MRB Theme Report_Oct26 2010

8/8/2019 MRB Theme Report_Oct26 2010

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Macr oRe se ar chBoar d

Independent Investment Strategy &Consulting

partnersmrbOcobr 26, 2010

Theme RepORt

M R B p A R t N e R S I N C . m w w w . m r b a r n r s . c o m m C o y r i g h 2 0 1 0 ( s f i n a l a g f o r f u l l c o y r i g h )

m th sw so for gold rics will rsis for a whil lon-

gr: monary condiions will rmain xrmly accom-

modaiv, king ral inrs ras low and h major

currncis unaaling. In urn, h idal wav of invs-

mn caial rushing ino gold is unlikly o vanish.

m Nonhlss, sculaiv xcsss ar alrady build-

ing and h ak in gold rics could b abru (similar

o 1980). Nimbl invsors may wish o rid h rnd

highr for now, bu longr-rm invsors should con-

sidr using ric srngh o gradually rim osiions

and rdirc funds ino roduciv asss.

m Goldwillnot proveeectiveatpreservingwealth in

theeventofacceleratinginationordeation.Either

oucom would likly b barish for bullion.

1

Nx thm Ror

The Ination/Deation Debate

tusday, Novmbr 2nd

The Gold Bull Market:Debunking Myths &Timing When To Sell

Gold prices have surged more than vefold from

hir 2001 low of roughly $260/ounc. th macro

and olicy forcs currnly a work hav crad a

sw so for his ass. Indd, i is ossibl ha

gold rics will xrinc a arabolic mov highr

(muchlikethe1979/80episode),giventheoodof

invsmn caial rying o nr his rlaivly il-

liquid mark.

Howvr, i is worrisom ha a mania mnaliy is alrady forming in h gold mark.

th rcious mal is now bing characrizd as a cash quivaln and h rfc ail

riskhedge(i.e.willbenetfromeitherinationordeation).Goldisneitherandshould

no b rgardd as a on-way b. Mos likly, gold will nd u causing a gra dal of

ain for invsors adoing a buy and hold sragy a his oin in h cycl. In fac, long-

rm invsors should considr using ric srngh o gradually rduc xosur and

rdirc funds ino roduciv asss wihin hos conomis ha do no fac cyclical or

srucural hadwinds.

Not A Hedge For Tail Risks

Financial aricians incrasingly rcommnd adding gold o an invsmn orfolio

asaprudentmeasuretohedgeagainstinationand/ordeation(i.e.aninsurancepolicy

youhopeisnotneeded).Someevensuggestthatgoldholdingsincreasediversication.

Unfortunately,goldisnotparticularlyeectiveatpreservingwealthineithertailrisk

scnario, and is corrlaion wih risk ass rics has risn markdly in rcn yars.

Gold should no

b rgardd as ahedgeforination

ordeation


2/12

2M R B p A R t N e R S I N C . m w w w . m r b a r n r s . c o m m C o y r i g h 2 0 1 0 ( s f i n a l a g f o r f u l l c o y r i g h )

mrb Theme RepORt mOcobr 26, 2010

thr is a widsrad and long-hld blif among invs-

ors ha gold movs wih, and ofn in aniciaion of

shiftsinconsumerpriceination.Theabilitytopreserve

walh during riods of rising ric rssurs is crain-

ly an aaling rory, givn ha almos all ohr as-

ss g hammrd during hs isods. Indd, gold

rics surgd during h 1970s whn U.S. and global in-

ationacceleratedtoadouble-digitpace.Bullionprices

thencollapsedalongwiththedisinationarytrendofthe

1980s and 1990s. Howvr, h rlaionshi bwn

goldandinationsubsequentlybrokedown:goldprices

sard rallying in 2001 dsi a coninuaion of h dis-

inationarytailwindintheglobaleconomy(chart 1). th

dcad long divrgnc suggss ha gold is no, or a

las no longr, drivn by xcd ric rssurs.

