Introduction to Session Four: Debate The Importance of ... · Middle East is behaving particularly badly, for a rush of investment buying into gold, seeking an ... fundamentally the

The LBMA Precious Metals Conference 2006, Montreux Page 63

Introduction to Session Four: Debate The Importance of Jewellery vs. Investment to the

Gold Market

Stewart Murray

LBMA Chief Executive

We now come to the final session of the day, which is a debate on the relative importance of jewellery and investment in the gold market. This is rather similar in format to the debate we had in Johannesburg, which was about hedging and which proved to be very popular. Today’s debate is going to try to elucidate what the important factors are in these two forms of gold demand, but more importantly, the four debaters are going to try to persuade you to change your mind on whether investment or jewellery is more important to the future of the gold market.

Perhaps the most famous debate in history was Cicero’s defence before the Roman Senate of Caelius, who was facing a number of charges, including sedation, theft and political assassination.

Cicero won this debate by persuading the Senate that his opponent, the prosecuting council, a man called Claudius, was both immoral and untrustworthy and also that his sister, Clodia, was a lady of easy virtue. I am sure that none of the panel are going to descend to the levels of personal insult used by Cicero, but they are here to try to persuade you that they are right and that their opponents are wrong. These will not be four boring presentations. We want them to feed off each other’s comments and to knock down the arguments that the opponents put up.

We have four fantastic debaters for you this afternoon. I won’t read through their biographies; these are in the programme and I’m sure they are very well known to all of you. But before we start, we are going to find out what you think of the motion that is before this house by having you vote on it. The motion is “This house believes that jewellery demand is more important than investment to the prosperity of the gold market.” The result will be revealed at the end of the debate, when you will vote again and we can see whether the four debaters have changed your minds on this subject.

[For debate contributions, see following pages.]

What we’re going to do now is have a second vote, if you have marshalled the arguments in your head and decided whether you have changed your mind or not since the beginning of the debate. Just to remind you, if you now believe that jewellery is more important, vote for the motion, and if you think investment is more important, vote against it.

First we’ll look at what the vote was at the beginning of the debate. In fact, 53% of you thought that jewellery was more important. Next, we’ll see if your views have changed as a result of the debate.

Clearly the advocates of investment have won significantly. Congratulations to Andy and Chris and commiserations to the gallant losers, and that brings the afternoon to an end. ■

53%43%

47%57%

I agree

I disagree

Before After

The MotionThis house believes that jewellery demand is more important than investment to the prosperity of the gold market



Session Four: Debate The Importance of Jewellery vs. Investment to the

Gold Market

Kelvin Williams

Former Executive Director, AngloGold Ashanti Ltd

Time is short, and this leaves little opportunity for polite padding, no thankyous to the LBMA for the invitation, etc, and certainly no jokes about investors.

I must say that – for the purposes of this debate – there is no more important guarantor of the long term health of the gold market than a healthy demand for gold in jewellery. This doesn’t mean that one doesn’t like investor demand, and ideally one would prefer to have both all the time but, expressed in terms for our multicultural, multilingual European audience today: “Einem geschenkten Gaul schaut man nicht ins Maul” – “I cavalo donato non si guarda in bocca” – “Ne pas donner des confitures à un cochon”. To put my view towards investment demand in plain English, “Don’t look a gift horse in the mouth”.

But for gold producers who produce gold daily, weekly, and not seasonally, or cyclically, we need a buyer every day, every week, every month, all year. The central banks who were our primary customers of first and last resort in the decades before 1985, have these past twenty years become net sellers of our metal in competition with us, and there is no other buyer in the business of gold with a size and a consistency of demand to match the jewellery market. The importance of this size and consistency is pertinent to every player – refineries, banks, gold dealers, fabricators, and, yes, also owners - in the real market for the metal, gold.

If one is part of the business of gold, one can hardly afford to wait for the three or four year period every decade when the US dollar is weak, or commodities are hot amongst the newest generation of investment managers, or the Middle East is behaving particularly badly, for a rush of investment buying into gold, seeking an essentially temporary home from other currently less happy investment, only to disappear as buyers for the next ten years and, worse still, become sellers of the metal as they did so damagingly not only to gold, but to all commodities through the 1990s.

Those who forget their history are doomed, I fear, to repeat it. As Voltaire observed: “History does not repeat itself, men do”.

By contrast, it was physical demand from the booming jewellery markets of the world and particularly from the developing world that held the floor for the gold market during those tough years in the 1990s, and that stopped the investors from pushing the metal price further down that the low prices we actually endured.

Jewellery demand for gold has the great merit that it is driven by a variety of different – and often unrelated factors – in quite distinct jewellery markets across the world. The jewellery market is not a monolith, and it is all the more valuable for being made up of different parts.

