Thoughts on Gold and Resources

The Forbes Manhattan Conference

Dr. Martin Murenbeeld

November 4, 2010

Overview

1. Gold bullion is in a long-term

bull market
2. Resources will continue to
benefit from Asian demand
for years to come

1
 Gold in a Bull Market
Nine bullish arguments:

1. Global fiscal and monetary reflation: PIIGS, US, etc.

2. Global imbalances: the dollar must decline
3. Global FX reserves are “excessive”: diversification
4. Central bank attitudes to gold: now positive
5. Gold is not in a bubble: room to rise
6. Mine supply is flat: “peak” gold?
7. Investment demand: long-run uptrend
8. Commodity price cycle: many years to run
9. Geopolitical environment: positive

Bullish: (1) Global Reflation

Antecedents of the (PIIGS) Sovereign Debt Crisis:

1. Baby-Boomer Retirements: The fiscal stresses

this would cause was visible years ago
2. The Great Recession: Pushed budgets into
record deficit – just when the early boomers are
about to retire
3. The Euro Common Currency: Membership in the
Euro System allowed interest rates to
“converge” - and “undisciplined” governments
to borrow excessively

2
 Bullish: (1) Global Reflation
The baby-boomers are about to retire …

US Scenarios Canadian Scenarios

Source: Congressional Budget Office, November 6th presentation by Director Elmendorf

Slide: Federal Debt Under CBO’s Long-Term Budget Scenarios Source: Office of Parliamentary Budget Officer
“Fiscal Sustainability Report”, Feb 18, 2010

Policy Options:
Increase retirement age Decrease benefits
Decrease payment per service Decrease number of services
Increase tax rates for services Institute new taxes (VAT?)
4

Bullish: (1) Global Reflation

Fiscal policy blown out by “Great Recession”
4
Fiscal Balances
2 % of GDP

-2

-4

-6

-8
2007 2009
-10

-12

-14
US Canada Japan Germany France Italy UK Greece Portugal Spain OECD China India
-16
Source: OECD, IMF

THEY ARE ALL PIGS!

5

3
 Bullish: (1) Global Reflation
Monetary policy blown up by “Great Recession”
2200
$bn
2000
US Monetary Base
1800
1600 September 2008
Federal Bailouts
Begin
1400
1200 September
11, 2001
Nixon
1000 Eliminates
The Fixed
Gold Price Y2K
800 WWII

600 1929 Stock Vietnam

Market Crash War
400
200
0
Last month: September 2010
-200
15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90 95 00 05 10

Bullish: (1) Global Reflation

So how will governments handle their debts?

Government Choices:
Renege on promises
Cut other services
Raise taxes

Print more money?

4
 Bullish: (1) Global Reflation
Money drives gold …
1350 12.0

1200 10.5

1050 9.0

900 Global Liquidity 7.5

(trillion$)
750 6.0

600 Gold (US$) 4.5

450 3.0

300 1.5
Latest month:
Liquidity: June 2010
Gold: September 2010
150 0.0
82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
Global Liquidity: FX Reserves + US MBase
Source: IMF, Federal Reserve

Bullish: (1) Global Reflation

Gold rises and falls with liquidity
60 42

48 35
Global Liquidity yoy%
36 28

24 21

12 14

0 7

-12 0

-24 -7
Gold yoy% Latest month:
Liquidity: June 2010
Gold: September 2010
-36 -14
82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
Global Liquidity: FX Reserves + US MBase
Source: IMF, Federal Reserve

5
 Bullish: (2) Global Imbalances
The US current account deficit is rising again
2 140
Current Account - %GDP
1 133

0 126

-1 119

-2 112

-3 105

-4 98

-5 US Dollar Index 91
(four currencies)

-6 84

-7 Last quarter: US recession

77
US$ - 2010-Q3
Current Account – 2010-Q2
-8 70
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
* So will continued recession!

10

Bullish: (2) Global Imbalances

The US trade deficit with China is unsustainable
0 0
$bn
US trade with China

-5 -50

-10 -100

-15 -150

-20 -200

12-month moving total bn$

-25 -250
US recessions

Last month: August 2010

-30 -300
96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

11

6
 Bullish: (2) Global Imbalances
China must revalue; reserves are excessive!
1 2700
RMB/US$
2 Chinese FX reserves ($bn) 2400

3 2100
The Chinese RMB was devalued
at year-end 1993 by 34% … of
4 1800
which only a little has been given
back recently
5 1500

6 1200

7 900

8 600

9 300

10 0
86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
Source: IMF

12

Bullish: (2) Global Imbalances

US energy deficit bleeds dollars on world markets
0 0
$bn
-4 US imports of crude oil -40

-8 -80
12-month running total
-12 -120

-16 -160

-20 -200

-24 -240
-28 US recessions -280

-32 -320
Total energy-related
-36 petroleum products -360
12-month running total

-40 -400
-44 -440
Last month: August 2010 $bn
-48 -480
96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

13

7
 Bullish: (2) Global Imbalances
The Obama Administration wants the dollar down

“We can’t go back to the era where the

Chinese or the Germans or other
countries just are selling everything to
us, we’re taking out a bunch of credit
card debt or home equity loans, but
we’re not selling anything to them”
President Obama on CNN in run-up to the G-20 Meeting in Pittsburgh, Sep
2009

So now we have “currency wars”!

