Financial analysis on money, gold and other precious metals

By Erwin Lubbers, BS (IT), MS (Finance)

Updated on Jan 6, 2013

SUMMARY!
Gold Price Regression Model
GOLD RESEARCHER shares my To predict the 2013 gold price, I use a general least insights on gold as an investment. squares regression model. The gold price is the function of I examine both the physical as the four factors, namely:
1. The quantity of money, captured as the combined electronically traded gold markets and monetary base of the US and Euro Zone in USD.
which factors drive the gold price. 2. Ination and opportunity cost, captured as the real interest rate.
Then the gold price is estimated for the 3. Currency factor, captured as the exchange rate of the end of 2013 and compared to USD against a basket of EUR, JPY, RMB and IRP.
4. Uncertainty in nancial markets, captured as the alternative investments, such as silver difference in value between BBB and AAA corporate and equity of gold producing companies.
bond indices.
Gold Performance

Although the gold price has been rising since the dotcom bubble burst in 2001, the current nancial crisis which started 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 speculators ed to the currency that was able to hold its value, namely gold. Today, gold is the 4th most traded currency.

2013 Gold Price Estimate

Different economic scenarios are assumed to make three gold price estimates. The most likely scenario to occur in 2013 is the continuation of monetary easing programs. And so, the 2013 gold price estimate is $1890 (+11.9%) under this scenario. According to a stagation 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 ination 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, ination rises and the USD appreciates under this scenario.

Demand from Emerging Markets

Nearly 60% of total consumer demand for gold comes from 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 foreign exchange holdings are diversifying their foreign currency holdings by adding gold to their portfolios.

Alternatives to Gold

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.

Supply Remains Tight

In 2011, global production was 2850 tonnes, or 1.6% of the total gold reserve. Even though Exploration and Production (E&P) budgets of gold mining companies have ballooned for some years, new discoveries have become increasingly 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 increase in the total gold reserve helps gold as currency to retain its value.

1!

LIST OF ABBREVIATIONS!
BoJ BS:

Bank of Japan


Balance Sheet
LTRO:
Long-term Renance Operations
MB: MBS:
Monetary Base

Mortgage Backed Securities

AGG:

iShares Total US Bond Market ETF
CME:

Chicago Mercantile Exchange
CPI:

Consumers Price Index
ECB: EM: ETF: EU: EUR: EZ: FED: FX:
European Central Bank


Emerging Markets

Exchange Traded Funds

European Union

Euro (currency)

Euro Zone

Federal Reserve Bank

Foreign Exchange

MRO:
Main Renance 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:
Peoples Bank of China
PLLT:
ETFS Physical Platinum Shares ETF
RMB:
Chinese Renminbi
RRR: SPY: US: VIX:
Reserve Requirements Ratio

iShares Silver trust ETF

State Street SPDR S&P500 ETF

United States

Volatility Index

ETN:
Exchange Traded Notes

FOMC:
Federal Open Market Committee
SLV: GDX:
Market vectors Gold Miners ETF
GLD:
SPDR Gold Trust ETF
HFT: IMF: INR: JPG: JPY:
High Frequency Trading

International Monetary Fund

Indian Rupee

Japanese Government Bonds

Japanese Yen

TARP:
Troubled Asset Relief Program
USD:
United States Dollar
ZIRP:
Zero Interest Rate Policy

LBMA:
London Bullion Market Association
LIBOR:
London Interbank Offered Rated

2!

GOLD HISTORY!

Chapter 1!

The massive golden funeral mask of Toetanchamon (1223 BC) contains almost 11Kg of gold.

I chronicle the history of gold for readers to gain an appreciation for gold investments.

3!

HOW GOLD BECAME MONEY!

For millenniums people have placed enormous trust in gold. Compared to other metals, its unique characteristics make it more suitable as a form of currency. It is a rare commodity and easy to press into coins. It neither tarnishes nor rusts. It has an identiable color and density. The history of gold, as a form of money, is interesting, but events after WWII are exceptionally insightful.
Ancient History

Gold has fascinated people since the beginning of recorded history. Golden artifacts 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.

Gold Standard

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 countries followed suit years later. Economies that had temporarily abandoned the gold standard during WWI suffered high ination 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.

Bretton Woods Period

The 1944 Bretton Woods agreement was the rst system proposed to govern monetary relations among independent nations. Under the agreement, the USD was fully backed by gold at a xed value of 1/35th Troy ounce. After WWII, the US emerged as the creditor of the world and the largest holder of gold. The USD became the worlds 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 to 1971, 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.

Fiat Currency

In 1971 Nixon defaulted on the US gold obligation and, subsequently, terminated the Bretton Woods agreement. The USD became a at currency, a currency backed by the future cash ow 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, deation would occur and in turn, economic hardship. And so, national and foreign investors accepted at money as a system of trading.

Gold Rushes

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 19th century captured the imagination of ordinary people. The supply of gold spread economic wealth to thousands of prospective gold miners and stimulated global trade and investment.

4!

THE NEW NORMAL!

After the collapse of the Bretton Woods To support the economy and the nancial system, central banks are increasingly intervening in the nancial markets. agreement, the USD was used as a Their intervention is either direct via monetary easing global reserve and asset to foreign programs and Zero Interest Rate Policy (ZIRP), or indirect via legislation and regulation. All asset classes are impacted national banks. To provide these USD, by the injection of massive liquidity from central banks. The the US had to run a permanent trade US and Europe have stalling economies and record amounts of debt. In spite of this, government bonds trade decit. The US print dollars to pay for at a record low yield and stock indices hover near record the excess of imported goods. Foreign highs. Central banks launch many programs that affect asset prices. Currently, the Federal Reserve Bank (FED) and the holders convert USD to US treasuries European Central Bank (ECB) have open-ended programs and issue local currency against those to buy debt in exchange for new money.
reserves. This method enables the US to The New Normal
export its ination. In 2012, the US debt The New Normal represents a paradigm shift in the nancial markets. It represents a state called nancial ballooned to $16T from a permanent repression, where money is transferred from creditors to ceiling of $400B that existed before debtors. This phenomenon is mainly achieved by negative real interest rates and debasement of a currency through 1975.
Trifn Dilemma

Trifn dilemma illustrates the main problem with the USD being the international reserve currency. The theory states that the US must run a trade decit in order to supply the world 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.
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 nancial 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 the US debt ceiling has been raised to only give temporarily relief. More political gridlock is expected with the approaching US scal cliff and pending Spanish bailout.

Central Bank Intervention

Risk On and Risk Off Phases

The rise of algorithm trading or High Frequency Trading (HFT) is another trend that increasingly threatens the stability 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 ee to the safety 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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KEY CONCEPTS!

Chapter 2!

Professor Larry Gopnik in the movie A Serious Man explains the basics.

Since gold is closely related to money, money supply, ination and interest rates,
I dene these concepts and introduce various measures for money.

6!

MONEY SUPPLY!
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 Measurements

The money supply measures the quantity of money. There is no single correct measurement for the money supply. The methods to calculate this differ, based on the function it 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, which forms 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.
A range of monetary aggregates, stated as M0 to M3, are employed in the measurement of the money supply. The exact details for the Ms 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 nancial 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.

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 worlds gold coins.

7!

INFLATION!
Consumers Price Index
Ination is the rise of prices during a Consumers Price Index (CPI) is an important period of time. It is a key driver in both measurement of ination. It is the price of a basket of consumer goods and services paid for by the average US the value of money and the gold price, urban consumer. As of Oct 2012, the level was 231, which Thus, ination needs to be understood indicates130% ination since Oct 1983.
in greater detail. Much like measuring CPI understates medical and educational expenses and excludes assets that usually cause bubbles, such as housing the money supply, there is neither a and stock prices. The Core CPI, on the other hand, single denition nor a cause of ination.
excludes food and energy which are volatile items. Ination

Ination is the rise in the general level of prices within an economy. The value of money decrease with ination and so does the purchasing power of consumers. In effect, consumers need more money to buy the same goods and services. Most economists agree a low ination rate is benecial for the economy. A rate at or below 2.00% encourages consumers to spend money but not to lose faith in the currency.
Therefore, it accepted as a more stable measurement for ination.

Hyperination

Hyperination is the exponential and perceptibly unstoppable rise in the general level of prices within an economy. While prices in foreign currencies stay relative stable, the local currency quickly loses value during hyperination. Argentina, Zimbabwe and Iran have recently experienced hyperination. Their central banks created a massive money supply and, in turn, the broad public lost faith in their currency.

CPI tracks the price change of a basket of consumer goods.

Deation

Deation is the decrease in the general level of prices within an economy. It increases the value of money over time. 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, deation is sometimes caused by rapid advancements in technology and can coexist with growth, like it did in US during the 19th century. Highly indebted governments use monetary policies to avoid deation.

8!

CAUSES OF INFLATION!
There is no single cause for ination. According to Keynes, Friedman and von Mises, the causes are demand-pull, and cost-push, growth in money supply and monetary expansion.
Keynesian Ination View

Named after the economist John Maynard Keynes (1883-1946), the Keynesian view on ination states that changes in the money supply do not directly affect pricing. Ination is caused by either Demand-Pull ination, which is identied as increased demand due to higher spending, or Cost-Push ination, which is characterized by too little supply to meet demand.

Austrian Ination View

The Austrian view started in Vienna with the likes of economists such as Ludwig von Mises (1881-1973). This view goes a step further than the monetarist ination view in that it states that ination 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 nd the CPI misleading.