Similarly, hr sms o b a growing consnsus ha

goldwillalsoprovideinsuranceagainstadebt-deation

siral. I may b ru ha in a coml collas of h

globalnancialandmonetarysystems,goldbars/coins

(no gold etFs or drivaiv roducs) will b a rfrrd

ass, along wih drid food and shoguns. Howvr,

shor of his Armagddon scnario, gold is no aricular-

lyusefulasadeationhedge.Indeed,goldpricesplunged31%duringthenancialmeltdownof2008,whenfears

of drssion scaladd and invsors ricd in ourigh

deation(chart 2). Bullion ourformd many risk as-

ss, bu grossly undrrformd cash and govrnmn

bonds. In his rgard, gold should no b rgardd as a

hedgeagainstdeationorasacash-equivalent.Classify-

ingthisassetasthelatterrunstheriskofaddingsigni -

can volailiy o an invsmn orfolio. Indd, hr

has bn a corrlaion of 0.82 bwn gold and mrging mark quiis ovr h asdecade,asbothhaverespondedtotheebbandowofgloballiquidity.

What Drives Gold?

physical gold has many aaling roris. I has a limid suly, is no a liabiliy of

anyon, has svral indusrial uss, and is aaranc has mad i rvrd for jwlry

and h ars for cnuris. Morovr, gold is virually indsrucibl and has boh a high

0

200

400

600

800

1,000

1,200

1,400

0

4

8

1

1

2

1975 1980 1985 1990 1995 2000 2005 2010

Gold Price (LS, $/oz)Global CPI Inflation (RS, %YoY)

Chart 1 Gold:NotAnInationHedge

MRB Partners Inc 2010

Correlation betweengold and infationbroke down earlylast decade

1,200

800

Gold Price ($/oz)

-4

-2

0

2

2007 2008 2009 2010

U.S. 1-Year CPI Swap Rate (%)

Chart 2 GoldDoesNotPreserveWealthDuringPeriodsOfDeation


Defationscare

-31%

1000


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valu-o-siz and valu-o-wigh raio, making i ora-

bl and asy o sor. ths roris ar criical during

convnional wars and rov usful o avoid walh con-

scationbysovereignauthorities.Manyhavealsoused

his rcious mal for ax-avoidanc. tha said, h wo

rimary drivrs of gold rics hav hisorically bn ral

inrs ras and currncy dbasmn.

1) Real Interest Rates

Theination-adjustedrateofinterestthatinvestorsre-

civ for lnding hir caial is h ooruniy cos of

holding gold. Whn ral ras ris i bcoms lss a-

aling o hold gold, givn ha h rcious mal dos

notprovidecashows(coupons,dividends,etc).Chart 3

highlighs his invrs rlaionshi.

During h 1970s, U.S. inrs ras wr consisnly

hld blow h ra of nominal conomic growh. this was

a consqunc of aggrssiv Fd suor during h 1970

and 1974 rcssions, and lagging olicy during h rcov-

ris. th rsul was a liquidiy-fuld conomic xansion ha combind wih srong la-

bor unions, ld o a fairly rdicabl ris in ric rssurs. In urn, ral yilds lungd as

policytrailedtheincreaseininationandinationexpectations,benetinggoldprices.

By h nd of h 1970s, h Fd undr h ladrshi of Chairman paul Volckr bcamdeterminedtobreakthebackofination.Thecentralbankdroveinterestratesdecisive-

ly highr han conomic growh, causing wo srious rcssions and allowing a riod of

sustaineddisinationtosetin.ThedisinationarytailwindwasaidedbyPresidentRea -

gans war agains labor unions. th consqunc was a sik in ral inrs ras and a

collapseingoldprices.TheFedsanti-inationbiaspersisteduntilearlylastdecadewhen

theU.S.experiencedadeationscareintheaftermathofthebursttechbubble.

DuringboththeinationaryanddisinationaryepisodesCPIandgoldpricesmovedto -

ghr, bu i was no h formr ha drov h lar. Boh rsondd o a rsisn dis-

equilibriuminmonetarypolicy.Asnotedabove,inationandgoldpriceshavediverged

in h as and can do so again.

