Introduction to Session 2: Gold Investment - LBMA · Introduction to Session 2: Gold Investment ......

The LBMA Precious Metals Conference 2003, Lisbon Page 27

Introduction to Session 2: Gold Investment

Frederick Lasserre

Head of Commodities Research, Société Générale

Good morning, ladies and gentlemen. First of all, those of you who know me (only a few) and those who know James Burton from the World Gold Council (that’s more of you) will have noticed that, actually, I’m not James Burton. Unfortunately, James could not join us today and that’s why I am very pleased and honoured to be the chairman of this session. I think that gold conferences should always start with a session on gold investment, since my feeling is that buying gold is always an investment, even in the case of jewellery. Personally, the best investment I ever made in my life was a gold investment in the basic form of a small ring. Our first speaker today will be Diego Parrilla from Goldman Sachs. Diego will try to put gold in a broader perspective by presenting on the topic of investment in the commodity markets; by making a clear distinction between direct and indirect investment – that is, in commodity producers’ equities. Diego will provide valuable conclusions on the performance of both types of investments. A session on gold investment couldn’t be considered complete without a hedge fund’s view of the market. Steve Mathews from Tudor will explain the way his institution analyses and selects the markets in which they want to invest. One should say that hopefully investing in gold isn’t only the business of hedge funds; private investors also deserve attention. John Reade from UBS Warburg will provide a comprehensive outlook of investment demand around the world and reasons to be optimistic for the future of gold as an investment for private individuals. To maintain the attractiveness of gold as an investment, investors probably want new products matching their needs in terms of cost, liquidity and performance. Graham Tuckwell of Gold Bullion Limited will present such a product developed in collaboration with the World Gold Council. ■

The LBMA Precious Metals Conference 2003, Lisbon 8


Investment-led Recovery in the Commodities Markets

Diego Parrilla

Executive Director, Goldman Sachs

The collapse of equity markets and the arrival of low interest rates have increased the investor presence in so-called, “alternative investments”, such as real estate and commodities. Investors always play an essential role in the commodity markets, providing liquidity and taking off commodity price risk from producers and consumers. By assuming this risk, investors receive a risk premium and the opportunity to capture meaningful investment returns. Commodities typically closely track economic growth, performing best in the late stages of the business cycle when strong demand has exhausted commodity supplies and performing worst in the early stages of the business cycle when capacity utilisation is weak and commodity supplies exceed commodity demand. Commodity returns have been unusually strong recently, decoupling from the normal pattern of weak early cycle returns, due to significant under investment in global commodity infrastructure during the past decade, as well as supply and demand shocks (such as the war in Iraq, the labour strike in Venezuela, and a cold winter in the Northern Hemisphere). GSCI total returns last year were 32%, outperforming world equities by 5,030 basis points and world bonds by 1,200 basis points.

Direct and Indirect Investment in Commodities (Not Just Gold) Investors participate in commodity markets via "direct" investments in the underlying physical and paper commodity markets (i.e. physical gold or crude oil futures) as well as via other “indirect” investments such as commodity-producer equities (i.e. individual equities or equity indices) or via commodity hedge funds (i.e. macro and technical hedge funds). To the extent that both direct and indirect investments have an impact on the underlying commodity markets, today I’d like to analyse the rationale behind these investments, with special focus on direct investments in underlying commodity markets, not just gold. Direct Commodity Investments The decision to invest in commodities can originate as a strategic choice, where the investor recognizes the value of commodities as an asset class and maintains a constant exposure via a passive allocation to a benchmark, such as

the Goldman Sachs Commodity Index, (GSCI). The choice can also be tactical, where the investor recognizes a profit-making opportunity, either as an overlay on a strategic allocation or simply as the expression of a trading view in the absence of a strategic allocation. Strategic It is public knowledge that PGGM and ABP, two of the largest pension funds in the world, are benchmarked to commodities via a passive allocation to the Goldman Sachs Commodity Index, with ABP between 2-4% and PGGM 4%. Since ABP manages $155bn and PGGM $50bn, and gold is 2.25% of the index, that represents implied exposure to gold of approx 275k oz for ABP and 135k oz for PGGM. Without going into much detail – but for the benefit of those not familiar with it – I would like to quickly run through the basics of the GSCI, which going forward I will use as a proxy for commodity markets in general.

Investment-led Recovery in the Commodities Markets Diego Parrilla


The GSCI Created in 1991, the GSCI was designed to provide investors with a reliable and publicly available benchmark for investment performance in the commodity markets. In much the same way as the S&P or the FT equity indices are market cap weighted, the GSCI is production weighted. The weightings of the individual GSCI commodities are determined by their relative levels of world production. This matches the underlying exposures to their relative importance in the real economy. Consequently, energy, which we all use every day, has a higher weighting than gold. The GSCI is widely used as an inflation tracker and benchmark.

Currently, the GSCI includes 25 commodity futures contracts in the five major commodity groups weighted as shown in the figure above, and has a futures and an options contract listed on the Chicago Mercantile Exchange (CME). The index assumes investment in nearby futures contracts, which are rolled over every month under a fixed and transparent methodology. The rules and regulations governing the GSCI are overseen by an eight person Policy Committee including members from PGGM, GIC, The Harvard Business School, the CME, The Industrial Bank of Japan, and Goldman Sachs. In our view, maintaining a direct long-only exposure to commodity futures markets adds value to a portfolio over the long run. Historically, a passive allocation to the GSCI has simultaneously resulted in higher returns and less risk in a balanced portfolio of equities/bonds. Since 1969, the GSCI has generated an average annual return of about 11%, comparable with equities.

More importantly, GSCI returns are negatively correlated with both equity and bond returns. Consequently, even a small GSCI allocation would have significantly improved portfolio characteristics, performing best when the portfolio needs diversification most, i.e. in “hostile markets” (defined as the bottom decile of monthly year-over-year returns). I have brought a number of hard copies of the “classic” research piece by Steve Strongin, Managing risk in hostile markets, for further details.

