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7/30/2019 Gold Researcher
http://slidepdf.com/reader/full/gold-researcher 1/84By Er win Lubber s, BS (IT), MS (Finance) Updated on Jan 6, 2013
Financial analysis on money, gold and other precious metals
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Although the gold price has been rising since the dotcom
bubble burst in 2001, the current financial crisis whichtarted in July 2007 caused a paradigm shift in the gold
market. Central banks in most developed countries began
experimenting with monetary easing programs by
expanding the monetary base and buying debt that was
not possible to sell in the open market. Many investors and
peculators fled to the currency that was able to hold its
value, namely gold. Today, gold is the 4 th most traded
currency.
Nearly 60% of total consumer demand for gold comes
rom India, China, and the Middle East. A global shift in
wealth towards Emerging Markets (EM) should translate to
a strong demand for gold. With the current rise of debt
and currency debasement, EM central banks with large
oreign exchange holdings are diversifying their foreign
currency holdings by adding gold to their portfolios.
n 2011, global production was 2850 tonnes, or 1.6% of theotal gold reserve. Even though Exploration and
Production (E&P) budgets of gold mining companies have
ballooned for some years, new discoveries have become
ncreasingly rare. Besides, the falling supply from South
Africa due to its labor unrest have offset the increase in
production from the US, Canada and Australia. A small
ncrease in the total gold reserve helps gold as currency to
retain its value.
To predict the 2013 gold price, I use a general least
squares regression model. The gold price is the function of
four factors, namely:
1. The quantity of money, captured as the combined
monetary base of the US and Euro Zone in USD.
2. Inflation and opportunity cost, captured as the real
interest rate.
3. Currency factor, captured as the exchange rate of the
USD against a basket of EUR, JPY, RMB and IRP.
4. Uncertainty in financial markets, captured as the
difference in value between BBB and AAA corporate
bond indices.
Different economic scenarios are assumed to make three
gold price estimates. The most likely scenario to occur in2013 is the continuation of monetary easing programs.
And so, the 2013 gold price estimate is $1890 (+11.9%)
under this scenario. According to a stagflation scenario,
which is a bullish gold scenario, the 2013 gold price can be
as high as $2115 (+25.5%). Under this scenario, central
banks increase monetary easing programs and inflation
rises. If the global economy recovers, which is a bearish
scenario for gold, the gold price will fall to $1580 (-6.4%)
by the end of 2013. All monetary easing programs halt,
inflation rises and the USD appreciates under this scenario.
Silver is the primary alternative for gold because its price is
highly correlated to the gold price. Unlike gold, silver has an
industrial use, which makes it more subject to economic
cycles and thus more volatile than gold. In a bull market,
silver outperforms gold but it lacks the safe haven status of
gold. Therefore, it is more suited for active traders than for
long-term investors. The equity of gold producing
companies is another alternative investment. These
companies struggle with the rising cost of production and
the threats of nationalization, causing their equity to
underperform compared to gold investment.
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BoJ Bank of Japan
AGG: iShares Total US Bond Market ETF
BS: Balance Sheet
CME: Chicago Mercantile Exchange
CPI: Consumers Price Index
ECB: European Central Bank
EM: Emerging Markets
ETF: Exchange Traded Funds
ETN: Exchange Traded Notes
EU: European Union
EUR: Euro (currency)
EZ: Euro Zone
FED: Federal Reserve Bank
FX: Foreign Exchange
FOMC: Federal Open Market Committee
GDX: Market vectors Gold Miners ETF
GLD: SPDR Gold Trust ETF
HFT: High Frequency Trading
MF: International Monetary Fund
NR: Indian Rupee
PG: Japanese Government Bonds
PY: Japanese Yen
LBMA: London Bullion Market Association
LIBOR: London Interbank Offered Rated
LTRO: Long-term Refinance Operations
MB: Monetary Base
MBS: Mortgage Backed Securities
MRO: Main Refinance Operations
NAV: Net Asset Value
NFP: Non Farm Payrolls
OMO: Open Market Operations
OMT: Outright Monetary Transactions
OTC: Over The Counter
PALL: ETFS Physical Palladium Shares ETF
PBOC: People’s Bank of China
PLLT: ETFS Physical Platinum Shares ETF
RMB: Chinese Renminbi
RRR: Reserve Requirements Ratio
SLV: iShares Silver trust ETF
SPY: State Street SPDR S&P500 ETF
TARP: Troubled Asset Relief Program
US: United States
USD: United States Dollar
VIX: Volatility Index
ZIRP: Zero Interest Rate Policy
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Chapter 1GOLD HISTORY
chr onicle the his tor y of gold for r eader s to gain an appr eciation for goldnves tments.
The massive golden funeral mask of Toetanchamon (1223 BC) contains almost 11Kg of gold.
3
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Gold has fascinated people since the beginning of recorded
history. Golden ar tifacts from ancient civilizations date back
to the third millenniums BC. Deities and royalty from the
Egyptian, Persian, Greek and Roman empires and those
from Indian dynasties enamored themselves with gold,
associating it with beauty and power. It also acted as a
medium of exchange and store of value among different
kingdoms and across periods.
Although gold was also popular amongst the European
crowned heads and churches, gold rushes of the US,
Canada, Australia, Brazil and South Africa during the 19 th
century captured the imagination of ordinary people. The
upply of gold spread economic wealth to thousands of
prospective gold miners and stimulated global trade andnvestment.
The exploitation of gold in recent history arose from the
premise that a metal must hold its value to be issued out
as money. Europe initially used the silver standard since it
was a more readily available metal. In 1821 England
switched to the gold standard. The Bank of England issued
notes that were fully backed by gold. Most other countriesfollowed suit years later. Economies that had temporarily
abandoned the gold standard during WWI suffered high
inflation rates. When these countries resumed the gold
standard, a larger quantity of money was backed by the
same amount of gold. Soon, it became clear that the
system of the gold standard could not cope with large
sudden shocks in the economy.
The 1944 Bretton Woods agreement was the first system
proposed to govern monetary relations among
independent nations. Under the agreement, the USD was
fully backed by gold at a fixed value of 1/35 th Troy ounce.
After WWII, the US emerged as the creditor of the world
and the largest holder of gold. The USD became the
world’s reserve currency. Thus, all international trade
including crude oil was to be paid in USD. Foreign central
banks that formally used gold could now take advantage of
the USD to back their own currencies. Between 1945 to1971, not only demand for the USD as an asset by foreign
central banks soar but so did demand to convert USD to
physical gold. Soon, the rapid conversion of USD to gold
by foreign central banks made the US gold reserve dwindle
from 20,000t tonnes to 8,133 tonnes.
In 1971 Nixon defaulted on the US gold obligation and,
subsequently, terminated the Bretton Woods agreement.
The USD became a fiat currency, a currency backed by the
future cash flow of the US economy. Fiat money has no
intrinsic value and its quantity is only limited by
regulation and politics. The global economic and political
environment of the 1970s was radically different from what
it is today. The US economy was fueled by cheap oil and
grew much faster than its debt. Given the slow expansion
of the global gold reserve, the US government choose not
to return to the gold standard. Otherwise, deflation would
occur and in turn, economic hardship. And so, national and
foreign investors accepted fiat money as a system of
trading.
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Triffin dilemma illustrates the main problem with the USD
being the international reserve currency. The theory states
hat the US must run a trade deficit in order to supply theworld with reserve currency. Its debt increases and, as a
results, becomes more risky. Due to this imbalance of
payments, tension rises between the national monetary
policy and global monetary policies. And so, many foreign
buyers of US debt, including China, Russia and other large
exporting countries, have ceased buying US debt. They
have begun to diversify their FX holdings with gold.
To support the economy and the financial system, central
banks are increasingly intervening in the financial markets.
Their intervention is either direct via monetary easing
programs and Zero Interest Rate Policy (ZIRP), or indirect
via legislation and regulation. All asset classes are impacted
by the injection of massive liquidity from central banks. TheUS and Europe have stalling economies and record
amounts of debt. In spite of this, government bonds trade
at a record low yield and stock indices hover near record
highs. Central banks launch many programs that affect asset
prices. Currently, the Federal Reserve Bank (FED) and the
European Central Bank (ECB) have open-ended programs
to buy debt in exchange for new money.
The New Normal represents a paradigm shift in the
financial markets. It represents a state called financial
repression, where money is transferred from creditors to
debtors. This phenomenon is mainly achieved by negative
real interest rates and debasement of a currency through
monetary easing programs. Another trend of the New
Normal is political gridlock, where politicians squabble
between each other rather than cooperate towards real
solutions. When financial markets force politicians to
intervene, they are forced to formulate last minute
solutions to provisionally resolve the state of affairs. Several
Southern Europe countries have been bailed out and theUS debt ceiling has been raised to only give temporarily
relief. More political gridlock is expected with the
approaching US fiscal cliff and pending Spanish bailout.
The rise of algorithm trading or High Frequency Trading
(HFT) is another trend that increasingly threatens thestability our our markets. Up to 60% to 70% of all stock
trades on the NYSE are generated by computers. Most
algorithms trade on trends in prices. The trend towards
growing automation drives up cross-market correlations
and causes short-term volatility. Central bank interventions
and HFT trading mainly make the market trade in Risk-On
and Risk-Off phases. In a Risk-On phase, investors
anticipate more action from politicians and central banks
and drive up risky assets, like stock, commodities (not gold)
and the Euro. In a Risk-Off phase, investors flee to thesafety of the USD, government bonds and gold. Gold is
seen as a thermometer and a rising gold prices signals a
risk-off phase.
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Chapter 2KEY CONCEPTS
Since gold is closely r elated to money, money supply, inflation and inter es t r ates,
define these concepts and intr oduce various measur es for money.
6
Professor Larry Gopnik in the movie “A Serious Man” explains the basics.
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Money has three primary functions. It is
a store of value, a standard of payment
and a unit of account. Gold is best suited
as a store of value. Its two other functions are impractical in our
economy. Just try to pay for a
hamburger with a Kruger Rand or
calculate your mortgage in ounces of
gold.
Money Supply Measur ements
The money supply measures the quantity of money. Theres no single correct measurement for the money supply.
The methods to calculate this differ, based on the function
t serves. Below is the most common measurement for
Money Supply:
Money Supply = coins and notes in circulation + the
demand deposits (immediate, accessible bank deposits),
excluding coins and notes in commercial and central bank
reserves
The monetary base (MB) is central bank money, whichorms the basis of which other money is created as credit.
Below is how MB is measured.
MB = coins and notes (circulating in public and in bank
vaults) + commercial banks reserve at the central banks
As of Nov 2012, the MB was $2,656B in US, € 1,617B in
Euro Zone (EZ), and 22,800B RMB in China.
Although no gold coins have been used as money for
decades, the South African Kruger Rand is the most held
and traded among all of the world’s gold coins.
A range of monetary aggregates, stated as M0 to M3, are
employed in the measurement of the money supply. The
exact details for the “M”s vary per country.
I decided to review the US money supply measurement in
this report. The more narrow measurements of the money supply are more controlled by monetary policies of central
banks whereas the broader measurements are set by
financial markets.
M0 = coins and notes in circulation outside central and
commercial bank faults
M0 was $1,126B in US, €868B in EZ and 5,340B RMB in
China as of Aug 2012.
M1 = M0 + demand deposits
M1 was $2,320B in US, € 5045B in EZ and 28,680B RMB
in China as of Aug 2012.
M2 = M1 + saving accounts, money market accounts, retail
money market mutual funds and small time deposits
(under $100,000)
M2 was $10,106B in US, € 8,878B in EZ and 94,370B RMB
in China as of Aug 2012.
M3 = M2 + large time deposits (over $100,000) + money
market funds
M3 was € 8,878B in EZ as of Aug 2012. The FED stopped
reporting M3 in 2006. It claims that it holds no additional
information. But experts maintain that the M3 supply was
growing too fast and the FED had few tools to intervene.
As of Aug 2012, EUR: USD1.2578 and USD:RMB 6.3484.
MONEY SUPPLY
7
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nflation is the rise in the general level of prices within aneconomy. The value of money decrease with inflation and
o does the purchasing power of consumers. In effect,
consumers need more money to buy the same goods and
ervices. Most economists agree a low inflation rate is
beneficial for the economy. A rate at or below 2.00%
encourages consumers to spend money but not to lose
aith in the currency.
Hyperinflation is the exponential and perceptibly
“unstoppable” rise in the general level of prices within an
economy. While prices in foreign currencies stay relative
table, the local currency quickly loses value during
hyperinflation. Argentina, Zimbabwe and Iran have recently
experienced hyperinflation. Their central banks created a
massive money supply and, in turn, the broad public lost
aith in their currency.
Deflation is the decrease in the general level of priceswithin an economy. It increases the value of money over
ime. Consumers tend to delay purchases in the hope that
products will be cheaper in the future. This behavior has a
harmful affect on the economy and can lead to a
depression. And yet, deflation is sometimes caused by rapid
advancements in technology and can coexist with growth,
ke it did in US during the 19 th century. Highly indebted
governments use monetary policies to avoid deflation.
Consumers Price Index (CPI) is an important
measurement of inflation. It is the price of a basket of
consumer goods and services paid for by the average USurban consumer. As of Oct 2012, the level was 231, which
indicates130% inflation since Oct 1983.
CPI understates medical and educational expenses and
excludes assets that usually cause bubbles, such as housing
and stock prices. The Core CPI, on the other hand,
excludes food and energy which are volatile items.
Therefore, it accepted as a more stable measurement for
inflation.
CPI tracks the price change of a basket of consumer goods.
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Named after the economist John Maynard Keynes
1883-1946), the Keynesian view on inflation states that
changes in the money supply do not directly affect pricing.
nflation is caused by either Demand-Pull inflation, which is
dentified as increased demand due to higher spending, or
Cost-Push inflation, which is characterized by too little
upply to meet demand.
The monetarist view, supported by the likes of Milton
Friedman (1912-2006), states that the growth in the
money supply drives inflation. Monetarists use empirical
evidence to show that throughout history inflation was
always a monetary phenomenon.
The Austrian view star ted in Vienna with the likes of
economists such as Ludwig von Mises (1881-1973). This
view goes a step further than the monetarist inflation view
in that it states that inflation is equal to the increase in the
money supply. Austrians reject empirical methods, claiming
human behavior is too complex and not rational.
They maintain that excess money will
concentrate in certain sectors to form
bubbles, like housing and stock bubbles.
Since the CPI does not include these
bubbles, Austrians find the CPI
misleading.
The primary tool that central banks use to control or
cause inflation is instituting monetary policies. The ECB has
a single mandate: price stability, which is stated as an
inflation rate at or just under 2.00% averaged throughout
the EZ. The FED has a dual mandate of stabilizing pricesand maximizing employment. Like the ECB, the FED targets
an inflation rate at 2.00%.
Why is 2.00% inflation seen as ideal? The FED claims higher
inflation reduces the public’s ability to make long-term
financial decisions and a lower rate could lead to deflation.
John Maynard Keynes
Milton Friedman
Ludwig von Mises
The monetarist view states the
quantity of money multiplied
by velocity of money is equal
o the price level multiplied by
he index real values of
expenditures.
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nter es t RatesThe interest rate is a percentage of the principle loan, paid
or compensation of inflation and risks. It is usually quoted
on an annual basis. Its equation can be calculated as:
nter es t r a te = R isk f r ee r ate + def ault r isk + liquidity
pr emium + matur ity pr emium
nterest rates are a crucial part of a central bank’s
monetary policies. By setting a low or even zero interest
rate policy (ZIRP), central banks aim to stimulate
nvestment and economic growth. However, when interest
rates are kept too low and for too long, financial bubbles
can occur, usually in the stock, housing and commodity
markets.
Real Inter es t RatesReal interest rates are the nominal interest rates adjusted
or inflation. Real interest rates can be calculated with the
Fisher equation:
Real inter es t r ate = (1+ nominal inter es t / 1+ inflation) -1
At present most developed countries have a negative real
nterest rate, meaning inflation is higher than the interest
rate. A negative real interest rate reverses money’s role as
a store of value. In essence, it destroys the real value of
fixed income and discourages saving.
Feder al Fund RatesThe US Federal Open Market Committee (FOMC) sets
he Federal Fund Target Rate, which is currently at 0.25%.
Commercial banks loan each other money on a overnight
uncollateralized basis. The average of the interest rates they
charge is the Fed Fund Effective Target Rate. The FED buys
or sells treasuries or other assets to make sure the
effective rate is near the target rate.
INTEREST RATES
London Inter bank Of fer ed RateLondon Interbank Offered Rate (LIBOR) is the average
rate banks in London charge each other. There are many
different rates, periods (overnight to one year) and
currencies. LIBOR is used as the basis for many financial
products and derivatives. LIBOR is similar to the Federal
Fund Effective Rate but has no monetary policies attached
to it. And so, it is preferred by most commercial banks.
However LIBOR also led to the LIBOR scandal, as
discussed in the chapter on gold market manipulation.
Deposit and Discount R ates
Banks are required to maintain reserves, as either cash in
their vaults or reserves with the FED. The amount of
reserves is approximately 10% of the banks liabilities. The
Deposit Rate is the interest paid on these reserve deposits.
The Discount Rate set by the FED, also known as the
Marginal Lending Rate set by the ECB, is the interest rate
used by central banks that loan out money to commercial
banks. Commercials bank use these loans as a last resort
since they usually borrow from each other at lower rates.
Prime and Mor tgage Rates
The Prime Rate is the interest rate banks charge their
preferred customers. It is the basis of most unsecured
consumer loan products, such as credit card loans. An extra
risk premium is added.
The Mortgage Rate is secured lending, since there is
property as collateral. The rate on a long term
government bond is used to determine the mortgage rate
and a premium is added. Since the FED promised to buy
Mortgage Backed Securities (MBS) in the QE3 program,
the spread between a bond and mortgage is very close to
zero.
Table 1 quotes the six US interest rates as of Dec 5, 2012.
Federal fund rate target 0.25%
Federal fund effective rate 0.17%
Discount rate 0.75%
Prime rate 3.25%
30Y Bond rate 2.76%
30Y Fixed mortgage rate 3.38%
10
Table 1. US Interest rates at Dec 5, 2012
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US public debt is money borrowed by the US national, state and
ocal governments to finance its deficit, or the difference
between government spending and income generated through
axes. The US debt clock indicates that the US government debt
tands around $16.42T on Dec 31, 2012. This figure is slightly
above the US debt ceiling of $16.39T set on Jan 30, 2012.
Government debt is issued by the department of treasury. There
are two forms of US public debt. Treasur y Bills, also known as T-
Bills, have a maturity of up to one year whereas Treasury Bonds
have a longer maturity.
