Uk Housing Reflationary Policy 2008 Sep

The Denver Gold Forum 2008 Gold – Has it run into trouble? Dr. Martin Murenbeeld September 9, 2008

The work of economists requires accuracy and good judgment!

1

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

Gold Price Scenarios 2007-avg

Scenario A: p.=.10% Scenario B: p.=.60% Scenario C: p.=.30%

2007-end

2008-avg

$661 $630 $587 $679 $736 $790 $698 $832 $968

___________________________________________

Probability-Weighted: $683

$754

$823

Actual:

$836

$???

$695

(Jan-Aug 2008 average: $906) 2

What Happened? Our forecast was not aggressive enough … 1.

2.

3.

4.

3

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

Overview Gold reacted sharply to the crisis … 1100

Bear Stearns

1000

Freddie Mac Fannie Mae

R2=.98 Credit crisis begins:

900

ECB pumps €95bn into eurozone banking system

800 700 600 500

si Ba

Cyclical Turning Point

d( n e ptr U c

2)

$638

(1) trend p U c i Bas

400 300

Friday data Last date: September 5, 2008

200 01

4

02

03

04

05

06

Last 07 date: March 08 23, 2007

Overview … but has since returned to its basic uptrend! 1050 Bear Stearns

1000 May 12,’06 high not exceeded until Sep 19,’07 That’s 16 months!!!

950

Freddie Mac Fannie Mae

900 850 800 750 700 650 600 ) d (2 n e r Upt c i s Ba

550 500

50-day moving average

200-day moving average

450 400

Daily p.m. fix Last date: September 5, 2008

350 05

5

06

07

08

Overview: Remember, gold always “corrects” in its long cycle 1600 1400

Shortest bull-cycle – 10 years 1200 1000 800 600

Real Gold Price - 2007$/oz

Several years of “countertrend” developments

400 200

10-year MA

0 1800

6

1825

1850

1875

1900

1925

1950

1975

2000

Our Eight Bullish Arguments: 1. 2. 3. 4. 5. 6. 7. 8.

7

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

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

There are only three ways to “stimulate” an economy: 1. Ease monetary policy – cut interest rates – print more money 2. Increase government spending – enlarge the budget deficit – cut taxes 3. Devalue the currency – boost exports – dampen imports Thereafter tariffs and trade wars …! 8

(1) Monetary Reflation US rates are low, foreign rates will follow 4 3 2

US real short term interest rate

1 0 -1

When below zero very positive for gold

-2 -3

When above 2% not positive for gold

-4

Last month: August 2008

-5 90

9

91

92

93

94

95

96

97

98

99

00

01

02

03

04

05

06

07

08

(1) Monetary Reflation US economy is in “recession” 700 600 500

US Job Creation 3-month MA – 000’s

400 300 200 100 0 -100 -200 -300 -400 -500

Mid-Cycle Slowdown

Recession?

US recession Last month: July 2008

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

10

(1) Monetary Reflation The US housing sector is a disaster 2700

1500 US recessions

new home sales (000’s)

2500

1350

2300

1200

2100

1050

1900

900

1700

750

1500

600

1300

450

1100

300

900

150

700

housing starts (000’s)

Last month: July 2008

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

11

0

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

180 160 140 120 100 80 60 40 US

JP

Can

UK

Source: OECD Economic Outlook – June 2008

12

GE

FR

IT

Spain

Switz

(1) Monetary Reflation Debt has risen sharply in US (and the world) 230

15.0

Last quarter: Debt 2008-Q1 Savings 2008-Q2

220

13.5

Savings Rate % of PDI

210

12.0

200

10.5

190

9.0

180

7.5

170

6.0

160

4.5

Total Outstanding U.S. Domestic Debt

150

3.0

% of GDP

140

1.5

130

0.0 Last quarter: 2007-Q4

120

-1.5

52

13

56

60

64

68

72

76

80

84

88

92

96

00

04

08

(1) Monetary Reflation Baby-boomer entitlements will stress budgets The US Congressional Budget Office estimates that federal government spending as a % of GDP will rise beyond 30% in coming years on the back of entitlement programs.