Strategic Case = Neutral to Benchmark

- Potential for high returns. The GSCI

historically has had high equity-like returns (11% per annum since 1970, including +41% in 1999, +50% in 2000 and -32% in 2002)

- Negative correlation with stocks and bonds imply that even a small allocation to commodities will reduce portfolio volatility (see efficiency frontier)

Source: JP Morgan US Government Bond Index for Gbond, S&P500 Total Return Index for S&P500 and GSCI Total Return Index for GSCI.

Strategic AllocationsHistorically high returns

5,000

0

1,000

2,000

3,000

4,000

Dec 1969 Aug 1981 Apr 1993

GSCI Total Return

S&P500 TR

US Bonds TR

Asset Class Cumulative ReturnsAsset Class Annual Returns

1970 – March 2002

11.65% 10.64

%

8.62%

GSCI S&P 500 Gbond

Correlations between quarterly returns of the GSCI in local currency and the financial asset. For bonds: JPM Total Return Government Bond Index of the respective country in local currency. Exception: for Switzerland the returns of 10y SWAP were converted into total returns. For Equity: S&P500 Total Return Index, Toronto 300TR, Nikkei 225, CAC 40, DAX, Amsterdam Stock Exchange Index (AMS), SBC Index & Zurich Stock Exchange Index (SMI), FTSE - UK all share

Dec 1987 – March 2003 Quarterly Correlations

Strategic AllocationsNegative Correlation

US

Canada

Japan

France

Germany

Netherlands

Switzerland

UK

Correlation between GSCI and Bonds Correlation between GSCI and Stocks

(0.18)

(0.13)

(0.22)

(0.26)

(0.20)(0.23)

(0.18) (0.19)

(0.26)

(0.10) (0.09)

(0.24)

(0.30)

(0.24)

(0.39)

(0.26)

The Goldman Sachs Commodity Index

GSCI Composition (Percentage Dollar Weights on 23 May 2003Energy Livestock Agriculture Industrial Metals Precious Metals

WTI Crude Oil25.02%Brent Crude Oil

11.16%Heating Oil 6.43%Natural Gas 13.58%Unl. Gasoline 7.21%Gas Oil 3.56%

Total 66.95%

Live Cattle 3.77%Lean Hogs 2.56%Feeder Cattle 0.94%

Total 7.27%

Corn 4.35%Wheat 3.96%Cotton 1.73%Soybeans 2.58%Coffee 0.69%Sugar 1.60%Hard Red Wheat 1.46%Orange Juice 0.39%Cocoa 0.39%Total 17.13%

Aluminium 3.13%Copper 1.75%Zinc 0.49%Nickel 0.66%Lead 0.21%

Total 6.23%

Gold 2.23%Silver 0.19%

Total 2.42%

Reliable and Public Benchmark since 1991

25 Commodities, 5 Sub-Indices

World Production Weighted

Re-investment in nearby futuresEnergy

68%

Livestock7%

Agriculture17%

Industrial Metals6%

Precious Metals2%



Strategy implementation: mainly via swaps, structured notes or futures. Tactical Direct “tactical” investments in underlying commodities have been supported by the recent weakness in equity markets and the USD, the low interest rate environment, the deterioration of credit markets, under investment in commodity infrastructure (which has led to production, distribution, and storage constraints), and the uneasy geopolitical backdrop (as in the case of September 11th terrorist acts and the war in Iraq). Potential implementation of a direct commodity investment spans a wide variety of products: - Over-the-counter products (such as look-

alike futures, swaps, options) - Exchange traded products (such as futures,

options, warrants) - Securitised instruments such as (notes,

warrants or certificates).

Indirect Commodity Investments Indirect commodity investments on their own have strong merits, but they should be clearly differentiated from direct investments in the underlying commodity markets. a) Commodity-Producer Equities - Commodity producer equities more closely

track equity markets than commodity markets, incorporating company-specific and country-specific risk that is not picked up in a futures investment.

- The case of gold equities (recent

consolidation, buy backs and relative value) is a clear case of interaction between the gold price and underlying gold producer equities.

o Target = maximise shareholder’s equity o Highly fragmented industry (room for

M&A) o Hedgers vs. non-hedgers show different

upside to gold price o Non-hedgers acquire hedgers = buy-

backs = higher gold price = higher valuations

o Increasing pressure on hedgers to buy back too…

b) Commodity Funds (technically or fundamentally driven) Investment in systems and intellectual capital. Steve Matthews, from Tudor Investment Corporation, who is here with us today, can tell us a bit more about their focus on commodities, and gold in particular.

Gold vs. Gold Equities

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350

400

May-2001

Aug-2001

Oct-2001

Dec-2001

Mar-2002

May-2002

Aug-2002

Oct-2002

Dec-2002

Mar-2003

May-2003

Gol

d (U

SD

/oz)

40

60

80

100

XA

U Index

Gold (USD/oz) XAU index

Strategic AllocationsEfficiency Frontiers

This graph shows the risk/return analysis of a balanced portfolio (60% equities/40% fixed income) whilst adding in the GSCI on a pro-rata basis

Note: Quarterly data from 31-Dec-1969 to 31-Dec-2002

10.5%

11.0%

11.5%

12.0%

12.5%

13.0%

4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0% 18.0% 20.0% 22.0%

Risk (Annualised Standard Deviation)

100% GSCI

60/40 Portfolio10% GSCI

32% GSCI

Strategic AllocationsHostile Markets

NAREIT REAL ESTATE

AUSTRALIAN EQUITIES

INTERNATIONAL EQUITIES

GSCI

CASH

BONDS

S&P 500 EQUITIES

CANADIAN EQUITIES

SMALL CAP STOCKS

60/40 PORTFOLIO

32.9%

-6.5%

-8.4%

-16.8%

-10.7%

-10.0%

-7.5%

-0.4%

7.4%

-12.3%

-20.0% -10% 0% 10.0% 20.0% 30.0% 40.0%-30.0%

Commodities Perform Best When the Financial Portfolio Performs WorstQuarterly Data from 31 December 1969 to 31 March 2003

We reviewed returns for a typical 60/40% balanced portfolio for Dec 1970-March 2003. From this period we looked at the periods when the portfolio posted its 10% worst returns and plotted the returns for other assets during those same periods.