14

Bullish: (3) Global Reserves

Foreign exchange reserves have exploded*
90 10
(e)
81 Global FX Reserves Global FX Reserves 9
% change yoy
72 8

63 65% of FX Reserves
7
are in US$!!
54 $7 trillion rise 6
since 2002
45 5

36 4

27 3

18 2

9 1

0 0
Source: IMF
-9 -1
69 73 77 81 85 89 93 97 01 05 09
* Most are held by emerging country central banks
15

8
 Bullish: (3) Global Reserves
Global reserves are “excessive”

Foreign Exchange Reserves

(countries over $100 bn)
bn$ bn$
China 2648.3 India 256.2
Japan 1015.1 Brazil 254.1
Russia 436.6 Switzerland 202.4
Saudi Arabia 422.4 Thailand 149.3
Taiwan 372.1 Algeria 146.2
Korea 281.4 Mexico 106.1
Hong Kong 260.6
TOTAL 6550.9
Addendum: Fuel Exporters $1350.5bn
Source: IMF - data through August 2010

16

Bullish: (3) Global Reserves

Diversification out of $’s in FX reserves likely

The choices for a central bank are limited:

1. Other currencies
• These currencies must have deep international
capital markets - some do not: renminbi, ruble: some
do: yen, pound, euro (but is euro now suspect?)
2. SDR’s issued by the IMF
• The SDR is a basket currency that includes only the
dollar, yen, pound, and euro - it has limited use
outside of central bank markets
3. Gold, other “hard” assets, mining investments
• But gold market is “narrow” and China likes
commodity-producing assets

17

9
 Bullish: (4) Central Bank Attitudes
Central bank attitudes towards gold have changed

1. CBGA signatories are selling less gold

(not selling at all)
2. China raised its gold reserves from 600
to 1054 tonnes
3. India bought 200 tonnes of IMF gold
4. Russia and India have suggested a new
SDR basket should include gold

18

Bullish: (5) Gold Not in a Bubble

Gold looks like it is in bubble …
1400
Friday p.m. fix
1300
1200
1100
1000
900
800
700
600
500
400
300
200
100
Last date: October 22, 2010
0
69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09

19

10
 Bullish: (5) Gold Not in a Bubble
… but that may be a function of perspective
10000
Friday p.m. fix
log scale

1000

B
100

Compound return from A to B is 6.8%

A From A to any other point it is more
Last date: October 22, 2010
10
69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09

20

Bullish: (5) Gold Not in a Bubble

It is not in a bubble in constant Dollars
1750
Last date: 2010-Q3
Gold peak of
$850 translates
1500 into $2385 in
today’s money!
Average price $635
1250 (2010-Q3$)

1000

750

500

250
Average price $371
(Nominal $)
0
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

21

11
 Bullish: (5) Gold Not in a Bubble
Not in terms of oil prices
35

30

25
Average:
15.03
20

15

10

5
Barrels of oil per ounce of gold
Latest month: September 2010
0
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

22

Bullish: (5) Gold Not in a Bubble

Not in terms of copper prices
800

700
Average:
343
600

500

400

300

200

100
Pounds of copper per ounce of gold
Latest month: September 2010
0
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

23

12
 Bullish: (5) Gold Not in a Bubble
Not if US gold had to “cover” US money supply
8000

7000 Price of gold to “cover” US M2 $7000

(Cover ratio = .24)
6000

5000

4000

3000 $3100

2000 Price of gold to “cover” US M1

(Cover ratio = .38)
1000

0
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
“cover ratio” as determined in 1934 when gold was revalued to $35

24

Bullish: (5) Gold Not in a Bubble

Gold still “cheap” In terms of financial assets
30 Ratio: S&P vs. Gold
1871 = 1.00
S&P Index: 1941-43=10.0
Peak - 2000
25

•Recession 1973-1975
20
•Gold “cut loose” in 1971
•Gold cut 5 years after peak
15
•Depression 1930-1933
•Gold revalued to $35 in 1934
10
•Gold revalued 5 years after peak

Current
10/01/2010
5 Gold $1315
SP 1150

0
1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
With gold = $1315 then S&P = 265
With S&P at 1150 then gold = $5660