Demand for gold jewellery in the USA is driven by quite different circumstances than demand would be in India. Or in the Middle East. This spectrum of circumstances and influences makes the offtake of gold in jewellery more robust than it would be as part of, say, a single global investment climate. A weak US dollar and a high oil price might eventually depress US consumer demand, but would lead to record levels of gold offtake in the Middle East. Whilst Western

Debate: Jewellery vs. Investment Kelvin Williams


market demand for gold is highest in the last four months of the year in the run-up to Western Christmas, Chinese demand is strongest early in the first two months of the calendar year with Chinese New Year, and Indian demand responds at other times of the year to the ending of monsoon season and to astrologically auspicious wedding seasons. It has other particularly useful characteristics, in that large parts of gold jewellery demand – like the US market – are relatively price-insensitive, whilst other important markets show useful price elasticity in that whilst they may buy less gold in a rising or volatile price environment, they most certainly buy increasing amounts of gold when the price weakens, thereby providing exactly the kind of buying support which the gold market needs when prices fall.

It is, in short, a most favourable market place for anyone concerned about clearing into safe and largely non-reselling hands the flows of metal which this market has to deal with every day from both current producers such as ourselves, and from countless numbers of the individual holders of stocks of gold above ground.

Because it has performed in aggregate, globally, so well, it is common to take jewellery demand for gold for granted (or even more foolishly, from the conspiracy camp of believers that Fort Knox is empty of gold, to attack gold demand in jewellery as destructive of the sacred monetary role of gold).

I would urge you not to take jewellery for granted. Imagine, if you can, if demand for gold in jewellery were to fluctuate in fashion or in cycles – the way investment demand for gold does. Where whole markets, like the USA, stopped buying gold in jewellery for five or ten years.

What if gold jewellery buyers or holders turned into sellers a là the official sector these past fifteen years? Perhaps it is when one considers what the condition of the gold market would look like if one of those events were to happen, one comes to appreciate more how fundamentally the prosperity of our market is founded on the buyers of gold jewellery.

It is important to recognise that jewellery demand cannot be taken for granted. Jewellery demand is neither as mindless nor as inevitable nor as uninfluenceable as the gold-as-money fundamentalists would have it. We have seen in recent years several warning signs that markets and values change, and that consumer demand for gold in jewellery is by no means a kind of biological given in all countries, in all stages of development, anywhere and everywhere in the world.

The first of these warning signs comes from the retail market of Japan, where Intergold, and then World Gold Council promotion, of gold saw Japanese demand for gold in jewellery grow steadily from 30 tons a year in the early 1980s to a peak of 126 tons of offtake in jewellery in that market in 1993.

JAPAN JEWELLERY OFFTAKE

0

50

100

150

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

tonnes

0

50

100

150

200

Yen

bn

Gold Promotion (RHS)

Gold Demand (LHS)

NEW YORK COMEX: COTR FOR GOLD (FUTURES & OPTIONS)1996 - 2001

-10

-5

0

5

10

15

Jan-

96M

ar-9

6Ju

n-96

Sep-

96De

c-96

Feb-

97M

ay-9

7Au

g-97

Nov-

97Ja

n-98

Apr-9

8Ju

l-98

Oct

-98

Dec-

98M

ar-9

9Ju

n-99

Sep-

99No

v-99

Feb-

00M

ay-0

0Au

g-00

Oct-0

0Ja

n-01

Apr-0

1Ju

l-01

Oct-0

1De

c-01

M O

zs

250

270

290

310

330

350

370

390

410

430

US$/

oz

NEW YORK COMEX: COTR FOR GOLD (FUTURES & OPTIONS):2002 – TODAY

0

5

10

15

20

25

Jan-

02Ap

r-02

Jun-

02Se

p-02

Dec-

02M

ar-0

3M

ay-0

3Au

g-03

Nov-

03Fe

b-04

Apr-0

4Ju

l-04

Oct-0

4Ja

n-05

Mar

-05

Jun-

05Se

p-05

Dec-

05Fe

b-06

May

-06

M O

zs

250

350

450

550

650

750

US$/

oz

Debate: Jewellery vs. Investment Kelvin Williams


From that year, however, WGC funding for the Japanese market was cut radically in order to fund promotion and programmes in newly-opening markets, particularly in India, China and South East Asia. By 1996, WGC spending on the gold jewellery market in Japan had fallen to only $500,000 and with this withdrawal of promotion came to end of gold jewellery in that market. By the early 2000s, offtake had fallen from 126 tonnes to 40 tonnes.

Similar stories are repeated in France, Germany and particularly Italy, where gold jewellery consumption has fallen since its high of 113 tons in 1997 to a recent low of 71 tons only. Whilst offtake of gold in jewellery has been maintained in the USA and more recently with more consistent funding and better management by the WGC, has grown, it is important to remember that this growth has been at a rate far lower than the rate of growth of consumer spending in the USA in general, and of spending in the luxury/discretionary sectors in particular. We have maintained offtake, but lost market share.

