Re: [A-List] Re: What Is Making Gold Move Up? And How Far?

["Salaam Blackmore" <blackmore@xxxxxxxxx>]

Mr Liu

It was a great pleasure to read your masterly exposition of the background
to gold pricing.

I now know a lot more than I did before.

I have only been a member of this List for a few days and I was beginning to
wonder what whimsical sprite had nudged me in this direction. I am not a
Marxist - I work in spiritual development - but where our paths appear to
cross is in opposition to war or, at least, the present mirage of horror
that some are trying to will into reality...

I would have been content with that.

So your pyrotechnic display of knowledge and good sense, Mr Liu, has come as
a much-valued and serendipitous bonus.

I thank you again.


Salaam Blackmore

Basel, Switzerland








----- Original Message -----
From: "Henry C.K. Liu" <hliu@mindspring.com>
To: "Jas Jain" <jas_jain@hotmail.com>; <TheNewForum@yahoogroups.com>;
<a-list@lists.econ.utah.edu>; <gang8@yahoogroups.com>
Sent: Sunday, December 22, 2002 9:02 AM
Subject: [A-List] Re: What Is Making Gold Move Up? And How Far?


> The historical high for gold is around $850 per ounce on January 21, 1980.
We
> are a long way from that since 1974, when President Ford restored
Americans'
> right to hold gold bullion. Those who bought gold or went long on gold in
1980
> have all gone down the drain. I personally knew a few of them.
>
> Gold Forward Rate Agreement (GOFRA) is a hedging instrument used by
producers
> who, having drawn down gold loans , can lock in forward gold interest rate
> exposure. The GOFRA hedges against the combined effect of moves in both US
> dollar and gold interest rates with settlement in dollars.
>
> The GOLFRA (Gold Lease Forward Rate Agreement) restricts itself to gold
interest
> rates with settlement in gold. The increased activity of the central banks
in
> lending gold to the market means that they, too, have exposure to gold
rate
> volatility and the GODFRA (Gold Deposit Forward Rate Agreement) is
tailored to
> their particular activities.
>
> Since July 1989, twelve market-makers have contributed to the GOFO page on
> Reuters their rates for lending gold (against US dollars) and at 10 am a
mean is
> calculated automatically giving the market, in effect, a gold LIBOR
(London
> Interbank Offered Rate).
>
> In 1997 a second page GOFO was added providing logical data, which allows
the
> user to apply the rates to other applications, such as spreadsheets and
charts.
> Reuters LBMA07 gives a full list of contributor codes.
>
> Reuter Monitor Dealing Service (RDS) is a communications system
established by
> Reuters and available to users on subscription. RDS is used increasingly
by
> professional traders in gold, especially by banks who also trade foreign
> exchange through this medium.
>
> Central banks choose to lend gold when they could have sold it for dollars
> because they would have gotten more dollars for their gold, and earned the
> dollar interest rate -- Gold lease rate differential.  Central Banks chose
to
> lease out their gold in preference to selling it for the following
reasons:  1.
> CBs believe that they should continue to back their currency with a
significant
> quantity of gold. They know that gold is the ultimate store of value, in
case
> dollar hegeminy collapses.  2.The duty of the CBs is to regulate the
financial
> markets - and not to make profit in sale-purchase of gold and/or other
precious
> metals.  3.CBs leased out their Gold not because they wanted to earn the
lease
> money, but to provide liquidity to the markets.
>
> The purpose of lending was to prevent a squeeze due to short-term increase
in
> demand and/or cornering of the market by big speculators.
>
> The continuity with which CBs lent Gold to the market at low lease rates
capped
> the price of gold, which is the policy goal of all CBs, to keep the value
of
> their respective currencies.  When gold price rises in dollars terms, all
> currencies depreciates against commodity prices regardless of their
exchange
> rate to dollars.  Lower prices resulted in higher physical demand and
lower
> mining output. Demand-supply gap continued to widen and the CBs continued
to
> fill this gap with easy lending. The bullion banks, gold producers and
others
> borrowed gold from the CBs and sold it in the cash market for dollars.
Though
> the CBs continue to hold the title to their gold, the physical gold will
not
> come back to them because of continuing leasing.
>
> In addition to the already booked interest rate -- lease rate
differential, the
> borrowers of gold are sitting over huge mark to market profits as the
price of
> gold was at 20 year lows. There is only one problem, a very big problem --
if
> the Central banks want their Gold back, then where will this gold come
from? For
> these Gold loans to be settled, either the future mining should exceed
future
> demand and/or the CBs  must sell their Gold holdings. If the CBs were to