Such indirect investments have their own merits, but should be seen as different to investments in underlying commodity markets. Returns on indirect investments are not necessarily correlated to commodity benchmarks. To conclude: - There is increasing awareness of

commodities as an asset class. - Direct strategic investments in commodities

provide a macroeconomic hedge that can help to simultaneously enhance returns and reduce the volatility of a portfolio.

- In addition, direct tactical investments in commodities provide a source of returns on their own, as well as relative value and event-risk hedging.

- Indirect commodity investments, such as commodity-producer equities or commodity macro or technical hedge funds have strong merits on their own, but are not necessarily correlated to commodity benchmarks.

Thank you very much. ■


A Hedge Fund’s Perceptions on Precious Metals

Steve Mathews

Commodities Strategist, Tudor Investment Corporation

Thank you for having me here to speak today; it’s a real pleasure and an honour. I work for Paul Jones of Tudor Investment Corporation as his commodities strategist. I’m telling you this because I want to make clear that my perspective may be an unusual one in this group. My precinct includes energies, grains, meats, softs, and base metals as well as precious metals. This is also something of a disclaimer because due to my personal limitations I am not a true expert in any of the commodities I track, but rather a relayer and synthesizer of expertise from specialists in each subject area. Some of those true experts are here in this room, and I apologise in advance for anything I present as an insight which is either trivial or well-known. Also, although I am an employee of Tudor Investment Corporation, nothing I say here is necessarily endorsed by Tudor, and certainly nothing should be construed as a trading recommendation. Tudor may be long or short any of the commodities we will be discussing, and those positions may change at any time, including during this talk.

When Tudor examined the problem of commodities analysis, it became clear to us that we needed to reduce the commodities data universe from a vast and diverse array of mine closures, cattle placements, and crop conditions to a set of statistics which could be compared on an apples-to-apples basis across trading instruments. When I’m in farm country, I sometimes attract a hostile glare from people who work with corn or soybeans for a living, because they see the attempt to distil their data as a devaluation of their expertise. But an analyst who compiles detailed information through exhaustive detective work makes the compressed, synthesised summaries that I offer possible. When Mr Jones is surveying the whole marketplace from equities to fixed income, and from currencies to commodities worldwide, the last thing he needs to see is every soybean emergence number. Therefore, Tudor has come up with a number of measures which allow a comparison of various diverse commodities on common terms.

Following is a table of the commodities we analyse as commodities. As you can see, they range from grains to metals to energies to meats. Maybe our attempt to condense the data makes more sense now.

Coffee C Arabica Nickel

Corn, No. 2, Yellow Platinum Copper, High Grade Silver Cotton, No. 2 Soybean Meal

Crude Oil, Lt. Sweet Soybean Oil, Crude

Gold Soybeans

Heating Oil, No. 2 Sugar, No. 11

Live Cattle Unleaded Gasoline

Lean Hogs Wheat

Pork Bellies Zinc

Natural Gas

We have decided that there are three primary non-chart-based areas of concern: volatility, liquidity, and fundamentals. Without sufficient volatility and/or liquidity, there is no potential for a trading return. Without fundamentals on our side, we are fighting the long-run pricing tendency of the market most of the time.

A Hedge Fund’s Perceptions on Precious Metals Steve Mathews


Liquidity First of all, liquidity is a big concern. For big accounts, the liquidity of a position can mean the difference between booking a small profit and getting stuck in a Roach Motel – which as you know is a place into which a roach can check in, but is unable to check out. This table displays the liquidity measure we use to assess the tradability of a commodities future:

Tudor Turnover Liquidity

Pork Bellies 11 Cocoa 44 Platinum 116 Coffee C Arabica 154 Soybean Oil, Crude 163 Silver 166 Lean Hogs 180 Copper, High Grade 198 Wheat 237 Cotton, No. 2 325 Sugar, No. 11 385 Live Cattle 390 Soybean Meal 414 Corn, No. 2, Yellow 465 Gold 538 Nickel 636 Zinc 987 Soybeans 994 Unleaded Gasoline 1174 Heating Oil, No. 2 1797 Brent Crude Oil 2543 Natural Gas 4041 Aluminium 4125 Crude Oil, Lt. Sweet 6930

As you can see, gold fits in right in the lower middle of the table, with a sufficient turnover to allow easy entry and egress from the market. Silver is less commodious, and platinum is relatively untradeable to a fund of our size.

Volatility Another issue for us is volatility. If a commodity future doesn’t move around in price, we can’t make any money on it without using options. We prefer simple directional bets, and that method has been successful for us. Here’s a ranked table of volatility as measured by the average % change per week. Gold looks fairly stationary, and silver and platinum are progressively better, if good is defined as volatile.

% per Week Average Change

Live Cattle 1.27 Gold 1.54 Aluminium 1.66 Zinc 1.84 Silver 1.99 Copper, High Grade 2.26 Soybeans 2.32 Corn, No. 2, Yellow 2.35 Cotton, No. 2 2.43 Platinum 2.53 Soybean Oil, Crude 2.54 Wheat 2.60 Soybean Meal 2.62 Cocoa 3.15 Nickel 3.22 Lean Hogs 3.74 Sugar, No. 11 4.04 Brent Crude Oil 4.22 Crude Oil, Lt. Sweet 4.27 Heating Oil, No. 2 4.33 Unleaded Gasoline 4.34 Coffee C Arabica 4.59 Pork Bellies 4.84 Natural Gas 5.41



Historical Volatility And here’s the same table using a more standard volatility measure, the standard deviation of historical price change. If anyone has any questions as to how we calculate these measures, I’ll be happy to address that afterwards, but in the interest of brevity I ask you to accept these figures as they are.