25

13
 Bullish: (5) Gold Not in a Bubble
It may one day be – but that day is not now
2500

GOLD PRICE 1971-1982

2000

1500

1000

500
Set to 100
NASDAQ 1990-2009
GOLD PRICE 2001-2010
0
1 2 3 4 5 6 7 8 9 10 11 12
Years

Bullish: (6) Gold Supply

Model suggests WW mine flat
2700
Tonnes

World Mine Output (GFMS)

2300

1900

1500

Model Estimate
The Mine Production Model is based on lagged
1100 gold prices and lagged production

Western World Mine Output (GFMS)

700
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12
Source: GFMS, Murenbeeld

27

14
 Bullish: (6) Gold Supply
The general commodity supply outlook is impaired

1. Difficult governments: i.e., Venezuela

2. Governments are in debt: i.e., Australia has
introduced a “resource super-profits tax” …
3. Environmental hurdles: i.e., the Gulf of Mexico
disaster changes the future for off-shore
drilling
4. “Peak” gold, “peak” oil, peak … : The low-
hanging fruit has been picked …

28

Bullish: (7) Investment Demand

Can we make a case for investment demand?

1. Central banks are rediscovering that gold is not another central

bank’s liability (i.e., China holds US Federal Reserve liabilities!)
2. The private sector is beginning to worry about the nature of fiat
currencies and the likelihood of currency debasement
3. The private sector is also discovering that gold has attractive
portfolio characteristics (gold improves the “efficient frontier”)
4. Commodities in general, and gold specifically, are morphing into an
“investment asset class” (like real estate did once it became
securitized)
5. Jewelry demand wasn’t always the dominant demand in the gold
market; private and central bank demand was historically more
dominant
6. Major deregulation of Asian gold markets encourages people with an
affinity for gold to invest in gold (and jewelry in many parts of the
world is seen to be investment as well as adornment demand)

29

15
 Bullish: (7) Investment Demand
The gold ETF rising strongly since introduction

1700
Last date: October 21, 2010

• ETF demand 1600

1500
1400
has been very 1300
1200 GOLD TONNAGE - ETF
strong during 1100
1000
this period of 900
800
700
financial stress 600
500
400
300
200
100
0
2003 2004 2005 2006 2007 2008 2009 2010

30

Bullish: (7) Investment Demand

Retail investment plus ETF demand rising
50
(e)
45 Net retail investment demand plus ETF’s as
a percent of total identifiable gold demand
40

35

30

25

20

15

10

0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Source: World Gold Council “Gold Demand Trends”
Based on data tabulated by GFMS
2010 estimate by DundeeWealth Economics
31

16
 Bullish: (7) Investment Demand
Retail investment demand will grow in Asia

Net Retail Investment Demand (excluding ETF’s)

Billion US$

1600 160
World – tonnes (e) China – tonnes (e)
1400 140
1200 120
1000 Without ETF 100
800 With ETFs 80
600 60
400 40
200 20 2001
2001
H1 H1
0 0
96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

120 250
US - tonnes India – tonnes
100
(e) (e)
200
80
150
60

40
100
2001
20 H1
50 2001
0 H1

-20 0
96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

Source: World Gold Council, GFMS

Estimates by DundeeWealth Economics

32

Bullish: (7) Investment Demand

Investment demand in gold/commodities will grow
70
Global financial assets Managed assets
60 total $ 117 trillion $ 40 trillion

Equities declined
50 by 45% in 2008

40

30
Managed
commodities
$ 300 billion
20

10

0
Equities Private Debt Government Managed Managed
Debt Assets Commodities
Source: McKinsey & Company, IMF, Barclay’s
Estimates are for 2008

33

17
 Bullish: (7) Investment Demand
Gold investment products more sophisticated

The Dynamic Strategic Gold Fund

GOLD BULLION GOLD EQUITIES

Physical bullion Senior, Intermediate & Junior Producers
Bullion certificates Production & Development
“Best-in-class companies”

34

Bullish: (9) Geopolitical

The biggest geopolitical crisis to date …
900

800
about $400 Cyclical peak in gold
(or 100%)
700

600

500

Iranian hostage crisis /

400
Russia in Afghanistan
300
Gold Price: 1979-1980
200
30-Jul-79 11-Oct-79 28-Dec-79 13-Mar-8030-May-8012-Aug-80 24-Oct-80 14-Jan-81 27-Mar-81

35

18
 Outlook: Six Bearish Arguments

1. Policy “exit strategies”: in US, Asia, Europe

2. Strong dollar: against the euro …
3. Deflation: government debt more attractive
4. Liquidity of last resort: for Greece, Italy, …
5. Dehedging finished: hedging to recommence
6. Chinese recession: commodity demand will
decline

36

Bearish: (1) Exit Strategies

Real rates will rise with “exit strategies”
5
US real short term
4 interest rate

When above 2% 3
gold prices
often “stall”
2

0 Exit
strategy!
-1 Real rates below zero are
very positive for gold
-2

-3

-4
Last month: September 2010
-5
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

37

19
 Bearish: (1) Exit Strategies
fiscal policies must be tightened

Assuming central banks do not “print money”:

1. Tighter fiscal policies will be a drag on economic

growth
2. Inflation pressures will remain subdued, and the
threat of deflation will linger
3. Confidence in monetary policy (and fiscal policy)
will improve
4. Which all will weigh heavily on the gold price

38

Bearish: (4) Liquidity of Last Resort

The PIIGS need cash!

