Why gold, and does it need any marketing?

June 1, 2010

By Igor

“Mr. Gold doesn’t give more time … or second chances”

Ms. Lilly Walker (Revolver (2005), Guy Ritchie)

We are what we eat, and we eat pork bellies, live cattle, corn, coffee and sugar. We do not eat gold, and do not even burn it, like we do gas, oil or timber. And yet, we prefer a few pounds of gold to a few pounds of pork or sugar. Furthermore, this paradox does not seem too paradoxical to any of us, doesn’t it? Of all the mysteries surrounding gold, the most intriguing to me was always its special place. And after I learned a little bit of marketing, I also realized that gold’s marketing is far from obvious to me. For a while I was puzzled with my inability to utilize eating principle, and turned to history books written on the subject. Below is a resume, or as one of my compatriots, Mikhail Prokhorov, recently put it – rez-yoom.

Those of us, who believe that Richard Nixon had murdered American Dream in early 70s, might as well be right. For a fact, we know that he did demonetized gold right around that time. By cutting ties with dollar, Nixon turned gold into an ordinary commodity, no different from, let us say, lean hogs. Nevertheless, gold keeps making its way into mainstream media, popular blogs, everyday conversations, and, consequently, our minds. It has been doing this recently, on a remarkably consistent basis. Note how ads about gold coins won the late night TV and radio spots from Florida swamps and even made it into prime time.

Judging by the scope of the commercials, those of us keen on inflation and volatility hedges are primary targets of this campaign. To the rest gold is being pitched simply as a unique investment opportunity. Gray-haired gentlemen in ironed suits pitch us the unprecedented rate of return, zero risk, and track-record longer than the age of humanity.

In case you find yourself dialing one of these 1-800 numbers or wondering if you should do it, my notes can come very handy. First thing I observed, was that unlike always confident gold-investment promoters, most commodity analysts tend to remain well-balanced about their gold price projections. Their renommée is not protected by fine print.

The encyclopedic report by Butterman and Amey, lists a variety historical and chemical reasons for the gold to be a candidate for the endowment effect test. To be called noble or precious, gold acquired characteristics of rarity, low recoverability, and uncosumability. Can you present the same case, oil? Can you?

Another report, coming from Gary O’Callahan, a researcher for International Monetary Fund (IMF), points out a tradition of maintaining secrecy around indicators such as market turnover or annual volume. Again, hard to name any other commodity with the same properties. We direct an interested reader to this short and yet comprehensive historical study, but since large chunk of history is missing in it, we make a quick historical digression.

As strange as it seems, but almost all the gold ever mined is still around, according to historian Peter Bernstein [4], who also estimates gold participated in shipwrecks as weighing about 125,000 tons. According to Green [5], prior to 1850 gold was genuinely rare. Its production between 1800 and 1850 constituted 1,200 tonnes. Then starting from 1851 and until 1900, as mining started in the United States, Australia, and South Africa, it grew more than tenfold. The reason the gold production is not through the roof now is its finite amount beneath the Earth. To quote J.M. Miller [3], the gold already found since we first laid our hands on it is twice the size of the amount remaining. He, in turn, quotes U.S. Geological Survey (USGS) report to estimate the remaining time before the gold becomes truly a precious metal to be 16 years [3].

On the subject of available gold amount we turn to the World Gold Council publication, which reports it at total volume of 158,000 tonnes. Apparently, the production has taken a dive since 2001, explained in this publication via the reduction in exploration budgets, the low gold price of the late 1990s, and the dropping rate of new discoveries. The World Gold Council also quotes the “independent analysts” projection that mine output will remain flat for the “next few years”. Looking at where the gold is at, we note USGS figures of 140,000 tons ever mined, with 15% being lost, “used in dissipative industrial uses, or otherwise unrecoverable or unaccounted for.” The USGS report further estimates 33,000 tons as official central banks stocks and 87,000 tons as privately held in coins, bullion, and jewelry [5].

