The Private Investor

Transcription

1 Precious Metals Analyst, UBS AG We have heard from Diego and Steve about the activities of institutional and fund participation in commodities and gold. I will address the role of the private investor in the gold market. The graph below shows the strong performance of the gold price since the end of 2. In dollar terms the move from the 22-year low to a seven-year high of $39/oz has been impressive. For most of the time gold moved higher in an orderly manner but in December last year gold rallied sharply on fears of war in Iraq before rapidly reversing these gains. The weak US dollar has kept gold firm since this sell-off, but I m not here today to talk about the outlook for gold others will do that this week. Rather, I would like to talk about the role of the private investor in the gold market. Gold from January 1999 US$/oz Positive Performance 38 UK announces "Investment' Gold Sale led rally 36 E-15 Central Comex 'Long' Attack Bank Rally On US 34 Agreement 32 Lease Rate Spike 3 28 Producers to Risk 26 deliver into US Dollar Aversion hedgebooks Comex Weakness Returns Short-covering 24 Jan-99 Jul-99 Jan- Jul- Jan-1 Jul-1 Jan-2 Jul-2 Jan-3 As this chart indicates, gold appears to be negatively correlated to US equity markets. Certainly gold fell in the second half of the 199s while equities roared ahead and gold has rallied as equities have slumped over the past few years. Whether this constitutes negative correlation or not will be proved in the years to come. What certainly can be said is that the correlation coefficient between returns in gold and returns in other asset classes is very poor. Source: Reuters; UBS Warburg There are a number of reasons why private investors might contemplate gold as an asset class. Diversification Gold US T-Bills International Govt Bonds US Govt Bonds Equity REITs Asset Allocation Attractions Gold and S&P Emerging Markets International Equities S&P5 Index Level 12 8 Correlation US$/oz Correlations calculated between January 1992 to December 21 Source: World Gold Council 4 25 Jun-92 Dec-93 Jun-95 Dec-96 Jun-98 Dec-99 Jun-1 Dec-2 S&P5 Gold Price Gold appears to be negatively correlated to US Equities In the 199s, equity markets reportedly crowded out gold This is compelling argument for gold investment Source: Reuters, UBS Warburg This chart, lifted from a paper written by the World Gold Council, shows the correlation coefficients between the S&P 5 and other asset classes. Based on this analysis, gold should be attractive to asset allocation experts for its diversification properties. The LBMA Precious Metals Conference 23, Lisbon Page 39

2 In fact, gold may be even more useful than this graph shows. Work commissioned by the World Gold Council demonstrates that gold s negative correlation is especially pronounced during periods of financial or geopolitical turmoil. So to quote this body, can your portfolio afford not to be invested in gold? The relationship between the dollar-denominated gold price and the value of the US dollar is certainly well established, as the next chart shows. Private investors already hold vast quantities of gold, twenty two thousand tonnes or 15% of the total, which is $25 billion dollars worth at $35/oz. This sum dwarfs the total market capitalisation of gold equities, which is between 5 and 7 billion dollars, I believe. So the total value of gold ever mined is about 1.7 trillion dollars (at $35/oz), which is a serious amount of money even for a banker to think about. But not all of this is available to the market. We have tried to work out how much gold could come to the market in one year and called this immediately available. Gold and the US dollar 41 8 Availability of stock of above ground gold US Dollars per Ounce Correlation June 1991 to date = Index (Inverted Scale) $1.8 $1.5 Refining capacity and CB agreement constrained Jun-91 Jan-93 Aug-94 Mar-96 Oct-97 May-99 Dec- Jul-2 Gold Price US Dollar Basket (Inverted) Gold is inversely correlated to the US dollar The two data series can move out of line, ie and Q But the negative relationship has remained strong over time Trillions of dollars $1.2 $.9 $.6 $.3 Unaccounted for Private Investment Official Sector Jewellery and Fabrication $. Source: Reuters, UBS Warburg Total stock Immediately available Source: GFMS, UBS Warburg I have lazily shown the dollar-gold price vs. the futures basket of the US dollar, as this information was readily available the story is the same when more robust measures of dollar strength and weakness are used. In any case, it can be seen that the argument for investment in gold is particularly appropriate for holders of US dollars (or currencies tied to the US dollar) when dollar weakness is a market factor. So how much gold is out there? This slide, from GFMS s work, shows that 148 thousand tonnes of gold has been produced since mining started in antiquity. Disposition of stock of above ground gold We define immediately available total as all private investment in gold, the central bank gold not subject to no sale statements or limited sale agreements and 1, tonnes of jewellery representing the capacity of refineries to recycle scrapped gold in one year. Now even $5 billion dollars is a fair chunk of money, but it pales into insignificance compared to the market capitalisation of the global equity markets and the total size of the government and corporate bond markets. Gold makes up only about 1% of the potential investable universe. Only a very small change by asset allocaters would have a profound impact on gold demand, and thus the price. Total produced 147 8t or 4.7 billion ounces Official Sector gold holdings 2% Jewellery 52% Private Investment 15% Other Fabrication Unaccounted for 11% 2% Source: GFMS, UBS Warburg The LBMA Precious Metals Conference 23, Lisbon Page 4