Gold producers simply do not do enough to look after the health of gold offtake in the most important sector of offtake, jewellery. Some do their bit, but 70% of producers do nothing, leaving the burden on the remaining 30% unbearably high.

The best of both worlds would surely be to make sure that we have, and enjoy a strong, healthy, annually growing jewellery market to provide the daily and weekly floor demand to support our price and to clear the market of the flows of metal on offer, and still enjoy the cyclical benefits from time to time when the Sleeping Beauty of investment deigns to wake up and pay us some attention for a while before disappearing – if you’ll forgive me – with another prick (of the bubble, that is). ■




Gold Market

Andy Smith

Analyst, Bracteà Asset Management (The Ridgefield Capital Group)

“Happiness: an agreeable sensation arising from contemplating the misery of another.” Ambrose Bierce, ‘The Devil’s Dictionary’, 1911

It goes without saying that my past year in a group of commodities and precious metals investment funds will in no way bias my remarks. Investors can be short too, or length-challenged as we must now say. Nevertheless, I’m required to preface my comments with the customary rigorous disclaimer, vetted by leading international auditors not yet serving prison time.

IMPORTANT: This presentation is intended for the use of individual delegates and may contain information that is confidential, plain wrong or unsuitable for overly sensitive persons with low self-esteem, no sense of humour or irrational religious beliefs. If you are not the intended recipient, any dissemination, distribution or copying is not authorised and constitutes an irritating social faux pas. Those of you with an overwhelming fear of the unknown will be gratified to learn that there is no hidden message revealed by reading this warning backwards. However, by pouring a complete circle of salt around yourself you can ensure that no harm befalls you and your pets.

Neither is our fund’s mission statement ‘rape and pillage’; we don’t do rape. Our objective is closer to that of Louis Napoleon. His life-goal, according to our keynote speaker, Professor Niall Ferguson (in The House of Rothschild), was to amass “plenty of money so that he can roger comfortably and get drunk when he likes.” But let’s assume for today’s purposes that funds know something about ‘prosperity’ or ‘enrichment’ as it’s now known. Rather less than Mahmoud here, of course. Which is possibly why we have just about four minutes to make our case. He’s currently faced with what’s called (if not quite spelt) a ‘carat and stick’ alternative. But he’s said he would not exchange his ‘gold’ (Iran’s nuclear enrichment plans) for ‘walnuts’ (western trinkets). Could there be a more glowing and topical endorsement of investment over consumerism?

….. now, what does this one here do?

He’s not the first with such vision, as Kelvin will remember. In October 2001 the CEO of AngloGold, Bobby Godsell, alluded to the kind of pickle the Mahmouds of this world might foment. In his candour, Mr Godsell implicitly acknowledged the primacy of gold investment over jewellery. “I’ve never been a

Debate: The Importance of Jewellery vs. Investment to the Gold Market Andy Smith


fan of the disaster scenario by the way”, Mr Godsell admitted, “because it always seemed to me that the proposition was that the good news is that the gold price is at $600, and the bad news is that somebody has just nuked Islamabad.” Well, apart from a few bucks per oz and a few miles…here we are. ‘Enjoying’ in the gold market the bittersweet nature of Bierce’s ‘happiness’. Understandably, Mr Godsell was “not sure that’s the kind world I want to live in”. But we have to live with and in it. Fear is the new black. It’s fashionable to be frightened. Since when was the gold industry against being fashionable? And isn’t fear the more enduring fashion than the ‘hope’ that drives jewellery demand? It was ever thus: in 1848, as Professor Ferguson recorded, one commentator put his finger on the button of the Rothschilds’ success: “in Brazil there is plague, and war in Italy, America is falling to pieces – everything is going splendidly.”

Which points up the second logical argument for recognising the dominance of investment over jewellery. Everyone by now is surely a member of the Church of the Commodity Supercycle, in which eternal price levitation is written in stone, copper, soyabeans, rhodium, even gold. So it’s almost heresy to suggest price downside. But what type of demand does the gold market think will keep price erect? A clue, in the shape of this outstanding exhibit from the Shanghai sex museum: the fascination with hard assets is now international, if, in some cases, behind closed doors and still ignored by some. If you are bullish on price, you must believe that investment will have to keep it up. Jewellery is not so much for the birds, as for the bears. But don’t take my word for it. Greater organs than mine, and probably yours, are pretty clear about the pecking order of investment and jewellery for the market. Let’s examine what the ‘Golden Consonant’, the LBMAGFMSWGC, has to say:

Jewellery is for the birds/bears

2000 2001 2002 2003 2004 2005 2006**-1500

-1000

-500

0

500

cum

ulat

ive

chan

ge s

ince

200

0 [to

nnes

]

Jew

elle

ry c

onsu

mpt

ion ,

iden

tifie

d in

vest

men

t

200

300

400

500

600

gold

pric

e $/

oz

Cumulative 'identified' investment

Cumulative jewellery demand

gold price

Source: derived from GFMS 'Gold Survey 2006',World Gold Council 'Gold Demand Trends' May 2006[** 2006 is annualised Q1 data, from latter]

• LBMA: in the Montreux conference ranking, investment is Session 2 – the first after the compulsory welcome. Fabrication occupies the slot, or crevice, before closing, Day 2. Otherwise known as ‘purgatory’.