60-day % Sigma Historical Volatility

Silver 9.72 Live Cattle 10.02 Gold 10.46 Aluminium 11.51 Zinc 11.67 Copper, High Grade 14.34 Soybean Oil, Crude 16.91 Corn, No. 2, Yellow 19.98 Soybeans 22.08 Wheat 22.69 Soybean Meal 22.98 Nickel 23.46 Lean Hogs 23.53 Cotton, No. 2 23.79 Cocoa 25.70 Platinum 26.79 Pork Bellies 32.11 Unleaded Gasoline 35.36 Brent Crude Oil 36.08 Heating Oil No. 2 36.72 Sugar No. 11 38.58 Crude Oil, Lt. Sweet 39.30 Natural Gas 44.30 Coffee C Arabica 69.95

The results are similar to the earlier method of volatility calculation, but show that silver is less volatile than gold.

Days Remaining of Supply The third cross-commodity metric that we like to use is DR or “days remaining of supply”. This measure is equivalent to a stocks-to-use ratio expressed in these terms: how many days of supply are in storage given no further production and continuing demand at a constant pace. Here’s the table of those. You may notice that the three precious metals I’m discussing are clustered at the top.

Days Remaining Fundamentals

Gold 6,677.41 Platinum 295.76 Silver 259.89 Coffee C Arabica 184.74 Cocoa 178.78 Sugar, No. 11 155.04 Cotton, No. 2 141.43 Brent Crude Oil 103.28 Crude Oil, Lt. Sweet 103.28 Corn, No. 2, Yellow 76.71 Nickel 74.38 Aluminium 71.36 Wheat 69.49 Zinc 57.00 Soybeans 54.12 Copper, High Grade 41.84 Soybean Oil, Crude 39.96 Heating Oil, No. 2 34.69 Natural Gas 33.14 Unleaded Gasoline 18.59 Lean Hogs 9.09 Pork Bellies 9.09 Live Cattle 4.65 Soybean Meal 2.59

To summarise all three comparisons of commodities – our trading interest within this analytic framework indicates that we have a difficult time finding trades in gold, and difficulty executing in platinum, whereas silver offers a fair compromise between an interesting market and adequate tradeability.



Let’s look at the days-remaining data in another way:

The commodities in the upper half of the table have the lower numbers of days remaining of supply. In some sense, this indicates how “on edge” the market is, or how easily perturbed it can be by real world events. You may have noticed that platinum has the largest stocks to consumption ratio on the chart. Silver appears in the lower half but ahead of such items as coffee, cocoa, and sugar. I have conspicuously omitted one commodity in my list. Here’s the chart with gold left in:

Now we can see graphically the huge difference between gold and all of the other commodities. It’s fair to say that nothing else even comes close. This leads us to a proposition that I’m sure some of you have thought about before: the right way to trade gold is as a foreign currency, not as a commodity. Now you will need to bring in someone else to give you a trading recommendation; I abdicate my duty to declare myself bullish or bearish flat price in the face of what I consider overwhelming evidence that gold resides outside my supply/demand analytical framework.

Let’s go into the process of the days remaining calculation a little more. The Tudor Investment Corporation supply/ demand analysis front end gives a good insight into the method behind the analysis. The right-hand panel of the display contains the three elements of a supply sufficiency forecast: production, consumption, and stocks. The left-hand panel contains a price chart and a chart of the changing supply situation over time. The lower left-hand box is the history of days remaining for this commodity – wheat, which varies from about 140 days to a current level around 80 days. This implies that with no further production, and with constant consumption, the world will run out of wheat in 80 days.

Silver has a less urgent supply situation, with a current level of between 100 and 400 days of supply remaining. Platinum has a little less urgent supply situation, with a maximum of 1800 days remaining in 1986, and a minimum of between 400 and 700 days. Gold, on the other hand, is out of the park: the current level of 7,019 days of supply remaining is low for gold, but still quite amazingly high for a commodity. This level is so high that almost no event in the world can substantively affect a consumer’s ability to fill his or her need for metal in a physical sense. In some commodity markets, there are such tight physical constraints on supply that some hypothetical events could mean that consumers could not get the material at any price. This is simply not true in the case of gold. It’s generally accepted in the commodities trading world that price is related to supply sufficiency. Traders in general believe that if supplies decline or demand increases prices will

Days Remaining of Supply for Various Commodities

7019.43440.84

216.02145.07138.64132.92105.26104.8399.7599.0797.7571.7868.7362.9338.5937.4732.6519.9918.049.569.564.282.42

0 1000 2000 3000 4000 5000 6000 7000 8000

Gold

Coffee

Cocoa

Aluminum

Crude Oil

Wheat

Corn

Nickel

Heating Oil

Unleaded Gasoline

Pork Bellies

Soybean Meal

Days Remaining of Supply for Various Commodities

440.84216.02

145.07138.64

132.92105.26104.83

99.7599.0797.75

71.7868.73

62.9338.5937.47

32.6519.9918.04

9.569.56

4.282.42

0 50 100 150 200 250 300 350 400 450 500

PlatinumCoffee

Sugar, No. 11CocoaCotton

AluminumSilver

Crude OilZinc

WheatCopper

CornSoybeans

NickelNatural GasHeating Oil

Soybean OilUnleaded

Lean HogsPork BelliesLive Cattle

Soybean



rise, and that the opposite is true as well. Testing this proposition is tricky, however. Just to show you that I’m not crazy, here is a plot from a well-known (in agricultural circles) forecaster showing the relationship between supplies of soybeans and soybean prices. As the stocks/use ratio (or carryout/use ratio) increases, the price decreases in a curvilinear fashion described by the black line on the chart.

I’ve taken a stab at a similar analysis with our commodities. Using the statistical method of linear regression, the computer drew a line through the middle of the data. By inverting the stocks/use relationship, I’ve removed the need for a curved line, so the computer could more easily fit a line to the data. I want to make it clear that this will show a linear relationship between the two data series if there is one to show, but the usual caveats apply. When you attempt to replicate this regression at home, your mileage may vary.

This is a solid regression featuring aluminium prices – as supply became tighter in the past, prices rose. As supply became looser, prices fell

– behaviour we expect from a commodities market. Platinum prices show a looser relationship with supply, but it’s visible nonetheless.

As we expect, the line slopes upward. There are more outliers and a much less significant regression line. Silver is a mess. According to this line, as consumption grows relative to supply, prices go down.

