If you ignore the paragraph about Blanchard...this piece from Picton is very good IMO:
From Minesite:
January 28, 2003
The Second Leg Of The Uptrend In The Gold Price has really begun.
By James Picton
Generally speaking, the gold price has moved in two very distinct, broad phases since the mid-to-late 1970’s, and the second leg of a third phase is now still in the fairly early stages of forming. It is that third phase we will concentrate on, but the background is important.
Phase 1 (mid 1970’s to 1980)
In the mid 1970’s there occurred what was in fact the second Arab oil price shock. This drove the western world from a period of low, single digit inflation to a rate of 13 per cent or so by the late 1970’s and triggered what became known as the “hard asset” or “inflation” boom. The gold price rose rapidly from a low of US$127 in 1977 to US$524/oz in 1979 before surging to spike at US$850/oz in January 1980 . Christmas Eve share trading in London in 1979 was the busiest since the Australian nickel boom exactly a decade earlier. But this was not to last for several reasons.
Phase 2 (1980 to 1999)
Firstly, Paul Volcker, then chairman of the US Federal Reserve, took swift action to kill such high inflation by raising interest rates sharply into double digits-a process which the world found painful and which had, by 1982, precipitated the worst US recession since World War 11, a collapse on Wall Street to around 620 points on the Dow Jones Industrial Average and a sharp decline in business and investment confidence everywhere. Gold , very sensitive to high interest rates, bottomed in 1982 at US$297/oz.
There were other factors at work. Individuals, overjoyed by the near seven-fold rise in gold between 1977 and early 1980, took gold artefacts for sale at jewellers and goldsmiths, irrespective of the fact that that the antique value of the gold pieces was often very considerably greater than the intrinsic value of the gold content.
Another key, fundamental factor behind gold’s demise in phase 2 was sporadic official gold sales by Central banks and the IMF. These sales, and the increasingly obvious fact that gold was in a definite downtrend punctuated only by various international political skirmishes, prompted bullion houses and some investment banks to sell gold short, often rolling over their positions and taking advantage of gold producers, worried by gold’s sharp fall, themselves selling gold forward (hedging) in order to lock in at a fixed price.
Under this onslaught gold finally bottomed at US$253/oz in 1999, shortly after UK Chancellor Gordon Brown announced the sale of over 400 tonnes of the UK’s gold reserves-a process which was completed at a weighted average price of US$275/oz.
Phase 3
Since 1999 several things have changed or become obvious. Officially there is a moratorium on further central bank sales until at least 2004. Secondly, since at least 1990, there has been a shortfall in the supply of new gold production. Demand has only been met by official sales, short selling by bullion houses and investment banks and forward selling (hedging) by the mines. Occasionally there has been minor disinvestment by horders of gold or owners of jewellery pieces.
The issue of how much gold has been sold short by investment banks and bullion houses is arguable and estimates range between 5,000 tonnes (almost two years new gold production) and 15,000 tonnes. Whatever the case it is a large amount and it cannot sensibly continue in a rising gold price climate. On the contrary, the question arises as to what price gold would have to reach in order for these “paper sales” of gold (ie non physical) to be covered.
In the middle of all this Blanchard & Co, the largest retailer of gold bars and coins in the US, filed a lawsuit against JP Morgan (investment bankers) and Barrick Gold (a major Canadian based gold producer) alleging illegal price fixing of gold and collusion between the two. If Blanchard & Co wins when the case gets to court it is almost inevitable that the US Justice Department would have to follow up with a criminal investigation as price fixing in the US is a criminal, jailable offence (as the billionaire chairman of Sotheby’s in the US has discovered).
Many mining groups have been persuaded by investors not to hedge their positions forward. Firstly, the exercise was self-defeating in that they only drove the gold price down against themselves. Secondly, investors in gold shares rightly pointed out that they invested because they believed in a rising gold price and they did not want mine managements to deprive them of that possibility by locking in at fixed prices.
At this point we come to a seminal speech by the current chairman of the US Federal Reserve, Alan Greenspan, on 19 December 2002 delivered to the Economic Club of New York. What was perhaps most surprising was not what he actually said about gold (fascinating though it was) but that he featured gold at all-and in the prime slot, right at the beginning of his speech. Here are some prime quotes.
“Although the gold standard could hardly be portrayed as having produced a period of price tranquility, it was the case that the price level in 1929 was not much different, on net, from what it had been in 1800. But in the two decades following the abandonment of the gold standard in 1933, the consumer price index in the United States nearly doubled. And in the four decades after that, prices quintupled.”