• Gold Fields Mineral Services: as Paul will acknowledge, the 2006 Gold Survey continues a trend begun in 1999, when they gained independence and so greater freedom to choose, by placing the



investment chapter third - the first substantive chapter after ‘summary’ and ‘gold prices’. Where’s ‘fabrication’? Chapter 7. Last. Ranked just above an appendix.

• World Gold Council: provide a 24-carat investment endorsement in their last Demand Trends. “we expect demand to recover…driven…by the increased desirability…that the price rise brings to the metal.” And in the US: “gold jewellery sales increase when gold is in the news.” And why is it in the news? Investment! Investment is important for the prosperity of …jewellery!

This is excuse enough to suggest the third major reason investment is the key to market prosperity – jewellery IS investment. I’ll develop this in a moment, but it seems to me that we can no more separate jewellery from investment than we can …

A budgerigarPresident of the

European Central Bank

Mr Burns Giscard d’Estaing

Pinocchio UK Prime Minister

Small tree-dwelling

creature

The England Captain

… you never see them in the same place at the same time, do you? QED. The case that jewellery IS investment is part of the argument that, since gold is, uniquely, ‘indestructible’, most of what we mistakenly call ‘demand’ and ‘supply’ should properly be redefined as ‘investment’ and ‘dis-investment’. After all, on the indestructible Titanic, the deckchairs were famously re-arranged, not supplied or consumed. If the market wants to preserve – for prosperity’s and posterity’s sake – gold’s unique brand, it’s time to throw traditional ‘demand/supply’ overboard. With one eye on the icebergs, I want to suggest that we are all (mostly) investors or disinvestors now.



S & D bars understanding

0 1,000 2,000 3,000 4,000 5,000

Demand

Supply

jewellery

'identified'investment

electrical/industrial

impliedinvestment

minede-hedging

mine output scrap official sales

tonnes

Source: derived from GFMS

Invest in a better brand

0 1,000 2,000 3,000 4,000 5,000

Investment

Dis-investment

jewelleryinvestment

'identified' investment

impliedinvestment

mineinvestment

mine output lesselectrical/industrial

privatedis-invt.

officialdis-invt.

tonnes

Source: derived from GFMS

• Disinvestment, unarguably, includes sales by central banks (from a 30,000+ tonne long position in

the vault) and private scrap sales (from a 100,000+ tonne long position in the ear, nose and other places displayed in the Shanghai sex museum).

• Investment, unarguably, includes GFMS’s ‘implied’ investment, ‘identified’ investment (coins,

bars, ETFs etc), plus, more arguably, mine de-hedging (adding to a long gold position underground which dwarfs that in central bank holes), plus… jewellery. All of it.

In this brave new order newly mined output (net of gold more or less used up in electrical/industrial demand) is a kind of condom on the market, keeping excess investment in check. But jewellery indistinguishable from investment? Pull the Shanghai sex museum exhibit? In fact, this argument has two prongs. First, we all agree, and Virtual Metals’ estimates confirm, that at least half of jewellery, the ‘upper class’ pure-gold half, can readily be classed as ‘investment-jewellery’. I’d argue further that every carat of jewellery deserves the hyphen. For 9 carat gold is as ‘forever’ an investment as a diamond – try selling either back. Second, both jewellery (in all its guises) and investment appeal to the same human frailty - personal vanity. Jewellery buyers are willing to pay a large mark up for some tiny (as a percent of bodyweight) accessory they think will turn them from a frog into a princess. Investors (at least in paper gold) are willing to pay contango (the premium of the future over the spot price) for a token gold holding (as a percent of their portfolio) to make them feel better, or look better to their peers. If/when Mr Ahmadinejad’s finger touches the button, will your first question really be: ‘Does my portfolio look good in this?’ No surprise that both sides of this investment coin use variations on the same marketing pitch. Heads: ‘jewellery’ hopes a billion Chinese will buy X grams each. Tails: ‘investment’ dreams that just 0.000003637 (approx.) of the $ trillions of investible money will stick to gold. Both sides are equally blinded by big numbers. So, logically, each should embrace the other in the dark. Finally, every business needs role models, thinking outside the (jewellery) box, if it is to prosper. Over four hundred years ago, Francis Bacon correctly diagnosed that “the mind grows languid that has no excesses.” The secret of gold’s success, its prosperity, surely lies in its excess?