But it isn’t only the US that will see rising entitlement payments! Source: WSJ, April 3, 2008

14

(1) Monetary Reflation US deficits are already rising dramatically … 400 200

4

Budget deficit

US recession

2

(billion $)

0

0

-200

-2

-400

-4

-600 -800

Budget deficit (percent of GDP)

-1000

What will F&F do to the deficit? And will the Fed buy debt? Last quarter: 2008-Q2

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

15

-6 -8 -10

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

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

16

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

Print more money: If the Fed can monetize Bear Stearns securities to prevent a "crisis," what is to prevent it from monetizing the U.S. Treasury's outstanding debt — as it is doing constantly on a small scale anyway – when Social Security and Medicare costs overwhelm the federal budget? The Fed has always — ALWAYS — been subservient to the Treasury. So when some future Executive with his agreeable Congress must fund burgeoning Social Security payments, and pressures the Fed to keep interest rates "low" so that the Treasury can market new securities to pay Social Security benefits, what will a pliant FOMC reply if it has the precedent of Bear Stearns in 2008? Will it say, "No, Mr. President; we cannot buy any more securities right now. That would cause inflation, and violate our pledge to keep the dollar stable?" CATO Institute: “The Imperial Fed: Does it Have Enough Power?” April 14, 2008

17

(1) Monetary Reflation Global liquidity drives gold 60

42

48

35

Global Liquidity yoy% 36

28

correlation =.57 24

21

12

14

0

7

-12

0

-24

-7

Gold yoy%

Latest month: Gold: Aug 2008 Liquidity: Jun 2008

-36 82

85

88

91

Global Liquidity: FX Reserves + US MBase Source: IMF, Federal Reserve 18

94

97

00

03

06

-14

(2) US Dollar The Dollar peaked in 2002 … and bottomed in 2008? 120

Dollar Index: Euro, Yen, Pound, CDN Dollar 2

January 25, 2002

115

(Jan 1999=100)

R =.98

110 105 100 95 90

$638

85 80 75

March 14, 2008 “Bear Stearns”

Friday data Last date: August 29, 2008

70 96

19

97

98

99

00

01

02

03

04

date: March 23, 05 Last06 07 082007

(2) US Dollar Gold moves inversely with the Dollar/Euro … 1.60

R2=.98

1.57

1020

The US Dollar in Euros

1.54

980

1.51

940

1.48

900

1.45

860 Correlation

1.42 Correlation

1.39

820

2007: .94

2006: .75

$638

1.36

780 740

Correlation

1.33

2008: .50

1.30 1.27

700 660 620

Gold

1.24

580

1.21

Daily 2007 data Last date: March 23, Last date: September 2, 2008

1.18

2006

20

1060

2007

2008

540 500

(2) US Dollar But it is time to shift our Dollar frame-of-reference … 120

Dollar Index: Euro, Yen, Pound, CDN, Aus, 2 Rupee, Yuan, SF R =.98

January 25, 2002

115

(Jan 1999=100)

110 105 100 95 90

Euro + CDN = 51% Yuan + Yen = 37%

$638

85

March 14, 2008 “Bear Stearns”

80 75

Friday data Last date: August 29, 2008

70 96

21

97

98

99

00

01

02

03

04

March 08 23, 2007 05 Last 06date:07

(2) US Dollar US trade deficit with China is unsustainable 2 0

Last month: June 2008

-2 -4

20 0 -20 -40

US Trade Balance - China monthly total

-6 -8

-60 -80

-10 -12

-100 -120

12-month total

-14 -16

-140 -160

Billion$

-18 -20

-180 -200

-22 -24

-220 -240

-26 -28

-260 -280 96

97

98

99

00

01

02

03

04

05

06

07

08

(2) US Dollar The RMB and Asian currencies need to rise 2000

2

FX reserves April 2008: $1.76 trn

3 4

1750 1500

The Chinese RMB was devalued at year-end 1993 by 34%!

5 6

1250 1000

RMB/US$ 7

750

8

500

9

250

10

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

23

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

Country

Current* currency/$

24

Estimate** Change currency/$

%

China India Japan Malaysia

6.850 43.88 108.8 3.393

5.450 37.10 90.10 2.470

25.7% 18.3% 20.8% 59.2%

Canada Euro***

106.2 1.467

102.0 147.0

4.9% 0.2%

Russia S Arabia

24.65 3.751

23.50 3.410

4.9% 10.0%

* Aug 29,08 ** July 2008 *** Inverse rate

(3) US Dollar Reserves Foreign exchange reserves have exploded 7.0

84

Global FX Reserves

Global FX Reserves

72

6.0

Trillion$

% change yoy

5.0

60

65-70% of FX Reserves are in US$!!