Indd, by 2001 h Grnsan-ld Fd, along wih h ohr major cnral banks, wr

aggressivelyattemptingtofendodeationarypressuresandwillingtoriskover-stim -

ulatinggrowthconditions.Despitepolicybeingaccommodative,consumerpriceina-

tionremainedsubduedduringthersthalfofthe2000s.Nonetheless,realinterestrates

drifd lowr and hld riggr an xlosiv ulg in gold rics.

Gold Price ($/oz)

0

5

1970 1980 1990 2000 2010

U.S. 5-Year Real Bond Yield* (%)

* Deflated by CPI inflation

Chart 3 Gold&RealBondYields


1200

800

400

200

100

th wo rimary

drivrs of gold

rics ar ral

inrs ras

and currncy

dbasmn


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th rally in h gold mark ovr h as dcad has also

bn aidd by h wll-lvisd shif by h major cnral

banksfromination-ghtingtoerringonthesideofrea-

ion, which rducd h uncrainy rgarding h dirc-

ion and lvl of ral inrs ras. Chart 4 shows h dif-

frnc bwn G7 GDp growh and olicy ras as wll as

h cumulaiv ga bwn hm. Whn h cumulaiv

ga is rising sadily, global cnral banks ar simulaing

growh condiions by roviding liquidiy and surssing

ral bond yilds. Convrsly, whn h ga dclins, i is

bcaus cnral banks ar adoing a rsriciv olicy s-

ing and ushing ral ras highr. Gold rics hav gnr-

ally movd wih his masur of liquidiy sinc h Bron

Woodssystemcollapsed in1971 andtheocialprice of

bullion was frd. In his rgard, gold can b characrizd

as a baromr of global liquidiy condiions.

Currnly, global monary auhoriis ar xlicily an-

choring ral inrs ras, wih h Fd sanding rady

o rovid addiional quaniaiv asing, if ndd, o

simula growh condiions and/or conain trasury yilds. Howvr, unlik h 1970s,

if ric rssurs wr o build in h currn nvironmn i is unlikly o b osiiv for

gold. Cnral banks ar agr o simula growh condiions, rovidd ha i dos no

hurttheircredibilitywithregardstoinationtargeting.Expectationsofasustainedriseinpricepressureswouldcausepolicymakerstoshutotheliquiditytapsandpushreal

yilds highr. If monary auhoriis ar sn o b comlacn or if hy fail o rsond

fas nough, bond vigilans will driv u yilds sharly, disruing h rcovry and

causingreneweddeationarypressurestothedetrimentofbullionprices.

Attheotherendofthespectrum,deationarypressuresprovidejusticationforcen-

tralbankstosuppressrealinterestratesbutoutrightdeationwouldbebearishforgold

rics. Alhough nominal olicy ras would say anchord a zro, ral inrs ras by

denitionwouldriseasconsumerpricesfall.Inthisscenario,investorswouldbebetter

obyholdinghigh-qualitygovernmentbondsorsittingoncash.

2) Currency Debasement

Invsors il ino gold during riods whn h global monary sysm is undr hra

orwhengovernmentocialsattempttodebasetheircurrencies.Throughouttheages,

rulrs hav rgularly dbasd hir currncis in ordr o xrac rsourcs from h ub-

lictocoverexpendituresthatcannotbenancedbytaxationorbondissuance.Episodes

of currncy dbasmn hav radiionally occurrd o fund wars and h xansion of

Gold can b

characrizd as

a baromr of

global liquidiy

condiions

1200

800

400

200

100

0

5

G7 Nominal GDP Growth MinusAverage Short Term Rates* (%)

1980 1990 2000 2010

Gold Price ($/oz)

Excess Liquidity**

* Average of G7 eurocurrency rates** Cumulative gap between G7 nominal GDP growth and average eurocurrency rate

Chart 4 Gold&Liquidity


Bullion prices are sensitive

to swings in global liquidity


5/12



mirs. evn during h ra of h gold sandard, convribiliy was morarily sus-

ndd by h Briish govrnmn during h Naolonic Wars and by h U.S. govrn-

mn during h Civil War (chart 5). Govrnmns of all h major combaans also sus-

ndd gold convribiliy in ordr o fund miliary oraions during World War I.

