Let the Hoarding Begin
The Rude Awakening
Wall Street, New York
Eric Fry, reporting from Wall Street...
"I'm proud to be out of touch," George Clooney declared last Sunday night,
while accepting an Oscar for best supporting actor. "I'm proud to be part of a
group of people who gave an Oscar to Hattie McDaniel in 1939, when blacks were
still watching movies from the back of the theatre...I'm proud to be out of
touch."
Mr. Clooney makes a superb point. The "out of touch" individual is often the
righteous individual; he is often the courageous individual; he is often the
innovative individual; and sometimes, he is the well-prepared individual...Noah,
for example, was out of touch.
Today's gold investors are also out of touch.
They are out of touch with the modern monetary system; they are out of touch
with the American "productivity miracle"; they are out of touch with Chairman
Bernanke's notion of a global "savings glut"; they are out of touch with the
belief in perpetual American economic hegemony; they are out of touch with the
concept of consumption-driven prosperity.
Gold investors are simply out of touch.
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Let the Hoarding Begin... By Eric J. Fry
If you buy an ounce of gold today, you might regret it tomorrow. But if you
don't buy an ounce of gold today, you might regret it two years from now...if
not sooner.
According to a freshly minted research report by Chevereux analyst, Paul
Mylchreest, the gold price is in the process of moving higher...much higher. The
confluence of several potent trends, says Mylchreest, will lift the gold price
to at least $1,000 an ounce by 2008. If the Chevereux analyst is on target,
today's gold investors need not be overly concerned whether they pay $550 or
$600 for an ounce off gold.
All major sources of supply are declining, says Mylchreest, at the very same
moment that many major sources of demand are rising...and will continue to rise.
To make things even more interesting, the global gold market already faces an
annual supply shortage of about 600 tonnes. Even though the gold price has
doubled over the last few years, Mylchreest believes it will double yet again
over the next few years, if not quadruple to a "super spike" price of $2000 an
ounce. We are persuaded by his bullish arguments.
First, let's take a peek at the waning sources of supply...
World mine production has failed to increase since the end of the 1990s, and
actually fell by 5% in 2004, according to the World Gold Counsel. The drop in
production is no great mystery. Gold prices were so low throughout the 1990s,
that the mining companies sharply curtailed their exploration efforts. "[Once]
exploration has been sharply cut," Newmont Mining's CEO, Pierre Lassonde,
explains, "it takes at least seven to eight years for a rise in price to
generate not just exploration, but the subsequent exploitation of the
results..." In other words, the global gold mining industry will not be ramping
up supplies any time soon.
Meanwhile, Western central banks appear to be curtailing both "official" and
"unofficial" sales of gold. In the name of "reserve diversification," these
banks have been unloading tonnes of gold from their vaults every year.
(Ironically, Eastern central banks have enlisted the identical phrase to
INCREASE their gold holdings). European central banks, in particular, have been
conspicuous sellers of gold for several years. At the same time, they have been
lending their gold to bullion banks, who in turn, have been selling it – in some
way, shape or form – into the open market.
But now it appears that Western central banks are reducing their direct
official sales, while also restraining their gold-lending activities. Chevreux
estimates that central banks have trimmed their gold loans outstanding by more
than 2,000 tonnes over the last two years.
The global gold mining industry is also reducing its gold- selling
activities. Throughout the 1990s, many gold producers "sold forward" their
production to lock in a profit. These hedging transactions have been
artificially suppressing the gold price for several years. But now that the gold
price is rallying, many mining companies fear that selling their future
production at today's prices will merely hedge away their future profits. So
they are cutting back. Chevreux estimates that global gold producers have
trimmed their forward sales by about 42% - a drop from 2,271 tonnes to 1,323
tonnes.
All the while that the above-cited sources of supply are drying up, demand is
soaring.
The central banks of China and Russsia, for example, have been boosting their
gold holdings, while promising to buy even more. Last November, the Russian
central bank announced plans to double its gold reserves. A few days later,
President Putin remarked, "I support the proposal that the central bank pay
greater attention to precious metals in forming our gold and foreign exchange
reserves." Chinese officials have voiced similar intentions...all of which
conjures up some fascinating 'what if' scenarios.
For example, even though Japan and China have the eighth and tenth largest
gold holdings in the world, these gold holdings are equivalent to only 1.1% and
1.3% of their respective reserves. "If we were to assume," Salman Partners
reasons, "that these two countries were to increase their holdings by 50%, to
[only] 1.6% and 2.0% of reserves, respectively, these two central banks alone
would have to purchase more than 680 tonnes of gold in the open market
(equivalent to 27% of last year's mine supply). We do not anticipate a change of
this magnitude in 2006; however,...even a slight shift towards higher gold
reserve levels outside of Europe and the USA could have an enormous impact on
the price of gold."
The notion is not so far-fetched, as the tables above implies. Several
Eastern central banks hold grotesquely large positions in U.S. Treasury
securities, alongside their curiously petite holdings of gold. But recently, a
few key banks have halted or slowed their purchases of Treasuries. "There has
certainly been a slowdown in the rate at which China has been buying US
Treasuries in the second half of 2005," Chevreaux notes, "and Japanese holdings
have been flat throughout 2005. These trends for the two largest holders of
Treasury securities are a potential worry for the US Treasury and the Fed."
...but a potential delight for gold investors!
Perhaps that's part of the reason that individual investors are also piling
into the gold market. Individual investors are snapping up everything from
numismatic coins to gold stock mutual funds. The streetTRACKS Gold Trust (NYSE:
GLD), which launched late in 2004 with a market capitalization of less than
$200,000, already boasts a market cap greater than $6 billion – making it the
seventh largest publicly traded gold stock.
But still, gold and gold stocks represent a surprisingly small portion of
most investment portfolios. The market capitalization of the world's ten largest
gold stocks totals less than $100 billion, which is less than one third of the
market cap of General Electric. The market for physical gold is also relatively
small. "The value of all the gold on the planet is $2.7 trillion, based on a
$550 price per ounce," Chevreux calculates. By comparison, the total value of
the US stock and bond markets exceeds $35 trillion.
"If, therefore, investors attempted to divert even 1% of the value of the
U.S. stock and bond markets into gold," Chevreux fantasizes, "this would be
equivalent to $350 billion, or roughly 19,800 tonnes of gold. This amounts to
13% of all the gold in existence and is nearly eight times the annual production
of mined gold."
Commodity funds are also sniffing around in the gold market. And while these
fickle, short-term investors might not establish long-term positions in the gold
market, their short-term activity could create the sort of drama that triggers
follow-on buying and leads to much higher prices.
"At some point, both central banks and private institutions will have their
fill of dollars," former Fed chairman, Paul Volcker, remarked one year ago. "I
don't know whether change will come with a bank or with a whimper, whether
sooner or later...It is more likely that it will be financial crisis rather than
policy foresight that will force the change."
At some point, in other words, gold will flirt with a four- digit price
tag...that point may be fast-approaching.
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Warning - Not For All Investors
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