The 2ndlook Gold Report – 2010

Buy gold … young man!

2ndlook has proposed to all and sundry, to buy gold for the last 20 months. Interestingly, a Chinese-blogger-online financial advisor, with some fan-following, going as Maoxian says, “I’d wager $20 that no one can show me an audited trading record for any system that has traded GLD since its inception that has beaten simply buying and holding GLD since then.”(errata – an American blogger, and not Chinese).

Now, 2ndlook is not a hedge fund, or a financial advisor! And will not pretend to be one either. But 2ndlook will take a 2ndlook, and put a context and perspective that others will not. And answer your question, “Is it the time to buy gold!”

How far and how high will gold go? Some history before that.

Nixon and Kissinger - 1972 (Courtesy - nytimes.com)

The Nixon Chop

On August 15th, 1971, ‘Tricky Dick’ Nixon emerged from Camp David, on an evening television show, and announced the end of dollar redemption against gold.

For the 10 years, France had been redeeming gold, even sent a French warship to escort gold from US to France. On August 13th, 1971, Britain also made an official request for dollar-redemption – and Nixon shut the door on that possibility.

And that was the end of Bretton Woods Agreement!

Dollar anchor shifts – from gold to oil

Over the next 10 years, the world saw severe stagflation (economic stagnation + price inflation). Gold prices zoomed from US$35 an ounce to US$800 an ounce.

Gold does not have any price-correlation is traditional wisdom! Correlation like inverse, perverse, reverse, positive!

From 1980, President Ronald Reagan, in the next 8 years, persuaded his Middle East allies to pump out more oil – cajoling, mixed with threats – ranging from the Iran to US-led increase in oil production. The resultant drop in oil prices cooled down inflation, strengthened the US dollar.

Surplus revenues from oil-sales by Middle East oil producers, were used to fund US deficit. By 1990, surplus petro-dollars vanished, with the drop in oil prices, and the increased cost of running welfare states in the Middle East.

In the last decade, it was the turn of the Chinese and the Japanese to prop up the dollar.

IN China, many people refer to the dollar as mei jin, or “American gold.” Government officials, businessmen and people on the street all use the term. So if a Chinese person tells you that he owes you 100 American gold, don’t expect a big fortune, because he’s planning to pay you $100.

US has been able to find lenders to bridge their deficit for more than 50 years. From the 1950s to 2010. Europe till the 70s, Middle East up to the 90s, Japan and China, till 2010!

Can the US find another target to fund their deficits.

The collapse of Soviet Union

In the 70s, with out-sized gains in oil, platinum and aluminum prices, the Soviet economy became a powerhouse, funding anti-US regimes across Africa, South America, Asia and the Middle East. Soviet Russia, one of the largest gold producers in the world, made windfall gains.

The expansion in subsidies by the USSR in the 1970-1990 period to its allies and sympathetic regimes created a huge pressure on Soviet finances. A simultaneous drop in oil and gold prices in the 1985-1995 period severely dented Soviet export earnings, leading to the economic collapse of the Soviet Union. In USSR’s economy, after WWII, commodities like oil, natural gas, metals (like gold, platinum, uranium) and timber accounted for 65%-80% of Russian exports.

Reagan managed to increase oil production, decrease Soviet earnings - and create an economic crisis in the USSR! (Cartoon by David Horsey from seattlepi.com).

Gold sales by central banks

The Central Bank Gold Sales Agreement, further dented gold prices, 1995 onwards. Gordon Brown, the then British Chancellor of the Exchequer, has been under pressure to ‘reveal’ details of British gold sales during this period.

The (British) bullion was sold in 17 auctions between 1999 and 2002, with dealers paying between $256 and $296 an ounce. Since then, the price has increased rapidly. Yesterday, it stood at $1,100 an ounce.

Dark stories are told that this was stolen gold during WWII, going around as the Yamashita gold, the Nazi gold, with marginal characters like Edmond Safra, playing an important role. It is suspected that the Soviet Union unloaded a lot of gold during the glasnost and perestroĭka period under Gorbachev.

The upshot of this was that for the first time in modern history (1800-2000), ‘declared’ gold reserves of governments across the world, reduced to a historic low of 20% of total global reserves.