3 So what have been the trends in gold investment over the past decade? This chart shows that total investment demand, as defined by Gold Field Mineral Services, has made up only a small component of total demand. South East Asia South East Asian Net Investment Demand Nearly recovered from dishoarding of Total Investment Demand Small component of total demand South East Asian Net Demand Jewellery Demand Total Investment Demand Considering retail investment demand, a proxy for the private investor, it is clear that retail demand has been a steadier but smaller component of investment demand. Looking at some individual retail demand stories: India South East Asia remains a steady purchaser of gold for investment purposes although the impact of the developing market crisis in 1998 is clear to see. Gold demand has nearly recovered to previous levels despite the return to economic stability; perhaps gold s role during that crisis was duly noted. Greater China Greater Chinese Net Investment Demand Slipping away 5 Indian Investment Demand The success story of the 199, but Greater China Indian Net Investment Demand Indian investment demand was the success story of the early 199s, but demand has slowed over the past five years due to high prices, less consistent agricultural production and, somewhat worryingly, signs of shifts in consumption patterns. Demand from Greater China, comprised of mainland China, Taiwan and Hong Kong, paints a very different picture: Deflation in Hong Kong; Recession in Taiwan; and An undeveloped investment market in the mainland. All contributed to this depressing picture. Many commentators have been remarkably bullish about the prospects for gold demand in deregulated China. There is no sign, from these statistics, of any pent-up demand. The LBMA Precious Metals Conference 23, Lisbon Page 41

4 United States US Net Investment Demand No sign of dollar diversification - Y2K more important When more frequent data is studied, the remarkable first quarter 22 surge in investment demand become apparent. Although investment demand in Japan has slowed considerably since then, the potential for a sudden and perhaps prolonged return cannot be ruled out while the countries economic difficulties remain unresolved United States Net Demand Japanese Net Investment Demand 2-2 Tremendous potential demonstrated in Q US investment demand appears to be driven by factors other than those that we have identified. Buying in anticipation of Y2K appeared to be the major factor in US gold demand over the past few years, while it was in fact coin demand that seemed to hit the end of the world in 2. Commentators that correctly highlight that rolling 12-month coin demand is up 82% yearon-year are perhaps guilty of looking at the shorter-term picture. Japan Japanese Net Investment Demand performance unexceptional Japanese Net Investment Demand Perhaps the most interesting retail demand story of the past few years has been the one in Japan. As this chart shows, Japanese investment demand is a material number, unsurprising considering recent equity and bond returns together with parsimonious returns on cash. Demand in 22, while higher than that of the preceding two years, was unremarkable compared to 1999 or Q2' Q3' Q4' Q1'1 Q2'1 Q3'1 Q4'1 Q1'2 Q2'2 Q3'2 Q4'2 Japanese Retail Investment Enough of history: where is private gold demand now and what can we expect going forward? UBS Warburg can confirm that there has been strong investment demand from the following categories: Our traditional private banking clients, predominantly in Switzerland and in the European time zone, are much more active in gold than they have been since the 198s. Some profit has been taken over the past year but new buying out-weighs selling by a considerable margin. We are also seeing indirect interest in gold from other financial institutions gold-linked products like medium-term notes and goldlinked bonds. So far we have had many enquiries and few trades, but this proportion has improved recently. I am not in a position to quantify the gold demand UBS has seen but anecdotally the level of demand is unprecedented, at least since the 198s. I believe that other institutions are experiencing similar interest. Except for in Switzerland itself, UBS does not sell gold at a physical retail level. And as an aside, recent experiences of trying to buy gold for friends have been illuminating. In the UK there are only a limited number of outlets to buy physical gold. When you do find a place to buy gold, the premium to the gold price is about 5-7% depending on size and type of coin or bar. The selling price is also unattractive, and a bid ask spread of perhaps 7% is typical for The LBMA Precious Metals Conference 23, Lisbon Page 42

5 physical gold. These are the sort of spreads you expect from mutual funds or holiday foreign exchange brokers. Hardly cheap. It is little surprise that private investors are turning to other avenues to play the gold market: spread betting websites, futures exchanges and the new quasi equity gold products like the product recently listed in Australia. Still, the rationale behind buying gold defines the choice of gold product. If you are concerned about systemic risk to the financial system, then anything other than physical gold under your bed is probably unsuitable. New Labour s mantra of education, education, education might equally be applied to private investment in gold. At the moment, mainstream financial advisors rarely discuss gold, and neither are there many products offered by retail banking networks in many countries not that they will ever be interested in pushing systemic risk. In addition, property has been the main beneficiary of poor stock market returns in many countries, not gold, and while house prices fail to fall sharply, gold may be crowded out. Conclusion To conclude, we believe that gold remains an investment asset class, but one that is held by a small proportion of investors. If gold is to break out of its historic niche, distribution channels need to be developed and new products launched. Education of financial advisers and investors must become a priority for the industry. The last two years have seen gold perform impressively well and investment demand reappear as an important factor. More work is needed if gold is to escape the prison of jewellery demand. The LBMA Precious Metals Conference 23, Lisbon Page 43

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