Ask yourself, what’s the more inspirational: • Being ‘investment driven’ or watching

jewellery take a ‘back seat’ in what the proposers of this motion will tell you is a longhorn bull market?

• Embracing the Viagra of volatility or the Tylenol of tonnage, the deadening, almost Soviet fixation with volume, as if we’re in the tractor business?

• Bed rocks or the bedrock of jewellery? • Evangelical fervour or even-handed

pragmatism? (Gallup, by the way, notes fast-growing, newer age religion in the US “generates worship participation” and comes with “highly involving, if not entertaining services”. Hallelujah!) Every religion needs good sects.

Whatever turns you on

of volatility of tonnage

Bed rocks Bedrock

Comatose Rowan

$8000,

man

On the one

hand…

Purely in the interests of fair play (no mystery why the English almost never win World Cups) let me finish by addressing two of what I expect will be the most popular objections to the notion of investment as the secret of success. First, the accusation that ‘you can’t wear an investment’. Patently false, and an insult to jewellery makers and the structurers of investment products alike.

COMEX Eye Share, by Tiffany

Second, the heretical doubt that this ‘can’t last forever’. How are investors going to get out of underwater positions? Hedging is never a bad idea – but we had that debate last year. A more universally acceptable answer surely lies, with most hopes (and the best museums), in China. Where they’re busy making lifebelts, or manufacturing inflation, depending on your point of view. ■




Gold Market

Paul Walker

Chief Executive Officer, GFMS Ltd

The start of my piece today is to look at this topic in a reasonably serious light; Kelvin was, for once, the sexy part of our presentation, and I am going to try to focus on the data. The data always hurts and it really always wins through. The age of reason was, I think, a time when everybody talked about self evident ideas, and I started out thinking that it must be a self evident truth that jewellery is more important than investment, not to discount the importance of investment in certain times and certain places. However, at the end of the day this is a self evident truth.

What I am going to try to do today is go through some of the data and show you that some of the stuff that Andy was suggesting does not really indicate much. Quite frankly it is the only stuff we have and if we have to rely on pictures of Pinocchio to win the day then I wonder whether we are missing the point somehow.

The thrust of what I want to do today is to look at what the real definition of prosperity is. It is a serious issue as to whether we put our funding into something like jewellery or we look at investment and how we actually prioritise this expenditure over time. My first instinct was to look at this debate as one about price, and here I am going to become a little bit pedantic and look at some of the supply and demand balances and just look at some basic economics 101 as to how prices are ultimately determined.

It is probably appropriate that we are in Montreux, and so close to Lausanne, where the school of marginalist thinking was first started by Walras back in the 1870s. I thought I would give you a quote from one of his contemporaries, Vilfredo Pareto: ‘Give me the fruitful error anytime, full of seeds, bursting with its own corrections. You can keep your sterile truth for yourself’. Well, I will leave you to decide for yourself whether the undoubtedly fruitful errors of the opposers of this motion are indeed full of seeds or something of a slightly more base organic nature.

What the Lausanne school did was give us the foundations of economics 101, supply and demand, and this is a reality we really cannot get away from in this market. It is what drives the

price and it is a theoretical framework, but I think it is one that most of us will feel fairly comfortable accepting.

The equilibrium in a market is simply an intersection of supply and demand. The propensity of consumers to demand gold, all other things being equal – herein lies one of the key issues of the debate. How large is investment relative to the jewellery? The demand curve sits in the space between price and quantity. The truth of the matter is that investment as a component of this demand curve is a relatively small proportion. I know that data sometimes gets in the way of a good argument – and I am sure that today will be no exception – but the truth of the matter is when you have a look at the GFMS data going back 30 years, you

Debate: Jewellery vs. Investment Paul Walker


will see that with a little bit of empirical work, a little bit of travelling and a little bit of talking to people in this market place that the demand curve is more a function of jewellery than it is of investment.

I think the error that has been made here by the ‘investmentists’ is that they are mistaking what happens at the margin with what happens in terms of the overall magnitude of this market. This is really a size issue, and I think that the size of the jewellery market shows through in driving these supply and demand curves.

When you have investment – and it does kick in from time to time – there is no doubt that it is going to move the price. Depending on just how sensitive the market is around that equilibrium point, you can really have a dramatic impact on the price as we have seen over the last year and a half.

But the issue is, where does this market really start? Does it start from investment, and we have jewellery as some addition to it? Or is it really the case that jewellery is the bedrock of this market and that investment rides on the back of jewellery and the fluctuations that we see around this kind of market equilibrium price are just a

function of the vagaries of investment from one period to the next?

Kelvin referred to looking the gift horse in the mouth. Arguably I would say that most of the work is done by jewellery in this market place and that investment is what is happening at the margin. The market can survive and at reasonable price levels in the absence of investment demand; we have seen that throughout the 1990s. The price would simply collapse without regular and sustained demand from the jewellery industry. As Kelvin has already noted, for the market to have a reasonable price level and for it not to be incredibly volatile we need a buyer every day, every week and every month, and this is what the jewellery market provides.