On major aal of gold is ha i hls rsrv walh and urchasing owr during

riods of currncy dbasmn. Govrnmns ar no abl o maniula h suly of

h rcious mal, hr is no rining rss aachd o i, and i canno b downgrad-

d by a raing agncy. Gold has bn subjc o incrass in suly du o nwly found

dosis or incrasd roducion, alhough on balanc his has bn rlaivly gradual

hroughou h cours of hisory (wih a fw noabl xcions). Looking ahad, hr

is vidnc o suggs ha h sock of gold will only incras modsly. Whil h hory

of ak gold is subjc o dba, h ac of nw discovris has dclind markdly

ovr h as 10-15 yars. producion has also slowd, wih gold ouu dclining in sv-

ral ky roducrs, including Souh Africa and Russia.

In modrn ims, gold has bn ricd in U.S. dollars and is aricularly snsiiv o

swings in h U.S. xchang ra (chart 6). Currncy dbasmn layd a suoring rol

during h gold bull mark of h 1970s. th U.S. xandd currncy in circulaion

raidly hroughou h 1960s and 1970s. Combind wih h ailwind from falling ral

interestrates,thepreciousmetalskyrocketedfromanarticiallydepressedocialprice

of $35/ounc o a ak of $850/ounc by 1980.

-4

0

4

8 CPI Inflation* (%YoY):

U.K.

0

10

1800 1825 1850 1875

U.S.

* Shown as a 4-year moving average

Chart 5 CurrencyDebasementDuringWartime


Gold Price ($/oz)

-160

-140

-120

-100

1980 1985 1990 1995 2000 2005 2010

U.S. Trade Weighted Currency* (Inverted)

* Source: IMF

Chart 6 GoldPrices&TheU.S.Dollar


1200

800

400

200

Invsors hid in

gold whn gov-

rnmns am

o dbas hir

currncis...

...hr is no

rining rssfor bullion

Napoleonic War

AmericanCivil War

Weak U.S. dollar has provideda tailwind for gold


6/12



thr is crainly an incniv in h currn backdro for

govrnmns who hav issud local currncy dnomina-

d db o dbas hir xchang ras in ordr o as

themassivescalburdenstheyface.SomearguetheU.S.

is subly aming his, alhough h growh of currn-

cy in circulaion has rmaind vry subdud. evidnc of

policymakers in anycountry intentionally inating their

way ou of slf-crad roblms would almos crainly

lad o a sovrign db crisis. th accomanying lndrs'

srik would rquir currn accoun balancs o shrink

abruly and rsul in ainful conracionary forcs wihin

h domsic conomy. th major cnral banks ar all

wll awar of his risk and hav no rsord o h rining

rsss in rcn yars. Narrow mony suly has mush-

roomd bu h vas majoriy of his has bn a ris in

banking sysm rsrvs. Currncy in circulaion has only

accound for a small rcnag of h incras (chart 7).

Final Word:Real interest rates and currency debasement

are the primary drivers of gold prices. While both can lead

to periods of ination, it is not the latter that drives the

price of the precious metal. In fact, contrary to most in-

vestors, we expect that a rise in ination would ultimately

prove bearish for gold. It would either be met with tightermonetary policy and higher real interest rates, or a disrup-

tive spike in bond yields as xed income investors force the

authorities to respond with discipline.

