The Denver Gold Forum 2008

Gold – Has it run into trouble?

Dr. Martin Murenbeeld
September 9, 2008
 The work of economists requires accuracy and
good judgment!

1
 Last Year’s Forecast at this Breakfast:
(Aug-Sep ‘07 average: $689!)

Gold Price Scenarios

2007-avg 2007-end 2008-avg

Scenario A: p.=.10% $661 $630 $587

Scenario B: p.=.60% $679 $736 $790
Scenario C: p.=.30% $698 $832 $968
___________________________________________
Probability-Weighted: $683 $754 $823
Actual: $695 $836 $???
(Jan-Aug 2008 average: $906)
2
 What Happened?
Our forecast was not aggressive enough …

1. While we anticipated some monetary

easing: “The US housing sector could force
monetary easing in the near term …”
2. … we did not anticipate the full-blown credit
market crisis around the world.
3. Our forecast looked spot-on … before
central banks started pumping liquidity into
the system …
4. … But that’s why we use “Scenarios” when
we forecast!

3
 Overview
Gold reacted sharply to the crisis …
Freddie Mac
1100 Bear Stearns
Fannie Mae

1000 R2=.98
Credit crisis begins:
900 ECB pumps €95bn into
eurozone banking system
800

700
2)
600 nd(
e
Uptr
c $638
Cyclical si
500 Ba
Turning Point (1)
c Up trend
Basi
400

300
Friday data
Last date: September 5, 2008
200
01 02 03 04 05 06 Last
07 date: March
08 23, 2007

4
 Overview
… but has since returned to its basic uptrend!
1050
Bear Stearns
1000
May 12,’06 high not exceeded until Sep 19,’07 Freddie Mac
950 That’s 16 months!!! Fannie Mae
900
850
800
750
700 200-day
moving
650
50-day average
600 moving
) average
550
end (2
r
500 ic Upt
Bas
450
400 Daily p.m. fix
Last date: September 5, 2008
350
05 06 07 08

5
 Overview:
Remember, gold always “corrects” in its long cycle
1600

1400
Shortest bull-cycle – 10 years
1200

1000
Several years
800 of “counter-
trend”
developments
600 Real Gold Price - 2007$/oz

400

10-year MA
200

0
1800 1825 1850 1875 1900 1925 1950 1975 2000

6
 Our Eight Bullish Arguments:

1. Monetary reflation is on the short-medium-long term

horizon
2. The dollar must decline against Asian, OPEC,
Russian currencies
3. Excessive dollar reserves are part of the global
financial problem – diversification is likely
4. Gold remains “cheap” on a relative basis
5. Gold supply remains constrained
6. Gold investment demand is in a long-run uptrend and
physical demand responds when prices drop
7. Commodity cycles last many years
8. The geopolitical/financial environment favors gold

7
 (1) Monetary Reflation
Monetary reflation is the key for gold

There are only three ways to “stimulate” an

economy:
1. Ease monetary policy – cut interest rates –
print more money
2. Increase government spending – enlarge
the budget deficit – cut taxes
3. Devalue the currency – boost exports –
dampen imports

Thereafter tariffs and trade wars …!

8
 (1) Monetary Reflation
US rates are low, foreign rates will follow
4

1 US real short term

interest rate
0

-1

When below zero

-2
very positive for gold
-3
When above 2%
-4
not positive for gold

Last month: August 2008

-5
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08

9
 (1) Monetary Reflation
US economy is in “recession”
700
600 US Job Creation
3-month MA – 000’s
500

400
300
200

100
0
-100

-200
Mid-Cycle Slowdown Recession?
-300
US recession
-400
Last month: July 2008
-500
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08

10
 (1) Monetary Reflation
The US housing sector is a disaster
2700 1500
US recessions new home sales (000’s)
2500 1350

2300 1200

2100 1050

1900 900

1700 750

1500 600

1300 450

1100 300

900 150
housing starts (000’s) Last month: July 2008
700 0
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08

11
 (1) Monetary Reflation
But house prices abroad also high …
200
HOUSE PRICE-TO-RENT RATIO
180 Long Term average = 100

160

140

120

100

80

60

40
US JP Can UK GE FR IT Spain Switz
Source: OECD Economic Outlook – June 2008

12
 (1) Monetary Reflation
Debt has risen sharply in US (and the world)
230 Last quarter: 15.0
Debt 2008-Q1
Savings 2008-Q2
220 Savings Rate 13.5
% of PDI
210 12.0

200 10.5

190 9.0

180 7.5

170 6.0

160 4.5
Total Outstanding
150
U.S. Domestic Debt 3.0
% of GDP

140 1.5

130 0.0
Last quarter: 2007-Q4
120 -1.5
52 56 60 64 68 72 76 80 84 88 92 96 00 04 08

13
 (1) Monetary Reflation
Baby-boomer entitlements will stress budgets

The US Congressional
Budget Office estimates
that federal government
spending as a % of GDP
will rise beyond 30% in
coming years on the
back of entitlement
programs.

