economic interest in a strong dollar than in a higher gold price.”
WGC’s Rebuttal: NONE
4. Conclusion: “In going through your Annual Report 2000, I realize that the largest part of the Council’s financial support comes from producers whose short sales of gold significantly exceed their annual production - producers that have a vested interest in the price of gold going down.”
WGC’s Rebuttal: NONE
5. Conclusion: “Barrick and AngloGold, the two biggest gold producers in the world, are also the two biggest short-sellers, each having short sales that are a multiple of their annual production. For them, the only downside to a falling price is the damage that it does to the value of their reserves. Barrick’s recent purchase of Homestake shows that they have that problem well in hand. They can continue to make an operating profit through their short sales while they buy up the reserves of their competitors, who have been ruined by the collapse in price.”
WGC’s Rebuttal: NONE
6. Conclusion: “The liquidity of the gold market is deteriorating and the new generation of central bankers, including those in the U.S. Federal Reserve, are questioning the wisdom of central banks owning any gold. The major precious metals analysts are now starting to talk about gold’s illiquidity... If, at some point, the central banks conclude that the liquidity of gold is no longer a given, then we’ll see a market rout of epic proportions.”
WGC’s Rebuttal: “Has there been a loss of liquidity in the market over the last 12 to 18 months? There is no clear cut answer to this question. It is probably true that it has become more difficult to buy or sell a substantial quantity of gold at one time without impacting the price significantly (the technical definition of liquidity)... There can be no denying that a decline in trading volumes in gold has occurred.”
The World Gold Council made no attempt to rebut the statement that central bankers are questioning the wisdom of owning any gold and that the lack of liquidity will eventually produce a market rout of epic proportions.
7. Conclusion: “Last year, for the first time in over 20 years, investors sold more gold than they bought... Since I believe we agree investment demand remains the most important determinant of gold prices, if the industry doesn’t even do enough marketing to insure retention of gold by existing owners, then the market could be in for a free-fall. There’s a lot of gold out there if nobody wants it.”
WGC’s Rebuttal: NONE
In a communication that we received from the Council on July 12, one of the Council’s senior economists said that “You have raised several interesting issues. These are now being discussed among my colleagues.” The most fundamental question that we asked, and one that we reiterated to the Council’s economists and to its Regional CEO, was, “Can the Council provide me with a reason why Blanchard’s clients and Blanchard should want to buy gold, or to keep the gold that we presently have?” If, after more than five months, the Council is still unable to answer that question, then there is no plausible answer. If you own gold bullion, sell it. If you’re thinking of buying gold bullion, don’t do it.
Eclectus
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