sell
> their Gold now, then what explanation do they have for leasing out their
Gold -
> when  they could have sold it and realized a much higher price?
>
> For mining production to exceed demand, the price of Gold must go up
> significantly. If the price of gold does go up significantly, then some
big
> bullion banks may go bankrupt. One big failure would result in chain of
> defaults. It appears that some CBs now realize this and, therefore, are
planning
> to sell their Gold reserves just to bail out some market players who are
short.
> It is possible that the Bank of England made the controversial decision to
sell
> their Gold reserves in order to protect some bullion banks. It is also
possible
> that for the same reason some other CBs may be ready to sell their gold
> reserves, whenever the price of Gold starts shooting upwards.
>
> It is the policy duty of CBs to correct any imbalances in the economy.
Their
> actions in the gold market during the last several years have created an
> explosive imbalance. Demand - supply gap was widening as the price was
falling.
> It is possible that at some point in the not too distant future, or now,
all the
> metal available for lease and/or sale will be gobbled up by consumers. At
that
> point will begin the mother of all squeezes - and then not even the G-7
would be
> able to bail out any bank and/or trader short. The Fed has recently
reminded us
> that it  can print currency and/or manipulate interest rates, but to bail
out
> somebody short in gold they will need gold, which the Fed cannot print.
>
> The biggest proof that the CBs have got it all wrong is that they are
being
> forced to sell Gold at 20 year lows and that too, at a time when the
physical
> demand is far in excess of the current mining.  Chinese demand for gold
between
> now and February 2003 is stagerring.
>
> A lot of analysts feel that gold has lost its value as a reserve asset.
They
> know that the sentiment among the gold investors has been bearish. They
believe
> that sooner or later the masses are going to stop buying gold and gold
jewelry.
> They are increasing looking wrong headed.
>
> In one fell swoop fifteen European central banks have effectively
transformed
> the fortunes of
> gold and, potentially, the way the gold market functions.  On September
26, the
> European Central Bank (ECB) and the central banks of Austria, Belgium,
Finland,
> France,
> Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain,
Sweden,
> Switzerland
> and England announced the following: "In the interest of clarifying their
> intentions with respect
> to their gold holdings, the above institutions make the following
statement:
>
> "1. Gold will remain an important element of global monetary reserves.
>
> "2. The above institutions will not enter the market as seller, with the
> exception of already decided
> sales.
>
> "3. The gold sales already decided will be achieved through a concerted
> programme of sales over the
> next five years. Annual sales will not exceed approximately 400 t and
total
> sales over this period
> will not exceed 2,000 tonnes.
>
> "4. The signatories to this agreement have agreed not to expand their gold
> leasing and their use of
> gold futures and options over this period.
>
> This agreement will be reviewed after five years."
>
> After issuing the statement the president of the ECB, Wim Duisenberg,
indicated
> that apart from
> the 15 signatories to the agreement, the US Federal Reserve had indicated
that
> it will not
> change its oft- stated stance on gold sales.
>
> The impact of this statement was immediate. As traders returned to their
desks
> the Monday after, the
> gold price exploded, breaching resistance level after resistance level.
After
> closing on Friday at
> US$268.50/oz, the price raced upwards to touch an intra-day high of
US$327.30/oz
> in New York
> on Tuesday, its highest level for almost two years. Profit taking forced
the
> price back somewhat,
> but it has since regained its upward momentum aided by a statement from
the Bank
> of Japan
> that it too had no plans to sell gold from its monetary reserves.
>
> Although the removal of uncertainty over outright sales has undoubtedly
provided
> the
> launch-pad for gold's rally, it has been sustained by the impact of point
four
> of the joint
> statement. By agreeing not to expand their activities in gold leasing, and
gold
> futures and
> options over the next five years, the signatories to the agreement have
removed
> the obstacle
> that has capped many of gold's previous rallies- producer forward selling.
By
> reducing central
> bank lending, miners and speculators can no longer rely on forward prices
being
> in contango,
> and in the short term at least this will have a dramatic impact on the way
these
> three parts of
> the gold market operate.
>
> The effect of this reduced liquidity can already be seen in gold lease
rates.
> According to Mining
