$ 900+ mid-cycle gold price prediction

Cheuvreux, the equity brokerage house Credit Agricole, raised its mid-cycle gold price estimate from $750/oz to $900/oz, suggesting the possibility gold could climb to $2,000 an ounce and higher, in a January 2006 sector report. Cheuvreux is ranked # 2 for Western European research by Institutional Investor and has eight offices in Europe, with 110 analysts.

London-based Cheuvreux Investment Analyst Paul Mylchreest claimed that "covert selling (via central bank lending) of gold has artificially depressed the price for about a decade, but Bank for International Settlements' data on gold derivatives suggests its impact in on the wan. ...Our $900/oz mid-cycle estimate takes into account the long-term average ratios between the gold price and the prices of oil and the Dow Jones Industrial average."

Mylchreest declared that "we also see the possibility of a spike to $2,000 or higher, if the story on diminished central bank gold reserves becomes widely accepted, if central banks in countries with large US dollar holdings compete to buy gold and diversify forex reserves away from dollars, and if the U.S. economy slides into either high rates of inflation or deflation."

He estimated that central banks have loaned out between a third and a half of their reported gold reserves or 10,000-15,000 tonnes of gold. The short position between the central bank and the billion bank "is the foundation for the gold derivatives market which grew rapidly in the 1990s and currently has a notional value of c.USD300bn. Non-gold producers account for the majority of the short position and may not be able to cover their shorts without causing a spike in the gold price," Mylchreest suggested.

Meanwhile, Mylchreest asserted that "despite official denials, there is much evidence to back the gold price suppression claims" made by the Gold Anti-Trust Action Committee (GATA), adding that "support for GATA has come from senior Russians officials."

"We estimated that there is a substantial supply deficit in the gold market of around 1,300 tonnes p.a. before any central bank selling and perhaps 700 tonnes p.a. after the publicly announced sales, but before covert selling," Mylchreest said. "This compared with world gold mine output of only 2,500 p.a."

Any quick fix to this deficit is not possible since central bank gold reserves are finite and the lead time on new mining projects is seven to 10 years, he asserted. Meanwhile, Mylchreest suggested "there is no way that the market can accommodate renewed buying by central banks like Russia."

Mylchreest said the gold price acts as a early warning of potential crisis, such as rising inflationary/deflationary pressures and general confidence in paper currency, particularly the U.S. dollar. "The U.S. economy will walk a fine line between inflation (possibly hyperinflation) and a deflationary slump in the next few years. In the short term, we see further reinflation with continuing asset inflation as slightly more likely," he suggested. "Even if the U.S. economy somehow muddles through, the short position in gold, central bank buying and low real yields will support the gold price."

"Gold and precious metals are the only asset class that should perform well in either an inflationary or deflationary scenario," Mylchreest declared.

Mylchreest predicted that "gold and gold mining stocks are posed for an unprecedented rise in prices and profile." Nevertheless, he added, the combined market capitalization of the 10 largest gold stocks on world stock markets is equivalent to only 30% and 40% of the market capitalizations of General Electric and British Petroleum respectively.

China and the US $

After England sold 55% of its reserves at an average price of $ 295 between 1999 and 2002 and Canada sold its entire reserve of 600 tonnes, European Central Banks have capped sales under the Washington Agreement at 500 tons per year.

The Financial Times reports that a spokesman for China's foreign exchange regulator (State Administration of Foreign Exchange (Safe)) indicated that China would seek to diversify its holdings of foreign exchange reserves ("China signals reserves switch away from dollar" Jan 5, 2005).

China holds an estimated US$ 800 billion in US $ assets in its reserves (an estimated 70% of its total reserves), which is expected to climb to $ 1 trillion during this year. If China begins to buy less US Treasuries or sell US $, this would major implications for foreign currencies and commodities. Gold jumped $ 11.60 during the day on this news.

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Inflation and M3 Data

In Nov 2005, the United States government quietly announced that it was discontinuing the publication of M3 data as of March 2006. It will still collect it but not disclose it.

M3 is the broadest definition of money supply, and includes coins, currency, checking accounts, money market funds, time deposits and institutional money market accounts.

Inflation is defined as rate of increase of money supply. The increase in money supply may lead to price increases at the consumer level due to demand factors.

Dr. Mark Skousen, an economist who teaches at Columbia University, quotes Nobel prize-winning economist Milton Friedman on this issue who said: "I don't know why the Federal Reserve discontinued the M3 chart. But inflation is clearly a problem right now."

But the crucial link here is to GDP growth. Nominal growth of goods and services produced has to be divided by an inflation factor. Inflation is therefore a key factor in the determination of GDP growth.

We have already seen Bill Gross of PIMCO (the largest bond fund manager in the US) accuse the government of manipulating inflation data to understate inflation by over 1% (which would overstate US GDP growth by 1%).