Unfunded liabilities are not included in US public debt. Social
Security, Medicaid and Medicare are the programs with the
argest unfunded liabilities. These unfunded obligations do not
appear on any balance sheet and are not integrated in any official
debt figures. The expenditures of these programs are expected
o rise faster than any other government program due to the
country’s growing senior population. The Wall Street Journalestimates the Net Present Value of the unfunded liability of
Medicare at $42.8T and Social Security at $20.5T. Until they are
called for, guaranteed obligations are also not included in US
public debt. The guarantees on assets of financial institutions,
along with mortgage liabilities of Fannie Mae and Freddie Mac
made in 2008, are examples of guaranteed obligations. If
unfunded liabilities, guaranteed obligations and the current public
debt of $16.42T are combined, the US government has an
estimated total of $87T in liabilities.
As of 2007, the annual budget deficit of the US was
$161B. Every year since 2008, the US has had an annual
deficit exceeding $1T. The 2011 deficit was $1.312T (8.6%
of GDP) then slightly improved to $1.089T$ (6.97% of
GDP) in 2012. With expenses on Social security, Medicaid
and Medicare growing much faster than the economy and
ax revenue, the US is expected to run a large deficit in
he foreseeable future.
n order to limit the amount debt which the departmentof Treasury can borrow, the US Congress has set a debt
ceiling, or the maximum amount of debt the government
can accumulate. Before it approves of increasing the debt
ceiling, Democrats and Republicans must make a deal to
reduce the growth of debt by either raise more taxes or
cut government spending. However, US politicians rather
quabble with each other than reach a solution.
Squabbling politicians during the 2011 debt ceiling crisis.
The US debt reached the debt ceiling of $14.4T on Aug
2011. At the time, US government spending comprised of
40% borrowed money and 60% tax revenues. Political
gridlock threatened US government spending to come to a
halt. After a credit quality downgrade of US government
debt and a minicrash in the financial markets, politicianswere forced to make a compromise. They raised the debt
ceiling to $16.4T.
To control the growing deficit, the US government also
prepared a set of tax increases and spending cuts, which is
now known as the 2012 fiscal cliff. It looks like the 2011
debt ceiling crisis will be repeated in 2013. On Jan 1, 2013,
tax increases and spending cuts will be activated.
As of Dec 2008, the US instituted its Zero Interest RatePolicy (ZIRP). Essentially, US treasury with maturity lower
than the ZIRP period has virtually no interest rate risk. It is
a cash equivalent and has near zero yield. US treasury with
a longer maturity (five to 30 years) does not have this
“protection”. There is high demand for short-term
treasury while that the demand for longer term treasury
dried up. Therefore, the FED was forced to launch
Operation Twist in order to buy US treasury with a longer
maturity and suppress interest rates on them. In 2011, the
FED bought $800B of long-term debt, or 61% of all issuedUS government debt.
The US private sector bought $136B and foreign investors
bought $287B in 2011. Due to the record low interest
rates and weak demand for government debt, the FED
prints new money to buy this debt. Since government
spending is not expected to decrease significantly, it is likely
the FED will remain the largest buyer of US debt. With
$85B per month, the FED will buy a significant percentage
of all new US government debt in 2013.
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Eur o Zone DebtThe total government debt of the 17 members of the
Euro Zone (EZ) was € 8.517T on June 2012. This
represented 90% of GDP. The EZ deficit was 4.1% of
GDP in 2011.
The Euro Stat agency compiles a report using each EZ
country’s statistics on government debt. Not only are
hese figures not audited, but the methods in which they
are collected and their report dates vary.
EZ Integr ation Dilemma
While EZ countries share a single currency and set of
monetary policies, they require different monetary policies
and exchange rates. The more austere Northern
European countries including Germany, the Netherlands,
Austria and Finland have export driven economies withow interest rates and are threatened by higher inflation
rates.
The Southern EZ countries such as Greece, Spain, Portugal
and Italy have high interest rates. Because the Euro
currency is valued too high for their economies, these
peripheral countries have trouble competing in the global
market. Investors, except some institutions in Europe, lost
aith in the periphiral countries, especially due to the
elective default on Greek bonds. Virtually no investors in
he open markets buy peripheral debt, forcing theSouthern EZ countries to depend on the ECB for help.
EURO ZONE GOVERNMENT
DEBT
12
Graph 1. Debt to GDP ratio of the US and Euro Zone
50%
60%
70%
80%
90%
00%
0%
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
US Debt/GDP
EZ Debt/GDP
Alternative Sour ces of Funding Some of the peripheral countries that run a large deficit
avoid asking for official help from the OMT program.
Because official help would lead to financial scrutiny of the
ECB, they use “alternative” funding, thus forcing pension
funds and commercial banks to buy their debt. Spain
forced its Social Security Reserve Funds to use €65B inreserves to buy risky Spanish government debt. Ireland
used its pension funds to buy shares in nationalized banks
and real estate. To buy its government debt, Greece
exploited its commercial banks.
These Southern EZ countries are afraid massive financial
fraud will be uncovered, which will put an end to the
political careers of the people in charge of asking for help.
Considering these dynamics, the ECB’s OMT program and
therefore ECB’s balance sheet and EZ monetary base
might expand modestly in 2013.
Graph 1 shows the debt to GDP ratio of the US and Euro
Zone. While politicians in the US attempt to spend their
way out of a recession, the EZ tries to implement austerity.
This different approach leads to a growing US GDP but a
stagnant in EZ GDP. What’s more, the US debt is growing
even faster than that of the EZ.
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A massive bubble in the Japanese stock and housing
markets peaked in1989. The Japanese government raised
nterest rates which caused the bubble to burst and stock
and housing prices to collapse. The government stepped in
o rescue banks and to stimulate the economy with a large
amount of newly printed JPY. The debt to GDP ratio roseabove 100% in 1997. It has since reached 230% in 2011.
To compare Japan’s debt to GDP ratio with other large
economies, refer to Table 2.
Table 2: Debt to GDP ratio of the
largest economies in 2011
apan 230%
US 99%
EZ 86%
Canada 85%
UK 83%
India 68%
Brazil 66%
China 26%Australia 23%
Russia 10%
Japan… the land of the rising debt.
Japan has a large and growing senior population. Its
national debt is gigantic. Its economy is stagnant. To
stimulate the economy, Japan’s central bank has launched
an endless stream of monetary easing programs.
Unlike the US and EZ, Japan has a high level of household
savings and its citizens and their pension funds are
willingness to buy low risk low yield Japanese Government
Bonds (JGB). However, household saving rates have been
declining for years and are approaching zero. The Bank of
Japan (BoJ) is forced to buy new JGB. Japanese are unable
to buy large quantities of JGBs and yields on JGB are too
low to interest foreign investors.
In Aug 2012, the IMF repor ted “even a moderate rise in
yields would leave the fiscal position extremely vulnerable”.
Therefore, Japan cannot raise its interest rates withoutdestroying its government finances and its economy. In an
attempt to integrate politics and monetary policies, the
newly elected Japanese Prime Minister Shinzo Abe is
attempting to force a 2% inflation target and outright
monetizing of government debt on the once independent
BoJ.
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Tab
The financial crises of 2008 exposed the flaws of the
socialist European system of excessive public spending and
high taxation. Margret Thatcher famously said “The
problem with socialism is that you eventually run out of
other people's money.”
Ignoring the rising problems in the European system, the
US is transforming into a society that resembles Europe.
Their large and growing entitlement programs seem
unsustainable in the long run. The US has increased
spending on entitlements which have led to a budget
deficit of over $1T each year since 2008. With interest
rates at a record low, it is impossible to sell such large
quantity of debt on the open market. This is much like
Japan’s situation.
The FED is the buyer of last resort. With its QE3 and QE4programs, the FED currently buys at an annual rate of $1T
of debt. As long as the budget deficit remains high, the FED
must purchase debt to keep the government finances
sustainable. A minority of the FOMC members are against
further monetary easing. As a response, the Evan rule was
introduced to limit the period of monetary easing. It is
unlikely these programs will stop. There are not enough
investors left to buy US debt at current low rates.
The US and EZ have handled the debt crises the same way
Japan did a decade ago. Here are some similarities.
• A growing elderly population
• The growing entitlement spending
• A stagnant economy
• High budget deficit for multiple years and rising debt
• A series of monetary easing programs and zero rate
interest policy
• The lack of structural change due to politicians clinging
to the status quo
• Central banks buy government debt which cannot besold in the open market at current low rates
• The bailout of all financial institutions and large
companies, which creates a zombiefied system
Japan is the best example that a country cannot borrow
itself out of economic hardship or resolve a debt crisis by
issuing much more debt. Without structural changes to
politics and society, the problems are only pushed to the
future. Therefore it seems unlikely that the ZIRP and
monetary easing programs of both the US and the EZ will
come to a halt in 2013.
n all probability, the ECB will buy significantly less debt
han the FED. And so, the expansion of the EZ monetary
base will be modest compared to that of the US. However,
none of the EZ countries have made any progress in terms
of the underlying issues of the debt crisis.
. The combination of rising entitlement spending, an
aging population and a shrinking workforce
2. A ballooning public sector which takes more than 50%
of the GDP, particularly within some EZ countries such
as France
3. High taxes that will suppress economic growth
Therefore, more debt will be issued in the future. With the
record low interest rates, investors appetite for this debt is
ow. Once all alternative sources of funding have been
exhausted, only the ECB will be left to buy the debt. Japans a shining example of how this scenario will appear in the
uture.
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A decade ago, high flying CEOs and hedge fund manager s wer e the super s tars of
the financial world. In the pr esent day, the per iod in which the New Normal r eigns,
eader s of centr al banks call the shots in the financial world. Tr ader s and investor s
is ten car efully to these key play er since their ac tions drive the gold pr ice. I explaincentral bank policies and their influence on the money supply and inter est rates in
Chapter 3.
Mario Draghi is the president of the ECB.
Ben Bernanke is the chairman of the US Federal Reserve Board.
Zhou Xiaochuan, the governor of the PBOC, will soon be replaced.
Chapter 3CENTRAL BANKS
15
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The Federal Reserve headquarters in Washington D.C.
The FED has a dual mandate of maximizing employment
and stabilizing prices. Its inflation target for stable pricing is
around 2.00% while its employment target is set between
5.20% to 6.00% of the unemployment rate. Although the
FED claims to be an independent organization, the head is
appointed by the US president and during a financial crises,
many of the FEDs decisions seem politically influenced.
The FED consists of the Board of Governors, the Federal
Open Market Committee and Regional Federal Reserve
Banks. The board of Governors consists of seven members
of the board and presidents of 12 regional Federal Reserve
Banks. The regional banks are responsible for implementing
monetary policies and for regulating the commercial banks
n their districts. Ben Bernanke is Chairman of the Board.
He was appointed by the US president for a 14-year term.His term ends Jan 31, 2014.
The Federal Open Market Committee (FOMC) is the
FED’s principal monetary policy body. It sets the monetary
policies of the FED. More specifically, it makes key
decisions about interest rates and the growth of the US
monetary base.
Open Market Operation (OMO) is the buying and selling
of government bonds on the open market to influence
the monetary base and money supply. The FED also uses
OMOs to make sure the Federal Fund Effective Rate is
near the target rate.
When demand for money increases, the FED buys assets,
like government bonds, Mortgage Backed Securities (MBS),
currency or gold in the open market. To pay for theseassets, new money is created and put in the commercial
banks’ reserve accounts, in turn raising the MB and keeping
interest rates stable. The increase of the commercial banks’
reserve is an example of money printing, although this
transaction is completely electronic. When demand for
money decreases, central banks sell assets and decrease
the commercial banks’ reserves and thus MB.
By the end of 2008, the FED lowered the Federal FundsTarget Rate from 5.25% to near zero. By doing so, ZIRP
aims to encourage investments and to allow consumers to
finance large purchases, like housing or cars, at low interest
rates. However, ZIRP destroys the real value of savings and
pensions. And so, it can be called a hidden tax on wealth. It
also helps the US government to finance its growing debt
pile, by keeping interest payments low.
In 2012 the FED pledged to keep the FED Fund Target
Rate near zero until 2015. This pledge has been replaced
by the Evans rule, which states the FED might discontinueZIRP when the unemployment rate is below 6.5% or
inflation above 2.5%.
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When the FED wants to stimulate the economy, they
ower interest rates to stimulate demand for credit and
nvestment. When the economy does not recover and
nterest rates are at zero, the FED can expand the MB in
hopes that this money finds it way to the real economy
and expands the money supply. But unlike China’s central
bank, the FED cannot force banks to make new loans.
The FED announced the first Quantitative Easing (QE)
progam in Dec 2008 with QE1. What followed was QE2 in
Nov 2010, Operation Twist in Sep 2011, QE3 in Sep 2012,
ollowed quickly by QE4 in 2013. QE programs target the
wealth effect. They aim to boost stock prices, thus spurring
he public to spend more money if it feels wealthier.
Analogous to the OMO, QE creates new money on the
FED’s balance sheet and buys assets, like government
bonds and MBS, in the open market. In turn, the reserveaccounts of commercial banks grow so they can invest or
oan out the new money.
The side effects of QE include lower interest rates at the
higher end of the yield curve, a declining USD, the
potential for currency wars and the loss of the USD as the
reserve currency of the world. The gold price, and that of
other precious metals, appears to react strongly to QE
programs too. Typically, the anticipation of QE rapidly drives
up the gold price. But, the moment a new QE program is
officially announced, the gold price could have already riseno a large extent. Therefore, investors search for clues in
he FED statement and economic indicators before any
uch announcements.
Troubled Asset Relief Program
Troubled Asset Relief Program (TARP) was signed into law
by U.S. President George W. Bush on Oct 3, 2008 to
address the subprime mortgage crisis. The FED purchased
assets and equity from financial institutions to strengthen
ts financial sector. It was originally authorized to buy $700B but only $431B was actually used.
QE1 and QE2 The goals of QE1 and QE2 differ from OMO. QE1 was
primarily aimed to unfreeze the crashed financial markets
n 2009. QE2 was intended to stimulate the economy and
encourage investors to buy riskier assets in order to drive
up stock prices. Gold prices were very sensitive and
ncreased by 36% during Q1 and by 21% during QE2.
On Sep 2011, the FED started Operation Twist. The idea
was to “twist” the yield curve to bring down longer-dated
securities in an effort to reduce borrowing costs. In effect
the FED bought long-term treasury and matched this by
sales of short-term treasury. This process is called
sterilization and does not expand the FED’s balance sheetand has limited influence on gold prices. Demand from
investors for long term treasury with record low yield is
limited, which is another reason the FED continues to buy
these bonds.
By creating demand for long-term bonds, it was able to
suppress long-term rates that form the basis for all kinds of
loans, like mortgages or corporate debt. Operation Twist
had little impact on the gold price because the FED’s
balance sheet and the MB did not increase.
Unlike the previous QE programs, QE3 targets the
unemployment rate. The FED purchases $40B of agency
MBS per month until the unemployment rate is in the
range of 5.2% and 6.0%. These rates are changed to the
Evans Rule on Dec 12,2012. QE3 is not sterilized and so, it
will expand the FED’s balance sheet and MB. Throughout
2012, QE3 will expand the FEDs balance sheet increased
by $40B per month.
On the Dec 12, 2012 FOMC meeting, the FED announced
that Operation Twist will be extended into 2013. Since the
FED does not have a large amount of short term US
treasury left on its balance sheet, the extended Operation
Twist will be unsterilized. QE4 will buy $45B in long term
treasury per month. QE3 and QE4 combined will add a
massive $85B to the FEDs balance sheet. Therefore, the
name QE4 is a more appropriate term for Operation
Twist.
On the Dec 12, 2012, the FED introduced the Evans Rule,
after the Chicago FED president Charles Evans. This rule
ties future monetary policy to the FED mandate of
maximum employment and price stability. More specifically,
changes or termination of monetary policies such as QE3,
QE4 and ZIRP can be made if the unemployment rate
falls below 6.5% or inflation rises above 2.5%.
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Chart 1. Scaled US monetary base, currency in circulation, money supply M1 and M2 and FED balance sheet
As of Nov 2012, the US CPI was 1.8%.
With the large quantity of new money
created by the FED, why does inflation
remain modest?
Low Inflation
Most of the money created by the central bank as reserve
money stays in the reserve accounts of commercial banks
and is not loaned to businesses or consumers. This is the
main reason for low inflation. Hence, it is important to
nvestigate if the money supply, or money in the real
economy, keeps pace with the MB, which is basically central
bank money.
Another reason for low inflation is that the CPImeasurement underestimates medical and educational
cost. Along with energy and food, these costs have seen
he highest increase in price over the last decade. Since the
government can spend money on education and medical
without the limits of market pricing mechanisms, bubbles
can result as predicted by the Austrian view of inflation.
Source: Federal Reserve Economic Data tool (FRED)
US Money Supply Chart 1 displays the MB and money supply M0, M1 and
M2. When TARP was issued in 2008 to provide liquidity to
a frozen interbank lending system, the MB increased
massively. The MB also increased at the start of QE1 on
Nov 3, 2010. QE2 ended on June 30, 2011 and thereafter the MB remained rather stable. Even so, with QE3 and
QE4 now active, a rising MB can be expected in 2013. The
currency in circulation, M1 and M2 modestly changed since
2008.
It appears that the money central banks create does not
find its way into the real economy and does not contribute
to inflation. At least, this is the case for the FED. Because
the FED, unlike the PBOC, cannot set loan targets to
commercial banks.
As discussed in chapter 6, MB has a statistical significant
relationship or a good fit with the gold price. Thus, I
included MB as one of the factors in the regression model
to estimate future gold prices.
18
MONETARY POLICIES’ IMPACT ON FED
BALANCE SHEET
0%
50%
00%
50%
00%
50%
00%
50%
Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13
MB
Curr
M1
M2
FED BS
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FED GOLD RESERVE
US Gold Reser veThe US government forcefully purchased its US gold
reserve from its citizens and banks in 1933. The reserve
has not changed since it stood at 8,134 tonnes in 1978. In
2011 the gold reserve represented around 75% of the
FED’s foreign currency holdings. It appears that the FED
has no intentions of buying or selling any gold in the
oreseeable future.
4,578 tonnes of the reserve is stored in the US Bullion
Depository of For t Knox, Kentucky. Around 7,000 tonnes
s stored in its underground vault of the Federal Reserve
Bank of New York. The 7,000 tonnes belongs to the US
and foreign nations, such as Germany and the Netherlands,
along with multilateral organizations such as International
Monetary Fund (IMF).
FX (25%)
$134B
Gold (75%)
$403B
2011 US Foreign
currency holding
It has been speculated that The Federal Reserve Bank of
New York stores the largest gold repository in the world.
This regional central bank has been featured in countless
Hollywood heist films and terrorist plots.