> Journal's Precious Metals Monthly Monitor, the one month lease rate
averaged
> 0.68% in
> January. Since then, the rate has steadily risen and in September averaged
> 3.92%. Since the central bank's announcement, lease rates have reached
almost
> 10% which, with the London Inter-Bank Lending Rate at a little over 5%,
means
> that gold is more expensive to borrow than cash and is effectively in
> backwardation.
>
> The implications of this new environment are serious. Producers that have
> protected themselves
> with hedges based on rolling lease-rate contracts are now in a dangerous
> situation. If they
> cannot borrow gold to roll contracts forward, they will have to deliver
gold
> that they have
> produced at the contract price or purchase gold on the spot market at the
> prevailing price to
> meet their obligations.
>
> Investment funds are also in a different environment. In the past, they
have
> taken advantage of
> the negative sentiment in the gold market through gold-carry trades -
borrowing
> gold at what
> until recently had been low lease rates, selling it on the spot market,
> investing the proceeds
> then buying back gold on the spot marking or rolling the contract forward.
The
> inability to roll
> forward such positions has fuelled much of the recent price rise.
>
> How long this situation lasts will depend on central banks that are not
involved
> in the
> agreement. According to Andy Smith, metals analysist with Mitsui in
London, such
> banks already
> account for up to 75% of all lending. In the medium to long term, they are
> likely to take
> advantage of the new environment and increase their lending which, says Mr
> Smith, will
> eventually reduce borrowing costs of gold. But he warns that this will
take a
> while and lease
> rates will be less predictable.
>
> At its peak, the Fed held over 12,700 tonnes (around 409 million oz), more
than
> one-third of global official stocks, on behalf of 73 nations or
international
> organisations, such as the IMF.
>
> The Fed's famous 'gold window' closed in 1971 when the United States no
longer
> sold gold for dollars at a fixed price, so the stockpile ceased to grow.
The
> bank's reputation as an impartial safe haven was also shaken in1979 when
the US
> government froze 50 tonnes (1.6 million oz) of Iran's gold at the Fed
during the
> Tehran embassy hostage crisis.  The fate of Saudi gold is not solid.
>
> During the 1990s, almost 2,600 tonnes (83 million oz) of gold was moved
out of
> the Fed as many other central banks mobilized their reserves for leasing,
swaps
> or sale. In 2000 and 2001 there was a further outflow of 355 tonnes (11.4
> million oz) and 259 tonnes (8.3 million oz) respectively, reducing stocks
of
> "earmarked gold" at the Fed to 6,703 tonnes (215.5 million oz) at the end
of
> December 2001. Much of the decline in stocks over the past dozen years has
> represented gold being moved to London for leasing; indeed, gold flows out
of
> the Fed have in the past often followed hard on rises in the gold leasing
rate,
> as central banks shifted more gold to benefit from higher rates.
(Conversely,
> when leasing rates have been very low - the situation during much of the
second
> half of 2001 - it has not paid foreign central banks to move stocks out of
New
> York.) The improvement in security following the collapse of the Soviet
Union
> has also encouraged some European countries to repatriate their gold
> holdings. The ongoing decline in Fed stocks means it may eventually lose
the
> cachet of having the world's largest stock in its vaults, because US
reserves in
> Fort Knox alone are around 4,600 tonnes.
> The Bank of England has always maintained an active, if modest, trading
role in
> gold, both for the management of UK reserves and to match its sales of
> Sovereigns, of which it remains the official distributor. Between July
1999 and
> March 2002 the Bank of England acted as an agent for the UK Treasury,
which
> initially planned to dispose of 415 tonnes (13.34 million oz) or 58% of
the
> country's gold reserves (the sales target was subsequently revised
downwards).
> The Bank of England held seventeen auctions, initially for 25 tonne (0.80
> million oz) lots, the sales quantity per auction later being lowered to
the 20
> tonne (0.64 million oz) level. The final auction took place on 5th March
2002
> and brought the total amount of metal sold on behalf of the UK Treasury to
a
> little over 400 tonnes (12.86 million oz). Following the conclusion of the
sales
> programme the UK was left with a stock of 315 tonnes (10.13 million oz),
> slightly more than originally forecast.
>
> The sale of UK gold reserves generated a fair amount of controversy. The
> National Audit Office (NAO) was instructed to prepare a report into the
method
> and execution of the gold sales. This report came to the broad conclusion
in
> January 2001 that, in the designing and implementing of the sales
programme, the