In A Sweet Spot, But

th currn macro backdro is vry suoriv of gold

and should lad o furhr ric arciaion. Monary

auhoriis across h glob ar forcfully aming

toreatetheireconomies.Themajorcentralbanksare

commid o k inrs ras anchord nar zro for

h forsabl fuur and h Fd is willing o ngag in anohr round of quaniaiv

easing,ifneeded,tostaveoacontractioninconsumerprices.Actualdeationwouldbe

a barish dvlomn for gold rics (as discussd abov) bu h aggrssiv am

by olicymakrs o rvn i from occurring is osiiv as i has draggd down h n-

ir couon curv, causing ral inrs ras o lung ino ngaiv rriory (chart 8).

th macro

backdro is

bullish for gold

12

14

16

18

20

22

2003 2004 2005 2006 2007 2008 2009 2010

Commercial Bank ReservesCurrency In Circulation

Developed Economies*:Monetary Base Components (% of GDP)

* Includes: Australia, Canada, Euro Area, Japan, New Zealand,

Norway, Sweden, Switzerland, U.K. & U.S.

Chart 7 QEHasBeenUsedToSupportBanks,NotDebaseCurrencies


1,250

1,000

750

Gold Price ($/oz)

0

1

2

2005 2006 2007 2008 2009 2010 2011

Implied Real 5-YearGovernment Bond Yield* (%)

* Nominal 5-year government bond yield minus 5-year CPI swap rate

Chart 8 OpportunityCostOfGoldIsExtremelyLow


The bull run has been

turbocharged bynegative real yields


7/12



Moreover,giventhatdeationisconsideredalegitimate

risk, bond invsors ar no ricing in monary ighn-

ing (h wo-yar yild is nar a rcord low) and vigilans

ar no forcing h long-nd of h curv highr.

Inrsingly, h global banking crisis has bn osiivfor gold rics:

m I has rquird unrcdnd quaniaiv asing as

themonetaryauthoritiesattempttoprovidesucient

liquidiy o banking insiuions (i.. driving inrs

ras lowr).

m th brokn monary ransmission mchanism in much

of h dvlod world mans ha h liquidiy ha has

bn crad is no raching h ral conomy (chart 9).

Thus,inationrisksarelimited,yetmoneyischeap.

m th uncrain oulook is curbing crdi dmand b-

caus businsss ar hsian o xand. this limis

h comiion h govrnmn facs for h xising

poolofdomesticsavingsandpreventsacrowdingouteect,whichwouldforcereal

inrs ras highr across h curv.

m Srucural hadwinds and rlaivly wak growh in h U.S., Jaans and euroan

conomis ar also lading o downward rssur on h major currncis. Alhough

mos of h major cnral banks would lik a char xchang ra, w doub any will

acivly ursu currncy dbasmn. Nonhlss, invsors ar sking alrnaivs

andthesoftU.S.dollarisbenetinggoldprices.

Successfulpolicyreationmayalsobeinitiallypositiveforgoldprices,giventhatthema-

jor cnral banks lan o lag h curv and allow h conomic rcovry o gain racion.

However,evidenceofasustainedexpansionoranywhiofpricepressuresbuildingwould

soon caus ral yilds o rach highr, rmoving a criical ailwind for gold rics. Sron-

gr global growh momnum may also riggr a rvival in riva scor crdi dmand.

Euphoria Is Worrisome

th currn macro nvironmn is vry suoriv of gold, laving onial for a manic

blowoinpricesbeforetheuplegcomestoanend.Nonetheless,investorsshouldbe

carful no o g caugh u in h uhoria ha is currnly building. Alhough gold dos

no hav any convnional valuaion yardsick, hr is vidnc ha froh is building:

th global

banking crisis has

bn osiiv for

bullion rics by

drssing ral

inrs ras

0.8

0.9

1.0

Developed Economies*:

Money Multiplier**

4

6

8

2000 2002 2004 2006 2008 2010

Broad Money Supply (%YoY)

* Includes: Australia, Canada, Euro Area, Japan, New Zealand,Norway, Sweden, Switzerland, U.K. & U.S.

** Broad money supply divided by monetary base

Chart 9 BankingCrisisJustiesAggressivePolicySettings


Stillbroken!

Liquidity notreaching realeconomy


8/12



m Price Appreciation: Gold prics hav surgd o an all

im high, jumping 32% ovr h pas yar and mor

han 100% sinc hir 2008 lows. th prcious mal

is now mor han $600/ounc abov is hisorical up-

ward sloping rnd (chart 10). evn whn rmoving

h U.S. dollar impac by using a global currncy, or

SDR1, gold prics ar 66% abov hir hisorical rnd.