Ludwig von Mises

John Maynard Keynes

Monetarist Ination View

The monetarist view, supported by the likes of Milton Friedman (1912-2006), states that the growth in the money supply drives ination. Monetarists use empirical evidence to show that throughout history ination was always a monetary phenomenon.
The monetarist view states the quantity of money multiplied by velocity of money is equal to the price level multiplied by the index real values of expenditures.

Monetary Policies regarding Ination

The primary tool that central banks use to control or cause ination is instituting monetary policies. The ECB has a single mandate: price stability, which is stated as an ination rate at or just under 2.00% averaged throughout the EZ. The FED has a dual mandate of stabilizing prices and maximizing employment. Like the ECB, the FED targets an ination rate at 2.00%.
Why is 2.00% ination seen as ideal? The FED claims higher ination reduces the publics ability to make long-term nancial decisions and a lower rate could lead to deation.

Milton Friedman

9!

INTEREST RATES!
Interest Rates

The interest rate is a percentage of the principle loan, paid for compensation of ination and risks. It is usually quoted on an annual basis. Its equation can be calculated as:
Interest rate = Risk free rate + default risk + liquidity premium + maturity premium
Interest rates are a crucial part of a central banks monetary policies. By setting a low or even zero interest rate policy (ZIRP), central banks aim to stimulate investment and economic growth. However, when interest rates are kept too low and for too long, nancial bubbles can occur, usually in the stock, housing and commodity markets.

London Interbank Offered Rate

London 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 nancial 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 Rates

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.

Real Interest Rates

Real interest rates are the nominal interest rates adjusted for ination. Real interest rates can be calculated with the Fisher equation:
Real interest rate = (1+ nominal interest / 1+ ination) -1
At present most developed countries have a negative real interest rate, meaning ination is higher than the interest rate. A negative real interest rate reverses moneys role as a store of value. In essence, it destroys the real value of xed income and discourages saving.

Prime and Mortgage 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 Rates

The US Federal Open Market Committee (FOMC) sets the 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.

Table 1. US Interest rates at Dec 5, 2012

Federal fund rate target
Federal fund effective rate
Discount rate
Prime rate
30Y Bond rate
30Y Fixed mortgage rate
0.25%
0.17%
0.75%
3.25%
2.76%
3.38%

10!

US GOVERNMENT DEBT!
US Public Debt

US public debt is money borrowed by the US national, state and local governments to nance its decit, or the difference between government spending and income generated through taxes. The US debt clock indicates that the US government debt stands around $16.42T on Dec 31, 2012. This gure 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. Treasury Bills, also known as TBills, 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 largest unfunded liabilities. These unfunded obligations do not appear on any balance sheet and are not integrated in any ofcial debt gures. The expenditures of these programs are expected to rise faster than any other government program due to the countrys growing senior population. The Wall Street Journal estimates 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 nancial 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.

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 nancial markets, politicians were forced to make a compromise. They raised the debt ceiling to $16.4T.
To control the growing decit, the US government also prepared a set of tax increases and spending cuts, which is now known as the 2012 scal 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.

Zero Interest Rate Policy

As of Dec 2008, the US instituted its Zero Interest Rate Policy (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 (ve 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 issued US 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 signicantly, it is likely the FED will remain the largest buyer of US debt. With $85B per month, the FED will buy a signicant percentage of all new US government debt in 2013.

US Government Decit

As of 2007, the annual budget decit of the US was $161B. Every year since 2008, the US has had an annual decit exceeding $1T. The 2011 decit 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 tax revenue, the US is expected to run a large decit in the foreseeable future.

Debt Ceiling

In order to limit the amount debt which the department of 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 squabble with each other than reach a solution.

Squabbling politicians during the 2011 debt ceiling crisis.

11!

EURO ZONE GOVERNMENT DEBT! Sources of Funding

Euro Zone Debt
Alternative
The 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 decit was 4.1% of GDP in 2011.
The Euro Stat agency compiles a report using each EZ countrys statistics on government debt. Not only are these gures not audited, but the methods in which they are collected and their report dates vary.
Some of the peripheral countries that run a large decit avoid asking for ofcial help from the OMT program. Because ofcial help would lead to nancial 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 in reserves 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 nancial 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 ECBs OMT program and therefore ECBs 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. Whats more, the US debt is growing even faster than that of the EZ.

EZ Integration 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 with low interest rates and are threatened by higher ination 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 faith in the periphiral countries, especially due to the selective default on Greek bonds. Virtually no investors in the open markets buy peripheral debt, forcing the Southern EZ countries to depend on the ECB for help.

Graph 1. Debt to GDP ratio of the US and Euro Zone

110%
100%
90%
80%
70%
60%
50%
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
US Debt/GDP
EZ Debt/GDP

12!

JAPAN GOVERNMENT DEBT!

Japanese Stock and Housing Bubble

A massive bubble in the Japanese stock and housing markets peaked in1989. The Japanese government raised interest rates which caused the bubble to burst and stock and housing prices to collapse. The government stepped in to rescue banks and to stimulate the economy with a large amount of newly printed JPY. The debt to GDP ratio rose above 100% in 1997. It has since reached 230% in 2011.
To compare Japans debt to GDP ratio with other large economies, refer to Table 2.

Japanese Debt

Japan has a large and growing senior population. Its national debt is gigantic. Its economy is stagnant. To stimulate the economy, Japans 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 reported even a moderate rise in yields would leave the scal position extremely vulnerable. Therefore, Japan cannot raise its interest rates without destroying its government nances 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% ination target and outright monetizing of government debt on the once independent BoJ.

Table 2: Debt to GDP ratio of the largest economies in 2011

Japan
US
EZ
Canada
UK
India
Brazil
China
Australia
Russia
230%
99%
86%
85%
83%
68%
66%
26%
23%
10%

Japan the land of the rising debt.

13!

FUTURE DEBT ISSUANCE !

EZ Debt Issuance

In all probability, the ECB will buy signicantly less debt than 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.
1.
The combination of rising entitlement spending, an aging population and a shrinking workforce
2.
A ballooning public sector which takes more than 50% ofthe 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 low. Once all alternative sources of funding have been exhausted, only the ECB will be left to buy the debt. Japan is a shining example of how this scenario will appear in the future.

US Debt Issuance

The nancial crises of 2008 exposed the aws 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 decit 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 Japans situation.
The FED is the buyer of last resort. With its QE3 and QE4 programs, the FED currently buys at an annual rate of $1T of debt. As long as the budget decit remains high, the FED must purchase debt to keep the government nances 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.

Japan Like Scenario

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 decit 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 be sold in the open market at current low rates
The bailout of all nancial institutions and large companies, which creates a zombieed system

Tab

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.

14!

CENTRAL BANKS!

Chapter 3!

Ben Bernanke is the chairman of the US Federal Reserve Board.

Mario Draghi is the president of the ECB.

Zhou Xiaochuan, the governor of the PBOC, will soon be replaced.

A decade ago, high ying CEOs and hedge fund managers were the superstars of the nancial world. In the present day, the period in which the New Normal reigns, leaders of central banks call the shots in the nancial world. Traders and investors listen carefully to these key player since their actions drive the gold price. I explain central bank policies and their inuence on the money supply and interest rates in Chapter 3.
15!

FEDERAL RESERVE SYSTEM!

The Federal Reserve System, informally known as the FED, is the central bank of the US. It uses several programs to control the money supply and the interest rate.
FED Mandate

The FED has a dual mandate of maximizing employment and stabilizing prices. Its ination 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 nancial crises, many of the FEDs decisions seem politically inuenced.

Federal Open Market Committee

The Federal Open Market Committee (FOMC) is the FEDs principal monetary policy body. It sets the monetary policies of the FED. More specically, it makes key decisions about interest rates and the growth of the US monetary base.

Open Market Operations

Open Market Operation (OMO) is the buying and selling of government bonds on the open market to inuence 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 these assets, 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.

FED Structure

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 in 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.

Zero Interest Rate Policy

By the end of 2008, the FED lowered the Federal Funds Target Rate from 5.25% to near zero. By doing so, ZIRP aims to encourage investments and to allow consumers to nance 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 nance 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 discontinue ZIRP when the unemployment rate is below 6.5% or ination above 2.5%.

The Federal Reserve headquarters in Washington D.C.

16!

FED MONETARY policies! FED monetary POLICIES!

Quantitative Easing

When the FED wants to stimulate the economy, they lower interest rates to stimulate demand for credit and investment. When the economy does not recover and interest rates are at zero, the FED can expand the MB in hopes that this money nds it way to the real economy and expands the money supply. But unlike Chinas central bank, the FED cannot force banks to make new loans.
The FED announced the rst 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, followed quickly by QE4 in 2013. QE programs target the wealth effect. They aim to boost stock prices, thus spurring the public to spend more money if it feels wealthier. Analogous to the OMO, QE creates new money on the FEDs balance sheet and buys assets, like government bonds and MBS, in the open market. In turn, the reserve accounts of commercial banks grow so they can invest or loan 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 ofcially announced, the gold price could have already risen to a large extent. Therefore, investors search for clues in the FED statement and economic indicators before any such announcements.

Operation Twist

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 FEDs balance sheet and has limited inuence 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 FEDs balance sheet and the MB did not increase.