48 36

4.0 3.0

24

2.0

12

1.0

0

0.0 -1.0

-12 69

73

Source: IMF 25

77

81

85

89

93

97

01

05

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

Foreign Exchange Reserves (countries over $50 bn) bn$ China

1779.1

Japan

Algeria

133.2

973.8

Malaysia

124.4

OPEC

527.0

Thailand

103.0

Russia India Taiwan Korea Brazil Singapore Hong Kong

554.1 302.3 291.4 257.7 199.8 176.7 158.9

Mexico Libya Poland Turkey Indonesia

93.0 88.6 79.2 75.5 55.1

Source: IMF - IFS June ‘08

26

bn$

Total

5973.0

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

350

600

280

Gold $/oz

500

210

400

140

300

70

200

0

100

-70

OPEC Current Account Balance $bn

0

-140

69

27

74

79

84

89

94

99

04

(4) Gold is “cheap” Gold cheap in constant Dollars 1750

Last date: 2008-Q2

Gold peak of $850 translates into $2300 in today’s money!

1500

Gold: Real Average price $602

1250

(2008-Q2$)

1000

750

500

250

Gold: Nominal average price $334 0

70

28

72

74

76

78

80

82

84

86

88

90

92

94

96

98

00

08

08

08

08

(4) Gold is “cheap” Gold is near an all-time low in terms of oil 49

Maximum 44.47 42

Last quarter: 2008-Q2

Barrels of oil per ounce of gold

35 1 St. Dev. (7.06)

Average 16.78

28 21 14 7

Minimum 6.95

1 St. Dev. (-7.06)

0 70 72 74 76 78

29

80 82 84 86 88 90

92 94 96 98 00

02 04 06 08

(4) Gold is “cheap” Gold “cheap” in terms of financial assets 30

Ratio: S&P vs. Gold 1871 = 1.00 S&P Index: 1941-43=10.0

Peak - 2000 25

•Recession 1973-1975 •Gold “cut loose” in 1971 •Gold cut 5 years after peak

20

15

10

•Depression 1930-1933 •Gold revalued to $35 in 1934 •Gold revalued 5 years after peak current

5 gold = $6275 with 1275 S&P

0 1870

1880

1890

1900

1910

1920

1930

1940

1950

1960

1970

1980

1990

With gold = $800 then S&P = 162 30

2000

2010

(5) Supply Model suggests WW mine output decline 2450

2100

Actual Western World Mine Output (Tonnes)

1750

Source: GFMS

1400

1050

Model Estimate

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

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

31

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

ƒ Loose gold totals about 4000 tonnes ƒ Some have sold gold in the past ƒ But now want more gold again, i.e. Argentina

tonnes WORLD TOTAL 29770.2 Subject to CBGA 12471.3 Unlikely to Sell 10319.4 US 8133.5 Japan 765.1 China 600.0 ing! y u b s i a Russia Russi 463.1 India 357.7 Official Institutions 3343.2 IMF 3217.0 BIS 126.2 LEFT OVER 3636.4 Source IMF - Jun '08

32

(6) Demand Consumer demand solid through 2007 Billion US$

Jewelry plus Net Retail Investment Demand

7 6

8

US - $bn

Recession

7

China - $bn

6

5

5

4

4 3

3

2

2

1

1

0

0 1996

1997 1998

1999

2000 2001

2002

2003 2004

2005

2006 2007

70 60

1996

1997 1998

1999

2000

2001 2002

2003

2004

2005 2006

2007

18

World - $bn 15

India - $bn

50 12 40 9

30 20

6

10

3

0 1996

1997 1998

1999

2000 2001

2002

2003 2004

Source: World Gold Council, GFMS

33

2005

2006 2007

0 1996

1997 1998

1999

2000 2001

2002

2003 2004

2005

2006 2007

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

1000

•

Gold demand is also stimulated by market deregulation and improvements in distribution of gold products …

900

80 tonne decline

Last date: August 28/08

800 700

GOLD TONNAGE - ETF

600 500 400 30 tonne decline

•

34

… and gold demand benefits from the shift to commodities as “an asset class”