Alhough ras of chang wr vn mor srchd

by h im prics pakd in 1980 in comparison o

oday, rcn pric acion dos suggs ha mania

forcs ar building.

m Real Prices: th ral pric of gold is alrady 2.5 san-

dard dviaions abov is pos-Bron Words avr-

ag (chart 10, boom panl). thos bullish on hprcious mal ofn poin ou ha ral gold prics

rachd a whopping $2120/ounc in 1980, suggsing

room for dramaically furhr upsid. Whil ru, on

mustkeepinmindthatthefnalspikehigherdoubled

ral gold prics in a mar of a coupl monhs. And h opping ou procss did no

las vry long bfor prics bgan wha would b a 70% collaps in ral rms. thus,

nimbl invsors wih h abiliy and disciplin o s sops may hav h abiliy o

capitalizeona temporaryspikeinprices.Longer-terminvestorswithlessexibility

willhavediculty.

m Investor Positioning: N sculaiv osiions ar a cyclical xrms and bullish con-

snsus masurs ar hovring around 80% (chart 11). Grand hs masurs hav

bn lvad for much of h bull-run and do no rovid usful iming signals. Non-

hlss, currn radings suggs ha hr is onial for a violn rvrsal in rics

onc h macro backdro urns lss favorabl for his ass (i.. ral inrs ras ris).

m Demand Composition: Invsmn dmand for gold (aricularly from etFs) has risn

dramaically in rcn yars and is having a marial imac on rics, givn h rla-

ivly limid suly of his rcious mal. Table 1 from h World Gold Council high-

lighs ha from h bginning of 2007 unil h nd of 2010 Q2, 13,152 onns of nw

gold suly has nrd h mark. Of his, roughly 2/3 was urchasd o cra nw

roducs (jwlry as wll as indusrial and dnisry alicaions). th rmaining 1/3 has

bn allocad o invsmns, which is xcionally high from hisorical sandards.

1SpecialDrawingRights(SDRs)arenancialinstrumentscreatedbytheIMFin1969andissuedperiodi-cally in nw ranchs sinc hn. SDRs rrsn a claim on IMF mmbr counris accouns wih hIMF. Currnly, SDRs ar comosd of 44% U.S. dollars, 34% uros, 11% yn and 11% U.K. ounds.

Gold Price ($/oz)

500

1,000

1,500

2,000

1970 1980 1990 2000 2010

Real* Gold Price ($/oz)

* Deflated by CPI inflation

Post-Bretton Woods Trend/Mean+/- 1 Standard Deviation(for both panels)

Chart 10 BullionPrices:TechnicallyStretched!


1200

800

400

200

100

Sculaiv

xcsss ar

building in h

gold mark


9/12



Rmarkably, invsmn dmand coninus o in-

cras raidly, raching 55% of suly (including min-

ingproduction,ocialsectorsales,andrecycledgold)

las quarr. pu anohr way, invsmn dmand is

now roughly quivaln o oal mining roducion.

In urn, gold rics ar bing forcd highr in ordr o

crowd ou jwlry, indusrial and dnal dmand, wll

as o nic individuals o rcycl hir xising jwlry.

In 2010 Q2, rcycld gold surassd jwlry dmand!

thus, vulnrabiliy is building, givn h rducion in

fundamnal dmand. prics could sik from hr if

investmentowscontinuetoincrease or dro sharly

if invsmn dmand wans. W susc h formr

condiion will rsis for a whil longr.

m Producer Hedging: Insad of locking in currn ric-

s, gold roducrs hav virually sod hdging.

Som of his dcision has bn in rsons o invs-

ors sking socks ha ar ur lays on gold rics.