If you have a look briefly at the supply and demand balances for GFMS in the table below, notwithstanding Andy’s rejection of this methodology, I think it does actually reveal something. You can see, for example, in the years 2001 to 2004 when investment and disinvestments were quite subdued, the world as we know it did not disappear. If this premise of investment is correct, then the price in the case of disinvestment would have been expected to collapse.

The fact that it did not is richly suggestive that there is something more important that drives the bedrock of this market and, of course, this is jewellery. Another issue overlooked by the ‘investmentists’ is the volatility that this brings to the market. Here you need to go into what is probably the notion of prosperity: is it price, or are there issues in this market? Of course, if you have a look at something like the Indian market, you have the better part of three million people working in the jewellery industry. If prosperity is defined more broadly than simply whether we have a higher price in this market, there is little doubt in my mind that jewellery is indeed the

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005SupplyMine Production 2,375 2,493 2,542 2,574 2,591 2,621 2,588 2,592 2,470 2,519Official Sector Sales 279 326 363 477 479 520 547 617 469 656Scrap 644 631 1,105 615 616 713 840 943 848 861Net Producer Hedging 142 504 97 506 - - - - - -Implied Net Disinvestment 83 257 - - 323 33 - - 59 -

Supply 3,523 4,210 4,107 4,172 4,009 3,887 3,975 4,153 3,846 4,036DemandFabricationJewellery 2,830 3,287 3,164 3,132 3,196 3,001 2,653 2,477 2,613 2,712Other 484 561 567 592 557 474 481 513 550 568Total 3,314 3,848 3,731 3,724 3,753 3,475 3,134 2,990 3,163 3,280Bar Hoarding 209 362 174 269 242 261 264 180 256 261Net Producer Hedging - - - - 15 151 412 270 427 131Implied Net Investment - - 203 179 - - 165 712 - 364

Demand 3,523 4,210 4,107 4,172 4,009 3,887 3,975 4,153 3,846 4,036



bedrock of the prosperity of this market going forward.

Of course, it is a mistake to construe high prices as necessarily being good for this market. All other things being equal, if you were to talk to the jewellery industry in India or elsewhere, I am sure that during the volatility and high prices that we have seen over the last two years that they have not been doing particularly well with those high prices – they definitely have had a negative impact.

The bottom line is that I think if you look at it from a prosperity perspective, jewellery is a sufficient condition for the long term prosperity of this market. The same cannot be said for investment. Most of us would agree the above-ground stock of gold bears down on this market; it is a point that Andy has made throughout the 1990s in the context of the European and central bank sales.

If we put private investment as 52% of the above-ground stock as opposed to jewellery, do we think the price would be where it is at the moment?

After all, demand would be similar, but in terms of what is bearing down on this market, when people are looking at the future price trajectory, when you are looking at the future prosperity of this market – if it were just private investment, there is no doubt that this would be bearing down on the market all of the time.

It is near market stocks of this metal that really matter. Jewellery has the unique capacity to sterilise a substantial proportion of the gold going into the market place. Have a look at the mark ups of jewellery going into the US market, Europe and elsewhere; 200% plus mark ups are not uncommon. This removes that metal from the market and, in terms of the long term prosperity of gold going forward, the more metal we remove from the market, the further away that it sits from the market, the longer we can expect to see sustained prices that are reasonable and prosperous for all.

There is, of course, a school of thought that there is no use in jewellery at all, and that if we were to change the story around completely and imagine a world in which private investment constituted everything that is out there – bar official sector holding and a bit of fabrication – there is very little doubt in my mind that the gold price would be significantly lower than we see today.

The last thing that I would like to say today is that the problem with investment is that, if this is the correct terminology to use, it is a double edged sword. On the upside it can be great, especially if the market gets less and less linear around the equilibrium we see. However, if it disappears, it is always going to be bearing down on the market, and expectations – and ultimately the price, when sentiment turns.

AboveAbove--Ground Stocks of Gold, endGround Stocks of Gold, end--20052005

Above-ground Stocks, end 2005 = 155,500t

Source: GFMS (Source: GFMS (Gold Survey 2006Gold Survey 2006))

Gold is not Gold is not ““consumedconsumed”” like most commodities; stocks can be like most commodities; stocks can be available at the right priceavailable at the right price……

Official Holdings

18%

Private Investment

16%

Other Fabrication

12%

Lost & Unaccounted

2%

Jewellery52%




Gold is not Gold is not ““consumedconsumed”” like most commodities; stocks can be like most commodities; stocks can be available at the right priceavailable at the right price……

Official Holdings

18%

Jewellery16%

Other Fabrication

12%

Lost & Unaccounted

2%

Private Investment

52%




Gold is not Gold is not ““consumedconsumed”” like most commodities; stocks can be like most commodities; stocks can be available at the right priceavailable at the right price…… Private

Investment68%

Official Holdings

18%

Other Fabrication

12%



The final point I would like to make is that investment is a function of jewellery demand. There is little doubt that market participants look at the jewellery industry as the bedrock of this market.