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The ECB has a single mandate. It manages the Euro to
afeguard price stability. The ECB targets an average
nflation rate of 2.00% throughout the 17 countries that
adopted the Euro currency, otherwise known as the Euro
Zone (EZ). It executes monetary policies to achieve this
arget. The ECB is an institution of the European Union,
which is a political entity. Especially after the appointment
of Mario Draghi as its president, the independence of EU
politics is questionable.
The ECB is integrated with the central banks of the EZ. It
also works together with the central banks of other EU
countries. The ECB Governing Council is the main decision
making body of the ECB and is composed of the six board
members of the Executive Board and the 17 governors of
he national central banks of the EZ member states. The
Executive Board oversees the day-to-day management of he ECB. The current ECB president, Mario Draghi, is also
president of the Executive board.
The ECB Governing Council defines EZ monetary policies
and sets interest rates for which it loans money to EZ
commercial banks. It also helps prepare new countries
oining the Euro.
The ECB provides the bulk of the liquidity in the EZ
hrough short-term repo-contracts in its Main Refinance
Operations (MRO). These contracts are short-term loans
of two weeks to three months. Nearly 1500 EZ
commercial banks can bid for these contracts. Interest
rates can be adjusted to match economic circumstances
because of the short-term nature of these contracts.
f their amount increases then the liquidity in the EZ
ncreases. Banks must provide collateral for the loans, with
EZ government debt being the preferred collateral.
ECB Headquarters in Frankfurt, Germany
The ECB uses Long-Term Refinance Operations (LTRO)
to provide emergency liquidity to EZ banks. These
programs draw on longer term loans of three months to
three years. Banks must come up with collateral, preferably
government bonds, but also some mortgage or asset
backed securities. This collateral forms the only limit on the
amount a bank can borrow from the ECB.
Although LTRO existed since the inception of the Euro in
1998, LTRO “took off ” during the European debt crisis,
with two giant steps. In LTRO1, the ECB provided €489B
to 523 banks in three-year 1% loans on Dec 21, 2011.
Shortly afterwards, in LTRO2, it provided €530B to 800
banks in three-year 1% loans on Feb 29, 2012.
The ECB’s LTRO differs from the FED’s QE. LTRO
provides liquidity in a stalled interbank lending system. QE
targets lower interest rates and economic stimulus.However, their results are similar. Central banks accumulate
government bonds and commercial banks hold more
freshly minted cash in their reserve accounts.
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The ECB announced on Sep 6, 2012 that it will make use
of Outright Monetary Transactions (OMT). It buys bonds
from the second hand market to suppress interest rates of
roubled EZ countries. A country must officially request
he ECB for assistance and undergo the financial scrutiny of
he ECB, EU and IMF combined, as known as the Troika.
Spain is widely expected to be the first country in the
program. And yet, Spain has not asked the ECB for
assistance.
Although ECB policies forbid directly aiding EU countries,
Mario Draghi claims that only debt with a maturity of up to
hree years is monetized. ECB interest rate policies cannot
otherwise affect peripheral countries because the markethas a greater influence on rates.
Deposit rate 0.00%
MRO or benchmark rate 0.75%
LTRO rate 1.00%
Marginal lending rate 1.50%
Table 3. ECB rates on Dec 5, 2012
Monetization means converting something into legal
currency. In exchange for freshly printed Euros, periphery
governments transfer their risky debt through commercial
banks to the ECB. The process of indirect debt
monetization is as follows:
1. The ECB creates repo contracts in the MRO or loans in
LTRO program.
2. EZ banks receive cash and put up their government
bonds as collateral.
3. EZ banks have more money in their reserve accounts
and can use this to buy new bonds.
4. Peripheral governments that have trouble selling debt in
the open market sell their debt to those banks.
5. EZ banks have new collateral for new loans at the ECB.
Their profits are generated from the spread between
the government debt yield and the ECB rates.
The ECB does not own the collateral. And so, it does not
publish information on it. However, when a government
would default, it is likely some or all of its commercial
banks will default too. This would leave the ECB with
unpaid loans and worthless collateral on its balance sheet.
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Chart 2. Scaled Euro Zone monetary base, currency in circulation(M0) and money supply M1 and M2
While the MB grew in the post Lehman period in order to
provide liquidity to the financial system, the LTRO
operations in Dec 2011 and Mar 2012 had the greatest
impact on the MB in the EZ. After LTRO2 the MB
remained stable.
Most of the money central banks create does not reach
the real economy, thus does not contribute to inflation.
Then why does the gold price have such close relationship
with the balance sheet of central banks and the monetary
base?
Inflation Thr eat
Since investing is about predicting to the future, gold
investors must be more worried about the threat of
inflation, rather than actual inflation. The FED and ECB
currently have record low interest rates. Similarly, their rates on loans and mortgages are at a historical low level.
However, if employment and GDP growth picks up, there
is a lot of liquidity in the reserve accounts ready to enter
the real economy. It is likely inflation will be much higher
than the current reading of 2.0% or 2.5%. In addition, it
may be difficult for central banks to reverse monetary
easing programs. To shrink the MB, they would have to sell
their accumulated bonds in the open market, taking
liquidity out of the economy, which could stall its recovery.
Source. ECB statistical data warehouse
n Nov 2012, the EZ CPI was 2.2%. The ECB, much like the
FED, created a large quantity of new money in recent
years. Is Europe’s situation similar to the US?
Eur o Zone Money Supply Although the ECB does not publish its MB directly, it can
be calculated as:
Monetary Base = Coins and notes in circulation + Current
Account (minimum reserve) + Deposit facility (voluntarily
held reserve).
Chart 2 suggests that the money created by the ECB does
not find its way into the real economy and, thus it does not
contribute to inflation. Both the ECB balance sheet as the
EZ MB have been stabilized since March 2012 and are
decreasing since Sep 2012. This indicates that the ECB has
not been involved in major monetary policies for the mostof 2012.
There are several reasons why commercial banks prefer to
keep money in their reserve accounts. Additional and
tricter regulation since the financial crisis has been set on
he financial industry, forcing banks to keep more money in
reserve. This regulation forced many banks to deleverage,
decreasing both assets and liabilities, while increase the
banks own equity, or financial reserve. Also, consumer
credit and mortgage demand remains weak throughout
he EZ. Demand for corporate loans is also weak sincecorporations are sitting on an increasingly large cash pile
and prefer to delay investments due to the economic and
political uncertainty.
22
MONETARY POLICIES’ IMPACT ON ECB
BALANCE SHEET
0%
50%
00%
50%
200%
250%
00%
Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13
Currency
MB
M1M2
ECB Balance Sheet
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EURO ZONE GOLD RESERVE
Eur o Zone Gold Reser ven 2011, the ECB and its 17 national central banks
combined held 10,787 tonnes of gold reserve, which is
63.20% of foreign currency holdings. The ECB held only
502 tonnes of gold reserve.
FX (32%)
$215B
Gold (68%)
$454B
2011 combined FX
holding of 5 largest
Euro zone countries
(Ge, Fr, It, Sp, Nl)
23
The ECB Governing Council at meeting in Frankfurt.
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Chart 3. US and EZ Monetary base and Balance Sheets in USD on left scale and gold price on right scale
Monetar y easing pr ogr ams ar e massive
iquidity (or capital) injec tions to financial
sys tems. The concept is a euphemism for
money printing and is linked to central
banks, balance sheets, monetary base,money supply and inflation.
The FED and the ECB along with the central banks of
England, Japan, China and Switzerland have made use of
hese programs since 2008. QE, LTRO and economic
timulus packages are examples.
Monetar y EasingA central bank creates new money with which it buys
financial assets such as bonds or MBS in the open markets.
These assets are put on the asset side of the central bank’s
balance sheet. In turn, the money paid for these assets is
deposited in the reserve accounts of commercial banks.
Reserve accounts are a par t of the MB. And so, they are a
ability for central banks. When a commercial bank loans
out money to customers in the form of new credit, it
needs a small amount of that loan in its reserve account.
The new credit is incorporated in the money supply, M1
and M2.
Gold and Monetary Base
Chart 3 displays the Balance Sheet of the FED and ECB,
the combined Balance Sheet and monetary base of the
FED and ECB on the left scale and the gold price on the
right scale. There appears to be a relationship between a
central’s balance sheet, monetary base and the gold price.
The monetary base will be a key factor in the gold price
regression model, as described in Chapter 6.
Source: FED and ECB websites
MONETARY EASING & MONEY
SUPPLY
24
Table 4. Gold price, monetary base and balance sheets of
the US and Europe
0
200
400
600
800
1,000
1,200
1,400
1,600
1,800
2,000
0
,000
,000
,000
,000
,000
,000
,000
Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13
EZ+US MB (B$)
EZ+US BS (B$)
Gold Price
Jul-07 Dec-12 Increase
Gold ($) 661 1,689 155.64%
FED (B$) 874 2,903 232.07%
US MB (B$) 852 2,650 211.02%
ECB (B€) 1,195 3,022 152.87%
EZ MB (B€) 836 1,630 95.01%
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China is the most cash rich country in the
world as well as the second largest global
economy. Its central bank, the People’s
Bank of China (PBOC), is secretly among
the largest buyers of gold. The monetary
policies of the PBOC are slightly different
to most central banks. The PBOC is under
control of the Communist Party and can
dictate the Chinese economy through the
commercial banks.
The PBOC has a dual mandate. It is decreed to promote
economic growth and to keep inflation low. It sets
monetary policies and regulates banks in mainland China.
30% of the Chinese CPI consists of food, compared to 8%or the US. Rising food prices are a sensitive subject among
China’s poor. The PBOC monitors food prices closely to
determine if monetary expansion is viable. Since the PBOC
s closely integrated with the politics of the Communist
Party, maintaining harmony in the Chinese society becomes
a crucial objective for the PBOC.
So to keep its society stable, the Chinese government
needs a steady GDP growth to support migration from
rural areas to cities and a low inflation rate. Historically, its
nflation rate averaged 4.23% from 1994 until 2012. As of Nov 2012, the inflation rate in China was 2.0% from a high
of 6.5% in July 2011.
The People’s Bank of China in Beijing
The PBOC is more integrated with politics than other
central banks. The governor of the PBOC is appointed by
the president of China. The PBOC has 9 regional branches
and 18 functional departments, such as the Currency, Gold
and Silver Bureau, the Monetary Policy Department and
Accounting and Treasury Department.
The FED and the ECB can only control interest rates on
the short end of the yield curve. The PBOC controls
interest rates across all maturities.
Comparable other central banks, the PBOC can buy or sell
assets or reverse repo to regulate liquidity in the financial
system.
The PBOC can change the Reserve Requirements Ratio
(RRR), which is the amount of Yuan commercial banks
must keep in their deposit accounts at the PBOC. The RRR
can be increased for excess liquidity to be absorbed.
In the past decade, China ran a massive trade surplus. It
exported more than it imported, which produced a steady
flow of USD in the Chinese financial system. To keep the
RMB pegged to the USD, the PBOC increased both themoney supply and the RRR. These measures kept the RMB
from rising against the USD and enabled the Chinese to
export cheap goods.
China is a majority shareholder of its five largest banks.
And so, the Chinese government controls these banks. It
sets loan targets and expects them to pursue its interests.
The banks act as subsides funding channels, issuing loans to
state-owned-enterprises at a set interest rate. But they are
not critical of the credit quality of their loans. As a part of
the 2008 stimulus package, the banks were forced to
provide massive loans to local government and centrally
planned infrastructure projects of dubious economic value.
The state-owned-enterprises also pursue the political goals
of the Chinese government. They are willing to invest in
negative NPV projects so that the Chinese GDP can grow
but not their own shareholder value.
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China requires businesses and individuals to turn over
foreign currency to the government, which ends up on the
balance sheet of the PBOC. The foreign currency reserve
of the PBOC consist of mostly US, EZ and Japanese debt
accumulated over the period of 2000 to 2011 to support
a low exchange rate for the RMB. Of all economies, China
has the largest MB since most foreign currency ends up on
the balance sheet of the PBOC.
Monetary expansions of the FED and the ECB balance
sheets were stimulus driven. But, the expansion of the
PBOC was the outcome of accumulating foreign assets. As
of Sep 2012, China’s trade surplus is valued at $27.7B, a
drop from its Dec 2008 record of 40.09B$.
Even so, there is an outflow of money from privateindividuals trying to escape government control and
artificially low rates on deposits. The Wall Street Journal
estimated this outflow at $225B in the 12 months ending
in Sep 2012. This massive outflow weakens demand for
the RMB and removes the need for foreign exchange
intervention. If China would run a trade deficit, it would
even need to sell some USD nominated assets, causing its
balance sheet to shrink.
As long as the PBOC has no need to expand its balance
sheet and to increase inflation in the near future, it is not
expected to launch any big stimulus package. Then again,
China makes its decisions based on politics and not
economics, so the loan targets to support GDP growth are
likely to be crucial in any monetary decision.
On Nov 9, 2008 the Chinese government launched a 4T
RMB ($586B) stimulus package to help its economy during
he period of the financial crisis. Most of the stimulus was
nvested in infrastructure and social projects. The outcome
can lead to a rise in inflation because these investmentswere made in an economy that was already overheated.
Since the decision was based on political rather than
economic motives, at least 20% of all loans under this
program were written off in 2011.
To promote its export industry, the Chinese government
keeps its currency pegged to the USD and other
currencies. The PBOC announces fixed exchange rates
daily and the market price can only deviate up to 1% fromhis target. When the PBOC runs a trade surplus, foreign
currency accumulates on its balance sheet. USDs are used
as assets so that RMB can be created against them. RMBs
are then placed in the reserve accounts of commercial
banks. The PBOC can raise the RRR to keep inflation in
check and prevent this new money from entering the real
economy.
Chart 4 shows the balance sheet of the PBOC expended
over the period of Jan 2004 and April 2012. The
expansion of the balance sheet came to a halt in 2012.
Nevertheless, the PBOC sits on the largest cash pile ever
accumulated in history as May 2012 with $3.29T.
Chart 4: Balance sheet of PBOC from Jan 2004 to May 2012
Source: Sprach Analyst and People’s bank of China
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Since the balance sheet expansion of
the PBOC has come to a halt, it is mor e
meaningful to inves tigate China’s gold
r eserve ins tead of its monetar y policies.
China’s Gold Reser ve My ster y n April 2009 the PBOC last reported its gold reserve at
054 tonnes, or 1.8% of its foreign currency holdings. The
Chinese State Council adviser Ji stated during the same
year, "we suggest that China's gold reserves should reach
6,000 tons in the next three to five years and perhaps
0,000 tons in eight to 10 years”.
Until these targets are met, any report on the official
Chinese gold reserve is not likely to be released, out of
ear of rising gold prices. “China needs to add to its gold
reserves to ensure national economic and financial safety,
promote Yuan globalization and as a hedge against foreign-
reserve risks”, according to Gao Wei, an Chinese official
rom the Department of International Economic Affairs of
Ministry of Foreign Affairs.
China is the world largest gold producer. It produced 380
onnes in 2011. It imports gold but forbids gold exports.Chinese imports from Hong Kong were 438 tonnes in
2011 and grew to 878 tonnes from the period of Jan 2012
o Aug 2012. China also imports directly from gold
producing countries like Australia. According to the
Australian Bureau of Statistics, gold sales to China were
$4.1B (or around 75 tonnes) in the period of Jan to Aug
2012. This figure surpassed coal to become Australia's
econd export product to China after iron ore.
Having a large gold reserve also stabilizes the RMB and
helps China with its goal of promoting the RMB as theworld’s reserve currency. Gold purchases come at the
expense of buying US treasuries and EZ debt, as predicted
n Triffin dilemma.
Gold Reserve
Es timating 2012 Gold Impor tsAccording to 2012TTM, Chinese consumer demand is 814
tonnes. Its gold production as of 2011 was 380 tonnes
and its total 2012 estimated imports are to 1080 tonnes,
of which 100 tonnes comes from Australia. Moreover, the total PBOC gold reserve is expected to increase to 746
tonnes by the end of 2012.
PBOC GOLD RESERVE
Gold
$390B
(11%)
FX holding
$3150B
2015est PBOC
Foreign currency
holding
Gold $30B
(1.52%)
FX holding
$1950B
Apr 2009 PBOC
Foreign currency
holding
27
PBOC Fu tur e ReserveThe PBOC expects to hit its target of 6,000 tonnes in gold
reserves in 2015. This quantity is still a small fraction of the
total FX reserve and is not comparable to that of the US
or EZ countries. The main reason is that the size of foreign
currencies is much larger and is expected to be $3150B as
of 2015. Since China ceased to buy additional US and EZ
debt, gold is expected to increase as a percentage of the
total foreign currency holdings.
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Chapter 4 explains the roles of supply and demand on the price of gold. Asian
consumers form the largest part of gold demand, and so, this report focuses on
demand from China and India.
Since recent data is employed, time frames vary in the report. Demand is reported
n quarterly intervals based the trailing twelve month 2012 method (2nd half of
2011 and 1st half of 2012). Supply is reported in annually intervals using 2011 data.
Gold reserve is based on data obtained in Sep 2012.
ndian culture dictates that brides receive dowries in the form of gold jewelry.
Chapter 4GOLD SUPPLY &
DEMAND
28
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Gold is a financial investment, not an industrial commodity,
ke crude oil or copper. Most physical demand in gold
comes from consumer use of jewelry, bars and coins and
official sector demand from central banks. A fraction of the
gold demand comes from industrial use, like high-end
electronics for the medical, space and aviation industries
and a small portion goes towards golden teeth.
t is not possible to accurately measure the supply and
demand of gold. Supply and demand statistics are estimates
o match the incremental gold output (flow of gold).
Besides, some large markets such as Indian and Chinese
also have large unofficial markets.
GOLD SUPPLY & DEMAND
TRENDSAn additional problem in measuring the physical gold
market, is that the current reserve of gold, termed the
stock, will never be consumed, unlike other commodities
such as corn or crude oil. The stock-to-flow ratio of gold is
the total reserve of gold compared to the annual amount
of newly produced gold. The ratio for gold is around 60and the ratio for silver is 20 and copper is about 1. Thus, it
is difficult to map the flow of existing gold between buyers
and sellers.
The annual demand and supply of gold barely changed
between 1997 and 2012, as shown on Charts 5 and 6.
In contras, the gold price increased from $280 in Jan 2000
to $1664 in Dec 2012. During this same period, demand
for jewelry declined while gold investments in the form of
bars and coins rose.
0
500
000
500
000
500
000
500
000
500
000
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012TTM
Central bank demand
Producers dehedging
Industrial
ETF
Coins&Bars
Jewellery
0
500
000
500
000
500
000
500
000
500
000
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012TTM
Sales Central banks
Recycling
Production
Chart 5: Annual gold demand in tonnes
Chart 6: Annual gold supply in tonnes
29
Source: World Gold Council
Source: World Gold Council
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Consumer demand, including jewelry and coins and bars,
was 3264 tonnes in 2012TTM.