The Great Collusion

By the end of The Great Depression, and the start of WWII, public sector (all the Governments of the world) owned some 50%-65% of the gold in the world. That is now reduced to less than 20%.

Will the State(s) sit back and allow the citizenry to become so independent – and the State to become ‘powerless’?

Improbable!

Global conclaves on economic matters (the G20 Summits, WTO Summits, the Copenhagen Summit) are getting organized easily and often. A global, mass nationalization of gold to ‘save the global economic system’ may be called for! Instead of warring with each other, Governments may decide to collude and jointly loot their respective citizens in a coördinated manner!

Was the US crackdown on Swiss banks a precursor to the global gold nationalization?

Central Banks own ≈20% of the world’s gold

Central banks the world over, claim to own something over 30,000 tonnes of gold – about 20% of the world’s total gold stocks. Officially, that is. Some of it is double counting. The most obvious example is IMF gold.

Most of IMF’s gold reserves are actually pledge papers by founder-member countries that they will pony up the gold. A book entry. This pledge was covered by a back-to-back with a reverse sale agreement by the IMF back to the pledgor -called ‘restitution agreement’ in IMF lingo.

The Bretton Woods agreement gave birth to IMF and World Bank (Pictured above: Treasury Secretary Henry Morgenthau speaking at the opening of the Bretton Woods conference on July 8, 1944.; picture credit - nytimes.com).

The hoax of IMF gold

Of the 3005 tons which is held by IMF at ‘designated’ depositories (meaning pledgor central banks), 2600 is covered by the restitution agreement. Of the balance, 403 tons, only some 191 tons remains with IMF. In fact, IMF does not have any gold – apart from 191 tons.

What it has, are pieces of paper that various central banks have given, ‘promising’ gold to the IMF – and this ‘promised’ gold was held in safe custody by the pledgor-central bank on behalf of the IMF.

Is this the right gold price

Estimated global economic output is some US$70 trillion. Gold is now ruling at some US$1200-1250 (per ounce). Total global reserves of gold (private, public, central banks, et al) are estimated at 130,000-140,000 tonnes. In dollar terms, the value of gold stock is US$5.0-5.5 trillion.

Gold futures (Image Source - Wall Street Journal).

If all the liquid capital in the world is measured in gold, then the total capital to output ratio turns out to be 1:14 ratio. For every 1 unit of gold, there are fourteen units of economic production (US$5 trillion of gold gives an output of US$70trillion). Of course, to make this liquid capital productive, other forms of capital are also required – namely land, buildings, factories, technology, education, healthcare, et al. Those could also be similarly valued – and added to the gold capital in the form of gold. Currency would become proxy for gold – and hence all currency units will be ignored as store of capital. Looking at the past, adjusting for inflation,

Gold is still at half the peak set in 1980, after adjusting for inflation. Then, prices rose to $US850, equal to $US2266 today.

If one were to measure gold as a proportion of global /national economy, it may give us a better idea about where gold is headed. Looking at it from this perspective, the upside for gold is definitely less than 100%. Based on current pace of liquidity creation – that is printing of Euros, dollars, yuan, yen, rupees, that various governments are printing. In Western markets, it is seen that

The yellow metal remains in a $1220-$1260 channel for the time being, and is still showing a Kilimanjaro-sized 975 tonne pile of long positions standing and casting a…long shadow in the market.

and … gold revealed some ‘disconcerting’ technical signals on the price charts and that in coming days ‘prices may not ‘necessarily strengthen.’

These weak signals, are largely due to some expected dampening in demand from India during June to September, in the generally slack monsoon season (though not quite so, last year).

Helicopter Ben is using his famous 'printing' technology!

Gold shortage!

There have been many reports about shortage of gold – in coins and bars form. Now this is strange.

In India, there is no such talk or shortage! The probable reason is that in India, gold lumps are also accepted by customers – without hallmarking! The jewellers, assayers and valuers are dime a dozen. Hence, gold fraud by the trade can be easily detected – especially in raw gold. Not to mention, that there are ‘dharam-kantas’ in every town and village across India – which does gold assaying for free.