Investment would not take place without it – the price risks that people are willing to take when putting a punt on this market are a function of their expectation that jewellery will always be there.

On the downside, think back to the 1990s when the price was under significant pressure. If it had not been for jewellery would we ever have seen investment coming back into this market?

Jewellery formed the bedrock of the price. We would have seen substantially lower prices during the 1990s, were it not for jewellery.

I would just like to finish off with a quote from Friedrich August von Hayek who said, ‘Do not let those intellects whose desires have outstripped their understanding persuade you otherwise’. Or perhaps better, as John Galbraith once said, ‘In economics the majority is always wrong’. Do not let him be right today. Thank you. ■



Gold Market

Chris Thompson

Ex-Chairman, World Gold Council

Not many of my keepers have had the courage to drag me out of retirement to come and speak at a conference. In retirement, one develops a certain degree of immunity and unaccountability, which allows you to say things you might not have said in the past – and this is a wonderful opportunity for me to say some of those things. Time and reflection have allowed me to indulge in some thoughts about what this industry has been doing and even perhaps indulge in a little revisionism. I am the last to speak and nobody yet has framed the debate. Allow me to try for a moment to make this a little more focused.

There is only one statistical bible available to us and that is the GFMS bible that we all read. It says that something like 3,500 tonnes of new gold is produced by the industry and something like 3,500 tonnes or a similar figure is consumed by jewellery each year. A casual analyst and, I think, most people , could easily come to the conclusion that jewellery is therefore vital to the future of the business and that this is a one trick pony business; nobody else consumes gold in any significant amount. Ipso facto it is very easy to come to the conclusion that promoting jewellery should and would be the only business that we can pursue. Indeed I believe there is much more to it than that.

Let me focus you strategically on where we are as an industry. My comments here really go to the leaders of the industry and the sort of behaviour that we have all witnessed over the last few years. It is not difficult in my mind to come to the conclusion that there is only one word to describe the some of that behaviour and that is insane; incompetent is not strong enough. To what I can ascribe it, I do not know. Perhaps it is because the industry has been run by engineers, but maybe it was insane engineers.

Just consider the position we were in. When the Bretton Woods system was withdrawn and gold was declared to be no longer a reserve asset, central banks were sitting on 35,000 tonnes of gold. In addition, I believe there were about a further 25,000 tonnes sitting in bullion form in private hands. Against this, we had a jewellery market that consumed only 3,000 tonnes a year. Now if all those people who held bullion reserves decided to sell, nobody was going to

save our souls. 3,000 tonnes a year of consumption was hopeless. We needed and have always needed a larger supplemental market for gold. Otherwise all of us – you, me, producers, dealers, central banks – could all go home.

There have been a number of ridiculous examples of bad behaviour by this industry. Consider the WGC faced with this strategic crisis for years. The WGC, despite some very noble efforts, have been unable to get the industry together to deal with it. At best today – and today is probably the best performance they have had for years – they have been able to round up something like 40% of the producers to contribute a dollar or a dollar and a half to try to promote their product. Somebody from Coca Cola would be astounded at the low dollar spend on promotion by this business.

Producers of other metals do a much better job than we do and yet we have a much greater

Debate: Jewellery vs. Investment Chris Thompson


challenge facing us but also one of the greatest opportunities in front of us. Platinum and aluminium are good examples.

Let me give you another example of weird behaviour – the hedging debate we went through several years ago. At a time when central banks were selling gold, when the issue was becoming more and more prominent, the reaction of some companies was to go and sell their gold reserves in the ground in a falling market – and publicly congratulate themselves on how much money they were making on their hedge positions while their stocks tanked, and gold went from $450 to $250.

No amount of badgering by some of us who could see it happening could persuade people from doing it. It was only when the central banks stood up and formed the Washington Agreement, and thank God they did, that they stopped this lemming-like rush for the cliffs. If the banks had not done it, quite frankly we would not all be here; this would be a completely moribund industry. It is stunning in retrospect that the industry never got itself together to deal with it. In the meantime, while that was all going on, we were debating – and I do not understand why we are still debating – whether jewellery was going to save the ship. Nobody could realistically think that 3,000 tonnes demand a year could save this ship if everybody decided to sell.

I now have four arguments for why you should think jewellery is not the future. First of all, jewellery is in fact investment. I will not spend a lot of time on this, but somewhere between 65-75% of jewellery sold in the world is sold as high-carat jewellery and is bought and sold by weight, plus or minus a percentage, and is bought by women, a lot of them subject to Sharia law, where the jewellery they obtain becomes theirs and they can retain it in the event of divorce. It is unquestionably a financial asset and has extensive investment dimensions to it.

