Rust Rare Coin, Inc. November, 2009

PRICE TRENDS (New York closes)

IN OUR OPINION . . . .

The topsy-turvy markets have never been as undefined as we see them right now. Virtually every so-called expert has a different take on why the markets are reacting the way they are. For example, just when we thought we understood India’s reasoning for not supporting gold prices at their current highs, to everyone’s surprise, they bought 200 tons of IMF gold at market levels.

What seems to be true in most economic sectors around the world is that holding onto too much US currency (dollars) is a bigger risk than owning precious metals at current levels. The dollar has lost an estimated 15% buying power so far in 2009. There is no indication of improvement in the near term as indicated by the Federal Reserve’s comments that the recovery is going to be a long process.

The importance of precious metals holdings as a vital part of portfolio management and protection has never been clearer. Opportunities are plentiful. Volatility creates good buying opportunities on the dips and profit potentials on the spikes.

We look forward to working with you in 2010. We wish you all a happy and successful holiday season.

SOMETHING’S GOTTA GIVE

Stocks, Bonds or Gold Place to Be?

Ian McGugan, Financial Post

What a magic act. Over the past year, despite the biggest economic crisis since the Great Depression, central banks around the world have managed to create an environment in which just about every type of financial asset—stocks, bonds, gold—has headed straight upward. The result of this great levitation is an environment that makes absolutely no sense from the viewpoint of standard interesting logic. A big run-up in the stock market, like the one we’ve seen over the past few months, would usually be seen as a bet on a strong recovery that will boost profits. A surge in bond prices, such as we’ve experienced over the past year, implies the opposite. It suggests buyers see a weak, faltering economy ahead and want the security of fixed payouts.

Things get even stranger. Bonds are supposed to be at their best during times of deflation, when prices fall and the purchasing power of a bond’s distributions goes up as a result. In contrast, gold is supposed to shine during periods of inflation, when prices climb and people want the security of owning a real asset that can keep pace with rising bills.

So, according to the market trends of the past year, investors expect both a strong recovery and a weak one, both inflation and deflation. You thought you were confused? It’s nothing compared with how Mr. Market feels. Perhaps the market is baffled. Or, more likely, it’s responding to the unprecedented level of government intervention during this crisis.

Some of the most notable interventions are low, low interest rates. Another is “quantitative easing” in which central banks, such as the US Federal Reserve and the Bank of England, have created massive amounts of money out of thin air to buy risky assets.

FED PRESIDENTS ARE CAUTIOUS

ABOUT ECONOMIC RECOVERY

Kristina Cooke, Reuters

On November 10^th Federal Reserve officials struck a cautious note on the US economy, citing high unemployment, heavy reliance on government support and commercial real estate woes as hurdles to recovery. Speaking less than a week after the Fed left interest rates unchanged at near zero, San Francisco Fed President, Janet Yellen, and Atlanta Fed President, Dennis Lockhart, said the economy was still vulnerable.

“The strength and durability of the expansion is in question,” Ms. Yellen said in Phoenix. “High unemployment, weak job growth and paltry wage increases are a recipe for sluggish consumer spending growth and a tepid recovery.”

The Fed chopped overnight interest rates to near zero last December and it has pumped more than US$1 trillion into the economy to spur a recovery from the deepest downturn since the Great Depression. The first week in November the Fed reaffirmed its commitment to keep borrowing costs ultra-low for “an extended period,” and financial markets will be listening to Fed officials closely to try to gauge when they may finally move to withdraw their economic support. Whether the private sector can pick up the slack once the government boost is gone also remains to be seen, Ms. Yellen said.

Mr. Lockhart, speaking at an Urban Land Institute conference in Atlanta, said he believed the economic recovery was underway but added he expects the pace of growth to be “relatively subdued” in the medium term. “The situation is much improved, but there are sobering aspects of the economic picture,” Mr. Lockhart said, noting that the economy has been supported by temporary government programs and that data on bank failures, foreclosures, unemployment and personal income “continue to disappoint.”

The Fed said last week that economic slack, subdued inflation trends and stable inflation expectations argued for a prolonged period of low rates. A Reuters poll during that same period showed economists do not expect the Fed to raise rates until the third quarter of next year. The Fed also emphasized three economic conditions to watch: resource utilization, inflation trends and inflation expectations. Analysts said that highlighting these three conditions bolstered the Fed’s case for keeping interest rates low for a long time.