QE3

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 FEDs balance sheet and MB. Throughout 2012, QE3 will expand the FEDs balance sheet increased by $40B per month.

QE4

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.

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 nancial institutions to strengthen its nancial sector. It was originally authorized to buy $700B but only $431B was actually used.

Evans Rule

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 specically, changes or termination of monetary policies such as QE3, QE4 and ZIRP can be made if the unemployment rate falls below 6.5% or ination rises above 2.5%.

QE1 and QE2

The goals of QE1 and QE2 differ from OMO. QE1 was primarily aimed to unfreeze the crashed nancial markets in 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 increased by 36% during Q1 and by 21% during QE2.

17!

MONETARY POLICIES IMPACT ON 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 ination remain modest?
Low Ination

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 ination. Hence, it is important to investigate 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 ination is that the CPI measurement underestimates medical and educational cost. Along with energy and food, these costs have seen the 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 ination.

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 nd its way into the real economy and does not contribute to ination. 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 signicant relationship or a good t with the gold price. Thus, I included MB as one of the factors in the regression model to estimate future gold prices.

Chart 1. Scaled US monetary base, currency in circulation, money supply M1 and M2 and FED balance sheet

350%
300%
250%
200%
150%
100%
50%
0%
Jul-07
MB
Curr
M1
M2
FED BS

Jan-08

Jul-08

Jan-09

Jul-09

Jan-10

Jul-10

Jan-11

Jul-11

Jan-12

Jul-12

Jan-13

Source: Federal Reserve Economic Data tool (FRED)

18!

FED GOLD RESERVE!

US Gold Reserve

The 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 FEDs foreign currency holdings. It appears that the FED has no intentions of buying or selling any gold in the foreseeable future.
4,578 tonnes of the reserve is stored in the US Bullion Depository of Fort Knox, Kentucky. Around 7,000 tonnes is 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).
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 lms and terrorist plots.
2011 US Foreign currency holding
FX (25%)
$134B

Gold (75%)
$403B

19!

EUROPEAN CENTRAL BANK!

The European Central Bank (ECB) is an institution of the European Union. The ECB uses several programs to control the money supply and the interest rate.
ECB Mandate

The ECB has a single mandate. It manages the Euro to safeguard price stability. The ECB targets an average ination 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 target. 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.

ECB Headquarters in Frankfurt, Germany

ECB Structure

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 the national central banks of the EZ member states. The Executive Board oversees the day-to-day management of the ECB. The current ECB president, Mario Draghi, is also president of the Executive board.

Long-term Renance Operations

The ECB uses Long-Term Renance 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 ECBs LTRO differs from the FEDs 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.

ECB Governing Council

The ECB Governing Council denes EZ monetary policies and sets interest rates for which it loans money to EZ commercial banks. It also helps prepare new countries joining the Euro.

Main Renance Operations

The ECB provides the bulk of the liquidity in the EZ through short-term repo-contracts in its Main Renance 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. If their amount increases then the liquidity in the EZ increases. Banks must provide collateral for the loans, with EZ government debt being the preferred collateral.

20!

ECB MONETARY POLICIES!

Outright Monetary Transactions

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 troubled EZ countries. A country must ofcially request the ECB for assistance and undergo the nancial scrutiny of the ECB, EU and IMF combined, as known as the Troika. Spain is widely expected to be the rst 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 three years is monetized. ECB interest rate policies cannot otherwise affect peripheral countries because the market has a greater inuence on rates.

Indirect Debt Monetization

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 prots 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.

Table 3. ECB rates on Dec 5, 2012

Deposit rate
MRO or benchmark rate
LTRO rate
Marginal lending rate
0.00%
0.75%
1.00%
1.50%

21!

MONETARY POLICIES IMPACT ON ECB BALANCE SHEET!

In 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 Europes situation similar to the US?
While the MB grew in the post Lehman period in order to provide liquidity to the nancial 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 ination. Then why does the gold price have such close relationship with the balance sheet of central banks and the monetary base?

Euro 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 nd its way into the real economy and, thus it does not contribute to ination. 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 most of 2012.
There are several reasons why commercial banks prefer to keep money in their reserve accounts. Additional and stricter regulation since the nancial crisis has been set on the nancial 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 nancial reserve. Also, consumer credit and mortgage demand remains weak throughout the EZ. Demand for corporate loans is also weak since corporations are sitting on an increasingly large cash pile and prefer to delay investments due to the economic and political uncertainty.

Ination Threat

Since investing is about predicting to the future, gold investors must be more worried about the threat of ination, rather than actual ination. 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 ination will be much higher than the current reading of 2.0% or 2.5%. In addition, it may be difcult 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.

Chart 2. Scaled Euro Zone monetary base, currency in circulation(M0) and money supply M1 and M2

300%
250%
200%
150%
100%
50%
0%
Jul-07
Currency
MB
M1
M2
ECB Balance Sheet

Jan-08

Jul-08

Jan-09

Jul-09

Jan-10

Jul-10

Jan-11

Jul-11

Jan-12

Jul-12

Jan-13

Source. ECB statistical data warehouse

22!

EURO ZONE GOLD RESERVE!

Euro Zone Gold Reserve

In 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.

2011 combined FX holding of 5 largest Euro zone countries

(Ge, Fr, It, Sp, Nl)

FX (32%)
$215B

The ECB Governing Council at meeting in Frankfurt.

Gold (68%)
$454B

23!

MONETARY EASING & MONEY Monetary easing programs are SUPPLY!price, monetary base and balance sheets of massive Table 4. Gold
liquidity (or capital) injections to nancial systems. The concept is a euphemism for money printing and is linked to central banks, balance sheets, monetary base, money supply and ination.


The FED and the ECB along with the central banks of England, Japan, China and Switzerland have made use of these programs since 2008. QE, LTRO and economic stimulus packages are examples.
the US and Europe

Gold ($)
FED (B$)
US MB (B$)
ECB (B)
EZ MB (B)

Jul-07
661
874
852
1,195
836

Dec-12
1,689
2,903
2,650
3,022
1,630

Increase
155.64%
232.07%
211.02%
152.87%
95.01%

Monetary Easing

A central bank creates new money with which it buys nancial assets such as bonds or MBS in the open markets. These assets are put on the asset side of the central banks balance sheet. In turn, the money paid for these assets is deposited in the reserve accounts of commercial banks. Reserve accounts are a part of the MB. And so, they are a liability 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 centrals 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.

Chart 3. US and EZ Monetary base and Balance Sheets in USD on left scale and gold price on right scale

7,000
EZ+US MB (B$)
6,000
5,000
4,000
3,000
2,000
1,000
0
Jul-07
EZ+US BS (B$)
Gold Price
2,000
1,800
1,600
1,400
1,200
1,000
800
600
400
200
Jan-08
Jul-08
Jan-09
Jul-09
Jan-10
Jul-10
Jan-11
Jul-11
Jan-12
Jul-12
0
Jan-13

Source: FED and ECB websites

24!

PEOPLES BANK OF CHINA! Gold Reserve!

China is the most cash rich country in the world as well as the second largest global economy. Its central bank, the Peoples 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.

PBOC Structure

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.

Interest Rates

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.

Open Market Operations

Comparable other central banks, the PBOC can buy or sell assets or reverse repo to regulate liquidity in the nancial system.

PBOC Mandate

The PBOC has a dual mandate. It is decreed to promote economic growth and to keep ination low. It sets monetary policies and regulates banks in mainland China.

Reserve Requirements Ratio

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 ow of USD in the Chinese nancial system. To keep the RMB pegged to the USD, the PBOC increased both the money supply and the RRR. These measures kept the RMB from rising against the USD and enabled the Chinese to export cheap goods.

Loan Targets

The Peoples Bank of China in Beijing

Ination Target

30% of the Chinese CPI consists of food, compared to 8% for the US. Rising food prices are a sensitive subject among Chinas poor. The PBOC monitors food prices closely to determine if monetary expansion is viable. Since the PBOC is 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 ination rate. Historically, its ination rate averaged 4.23% from 1994 until 2012. As of Nov 2012, the ination rate in China was 2.0% from a high of 6.5% in July 2011.

China is a majority shareholder of its ve 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.

25!

PBOC MONETARY POLICIES!

Chinese Stimulus Program

On Nov 9, 2008 the Chinese government launched a 4T RMB ($586B) stimulus package to help its economy during the period of the nancial crisis. Most of the stimulus was invested in infrastructure and social projects. The outcome can lead to a rise in ination because these investments were 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.

Chinas Monetary Base

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, Chinas trade surplus is valued at $27.7B, a drop from its Dec 2008 record of 40.09B$.
Even so, there is an outow of money from private individuals trying to escape government control and articially low rates on deposits. The Wall Street Journal estimated this outow at $225B in the 12 months ending in Sep 2012. This massive outow weakens demand for the RMB and removes the need for foreign exchange intervention. If China would run a trade decit, 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 ination 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.

RMB Peg to USD

To promote its export industry, the Chinese government keeps its currency pegged to the USD and other currencies. The PBOC announces xed exchange rates daily and the market price can only deviate up to 1% from this 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 ination in check and prevent this new money from entering the real economy.

PBOC Balance Sheet

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 Peoples bank of China

26!

PBOC GOLD RESERVE! Gold Reserve!