But it isn’t only the US

that will see rising
entitlement payments!

Source: WSJ, April 3, 2008

14
 (1) Monetary Reflation
US deficits are already rising dramatically …
400 4
US recession
Budget deficit
200 (billion $)
2

0 0

-200 -2

-400 -4

-600 What will F&F do -6

to the deficit?
And will the Fed
-800 Budget deficit -8
(percent of GDP)
buy debt?
Last quarter: 2008-Q2
-1000 -10
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08

15
 (1) Monetary Reflation
… and choices for debt reduction are limited

Government Choices:
Renege on promises
Cut other services
Raise taxes
Print more money

16
 (1) Monetary Reflation
Do we really mean “print more money”?

Print more money:

If the Fed can monetize Bear Stearns securities to prevent a "crisis," what
is to prevent it from monetizing the U.S. Treasury's outstanding debt — as
it is doing constantly on a small scale anyway – when Social Security and
Medicare costs overwhelm the federal budget? The Fed has always —
ALWAYS — been subservient to the Treasury. So when some future
Executive with his agreeable Congress must fund burgeoning Social
Security payments, and pressures the Fed to keep interest rates "low" so
that the Treasury can market new securities to pay Social Security
benefits, what will a pliant FOMC reply if it has the precedent of Bear
Stearns in 2008? Will it say, "No, Mr. President; we cannot buy any more
securities right now. That would cause inflation, and violate our pledge to
keep the dollar stable?"

CATO Institute: “The Imperial Fed: Does it Have Enough Power?”

April 14, 2008

17
 (1) Monetary Reflation
Global liquidity drives gold
60 42

48 35
Global Liquidity yoy%
36 28
correlation =.57
24 21

12 14

0 7

-12 0

-24 -7
Gold yoy% Gold:
Latest month:
Aug 2008
Liquidity: Jun 2008
-36 -14
82 85 88 91 94 97 00 03 06
Global Liquidity: FX Reserves + US MBase
Source: IMF, Federal Reserve

18
 (2) US Dollar
The Dollar peaked in 2002 … and bottomed in 2008?
120
Dollar Index: Euro, Yen,
January 25, 2002
115 Pound, CDN Dollar 2
(Jan 1999=100) R =.98
110

105

100

95

90
$638

85

80

75
Friday data March 14, 2008
Last date: August 29, 2008
“Bear Stearns”
70
96 97 98 99 00 01 02 03 04 05 Last06
date: March
07 23,
082007

19
 (2) US Dollar
Gold moves inversely with the Dollar/Euro …
1.60 1060
R2=.98
1.57 1020
The US Dollar in Euros
1.54 980
1.51 940
1.48 900
1.45 860
Correlation
1.42 820
Correlation 2007: .94
1.39 780
2006: .75 $638
1.36 740
1.33 Correlation 700
2008: .50
1.30 660
1.27 Gold 620
1.24 580
1.21 Daily 2007
data 540
Last date: March 23,
Last date: September 2, 2008
1.18 500
2006 2007 2008

20
 (2) US Dollar
But it is time to shift our Dollar frame-of-reference …
120
Dollar Index: Euro, Yen,
January 25, 2002
115 Pound, CDN, Aus, 2
Rupee, Yuan, SF R =.98
110 (Jan 1999=100)

105

100

95

90 Euro + CDN = 51% $638

Yuan + Yen = 37%
85
March 14, 2008
80 “Bear Stearns”

75
Friday data
Last date: August 29, 2008
70
96 97 98 99 00 01 02 03 04 05 Last
06date:07
March 08
23, 2007

21
 (2) US Dollar
US trade deficit with China is unsustainable
2 20
Last month: June 2008
0 0
-2 -20
-4
US Trade Balance - China -40
monthly total
-6 -60
-8 -80
-10 -100
-12 -120
12-month total
-14 Billion$ -140
-16 -160
-18 -180
-20 -200
-22 -220
-24 -240
-26 -260
-28 -280
96 97 98 99 00 01 02 03 04 05 06 07 08
 (2) US Dollar
The RMB and Asian currencies need to rise
2 2000