When a regression result contradicts what we know of reality, we throw it away and start over. In this simple case, the regression technique is not working for silver.



The same thing for gold: this shows no significant relationship between supply and price. I contend that the reason for this failure is that supply hasn’t varied enough for the relationship to become visible. As supply draws down or consumption grows, I think you would start to see a relationship between the two, but since we have no data showing that, we can’t know for sure.

The next chart of gold and the euro is where we find a strong relationship, at least from visual inspection.

I’m going to go back to something I said earlier: gold is not a commodity. My fundamental analysis framework is inappropriate for forecasting gold prices. Obsessively following mine production and demand are valuable only as a way of anticipating actions of other traders. Gold trades as a form of foreign exchange.

To summarise: silver has a commodity-like set of fundamentals, decent volatility and decent liquidity. Platinum is ruled out by severely constricted liquidity – it would take a stupendous investing opportunity to justify a foray into such an illiquid commodity. And last but not least, I don’t classify gold as a commodity at all. ■


The Private Investor

John Reade

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 2000. In dollar terms the move from the 22-year low to a seven-year high of $390/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.

There are a number of reasons why private investors might contemplate gold as an asset class.

As this chart indicates, gold appears to be negatively correlated to US equity markets. Certainly gold fell in the second half of the 1990s 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.

This chart, lifted from a paper written by the World Gold Council, shows the correlation coefficients between the S&P 500 and other asset classes. Based on this analysis, gold should be attractive to asset allocation experts for its diversification properties.

Source: Reuters; UBS Warburg

Gold from January 1999Positive Performance

240

260

280

300

320

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380

Jan-99 Jul-99 Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03

US$/o

z

UK announcesGold Sale

Producers to deliver into hedgebooks Comex

Short-covering

E-15 Central Bank

Agreement

Lease Rate Spike

Comex 'Long' Rally

US Dollar Weakness

AttackOn US

"Investment' led rally

Risk AversionReturns

DiversificationAsset Allocation Attractions

-0.20 0.00 0.20 0.40 0.60 0.80 1.00

S&P500

International Equities

Emerging Markets

Equity REITs

US Govt Bonds

International Govt Bonds

US T-Bills

Gold

Correlations calculated between January 1992 to December 2001

Source: World Gold Council

Gold and S&P 500

Source: Reuters, UBS Warburg

Gold appears to be negatively correlated to US Equities

In the 1990s, equity markets reportedly crowded out gold

This is compelling argument for gold investment

400

800

1200

1600

Jun-92 Dec-93 Jun-95 Dec-96 Jun-98 Dec-99 Jun-01 Dec-02

Index

Leve

l

250

310

370

430

US$/o

z

S&P500 Gold Price

Correlation -0.88

The Private Investor John Reade


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.

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.

Private investors already hold vast quantities of gold, twenty two thousand tonnes or 15% of the total, which is $250 billion dollars worth at $350/oz. This sum dwarfs the total market capitalisation of gold equities, which is between 50 and 70 billion dollars, I believe. So the total value of gold ever mined is about 1.7 trillion dollars (at $350/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.

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 10,000 tonnes of jewellery – representing the capacity of refineries to recycle scrapped gold in one year. Now even $500 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.

Gold and the US dollar

Source: Reuters, UBS Warburg

Gold is inversely correlated to the US dollar

The two data series can move out of line, ie 1997-1999 and Q1-03 ...

… But the negative relationship has remained strong over time

250

290

330

370

410

Jun-91 Jan-93 Aug-94 Mar-96 Oct-97 May-99 Dec-00 Jul-02

US D

ollar

s per

Oun

ce

80

91

102

113

124

Index

(Inv

erted

Sca

le)

Gold Price US Dollar Basket (Inverted)

Correlation June 1991 to date = -0.80

Disposition of stock of above ground gold

Source: GFMS, UBS Warburg

Total produced 147’800t or 4.7 billion ounces

Jewellery 52%

Private Investment 15%

Other Fabrication11%Unaccounted for

2%

Official Sector gold holdings

20%

Availability of stock of above ground gold

Source: GFMS, UBS Warburg

Refining capacity and CB agreement constrained

$0.00

$0.30

$0.60

$0.90

$1.20

$1.50

$1.80

Total stock Immediately available

Trilli

ons o

f doll

ars

Unaccounted for

Private Investment

Official Sector

Jewellery and Fabrication



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.

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

Indian investment demand was the success story of the early 1990s, 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.

South East Asia

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

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.

Total Investment Demand 1993-2002Small component of total demand

0

700

1400

2100

2800

3500

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Tonn

es

Jewellery Demand Total Investment Demand

Source: GFMS, WGC

Indian Investment Demand 1993-2002The success story of the 1990, but ...

0

30

60

90

120

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Tonn

es

Indian Net Investment Demand

Source: GFMS, WGC

Greater Chinese Net Investment Demand 1993-2002Slipping away

0

10

20

30

40

50

60

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Tonn

es

Greater China

Source: GFMS, WGC

South East Asian Net Investment Demand 1993-2002Nearly recovered from dishoarding of 1997-98

-40

-20

0

20

40

60

80

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Tonn

es

South East Asian Net Demand

Source: GFMS, WGC



United States

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 2000. Commentators that correctly highlight that rolling 12-month coin demand is up 82% year-on-year are perhaps guilty of looking at the shorter-term picture. Japan

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 2002, while higher than that of the preceding two years, was unremarkable compared to 1999 or 1995.

When more frequent data is studied, the remarkable first quarter 2002 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.