CONSUMER DEMAND
Global demand was 4456 tonnes in 2012 TTM (2H 2011
+ 1H 2012).
Gold consumers in emerging markets
nvest more in jewelry than coins and
bars while consumers from developed
markets do the opposite. Albeit,nvestment in jewelry is also a financial
nvestment in gold.
Eur opeEurope consumed a total of 369 tonnes in 2012TTM. It
was the largest consumer of gold bars and coins at 354
onnes and jewelry demand was negligible at 15 tonnes.
Demand was very low before 2008, but it skyrocketed
when the credit crises started. Virtually all of the gold in
Europe was sent to Germany and Switzerland, possibly to
meet demand by investors from Southern European
countries.
United States
The US market for gold was relatively small with a total of
26 tonnes in 2012TTM. Consumption of jewelry was 80
onnes and gold and coins was 46 tonnes. Although data
on individual investors is unavailable or unpublished by
exchange traded fund (ETF) providers, it can be assumed
hat US investors are more interested in paper gold suchas gold backed ETFs.
India, 765,
23%
China, 814,
25%
Middle East,
343, 11%
Europe,
369, 11%
USA, 126,
4%
Other, 835,
26%
Consumer demand
(Jewelry, bars and coins)
and % of global demand
in tonnes 2012TTM
jewelry
1838, 41%
Bar and
Coin, 1426,
32%
Technology,
440, 10%
ETF, 243,
6%
Central
banks, 509,
11%
Total demand in tonnes
and % of global
2012TTM
IndiaIndia has always been a large gold consumer market. Its
market consumed a total of 765 tonnes or nearly 24% of
the global demand in 2012TTM. 505 tonnes of jewelry was
consumed along with 260 tonnes of coins and bars. Gold
demand has decreased because the gold price in Rupee
increased much more than in USD.
ChinaChina consumed a total 814 tonnes or 25% of the global
market. Demand for jewelry was at 538 tonnes and coins
and bars at 278 tonnes. The Chinese government hoards
gold and encourages its citizens to do the same. The gold
price in Yuan rose significantly less than in USD, increasing
demand.
There could be more room for growth in Chinese
demand. Given, the GDP of China is three times that of
India, China is on its way to overtake India as the largest
gold consumer market in the world.
Middle Eas t and Tur key Most demand comes from the more wealthy Middle East
countries, Turkey, Saudi Arabia and the UAE. Much like
China and India, demand is mainly in the form of jewelry at
229 tonnes and only 114 tonnes in coins and bars.
30
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Chart 7. Indian consumer demand in tonnes on the left scale and the gold price in Rupees on right scale
Chart 8. Chinese consumer demand in tonnes on left scale and the gold price in Renminbi on right scale
Compared to gold in USD, the gold price in Rupees increased dramatically from Jul 2007 to Sep 2012. Chart 7 shows
that the demand in the gold price decreased in last the four quarters. The seasonal pattern of a spike in jewelry demand,
where it peaks in 3Q is barely evident. This phenomenon may have been either over-estimated or smoothed out, if the
assumption holds true that customers purchased jewelry long in advance.
A strong Yuan from Jul 2007 to Sep 2012 made the rise in gold prices more modest in China. Chart 8 suggests a trend of
rising demand for both jewelry as coins and bars. Annually, demand is highest in the Q1, mainly due to the seasonaldemand during the Chinese new year.
0
10000
20000
30000
40000
50000
60000
70000
80000
90000
100000
0
50
00
50
200
250
00
50
400
Coins & Bars
Jewellery
Goldprice (Rupee) +258%
0
2000
4000
6000
8000
10000
12000
14000
0
50
00
50
00
50
00
50
00Coins & Bars
Jewellery
Goldprice (RMB)
+127%
31
CONSUMER DEMAND TRENDS
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Chart 10 presents European consumer demand in tonnes on the left scale and the gold price in Euro’s on the right scale.
European consumers had little appetite for gold until the financial crises became headline news with the LehmanBrothers bankruptcy. Although the data includes European demand from the EZ, UK and Switzerland, almost the entire
gold demand comes from Germany and Switzerland, perhaps from clients in peripheral countries.
Chart 9. US consumer demand in tonnes on left scale and the gold price in US Dollars on right scale
0
200
400
600
800
1000
1200
1400
1600
0
50
00
50
00
50
00
50
00
Coins & Bars
Goldprice (EUR)
+191%
0
200
400
600
800
1000
1200
1400
1600
1800
2000
0
50
00
50
00
50
00
50
00
Coins & Bars
Jewellery
Goldprice (USD)
+174%
Chart 9 displays US consumer demand in tonnes on the left scale and the gold price in USD on the right scale. US gold
demand has declined for some years. While demand for coins and bars increased after the Lehman Brothers bankruptcy,
demand was steady thereafter. It may be possible that US consumers buy more paper gold like the SPDR GLD ETF.
Chart 10. European consumer demand in tonnes on left scale and the gold price in Euros on right scale
32
CONSUMER DEMAND TRENDS
Source: World Gold Council
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From the second half of 2011 to the first half of 2012, 59%
consumer demand came from China, India, Turkey and
Middle East and15% came from EZ and US.
ndia and China are the primary countries for the global
gold market. A large part of consumer demand in the form
of jewelry, coins and bars comes from these two populous
countries. EM central banks also have started buying gold
o diversify their foreign currency holdings. The relative shift
of wealth and power from Europe and the US towards
Asia could provide a strong demand for gold in the future.
Gold supply & demand
0
2,000
4,000
6,000
8,000
0,000
2,000
4,000
6,000
USA
Euro Area
China
Asia-Pacific
Middle East
+16
+10%
+60%
+56%
+29%
+136%
+50%
+60%
-3%
+3%
Source: IMF World Economic Outlook Database Oct 2012
Chart 11 shows historical GDP and future estimation of
the most important gold markets. Asia-Pacific include India,
Russia, South Korea, Thailand and Indonesia but excludes Japan and China. Middle East includes Turkey, Saudi Arabia,
UAE, Egypt, Iraq and Iran.
The growth of the gold within the 5-year period between
2007 to 2012 and the growth estimate between 2012 and
2017 is displayed in %. In 2017, the combined Asian
economies will be the size of the US and EZ combined.
EMERGING MARKET DEMAND
Chart 11. Historical and future estimates of GDP of major countries and regions in million USD
33
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ewelry demand was 1963 tonnes worldwide in 2011; thus accounting for
almost half of the total gold demand.
ndia represents the biggest market for jewelry. Gold
demand usually peaks during the festival season, starting in
August with Eid and ending in October with Diwali, then
ollowed by the traditional wedding season. This pattern did
not emerge in 2011 according to the quarterly Consumer Demand statistics. Other factors such as the high gold
price along with a low rupee exchange rate made demand
all by 14%. Extreme monsoon rain may also lower the
gold demand. Due to bad harvests, rural consumers have
ess money to purchase gold. Besides, Indians are permitted
o only hold financial assets in Rupees. So, gold is a sound
nvestment to hedge against high Indian inflation.
ndia 567 tonnes in 2011
China
511tonnes in 2011
Consumer demand for jewelry and coins and bars peaks
on the Chinese new year in late Jan or mid Feb, which
supports the seasonal pattern of higher first quarter
demand. Golden jewelry is often bought for wedding
ceremonies and the Chinese new year. Most of it is pure
gold. 75% of urban woman in China own more than one
golden piece. They view gold as an investment and lavishly
spend money on it to display their income or wealth. The
Chinese government also encourages its citizens to buy
gold. Demand was up 13% in 2011, reflecting China’sgrowing wealth.
n 2011, there was a 28% increase in the gold price in USD. jewelry demand remained strong, dipping by 3% since 2010.
Unsurprisingly, most countries with huge jewelry demand from citizens have central banks that started to purchase goldo diversify their foreign currency holdings.
Turkey and Middle East 230
tonnes in 2011
Turkey, Saudi Arabia and UAE have a relatively large gold
emand compared to the size of their economies. And yet,
emand took a dip by 17% in 2011.
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Par adigm Shif t in Gold Mar ketSince 2009 a powerful new demand factor in the gold
markets appeared. Several central banks of EMs started to
purchase gold to diversify their foreign currency holdings.
Traditionally, they held reserves primarily in USD, against
which they issued their own currency. However, because
most developed countries have ever increasing debt,monetary expansion and negative real interest rates, the
EM central banks are looking for alternatives. Until 2008
central banks of developed nations were sellers of gold.
Since the threat of a large amount of gold being dumped
n the global market has always existed, central banks of
developed nations suppressed the gold price.
Missing or Unaccounted GoldSome gold purchases are not reported in the demand
data, particularly purchases made by the PBOC, hedgeunds or private purchases. Because of nondisclosure,
hese gold purchases are not a part of the official data
provided by Thomson/Reuters. It is unclear who is selling
his gold. The most likely candidates are central banks of
highly indebted countries.
Central banks are not audited. They can report any figure
hey see fit. Possibly through constructions like leasing out,
repurchase agreements or gold deposits, central banks can
claim the original amount of gold reserve on their balanceheet. All of this without physically holding the complete
gold reserve. Both the FED and ECB claim their gold
reserves include gold deposits and gold swaps.
Gold Reserve
Germany, Austria and the Netherlands, among others, have
most of their gold stored abroad, thus making it even
harder to audit central banks. More public demand for
auditing and repatriating the national gold reserve is heard
in these countries.
Central Bank of RussiaThe Central Bank of Russia (CBR) can be used as an
example to illustrate central bank demand of gold. The
CBR is the world’s largest (officially reported) buyer of
gold, which is most or all locally produced gold. Russia
doubled its reserve from 460 tonnes in 2Q 2008 to 918
tonnes in 2Q 2012. In 2011, it held a total FX reserve of
$497B of which 8.8% was in gold.
Chart 12 suggests there is no relationship between the
CBR’s quarterly purchases of gold and the gold price. The
CBR currently buys gold at a rate of around 100 tonnesper year. The purchases are related to the income of years
of high oil and natural gas exports.
A similar development can be observed at many other EM
central banks like those of Turkey, Saudi Arabia, South
Korea, India, Kazakhstan, Mexico, Philippines, Brazil and Iraq.
These banks all bought gold recently, although in smaller
scale or not as frequently as the CBR. Therefore, central
bank demand is not related to the gold price but it can be
an important factor for a higher future gold price.
CENTRAL BANK DEMAND
0
200
400
600
800
1000
1200
1400
1600
1800
-
10
20
30
40
50
60
70
Q3
2007
Q4
2007
Q1
2008
Q2
2008
Q3
2008
Q4
2008
Q1
2009
Q2
2009
Q3
2009
Q4
2009
Q1
2010
Q2
2010
Q3
2010
Q4
2010
Q1
2011
Q2
2011
Q3
2011
Q4
2011
Q1
2012
Q2
2012
CBR Quarterly demand
Gold price (USD)
Source: World Gold Council
Chart 12: CBR quarterly gold demand on the left scale and the gold price in USD on the right scale
35
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The gold output is expected to increase with a small
amount in 2012 due to the continued expansion of
exploration and development budgets of global mining
companies. Nearly 64% of the gold supply in 2011 was
new production from mines. South Africa seems to be the
exception. Due to severe labour unrest, its supply will likely
fall in 2012. Not all new gold production is sold on the
open market. For example, China and Russia do not
export gold.
The remaining 36% of gold supply is recycled gold from
mainly old jewelry. When gold prices rise, scrap gold supply
usually picks up. This trend did not occur during the first
half of 2012. With gold price near records at $1750,
consumers felt it could go even higher.
GOLD SUPPLY
0
50
00
50
200
250
300
350
400
China Aus US SA Russia Per u Ghana Canada Indonesia Mexico
Y2010 Y2011
Gone are the days of prospectors finding cherry sized
nuggets with simple tools. In our modern times, gold is
ound as tiny particles in large ore deposits deep down in
he earth. The process of producing gold is increasingly
difficult and expensive which drives up the cost of mining
companies.
Chart 13 shows the top gold producing countries as of
2010 and 2011. China, Australia and the US produced at
east 240 tonnes of gold in 2011. South Africa ranked fifth
after being the world largest gold producer for decades. Its
drop in production is mainly due to its high cash cost, a
erm which will be discussed in further detail in Chapter 8.
Regardless, South Africa holds one of the largest gold
reserves and Anglo Ashanti and Gold Fields which are
South African based gold mining giants have expandedheir global operations.
Chart 13: Annual gold production in tonnes per country
36
Source: World Gold Council
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Gold Reserve Above Gr oundThomson and Reuters estimated that
he total gold reserve was 171,000
onnes at the end of 2011. This
quantity can fill 3½ Olympic size
wimming pools.
Who are the biggest owners of gold?
With a large demand and long history,
he Indian consumer hold 18,000onnes of gold. Although China is
wealthier than India, gold purchases
are relative new and the Chinese
consumer holds 6,000 tonnes.
ABOVEGROUND GOLD RESERVE
171,000 tonnes
total reserve end of 2011
Gold held in trust for the SPDR Gold trust ETF
8134
4000
3396
2814
2452
2435
1318
1040
937
765
613
558
502
423
383
366
323
310
287
282
0
000
2000
3000
4000
5000
6000
7000
8000
9000
Chart 14: Gold reserve on Sep 2012 in tonnes, China estimated
37
jewelry,84,300, 49%
Central banks,29,500, 17%
Investmens,33,000, 20%
Technology,20,800, 12%
Unaccounted
, 3,600, 2%
Global above ground
reserve 2011 in tonnes
Source: World Gold Council
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The Grasberg mine in Indonesia is the world’s largest
gold mine with a 2011 production of 63 tonnes of gold.
Source: Respective companies financial statements 2011
Table 5 summaries the 12 largest publicly traded gold
producing companies. In 2011, their annual combinedproduction was 1032 tonnes, which is 36.72% of the global
output. These 12 companies had a combined gold reserves
of 25,205 tonnes. If we assume this would also be 36.72%,
he total underground gold reserve would be 68,646
onnes. This is the amount of gold that is economically
viable to extract at current prices and technology. With
higher gold prices in the future, more gold reserve could
be added. The US Geological Survey estimates the global
underground gold reserve at 100,000 tonnes.
Gold
Production (in
tonnes)
Gold
Reserve
(in tonnes)
Barrick Gold (ABX) 229 4,352
Newmont (NEM)
177
3,073
AngloGold Ashanti (AU) 133 2,351
Goldfields (GFI) 107 2,414
Kinross (KGC) 75 1,947
GoldCorp (GG) 74 2,012
NewCrest 71 2,460
Polysus Gold 45 2,813
Harmony (HMY) 40 1,294
Freeport McMorran (FCX) 33 1,054
Yamana (AUY) 29 530
Eldorado (EGO) 20 903
Total 12 companies 1,032 25,205
World 2,810 68,646
2 Companies share 36.72%
70,000 -100,000s the es timated gold r eser ve s till in the ear th.
36 years
is the expected time that it will take for all gold in the
proven reserve to be mined, given the current extraction
rate. In contrast, it is likely to take 54 years for all the oil in
the proven reserve, including tar sands, to be extracted.
Although the gold price and exploration
budgets rose significantly every year
since 2000, major new discoveries have
been declining since 2006.
The last giant discovery of gold was the Oyu Tolgoi deposit
in Mongolia in 2001. It is to become one of the largest
gold, silver and copper mines in the world with 1275
tonnes of gold reserve. The mine began construction as of
2010. The commencement of operations is scheduled for
2013. Oyu Tolgoi is jointly owned by Ivanhoe mines, Rio
Tinto and the government of Mongolia.
38
Table 5. Gold production and reserves with publicly traded
gold producers
UNDERGROUND GOLD RESERVE
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n Chapter 4, I describe the markets in which gold is traded and estimate the total
size of the gold markets. Also I investigate the historical gold price and analyse
whether the gold market is manipulated.
Chapter 5
GOLD MARKETS & ""THE GOLD PRICE
39
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The term paper gold is used to describe gold investment
hat does not involve physical gold. It was once a paper
hat was a claim on a certain amount of gold. Nowadays,
most trades are performed on computers and the vast
majority of traded gold does not involve any physicalexchange of ownership.
Gold Bullion refers to gold in bulk, usually in the form of
bars or coins, traded as a commodity. The London Bullion
Market Association (LBMA) represents the bullion market
or gold and silver in London. The majority of all gold and
ilver is traded Over The Counter (OTC). OTC
ransactions are performed between buyers and sellers
outside public exchanges and unreported to the public.The members of the LBMA handle the majority of those
rades between clients, such as central banks, mining
companies and traders.
The London fixing price is used for many large gold
ransactions. It is set twice a day at 10:30 and 15:00 GMT
ime zone. The gold price moves up and down, until
demand and supply are matched, and the price is declared
fixed. All business is conducted on the fixed price.However, since all gold transactions at the LBMA are OTC
and thus unreported, the London fix price can be
manipulated in similar ways as the LIBOR rate is.
London is the city where most of the world’s gold is traded.
Bullion banks are investment banks dealing in large
quantities of gold that handle gold transactions, deposits
and storage. They are also the conduits for central bank
gold transactions. Since gold does not produce any income,
including interest or coupon payments, central banks can
loan their gold supply to third parties for a fee or in the
form of either swaps, lease or buyback constructions. DB,
HSBC, JPM, UBS, Barclays and ScotiaMocatta are bullion
banks of the LBMA that handle gold loans.
A client can hold an unallocated gold account with any
gold bullion bank of the LBMA. The LBMA website states
this account is one “where specific bars are not set aside
and the customer has a general entitlement to the metal. Itis the most convenient, cheapest and most commonly used
method of holding metal.” The website further explains
that “credit balances on the account do not entitle the
creditor to specific bars of gold or silver, but are backed by
the general stock of the bullion dealer with whom the
account is held. The client is an unsecured creditor.”
An unallocated gold account is similar to a checking and
savings account at a commercial bank. A client does not
own the gold deposit but only a claim on it. The bank does
not have all the gold deposits in reserve, but only a
fraction. It can use the deposit for its own purposes.
Since gold at the LBMA is traded OTC, it is difficult to
estimate the size of the total gold market. To validate that
gold is a high-quality liquid asset to the Basel 3 commission,
the LBMA conducted a voluntary survey in 2011. Based on
data obtained on the trading activity of 36 of its 56 full
members, the report claimed that the estimated total
London daily turnover of gold was 174M Oz, or 5400
tonnes, per day. This daily volume represented a value of
$241B. It is larger than the annual physical gold demand.