3
FX reserves 1750
April 2008: $1.76 trn
4 1500
The Chinese RMB was devalued
at year-end 1993 by 34%!
5 1250

6 1000
RMB/US$
7 750

8 500

9 250

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
Source: IMF

23
 (2) US Dollar
The Peterson Inst. For Intl. Econ. estimates how much:

Country Current* Estimate** Change

currency/$ currency/$ %

China 6.850 5.450 25.7%

India 43.88 37.10 18.3%
Japan 108.8 90.10 20.8%
Malaysia 3.393 2.470 59.2%
Canada 106.2 102.0 4.9%
Euro*** 1.467 147.0 0.2%
Russia 24.65 23.50 4.9%
S Arabia 3.751 3.410 10.0%
* Aug 29,08
** July 2008
24
*** Inverse rate
 (3) US Dollar Reserves
Foreign exchange reserves have exploded
84 7.0

Global FX Reserves Global FX Reserves

72 Trillion$ 6.0
% change yoy

60 5.0

48 65-70% of FX 4.0
Reserves are in
36 US$!! 3.0

24 2.0

12 1.0

0 0.0

-12 -1.0
69 73 77 81 85 89 93 97 01 05

Source: IMF

25
 (3) US Dollar Reserves
18 countries hold a collective $6.0 trillion

Foreign Exchange Reserves

(countries over $50 bn)
bn$ bn$
China 1779.1 Algeria 133.2
Japan 973.8 Malaysia 124.4
OPEC 527.0 Thailand 103.0
Russia 554.1 Mexico 93.0
India 302.3 Libya 88.6
Taiwan 291.4 Poland 79.2
Korea 257.7 Turkey 75.5
Brazil 199.8 Indonesia 55.1
Singapore 176.7
Hong Kong 158.9 Total 5973.0
Source: IMF - IFS June ‘08

26
 (3) US Dollar Reserves
OPEC’s current account balance rising again
700 350

600 280

Gold
500 $/oz 210

400 140

300 70

200 0

100 -70
OPEC Current Account Balance
$bn
0 -140
69 74 79 84 89 94 99 04

27
 (4) Gold is “cheap”
Gold cheap in constant Dollars
1750
Last date: 2008-Q2
Gold peak of
$850 translates
1500 into $2300 in
today’s money!
Gold: Real Average price $602
1250 (2008-Q2$)

1000

750

500

250

Gold: Nominal average price $334

0
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 08 08 08 08

28
 (4) Gold is “cheap”
Gold is near an all-time low in terms of oil
49
Maximum 44.47 Last quarter: 2008-Q2

42
Barrels of oil per ounce of gold
35
1 St. Dev. (7.06) Average 16.78
28

21

14

1 St. Dev. (-7.06) Minimum 6.95

0
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08

29
 (4) Gold is “cheap”
Gold “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

gold =
$6275 with
0 1275 S&P
1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
With gold =
$800 then
S&P = 162

30
 (5) Supply
Model suggests WW mine output decline
2450

2100
Actual Western
World Mine
Output (Tonnes)
1750
Source: GFMS

1400
Model Estimate

1050 The Mine Production Model is based on

lagged gold prices and lagged production

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

31
 (5) Supply
“Loose” Central Bank gold is benign

tonnes
WORLD TOTAL 29770.2
ƒ Loose gold totals Subject to CBGA 12471.3
Unlikely to Sell 10319.4
about 4000 tonnes
US 8133.5
ƒ Some have sold Japan 765.1
China ing! 600.0
gold in the past a i s b uy
Russia Russi 463.1
ƒ But now want India 357.7
Official Institutions 3343.2
more gold again,
IMF 3217.0
i.e. Argentina BIS 126.2
LEFT OVER 3636.4
Source IMF - Jun '08

32
 (6) Demand
Consumer demand solid through 2007
Billion US$
Jewelry plus Net Retail Investment Demand
7 8
US - $bn China - $bn
Recession
6 7

6
5
5
4
4
3
3
2
2
1 1

0 0
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

70 18

60
World - $bn India - $bn
15
50
12
40
9
30

20 6

10 3

0 0
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Source: World Gold Council, GFMS

33
 (6) Demand
Investment demand is stimulated by the ETF’s

1000
Last date: August 28/08 80 tonne decline
• Gold demand is also 900
stimulated by market 800
deregulation and 700 GOLD TONNAGE - ETF
improvements in 600
distribution of gold 500
products … 400
30 tonne decline
300
• … and gold demand 200
benefits from the
100
shift to commodities
0
as “an asset class” 2003 2004 2005 2006 2007 2008