Since the balance sheet expansion of the PBOC has come to a halt, it is more meaningful to investigate Chinas gold reserve instead of its monetary policies.
Chinas Gold Reserve Mystery

In April 2009 the PBOC last reported its gold reserve at 1054 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 ve years and perhaps 10,000 tons in eight to 10 years.
Until these targets are met, any report on the ofcial Chinese gold reserve is not likely to be released, out of fear of rising gold prices. China needs to add to its gold reserves to ensure national economic and nancial safety, promote Yuan globalization and as a hedge against foreignreserve risks, according to Gao Wei, an Chinese ofcial from the Department of International Economic Affairs of Ministry of Foreign Affairs.
China is the world largest gold producer. It produced 380 tonnes 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 to 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 gure surpassed coal to become Australia's second 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 the worlds reserve currency. Gold purchases come at the expense of buying US treasuries and EZ debt, as predicted in Trifn dilemma.

Estimating 2012 Gold Imports

According 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.

Apr 2009 PBOC Foreign currency holding

Gold $30B
(1.52%)

FX holding
$1950B

PBOC Future Reserve

The 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.

2015est PBOC Foreign currency holding

Gold $390B
(11%)

FX holding
$3150B

27!

GOLD SUPPLY & DEMAND!

Chapter 4!

Indian culture dictates that brides receive dowries in the form of gold jewelry.

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 in 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.

28!

GOLD SUPPLY & DEMAND TRENDS!problem in measuring the physical gold Gold is a nancial investment, not an industrial commodity, An additional
like crude oil or copper. Most physical demand in gold comes from consumer use of jewelry, bars and coins and ofcial 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.
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-ow ratio of gold is the total reserve of gold compared to the annual amount of newly produced gold. The ratio for gold is around 60 and the ratio for silver is 20 and copper is about 1. Thus, it is difcult to map the ow 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.

It is not possible to accurately measure the supply and demand of gold. Supply and demand statistics are estimates to match the incremental gold output (ow of gold). Besides, some large markets such as Indian and Chinese also have large unofcial markets.

Chart 5: Annual gold demand in tonnes

5000
4500
4000
3500
3000
2500
2000
1500
1000
500
0
1997
1998
1999
Source: World Gold Council

2000
2001
2002
2003
2004

Central bank demand

Producers dehedging
Industrial
ETF
Coins&Bars
Jewellery

2005

2006

2007

2008

2009

2010

2011
2012TTM

Chart 6: Annual gold supply in tonnes

5000
4500
4000
3500
3000
2500
2000
1500
1000
500
0

1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012TTM

Sales Central banks

Recycling
Production

Source: World Gold Council

29!

CONSUMER DEMAND!
Gold consumers in emerging markets invest more in jewelry than coins and bars while consumers from developed markets do the opposite. Albeit, investment in jewelry is also a nancial investment in gold.
Europe

Europe consumed a total of 369 tonnes in 2012TTM. It was the largest consumer of gold bars and coins at 354 tonnes 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.

India

India 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.

China

China 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 signicantly 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.

United States

The US market for gold was relatively small with a total of 126 tonnes in 2012TTM. Consumption of jewelry was 80 tonnes 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 that US investors are more interested in paper gold such as gold backed ETFs.

Middle East and Turkey

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.

Central banks, 509, 11%

ETF, 243, 6%
Technology, 440, 10%

Total demand in tonnes and % of global 2012TTM

Consumer demand (Jewelry, bars and coins) and % of global demand in tonnes 2012TTM

Other, 835, 26%
USA, 126, 4%

India, 765, 23%

jewelry 1838, 41%

Bar and Coin, 1426, 32%

Europe, 369, 11%

Middle East, 343, 11%

China, 814, 25%

Global demand was 4456 tonnes in 2012 TTM (2H 2011 + 1H 2012).

Consumer demand, including jewelry and coins and bars, was 3264 tonnes in 2012TTM.

30!

CONSUMER DEMAND TRENDS!

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.

Chart 7. Indian consumer demand in tonnes on the left scale and the gold price in Rupees on right scale

400
350
300
250
200
150
100
50
0
Coins & Bars
Jewellery
Goldprice (Rupee)
100000
90000

+258%

80000
70000
60000
50000
40000
30000
20000
10000
0

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 seasonal demand during the Chinese new year.

Chart 8. Chinese consumer demand in tonnes on left scale and the gold price in Renminbi on right scale

400
350
300
250
8000
200
6000
150
100
50
0
4000
2000
0
Coins & Bars
Jewellery
Goldprice (RMB)
14000

+127%

12000
10000

31!

CONSUMER DEMAND TRENDS!

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 9. US consumer demand in tonnes on left scale and the gold price in US Dollars on right scale

400
350
300
250
200
150
100
50
0
Coins & Bars
Jewellery
Goldprice (USD)
2000

+174%

1800
1600
1400
1200
1000
800
600
400
200
0

Chart 10 presents European consumer demand in tonnes on the left scale and the gold price in Euros on the right scale. European consumers had little appetite for gold until the nancial crises became headline news with the Lehman Brothers 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 10. European consumer demand in tonnes on left scale and the gold price in Euros on right scale

400
350
300
250
200
150
100
50
0

Source: World Gold Council

1600
Coins & Bars
Goldprice (EUR)

+191%

1400

1200

1000
800
600
400
200
0

32!

EMERGING MARKET DEMAND! Gold supply & demand!

From the second half of 2011 to the rst half of 2012, 59% consumer demand came from China, India, Turkey and Middle East and15% came from EZ and US.
India 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 to 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.

Chart 11 shows historical GDP and future estimation of the most important gold markets. Asia-Pacic 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.

Chart 11. Historical and future estimates of GDP of major countries and regions in million USD

16,000
USA
14,000
Euro Area
China
Asia-Pacic
12,000
Middle East

+3%

+16 %
+10%

-3%

10,000

+60%
+56%

8,000

+50%

6,000

4,000

+136%

+29%

2,000

+60%

0

Source: IMF World Economic Outlook Database Oct 2012

33!

JEWELRY SUPPLY & DEMAND!

Jewelry demand was tonnes worldwide in 2011; thus accounting for almost half of the total gold demand.

In 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 gold to diversify their foreign currency holdings.

1963

India

567 tonnes in 2011

India 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 followed 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 fall by 14%. Extreme monsoon rain may also lower the gold demand. Due to bad harvests, rural consumers have less money to purchase gold. Besides, Indians are permitted to only hold nancial assets in Rupees. So, gold is a sound investment to hedge against high Indian ination.

China

511 tonnes 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 rst 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, reecting Chinas growing wealth.

Turkey and Middle East

tonnes in 2011

230

Turkey, Saudi Arabia and UAE have a relatively large gold demand compared to the size of their economies. And yet, demand took a dip by 17% in 2011.

34!

CENTRAL BANK DEMAND! Gold Reserve!

Paradigm Shift in Gold Market

Since 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 in the global market has always existed, central banks of developed nations suppressed the gold price.
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 Russia

The Central Bank of Russia (CBR) can be used as an example to illustrate central bank demand of gold. The CBR is the worlds largest (ofcially 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 CBRs quarterly purchases of gold and the gold price. The CBR currently buys gold at a rate of around 100 tonnes per 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.

Missing or Unaccounted Gold

Some gold purchases are not reported in the demand data, particularly purchases made by the PBOC, hedge funds or private purchases. Because of nondisclosure, these gold purchases are not a part of the ofcial data provided by Thomson/Reuters. It is unclear who is selling this gold. The most likely candidates are central banks of highly indebted countries.

Central banks are not audited. They can report any gure they see t. Possibly through constructions like leasing out, repurchase agreements or gold deposits, central banks can claim the original amount of gold reserve on their balance sheet. 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.

Chart 12: CBR quarterly gold demand on the left scale and the gold price in USD on the right scale

70
60
50
40
30
20
10
-
Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 2007
2007
2008
2008
2008
2008
2009
2009
2009
2009
2010
2010
2010
2010
2011
2011
2011
2011
2012
2012

Source: World Gold Council

CBR Quarterly demand

Gold price (USD)

1800
1600
1400
1200
1000
800
600
400
200
0

35!

GOLD SUPPLY!
Gone are the days of prospectors nding cherry sized nuggets with simple tools. In our modern times, gold is found as tiny particles in large ore deposits deep down in the earth. The process of producing gold is increasingly difcult 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 least 240 tonnes of gold in 2011. South Africa ranked fth after being the world largest gold producer for decades. Its drop in production is mainly due to its high cash cost, a term 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 expanded their global operations.
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 rst half of 2012. With gold price near records at $1750, consumers felt it could go even higher.

Chart 13: Annual gold production in tonnes per country

400
350
300
250
200
150
100
50
0
China
Aus
US
SA
Russia
Peru
Ghana
Canada
Indonesia
Mexico
Y2010
Y2011

Source: World Gold Council

36!

ABOVEGROUND GOLD RESERVE!

171,000 tonnes

Gold Reserve Above Ground

Thomson and Reuters estimated that the total gold reserve was 171,000 tonnes at the end of 2011. This quantity can ll 3 Olympic size swimming pools.
Who are the biggest owners of gold? With a large demand and long history, the Indian consumer hold 18,000 tonnes of gold. Although China is wealthier than India, gold purchases are relative new and the Chinese consumer holds 6,000 tonnes.

total reserve end of 2011

Technology, 20,800, 12%
Unaccounted
, 3,600, 2%

Global above ground reserve 2011 in tonnes

Investmens, 33,000, 20%

jewelry, 84,300, 49%

Central banks, 29,500, 17%

Gold held in trust for the SPDR Gold trust ETF

Chart 14: Gold reserve on Sep 2012 in tonnes, China estimated

9000
8000
7000
6000
5000

4000
8134

4000
3000
2000
1000
0

3396
2814
2435

2452
1318

1040
937

765
613

558
502

423
383

366
323

310
287

282

Source: World Gold Council

37!