> objective of selling 'in a transparent and fair manner while achieving
value for
> money' had been successful. However, the NAO report suggested that the
Treasury
> review the possibility of adapting the auction design or even using the
London
> gold fixing as an alternative or additional means of selling gold. This
> conclusion may well explain the subsequent decision (referred to above) to
> reduce the amount of gold offered at each auction.
>
> The Bank of England has played an additional role in the gold market as a
> recognised International Monetary Fund (IMF) depository. It holds gold on
behalf
> of many nations and often acts on their behalf in gold transactions.
Because of
> its unique experience with gold among central banks, it has done much to
develop
> the leasing and swap market, which is centred primarily on London. The
Bank of
> England also lends out to the market a small percentage of the UK's own
gold
> reserves.
>
> Many central banks have come to rely on the Bank of England in introducing
them
> to these gold market activities, which has resulted in even more foreign
gold
> reserves moved to the bank's vaults. And from the first steps of the
lending
> market, they have often entrusted the bank to execute other operations,
whether
> in derivatives or outright sales. Thus the Bank of  England has been at
the core
> of widening central bank involvement in gold.
>
> The leasing of gold became an integral and increasingly important part of
the
> more sophisticated gold market of the 1990s, especially in the provision
of
> liquidity to facilitate forward and derivative transactions.
>
> Central banks are the predominant source of leased gold. According to
GFMS, by
> the end of 2001 over 80 of them were providing through their deposits and
swaps
> more than 4,650 tonnes (150 million oz) to the market, earning a return on
an
> otherwise sterile asset. By comparison, under 500 tonnes (16 million oz)
of
> leased gold is available from non-official sources. Central banks, in
short,
> provide the market's liquidity.
>
> Moreover, the mobilizing of their gold for leasing has brought many
central
> banks back into the market for the first time in three decades, and given
them
> an insight into what else it can offer in terms of writing options on
their
> reserves or outright sales. Central banks have got a taste for earning a
return
> on gold through their leasing, making them eager to see how else they can
> profit.
>
> Central bank gold has provided liquidity for many gold market operations,
> whether gold loans or forward and option books by mining companies,
masking gold
> sales by central banks until the moment of delivery, underwriting
speculators'
> short positions, underpinning bullion dealers' consignment stocks, or
simply
> providing jewellery manufacturers with working metal. However, producer
hedging
> has provided up to two-thirds of the liquidity requirements much of the
time,
> except when a large central bank sale was underway calling for borrowed
metal to
> conceal sales in published gold stocks until it was all over.
>
> Initially, leasing often came from central banks in developing countries,
eager
> for some return on gold but, increasingly, major European central banks,
> including the Austrian, Belgian, Netherlands, German and UK central banks,
came
> to participate. Even the Swiss National Bank joined in. GFMS estimate that
> between 1995 and 1999 over 60% of new leasing came from European central
banks.
>
> Thus the Washington Agreement of September 1999 in which 15 European
central
> banks announced, among other things, that they would not increase their
leasing,
> had an immense impact on the gold lease rate, which momentarily went to
10%
> Clear evidence of how the gold market has come to live on leased central
bank
> gold. Although less than 15% of all world official gold holdings are
currently
> leased, the Washington Agreement, combined with the reluctance of other
large
> holders such as the United States to enter the leasing market has put a
question
> mark against the assumption that liquidity from the central banks will
always be
> readily available to the market. On the other hand, many central banks
have
> shown a reluctance to close out swaps and reduce their existing deposits.
This
> has been the case in spite of a slump in the level of gold leasing rates,
itself
> mainly caused by a reduction in outstanding producer hedge positions in
2001,
> which has continued in the first half of 2002.
> An open position resulting from a sale is known as a short position. It is
> created because the trader or speculator believes the price will fall and
he/she
> can cover later at a lower price and make a profit. For
> example, he/she may sell gold at $300 an ounce, hoping the price will fall
to
> $280 at which level he/she can buy to cover the position.
>
> The establishing of short positions can depress the price because it
implies
