GOLD ANOTHER DAY
"The population of the world is increasing at a rate of 6,000 every hour. A small
percentage of these people will become gold hoarders, people who are frightened of currencies, who like to bury some sovereigns in the garden or under the bed. Another percentage needs gold fillings in their teeth. Others need gold-rimmed
spectacles, jewelry or engagement rings. All of these new people will be taking tons of gold off the market every year. New industries need gold wire, gold plating, and amalgams of gold. Gold has extraordinary properties, which have been put to new uses every day. It is brilliant, malleable, ductile, almost unalterable, and denser than any other common metal except platinum. There is no end to its uses. But it has two defects. It isn't hard enough. It wears out quickly, leaving itself on the linings of our pockets and in the sweat of our skins. Every year, the world's stock is invisibly reduced by friction. I said that gold has two defects… the other, and by far the major defect, is that it is the talisman of fear. Fear, Mr. Bond, takes gold out of circulation, and hoards it against the evil day, it is fair enough to say that a fat proportion of the gold that is dug out of one corner of the earth is at once buried in another corner".
For thousands of years, gold enjoyed a dual role, both as a commodity and an ultimate store of value. It was the store of value quality that helped propel gold from $50 to a record $850 an ounce in the volatile inflationary period of 1980. For the next twenty years, inflation was wrung out of the system and the dollar replaced gold. That has changed. Gold is coming back. Increased demand from the Far East coincided with the resurrection of gold. Japanese are buying gold, not for jewelry consumption but as a
hedge against a depreciating yen. Gold is regaining its position as a store of wealth. Meanwhile global demand grew at two percent to three percent, while production declined. This shortfall of supply was filled by central bank sales, which are limited by the Washington Agreement. Looking ahead, however, the gap is unlikely to be filled by the mining industry, which has been unable to replace reserves due to a low gold price, a
decline in exploration, and the new South African Empowerment Bill.
Oh, how the mighty have fallen. The US dollar has dropped more than thirteen percent from its twelve month highs to a three year low against the euro. Until recently, no asset since gold in the 19th Century has enjoyed such a broad acceptance as a medium of exchange than the US dollar. Earlier this year it was widely expected that the US dollar could only go one way, up. However this spring, the overvalued greenback lost ground giving gold a lift, which is priced in US dollars. Since then the dollar rallied a bit but with the Fed's latest interest rate cut, the dollar has again come under pressure retesting last year's lows. The dollar's problem was caused in part by the unwinding of positions by foreigners that borrowed in cheap currencies to finance purchases of higher yielding dollar assets. But the drop in US interest rates caused a reversal of this "carry trade" and Middle East investors, in particular, are keeping their funds closer to home in the wake of a Saudi witch-hunt.
The Twin Tower of Deficits
Our bullish stance on gold is based on the expectations of a multi-year dollar decline because of the shift in economic fundamentals. This view has been strengthened by the recent expansionist stance of the major industrialized countries, coupled with the continued overvaluation of the stock markets. The United States consumes more of the world's goods than it produces with the difference being the huge current account deficit. The deficit will reach a record $500 billion this year and threatens to approach 6% of gross domestic product (GDP) next year. The world's largest debtor pays more to
foreigners in profits, interest and royalties than they receive. Mr. Bush's new economic team is now likely to usher a shift in dollar policy, which would force Europe and Japan to adopt America's massive reflationary policies and another round of competitive devaluations. That will be good for gold. And of course there is the other deficit, the budget deficit. Within two years, the
economy has gone from a $200 billion surplus to a $200 billion deficit for fiscal 2003. Spending under Bush is the biggest since the Vietnam War diverting needed resources from the private sector and the recovery. At the very least, the budget deficit will exceed the record $290 billion of red ink in 1992 even without waging war with Iraq. Departed economic chief, Larry Lindsey suggested that a war with Iraq might cost $200 billion.
William Nordous of Yale University estimated the price tag to rebuild Iraq after a war would be $600 billion. While the deficit so far remains relatively small as a percentage of GDP, it must be remembered that deficits too must be financed. The Congressional Budget Office says the combination of recent spending trends and tax cuts will cause the deficit to reach a whopping $900 billion in the next decade if left unchecked. This dollar decline is self-feeding. When overseas investors lose money because of
currency movements, they become less willing to hold dollar assets, which results in further declines. According to Japan's Ministry of Finance, the Japanese bought a net $9 billion worth of foreign stocks and bonds in October. Of that total, less than 10 percent was spent on US securities. According to US Treasury data, net purchases of US long-term securities by Europeans plunged to $18.49 bullion form January to September compared with $78.92 billion for all of 2001. Moreover, if the US were to become an
occupation force in Iraq, this would delay a return of foreigners to US assets. In September of 1985 following the Plaza Accord, gold increased 78% while the dollar fell 35%. Today the dollar has fallen to a three year low against the euro and gold has jumped to a five year high.