UNDERGROUND GOLD RESERVE!

The Grasberg mine in Indonesia is the worlds largest gold mine with a 2011 production of 63 tonnes of gold.

70,000 -100,000

Is the estimated gold reserve still in the earth.

Table 5 summaries the 12 largest publicly traded gold producing companies. In 2011, their annual combined production 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%, the total underground gold reserve would be 68,646 tonnes. 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.

36

years

Table 5. Gold production and reserves with publicly traded gold producers

Gold Gold Production (in Reserve
tonnes)
(in tonnes)
4,352
Barrick Gold (ABX)
229
Newmont (NEM)
177
3,073
AngloGold Ashanti (AU)
133
2,351
Goldelds (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
12 Companies share
36.72%


Source: Respective companies nancial statements 2011

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 signicantly 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!

GOLD MARKETS & "THE GOLD PRICE!

Chapter 5!

"

In 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.

39!

LONDON BULLION MARKET ASSOCIATION !

No Longer Paper Gold

The term paper gold is used to describe gold investment that does not involve physical gold. It was once a paper that 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 physical exchange of ownership.

Bullion Banks

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.

London Bullion Market Association

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 for gold and silver in London. The majority of all gold and silver is traded Over The Counter (OTC). OTC transactions are performed between buyers and sellers outside public exchanges and unreported to the public. The members of the LBMA handle the majority of those trades between clients, such as central banks, mining companies and traders.

Unallocated Gold Accounts

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 specic bars are not set aside and the customer has a general entitlement to the metal. It is 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 specic 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.

London Gold Fixing Price

The London xing price is used for many large gold transactions. It is set twice a day at 10:30 and 15:00 GMT time zone. The gold price moves up and down, until demand and supply are matched, and the price is declared xed. All business is conducted on the xed price. However, since all gold transactions at the LBMA are OTC and thus unreported, the London x price can be manipulated in similar ways as the LIBOR rate is.

2011 LBMA Survey

Since gold at the LBMA is traded OTC, it is difcult 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.

London is the city where most of the worlds gold is traded.

40!

GOLD FUTURES MARKET!

Gold Futures Market

A Gold Future Contract is an agreement for the delivery of physical gold at a specic date for a specic price. Gold futures 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 in most of the worlds nancial 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 still a small number of gold futures traded in the open outcry system, where traders in colourful jackets shove and scream for orders in a pit. However, around 97% is traded on Globex, which is the CMEs electronic trading system.

CME Gold Volume

Unlike equity, where the total prot or loss depends on how much the stock goes up or down, futures are a zero sum game, where total losses equal total prots.
Underlying futures is the concept of open interest, which is the amount of long and short contracts that investors hold. The CME website reports 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 signicantly 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.

Unlike other commodities, gold futures are solely driven by the 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 Table 6. Average daily volume of Gold and Silver Futures higher price than shorter dated contracts. At present, the and Options traded on the CME/COMEX
amount of contango is around 0.70% of its annual underlying value. Future contracts require a small amount Jan 2012-Nov 2012
Contracts
Million oz
Billion USD
(usually around 10%) of the underlying value in margin, Comex Gold Futures
179,374
17.94
29.91
held in cash or a cash equivalent like US treasury.
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
37.88
Comex 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

CME Headquarters in Chicago

41!

GOLD ETF MARKET!

Gold Backed Exchange Traded Funds

Gold 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 banks 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 ETFs was 2623 tonnes.

Alternatives to SPDR Gold Trust

Other 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 Traded Notes

According 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 to mimic a gold bullion investment. They can be engineered to have more leverage or go short on a gold investment. However, when a nancial 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).

SPDR Gold Trust

The SPDR Gold Trust (GLD) is the largest of all gold backed ETFs and receives the most media attention. GLD is 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 Value of $72.24B, representing 1350 tonnes of gold. Its average daily volume at the NYSE was 17.56M contracts, or 1.756M 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.

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

200
180
160
140
120
100
80
60
40
20
0
Jul-07
Jan-08
Jul-08
Jan-09
Jul-09
Jan-10
Jul-10
Jan-11
Jul-11
Jan-12
Jul-12
GLD Price
GLD Tonnes of Gold
1,600
1,400
1,200
1,000
800
600
400
200
0
Jan-13

42!

SIZE OF GOLD MARKETS!

Measuring the Gold Market

It is not possible to accurately measure the total size of the gold market, which is dened 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 data that is accessible and ignore different time frames, sources and methods.
Table 7 reports the gold traded volume and market (i.e. share) from the following sources of information.
1. 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

LBMA (1Q 2011)
CME/COMEX 2011
Gold ETFs 2011
Others 2011
Total gold volume

Daily Volume
173.71
24.20
3.51
6.77
208.19

Annual Volume
Share
43,776
83.50%
6,072
11.58%
885
1.69%
1,692
3.23%
52,424
100.00%

43!

GOLD AS A CURRENCY!
Foreign Exchange Market

The foreign exchange market, also referred to as forex, FX or currency market, is the market in which currencies are internationally traded. Since FX market is a global, it is open 24 hours a day. Most trades take place in Tokyo, London and New York. The exact size of the FX market is difcult to obtain as most currency is traded OTC. Still, it is by far the largest of all nancial markets.
In 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 traded 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.

Gold as a Currency

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 worlds 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, ination and the money supply also drive the currency trade.
The rst 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:EUR
USD:JPY
USD:GBP
Gold
USD:AUD
USD:CAD
USD:CHF
EUR:JPY
EUR:GBP
Turnover stock at NYSE

USD Billion
Year
1,101
2010
568
2010
360
2010
255
2010-2011
249
2010
182
2010
168
2010
111
2010
109
2010
1,509
2011

44!

NOMINAL & INFLATION ADJUSTED GOLD PRICE!

To understand the current and future gold price, I looked at the historical gold price rst. The gold price before 1971 is of limited value. It was not set in the free market and thus relatively stable. In the inationary 1970s, gold was in a bull market that lead to a speculative spike in 1980. What followed 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.

$2473

Ination adjusted Gold Price in Jan 1980, stated in today's (Nov 2012) USD

Chart 16: Nominal gold price and ination adjusted (US CPI) gold price in USD

2400
2200
2000
1800
1600
1400
1200
1000
800
600
400
200
0
Gold Nominal
Ination Adjusted

Source: Federal Reserve Economic Data tool

1980 Gold Spike

The gold price hit a peak of $835 on Jan 18, 1980. If it was adjusted for ination, 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 inuenced the global oil and nancial markets. Government overspending and an oil price spike caused ination to run rampantat at 14% as of Jan 1980. To combat ination, the FED raised interest rates. The FED Fund 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 Record Price

On 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 difculty breaking this price level.

45!

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 in other currencies, I examine the veyear gold price in USD along with Euros (EUR), Chinese Yuan (RMB) and Indian Rupee (INR).

Charts 17 to 20 conrm that gold in all currencies increased 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 is likely that other factors drive the gold price too.
Most global consumers buy gold in currencies other than the USD. It is difcult to determine the impact of the uctuating 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.

Chart 18: Gold price in Euros

1,600
1,400
1,200
1,000
800
600
400
200
0
Gold (EUR)

+191%

Chart 19: Gold price in Yuan

14,000
12,000
10,000
8,000
6,000
4,000
2,000
0
Gold (Yuan)

+127%

Chart 17: Gold price in USD

2000
1800
1600
1400
1200
1000
800
600
400
200
0
Gold (USD)

Chart 20: Gold price in Rupees

100,000
90,000
80,000
70,000
60,000
50,000
40,000
30,000
20,000
10,000
0
Gold (Rupee)

+174%

+258%

Source : World Gold Council

46!

GOLD & SILVER PRICE MANIPULATION!

According to Wikipedia, market manipulation is a deliberate attempt to interfere with the free and fair operation of the market and create articial, 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 Central Bank Manipulations of all asset markets are the largest of an endless stream of reported nancial market manipulations. They paint a picture that all nancial markets are rigged by both commercial banks and governments.
Investors in precious metals must understand that all nancial 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 the easiest 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 certainly no shortage 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.

LIBOR Manipulation

The LIBOR scandal is the largest manipulation in the nancial markets uncovered. It ts exactly with the denition of manipulation. Banks reported a higher or lower LIBOR interest rate than the actual used rate. LIBOR is 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. Barclays Bank was identied as the ringleader. The manipulation may have happened with the knowledge of the Bank of England too.

JP Morgan and HSBC Manipulation

On 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 short selling. With a lower silver price, their large short position in call options on silver declined in value, thus creating huge prots 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.

Central Bank Manipulations

Central Banks openly intervene or try to indirectly inuence the prices of all asset markets. The market for debt is inuenced directly by the central banks, who keep the short term interest rates near zero and buy an enormous quantity of Treasuries and MBS. Equity, commodity and currency markets are inuenced indirectly by the inux of huge sums of articially created money that nds its way to these markets. Although performed openly by central banks, these actions can still be classied as manipulation.