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 1980s. 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 gold-linked 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 1980s. 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

US Net Investment Demand 1993-2002No sign of dollar diversification - Y2K more important

-40

-20

0

20

40

60

80

100

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Tonn

es

United States Net Demand

Source: GFMS, WGC

Japanese Net Investment Demand 1993-20022002 performance unexceptional

0

30

60

90

120

150

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Tonn

es

Japanese Net Investment Demand

Source: GFMS, WGC

Japanese Net Investment Demand 2000-02Tremendous potential demonstrated in Q1-02

0

10

20

30

40

50

Q2'00 Q3'00 Q4'00 Q1'01 Q2'01 Q3'01 Q4'01 Q1'02 Q2'02 Q3'02 Q4'02

Tonn

es

Japanese Retail Investment

Source: GFMS, WGC



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. ■


A New Approach to Gold Investment: The Story So Far

Graham Tuckwell

Chairman, Gold Bullion Limited

I'd like to thank the LBMA for this opportunity to introduce many of you, perhaps for the first time, to the concept of buying gold bullion by buying a share listed on a stock exchange, and to share with you some of the experiences thus far. Gold bullion securities have only been listed as of two months, and so to us they are still very new and still being learned about by many market participants. Contrary to what Kamal mentioned, there has been a great deal of interest in the product, but it does take time for people to convert their interest into a sales order and into generating assets in the trust. We started with virtually a zero asset base and we’re already at nearly three tons. We think that’s not a bad effort with very, very little marketing behind us. Gold Bullion Limited is a joint initiative with the World Gold Council, and I’d certainly like to publicly acknowledge all the help and support that the World Gold Council and their executive team have given us over the last six months.

Gold Investment Where did we start from? The London gold bullion market, in my opinion, is a great market. It’s transparent, it’s well regulated, it’s truly global and highly liquid – but it’s not used by mainstream investors. It’s really a market for the gold industry. So when most mainstream investors want to buy gold bullion, how do they go about it? Well, with great difficulty, as John mentioned. As the chief executive of the World Gold Council, James Burton, said in our prospectus and I’ll quote: “Many investors have found investing in gold bullion to be a cumbersome and costly process. Retail and institutional investors have encountered barriers to entry in the form of difficulties with purchase, storage and insurance.” Even sophisticated investors who run gold funds have had great difficulties. I can cite specific cases of guys in London, San Francisco and New York who did want to buy gold bullion, spent months looking at how to do it, what authorities they needed under their trustees, what authorities they needed to open metal accounts, and all three gave up in frustration. If those guys can’t do it, what hope is there for the rest of us?

And for retail investors, what’s available? Deposit accounts – unallocated gold, as it’s known – are not widely available in the banking system or even generally known about if they are. Gold bars and coins can be bought over the Internet and from some banks and refineries but, as John mentioned, the premiums are high; the bid offer spread large. And you’re never too sure whom you’re dealing with and even if you are, the storage costs can be prohibitive. Asking investors to buy and hold physical gold, in my view, is a bit like asking people dealing with currencies to hold suitcases full of bank notes. It’s just not attractive. So what happens? What do the investors do? They buy shares in gold mining companies. And that has a perverse effect on the gold market. Instead of increasing demand for physical gold, it increases the supply of physical gold because the capital supply for the mining companies is used to generate gold. What is the best way to make gold investment available to mainstream investors? Firstly, make it widely accessible by using the stock exchanges. All investors have brokerage accounts, but very few people have metal accounts and many people are simply not

A New Approach to Gold Investment Graham Tuckwell


allowed to open metal accounts. But they can all buy listed securities. Secondly, use the London market as I mentioned. It’s a great one, but securitise it – break it down so people can buy in small chunks. How do we do that? From our perspective, we sign one bullion account agreement that basically covers all investors. We issue shares that correspond to gold in the trust. We break the dealing size down to trading levels on the exchanges and of the issue, which in our case is a tenth of an ounce, so about US$30 per share. We run an open-ended fund so that the shares are freely exchangeable with the OTC gold. The custodian of the gold and share registry, once it’s set up, simply matches the gold in the trust with the shares on issue, one for one – that’s it. It’s that simple and that’s what investors need. From our perspective as a company, once we’ve put it in place, we focus on the sales effort. The firms that act as an interface in creating these shares are those that have both an equities capability and a gold desk. Or, if they don’t have the gold desk, they’ve got an arrangement with a firm that does have a gold desk, and that’s what we've seen develop already. The securitisation of gold on an exchange is, in my opinion, really quite simple. But there can be differences in the documentation and the devil is in the detail. Why has it taken so long? Why has the industry not had a product like this before? I don’t know – I find it quite bizarre. You hear about gold, people talk and get emotional about it, but can’t buy it readily. Very strange. Was it hard to do? For us it took a few months to develop. The product was, in fact, ready late last year but with the help of the World Gold Council we improved it and brought it out a couple of months ago. I know a few firms looked at doing something like this themselves but gave up. They backed off because they thought it would just be too expensive to develop. The trick is to get it done in a cost-efficient manner and, in each jurisdiction where one’s doing a primary listing, work through the myriad of the corporate and taxation laws and the listing rules. The overlap of those in any jurisdiction does not necessarily present an opportunity to have these securities available. You may need waivers of listing rules which are probably a little easier to come by than asking the government to change taxation laws or the corporate law just to bring a product like this to market. So that’s what we were able to achieve, fortunately, in the Australian jurisdiction, which is one that’s widely accepted by the international

investing community – probably one of half a dozen legal jurisdictions that global investors feel totally comfortable with. As a result, Gold Bullion Limited became the first company to list on the stock exchange offering this product: a pure, unleaded, gold investment. A Gold Bullion Security What is a Gold Bullion security? It’s allocated gold first and foremost. It’s no credit risk. If Gold Bullion goes under, you don’t lose your money. The investors still own the gold. It’s held on trust in London with HSBC, which, as most of you know, is the largest clearer in the market. Even if HSBC went bust, and I’m sure they won’t, you’re still entitled to the gold. And that’s what investors are after. It’s an open-ended fund with creations and redemptions at the spot price. New Gold Bullion securities are issued by the ASX Perpetual, in our case our share register, similar to DTC for example, only after gold is deposited in the trust. Until gold goes in the trust no new shares are issued. Someone deposits gold in the trust, you get new shares, and vice versa for redemptions. Each Gold Bullion share is a tenth of an ounce, which will decline slightly over time because we will sell some of that gold to pay management expenses of storage and insurance and to run the company. It’ll take more than four years for it to decline to even 99% of a tenth of an ounce. Therefore, the decay is very small and in fact for the first couple of years will be minimal compared to which day you buy the gold price on or the brokerage you actually pay. The fees are quite low, ten basis points for creations and a nominal amount for redemptions – really just an admin fee to stop retail investors coming to us. We’d rather they just sell on the exchange. And the monthly fee I mentioned is only two basis points per month. If you compare it with ETFs, there are very few in the market with lower fees than that, and they’re the really big ones such as the QQQs, spiders and the diamonds. How does it trade? It’s pretty boring, really. It tracks the gold price – that’s what it’s meant to do. As trust assets build up, one would expect it to trade at a very small premium over the offer price for gold, reflecting the cost in creating new shares – the creation fee – and the cost of a market maker bothering to sit there trading. That’s what we’ve seen. It’s been very consistent. We have all seen products announced or coming onto the market. How does one go about analysing the differences? They might each represent unleaded gold but the differences can