So only a small part of the jewellery sold around the world really is baubles, where the value of the product far exceeds the value of the gold content. It always amazes and surprises me – and I hark back to the days when we were trying to persuade other producers to join the WGC – how many mining CEOs have in their minds a public perception that the gold and jewellery we sell is the stuff that you see being sold over the counter in Zales in America. That is not what it is all about; jewellery is in fact the stuff we sell mostly through the Middle East and India and other places, where it is sold primarily as investment.

The second issue is slightly more complex, and with it I hope to be able to change some of the thinking in the business. We use entirely the wrong conceptual model for analysing the gold business. Unfortunately, it is the only one that we have, and because of the scarcity of good numbers, it is very difficult to change it.

The best way for me to explain it is by way of a parallel – the US housing market. The US housing market is roughly 120 to 130 million existing units; to which is added about 1.5 to 2 million houses a year. Some houses are torn down and destroyed as others are built; the total grows incrementally in small amounts. Nobody in their right mind would ever try to analyse the US housing market and the price of houses purely by looking at the supply and demand for new houses alone.

Yet we in this business – when there is arguably 80,000 tonnes of gold that is liquid in other people’s hands – analyse and focus only on the supply and demand for 3,000 tonnes a year, and that is simply the supply of new gold versus the demand for jewellery. This leads to a mindset and debate that says jewellery is all that is relevant; it is not. There is probably more than 70,000 tonnes out there, all of which is potentially liquid, with some notion of underlying value, some notion of when they might sell or might not sell, and some of which trades below the radar screen and we never see it. That, I argue to you, is the real gold market. Simply to measure jewellery conceptually is unsound.

What then are the possible implications of a business that really is only jewellery? Sometime back when I was CEO of Gold Fields, when everybody was selling all their gold for $250 and there seemed to be no end in sight, one of the responses we thought of was to integrate vertically. We would go and buy a refiner, buy some fabricators, buy up jewellery retailers and we would become top to bottom a gold producer, producing our own gold and selling at whatever price we wanted through the jewellers. It would at least, in the circumstances before the central banks decided on the Washington Agreement, possibly have guaranteed our survival.

There was no question that there were considerable cost savings through the integration step, and initially it seemed a great idea. In fact, it was a disastrous idea. Let me tell you why. First, if you go back over time, and I invite some of the analysts in the audience to do it, you will see that if you compare the PE ratio of the gold index with the S&P 500 PE ratio since the war through to today, on average gold equities traded

Debate: Jewellery vs. Investment Chris Thompson


about three times the multiple of the S&P 500 and this was a fairly stable thing. There is a weird phenomenon that we have lived with and know so well, which is that gold equities trade at a substantial premium to their underlying value. It is a mystery, but it became clear to me that the moment we turned Gold Fields into an integrated gold jewellery producer we would have become just like any other industrial company and the gold multiple would disappear. The other reason is that if we all did that and only focussed on selling gold to the jewellers and promoting that business, then all the bullion dealers would be out of business and the central banks would be looking for jewellers to sell their gold to. If we made jewellery the sole focus of our business, it would be the end of the business. The real business of gold is that it is a fiscal asset, it has mystique and it has a future elsewhere.

Let me talk a little about the vision and the prospects for the ETF. The strategic situation is that we have substantial holdings of bullion and a gold market for jewellery and little else. On top of that, for most of the last century there were restrictions on private ownership of gold at least in the US, South Africa and Japan. At the time it was difficult to think of developing the investment business, but at least it had some prospects. If 25,000 tonnes of bullion were owned privately through individuals and institutions at a time when there were severe restrictions, what would happen if we removed those restrictions and made it much easier and cheaper to buy and sell gold?

That intuitively is a very inviting prospect for an investment business. The ETF’s foundation point was to try to make it easy for people to own gold. Under US legislation, when the ownership of gold was prohibited, most investment mandates prohibited the ownership of gold and sometimes commodities. The challenge was to create an instrument that was a defined security without being gold which explains why it took so long to get the ETF listed because we had to define through sophistry an instrument that could be treated as a security.

Having done that, the door has opened for much wider ownership and potentially a much bigger market. The challenge ahead is to expand that ownership, because only then, if the central banks no longer have any formal reliance on gold as a reserve asset and can sell it, can we create a market that has a realistic opportunity of absorbing the gold. Even if the process persuades central banks that gold really is a valuable asset – and I think that is happening – then we will be able to restore gold’s prominence and prestige. That then is what the ETF is all about. It has only just begun – we are only through 500 tonnes – but the potential, if we can get pension funds to believe and we can get the liquidity levels up, is to make this a really exciting business again. ■


Documents

Introduction to Session Four: Debate The Importance of ... · Middle East is behaving particularly badly, for a rush of investment buying into gold, seeking an ... fundamentally the