47!

GOLD PRICE REGRESSION MODEL!

Chapter 6!

In 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.

48!

REGRESSION ANALYSIS!
Properties of Gold Investment

Gold is a rather rare commodity and so, as investment, it has unique properties.
1. 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 xed 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 cash ow from which its value can be derived. Cash ow 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 their future estimation. I will analyze and quantify which factors drive the price of gold in this chapter

Regression Analysis

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 xing 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 t for each model, I use the coefcient of determination, also called the R squared measure of goodness of t. Also, all factors must be statistically signicant at the signicant level below 5%

Data Period

The gold regression model uses historical monthly data from the period of July 2007 to Nov 2012. 2012 is the 5th year of the nancial 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 BNP Paribas 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.

49!

QUANTITY OF MONEY FACTOR!

Quantity of Money

Chart 21 suggest that the gold price and monetary base increased by more than 150% over a ve year period of July 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 future. 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 the 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 and remain at that level for a prolonged period. To smoothen these 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 signicant relationship. The money supply, captured as M0, M1, M2, has no statistical signicant relationship with the gold price.

Chart 21: Gold price, the monetary base (MB) and the 12 month moving average of the MB

280%
260%
240%
220%
200%
180%
160%
140%
120%
100%
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

50!

REAL INTEREST RATE FACTOR!

Real Interest Rate

The real interest rate is a factor related to the gold price. In 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 change in the US CPI Index as the ination rate.
The gold regression model conrms that the real interest rate has a statistically signicant relationship with the gold price. But, ination 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 inuenced by ination and 1 Year Treasury over a twelve year period of Jan 2000 to Nov 2012.
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.

Chart 22: Real interest rate in the period 2000 to 2012

8.00%
6.00%
4.00%
2.00%
0.00%
-2.00%
1Y Treasury
-4.00%
-6.00%
CPI Ination
Real interest rate

51!

CURRENCY FACTOR!
Currency Factor

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 investors 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 in 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 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 the currency basket.

Basket4

Basket4 has the best t 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).

Chart 23: Performance of four currencies against the USD in the July 2007 to October 2012 period

140%
130%
120%
110%
100%
90%
80%
70%
60%
USD:EUR
USD:YEN
USD:RMB
USD:INR
USD:Basket4

52!

FINANCIAL UNCERTAINTY FACTOR!

Supply and Demand Factor

The physical supply and demand of gold does not produce a good t in the regression model. I assume that the size of the physical gold market is too small compared to the paper traded gold market to make an impact on gold prices. It seems that the gold price is inuenced by the paper gold market, which treats gold as a currency. Therefore, I dismiss the momentum factor in my nal regression model.

Uncertainty in Financial Markets

The uncertainty in nancial 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 the Volatility Index (VIX) of the S&P500. However, these two common measures are not statistically linked to the gold price.
I 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 factor because it is statistically related to the estimated gold price. However, the measure is a negligible factor.

Momentum Factor

Momentum is an important factor in setting the price in many assets classes. It means that the current price is dependent 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 nal regression model.

53!

GOLD PRICE REGRESSION MODEL!

In and Out of Sample Periods
After experimenting with different To make sure the gold regression model is valid, the model factors that are considered to be drivers is constructed using data in the in sample period from July 2007 to Dec 2011. To check if the gold regression model of the gold price, my gold regression will make accurate estimations, the data for the out-ofmodel proves that the quantity of sample period from Jan 2012 to Nov 2012 is used to money is the biggest driver of the gold estimate the gold price. This estimate is compared to the observed gold price.
price. Other factors such as exchange can nd in a data set based rates, ination and interest rates shift the Curve ttinginstead ofthe optimal resultHowever, when the on statistics good modeling. price within a certain bandwidth. model is employed, it can produce unrealistic estimates. Therefore, the out-of period data is used to test the Because there is no end in sight to accuracy of the model.
monetary easing, the quantity of money All variables where signicant at or below the 5% factor can drive gold prices higher in signicance level. They also passed standard tests for serial correlation, heteroskedasticity and collinearity.
2013 and beyond.

(%Ch GOLDt) = -3.0384*(Ch REALRATEt) - 0.9616*(%Ch BASKET4t)

+ 0.7207*(%Ch MB-12t) + 2.63E-05*(Ch BONDSPREADt)

R=0.4112, Adjusted R=0.3759, n=54

The equation above uses the following parameters:

1. %Ch GOLD is the percentage change in the average monthly gold price, set in the 3PM London xing 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 ination 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.

54!

FIT OF ESTIMATION!
The monthly average observed gold price and the estimated gold price are illustrated in Charts 24 and 25, for the in-sample period and out of sample period, respectively.
The actual gold price is more volatile than the estimated gold 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 indicates that the model is reliable and can be used to predict the future gold price.
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 ination 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 quantiable and thus is not included in the gold regression model.

Chart 24: The observed and estimated gold price in the in sample period

2000
1800
1600
1400
1200
1000
800
600
400
200
0
Jul-07
Gold 3pm xing
Gold estimated
Jan-08
Jul-08
Jan-09
Jul-09
Jan-10
Jul-10
Jan-11
Jul-11
Jan-12

1652

1513
665

Chart 25: The observed and estimated gold price in the out of sample period

1800
1750
1700
1650
1600
1550
1500
Jan-12
Feb-12
Mar-12
Apr-12
May-12
Jun-12
Jul-12
Aug-12
Sep-12
Oct-12
Nov-12
Dec-12

1733

1689
1653

Gold 3pm xing

Gold estimated

55!

GOLD PRICE ESTIMATES!

The model to estimate the gold price is not very intuitive. Several steps are necessary to estimate its price.

1. The change in the real interest rate must be calculated based on estimations for short-term interest rates and ination.
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
Ination and Interest Rates: CPI Nov 1.77%, 1Y Treasury: 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

GENERAL VIEW

The most expected scenario is a continuation of current developments.

A deal for the US scal 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 throughout 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. Ination remains at 2.25% and short-term interest rates remain at 0.18% in the US and the EZ. The EUR:USD is stable at 1.30 throughout 2013 and the USD strengthens slightly against a basket of currencies. The bond index value difference remains unchanged to reect no change in risk.

If current trends continue, then the gold price 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:

$1890

(+11.9%)

The general view is based on the following assumptions:

1. 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 ination at 1.8%.
6. The BBB-AAA bond spread remains unchanged at 129 points (0% change).

56!

GOLD PRICE ESTIMATES!

ECONOMIC RECOVERY, bearish gold scenario

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 will decrease to 1.20. Ination will increase to 2.5%, while short-term interest rates remain at 0.25%.
Higher ination and decreased economic pressure will lead to a halt of all monetary easing programs. The balance sheet and monetary base in the US and EZ will remain stable (but shrink in USD terms). Finally, the bond index value difference will decrease with 80 points to reect the lower risk.

2013 would see gold prices near the 2012 low $1540. At the end of 2013, the gold price will be:

$1580

(-6.4%)

The bearish gold scenario is based on the following assumptions:

1. 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 ination increases to 2.5%.
6. The BBB-AAA bond index value decreases with 80 points (-38%).

STAGFLATION, bullish gold scenario

The stagation scenario sees ination 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 to 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 reect more uncertainty.

2013 would see the end of the consolidation phase of the gold price since 2011, as it breaks through the important psychological barrier of $2000. At the end of 2013, the gold price will be:

The bullish gold scenario is based on the following assumptions:

1. 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 ination increases to 2.50%.
6. The BBB-AAA bond index value increases with 200 points (+55%).

$2115

(+25.2%)

57!

GOLD STANDARD VALUATION!

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 regression model are in the correct range.
Gold Standard Valuation

An alternative valuation method for gold, is to look at the gold standard as it was dened 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 denition of the money supply is very broad, I will use the monetary base (MB), like in the Bretton Woods period.
The global money supply can estimated using the nine largest economies combined (EZ counted as one), which represent 72.68% of GDP in 2011. Given that they have a combined MB of $11,243B, I extroplate that 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

Difculty in Return to Gold Standard

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 countrys gold supply grows slower than these two measures, there would be too little money, which would result in deation. 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 condence in the monetary system and demand the return of some form of gold standard.

US Gold price

10,350

USD/Oz

Based on 8134 tonnes reserve, $1778.50 gold price,

MB 2011: $2,653B

Euro Zone Gold price

Global Gold price

13,450

6,700

USD/Oz

USD/Oz

Based 30,563 tonnes reserve,

MB 2011: 15,450B

Based 10,787 tonnes reserve, EUR:USD 1.30,

MB 2011: 2,276B

China Gold price

28,500

USD/Oz

Based on 4000 tonnes est. reserve, USD:RMB 6.35,

MB 2011: Yuan 22,800B

58!

GOLD/BRENT VALUATION!
How many barrels of Brent crude can 1 Oz of gold buy? Both commodities are expected to rise with higher ination.

Gold / Brent Valuation

Gold and Oil share some characteristics, such as performing well in times of high ination 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.
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 difcult to accurately predict than gold prices,

At the end of 2013, the gold price will be:

1,568

USD/Oz

Based on Gold/ Brent ratio of 15.40

Chart 26: Gold price per Oz divided by Brent crude price per barrel

35
Gold / Brent ratio
30
25
20
15
10
5
0

59!

GOLD INVESTMENT RISKS!