• The PIIGS hold over Gold Reserves

3000 tonnes of gold tonnes
Greece 112
• We have been
Ireland 6
concerned about Italy Iceland 2
for years Italy 2452
• But Greece, Portugal, Portugal 383
and Spain might be Spain 281
the first to sell – were
it to come to that Total 3236

39

20
 Bearish: (6) A Chinese Recession
Commodity demand could tumble

1. China’s growth rate will decline (a recession is <6%)

2. Investment cools - money could leave China
3. World equity markets sell off – some very sharply
4. A flight to safety will almost certainly favor US Treasuries
5. Chinese gold demand will suffer

But policy will respond …

1. The PBoC will likely “print money”, and the government will
expand fiscal policy
2. Other Asian central banks will want to insulate their
economies, and print/devalue
3. Which could eventually see gold demand rise to new highs

40

The October 2010 Forecast*

We are bullish – Scenario A is given low probability

Gold Price Scenarios

2010-avg 2010-end 2011-avg

Scenario A: p.=.10% $1187 $1215 $1074

Scenario B: p.=.45% $1217 $1340 $1398
Scenario C: p.=.45% $1237 $1420 $1559
_______________________________________________
Weighted: $1223 $1365 $1438

* Forecasts are updated quarterly

41

21
 Commodity/Resources
The IMF forecasts a moderate global recovery …
6 Billion US$ 18

World GDP (%) 16 China GDP (%)

5
14
4 12

10
3
8
2 (e) 6

1 4

2
0
0

-1 -2
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
12 5

4
10 India GDP (%)
3 (e)
8 2

1
6
0
4
-1

2 -2

-3
0
-4 EU GDP (%)
-2 -5
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

Source: IMF, October 2010

42

Commodity/Resources
China has a major impact on commodities
30
Chinese consumption of copper
27 As a % of world copper consumption

24
21
18
15
12
9
6 US consumption of copper
As a % of world copper consumption
3
0
-3
90 92 94 96 98 00 02 04 06 08 10
Source: World Metals Bureau

43

22
 Commodity/Resources
China’s oil consumption has risen dramatically
45
Percent of world consumption
40 Up 839%

35

30

25

20

15

10

0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

44

Commodity/Resources
China’s nickel consumption has risen significantly
9
As a percent of world consumption

8 Up 410%

0
1980 1985 1990 1995 2000 2005 2010

45

23
 Commodity/Resources
BRIC’s appetite for commodities has surged
60
Percent of world consumption
2000 2009
50

40

30

20

10

Copper Aluminum Nickel Zinc Lead

46

Commodity/Resources
BRIC set to overtake US oil consumption
30
Percent of world consumption

BRIC US
25

20

15

10

5
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

47

24
 Commodity/Resources
All commodities exhibit long cycles …*
700
650
600 Shortest cycle – 16 years
Real Copper Price
550
2009 cents/lb
500
450
400
350
300
250
200
150
100 10-year MA

50
1850 1875 1900 1925 1950 1975 2000

*despite reversals, which are common in all cycles

48

Commodity/Resources
Including gold – which has had no reversal to date
1600

1400
Shortest bull-cycle – 10 years
1200

1000
Several years
800 of “counter-
Real Gold Price - 2009$/oz trend”
developments
600

400

10-year MA
200

0
1800 1825 1850 1875 1900 1925 1950 1975 2000

49

25
 Commodity/Resources
In short, the demand side of market has exploded

1. Commodity prices have been driven higher by

fundamental structural changes in the global
economy
2. Which suggests that the long-cycle is intact and
will continue for many years
3. Some short-term price weakness is of course
possible as China’s economic growth decelerates
to more normal and sustainable levels (8%-9%)
and demand in OECD remains subdued.

50

Last Thought
Boomers create asset bubbles …

Boomers have rotated through three assets:

Equities – Saving, Pension Assets
This asset bubble exploded in 2000-2001
Real Estate – Family Home, Recreational Property
This asset bubble exploded in 2007-2008
Debt Instruments – Retirement Income
This asset bubble exploded in 2011-2012 ??
After debt?
Resources and Gold – the emerging asset class?

51

26
Thank you for your attention

27