Gold futures and gold's future

Charles R. Stahl

Edgar Allan Poe first used the word 'gold-bug' in a short story published in 1843 and in fact entitled 'The Gold Bug.' The original meaning of the word was 'fictitious insect', but over the years it gradually evolved into the current Webster definition of "an advocate or supporter of the gold standard." Next year, newspaper columns will quote the closing price of gold on commodity exchanges sandwiched between potatoes and boneless beef on the New York Mercantile Exchange, and between shell eggs and frozen pork bellies on the Chicago Mercantile Exchange. Isn't it going to be depressing for those who believe that gold. is a store of value — the ultimate money — to see the price of gold listed next to those other commodities?

Be that as it may, it should be said that although gold is not necessarily a store of value and a good hedge against inflation, it certainly is an insurance of last resort, which like any other kind of insurance proves useful in an emergency, particularly during a foreign invasion, the failure of a central bank, Or similar catastrophe. Therefore those who buy a little gold to put aside — to have it just in case everything else should fail — may sleep some nights better than others, but the traders of gold futures will not be so blessed, because even before the US futures markets open their pits to trading, gold has become extremely volatile and anything but a store of value and an inflation hedge.

For example, those who bought gold around $180 per ounce in February of this year have seen its price decline to $127, and then recover to around $160; so far, they not only failed to protect themselves against inflation, but in fact they have an actual loss on their bullion position, plus the loss of not collecting interest on the money they invested in gold. This applies not only to short term swings in the price of gold, but often to long term trends also:For example, if in 1949 a conservative US investor had placed the equivalent of one million dollars in West Germany for a period of twenty-five years at a yearly average interest of 63/4 per cent, by June of this year he would have been able to repatriate $8.8 million. The exact calculation runs as follows: for $1 million twenty-five years ago, one would have obtained DM4,200,000, which at 6% per cent over twenty-five years would amount to DM21,499,800, representing the equivalent of $8,775,000. This shows that, on occasion, paper money can prove to be a better store of value than gold, since $1 million invested in gold and bought at $35 per ounce in 1949 would represent today a value of $4.5 million (less storage Charges over a period of twenty-five years).

So, like everything else which is connected with the propitious use of money, the timing of purchases and sales of gold bullion or futures is very important. And because of this timing element, the myth of gold being a store of value is rapidly being destroyed. It was only at times when the price of gold was pegged that people could speak of gold as a commodity with intrinsic value, in which case however it did not protect against inflation. Reviewing gold's record as a store of value, one is confronted with the following facts: the original gold standard was started in England in 1816 and lasted until 1914. During ninety-two years out of those ninety-eight years, the value of gold remained fixed at the rate of £3.17.101/2 per ounce. But in the previous century, betweeu 1700 and 1800, when the gold standard did not even exist, the price of gold was also stationary. Yet, over those two centuries, the prices of other goods increased considerably.

Man's folly has immemorially created monetary problems with recurring consistency, and neither the pure gold standard nor the semi-gold standard nor flexible rates nor rigid rates have been able to steer the world's economies through calm waters forever. Deflation and inflation, prosperity and recession, have occurred under each of the monetary systems ever invented by man. Debasement of money existed even at a time when paper money was not in use. For example, the gold content cif French coins fell from 3.2 grams of fine gold in 1351 to 0.29 grams in 1795, a debasement of over 90 per cent, and the gold content of British coins fell by almost 80 per cent between 1257and 1816. • However, I must re-emphasise that although gold's historical record has not always been synonymous with what one could call a good inflation hedge, its value as insurance of last resort has been continuously validated. And so, over thousands of years, gold has been hoarded in the hope that it would not have to be used, but ought to serve its owners in times of catastrophes limited to specific geographic areas. For example, during the second world war, gold helped people under the Soviet or German occupation to buy their way to freedom. That was a noble role of gold; in general under tyranny, during war times, famine etc, gold may help an individual to survive. But this gold-given help to survive has meaning only if there is a place to go where freedom flourishes.