89% of it was traded at the spot price, probably in
unallocated gold accounts.
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A Gold Future Contract is an agreement for the delivery
of physical gold at a specific date for a specific price. Gold
utures trade at different exchanges. The largest
commodity futures exchange trading gold is The Chicago
Mercantile Exchange group (CME) and its divisions
COMEX and NYMEX. Smaller exchanges are found inmost of the world’s financial centres such as Tokyo,
Shanghai and Dubai.
A gold future at the CME has an underlying value of 100
Oz. By the end of Nov 2012, the future was worth an
estimate of $172,000. At expiration of the future, 100 Oz
of gold must be delivered by the short seller to the long
holder of the contract. To avoid physical delivery the vast
majority of contracts are sold before expiration. There is
till a small number of gold futures traded in the open
outcry system, where traders in colourful jackets shove andcream for orders in a pit. However, around 97% is traded
on Globex, which is the CME’s electronic trading system.
Unlike other commodities, gold futures are solely driven by
he spot price and the interest rate. Since interest rates are
always positive, the gold future market is always in
contango, a situation where longer dated contracts have a
higher price than shorter dated contracts. At present, the
amount of contango is around 0.70% of its annual
underlying value. Future contracts require a small amount
usually around 10%) of the underlying value in margin,
held in cash or a cash equivalent like US treasury.
CME Headquarters in Chicago
Jan 2012-Nov 2012 Contracts Million oz Billion USD
Comex Gold Futures 179,374 17.94 29.91
Comex Gold Options 37,733 3.77 6.29
Total CME Gold 217,107 21.71 36.20
Comex Silver Futures 54,398 271.99 8.45
Comex Silver Options 6,861 34.31 1.07
Total CME Silver 61,259 306.30 9.52
Jan 2011-Nov 2011 Contracts Million oz Billion USD
Comex Gold Futures 201,190 20.12 31.49
Comex Gold Options 40,800 4.08 6.39
Total CME Gold 241,990 24.20 37.88Comex Silver Futures 81,926 409.63 14.55
Comex Silver Options 8,833 44.17 1.57
Total CME Silver 90,759 453.80 16.12
Table 6. Average daily volume of Gold and Silver Futures
and Options traded on the CME/COMEX
Unlike equity, where the total profit or loss depends on
how much the stock goes up or down, futures are a zero
sum game, where total losses equal total profits.
Underlying futures is the concept of open interest, which is
the amount of long and short contracts that investors hold.
The CME website repor ts open interest. On Dec 10, 2012,480,000 gold future contracts on the CME represented
48M Oz or 1500 tonnes of gold. However, the traded
volume must be determined to estimate the size of the
global gold market.
Table 6 compares the average daily volume of gold and
silver traded on the CME in 2011 and 2012. The gold
futures market shrank slightly in the one year period. The
amount of gold futures decreased by10%. But, due to its
higher gold price in 2012, it decreased by 4.4% in USD
terms. The silver market shrank significantly in the one year period. It also shrank as a percentage of the gold market.
While the silver future market was 42.56% of the gold
market in 2011, it decereased to 26.30% in 2012.
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GOLD ETF MARKET
Gold Backed Exchange Traded FundsGold backed Exchange Traded Funds (ETFs) are publicly
traded investment funds that track the price of gold minus
their expenses. With the money invested in these funds,
the funds manager buys gold bullion and stores it in a
custodians bank’s vault. Gold backed ETFs can be bought
on many stock exchanges these days, including those in
New York, London, Johannesburg , Melbourne, Hong Kong,
Tokyo and Singapore. On Dec 4, 2012 the total amount of
gold held by all gold backed ETF’s was 2623 tonnes.
SPDR Gold Trust
The SPDR Gold Trust (GLD) is the largest of all gold
backed ETFs and receives the most media attention. GLD
s managed by State Street Global Advisors for an annual
fee of 0.40%. Usually around 96% money is invested in
gold bullion. On Dec 31, 2012, GLD had a Net Asset Valueof $72.24B, representing 1350 tonnes of gold. Its average
daily volume at the NYSE was 17.56M contracts, or
.756M Oz of gold, in 2011. The volume dropped with
43% to 9.95M contracts, or 0.995 M Oz of gold in 2012.
Chart 15 shows the price of a share in GLD and the
amount of gold in reserve in tonnes in the period of Jul
2007 to Dec 2012. At the start of the Q1 and Q2
programs, the reserve increased and thereafter it remained
stable. The price of gold seems to have little impact on the
total demand of GLD.
42
Alternatives to SPDR Gold TrustOther gold backed ETFs include:
• ETF Securities Swiss Gold Shares (NYSE:SGOL)
• ETF Securities Physical Asian Gold Shares
(NYSE:AGOL)
These alternatives differ from GLD in that GLD stores its
gold in the US, SGOL stores its gold in Zurich vaults and
AGOL in Singapore vaults.
Exchange Tr aded NotesAccording to US regulation, ETFs must invest in the
products they promote. For this reason, ETFs with the
name gold in them must invest in physical gold bullion.
Exchange Traded Notes (ETN) are mainly issued in Europe
and these restrictions do not apply to ETNs. ETNs can
invest in gold future contracts or a total return swap tomimic a gold bullion investment. They can be engineered
to have more leverage or go short on a gold investment.
However, when a financial derivative is held instead of gold
bullion, an extra layer of risk is introduced, namely counter
party default risk. In case of default of the counterparty,
investors in an ETN could be left with little or no money.
The following are examples of ETNs:
Powershares DB Gold ETN (NYSE:DGL),
Powershares DB Gold Double Long ETN (NYSE:DGP)
Powershares DB Double Short ETN (NYSE:DZZ).
Chart 15. The price of a share in the GLD ETF on the left scale and the total gold reserve of GLD in tonnes
on the right scale
0
200
400
600
800
1,000
1,200
1,400
1,600
0
20
40
60
80
100
120
140
160
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Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13
GLD Price
GLD Tonnes of Gold
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SIZE OF GOLD MARKETS
43
Measur ing the Gold Mar kett is not possible to accurately measure the total size of the
gold market, which is defined by its daily traded volume.
The majority of the gold market is OTC and the data
available to the public is fragmented over many exchanges
and products. Thus, I estimate the gold market from datahat is accessible and ignore different time frames, sources
and methods.
Table 7 reports the gold traded volume and market (i.e.
hare) from the following sources of information.
. The daily volume of gold traded was obtained from
the Q1 2011 LBMA survey.
2. The average daily volume of gold futures and options,
spanning Jan 2011 to Nov 2011 was retrieved from
the CME website.
3. The Gold ETF volume, which is estimated to be twice
the volume of the State Street SPDR Gold ETF in
2011, was retrieved from the spdrgoldshares.com
website.
4. Other data was derived from Reuters/GFMS 2012.
Based on estimates from Table 7, I conclude that:
1. The OTC gold market at the LBMA is far larger than the
publicly traded gold future market at the CME. The
Gold ETF market is neglible.
2. The 2011 annual physical gold demand of 4500 tonnes
is dwarfed by the daily traded gold volume of 204M Oz
or 6330 tonnes. Every trading day an amount larger
than the annual physical demand is traded.
Large investors can buy gold at the LBMA and sell gold
futures on the CME for hedging or arbitrage opertunities.
Because only the large sell order is visible to the public,
some may assume that the gold price is manipulated. That
said the gold market may be manipulated. And so, follow
up research on the issue will be reported soon.
Table 7. Daily and annual gold traded volume in million Oz
Daily Volume
Annual
Volume Share
BMA (1Q 2011) 173.71 43,776 83.50%
ME/COMEX 2011 24.20 6,072 11.58%
old ETFs 2011 3.51 885 1.69%
thers 2011 6.77 1,692 3.23%
otal gold volume 208.19 52,424100.00%
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The foreign exchange market, also referred to as forex, FX
or currency market, is the market in which currencies are
nternationally traded. Since FX market is a global, it is open
24 hours a day. Most trades take place in Tokyo, Londonand New York. The exact size of the FX market is difficult
o obtain as most currency is traded OTC. Still, it is by far
he largest of all financial markets.
n 2010, the Bank of International Settlements (BIS)
conducted the “Triennial Central Bank Survey 2010” to
study the size of the FX market. The average traded daily
volume in the FX market, including spot transactions and
derivatives, was estimated at $4.0T. To compare the
currency market with the gold market, I report the most
raded currencies on the FX market on Table 8.
For the estimation of the daily turnover in gold estimation, I
used the average traded volume of gold in Oz of 2011 and
multiplied that with the average gold price of 2010.
The estimated daily traded volume of gold represents a
daily value of $255B in 2010. If gold is viewed as a
currency, this quantity makes it the world’s 4th most traded
currency. Because of the enormous size of the gold market,gold must be thought of more as a currency than as a
precious metal.
Gold is often considered as a currency. It has the currency
code XAU, which is not to be confused with the gold
mining index with the same code. Many investment banks
trade gold at their currency trading desks instead of their
commodity trading desks. As mentioned in Chapter 3,
central banks consider their gold reserve a part of their
foreign currency holdings.
Since the volume of paper traded gold is much larger than
physically traded gold, the gold price is set on the
electronic markets and not the physical gold trade. In
Chapter 6, I will determine that factors driving the gold
price such as interest rates, inflation and the money supply
also drive the currency trade.
The first characteristic of the gold currency is that it pays
0% interest, which is slightly lower than the 0.18% on the
short-term US treasury on Nov 2012. The second is that
is that its supply increased in 2011 with a modest 1.6%,while the USD M1 and M2 increased at 18.03% and
9.83%, respectively.
Table 8. Daily currency average turnover in USD billion
USD Billion Year
USD:EUR 1,101 2010
USD:JPY 568 2010
USD:GBP 360 2010
255 2010-2011
USD:AUD 249 2010
USD:CAD
182
2010
USD:CHF 168 2010
EUR:JPY 111 2010
EUR:GBP 109 2010
Turnover stock at NYSE 1,509 2011
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NOMINAL & INFLATION ADJUSTED GOLD PRICE
1980 Gold SpikeThe gold price hit a peak of $835 on Jan 18, 1980. If it was
adjusted for inflation, the price would be $2463 on Sep
2012. But the world in 1980 was very different from 2012.
The US was still involved in the cold war. Russia was in
open warfare in Afghanistan. The outfall of the Iranian
revolution influenced the global oil and financial markets.
Government overspending and an oil price spike caused
nflation to run rampantat at 14% as of Jan 1980. To
combat inflation, the FED raised interest rates. The FEDFund Rate was at a record 17.9% on April 1980. The gold
price lost half it value in the following year as the US
plunged into a recession.
2011 Recor d Pr iceOn Sep 5, 2011 the gold price set a record high in nominal
terms of $1895. Unlike 1980, where the gold price shot up
like a bullet, a slower trend running for a decade led to this
2011 record. Unlike the gold price collapse after the 1980
spike, it is expected to go up again in the near future. The
gold price can reach the $1895 level again, but it might
have difficulty breaking this price level.
$2473Inflation adjusted Gold Price in Jan 1980, stated in
today's (Nov 2012) USD
Source: Federal Reserve Economic Data tool
Chart 16: Nominal gold price and inflation adjusted (US CPI) gold price in USD
To understand the current and future gold price, I looked
at the historical gold price first. The gold price before 1971
s of limited value. It was not set in the free market and
hus relatively stable. In the inflationary 1970s, gold was in a
bull market that lead to a speculative spike in 1980. What
ollowed was the collapse of the bull market and a long
bear market in the 1980s and 1990s. Ever since the dot
com bubble burst in 2001, the gold price has steadily risen.
45
0
200
400
600
800
000
200
400
600
800
000
200
400Gold Nominal
Inflation Adjusted
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0
200
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800
000
200
400
600
800
000
Gold (USD)
+174%
0
200
400
600
800
1,000
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1,400
1,600
Gold (EUR)
+191%
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
Gold (Yuan)
+127%
0
10,000
20,000
30,000
40,000
50,000
60,000
70,000
80,000
90,000
100,000
Gold (Rupee)
+258%
GOLD PRICE IN MAIN CURRENCIES
The USD is the world reserve currency,
thus the gold price is set in USD. But to
determine how the gold price is affected
n other currencies, I examine the five-
year gold price in USD along with Euros
(EUR), Chinese Yuan (RMB) and Indian
Rupee (INR).
Charts 17 to 20 confirm that gold in all currencies
ncreased from Jul 2007 to July 2012. Therefore, I can
conclude that currencies are an important factor in the
gold price. But the return on gold in local currencies
varies. For example, there is a +127% change in the gold
price in Yuan and a +258% change in Rupee. And so, it isikely that other factors drive the gold price too.
Most global consumers buy gold in currencies other than
the USD. It is difficult to determine the impact of the
fluctuating exchange rates on gold demand. Some
consumers may delay purchases. Others may buy
cheaper substitutes such as silver. And a few may consider
the higher prices as proof of a good investment.
Source : World Gold Council
46
Chart 17: Gold price in USD
Chart 18: Gold price in Euros
Chart 20: Gold price in Rupees
Chart 19: Gold price in Yuan
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According to Wikipedia, “market manipulations a deliberate attempt to interfere with the
free and fair operation of the market and
create artificial, false or misleading
appearances with respect to the price of, or
market for, a security, commodity or currency”. Market manipulation is prohibited
under section 9 of the US Security Exchange
Act of 1934. Similar market manipulation
prohibition rules are set by the European
commission. The LIBOR scandal and CentralBank Manipulations of all asset markets are
the largest of an endless stream of reported
financial market manipulations. They paint apicture that all financial markets are rigged by
both commercial banks and governments.
LIBOR ManipulationThe LIBOR scandal is the largest manipulation in the
financial markets uncovered. It fits exactly with the
definition of manipulation. Banks reported a higher or
ower LIBOR interest rate than the actual used rate. LIBOR
s the average interest rate that London banks charge each
other. And, it is used as a basis for en estimated $350T in
derivatives.
Although the Financial Times only printed about it on Jul
27, 2012, the scandal can be traced back as far as two
decades ago. It involved most of the major European and
American banks. Barclay’s Bank was identified as the ring-
eader. The manipulation may have happened with the
knowledge of the Bank of England too.
Central Bank ManipulationsCentral Banks openly intervene or try to indirectly
nfluence the prices of all asset markets. The market for
debt is influenced directly by the central banks, who keep
he short term interest rates near zero and buy an
enormous quantity of Treasuries and MBS. Equity,
commodity and currency markets are influenced indirectly
by the influx of huge sums of artificially created money
hat finds its way to these markets. Although performed
openly by central banks, these actions can still be classified
as manipulation.
Investors in precious metals must understand that all financial markets are manipulated. The
correct question is to what extend are gold
and silver markets manipulated ? The silver
markets, which is much smaller and more
volatile than the gold market is probably theeasiest and most severely manipulated.
However, it is likely that gold markets are
manipulated to a certain extent as well.
Gold Market Manipulation Since both central banks and commercial banks are
involved in some form of market manipulation, it is
necessary to investigate to the extend that the gold and
silver markets are manipulated. There is cer tainly noshortage of stories. Those based on proven cases and
others just bizarre rumours.
There are a few topical stories on the manipulation of gold
and silver markets. Naked short selling of gold, which is the
selling of gold derivatives without owning any physical gold,
can be easily done on a large scale using unallocated gold
accounts at the LBMA and/or gold futures at exchanges
such as the CME/Comex. It is simple for central banks or
large commercial banks to offset the rising price of physical
gold by short selling paper traded gold, such as gold future
contracts.
JP Morgan and HSBC ManipulationOn Apr 2010 a former Goldman Sachs trader publicized
his assertion that JP Morgan and HSBC manipulated the
gold and silver markets. By working together, the two banks
suppressed silver futures by naked shor t selling. With a
lower silver price, their large short position in call options
on silver declined in value, thus creating huge profits for
the two banks. After the market is “broken”, many investors dumped their long positions to prevent further
losses or were forced to sell after a margin call. This
allowed the two banks to cover their short position. An
investigation by the US commodity Futures Trading
Commission (CFTC) ensued with the CFTC reporting that
on Nov 2009, HSBC and JP Morgan held 43% of the
commercial net short position in gold and 68% in silver at
the CME/COMEX. The two banks were short 123,331
gold future contracts and 41,318 silver future contacts
against a negligible long position.
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n Chapter 6, I create a model using regression analysis to estimate the gold price
based on 4 factors. Then I develop three scenarios with input for this model and
estimate the gold price for the end of 2013.
Chapter 6
GOLD PRICE
REGRESSION MODEL
48
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Gold is a rather rare commodity and so, as investment, it
has unique properties.
. Unlike other commodities, gold has virtually no
industrial use and is not physically consumed.
2. Because there is small and stable annual gold
production, the gold price is shielded from sudden
increases seen in other commodities such as iron ore
or natural gas.
3. Physical gold has no default risk, unlike equity or fixed
income.
4. Physical gold does not rust, degrade or perish over
time, making it suited as a long-term store of value.
5. A small physical size of gold represents a large value,
making it relatively cheap to store.
6. Like most commodities, gold does not provide any cashflow from which its value can be derived. Cash flow
includes income from coupon payments and dividends.
For these reasons, gold is not dependent on economic
cycles. Its value must be derived from other factors and
heir future estimation. I will analyze and quantify which
actors drive the price of gold in this chapter
General least squares regression analysis is a statistical
approach that researchers employ to model relationships
between variables. I make use of an exploratory approach
to construct and test regression models in order to
estimate the 2013 gold price.
The gold price is the dependent parameter in my models.
I make use of the monthly average of the daily 3PM
London fixing price as the gold price. To uncover which
factors have the greatest impact on the gold price, I use
several independent parameters. To measure goodness of
fit for each model, I use the coefficient of determination,
also called the R squared measure of goodness of fit. Also,
all factors must be statistically significant at the significant
level below 5%
The gold regression model uses historical monthly data
from the period of July 2007 to Nov 2012. 2012 is the 5 th
year of the financial crisis, which is a combination of the US
mortgage crises and European sovereign debt crises. Its
onset can be traced back to August 2007, when BNPParibas blocked its investors from withdrawing from three
of its hedge funds.
I draw on monthly data for this study since some of the
factors, like the CPI index and US monetary base, are
published monthly and bimonthly. When data, such as the
gold price is published more frequently, the monthly
average is used, not the end of the month observation.
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Chart 21: Gold price, the monetary base (MB) and the 12 month moving average of the MB
QUANTITY OF MONEY FACTOR
Quantity of Money Chart 21 suggest that the gold price and monetary base
ncreased by more than 150% over a five year period of
uly 2007 to Dec 2012. As discussed in the chapter on
government debt, it is unlikely that the current monetary easing policies of central banks will cease in the foreseeable
uture. Although the increase in the MB has stabilized in
2012 , with the FED expected to buy a massive $1T in
2013, an expanding money supply can drive the gold price
higher in 2013 and beyond.
