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To:John Barendrecht who wrote (399)
From: mikesloan Tuesday, Jul 15, 1997 2:44 PM
Respond to of 82910

Wool sets a shining example for gold
Australian Financial Review April 28/97

By Stephen Wyatt

The wool market surged last week to hit its highest level
since September 1995. At last, the Australian wool
industry is crawling out from under its mushroom of

Wool prices are now 60 per cent above their 1993 lows
and the massive wool stockpile, the result of a disastrous
price support scheme over the 1980s, has been reduced
by nearly two thirds.

Now, Dr Bob Richardson, the man charged with
liquidating the stockpile, could be headhunted by one of
the world's central banks. After all, just as Australia's
wool industry has been burdened by an oppressive wool
stockpile, so too has the world gold market. Massive
stocks of gold held by central banks have been weighing
down the gold price.

Central banks and international bodies, such as the IMF,
hold about a third of all the gold ever mined. More than
34,000 tonnes of it. This is equal to 14 years production
at today's levels and is 10 times annual consumption. The
wool stockpile, relative to the gold stockpile, is a little
heap of dust.

Back in 1991, when the Wool Reserve Price Scheme
collapsed, the Australian Wool Corporation, the then
administrator of the scheme, held more than 820,000
tonnes of wool, about 75 per cent of Australia's
production at the time and just a quarter of total world
wool production.

But the big difference between the two industries is that
wool has gone a long way towards liquidating its
stockpile. It is now around 300,000 tonnes, almost two
thirds less than its peak level in 1991.

The gold industry has hardly begun. Not that anyone
really expects central banks to liquidate their entire gold
holdings. But it is the fear that they are now on the
threshold of liquidating some of the stockpile that has
constantly pressured the gold price lower. In the past 15
months, gold has fallen $US77/oz, or nearly 19 per cent.

If Austria, Belgium, the Netherlands, Portugal, Spain and
the UK were to reduce gold to 10 per cent of their
reserves -- now between 11 and 38 percent -- 2,137
tonnes would have to be sold. If France, Germany, Italy
Switzerland and the US did the same, a further 17,688
tonnes would be sold and this would be the equivalent of
nine years of mining output.

Gold miners themselves suggest that the gold price is
affected more by central bank activity these days, than by
the more traditional fundamentals like political and
economic instability and inflation.

"I think that the correlation between gold and inflation has
been broken a long time ago," said Mr Jack Thompson,
CEO of US gold producer Homestake Mining last week.
"It's more a question of supply and demand and what the
central banks do."

So, there may be a place in central banks for
experienced stockpile managers. And perhaps gold
producers should take heed of the plight of wool
growers. There may be a lesson or two in how wool
growers had to readjust to a sudden rise in supply and
how the price signals they had been receiving were
distorted by demand from the stockpile manager.

In 1991, the Australian wool industry was forced to
recognise that world economic realities were far too
powerful to fight, especially with the collapse of
Australia's biggest customer for wool -- the USSR. The
wool Reserve Price Scheme foundered. With massive
wool stocks and a debt of $2.7 billion, the game was
over for wool growers and their price support scheme.

And worse, wool growers had not received the right
messages from the market that there was, in fact, plenty
of wool in the world. Instead of reducing production in
the late 1980s and early 1990s, Australia's wool
production soared to hit a record 1.1 million tonnes in
1989-90, the year before the price support scheme

For a while, the Australian Government used sandbags to
hold back the inevitable rising tide of market forces. The
floor price for wool was reduced. But still the levy broke
under the forces of slumping demand and over-supply.
The last line of defence was abandoned -- no more price
support, no more wool central bank.

The stockpile had to go. The wool market had to take its
medicine. Inevitably, wool prices collapsed and today
more than 15 per cent of Australia's wool growers are
terminally bankrupt, according to Dr Bob Richardson of
Wool International, the body responsible for liquidating
the stockpile.

But the wool market is in recovery mode. The stockpile
has been significantly reduced, wool production has fallen
dramatically as the price signals finally hit home (albeit,
none too subtly), adjustment has been made for the loss
of the USSR and wool prices are back up at reasonable

The parallels between the wool story and the gold market
are many.

Already this decade central banks have begun to reduce
their gold holdings. They have sold more than 2,500
tonnes. But the key to further liquidation depends on the
role of gold in the world monetary system. For 200
years, gold was central to international trade and was
unquestioned as a medium of exchange and store of

Now, just as the world economy has dramatically
changed over the past 200 years, so too has the role of
gold as a monetary asset. Some analysts, such as Andy
Smith at Union Bank of Switzerland and Ted Arnold at
Merrill Lynch, argue that gold is losing its monetary
status; that it is less a reserve currency now with the
absolute termination of the gold standard in 1968; that it
is losing its usefulness as a hedge against inflation and as
the ultimate insurance against catastrophe.

Such views have triggered a general fear in the gold
market that central banks will reduce their holdings of
gold. Central bank gold is increasingly seen as a
commodity, as a stockpile hanging over the heads of gold
producers and central banks, just as the wool stockpile
hung over wool growers.

And if gold is viewed more as a commodity and less as a
monetary instrument, then on traditional measures of
valuing commodities, such as stocks-to-use ratios, the
price of gold would be way below where it is today. The
World Gold Council, a body representing gold
producers, disagrees with such views.

It suggests that due to gold's monetary role, then
traditional measures of commodity fundamentals --
measures such as stocks-to-use ratios -- are
inappropriate. It argues that the gold stockpile is a
necessary component of a central bank's asset portfolio.
It is therefore isolated from the market place and these
stocks should be ignored.

In fact, this has been, until recently, the conventional
wisdom in the gold market. Analysts, especially those
that work for stock brokers whose job it is to sell gold
shares, would forecast future gold mine production and
future gold consumption to make their gold price
forecasts. No mention was made of 34,000 tonnes of
gold locked up in the vaults of central banks, nor the
mass of bullion privately hoarded.

But things have changed quite a bit. Union Bank of
Switzerland's precious metals analyst, Andy Smith,
published a report last week entitled, Central Bank
Gold -- The Picture of Less Reserve.

"The official (central bank) attachment to gold has little to
do with gold's advantages as a medium of exchange -- its
"transactions role", Smith wrote. "Gold has long lost its
transactions day-job to hard currency."

In the past 20 years, central bank gold reserves have
hardly changed, while foreign exchange reserves have
risen by 400 per cent.

More central bank gold sales "are certain" Smith argues.
In his view, this is clear from the radically changed
attitude to gold by the Swiss National Bank, the doyen of
central bank conservatism. To Smith, the issue now is
how much, and by what means, will central bank gold be


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