For the last two centuries, such a place was the United States of America. Nowadays, for a US citizen to buy gold abroad in order to survive a worldwide depression or some other kind of natural or man-made cataclysm is nonsensical, because there is no other place on this planet where freedom and opportunities are greater than in that country. Therefore, if you wish to hold gold as an .insurance of last resort, it has to be kept close to home so that, if, God forbid, circumstances should occur which would require the use of that gold, it would be at hand. (Holding gold as an insurance of last resort, for example, in Switzerland, is the wrong medicine, even if all the ills predicted by so many merchants of fear should come to pass: the Swiss cavalry, 4,000 horses strong, would not be able to defend it.) The foreign central banks do realise that their gold is not as secure in their own countries as it is in the United States. Seventy different countries and international organisations keep some 400 million ounces of their gold, worth over $60,000 million at the free market price, with the Federal Reserve Bank in New York, a fact which should

Spectator November 9, 1974 give Americans who keep their illegally bought gold abroad some food for thought. ... I expect that When gold ownership in the US is restored by the end of this year, there will be a reflow of American capital to those shares, and tha,t, many Americans who owned gold illegally 'e'in liquidate their positions abroad and cover the needs partially in the US futures markets all,c1 partially by acquiring gold bullion from the Treasury's hoard.

Speculators will discover that there is neither

a scarcity in the new production of gold, nor a large demand from industry for its use, and that there exists an abundant supply above grOUnd' From the beginning of time until today, about three thousand million ounces of gold were mined, and most of it still ekists in one form (int another. The central banks alone own million ounces of gold, valued at about $177,0u'' million at the free market price. The world's yearly production al gold amounts to about 1,500 metric tons, or slightly over 48 ounces. This year, industrial consumption wit' be only 750 tons, or 24 million ounces. It is now generally agreed that within a .decade, the gold production of the Soviet Urli°,11 may closely match that of South Africa. In connection, it has to be remembered that at SSA.' per. ounce, South Africa's unmined reserves were estimated at about 500 ounces:at $70 per ounce, the economical minable gold in South Africa was estimated t° be in excess of 1,200 million ounces, and so However, one has to consider the iompact inflation on the cost of production, ari7 therefore those figures may be arguable to tha` extent. But whether or not they are arguabieci the point is that the potential of new goil, production is much greater than is conlirwrly accepted. Once trading in gala bullion and futures begins in the United States, the US Treastill will avail itself of the opportunity to cash in eilf its gold hoard. We all remember the sales Uncle Sam's silver hoard, and are keenly awarof the Treasury's ability to manage such As a matter of fact, the silver sales of the Treasury were one of the most profitable ae successful transactions ever conducted by 01,, US Treasury, and the anticipation is that the", might do as well in gold. I believe that Trea5t00 sales will be conducted through GSA tt domestic users and other domestic bidders al weekly or monthly auctions, and by the Feder3 Reserve Bank in New York for other purpOse4 Contrary to the opinion of many gold-bugs, not believe that the Treasury will try to the price of gold down. After all, gold is a 0°7 asset, and if they can get a higher price rattled than a lower price for it, they certainly will tpj to get that higher price. Since gold is no longthe numeraire, i.e. the pivot of the monetaraY system, and its role is confined to that of a reserve asset only, all central banks have 5 common interest in getting for their gOld a

high a price as possible. •e of

Nevertheless, I do not believe that the price ht gold will have a spectacular rise above ri'a, previous intra-day high of $184 per (Weill despite the fact that the central bankers Wr„ not press their sales. Barring a major Ivor, orevt small war near South Africa's border, 1 exPe a that for many years gold will be tradingi if!,5 range between $125 on the downside and S°2. on the upside, give or take $10 to $20 either vearii with central bankers being buyers when trades between $125 and $150, and sellers vv"e.,. it trades between $150 and $185. This intenni tion by the central banks in the gold market probably cause investors in the yellow met°11, think twice before holding it for the long Oise but it will incite traders to participate in fluctuations over a range of $69480. Therel°be those who will buy gold on weakness Willhvy able to make a profit, and those who Will 'th, gold on strength, expecting further strellg ny will be losers, like most traders it 1 ad heir commodity. Domestic users should ael“,`"eir strictly to this policy and replenish t" inventory on weakness only.