Mineral Commodity Summaries publication [6] points at positive influence of 19th century adoption of the gold standard by most countries on national monetary gold stocks. In particular, the U.S. stock grew rapidly and hit 22,000 tonnes by 1950 (Butterman, 1980). This trend reversed during 60s and 70s, and in 1971 along came Nixon. As convertibility of the dollar to gold was suspended, the U.S. stock sled to 9,000 tones, while European stocks went the other way, to more than 20,000 tonnes. Since then, there was a marginal change to total of 33,000 tonnes of net World stocks in 1999 [6].

As for price prognosis, in his 2000-2020 Gold Outlook (dated 05/02/98) J.M. Miller cautiously suggests possible range between $2,000 and $3,000 per ounce [8-9]. We can contrast it with very recent train of forecasts. Siddharth Rajeev, vice president of research for Fundamental Research Corporation, promises sizable returns on gold, but puts its price at modest $750 around year 2012 [10]. Another optimistic pessimist, Marc Faber, the Swiss fund manager and editor of Gloom Boom & Doom, who once told rightfully told Bill Gates to sell Microsoft shares and to buy gold, also talks about price dive. Yet he places gold at $950 or $1,000, and expects no more downside. Faber then adds: “I don’t see any scenario where gold will collapse. The one thing I will never do in my life is sell my gold” [11].

Going back to November of last year, we observe the correct prediction made by another writer for Gold Eagle – David Levenstein of $1100 followed by $1300 technical analysis prognosis. At the moment the optimism was shared by MF Global analyst Tom Pawlicki, who linked gold prices to continuing increase in the US government debt [12].

And finally, we recall how Mr. Soros, who you all know as the celebrity investor and part-time philosopher, stirred controversy at World Economic Forum, by being very liberal with the choice of his words. Here is his sound-bite without any alteration: “When interest rates are low we have conditions for asset bubbles to develop, and they are developing at the moment. The ultimate asset bubble is gold.” Note something unsavory about the word “ultimate” above, but what is said is said (see the discussion in [13]).

If you waiting for a summary, it probably is not going to happen. Instead I can offer reminiscence about one of these finance classes taken. Quite literally the history of gold shows a very low beta. That is, gold can be as volatile as they come, and yet, its time series have almost no knowledge about the market. Perhaps this is important capability, but it is was never used for marketing purposes.

Apparently, there is a healthy alternative to eating and finance principles. It is called endowment principle. To keep it simple, it is the idea of you getting your hands on an item, and then automatically perceiving this item’s value as something way more valuable than it was purchased for. According to this principle if you sell a donkey for a certain price, and then try to buy it back from the same individual, he will tell you to get lost. Makes perfect sense, right? Right?

Here is some references for your reading pleasure:

[1]Mineral Commodity Profiles—Gold By W.C. Butterman1 and Earle B. Amey III Open-File Report 02-303

[2]Joseph M. Miller, A possible gold price scenario 1998- ?, Gold-Eagle (2 May 1998).

[3]Joseph M. Miller, A possible gold price scenario 1998- ? (revised), Gold-Eagle (25 September 2000).

[4]Peter L. Bernstein, The Power of Gold: The History of an Obsession, New York, John Wiley & Sons (2000).

[5]T. Green, Central bank gold reserves: an historical perspective since 1845, WGC Res. Study No. 23 (1999).

[6]Gold – past and present, World Gold Council.

[7]U.S. Geological Survey, Mineral Commodity Summaries, Gold (January 2002)

[8]Joseph M. Miller, Gold outlook from 2000 to 2020, Gold-Eagle (2000).

[9]Joseph M. Miller, Gold outlook from 2000 to 2020 – re- vised, Gold-Eagle (October, 2002).

[10]Economic recovery to push down gold to $750/oz CommodityOnline: February 13, 2010 at 15:35

[11]Gold price will not collapse CommodityOnline: February 14, 2010 at 06:45

[12] http://goldnews.bullionvault.com/ Nov 6 09

[13] http://goldnews.bullionvault.com/ 11 Feb ’10

[13]Adam Hamilton, Gold-Eagle (2000).

[14]U.S. Geological Survey (November 6, 2009), World Gold Production: 1900-2008.

[15]World Gold Council, World Gold Production: 1835- 1945, Sources: Adolph Soetbeer; Bureau of the Mint (US); Joseph Kitchin (Union Corporation).

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