Regardless,thisisanindicationofcorporateovercondenceinthecontinuedstrength

of rcious mal rics. Indd, gold comanis hav a oor hisorical rcord in im-

ing hir hdging aciviis (i.. should b sn as a conrarian indicaor).

m Anecdotal: There are also a signicant number of anecdotal signs that the gold

mark is bcoming frohy. ths includ h widsrad anion h rcious mal

isgettinginthenon-nancialpress,thesharpincreaseinthenumberofcash-for-gold

infomrcials, and h inroducion of gold vnding machins in svral counris,

including Grmany and h U.S.

Supply (Tonnes) 2007 2008 20092010

Q1

2010

Q2

Total

2007-Q'2

Mine Supply 2,029 2,058 2,322 586 644 7,639

Official Sector Sales 484 232 30 - 38 - 8 700

Recycled Scrap Gold 982 1,316 1,673 350 496 4,817Total Supply 3,494 3,605 4,024 897 1,131 13,151

Demand (Tonnes) 2007 2008 20092010

Q1

2010

Q2

Total

2007-Q'2

Jewellery 2,417 2,193 1,759 502 406 7,277

Industrial and Dental 465 439 373 103 107 1,487

Investment Including (ETFs) 612 973 1,892 292 618 4,387

Total Demand 3,494 3,605 4,024 897 1,131 13,151

Table1 GoldMarket:SupplyAndDemandComposition*

Invsmn

dmand is now

quivaln o

mony roducion

75

50

25

1,200

800

400

Gold Price ($/oz)

1995 2000 2005 2010

Bullish market sentiment (%)

Chart 11 InvestorsPositionedForHigherPrices


Lots ofgold bulls

* Source: World Gold Council


10/12



Inrsingly, valuaions for gold quiis sm somwha mor aaling. Global gold

sock rics hav dramaically laggd h ric arciaion in h undrlying commod-

iy in rcn yars. par of his is srucural, givn ha h craion of gold etFs has ro-

vidd invsors wih a liquid and rlaivly asy mans o add h rcious mal dircly

o hir orfolios (rahr han using gold comanis as a roxy). th divrgnc is also

rlad o dclining rsrv ouus and highr roducion coss for gold comanis.

Nvrhlss, hr is room for a las a arial cach-u has in h monhs ahad

(las s our Ocobr 8hMonthly Asset Allocation Strategyfor furhr dails).

When To Sell?

Wih h gold mark bcoming frohy, a rudn sragy would b o scal back osi-

ions bfor a clar barish cas can b mad. Invsors should ay clos anion o

h following as a warning ha h macro landsca is bginning o shif unfavorably for

gold rics:

m Real interest rates rise materially: Our viw is ha ral yilds hav limid downsid

from currn lvls (for furhr dails las s our Ocobr 5hTheme Report, Gov-

ernment Bonds: Not A Bubble, But). Howvr, cnral banks ar aggrssivly rying

o rvn, or a las ca, any yild backu. A shif away from his dovish sanc or

failur o anchor bond yilds would caus a shakou in gold rics.

m Evidence of a robust global recovery: Our bas cas is ha h global conomy will

xrinc a susaind, albi subdud rcovry. Signs ha condiions ar marially

imroving would nd downward rssur on ral inrs ras, and allvia concrnsof currncy dbasmn. evidnc of imrovmn in U.S. consumr snding would

b mos crucial o h rcovry hsis. thus, w coninu o closly monior consumr

condenceandemploymentindicators.Sofar,theleadinggrowthindicatorsarestill

roviding no indicaion ha condiions ar abou o acclra marially.

m Monetary transmission mechanism repairs: Signs of haling in h global banking

sysm and crdi channls would b osiiv for h conomic oulook and as h

nd for aggrssiv olicy suor. Indd, h major cnral banks would b forcd

o rvrs cours and soak u xcss liquidiy if mony mulilirs and monary ag-

grgas sard o imrov. So far, hr is vry lil indicaion of such a shif.

m Private sector credit demand strengthens: th corora scor is halhy in mos

countriesbutlackscondenceandishesitanttoexpandoperations.Asbusinessesbe-

comemorecondentinthesustainabilityofearningsandwillingtoborrowinorder

o ursu caial xndiur lans, ral inrs ras will b ushd highr. this will

boh incras h ooruniy cos of gold and incras h invsmn aal of ro-

duciv asss. Currnly, riva scor crdi dmand rmains vry wak.