be quite important, particularly when an investor needs to make a choice between one or the other and just sit with that choice rather than bothering to analyse two different instruments. There are three essential components of listed security in our opinion. Firstly, ownership of the gold. Investors want allocated gold. Not a third party credit risk, which is what unallocated gold is. In fact, you could argue unallocated gold isn’t gold, it’s just a piece of paper issued by a bank and in most cases unsecured risk. Investors want to own gold bars. That’s the feedback we’ve been given and that’s what we’ve given them. On our website we publish all the details of every gold bar we hold in the trust. We don’t invite visits to the vault, but do give people the comfort of seeing the gold bars by going to the website. In any case, I don’t think unallocated gold is really on people’s radar screens at the moment given that there’s very little yield give up between unallocated gold and the storage costs on allocated gold because of the very low lease rates. Liquidity is the second element. First and foremost, it must be redeemable in gold at the spot price. If it’s not redeemable at the spot price, I don’t think people are going to be interested, because they will always go to that market where they can exchange with gold and get that guaranteed liquidity and no discount. The third element: it must be cost-effective. Once you’ve got the liquidity peg in the ground – in other words, you can always get the inter-bank spot price, you can always get gold with no discount – the only difference is fees. How much do you charge to create it? How much do you charge on an ongoing basis? That's assuming the security structures are set off. The Target Audience Who’s our target audience? Where are we going on all of this? Well, it is not the people most of you in this room might deal with – they can deal with you directly; they don’t need this product. And it’s not those in business who are already buying gold mining companies where they get leverage to the gold price and the benefits and costs of exploration and corporate upside and downside. Well, we didn’t think it was those investors. Our audience, by and large, is a whole new group of investors who have never bought gold before – the chief investment officers, the asset allocators and the fund actuaries. And it is financial planners and a broker for private clients. We are marketing gold as a financial tool to reduce portfolio risk. It doesn’t actually matter that it’s gold. What matters is that it’s

negatively correlated to equities, it’s listed and highly liquid. The fact that it’s gold is purely coincidental. So we’re tackling this from a statistical and actuarial approach. In fact, as part of our early development, we commissioned a report from the head of the actuarial department at Melbourne University to decide whether or not we wanted to go ahead with developing this product. That report subsequently became Price Waterhouse’s actuarial report, and it’s on our website. Based on work with the World Gold Council which has been extremely helpful and has been alluded to indirectly by some of the speakers this morning, we argued that there should be an allocation of around 2.5-7.5% of a total portfolio to gold for a benchmark, depending on where one views potential price performance of gold relative to other assets. Diego had 10% in commodities total, but only a small allocation to gold. We would consider the liquidity in gold and the ability to have it stored and not have third party credit risk. I wouldn’t want to store too many barrels of oil in my back yard or in a vault somewhere: you just can’t do it. In theory you might want to have a spread of commodities, but in practise, it’s the liquidity and the ability to store it that drives people to gold. Therefore, I think there can be a substantial allocation of gold within an overall allocation to commodities. These arguments are, in fact, set out in an information booklet that we wrote with the help of the research people at the World Gold Council, which sets out why invest in gold, and how much to invest, and looks at it from a statistical point of view. Some of the charts presented this morning are in that booklet. From where are we trying to access the demand? Both institutional and retail investors. We can market to institutional investors around the world because, from their perspective, it’s not a dollar investment, it’s a gold investment. A lot of institutional investors have the ability to buy equities or listed securities in most countries. So they’re interested in buying because it qualifies as an eligible investment under their trust deed by dint of it being listed on the stock exchange. In fact, we issued a press announcement a couple of weeks ago saying that the majority of investment in funds so far has come from offshore. And I know that some investors are buying this in euros, in sterling and in US dollars, and they’re asking the market makers to give them a fixed price to deal in those currencies while Australia’s closed.



So an institutional investor can phone up and say, “What’s your price for gold bullion? What’s your price for Gold Bullion securities?” They can then cut a deal with the market maker and get a contract note issued in any currency they want. Retail investors, though, are generally coming just out of the Australian market. International retail investors usually find it quite expensive to go cross-border because I often find they’re paying double amounts of brokerage. Market Reaction And the market reaction? Very positive. Exponential growth in trust assets, as I mentioned, from a zero base. We have a view on this, “from acorns do large trees grow”. We’d like to get the trust assets up as fast as possible, but we’re in no hurry. As I mentioned, we’ve got about three tonnes in there. We think we’ll get at least fifty tonnes within the first 12 months, and we think that’s not a bad start. Hopefully we’ll do even better. When you look at it, that’s not a large amount. There’s 60 billion invested in gold equities alone. A number of investors have said to us quite clearly they will rotate out of mining companies into gold bullion because that’s what they’re really after, a play on the gold price. If they want a leverage play, they can arrange that leverage themselves. If they want an unencumbered purchase, they can just buy the gold bullion securities. So we’re extremely pleased with the feedback that we’ve been given. Many times the meeting will start with, “what a great idea, why hasn’t somebody done it before?” People are very comfortable with the security structure. As I said, it’s just HSBC and ASX Perpetual – just matching it up. It’s that simple. Gold goes in, giving you share. Gold goes out, cancel the share. Most of the questions have, in fact, been on how to go about buying it. Is there a currency exposure? What is the role of the World Gold Council? Now, all of you here may understand the bullion market, but I can assure you most of the people we see don’t understand the gold market. So, apart from convincing them as to why buy gold, they have to get comfortable with understanding that particular market. They understand equities but not the bullion market. In fact, in many cases, working with the World Gold Council, we’ve been around for meetings where we have been the ones who have introduced the equity guy to the gold guy within the same firm. They’d never met. So, we are