To identify the best measure for the quantity of money in
he regression equation, I put to the test different variables,
namely: monetary base, balance sheet of central banks and
money supply M0, M1 and M2. The MB and balance sheets
of central banks can increase dramatically in a day andremain at that level for a prolonged period. To smoothen
hese sharp upturns, I employ a 12 month moving average
MA-12).
The combined MB of the US and EZ, stated in USD, has a
robust relationship with the gold price. The balance sheet
of the FED and/or the ECB has a less significant
relationship. The money supply, captured as M0, M1, M2,has no statistical significant relationship with the gold price.
80%
00%
20%
40%
60%
80%
00%
20%
40%
60%
80%
Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13
Gold
MB
MB MA-12
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REAL INTEREST RATE FACTOR
Real Inter est R ateThe real interest rate is a factor related to the gold price.
n this study, the real interest is calculated using the Fisher
equation with the one-year US government treasury bill
1Y Treasury) as the interest rate and the annual changen the US CPI Index as the inflation rate.
The gold regression model confirms that the real interest
rate has a statistically significant relationship with the gold
price. But, inflation rate and interest rate, individually, have
a weaker relationship with the gold price in the
regression equation. Chart 22 shows how the shifts in the
real interest rate are influenced by inflation and 1 Year
Treasury over a twelve year period of Jan 2000 to Nov
2012.
.00%
.00%
.00%
.00%
.00%
.00%
.00%
.00%
1Y Treasury
CPI Inflation
Real interest rate
Chart 22: Real interest rate in the period 2000 to 2012
51
Since gold provides no income, periods of negative real
interest rates lower the opportunity cost of holding gold.
During the 1970s, the US had negative interest rates and the
period after 2008 has also had long negative interest rates.Both periods also have a rising gold price. Conversely, the
positive real interest rates of the 1980s and 1990s triggered
the gold price to decline. Therefore the real interest rate has
a reverse relationship with the gold price.
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CURRENCY FACTOR
Cur r ency Fac tor Gold has a reverse relationship with the exchange rate of
the USD against other currencies. If the USD strengthens
against the EUR (e.g. lower value for EUR:USD or higher
value for USD:EUR), then it is more costly for European
nvestors to buy gold nominated in USD. In turn, the gold
price is expected to decrease. In addition, when the USD
strengthens, it will be more in demand as a safe haven
asset, at the cost of other safe haven assets such as gold.
Gold is traded globally in USD and so, the currency factor
n my regression model measures the exchange rate of
the USD against a basket of currencies. The widely used
USD index (NYSE:DXY), a basket of EUR 57.6%, JPY
13.6%, GBP 11.9%, CAD 9.1%, SEK 4.2%, CHF 3.6%) is too
biased towards European countries.
Chart 23: Performance of four currencies against the USD in the July 2007 to October 2012 period
Chart 23 shows the performance of the USD against the
currencies of the largest economies and/or gold markets:
Euro, Japanese Yen, Chinese Renminbi and Indian Rupee. To
capture the currency factor in the regression models, I
tried several different combinations of currencies in thecurrency basket.
Basket4
Basket4 has the best fit for the regression model. The
currency factor measures the monthly change in the
USD value of a basket of four currencies, weighed
according to their GDP in 2011. The basket consists of
44.85% Euro (32.67 EUR), 26.85% Chinese Renminbi
(203.41RMB), 21.59% Japanese Yen (2620.72 JPY) and
6.72% Indian Rupee (270.57 INR).
60%
70%
80%
90%
00%
0%
20%
30%
40%USD:EUR
USD:YEN
USD:RMB
USD:INR
USD:Basket4
52
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The uncertainty in financial markets is another factor
related to the gold price. One common measure of
uncertainty or market risk is the yield spread between BBB
and AAA corporate bonds. Another common measure is
he Volatility Index (VIX) of the S&P500. However, these
wo common measures are not statistically linked to the
gold price.
also measured market risk using the annual change of the
value difference between two distinct indices, namely,
“Merrill Lynch total return index BBB Corporate bonds”
and “Merrill Lynch total return index AAA Corporate
bonds” . This measure better captures the market risk actor because it is statistically related to the estimated
gold price. However, the measure is a negligible factor.
The physical supply and demand of gold does not produce
a good fit in the regression model. I assume that the size
of the physical gold market is too small compared to thepaper traded gold market to make an impact on gold
prices. It seems that the gold price is influenced by the
paper gold market, which treats gold as a currency.
Therefore, I dismiss the momentum factor in my final
regression model.
Momentum is an important factor in setting the price in
many assets classes. It means that the current price isdependent on the price of a previous period and explains
an extended period of rising or falling prices. I capture it as
a one-month to 12 month price lag. None of the different
lags had any explanatory power in my regression
equations. Therefore, I dismiss the momentum factor in my
final regression model.
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In and Out of Sample PeriodsTo make sure the gold regression model is valid, the model
is constructed using data in the in sample period from July
2007 to Dec 2011. To check if the gold regression model
will make accurate estimations, the data for the out-of-sample period from Jan 2012 to Nov 2012 is used to
estimate the gold price. This estimate is compared to the
observed gold price.
Curve fitting can find the optimal result in a data set based
on statistics instead of good modeling. However, when the
model is employed, it can produce unrealistic estimates.
Therefore, the out-of period data is used to test the
accuracy of the model.
All variables where significant at or below the 5%significance level. They also passed standard tests for serial
correlation, heteroskedasticity and collinearity.
GOLD PRICE REGRESSION MODEL
The equation above uses the following parameters:
. %Ch GOLD is the percentage change in the average monthly gold price, set in the 3PM London fixing price.
2. %Ch REALRATE is the monthly percentage change in the real interest rate, calculated as the YTM on the 1Y US T-bill
minus the annual inflation rate as measured by the US CPI Index.
3. %Ch BASKET4 is the monthly percentage change in the value of the USD:Basket4.
4. %Ch MB-12 is the monthly percentage change in the combined monetary base of the US and EZ (converted to
USD), measured as a 12 month moving average.
5. %Ch BONDSPREAD is the annual percentage change in the value of the BAML Total return index BBB corporate
bonds minus BAML Total return index AAA corporate bonds.
After experimenting with different
factors that are considered to be drivers
of the gold price, my gold regression
model proves that the quantity of money is the biggest driver of the gold
price. Other factors such as exchange
rates, inflation and interest rates shift the
price within a certain bandwidth.
Because there is no end in sight to
monetary easing, the quantity of money
factor can drive gold prices higher in2013 and beyond.
(%Ch GOLDt) = -3.0384*(Ch REALR ATEt) - 0.9616*(%Ch BASK ET4t)
+ 0.7207*(%Ch MB-12t) + 2.63E-05*(Ch BONDSPREADt)
R ²=0.4112, Adjusted R ²=0.3759, n=54
54
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Chart 24: The observed and estimated gold price in the in sample period
Chart 25: The observed and estimated gold price in the out of sample period
55
The monthly average observed gold price and the
estimated gold price are illustrated in Charts 24 and 25,
or the in-sample period and out of sample period,
respectively.
The actual gold price is more volatile than the estimatedgold price. On Dec 2012, the out-of-sample estimate was
2.64% higher than he observed gold price. The small
difference between the estimated and observed gold price
ndicates that the model is reliable and can be used to
predict the future gold price.
FIT OF ESTIMATION
500
550
600
650
700
750
800
Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12
Gold 3pm fixing
Gold estimated
1653
1689
1733
0
200
400
600
800
000
200
400
600
800
000
Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12
Gold 3pm fixing
Gold es timated
1513
1652
665
The difference between the observed and estimated gold
price can partially be attributed to the FEDs introduction
of the Evens rule in Dec 2012. This rule couples monetary
policies with inflation and unemployment. Where
previously investors expected 3 years of continuation of
the current monetary policies, this now becomes
uncertain, surprising the gold price. However, this is not
quantifiable and thus is not included in the gold regression
model.
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The model to estimate the gold price is
not very intuitive. Several steps are
necessary to estimate its price.. The change in the real interest rate must be calculated
based on estimations for short-term interest rates andinflation.
2. The change in the USD value of the currency basket 4
must be calculated based on estimations for the rate of
the USD against the EUR, RMB, JPY and INR.
3. The increase in the MB, both in the US and the Euro
Zone, must be estimated. The EZ MB must be
converted to USD and added to the US MB. Next, the
12 Month Moving Average of the combined MB must
be calculated.
4. The value Merrill Lynch corporate bond total return
index BBB minus AAA must be calculated.
The following are the December 2012 starting values for
the 2013 estimation:
• Average gold price: $1688.53 /oz
• Quantity of Money: MB US: $2650B, MB EZ: 1626B€
and the combined 12M moving average: $4809B
• Inflation and Interest Rates: CPI Nov 1.77%, 1YTreasury: 0.16%, Real Interest Rate: -1.57%
• Market Risk Meaures: Bond AAA index: 545.2 and Bond
BBB index: 674.6, Indice difference: 129.41
• Basket4 value of 89.39, based on exchange rates:
USD:EUR 0.7624, USD:JPY 83.64, USD:RMB 6.233,
USD:INR 54.67
56
GOLD PRICE ESTIMATES
The general view is based on the following assumptions:
. The FED BS increases to $3923B. US MB increases to $3582B (remains 91% of BS).
2. The ECB BS increases to € 3472B. EZ MB increases to €1873B (remains 54% of BS).
3. The Combined MB increases to $6375B. The MA12 increases to 5583 (+16.8%).
4. USD remains almost unchanged (+0.34%) against a basket of 4 currencies, EUR:USD=1.30, JPY, RMB, INR unchanged
5. Real interest rate remains unchanged at -1.61% (0% change). 1Y Treasury remains at 0.18% and inflation at 1.8%.
6. The BBB-AAA bond spread remains unchanged at 129 points (0% change).
$1890 (+11.9%)
GENER AL VIEW
The most expected scenario is a
continuation of current developments. A deal for the US fiscal cliff is made and will not plunge the
US economy in a recession, partly due to an increase in
monetary easing. The FED buys $85B per month of assets
hroughout 2013.
The EZ will not break up. Greece does not leave and Spain
does not request a sovereign bailout. The ECB starts
buying periphery debt with its OMT program at an annual
rate of 450B€. Inflation remains at 2.25% and short-term
nterest rates remain at 0.18% in the US and the EZ. The
EUR:USD is stable at 1.30 throughout 2013 and the USDtrengthens slightly against a basket of currencies. The bond
ndex value difference remains unchanged to reflect no
change in risk.
If current trends continue, then the goldprice will remain below the important
resistance value of $1890, the nominal
record price set in 2011.
At the end of 2013, the gold price will be:
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ECONOMIC R ECOVERY, bear ish gold scenario
$1580 (-6.4%)
A global economic recovery will likely be a
negative scenario for the gold price. A global
recovery will be led by the US, with the USD strengthening
against all currencies in the Basket4. The EUR:USD willdecrease to 1.20. Inflation will increase to 2.5%, while
hort-term interest rates remain at 0.25%.
Higher inflation and decreased economic pressure will lead
o a halt of all monetary easing programs. The balance
heet and monetary base in the US and EZ will remain
table (but shrink in USD terms). Finally, the bond index
value difference will decrease with 80 points to reflect the
ower risk.
The bearish gold scenario is based on the following assumptions:
. The FED BS remains $2903B. US MB remains at $2650B in 2013 (91% of FED BS).
2. The ECB BS remains stable at €3022B. EZ MB remains stable at 1630B€ in 2013 (54% of BS).
3. The Combined MB decreases to $4614B. The MA12 increases to 4704 (-1.6%).
4. USD strengthens (+7.3%) against a basket of 4 currencies (EUR:USD=1.20, USD:RMB=6.50, USD:JPY=90.00,
USD:INR=60.00).
5. Real interest rate decreases with (-0.64%) to -2.25%. 1Y treasury increases to 0.25% and inflation increases to 2.5%.
6. The BBB-AAA bond index value decreases with 80 points (-38%).
57
2013 would see gold pr ices near the 2012
low $1540. At the end of 2013, the gold
pr ice will be:
GOLD PRICE ESTIMATES
$2115 (+25.2%)
STAGFLATION, bullish gold scenar io
The stagflation scenario sees inflation
picking up to 2.50% with no economic
growth. Central banks have to step up their monetary
easing programs to prevent a depression, which would lead
o an depreciating USD. The FED will continue to buy
$85B of assets per month. The ECB will buy an annual
B450€ of bonds in its OMT program and Spain will need
B500€ bailout. The USD will decrease in value against the
EUR and JPY, but remain stable against the RMB and INR.
The bond index value difference will increase to reflect
more uncertainty.
The bullish gold scenario is based on the following assumptions:
. The FED BS increases to $3923B. US MB increases to $3582B (remains 91% of BS).
2. The ECB BS increases to €3972B. EZ MB increases to €2142B (remains 54% of BS).
3. The Combined MB increases to $7273B. The MA12 increases to $6015B (+25.8%).
4. USD weakens (-4.4%) against a basket of 4 currencies (EUR:USD=1.40, EUR:JPY=78.00, USD:RMB=6.23,
USD:INR=54.67).
5. Real interest rate decrease with (-0.79%) to -2.40%. 1Y Treasury at 0.10% and inflation increases to 2.50%.
6. The BBB-AAA bond index value increases with 200 points (+55%).
2013 would see the end of the
consolidation phase of the gold pr ice since
2011, as it br eak s thr ough the impor tant
psychological bar rier of $2000. At the end
of 2013, the gold price will be:
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The alternative valuation methods used
are based on highly uncertain estimates
and assumptions. The function of the
alternative valuations is to see if the
estimates based on the gold regressionmodel are in the correct range.
An alternative valuation method for gold, is to look at
he gold standard as it was defined in the Bretton
Woods period. One can ask the hypothetical
question, what if the total global money supply would
be backed by the global gold reserve? Since the
definition of the money supply is very broad, I will usehe monetary base (MB), like in the Bretton Woods
period.
The global money supply can estimated using the nine
argest economies combined (EZ counted as one),
which represent 72.68% of GDP in 2011. Given that
hey have a combined MB of $11,243B, I extroplate
hat the global MB is worth $15,450B.
The global MB divided by the gold reserve of 171,000
Tonnes or 5,387 M oz brings the gold price to $2,871/Oz.The MB was considerably lower before 2008, then the
monetary base ballooned. The current high MB makes this
valuation somewhat unrealistic.
However, central banks do not own the complete global
gold supply. They hold only 30,563 tonnes of gold in Sep
2012. Given this quantity, the gold price would be
$13,450/Oz
The total gold reserve is not as important of a factor to
valuate the gold standard as the annual growth rate of the
gold supply. To have a stable gold standard, the growth of
the gold supply (1.6% as of 2011) must match the growth
in the global population (1.1% as of 2011) along with the
growth in global labour productivity (2.5% in 2011).
If a country’s gold supply grows slower than these two
measures, there would be too little money, which would
result in deflation. To counter this scenario, central banks
would decrease the gold reserve per currency unit. They
would be able to once again manipulate the money supply,
which would defeat the purpose of the gold standard.
The abovementioned situation creates a great arbitrage
opportunity for a spectulator who is trading long gold and
short currency. The spectulator waits for the central bank to devaluate the amount of gold per currency unit. Then,
he sells his gold for a large amount of currency.
However, with the continues growth in debt of almost all
governments, along with money debasements, it would not
be impossible that people loose confidence in the
monetary system and demand the return of some form of
gold standard.
10,350 USD/Oz
Based on 8134 tonnes reserve,
$1778.50 gold price,
MB 2011: $2,653B
6,700 USD/Oz
Based 10,787 tonnes reserve,
EUR:USD 1.30,
MB 2011: €2,276B
28,500 USD/Oz
Based on 4000 tonnes est. reserve,
USD:RMB 6.35,
MB 2011: Yuan 22,800B
13,450 USD/Oz
Based 30,563 tonnes reserve,
MB 2011:€
15,450B
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1,568 USD/Oz
Based on Gold/ Brent ratio of 15.40
0
5
10
15
20
25
30
35
Gold / Brent ratio
The US Energy and Information Administration (EIA)
estimates an average Brent crude price of $103 in 2013
based on sluggish global growth. Although oil prices are
more difficult to accurately predict than gold prices,
Chart 26: Gold price per Oz divided by Brent crude price per barrel
How many barrels of Brent crude
can 1 Oz of gold buy? Both
commodities are expected to risewith higher inflation.
Gold / Br ent ValuationGold and Oil share some characteristics, such as
performing well in times of high inflation and uncertainty.
Although the two commodities are slightly correlated
0.35), crude oil is mainly dependent on economic cycles
as shown in Chart 26.
The average Gold / Brent ratio for the period of 1990 to
2012 average is 15.40. It is either driven by gold strength
or oil weakness at different periods. Thus, the gold/brent
valuation is not very reliable for estimating the gold price.
59
At the end of 2013, the gold price will be:
GOLD/BRENT VALUATION
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GOLD INVESTMENT RISKS
Phy sical gold does not have counter-
par ty r isk . Theor etically, paper gold has
this risk bu t no futur e contrac t or ETFs
traded in the US has defaulted so far.
Phy sical-backed ETFs ar e a r elatively new inves tment categor y, which makes it
dif ficult to quantif y the associated risks.
However, all types of gold inves tments
have market r isk , which means a dr op in
the gold pr ice.
Economic Recover y
ronically, an improving economy is the biggest risk for gold
nvestments. Since US monetary policies are linked to
nflation and employment with the Evans rule, investors are
unsure if or when the ZIRP, QE3 and QE4 programs will
be terminated. However with a total government debt of
over $16T and a annual deficit of over $1T in 2012, it is
unlikely the government can afford to put a halt to all these
programs.
Economic recovery in Europe could mean periphery
countries such as Spain can issue new bonds in the
nternational market without the support of the ECB and
ts OMT program. An end to the various monetary easing
programs stops the expansion of the MB, which the biggest
actor driving a higher gold price.
Str onger USDSince the US leads most global recoveries, the USD is likely
o strengthen against most other currencies. The USD can
also strengthen during a global financial crash because it iseen as a safe haven. A stronger USD is expected to drive
down the gold price..
Fiscal Clif f The US Fiscal Cliff is the end of temporary tax brakes,
including Payroll tax cuts and Bush income tax cuts, the
introduction of new taxes related to Obama care and the
decrease in government spending. These rules were set in
place during the 2011 negotiations on raising the debt
ceiling, for the reason that deficit spending should not run
out of control. Unless a deal is made between Democrats
and Republicans, the Fiscal Cliff scenario will automatically
be enabled on Jan 2013. If the program is unchanged, it
could have an enormous drag on the economy, thus
plunging the US into a recession. On Jan 2th 2013 a deal
has been made to delay the fiscal cliff decision with 2
months.