> steady selling. But going short can also cause problems both for the
individual
> and the market if, instead, the price rises. If
> substantial short positions have been built up (and there are examples of
> speculators being short between 1 and 10 million oz) a sudden increase in
price
> may force them to cover. Such a run for cover, known as a "short squeeze"
or
> "short covering" only accelerates the rise.
>
> In options the grantor or writer of a call is also potentially short
because
> he/she may be called upon to deliver gold and therefore will normally
delta
> hedge the position.
>
> The London Bullion Market Association (LBMA) was established in 1987 to
> represent the interests of the participants in the wholesale bullion
market.
>
> The LBMA comprises:  10 market making members who quote prices for buying
and
> selling gold (and silver) throughout each working day from 8.00 am until
5.00 pm
> (See also: LBMA Market Makers) 44 ordinary members, covering a wide range
of
> banks, trading companies, assayers and refiners, mints and security
companies 24
> international associates; a category of membership that was introduced
during
> 2000.
>
> The LBMA works with: The Financial Services Authority (FSA), which
supervises
> the major market participants, who operate under the London Code of
Conduct HM
> Customs & Excise on tax policy, such as Value Added Tax
>
> The LBMA maintains: The London Good Delivery List for gold and silver
through
> its Physical Committee
>
> The LBMA organises: An annual Precious Metals conference. The inaugural
event
> took place in Dubai in February 2000, a second LBMA conference was held in
> Istanbul in May 2001, with a third one following in June 2002 in San
Francisco.
> A fourth Precious Metals conference is planned to take place in Shanghai
in
> 2003.
>
> London bullion market clearing turnover:
> Annual daily averages
> Ounces transferred (millions)       Number of transfers
>  1997             36.8                        1,285
>  1998             31.2                        1,188
>  1999             31.0                        1,007
>  2000             23.2                           793
>  2001             21.5                           802
>
> Monthly daily averages
> Ounces transferred (millions)    Number of transfers
> 2002
> January         16.3                       662
> February       20.1                       822
> March           17.4                       714
> April              19.2                       739
> May               19.3                       744
> June               21.0                        842
> July                17.3                        744
> August           17.1                        718
> September      16.4                       728
> October          17.5                        659
>
> It is very unlikely we will see $500 gold in the foreseeable future, let
alone
> another all time high.
>
> Henry C.K. Liu
>
>
> Jas Jain wrote:
>
> > The move up in the price of gold, for the past year or so, has been
> > primarily driven by fundamentals. In order of decreasing importance they
> > are:
> >
> > 1. Very low short-term rates
> >
> > When the risk-free returns on short-term instruments were 5-6%, the cost
of
> > carrying gold was relatively high. With rates now close to 1% there is
> > little reason to risk paper money.
> >
> > 2. Falling Dollar
> >
> > The price of gold has been lot more stable in terms of Swiss franc and
the
> > Euro. As dollar has been falling, it automatically has given boost to
gold.
> >
> > 3. Risk Inherent in Paper Currencies
> >
> > This would become far more important as the world economies slide into
> > depression. Currently, a small risk premium has come into play in people
> > wanting to put their savings in gold.
> >
> > These fundamental forces alone should take the gold price to $500 an
ounce
> > over the next two years. However, once speculators get the whiff there
is no
> > telling how far the price of gold could go.
> >
> > To gauge how far speculation could take the price of an ounce of gold,
we
> > resort to numerology, or relative prices of assets under speculative
fervor.
> > And what better guide than NASTYQ!, aka NASDAQ, market. We surmise that
an
> > ounce of gold is worth at least as much as a share of NASTYQ! Since
NASTYQ!
> > peaked at 5,148, we project that $5,148 for an ounce of gold is not only
not
> > farfetched but a realistic target. Conversely, the low price of gold in
> > recent years, around $260, is a good target for NASTYQ!
> >
> > Gold is real money. Paper money is based on faith only. Who do you have
> > faith in? How many governments have fallen and how many paper currencies
> > have disappeared for good?? You need to have a very long time horizon to
> > answer these questions properly.
> >
> > Jas
> >
> > _________________________________________________________________
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>
>