There is no question but that, from -Tart

1975 on, the place where the price of gold will be determined will be the United States, where the Markets will be the broadest and the most open. The London bullion dealers and the Zurich gold Pool do not publish their daily trading volume. In London at present purchasers know the Price for sure only at the fixing at 10.30 in the rning and at 3 o'clock in the afternoon. Whatever happens during the rest of the day is a closely guarded secret. That will not be the case in the US, since all trades will be ,colnpleted by open outcry and printed on tape ior all the world to see. In addition, depositories ?Proved by the various exchanges will selose every day the amount of gold in

rage . s No such figures are available in

ndon and Zurich. Of course, it does not mean ,s'at American commodity exchanges are Perfect; it simply means that all other markets are less supervised and less open.

It

smnow remains to be seen how the gold ugglers will adapt to those new realities. Gold smugglers are a very important link in the chain of the worldwide distribution of gold, since more than 50 per cent of the yearly gold Production goes through such routes. Gold efreltiling from Zurich, and, to a smaller extent, t °In London, goes to the following centres: 1. Tc)„ P.eirtlt, from where it is smuggled into Vre•e31, Egypt, Jordan and Saudi Arabia; 2. to iiiawait, from where it was smuggled into Iran ch°wever, on September 18 the law was anged in Iran and Iranian citizens are now rrrnitted to import, own and trade in gold, and _ranian banks have the right to keep up to 10 cent of their net worth in gold); 3. to Dobai, 13°111 where it is smuggled into Karachi, 4°,111.1baY and other spots in India and Pakistan; 6 '0 Vientiane, from where it is smuggled into fr°„112a, Thailand and Vietnam; 5, to Singapore,

Where it is smuggled into Indonesia,

nam and Thailand; 6. to Hong Kong, from 1_ ere it is smuggled into Thailand, and, until ;at Year, also to Japan (in April 1973, the 2a°131 Mese authorities legalised the import of r-1,,c;',„ "and that of course weakened the

Kong position as a viable station in the

stbuggling chain); 7. to Geneva, from were it is smuggled into France; and 8. to b„,liasso, from where it is smuggled into Italy in , st"itio0 form, to be manufactured into jewellery -"rd. rearnoggled out of Italy to other countries. dire which do allow imports of

gold buy from Zurich, London or Toronto. After

on and Zurich, Dubai was the largest bearket for gold, and at times it has handled yWeen 250 and 300 tons of gold per year. Next °Mall this gold smuggling business, because tra,`!le wide dissemination of prices due to

'Mg in the United States, may become more coOpetitive by allowing the smugglers to

their positions to protect their profits. lar"g ill oil-producing Arab countries become susilboYers of gold? It is my opinion, so far eou'rled by fact, since none of the OPEC res,ntries has increased the gold part of its th_erve assets, that for the Arabs to exchange ef oil in their wells for gold in their vaults is an prtuPeroductive swap, because over the years the gre:t aPPreciation qf oil reserves may be oiler than that of gold, and therefore podu • preser mng countries which are interested in grou rving wealth may prefer to keep oil in the Ces,nd rather than gold in the vaults, and the bet,su Which they are currently collecting is ine"ng used by them for increased imports and l'iirlle-producing investments abroad. namt last point is the question of gold's enemy een—t er one, i.e. compound interest. At 12 per abouieTnPound interest, money doubles in Yearqs!)( Years; at 10 per cent, in about seven gold: •x). unless the increase in the price of do better than that, there is very little `•"tive for an investor to hold gold.

Chart note es Stahl, who contributes Wall Street cons,.,t9 The Spectator, is President of the condos4nic New & Agency. This article is a Arne,„-./Ised versiOn of his recent speech to the 'can Metal Market Gold Forum.