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 gloom.
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 collapsed.
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 levels.
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 value.
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 liquidated.