I is rudn o

bgin scaling

back osiions

bfor h macro

backdro urns

ngaiv for

bullion

prics ar now

crowding ouradiional

dmand


11/12



m Ination expectations build: A h momn, boh invsors and olicymakrs ar

xatedondeationrisks,whichinouropinionisthegreaterthreatinthecurrenten -

vironment.Nonetheless,thefocuscouldshiftabruptlybacktoinationaseconomic

concrns as, givn h uncrainy and angs crad by unrcdnd olicy su-

port.Centralbankswillnotallowinationexpectationstoescalateforverylong.To

monior his risk, w rfr o wach CpI swa ras, which rmain nar cyclical lows.

m U.S. dollar sentiment rms: Gold rics rmain invrsly corrlad wih h U.S. dol-

lar and hav bn urbochargd by h highnd concrn of currncy dbasmn.

An imrovmn in invsor snimn oward h currncy (which will likly awai

rmerU.S.economicdata)willpresentaheadwindforthepreciousmetal.

m Technicals: Gold is havily radd using chnical indicaors, much lik h currncy

mark. thrfor, invsors should ay clos anion o ric rnds and momnum

indicaors. Mos of hs masurs ar srchd, bu could rach mor xrm lvls

a h o of h bull mark.

Final Word: The sweet spot for gold prices will persist for a while longer. The recovery re-

mains fragile and deationary pressures will linger, encouraging the authorities to keep

monetary conditions extremely accommodative. In turn, the tidal wave of investment capi-

tal rushing into the market is unlikely to vanish anytime soon.

Nonetheless, speculative excesses are building. The peak in gold prices when it eventually ar-

rives could be abrupt and followed by a violent shakeout (similar to 1980). Nimble investors

may wish to ride the trend higher for now, but longer-term investors should consider using

price strength to gradually trim positions and redirect funds into productive assets.

Provided that global authorities can avoid debt-deation (as we expect), then this is a great

environment for risk assets and currencies in markets which do not face structural or cyclical

impediments. In fact, there are many productive assets in the emerging world and commodity

markets with less froth and better valuations than gold. For further details on this topic, please

see our September 24thTheme Report, Goldilocks Is Dead: Proting In An Unbalanced World.

Phillip ColmarGlobal Sragis & parnr

[email protected]

Signs of susaind

conomic growh

and imroving

mony mulilirs

will b warnings

for gold

th ak in h

bull mark could

b abru andfallowd by a

violn shakou


12/12

Macr oRe se ar chBoar d

Independent Investment Strategy &Consulting

partnersmrb

12M R B p A R t N e R S I N C . m w w w . m r b a r n r s . c o m m C o y r i g h 2 0 1 0

Ocobr 26, 2010

Copyright 2010, MRB Partners Inc. All rights reserved.

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MRB Partners is a nwly-formd indndn

investment research and consultancy rm,scializing in roviding o-down global ass

allocaion advic and idas o invsmn managrs

around h world. W dvlo invsmn sragy

and rcommndaions by idnifying h ky

srucural and cyclical hms driving h global

conomy and ass marks, uilizing rigorous and

comrhnsiv roriary forcasing modls

and indicaors, whil lvraging h xnsiv

experience of our senior sta. The core of our

hilosohy is srong, inraciv and rsonalizd

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prvious Theme Reports

Set Sail, Don't Bail:China's Growth Wave ContinuesOctober 19, 2010

Oil Is The Next Emerging Market PlayOctober 12, 2010

Government Bonds: Not A Bubble, But...October 5, 2010

Goldilocks Is Dead:Profiting In An Unbalanced WorldSeptember 24, 2010

The Next Investment Bubble:

Now Its The Emerging Worlds TurnSeptember 17, 2010

to rciv any of hs rors las conac

our clin srvics.

www.mrbarnrs.com m [email protected]

Documents

MRB Theme Report_Oct26 2010