The Next Big Worry
With the dollar's luster already tarnished by corporate scandals and three successive years of falling prices on Wall Street, the lower greenback will exacerbate the deficit. This will also diminish the abilities of existing assets to fund future streams of foreign liabilities. A slumping dollar comes at an awkward time for policymakers, particularly for Bush's new economic team. To date, the dollar's strength has dampened inflation in America; a falling dollar will tend to revive inflation, putting pressure on the Fed to raise
interest rates not cut further. With the obituaries of inflation written, the majority of portfolio managers today do not know the meaning of inflation. Many were still in school or not even born. We can recall when 10% inflation was normal but that also it halved the value of money in less than seven years - that's something even James Bond remembers.
The script for inflation's return has been written before. Inflation is a monetary phenomena. Today's money supply has grown at double-digit rates. Second, oil prices are now above $30 a barrel, more than double from a year ago. Third, in the past month, commodity and metal prices have increased foretelling a cyclical recovery. The Federal Reserve has little room to maneuver having cut interest rates to 40 year lows; Bush's government has to spend more and tax less just to keep the economy going. We believe
his policies will result eventually in a pick-up in inflation at a time when the world is worried about deflation. Deflation does not happen with 3% growth, deflation does not happen with twin deficits, deflation does not happen with negative real interest rates, and deflation does not happen when New York's transit workers were asking for 24 percent wage increases for the next three years. Today, American savers do not have nest eggs to worry about. Debt and consumer borrowing attracted by near-zero interest rates have
been very strong and as a percentage of assets among households reached new highs. The economy is labouring under a huge debt load. Americans have become the world's biggest debtors and ironically would not object to a little bit of inflation since inflation devalues both debt and a country's currency.
A little bit of inflation is like being a little bit pregnant - it's the real deal.
It is not higher earnings that have sustained the market but ridiculously low interest rates. And this easy money stance will eventually revive inflation. With the pick-up in inflation, foreign capital will be looking for a safer home, not wanting to hold on to depreciating dollars.
The US has grown accustomed to a steady inflow of foreign cash, needing to attract $1.5 billion in overseas funds every day to keep share prices up, interest rates low and the dollar from falling. With international investors becoming convinced that the next direction of the dollar is down, capital outflows will accelerate and interest rates will rise. Inflation will pick-up renewing the downward pressure of stock prices. Gold is a good thing to have.
Finally Stocks Will Outperform Bullion
Gold this year finally broke through $330 an ounce due to the weaker dollar. The mining industry has reversed their hedges and bought back or delivered an estimated 255 tonnes in the first half of this year, leaving an estimated 2,800 tonnes on their hedge books equivalent to one year of mine production. In the past, the gold industry protected itself against a falling price by hedging but they could not hedge against a rising gold price.
With higher prices looming, the industry is expected to become big buyers providing a floor under the gold price. Hedging like smoking is no longer fashionable. The next target is $375 an ounce and we expect gold to trade at $510 an ounce next year, as the US dollar collapses. We commented earlier that bullion would outperform equities in the latest consolidation phase until gold broke through $330 an ounce. After the breakout, equities are expected to outperform bullion until $375 an ounce is achieved. From a risk/reward point of view, we see the downside risk next year at $300 an ounce and the upside potential at $510 an ounce. Auric Goldfinger would like those odds.
John R. Ing
416-947-6040
21 December 2002
130 Adelaide St. West - Suite 906
Toronto, Ont. M5H 3P5
Maison Placements Canada
The information contained herein has been obtained from sources, which we believe reliable but we cannot
guarantee its accuracy or completeness. This report is not and under no circumstances is to be construed as an offer to sell for the solicitation of an offer to buy any securities. This report is furnished on the basis and understanding that Maison Placements Canada Inc. is to be under no responsibility whatsoever in respect thereof. Directors, shareholders or employees of this company may be beneficial owners of the securities referred to herein.
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