300 200 100 0 2003

2004

2005

2006

2007

2008

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

60

Managed assets $ 55 trillion

50 40 30

Managed commodities $ 250 billion

20 10 0 Equities

Private Debt

Government Debt

Source: McKinsey & Company, IMF, Barclays

35

Managed Assets

Managed Commodities

(7) Commodity Cycle The shortest copper cycle lasted 16 years 600 550

Shortest cycle – 16 years 500

Real Copper Price

450

2005 cents/lb

400 350 300

10-year MA

250 200 150 100 50 1850

36

1875

1900

1925

1950

1975

2000

(7) Commodity Cycle The shortest wheat cycle is 13 years 40 35

Data affected by Russian shortages

Real Wheat Price 2005$/bushel

30 25 20 15 10

Shortest cycle – 13 years

5

10-year MA

0 1800

37

1825

1850

1875

1900

1925

1950

1975

2000

(8) Geopolitical Iran had an impact the last time around 900 800 700

about $400 (or 100%)

Cyclical peak in gold

600 500 400 300

Iranian hostage crisis / Russia in Afghanistan Gold Price: 1979-1980

200 30-Jul-79 11-Oct-79 28-Dec-79 13-Mar-8030-May-8012-Aug-80 24-Oct-80 14-Jan-81 27-Mar-81

38

(8) Financial Gold always rises when “financial system” at risk 525 500 475

Mexican Debt Crisis

450 425 400

Penn Square Collapse

375

about $180 (or 60%)

350 325

Gold Price: 1981-1983

300 275 Daily data November 7, 1981 to December 30, 1983

250 02-Nov-81

39

09-Feb-82

14-May-82 17-Aug-82

17-Nov-82

23-Feb-83

31-May-83 31-Aug-83

30-Nov-83

Bearish Arguments Unfortunately … there are some strong ones:

1.

2.

3.

4.

5. 40

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

(1) Euro Turning Points Will gold follow when the euro declines … or …? 1000

1.80 Gold not correlated with Euro

Euro in US dollars (Reconstructed prior to 1999)

900 800

1.50

Gold correlated with Euro

700

1.35

600

1.20

500

1.05

400

0.90

300

0.75

Gold Last month: August 2008

200

79

41

1.65

81

83

85

87

89

91

93

95

97

99

01

03

05

07

0.60

(2) Recessions Gold often declines on back of US recessions 1000

US Recession 900 Probable US Recession

800 700 600 500 400 300 200

But gold didn’t decline during the last recession!

100

Last month: August 2008

0 70 72 74 76

42

78

80 82

84 86 88

90 92

94 96

98

00 02 04 06

08

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

US Recession 450 400 350 300 250 200 150 Reuters-Jeffries CRB Index

Probable US Recession

(19 commodities)

100

Last month: August 2007

50 70 72

43

74 76

78

80 82 84 86

88

90 92

94 96

98

00 02

04 06

08

(3) Real Interest Rates Real rates will rise again when the crises pass 4 3 2

US real short term interest rate

1 0 -1

When below zero very positive for gold

-2 -3

When above 2% not positive for gold

-4

Last month: August 2008

-5 90

44

91

92

93

94

95

96

97

98

99

00

01

02

03

04

05

06

07

08

(4) Dehedging Will End … and gold will lose this “demand” component Year 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Total

Hedging Net 4 38 62 45 149 353 178 234 66 135 142 105 475 142 504 97 506 3235

Year 2000 2001 2002 2003 2004 2005 2006 2007 2008

ASSUMED 2009 2010 2011

-300 -200 -32

Total

-3235

source: GFM S, M urenbeeld estimates 45

Dehedging Net -15 -151 -412 -289 -438 -92 -410 -446 -450 (e)

A simple calculation suggests that there will only be about 530 tonnes of gold left to be “dehedged” at the end of 2008!

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

Gold Price Scenarios 2008-avg

Scenario A: p.=.15% Scenario B: p.=.40% Scenario C: p.=.45%

2008-end

2009-avg

$860 $738 $686 $876 $820 $823 $897 $930 $1002

___________________________________________

Probability-Weighted: $883 $869 (Jan-Aug 2008 average: $906)

46

$883

Gold has run into short-term trouble. Over the next several years gold must depend on “reflationary” policies. We think such policies will be introduced to deal with weak economic growth and “disinflation”. The gold market will be volatile in the meanwhile. The long-run outlook remains positive!

THANK YOU 47