Current political gridlock makes it difficult for US politicians
to reach an agreement beforehand. The Fiscal Cliff iscombined with raising the debt ceiling from its current
value of $16.4T. In the summer of 2011 this led to a
mini-crash, which was actually bullish for the gold price.
Therefore these events are a gray swan, a known future
event with a unknown outcome for the economy and the
gold price.
India and China’s Slowing demand
The slowing growth of the Indian and Chinese economies,which account for half of the consumer demand, can
decrease the global demand of gold along with the price of
gold. Also taxing gold imports, trade or possession might
decrease demand. For example, on Jan 17, 2012, India
doubled its import tax on gold and silver from 2% to 4%.
Since India is the largest gold consumer market and
imports most of its gold, the tax raise could hurt demand
and thus gold prices.
60
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A financial bubble is an asset trading far above its intrinsic
value and historical average with high volume. Bubbles
often take several years of high price increases to spike up
o a record high. Prices are unsustainably high and soon
elling starts, followed by panic and a collapse in the price.A bubble can occur because the majority of investors do
not recognize them as such. Bubbles can be easily
dentified only in hindsight.
Bubbles are driven by two basic human emotions: greed
and fear. The Japanese stock and housing or US dot com
bubbles were driven by greed. The gold price bubble in
970-1981 was driven by fear of high inflation and money
debasement.
n 1841, the Scottish journalist Charles Mackey wrote the“Extraordinary Popular Delusions and the Madness of
Crowds”. The book explains the bubble phenomenon.
Although it is more than a century old, its description of
he bubbles, such as the Dutch Tulip mania, follow the same
patterns as bubbles today. History is filled with other
bubbles. Some recent examples include the gold price
bubble of 1970 to1981, Japan housing and stock bubble of
970 to1992, US dot com bubble of 1990 to 2002, Crude
oil of 2001 to 2009 and US housing of 1970 to 2009.
A bubble usually has four distinctive phases.
1. Stealth phase: The asset is undervalued and trading
volume is low.
2. Awareness phase: Investment in the asset starts to get
attention of professionals, but not the public. Prices are
rising but still near the intrinsic value of the asset.
3. Mania phase: Many investors chase the asset, which is
detached from its fundamental value. Theories crop up
with the justifications of “this time it’s different”. This
must be accompanied by a substantial price increase.
4. Blow-off phase: Investors realize they held an asset far
above its intrinsic value and demand at the same time
as prices collapse.
The 4 phases of a financial bubble
Currently, the gold price is at the end of the awarenessphase or start of the mania phase. Gold prices have not
seen extreme volatility, but prices have been steadily rising
over the past decade. More news on gold is appearing in
the media and the idea of a gold investment is starting to
take root with the public psyche of developed nations.
Conversely, Asian and Middle Eastern consumers have a
long tradition of gold investment and are very aware of
gold investments.
When central banks lose faith in each other and want to
invest in larger gold reserves instead of foreign currencies
and debt, the gold price is bound to move to the mania
phase.
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Chapter 7 explains sever al inves tment alternatives to gold. The best k nownalternatives ar e other pr ecious metals such as silver and platinum. Although ther e is
ndus tr ial demand for these subs titute metals, their mar kets ar e of ten much smaller
than the gold market. Silver has ear ned the name Devils Metal by silver traders
because of its high volatility and small and easily manipulated mar ket. The other
alternative is to inves t in equity of gold pr oducing companies. If their r evenues
ncr ease fas ter than their costs, then these companies can be sound inves tments.
However, r ising budgets for explor ation and development and higher cash cos t candes tr oy pr ofits.
Chapter 7ALTERNATIVE GOLD INVESTMENTS
62
American Eagle silver coins are the most held silver coin and still minted today.
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Silver DemandDemand for silver remained stable in the last decade,
hovering around 24,000 tonnes per year. For centuries,
ilver has been valued as jewelry and viewed as investment
n the form of coins, medals and silverware. But is less
perceived as a financial asset compared to gold. Silver is
mainly used for industrial purposes. Compared to other
precious metals, silver has the highest electrical
conductivity. And so, it is often used in electronics. Silver
also has one of the highest optical reflectivity. It is used in
mirrors and a technique called silver photography. A cell
phone contains around 0.2gr and a laptop 0.75gr. A solar
panel, a growing source of renewable energy, holds even
more silver, almost 20gr. It is the largest growing sector in
ilver demand.
0
5,000
0,000
5,000
20,000
25,000
30,000
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Scrap silver
Net Gov Sales
Mining
0
5,000
0,000
5,000
20,000
25,000
30,000
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Coins&Medals
Silverware
Jewelerry
Photo
Industrial
Unlike gold, only a small fraction of silver is recycled back.
Due to its modest price, many consumers in EMs can buy
silver. But, demand from central banks is relatively small.
Silver Supply Most silver is produced as a by-product of processing and
smelting copper, gold and lead-zinc ore. But as of late, silver
mines have begun production due to its steady price
increase. Around 400,000 tonnes of silver reserve remains
underground.
EMs like Peru and Poland hold the largest supply. Mexico is
the top producer of silver.
Source: The Silver Institute
Chart 28: Annual silver demand in tonnes
63
Chart 27: Annual silver supply in tonnes
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Chart 29: Price of SLV ETF in USD
Silver as a Cur r ency Silver can be viewed as a currency, just like gold. Silver
currency code is XAG. However, the silver market is
maller than the gold market and silver is not the store of
value and save haven metal that gold is.
Silver Trus t ETFt is hard to get information on the OTC silver market.
Unlike gold, the LBMA has never published any information
on the OTC silver trade. Judging by the volume silver
utures trade at the CME, the silver futures market is much
maller than the gold futures market. However, there is a
decent volume in the iShares Silver Trust ETF (NYSE:SLV).
This ETF is the largest silver backed investment fund. In
Dec 2012, SLV held 9900 tonnes in physical silver worth
$11B.
On Apr 2006, the price of a share in the SLV ETF was
equal to the price of 1 Oz of silver. On Dec 2012, the
price difference is $1.08 because of the annual
management fee of 0.50%, which is deducted from the
price of the ETF.
Silver Pr ice ManipulationSince the value of the silver market is relative small
compared to the gold market, it has a long history of price
manipulation. The US government bought silver to support
its miners until 1945 and started selling it until the US
government ran out of supply in 2002. More information
can be found in the chapter on gold market manipulation.
64
Chart 29 shows the price of the SLV ETF in USD since its
inception in April 2006. SLV crashed significantly in 2008,
wiping of half of the price. SLV recovered strongly during
the QE1 and QE2 programs to reach a speculative high of
48.35 in 2011.
0.00
5.00
0.00
5.00
0.00
5.00
0.00
5.00
0.00
5.00
0.00
Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13
SLV
Lehman
10.95
QE1
10.19
End QE1
17.14
QE2
24.25
End QE2
33.84
High
48.35QE3
33.61
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0
5
0
5
0
5
0
5
0
5
0
5
Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13
Gold / Silver Ratio
Investors use the Gold/Silver ratio as a method to validate
whether silver is cheaper or more expensive than gold.
The ratio measures the amount of Oz of silver that can be
bought for 1 Oz of gold. In this research study, it is
calculated as:
Gold/Silver ratio = London 3PM fixing gold price / Londonfixing silver price Over the last three decades, the ratio has swung wildly. The
lowest ratio of 31.44 was recorded on Apr 28, 2011 when
the price of silver rose to a record of $48.70 / Oz. The
highest ratio was recorded on Oct 16, 2008 during the
Lehman Brothers bankruptcy when the silver price
collapsed to $9.99.
In general, Gold/Silver ratio rises in times of uncertainty
because investors flee to the safety of gold. In times of economic recovery, the ratio drops because investors sell
gold to buy more risky assets and industrial demand for
silver rises.
Its average ratio from the Jul 2007 to Dec 2012 period
was 57.46. On Dec 31, 2012, the ratio was 55.56 which
indicates silver is fairly valued compared to gold.
Chart 30:The Gold / Silver Ratio in the period July 2007 to Dec 2012
65
The silver price is highly correlated
with the gold price. However, it is
ess suitable as a store of value than
gold. It has a relatively low value per ounce. It takes more space to store
silver. And unlike gold, it oxides
over time. And because it has
significant industrial use, its price is
more dependent on economic
cycles. These characteristics makesilver behave like a combination of
gold and industrial metals.
55.56Gold: / Silver R atio
on Dec 31, 2012
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n and Out of Sample Per iodsThe methodology of creating the silver regression model is
imilar to the gold regression model. The model is created
using data from the in-sample period which spans July
2007 to Dec 2011. To make sure the silver regression
model is accurate, I use the out of sample period from Jan
2012 to Nov 2012 to estimate the silver price. This
estimate is then compared to the observed silver price.
draw on monthly data for this study since the factors are
published monthly. All variables where significant at the 5%ignificance level. They also passed standard tests for serial
correlation, heteroskedasticity and collinearity.
66
(%ch SILVER) = 1.5544*(%ch GOLD) + 0.4864*(%ch SP500)R ²=0.6370, Adj R ²=0.6300, n=54 ( July 2008 to Dec 2011)
The silver price was estimated using a
regression model with two factors. The
gold price captures the investment side
of silver, while the S&P500 Index
captures the industrial demand for silver.
The regression model suggests that silver is both a
precious metal due to its robust relationship with the gold
price and an industrial commodity because of its strong
relationship with the S&P500. Because the factor 1.55 on
he change in the gold price, it is implied that the silver
price is more volatile than the gold price.
The equation above uses the following parameters:
. % Change SILVER is the percentage change in the average monthly London fixing silver price.
2. % Change GOLD is the percentage change in the average monthly 3 p.m. London fixing gold price.
3. % Change SP500 is the percentage change in the S&P500 Index.
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The observed monthly average London fixing silver price and the estimated silver price are illustrated in Charts 31 and
32, for the in-sample period and out of sample period, respectively.
For the out-of-sample period, the estimated silver price is higher in every month than the actually observed silver price.
On Dec 2012 the silver price estimation was 11.21% higher than the gold price. Although the silver regression model had
a better fit of data than the gold regression model, as measured by the R ² , the out-of-sample period shows the silver
regression model to be inaccurate. I will attempt to improve the accuracy of the silver regression model with follow up
research.
67
Chart 31: The actual and estimated average monthly silver price in the in sample period
Chart 32: The actual and estimated average monthly silver price in the out-of-sample period
0
5
10
15
20
25
30
35
40
45
Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11
Silver London fixing
Silver Estimate
12.91
30.41
26.21
26
27
28
29
30
31
32
33
34
35
36
37
38
Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oc t-12 Nov-12 Dec-12
Silver London fixing
Silver Estimate
35.55
31.96
29.32
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The most likely scenario for the silver price is the continuation of current trends.
. The gold price increases 11.9% to $1890/oz.
2. The S&P 500 increases 4% to the 2012 high at 1480.
GENER AL VIEW
The bearish scenario for silver is based on the bearish scenario of gold.. The gold price decreases -6.4% to $1580/oz.
2. The S&P 500 rises 10% to the all time high of 1565
ECONOMIC R ECOVERY, bear ish gold scenario
The bullish scenario for silver is based on the bullish scenario of gold. . The gold price increases 25.5% to $2115/oz.
2. The S&P 500 falls -15.6% to 1200, near the 2011 low
STAGFLATION, bullish gold scenar io
68
Chapter 7 estimates the silver price at the end of 2013 based on the silver
regression model. Unlike the gold regression model, the silver regression model is
easy to use. It is dependent on two intuitive factors, the change in the gold price
and the change in the S&P 500. In Dec 2012, the average silver price was 31.96 and
the average S&P 500 index value was 1422.
At the end of 2013, the silver price will be:
Silver $38.50 /Oz (+20.5%)
At the end of 2013, the silver price will be:
Silver $30.40 /Oz (-4.9%)
At the end of 2013, the silver price will be:
Silver $42.10 / Oz (31.7%)
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The most likely scenario is the continuation of current trends.
. The gold price increases to $1890/oz.
2. The Gold / Silver Ratio is 57.46, which is the average of the July 2008 to Dec 2012 period.
GENER AL VIEW
With higher global economic growth, gold is sold by investors in pursuit for more
risky assets and the industrial demand for silver increases. These factors bring down
the Gold / Silver Ratio to a record low value.. The gold price decreases to $1580/oz.
2. The Gold / Silver Ratio is 31.44, which is the lowest of the July 2008 to Dec 2012 period.
ECONOMIC R ECOVERY
A scenario with no economic growth and increasingly large monetary easing
programs drives investors to the safety of gold. Silver along with other risky assets
will drop in value, pushing the Gold / Silver ratio to a record high.. The gold price increases to $2115/oz.
2. The Gold / Silver Ratio is 83.79, which is the highest of the July 2008 to Dec 2012 period.
STAGFLATION
69
An alternative silver price estimate model is based on the Gold / Silver Ratio. The three gold scenarios are used as a
basis to set the gold price. An average, high and low value for the Gold / Silver Ratio is then used in the different
cenarios to estimate the silver price.
The Economic Recovery Scenario and the Stagflation Scenario predict silver prices that are the opposite of the silver
price estimates calculated with the silver regression model. By looking at the historical prices, gold and silver usually
move in the same direction, which makes the alternative silver price estimates less realistic than the estimates from the
ilver regression model.
At the end of 2013, the silver price will be:
Silver $32.85 /Oz (+2.8%)
At the end of 2013, the silver price will be:
Silver $50.30 /Oz (+57.5%)
At the end of 2013, the silver price will be:
Silver $25.25 / Oz (-21.0%)
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113
76
36
Catalysator
Jewelry
Others
Platinum investments are more volatile than gold because
of their stronger association to global economic growth,
mainly the car industry. Platinum prices can react to specific
circumstances, like unrest or nationalization treats of South
African mines.
nvestments in platinum can be made by purchasing
platinum proof coins or platinum backed ETFs. The largest
platinum ETF is ETF Securities Platinum backed ETF
NYSE:PPLT), which is backed by platinum bullions and had
Net Asset Value of $770M in Dec 2012.
nvestors have the choice of purchasing
other precious metals aside from gold
and silver. The Platinum Group Metals
(PGM) of Platinum, Palladium and
Rhodium are often found in the same
ore and have similar uses. They can react
to very specific factors which make
them unsuited for most investors.
Platinum is a small market and the
markets in Palladium, Rhodium, Osmium
and Iridium are vir tually non-existing.
Platinum InvestmentPlatinum is much more rare than gold. South Africa
contains 80% of the worlds platinum reserve. In 2010, 245
onnes was produced. The metal is used in catalytic
converters of cars and jewelry.
Platinum can be har d to dis tinguish
f r om Silver or Palladium
Palladium InvestmentPalladium is similar to platinum and used mainly in catalytic
converters of cars and electronics. South Africa and Russia
produce almost the complete supply. Although its cheaper
to use other metals, palladium can be used in jewelry to
create “white gold”.
One can investment in palladium by purchasing Palladium
coins or Palladium backed ETFs, like ETFS Physical
Palladium (LSE:PHPD) or ETFS Palladium Shares
(NYSE:PALL). By the end of 2012, PALL had a Net Asset
value of $501M, backed by Palladium bullions.
Rhodium Inves tmentUnlike Platinum or gold, Rhodium is not metal-like.
Surprisingly, it is brittle and thus not suited for coins.
Rhodium production was less than 30 tonnes in 2010, of
which 80% came from South Africa.
More than 80% of all Rhodium is used in catalytic
converters. It is used in white gold to give it a shiny surface
and also in fibre optical cables. Rhodium can be salvaged
from used uranium but the procedure is complex and
expensive.
Rhodium is a by-product of the PMG and shares the same
investment characteristics as Platinum. There is no efficient
way to invest in Rhodium. Kitco sells Rhodium with a $100spread on a $1250 price.
70
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The XAU and HUI indices are used for
benchmarking the gold producing
ndustry. The GDX is an ETF that gives
nvestors exposure to a broad range of
gold mining companies.
The Philadelphia Gold and Silver Index (NYSE:XAU) is a
gold and silver mine index. The XAU index consists of 16
publicly traded companies on the NYSE. These companies
are active in gold and silver mining. The index is a market
cap weighted index. It holds a large position in FCX, which
s primarily a copper producer.
The index is used for reference and investments in the
XAU index (and the Gold Bug index) can only be done
with options.
The NYSE/ARCA Gold Bug Index (NYSE:HUI), referred to
as HUI, is an alternative index to the XAU. It is a basket of
unhedged gold companies traded on the NYSE. HAU does
excludes gold and silver producing companies that hedge
gold production longer than 1.5 years. While the twoindices are highly correlated, the biggest difference is that
the HUI does not hold FCX. Having unhedged gold
producers, it is likely that HUI will outperform the XAU
during periods of increasing gold prices.
A Mozambican gold miner
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GOLD MINE ETFS
Gold Miner s ETF GDXThe XAU and HUI indices are for reference and cannot be
used as an investment. There are alternatives to these
ndices. Investors can buy the basket of all shares of the
XAU and HUI indices on the NYSE. A more convenient
alternative is the Van Eck Market vectors Gold Miner ETF
NYSE:GDX). Compared to other gold mining ETFs, GDX
s the only one with good liquidity and thus cheap to trade.
XAU HUI GDX
Barrick Gold (ABX) 21.98% 15.21% 13.43%
GoldCorp (GG) 14.92% 13.59% 12.15%
Newmont (NEM) 14.13% 10.41% 9.03%
Kinross (KGC) 7.73% 4.27% 4.49%
AngloGold Ashanti (AU) 6.55% 4.49% 4.69%Agnico-Eagle (AEM) 4.65% 4.61% 5.11%
Yamana (AUY) 3.47% 4.49% 5.16%
Goldfields (GFI) 3.98% 4.53% 4.25%
Randgold Res (GOLD) 2.34% 3.98% 4.69%
Buenaventura (BVN) 0% 5.39% 4.50%
Harmony (HMY) 3.13% 4.37% 2.06%
Silver Wheaton (SLW) 1.05% 0% 5.20%
Eldorado (EGO) 0% 0% 4.25%
Freeport McMorran (FCX) 12.92% 0% 0%
Total 83.93% 75.34% 79.01%
72
0.06
0.08
0.10
0.12
0.14
0.16
0.18
0.20
0.22
0.24
0.26
XAU / Gold
Chart 33: Gold & silver index XAU divided by the gold price
Chart 33 shows the amount of gold in Oz that one unit of
he XAU index can buy. The decreasing amount indicates
hat gold mining stock is underperforming a gold
nvestment. There is little reason to believe this will change
n the near future.
