Invest in Gold Keyword: Let the Hoarding Begin
by Eric J. Fry
The Rude Awakening
Wall Street, New York
Tuesday, March 7, 2006 Eric Fry discusses a recent report making the case for an upcoming surge in gold prices, and that it's the right time to Invest in Gold. ------------------------- - Taking a peak at the waning sources of supply for
everyone's favorite shiny yellow metal and,
- What if China...? A couple of hypothetical situations
for thought,
- Nothing about Brokeback Mountain
------------------------- 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. Invest in Gold: Supply Dwindling 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. Sign Up for The Rude Awakening Start your mornings off with a dose of Rude news. The Rude Awakening is dedicated to highlighting phenomena in the financial markets that others may not see. Let the Wall Street Journal and the New York Times "break news." Sign up FREE Today! We will not share your email address with anyone else, period.
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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.  Invest in Gold: Demand Soaring 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! Invest in Gold: Individual Investors Piling On 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-
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