Physical gold does not have counterFiscal Cliff
The US Fiscal Cliff is the end of temporary tax brakes, party risk. Theoretically, paper gold has including Payroll tax cuts and Bush income tax cuts, the this risk but no future contract or ETFs introduction of new taxes related to Obama care and the decrease in government spending. These rules were set in traded in the US has defaulted so far. place during the 2011 negotiations on raising the debt Physical-backed ETFs are a relatively ceiling, for the reason that decit spending should not run new investment category, which makes it out of control. Unless a deal is made between Democrats and Republicans, the Fiscal Cliff scenario will automatically difcult to quantify the associated risks. be enabled on Jan 2013. If the program is unchanged, it could have an enormous drag on the economy, thus However, all types of gold investments into a recession. have market risk, which means a drop in plunging the US to delay the scalOn Jan 2th 2013 a 2deal has been made cliff decision with the gold price.
months.
Economic Recovery

Ironically, an improving economy is the biggest risk for gold investments. Since US monetary policies are linked to ination 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 decit 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 international market without the support of the ECB and its OMT program. An end to the various monetary easing programs stops the expansion of the MB, which the biggest factor driving a higher gold price.

Current political gridlock makes it difcult for US politicians to reach an agreement beforehand. The Fiscal Cliff is combined 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 Chinas 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.

Stronger USD

Since the US leads most global recoveries, the USD is likely to strengthen against most other currencies. The USD can also strengthen during a global nancial crash because it is seen as a safe haven. A stronger USD is expected to drive down the gold price..

60!

IS GOLD A BUBBLE ?!
What is Bubble?

A nancial 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 to a record high. Prices are unsustainably high and soon selling 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 identied 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 1970-1981 was driven by fear of high ination and money debasement.
In 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 the bubbles, such as the Dutch Tulip mania, follow the same patterns as bubbles today. History is lled with other bubbles. Some recent examples include the gold price bubble of 1970 to1981, Japan housing and stock bubble of 1970 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 justications of this time its 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 nancial bubble

Awareness Phase

Currently, the gold price is at the end of the awareness phase 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.

61!

ALTERNATIVE GOLD INVESTMENTS!

Chapter 7!

American Eagle silver coins are the most held silver coin and still minted today.

Chapter 7 explains several investment alternatives to gold. The best known alternatives are other precious metals such as silver and platinum. Although there is industrial demand for these substitute metals, their markets are often much smaller than the gold market. Silver has earned the name Devils Metal by silver traders because of its high volatility and small and easily manipulated market. The other alternative is to invest in equity of gold producing companies. If their revenues increase faster than their costs, then these companies can be sound investments. However, rising budgets for exploration and development and higher cash cost can destroy prots.

62!

Silver Demand

Demand for silver remained stable in the last decade, hovering around 24,000 tonnes per year. For centuries, silver has been valued as jewelry and viewed as investment in the form of coins, medals and silverware. But is less perceived as a nancial 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 reectivity. 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 silver demand.
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.

Chart 27: Annual silver supply in tonnes

30,000
25,000
20,000
15,000
10,000
Scrap silver
5,000
0
2002
2003
2004
2005
2006
2007
2008
2009
Net Gov Sales
Mining
2010
2011

Chart 28: Annual silver demand in tonnes

30,000
25,000
20,000
15,000
10,000
5,000
0
2002
2003
2004
2005
2006
2007
2008
2009
Source: The Silver Institute
Coins&Medals
Silverware
Jewelerry
Photo
Industrial
2010
2011

63!

Silver as a Currency

Silver can be viewed as a currency, just like gold. Silver currency code is XAG. However, the silver market is smaller than the gold market and silver is not the store of value and save haven metal that gold is.

Chart 29 shows the price of the SLV ETF in USD since its inception in April 2006. SLV crashed signicantly 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.

Silver Trust ETF

It 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 futures trade at the CME, the silver futures market is much smaller 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 Price Manipulation

Since 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.

Chart 29: Price of SLV ETF in USD

50.00
45.00
40.00
35.00
30.00
25.00
20.00
15.00
10.00
5.00
SLV

High
48.35
QE2
24.25
End QE1
17.14

End QE2
33.84

QE3
33.61

QE1
10.19

Lehman
10.95

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

64!

The silver price is highly correlated with the gold price. However, it is less 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 signicant industrial use, its price is more dependent on economic cycles. These characteristics make silver behave like a combination of gold and industrial metals.

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 xing gold price / London xing 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 ee 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

85
80
75
70
65
60
55
50
45
40
35
30
Jul-07
Gold / Silver Ratio
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

on Dec 31, 2012

55.56

65!

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 the change in the gold price, it is implied that the silver price is more volatile than the gold price.

In and Out of Sample Periods

The methodology of creating the silver regression model is similar 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.
I draw on monthly data for this study since the factors are published monthly. All variables where signicant at the 5% signicance level. They also passed standard tests for serial correlation, heteroskedasticity and collinearity.

(%ch SILVER) = 1.5544*(%ch GOLD) + 0.4864*(%ch SP500)

R=0.6370, Adj R=0.6300, n=54 (July 2008 to Dec 2011)

The equation above uses the following parameters:
1. % Change SILVER is the percentage change in the average monthly London xing silver price.
2. % Change GOLD is the percentage change in the average monthly 3 p.m. London xing gold price.
3. % Change SP500 is the percentage change in the S&P500 Index.

66!

The observed monthly average London xing 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 t of data than the gold regression model, as measured by the R , 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.

Chart 31: The actual and estimated average monthly silver price in the in sample period

45
40
35
30
25
20
15
10
12.91
5
0
Jul-07
Jan-08
Jul-08
Jan-09
Jul-09
Jan-10
Jul-10
Jan-11
Jul-11
Silver London xing
Silver Estimate

30.41

26.21

Chart 32: The actual and estimated average monthly silver price in the out-of-sample period

38
37
36
35
34
33
32
31
30
29
28
27
26
Dec-11
Jan-12
Feb-12
Mar-12
Apr-12
May-12
Jun-12
Jul-12
Aug-12
Sep-12
Oct-12
Nov-12
Dec-12
Silver London xing
Silver Estimate

35.55

31.96
29.32

67!

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.

GENERAL VIEW

The most likely scenario for the silver price is the continuation of current trends.

1. The gold price increases 11.9% to $1890/oz.
2. The S&P 500 increases 4% to the 2012 high at 1480.

At the end of 2013, the silver price will be:

Silver

$38.50

/Oz (+20.5%)

ECONOMIC RECOVERY, bearish gold scenario

The bearish scenario for silver is based on the bearish scenario of gold.

1. The gold price decreases -6.4% to $1580/oz.
2. The S&P 500 rises 10% to the all time high of 1565

At the end of 2013, the silver price will be:

Silver

$30.40

/Oz (-4.9%)

STAGFLATION, bullish gold scenario

The bullish scenario for silver is based on the bullish scenario of gold.

1. The gold price increases 25.5% to $2115/oz.
2. The S&P 500 falls -15.6% to 1200, near the 2011 low

At the end of 2013, the silver price will be:

Silver

$42.10

/ Oz (31.7%)

68!

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 scenarios to estimate the silver price.
The Economic Recovery Scenario and the Stagation 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 silver regression model.

GENERAL VIEW

The most likely scenario is the continuation of current trends.

1. 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.

At the end of 2013, the silver price will be:

Silver

$32.85

/Oz (+2.8%)

ECONOMIC RECOVERY

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.

1. 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.

At the end of 2013, the silver price will be:

Silver

$50.30

/Oz (+57.5%)

STAGFLATION

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.

1. 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.

At the end of 2013, the silver price will be:

Silver

$25.25

/ Oz (-21.0%)

69!

Investors 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 specic factors which make them unsuited for most investors. Platinum is a small market and the markets in Palladium, Rhodium, Osmium and Iridium are virtually non-existing.
Platinum Investment

Platinum is much more rare than gold. South Africa contains 80% of the worlds platinum reserve. In 2010, 245 tonnes was produced. The metal is used in catalytic converters of cars and jewelry.

Platinum can be hard to distinguish from Silver or Palladium

Palladium Investment

Palladium 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.

36

113

76

Catalysator
Jewelry
Others

Rhodium Investment

Unlike 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 bre 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 efcient way to invest in Rhodium. Kitco sells Rhodium with a $100 spread on a $1250 price.

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 specic circumstances, like unrest or nationalization treats of South African mines.
Investments 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.

70!

GOLD MINE INDICES!

The XAU and HUI indices are used for benchmarking the gold producing industry. The GDX is an ETF that gives investors exposure to a broad range of gold mining companies.
Philadelphia Gold and Silver Index

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 is 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.

NYSE/ARCA Gold Bug Index

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 two indices 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

71!

GOLD MINE ETFS!

Chart 33 shows the amount of gold in Oz that one unit of the XAU index can buy. The decreasing amount indicates that gold mining stock is underperforming a gold investment. There is little reason to believe this will change in the near future.

Chart 33: Gold & silver index XAU divided by the gold price

0.26
0.24
0.22
0.20
0.18
0.16
0.14
0.12
0.10
0.08
0.06
XAU / Gold

Gold Miners ETF GDX

The XAU and HUI indices are for reference and cannot be used as an investment. There are alternatives to these indices. 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 is the only one with good liquidity and thus cheap to trade.