coming from a very low knowledge base for many of these people. But once they work out how to do it – they’ve got to co-ordinate two trading desks, decide how to share out the profits and link the systems – once they do their first trade, they’re fine. They’re comfortable with it, but it does take time. We’ve got two market makers already and we think we’ll get more as the volume builds up. How are investors buying this? We allow them to buy it directly from the company, but all of them have been going through the market makers. That way somebody’s got to buy the gold to put it in the trust. You may as well leave it to the investment banks that deal in the gold to do that. So a client simply phones and tells them they want an order. No matter what the size, as long as they can cover it in the gold market, they can deal on the securities. They do not need to look at the Australian stock exchange, the turnover, the amount on offer or the amount bid for. All they need to do – because new shares can be created or redeemed at any time – is simply phone up the market and make them say, “What’s your price for 15 million, 100 million?” As long as they can deal in the gold market they can get set. That’s what’s happening. Private clients, as I mentioned, have bought in Australia, but international clients are having trouble accessing the market. In fact, the biggest hits to our website have come from the US and most of the e-mails we’ve received querying how to buy also come from the US. Asset allocators and financial planners are interested. Some of them are putting their clients into it quite quickly on the brokers of private clients side. The asset allocators and actuaries will take time – I’ve no doubt that it could take 6-12 months before we convince the first of the big actuarial firms to make a recommendation to their clients. But once those gatekeepers to the big pots of money turn a positive recommendation, the floodgates could truly open. Global Rollout How do we see the global rollout? At the moment, Gold Bullion securities, and more recently, the Perth Mint-issued warrants are only listed on one exchange, the ASX. As we all know, the World Gold Council has filed for a NYC listing but the timing of that will clearly depend on SEC approval. The Central Gold Trust, the same managers that manage the Central Fund of Canada, is in the market at the moment, having filed for a TSX-listed product but, in our opinion, it’s more like a closed-end fund. The devil in that detail – their



documentation – is that redemption is at 90% of market value or even less. As I mentioned, the big peg in the ground has got to be that it is redeemable at the spot price. From our perspective, we’re currently examining the costs and benefits of other listings, but the viability of any new listing will obviously depend on the legal requirements in each jurisdiction and the incremental demand. I’d stress that in examining other listings, obviously we’ve got to be very mindful of the WGC’s role and objectives with its products and we’re working together with them closely on that. So without pre-empting anything, I believe that over the next 12 months there will be a rollout of these products on a number of different exchanges, particularly so that retail investors and many funds that are restricted to investing only in their domestic market can buy.

I think, in fact, this product will end up being listed on every major stock exchange around the world, possibly within 12 months, other than perhaps Japan. I believe the product will be available in the US, Canada, UK, Europe, Australia, South Africa and Asia. We will see. It will be interesting to find out what the New Year brings in terms of demand. We believe we’ve witnessed the birth of a new source of demand for gold. Time will tell just how potent that new source of demand is. Thank you. ■


Session 2: Gold Investment Questions and Answers

Bernhard Schnellmann, Argor-Heraeus: I have a question about the legal structure of the gold bullion. Who is the beneficial owner of the allocated gold at the vault of HSBC? Is this the shareowner or is this Gold Bullion? Graham Tuckwell: It is the holder. The beneficial ownership of the gold belongs to the person that owns the security. B. Schnellmann: So HSBC will have hundreds and thousands of accounts? Graham Tuckwell: No, no. As I mentioned, there’s only one gold bullion account. By dint of a holder going onto the share register, under the trustee and documentation they are the beneficial owner of gold in that trust. It’s under a master trust deed whereby each person is, in fact, created as having their own separate trust entitlement. B. Schnellmann: But as a customer, I am a beneficial owner of your share and not the beneficial owner of the allocated gold? Graham Tuckwell: No, in fact you get two things. A gold bullion security comprises two things: a gold bullion share plus a beneficial interest in a trust specifically created to give ownership of that gold in the vault. That’s how we’ve done it, but you’ve quite correctly pointed out a technical detail I didn’t think I wanted to go into as it might confuse people, but it is quite essential when we give presentations to most investors or the big institutional investors as to what’s happening. Stewart Murray, LBMA: We heard about spread betting. People have talked on the sides of this Conference about warrants that were issued in the early 1990s. Could I ask Steve Mathews if what he’s seen today is going to make him an investor in gold bullion?

Steve Mathews: I think the securitised products that we’re talking about here are very exciting, especially from a retail perspective. As far as hedge funds, they already have quite adequate access to the bullion markets and the precious metals futures markets. So I would say our view of this exchange-traded fund phenomenon is that it’s very important from a retail point of view and it’s very important for overall gold demand. However, it’s not administratively all that significant for us because we already have adequate access. Participant: Just a question for Steve – you said in your presentation that eventually you consider gold more as a currency, in fact. And then you showed a chart with the correlation between gold and the euro. Then my question is, why should you trade gold – since you will find more liquidity and volatility in the FX market – if it’s just for you a substitute or a sort of currency? Steve Mathews: That strong correlation has not always been the case. That’s been a very noticeable thing recently, and you could maybe see it as investors who are sort of intellectually confined to the area of foreign exchange, sloshing around from one to another in search of something that will retain value as the dollar goes down. But I think there are investors out there, certainly among the hedge fund community and elsewhere, who see gold as a foreign exchange which is outside the fiat currency framework – and, therefore, may have superior attributes to the euro or any fiat currency available. ■

Introduction to Session 2: Gold Investment - LBMA · Introduction to Session 2: Gold Investment ......

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