Table 9. Overview of most positions for the XAU and
HAU indices and GDX ETF in 2011
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To determine if an investment in a gold producing
company is a good alternative for a gold investment, I first
had to determine how gold mines are valuated. Valuating
mining companies is different from valuating most other
companies. After a certain period, a gold mine is depleted.
As a consequence, traditional valuation ratios such as P/E
can be misleading. If a mining company has a P/E of 10 and
dividend payout ratio of 50%, an investor can earn his
nvestment back in 20 years. If a mine is depleted in 8
years, the payout ratio can be considerably reduced.
VALUATING GOLD PRODUCING COMPANIES
73
Cash Cos tTo valuate a mining company, a relatively easy method is
examine the cash cost of a company. This cost is the price
of extracting 1oz of gold from the ground without
overhead costs (Depreciation and General & Admin) and
nclude exploration, royalties, administration cost etc. Since
gold is sold on the global market for the same price, the
company with the lowest cash cost is expected to make
he highest profits. However, the gold reserve a company
holds is its most valuable asset and is unaccounted for in
he cost.
The cash cost is the cost necessary for a mining company
o produce 1oz of gold, excluding its overhead and
depreciation and depletion cost. Labour usually accounts
or half of the cash cost. Rising cash cost puts a downside
protection on the gold price. When cash cost is higher
han the gold price, company will halt production until the
gold price increases.
Net Asset ValueA more inclusive method to valuate a mining company is
o estimate its Net Asset Value (NAV), which is the Net
Present Value (NPV) of its future cash flows and other
balance sheet items. The future Free Cash flow for each
mine is based on an estimated future gold price, future
costs, annual production rate and gold reserve. To calculate
he NPV of these cash flows, a discount rate must include
various risks including financial risk (bankruptcy), political
risk (nationalization and strikes) and geological risk
earthquakes or floods).
No investor wants to pay more for a mining company than
the worth of its NAV. But it is common for the Price /
NAV to hover around 1.5 to 2.5. This ratio is based on the
leverage effect of gold mines. When the gold price
increases by 20% from $1500 to $1800 and a company’scash cost remains at $600, its profit margin increases by
33% from $900 to $1200. Therefore, this leverage must be
included in the valuation. The following are steps to make a
realistic valuation when buying a mining company:
1. If the market value of a company is higher than its NAV,
the investment is a speculation that the gold price will
increase.
2. Apply the Black Sholes option pricing model to
calculate an “option value” for the gold reserve.
3. Add the option value to the NAV.
Nationalization
Argentina, Venezuela and Bolivia have recently nationalized
companies. Recently, politicians in South Africa have
threatened nationalization. It can be difficult to quantify the
threat of gold mine nationalization. When the gold price
rises, so does the envy of some politicians. As the gold
price increases, the chance that a government will
nationalize the mine directly, or indirectly through high
royalties, may increase too.
Gold Pr ice SpeculationInvesting in gold mine stock is in effect the act of
speculating on a rise in the gold price. During the period of
June 2007 to Sep 2012, an investment in gold had a
superior return and lower volatility than an investment in
mining stock. Therefore, it can be assumed that investing in
assets designed to speculate on the gold price, namely
Gold Futures, Gold ETFs or options on those, is a better
investment than stock.
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compar e the his tor ical per formance and charac teris tics of a gold inves tment to
the main alternatives, silver and equity in gold producing companies in Chapter 8.
The purpose for this compar ison is to discover the r eturn and associated r isk of
these investments and to deter mine is they ar e a safe haven inves tment. In or der to
do so, I compar e gold, silver, mining equity, the S&P500 index and the AGG Bond
ndex ETF.
Chapter 8
INVESTMENT PERFORMANCE
74
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Gold Per for mancechoose ETFs for all asset classes to impartially compare
precious metals, equity of mining companies and equity
and bond indices.
. GLD: State Street SPDR Gold Trust ETF2. SLV: iShares Silver Trust ETF
3. GDX: Van Eck Market vectors Gold Miners ETF
4. SPY State Street SPDR S&P 500 ETF
5. AGG iShares Total US Bond Market ETF (previous
known as Lehman Bond index)
The return on these ETFs include management fees and
have their paid out dividends reinvested.
Chart 34 displays the performance of these five ETFs.
While most asset classes collapsed after the LehmanBrothers bankruptcy in 2008, the gold price and bond
ndex decreased only modestly. Both gold and bonds
recovered quickly by the end of 2008, while other asset
classes only bottomed in march 2009. Equity, both in the
broad S&P500 index and the gold mine index, had the
worst performance, with a minimal gain in the 5½ year
period.
GOLD PERFORMANCE
Chart 34: Relative performance of gold and comparable investments in the period July 2007 to Dec 2012
75
25%
50%
75%
00%
25%
50%
75%
200%
225%
250%
275%
300%
325%
350%
375%
Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13
Gold (GLD)
Silver (SLV)
Mining stock (GDX)
S&P500 (SPY)
Bond index (AGG)
249%
232%
140%
118%
104%
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Silver has different characteristics to that of gold. It has
many industrial uses, thus more dependent on economic
cycles than gold. The silver market is much smaller than the
gold market, which result in larger price swings. These
actors make silver more volatile, thus a riskier investment.
Silver characteristics can benefit investors. Chart 35
lustrates that silver outperforms gold in a bull market but
ilver prices plunge in bear markets, lacking the safe haven
tatus of gold. Active traders can switch between gold and
ilver to take advantage of bull and bear markets. However,
ong term stable investors should prefer gold over silver.
Chart 35: Annual return on several assets
40%
30%
20%
10%
0%
10%
20%
30%
40%
50%
60%
70%
80%
2007 2008 2009 2010 2011 2012
GLD
SLV
GDX
SPY
AGG
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However, nationalizing any asset drives out investment.
Instead of fully nationalizing, governments can raise levies,
or force a majority of ownership to a national company.
Nationalization makes investing in mining companies less
desirable for investors, in turn, decreasing the value of the
companies.
Rising labor cost causes mining equity to underperform. As
soon as workers see record high gold prices, they demand
more reimbursement and can go on strike, like in South
Africa in Sep 2012. Unrest usually suppresses the gold
production and also profits of mining companies. But
unrest can increase the price of the affected commodity,
like gold or platinum.
Equity in gold and silver producing companies lag behind
he price of gold and silver for several reasons.
The increasing cash cost of mining companies is one
reason. A long time ago, easy to reach gold was mined.
The remaining gold ore is of an increasing lower quality,
containing less gold per tonnes of ore. Hence, the cost of
abor and energy to produce an Oz of gold is much higher
han just a decade ago. It is unlikely the cash cost will
decline in the future.
The increasing exploration budgets and capital expenditure
s another reason. Companies need to develop new mines
o replace the depleted older mines. These budgets grow
aster than the gold price, hurting the profits of miningcompanies.
The envy factor is noteworthy reason for mining
companies lag behind the price of gold and silver. Hedge
und manager Hugh Hendry clarifies the envy factor
effortlessly. “There is no rationale for owning gold mining
equities. It is as close as you get to insanity. The risk
premium goes up when the gold price goes up. Societies
are more envious of your gold at $3000 than at $300. And
here is no valuation argument that protects you against
he risk of confiscation.”
Labor unrest at Lonmin’s Marikana platinum mine, where clashes
in pursuit of higher pay resulted in 34 deaths.
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Gold is thought of as purely a financial investment or
urrency. Conversely, base metals have only an industrial
urpose. Base metals are represented by the Powershares
Base Metals Fund (NYSE:DBB), which consists of Copper,
Aluminum and Zinc future contracts.
The correlation matrix below shows the spectrum of
metals ranging from gold to base metals. Silver and
latinum have a higher correlation with gold. Palladium and
opper are more correlated to base metals.
Gold Silver Platinum Palladium Copper
Base
Metals
Brent
Crude S&P500 GDX EUR:USD Bonds
Gold 1.00 0.80 0.72 0.55 0.26 0.25 0.35 0.03 0.80 0.40 -0.04
Silver 0.80 1.00 0.72 0.65 0.44 0.46 0.49 0.29 0.76 0.45 0.05
Platinum 0.72 0.72 1.00 0.79 0.60 0.64 0.56 0.52 0.70 0.46 -0.08
Palladium 0.55 0.65 0.79 1.00 0.61 0.64 0.52 0.61 0.62 0.41 -0.16
Copper 0.26 0.44 0.60 0.61 1.00 0.91 0.50 0.53 0.42 0.39 0.00
Base Metals 0.25 0.46 0.64 0.64 0.91 1.00 0.51 0.56 0.42 0.43 0.04
Brent
Crude 0.35 0.49 0.56 0.52 0.50 0.51 1.00 0.43 0.45 0.39 -0.03
S&P500 0.03 0.29 0.52 0.61 0.53 0.56 0.43 1.00 0.35 0.34 0.18
GDX 0.80 0.76 0.70 0.62 0.42 0.42 0.45 0.35 1.00 0.47 0.00
EUR:USD 0.40 0.45 0.46 0.41 0.39 0.43 0.39 0.34 0.47 1.00 0.11
Bonds -0.04 0.05 -0.08 -0.16 0.00 0.04 -0.03 0.18 0.00 0.11 1.00
Correlation matrix based on weekly returns between July 2007 and Dec 2012
The GDX mining equity ETF has a higher correlation with
gold than the S&P500. Hence, gold is the main driver of
the price of mining stock rather than the broad stock
market.
Bonds, as represented by the AGG ETF, have no
correlation with precious and base metals. In Chapter 9, I
explain why bonds are a good asset to diversify a
commodity based portfolio.
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The three major statistical methods to measure and
quantify the financial risk of an investment are Standard
Deviation (Stdev), Value at Risk (VaR) and the SP ratio.
Stdev shows how spread-out the measured data is from
the average (mean) or expected value. In finance, Stdev
measures volatility, or how much returns can differ fromthe mean over a given period. VaR quantifies the
maximum potential loss over a period with a certain
probability. It is often used in risk management.
Most investors guard against an investment with higher
expected returns when the risks associated with it rise
even faster. Since the returns of the investment must be
compared to the associated risks, performance is calculated
using a r isk adjusted return. The SP ratio is the best
measure to assess financial performance.
The SP ratio = (Return – RF-rate) / Standard d ev iat ion
79
Table 10: Risk adjusted returns of several investments
RISK ADJUSTED RETURNS
Gold and bonds, which are represented by the AGG ETF,
had the best SP ratios during the 2007 and 2012 period.
Silver had a return to similar gold but with a higher
volatility. Gold mining equity, such as the S&P500 equity
index, had a poor SP ratio.
Bonds have a reverse relationship with interest rates.
During the 2007 to 2012 period, interest rates dropped
considerably. Thus, bonds profited from the decrease in
interest rates. Since interest rates dropped at a record low,
they have little room to drop further. And so, I expect that
in 2013 the return on AGG to be less favorable.
Weekly Data 7/6/2007 to 12/31/2012
GLD SLV GDX SPY AGG
Return 18.16% 16.57% 3.04% 0.74% 6.36%
Stdev 20.52% 38.87% 42.18% 23.08% 6.63%
0D VaR 95% -5.99% -10.74% -12.94% -6.59% -1.19%
Sp ratio 0.88 0.42 0.07 0.03 0.94
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Chart 36: Relative performance of several assets during the 2011 debt ceiling mini-crash
80
GOLD AS SAFE HAVEN
80%
85%
90%
95%
00%
05%
10%
15%
20%
GLD
SLV
GDX
SPY
AGG
2011 US Debt Ceiling Mini Crashn the summer of 2011, US politicians were in a dead-lock
on the issue of raising the debt ceiling to $16.4T. Their
political indecisiveness triggered a downgrade of US debt
by the S&P. While investors fled to the safety of gold and
bonds, most other assets including silver and mining
tocks plunged. Although the problem was related to theUS government and USD, the USD and US treasuries did
not depreciate. Therefore, gold had the status of a safe
haven, just like treasuries and the USD.
Gold as a Safe Haven
Chart 36 illustrates the relative performance of five assets
ncluding gold, silver, mining stock, S&P500 and bond
ndex over the one month period of Jul 18, 2011 to Aug
7, 2011. Based on relative performance along with risk
measurements and characteristics, I conclude that goldand bonds are safe havens. They protect an investors
capital in troubled times. Silver is not a safe haven. While
t is highly speculative, silver can outperform other asset
classes in a bull market. Since 2013 is expected to be a
gold and silver bull market, active traders can use silver as
a speculative alternative to gold. Finally, gold mining
equity, like other equity is not a safe haven. Gold mining
equity should not be considered as an alternative to a
gold investment.
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Supply and demand characteristics look favourable for the
gold price. Strong demand from consumers of EMs
outstrips stagnant demand in developed economies. Above
and beyond the shift in wealth to EMs, central banks in
hose countries buy increasingly large amounts of gold todiversify their investments. Supply is likely to increase only
modestly in 2013. Supply disruption and nationalization
hreats, such as those that arose in South African, can easily
go global. Indonesia and South American mines are
particularly vulnerable to unrest. Nonetheless, supply and
demand factors have a limited impact on gold prices
compared to that of monetary polices.
nstitutional investors view gold as a currency and trade itat their currency desks. Central banks report on their gold
reserves as part of their foreign currency holdings. Gold as
a currency pays no interest but act as a reliable store of
value. Since the electronic or paper traded gold market is
very large compared to the physical gold market, prices are
determined on the electronic market and driven by factors
such as inflation and interest rates, money supply, currency
rates and financial market risk.
There are many similarities between the current financialcrises in the US and Europe and the situation in Japan a
decade ago. Therefore, it seems likely that the US and
Europe will continue on the “Japan scenario”, with endless
monetary easing programs, ZIRP and a stagnant economy.
These factors should keep demand for gold as a currency
high throughout 2013.
By the end of 2013, the estimated gold price will be $1890
per oz. (+11.9%). The price increase in 2013 is mainly due
to the ongoing monetary easing policies of the FED and
the ECB. If central banks halt their monetary easing
programs and the economic recovery picks up, the goldprice is expected to decline to $1580 per Oz (-6.4%). In a
stagflation scenario, where central banks increase their
monetary easing programs, the gold price will rise to
$2115 per oz (+25.5%).
The gold price does not show the characteristics of a
bubble. Although its steady rise of the last decade suggests
that it is at the end of the awareness phase and bordering
the mania phase. In the short-term, between the end of
2012 to early 2013, a higher than average volatility in the
gold price is expected. The US fiscal cliff, debt ceiling andpossible Spanish sovereign bailout are possible reasons for
the volatility.
For the long term investor, gold is a better investment than
popular alternatives such as silver or gold mining equity.
Since July 2007, silver had a similar return to gold but it was
much more volatile. It is not a safe haven and silver prices
plunge in a bear market. However, silver outperforms goldin a bull market, making it suitable for active traders. Since
2013 is seen as a bull market for gold, silver can be used as
a more speculative alternative. With the continuation of
monetary easing policies and the S&P 500 index increasing
modestly , the silver price is estimated at $38.50 /oz
(+20.5%) at the end of 2013.
Equity in gold producing companies should not be
considered as an alternative for gold. Rising cash cost and
nationalization treats/ risks make an investment in mining
equity underperform an investment in gold. Mining equity isalso not a safe haven. Finally, an investment in a gold
producing company which is valued higher than its NAV is
essentially a speculation on the increase of the gold price.
Buying gold, gold ETFs or gold future contracts are better
methods to speculate on an increasing gold price.
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Mr. Erwin Lubbers, has been a financial analyst and trader with a
focus on commodities, energy and mining companies since 2006. He
received a Masters in Financial management from the Erasmus
Rotterdam School of Management in 2011. He has the Dutchnationality and currently lives in Cape Town, South Africa. Feel free
to contact me at:
erwin.lubbers@gmail.com
www.linkedin.com/pub/erwin-lubbers/24/6b4/b72
This document is featured and updated on my website. For more
information, please visit:
www.goldresearcher.com
would like to thank my wife Dr. Maha Golestaneh for her impeccable English and
putting long hours in editing this document. I would like to thank Tyler Durden for
many great articles, giving me a better insight in the gold markets.
Disclosure
The Author of this GoldResearcher, Erwin Lubbers, is a independent, self employed analyst and trader.
He is not compensated by any company or individual to provide opinion on specific companies or
products. His blogsite goldresearcher.com does not feature any advertisement. Erwin trades long
positions in Gold and Silver Futures, along with short or long positions in EUR:USD.
Disclaimer With respect to ETFs, mining equities, futures, options, warrants and other products, please refer to
your broker or financial advisor as these are regulated financial products. The inclusion of a particular firm does not constitute the endorsement or recommendation of that firm. Goldresearcher has not
examined the financial condition of any firm that may appear in this document. Consumers are advised
to verify all purchase and sale terms and conditions, payment procedures, pricing and costs of other
services offered by a particular vendor. Goldresearcher provides no investment advice or offer any
opinion on the suitability of precious metals, equity or ETF investments. This document does notconstitute an offer to sell or a solicitation to buy. Precious metals markets are volatile. An investment in
precious metals provides no interest or yield. As with any investment, consumers should check with their financial professional regarding suitability, tax consequences and other pertinent matters involving
their own particular financial circumstance, before making an investment.
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Supply & Demand data from World Gold Council and Thomson / Reuters GFMS websites
www.gold.org/investment/research/regular_reports/gold_demand_trends/
Gold price in USD, EUR, RMB, Rupee from World Gold Council and Thomson / Reuters GFMS websites
www.gold.org/investment/statistics/gold_price_chart/
Prices of Gold Indices and ETFs from Yahoo Financefinance.yahoo.com/
Several articles about the history and general information of precious metals from Wikipedia
en.wikipedia.org/wiki/Gold
en.wikipedia.org/wiki/Silver
Several articles on website Zerohedge
www.zerohedge.com
Macro economic data, interest rates and inflation from Federal Reserve Economic Data FRED toolresearch.stlouisfed.org/fred2/
GDP of specific countries, IMF World Economic Outlook Database
www.imf.org/external/ns/cs.aspx?id=28
FED, ECB Balance sheet from respective ECB and FED website
dw.ecb.europa.eu/browse.do?node=bbn129&
www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm
FED press release Dec 12, 2012 regarding Operation Twist and ZIRP
www.federalreserve.gov/newsevents/press/monetary/20121212a.htm
nformation on polices of the PBOC
www.alsosprachanalyst.com/
LBMA 2011 Gold turnover survey
www.lbma.org.uk/assets/Loco_London_Liquidity_Surveyrv.pdf
BIS Triennial central bank survey 2010
www.bis.org/publ/rpfxf10t.htm
CME volume and open interest reports
http://www.cmegroup.com/wrappedpages/web_monthly_report/Web_Volume_Report_CMEG.pdf
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