“Monetary policy, unleashed from the constraint of domestic gold convertibility, has allowed a persistent over-issuance of money. As recently as a decade ago, central bankers, having witnessed more than a half-century of chronic inflation, appeared to confirm that a fiat currency was inherently subject to excess.”
“Although the US economy has largely escaped any deflation since World War 11, there are some well founded reasons to presume that deflation is more of a threat to economic growth than is inflation...Clearly, it would be desirable to avoid deflation. But if deflation were to develop, options for aggressive monetary policy responses are available”.
This all suggests that a plan to fight deflation is in fact being pursued by the Federal Reserve and, indeed, by the Bush administration generally. Hence the sacking by Bush of Treasury Secretary O’ Neill, who is a supporter of a strong dollar, shortly before Greenspan made his 19 December speech. And recently there have been Bush’s tax cuts on dividend income which are undoubtedly an expansionary move.
It seems that expansion is now the keyword -not inflation - regardless of the effect on the dollar. In all this, gold is no longer a reject subject. Indeed, Greenspan has introduced gold’s new role in two ways. First, gold is a means of price predictability; second, gold offers a control function over the natural excesses of the fiat money system and thus a control over the over-production of money.
Doing some theoreticals, if full gold convertibility were to be re-introduced in the US alone, it would require a gold price of over US$2,000/oz. And the US has the highest proportion of gold in its total reserves ( over 57 per cent). On a world-wide basis it would need a gold price of over US$4,000 /oz to match gold reserves with total fiat money (paper currency). The UK’s gold reserves are a miserable 7 per cent or so of total reserves after Chancellor Gordon Brown’s efforts initiated in 1999.
It is highly unlikely that Alan Greenspan has those sort of gold price numbers in mind, but they do highlight just how much the world has relied on the printing press over the last fifty years.
Conclusion
The two decade bear market in gold is over. The prime reason for saying this is the generational change in official US attitudes towards the metal’s role. Furthermore, many mines have ceased selling forward and thus shooting themselves in the foot, while investment banks and bullion houses will, once they have sorted out their paper short positions in gold, likely cease the game they have been playing for the last decade and more - ie. selling gold short in which they were assisted by the then unwitting mines and people like Gordon Brown.
This may all take a while to manifest itself in a quantum move in gold to, say, over US$450/oz as:
(a) Greenspan’s remarks were, surprisingly, not at all widely reported in the financial media, either in the US or UK,
(b) some mines will still be tempted to hedge at the higher prices now prevailing and
(c) investment banks and bullion houses who are short of gold will desperately try to cover their positions without moving the price. On the point of lack of coverage of Greenspan’s 19 December speech highlighting gold, the Economist has always treated it as something of a joke, while the Financial Times also failed to grasp the nettle-as did CNBC and plenty of others. One wonders why their financial reporters are employed at all. This incompetence has cost their readers money.
Nevertheless, it seems that gold is now in a firm and well based uptrend for the first time since Paul Volcker killed the price back in the early 1980’s. International political issues such as Iraq and terrorist threats can only add to that. Gold is once again taking its place as a serious asset class. As Greenspan hinted, more fiat money can only be issued with a checking mechanism in place-and that mechanism is gold. Predicting an eventual new price level is hazardous, but US$450 or more by the end of 2003 looks quite possible. Remember, it is the groundswell of economic change that moves the gold price on a major and lasting basis, while unsettling political events just add to that. One must know “what game is being played in town”- and Alan Greenspan has changed the game.
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James Picton is currently a Mining Research analyst with a UK broker. Before that he worked for 18 years in South Africa, notably with what is now JP Morgan (Fleming Martin), Investec (Fergusson Bros), SocGen and Standard Corporate Merchant Bank Securities. He won the Financial Mail institutional no.1 award for Diamonds eight times and the no.2 award for Mining Houses six times. He spoke at numerous Mining conferences world-wide, eg in Johannesburg 1994 (twice), the FT Diamond Conference 1996, the World Diamond Conference 1997, the Gemological Institute of America’s “Meeting the Millenium Symposium” in 1999. Before that he was head of Mining Research and a partner at Fielding, Newson-Smith and then Capel Cure Myers in London (11 years). And before that he was with a mining group in Johannesburg and London which transmogrified into BHP-Billiton (5 years). |