In the bond market, the officials’ remarks supported prices of Treasuries, easing investors’ worries about higher interest rates in the near future. In October, the unemployment rate—a way to track resource utilization—unexpectedly surged to 10.2%. Mr. Lockhart said he expects very slow job gains next year. “At this juncture, it’s hard to be encouraged about a fast rebound in job growth,” he said.

Answering reporters’ questions after his speech, Mr. Lockhart said that there could be scenarios in which the Fed may have to tighten policy even with unemployment still “frustratingly high” if other economic conditions warrant a move. In his speech, he said for now the overall objective of economic policy should be to bring about “a durable economic recovery and an environment that reduces unemployment as quickly as possible while containing inflationary pressures.” He said there will have to be a “judicious removal” of government support.

Ms. Yellen said in her speech that she was not worried about inflation, arguing instead that the possibility of a problematic drop in consumer prices was the greater risk. Both officials flagged the prospects for commercial real estate as worrisome and said the banking industry was far from healthy. Mr. Lockhart said commercial real estate’s problems could slow the pace of recovery and said the link between bank lending, small business employment and commercial real estate values was a concern.

COMMODITY ONLINE

Precious Metals: Silver is not luring new investors

It might seem a bit odd to say silver is under-performing, when during October it rose 7.9% (to 20^th October), compared with gold, which managed 6.6% during the same first three weeks of the month. Moreover, silver has popped over $18/oz in intra-day trading. But if looking at the period since both metals’ previous peaks back on September 17^th, gold to its latest peak on the 20^th October gained 4.2%, whereas silver in that same period gained just 3.2%. This is not the normal pattern when both metals are charging higher.

One possible explanation for silver being less strong than gold is that base metal prices over that period fell by 2.7% (judging by LME’s LMEX index of key base metals) – and of course silver is to an extent a key industrial metal. Some support for this explanation also derives from platinum, another industrial precious metal, which managed only a 1.2% gain in that period. But that theory is undermined somewhat by palladium, which rose 8% during that period. And silver has done worse since than base metals or the PGMs. However, the strongest explanation for gold relatively outpacing silver is that when the US currency comes under hostile attack, gold really comes into its own – and others tend to lag behind.

Silver Outlook

Silver is currently enjoying the precious metal rally but ETF and futures data suggest it hasn’t seen as much investor interest as might have been expected. This might mean it is poised for another leap higher, or that the market is getting wary at these high prices. We don’t think a correction in the industrial metals will knock it much lower, so long as gold holds up.

Reuters (11/03/2009). IMF sells India 200 tonnes of Gold for $6,7bn. BusinessDay.

The International Monetary Fund (IMF) has sold 200 tons of gold to the Reserve Bank of India (RBI) for $6.7 billion, quietly executing half of a long-planned bullion sale that has threatened to slow gold’s ascent. The deal, which surprised traders who expected China to be the most likely buyer, will relieve the gold market of some uncertainty over how and when the IMF would sell 403.3 tons of gold, about one-eighth of its total stock. The deal will increase India’s gold holdings to the tenth largest among central banks. It also fuelled speculation that other governments, including Beijing, may be ready to diversify their reserves even at near-record gold prices, helping soak up IMF supply that the fund may otherwise be forced to sell on the open market.

“Central banks in India and China will be happy to accumulate gold at these levels. I will not be surprised to see even some Southeast Asian banks buying gold,” said Aaron Smith, Asian head of the $1.65 billion technical trading fund Superfund.

Spot gold prices earlier rose by nearly 1%, but later reversed those gains to trade little changed at around $1,058 an ounce on November 2^nd, within striking distance of October’s $1070.40 record despite a rallying dollar. Traders said the IMF news could add to the market’s upward momentum.

“It’s potentially bullish from several points of view,” said Commerzbank analyst Eugen Weinberg. “Gold was kept off the market and sold directly to central banks so potential sales on market are limited by this. Secondly, it showed large buyers are ready to accept the current price levels. Thirdly, the central banks are increasing their gold reserves. Last, but not least, the central bank gold agreement sale of 400 tons is half empty already.”

The RBI said the purchase was an official sector off-market transaction and was executed during October 19-30^th at market-based prices. An IMF official said the sale was concluded at an average price of about $1,045 an ounce and that the transaction would be paid in hard currency and not in IMF Special Drawing Rights.

SURPRISE BUYER

Although the IMF’s plan to sell a share of its gold holdings in order to increase low-cost lending to poor countries had been flagged for a year before it was formally approved in September, the speed, scale and identity of the buyer were a surprise.