Table 9. Overview of most positions for the XAU and HAU indices and GDX ETF in 2011


Barrick Gold (ABX)
GoldCorp (GG)
Newmont (NEM)
Kinross (KGC)
AngloGold Ashanti (AU)
Agnico-Eagle (AEM)
Yamana (AUY)
Goldelds (GFI)
Randgold Res (GOLD)
Buenaventura (BVN)
Harmony (HMY)
Silver Wheaton (SLW)
Eldorado (EGO)
Freeport McMorran (FCX)
Total
XAU
21.98%
14.92%
14.13%
7.73%
6.55%
4.65%
3.47%
3.98%
2.34%
0%
3.13%
1.05%
0%
12.92%
83.93%
HUI
15.21%
13.59%
10.41%
4.27%
4.49%
4.61%
4.49%
4.53%
3.98%
5.39%
4.37%
0%
0%
0%
75.34%
GDX
13.43%
12.15%
9.03%
4.49%
4.69%
5.11%
5.16%
4.25%
4.69%
4.50%
2.06%
5.20%
4.25%
0%
79.01%

72!

VALUATING GOLD PRODUCING COMPANIES!

To determine if an investment in a gold producing company is a good alternative for a gold investment, I rst 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 investment back in 20 years. If a mine is depleted in 8 years, the payout ratio can be considerably reduced.

Cash Cost

To 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 include 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 the highest prots. However, the gold reserve a company holds is its most valuable asset and is unaccounted for in the cost.
The cash cost is the cost necessary for a mining company to produce 1oz of gold, excluding its overhead and depreciation and depletion cost. Labour usually accounts for half of the cash cost. Rising cash cost puts a downside protection on the gold price. When cash cost is higher than the gold price, company will halt production until the gold price increases.

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 companys cash cost remains at $600, its prot 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 difcult 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.

Net Asset Value

A more inclusive method to valuate a mining company is to estimate its Net Asset Value (NAV), which is the Net Present Value (NPV) of its future cash ows and other balance sheet items. The future Free Cash ow for each mine is based on an estimated future gold price, future costs, annual production rate and gold reserve. To calculate the NPV of these cash ows, a discount rate must include various risks including nancial risk (bankruptcy), political risk (nationalization and strikes) and geological risk (earthquakes or oods).

Gold Price Speculation

Investing 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.

73!

INVESTMENT PERFORMANCE!

Chapter 8!

I compare the historical performance and characteristics of a gold investment to the main alternatives, silver and equity in gold producing companies in Chapter 8.
The purpose for this comparison is to discover the return and associated risk of these investments and to determine is they are a safe haven investment. In order to do so, I compare gold, silver, mining equity, the S&P500 index and the AGG Bond index ETF.

74!

GOLD PERFORMANCE!
Gold Performance

I choose ETFs for all asset classes to impartially compare precious metals, equity of mining companies and equity and bond indices.
1. 2. 3. 4. 5. GLD: State Street SPDR Gold Trust ETF
SLV: iShares Silver Trust ETF
GDX: Van Eck Market vectors Gold Miners ETF
SPY State Street SPDR S&P 500 ETF
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 ve ETFs. While most asset classes collapsed after the Lehman Brothers bankruptcy in 2008, the gold price and bond index 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 5 year period.

Chart 34: Relative performance of gold and comparable investments in the period July 2007 to Dec 2012

375%
350%
325%
300%
275%
250%
225%
200%
175%
150%
125%
100%
75%
50%
25%
Jul-07
Jan-08
Jul-08
Jan-09
Jul-09
Jan-10
Jul-10
Jan-11
Jul-11
Jan-12
Gold (GLD)
Silver (SLV)
Mining stock (GDX)
S&P500 (SPY)
Bond index (AGG)

249%
232%

140%

118%
104%

Jul-12

Jan-13

75!

SILVER PERFORMANCE!
Silver Performance

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 factors make silver more volatile, thus a riskier investment.
Silver characteristics can benet investors. Chart 35 illustrates that silver outperforms gold in a bull market but silver prices plunge in bear markets, lacking the safe haven status of gold. Active traders can switch between gold and silver to take advantage of bull and bear markets. However, long term stable investors should prefer gold over silver.

Chart 35: Annual return on several assets

80%
70%
60%
50%
40%
30%
20%
10%
0%
-10%
-20%
-30%
-40%
2007
2008
2009
2010
2011
2012
GLD
SLV
GDX
SPY
AGG

76!

MINING EQUITY PERFORMANCE!

Mining Equity Underperformance

Equity in gold and silver producing companies lag behind the 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 labor and energy to produce an Oz of gold is much higher than just a decade ago. It is unlikely the cash cost will decline in the future.
The increasing exploration budgets and capital expenditure is another reason. Companies need to develop new mines to replace the depleted older mines. These budgets grow faster than the gold price, hurting the prots of mining companies.
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 prots of mining companies. But unrest can increase the price of the affected commodity, like gold or platinum.

The Envy Factor

The envy factor is noteworthy reason for mining companies lag behind the price of gold and silver. Hedge fund manager Hugh Hendry claries 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 there is no valuation argument that protects you against the risk of conscation.

Labor unrest at Lonmins Marikana platinum mine, where clashes in pursuit of higher pay resulted in 34 deaths.

77!

CORRELATION MATRIX!

Correlation Matrix

Gold is thought of as purely a nancial investment or currency. Conversely, base metals have only an industrial purpose. 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 platinum have a higher correlation with gold. Palladium and copper are more correlated to base metals.
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.

Correlation matrix based on weekly returns between July 2007 and Dec 2012

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

Base Silver
Platinum
Palladium
Copper
Metals
0.80
1.00
0.72
0.65
0.44
0.46
0.49
0.29
0.76
0.45
0.05
0.72
0.72
1.00
0.79
0.60
0.64
0.56
0.52
0.70
0.46
-0.08
0.55
0.65
0.79
1.00
0.61
0.64
0.52
0.61
0.62
0.41
-0.16
0.26
0.44
0.60
0.61
1.00
0.91
0.50
0.53
0.42
0.39
0.00
0.25
0.46
0.64
0.64
0.91
1.00
0.51
0.56
0.42
0.43
0.04

Brent Crude
S&P500
0.35
0.49
0.56
0.52
0.50
0.51
1.00
0.43
0.45
0.39
-0.03
0.03
0.29
0.52
0.61
0.53
0.56
0.43
1.00
0.35
0.34
0.18

GDX
EUR:USD
Bonds
0.80
0.76
0.70
0.62
0.42
0.42
0.45
0.35
1.00
0.47
0.00
0.40
0.45
0.46
0.41
0.39
0.43
0.39
0.34
0.47
1.00
0.11
-0.04
0.05
-0.08
-0.16
0.00
0.04
-0.03
0.18
0.00
0.11
1.00

78!

RISK ADJUSTED RETURNS!

The three major statistical methods to measure and quantify the nancial 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 nance, Stdev measures volatility, or how much returns can differ from the mean over a given period. VaR quanties 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 risk adjusted return. The SP ratio is the best measure to assess nancial performance.
The SP ratio = (Return RF-rate) / Standard deviation
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 proted 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.

Table 10: Risk adjusted returns of several investments

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%
10D 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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GOLD AS SAFE HAVEN!

2011 US Debt Ceiling Mini Crash

In 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 ed to the safety of gold and bonds, most other assets including silver and mining stocks plunged. Although the problem was related to the US 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 ve assets including gold, silver, mining stock, S&P500 and bond index over the one month period of Jul 18, 2011 to Aug 17, 2011. Based on relative performance along with risk measurements and characteristics, I conclude that gold and bonds are safe havens. They protect an investors capital in troubled times. Silver is not a safe haven. While it 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.

Chart 36: Relative performance of several assets during the 2011 debt ceiling mini-crash

120%
115%
110%
105%
100%
95%
90%
85%
80%
GLD
SLV
GDX
SPY
AGG

80!

CONCLUSIONS!
Gold Supply and Demand

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 those countries buy increasingly large amounts of gold to diversify their investments. Supply is likely to increase only modestly in 2013. Supply disruption and nationalization threats, 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.

Upwards Potential Gold Price

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 gold price is expected to decline to $1580 per Oz (-6.4%). In a stagation 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 scal cliff, debt ceiling and possible Spanish sovereign bailout are possible reasons for the volatility.

Gold as a Currency

Institutional investors view gold as a currency and trade it at 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 ination and interest rates, money supply, currency rates and nancial market risk.

There are many similarities between the current nancial crises 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.

Alternative Investments

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 gold in 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 is also 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 nancial 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 Dutch nationality and currently lives in Cape Town, South Africa. Feel free to contact me at:
[email protected]
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

I 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 specic 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 nancial advisor as these are regulated nancial products. The inclusion of a particular rm does not constitute the endorsement or recommendation of that rm. Goldresearcher has not examined the nancial condition of any rm 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 not constitute 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 nancial professional regarding suitability, tax consequences and other pertinent matters involving their own particular nancial circumstance, before making an investment.

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RESOURCES!
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 Finance
nance.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 ination from Federal Reserve Economic Data FRED tool
research.stlouisfed.org/fred2/

GDP of specic 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
sdw.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

Information 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

SPDR Gold Shares ETF (GLD)
http://www.spdrgoldshares.com/usa/historical-data/
iShares Silver Trust ETF (SLV)
http://us.ishares.com/product_info/fund/overview/SLV.htm

Valuation of gold mines with NAV and gold options
www.paulvaneeden.com/Home

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