In jewellery form, however, there is rampant mis-declaration of purity. So, buying gold in India is, as of now, not a problem!

Due to this ‘shortage’ in some Western markets, for sometime gold futures were cheaper than gold for physical delivery. The US mint and the Perth mint in Australia have suspended coin sales – supposedly, as they were swamped by orders, and demand.

Let us look at old mining and productions figures, to get some context.

All the gold in the world

Annual global gold production at some 2200 tons, is itself seen as an issue! Gold mining companies are “digging deeper to extract dwindling reserves, with mines in South Africa extending as far as 3.8km down” Apart from having to dig deeper, the other issue is “Ore grades have fallen from around 12 grams per tonne in 1950 to nearer 3 grams in the US, Canada, and Australia.”

China, Australia and the 16 other largest mining nations averaged weekly output of 42.3 tonnes last year, researcher GFMS estimates. Even though prices have fallen 5.8 percent to $US1177.10 from a record $US1249.40 an ounce May 14, the median prediction in a Bloomberg survey of 23 traders, analysts and investors is that it will reach $US1500 by the end of the year.

Investment, including bars and coins, almost doubled to 1901 tonnes last year, exceeding jewellery demand for the first time in three decades, according to GFMS. Jewellery will jump 19 per cent to 2100 tonnes this year and industrial use 8 per cent to 398 tonnes, Sydney-based Macquarie Group says.

The gap in demand and supply is being met by scrap sales.

In Southeast Asia, scrap sales, which are routed through Australia and sold on to India, are already up.

“When gold gets to these sorts of levels, Southeast Asia gets interested in dishoarding,” said Nigel Moffatt, treasurer at the Perth Mint in Australia. “We’ve been seeing it now for some weeks.”

Which way the wind blows?

With the world’s largest private reserves of gold, and as the world’s largest consumer of gold, India has a significant role to play in gold prices.

The Bloomberg poll of 23 traders (linked and extracted above), gives a consensus estimate of some US$1500 an ounce.(31.1034768 grams). Which translates to about Rs.21000-23000 per tola (10 gm) range. Dollar rupee exchange rate will also make a difference. That is an appreciation of about Rs.3000-5000 – some 15%-25% from current prices (Rs.18,100-18,500 range). A strong and stable gold price during July-September period could easily see gold cross 21,000 by October. A weak 3 quarter, will corner gold to the 20,000 barrier.

In another post, Maoxian remarks,

Two years ago when I wrote the post, Jim Sinclair’s Crazy Bet, I annoyed the tinfoil hatters. One commenter wondered where a pajama blogger dude sitting in a crappy little Third World apartment would get the money to take a million dollar bet.

I thought it was time for an updated post/chart given the Greek drama and Euro crisis. Recall that Sinclair’s wager was: “Gold will trade at USD $1650 before the second week of January 2011.” Price could still make it there, but looking at the chart, it seems as improbable to me now as it did back in 2008.

Will Government’s scam people out of gold

Let us deconstruct this price upmove.

A US$1650 gold price @Rs.50 to a USD price means some Rs.26,500 per tola. At that rate, in Jan 2ndweek, we are talking about a 45% appreciation in 6 months. Take gold at US$1650 @Rs.42 to a USD, translates to about Rs.22,300 per tola.

At about 21,000-23,000, Indian consumer buying is likely to be anemic – and investment demand from OECD+China will have to make up for weak Indian demand. At Rs.26500 per tola, the Indian consumer may start selling gold – and we may see a small replay of the Hunt Brother’s silver saga in gold. Scrap sales of gold out of India may dampen prices much.

The third scenario may see gold at about 33000-36000 per tola. To do this the Indian rupee must trade at Rs.60 to a dollar, to get Indian consumers to part with their gold. Like the successful scam by Winston Churchill-Montagu Norman between 1929-1939 to loot the Indian peasant of his gold.

We may see a variation on that play!

Related articles

• The gold rush is on – and the clock is ticking (independent.co.uk)
• Gold standard (bbc.co.uk)
• Gold reaches all-time high of $1,457 per ounce (telegraph.co.uk)
• Mexico bolsters its gold reserves (bbc.co.uk)
• Factbox: Gold milestones on the road to record highs (reuters.com)