“It was always thought that some of it would be sold off-market, but it was a bit of a surprise that as much as 200 tons had been sold off-market,” said Simon Weeks, director of precious metal sales at Bank of Nova Scotia.

Although India is the world’s biggest consumer of gold, primarily in the form of jewelry and investment among its billion-plus people, its central bank had given few signs of seeking to diversify its reserves pool into bullion. The proportion of gold as part of its total foreign reserves has fallen from over 20% in 1994, to just less than 4%. India’s foreign exchange reserves held at the central bank totaled $285.5 billion on October 23^rd, of which gold comprised just over $10 billion. The latest purchase will lift its share of gold holding from near 4% to about 6%, much less than most of the developed world but four times China’s share.

The RBI does not officially talk about its diversification strategy. On Nov. 2^rd, the RBI said the purchase of IMF’s gold was done as part of its foreign exchange reserve management. But there may also be a geopolitical motive behind the deal: India, like China, is also seeking closer ties with the IMF to assert its authority on the global economic stage.

“This transaction is an important step toward achieving the objectives of the IMF’s limited gold sales program, which are to help put the fund’s finances on a sound, long-term footing and enable us to step up the much-needed concessional lending to the poorest countries,” the IMF’s managing director, Dominique Strauss-Khan, said in a statement on Monday.

NO MARKET DISRUPTION

A senior IMF official, speaking on condition of anonymity, declined to say whether other central banks have expressed interest in buying the remaining gold for sale. He said if no other central banks came forward, the IMF would proceed as planned to sell the gold in the market, but reiterated that the fund would publicize its intentions before doing so to avoid disrupting the market.

Still, the threat of further open-market sales remains a source of concern for gold traders, mindful of the five-year pact among European central banks to sell down a maximum of 400 tons a year of their holdings, an agreement that was renewed in August and includes the IMF volume.

The market’s focus has now shifted to China, which has reportedly been in talks with the IMF about buying some of the fund’s bullion as Beijing seeks to shift some of its more than $2 trillion in foreign exchange reserves away from the U.S. dollar.“Now people may think China will buy the other half,” said Ronald Leung, director of Lee Cheong Gold Dealers in Hong Kong. Already the world’s top producer of gold and rivaling India as a consumer, China revealed this year that it had quietly lifted its own government holding of gold stocks to 1054 tons from 600 tons when it last reported its holding in 2003.

It is the first time since 2000 that the IMF has sold gold to a central bank. Between December 1999 and April 2000 in separate transactions, the IMF sold a total of 12.9 million ounces of gold to member countries Brazil and Mexico.

Peter Koven, Financial Post

When the International Monetary Fund said several months ago that it would auction off 403.3 tons of gold, the presumed buyer in most people’s mind was China, which is desperate to diversify its reserves away from U.S. dollars. Instead, it was India that snapped up 200 tons from the IMF.

So who will buy the rest of the IMF gold? Morgan Stanley analysts Peter Richardson, Jeremy Friesen and Hussein Allidina, said that while China is still the most obvious buyer, it is now the world’s largest producer of gold and can buy its own output. That would reduce its risk of exposure to the “market prices” that India had to pay.

“As such, the higher gold prices rise, the less likely China will be interested in IMF gold, in our view, and the less likely the remainder of the sales will be completed ‘off-market’ in 2009-10,” they wrote. “Nevertheless, given the reduced IMF overhang and continuing fiscal and monetary stimulus policies, the [gold] market may rise even without Chinese buying.”

The analysts also wrote that the India sale is a sign that gold’s near-term direction seems to be “squarely in the hands of the central banks.” The view that central banks will be net buyers of gold is bolstered by dovish policy from the U.S. Federal Reserve, a rise in U.S. unemployment, and the continuing commitment of economic stimulus by G20 finance ministers. All of those factors suggest more U.S. dollar weakness and inflation risk in the longer-term, the analyst wrote. Their base-case forecast for gold in 2010 is US $1,000 an ounce.

From the London Bullion Market Association Conference . . .

“I wouldn’t be taking a huge risk to imagine that official holdings of gold [globally] will stabilize or increase. I must stress that gold is still a vital asset for Europe’s central banks.” –Paul Mercier, ECB’s principal advisor in market operations

Mehdi Barkhordar of the Swiss refining group MKS noted a “new Western mindset” more typically seen during Eastern gold hoarding: Lack of trust in governments; Lack of trust in the local currency; Lack of trust in the financial system; Fear of inflation; Only trust physical gold.

Rust Rare Coin, Inc. publishes MARKET WATCH monthly as an educational service to its clients.

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