34
 (6) Demand
Investment demand has a long way to grow!
70
Global financial assets Managed assets
60 total $ 123 trillion $ 55 trillion

50

40

30
Managed
commodities
$ 250 billion
20

10

0
Equities Private Debt Government Managed Managed
Debt Assets Commodities
Source: McKinsey & Company, IMF, Barclays

35
 (7) Commodity Cycle
The shortest copper cycle lasted 16 years
600

550
Shortest cycle – 16 years
500
Real Copper Price
450 2005 cents/lb

400

350

300 10-year MA
250

200

150

100

50
1850 1875 1900 1925 1950 1975 2000

36
 (7) Commodity Cycle
The shortest wheat cycle is 13 years
40
Data affected by
Real Wheat Price Russian
35
2005$/bushel shortages

30

25

20

15

10

5 Shortest cycle – 13 years

10-year MA

0
1800 1825 1850 1875 1900 1925 1950 1975 2000

37
 (8) Geopolitical
Iran had an impact the last time around
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

38
 (8) Financial
Gold always rises when “financial system” at risk
525

500 Mexican
475 Debt Crisis
450

425 Penn Square

400
Collapse
375
about $180
350
(or 60%)
325
Gold Price: 1981-1983
300

275
Daily data
November 7, 1981 to December 30, 1983
250
02-Nov-81 09-Feb-82 14-May-82 17-Aug-82 17-Nov-82 23-Feb-83 31-May-83 31-Aug-83 30-Nov-83

39
 Bearish Arguments
Unfortunately … there are some strong ones:

1. The euro could decline further against the dollar

and $/euro correlation could remain high for
longer than we think
2. Recessions reduce demand for commodities,
reduce inflation pressures … and gold often
suffers
3. The rest of the world may not be “decoupled”,
weak growth in India and China could hurt gold
demand
4. US real interest rates will rise when the credit
crisis and recession ends
5. Dehedging will come to an end

40
 (1) Euro Turning Points
Will gold follow when the euro declines … or …?
1000 1.80
Euro in US dollars Gold not
(Reconstructed prior to 1999) correlated with
900 1.65
Euro

800 Gold 1.50

correlated
with Euro
700 1.35

600 1.20

500 1.05

400 0.90

300 0.75
Gold
Last month: August 2008
200 0.60
79 81 83 85 87 89 91 93 95 97 99 01 03 05 07

41
 (2) Recessions
Gold often declines on back of US recessions
1000
US Recession
900
Probable US
Recession
800

700

600

500

400

300

200 But gold didn’t decline

during the last
100 recession!
Last month: August 2008
0
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08

42
 (2) The World May Not “Decouple”
CRB index always declines during US recessions
500
US Recession
450

400

350

300

250

200

150
Reuters-Jeffries CRB Index Probable US
(19 commodities) Recession
100
Last month: August 2007
50
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08

43
 (3) Real Interest Rates
Real rates will rise again when the crises pass
4

1 US real short term

interest rate
0

-1
When below zero
-2
very positive for gold
-3
When above 2%
-4
not positive for gold

Last month: August 2008

-5
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08

44
 (4) Dehedging Will End
… and gold will lose this “demand” component
Hedging Dehedging
Year Net Year Net
1983 4 2000 -15
1984 38 2001 -151
1985 62 2002 -412
1986 45 2003 -289
1987 149 2004 -438 A simple calculation
1988 353 2005 -92
suggests that there
1989 178 2006 -410
1990 234 2007 -446 will only be about
1991 66 2008 -450 (e) 530 tonnes of gold
1992 135 left to be “dehedged”
1993 142
1994 105 ASSUMED
at the end of 2008!
1995 475
1996 142 2009 -300
1997 504 2010 -200
1998 97 2011 -32
1999 506
Total 3235 Total -3235
source: GFM S, M urenbeeld estimates

45
 The September 9th Forecast:
Bearish factors given more weight …

Gold Price Scenarios

2008-avg 2008-end 2009-avg

Scenario A: p.=.15% $860 $738 $686

Scenario B: p.=.40% $876 $820 $823
Scenario C: p.=.45% $897 $930 $1002
___________________________________________
Probability-Weighted: $883 $869 $883
(Jan-Aug 2008 average: $906)

46
 Gold has run into short-term trouble.

Over the next several years gold must

depend on “reflationary” policies. We think
such policies will be introduced to deal with
weak economic growth and “disinflation”.

The gold market will be volatile in the

meanwhile.

The long-run outlook remains positive!

THANK YOU
47