LBMA Precious Metals Conference 2003 - Lisbon

Welcome to the fourth LBMA Precious Metals Conference. Personally, I am extremely happy to be in Lisbon. It was 25 years ago when I last organised an event – not quite here, but in Estoril, just along the coast. I must say, in the intervening quarter of a century, Lisbon has come on fantastically. The city manages to combine a long historical tradition and modernity in a really fascinating way and I’m very happy to be back.

It was only nine weeks ago that we decided to come to Lisbon. Usually it takes us nine months to organise a Conference, so there’s been a certain amount of hard work done in the couple of months or so since then. And because of that, I would like to say a particular word of thanks to our team – if you like, to blow our own trumpet just for once.

Finding this venue was the result of Maggie Nash’s database and her extensive network of contacts, and it is a wonderful venue. The hotel
has been just great; the staff are efficient and friendly, and it’s made it a real pleasure to organise this meeting.

The LBMA Executive team of Andrea Smith, Cherry Hart and Susanne Capano have done a tremendous job of re-organising the event and
dealing with all the associated issues over the very brief course of two months.

Now looking beyond our own administrative efforts, there are a number of other people on my list of thank yous.

Firstly, NYMEX for generously sponsoring last night’s opening reception – incidentally the third
time in a row that they’ve done this – for which we are most grateful. Then, the speakers, panellists and session chairmen, thanks to whom we’re going to leave Lisbon tomorrow afternoon a lot more informed about what’s driving the precious metal markets. I know how much effort it takes to produce these speeches and presentations, and I would like to thank the speakers for responding so promptly to our requests for all the information that they’ve provided.

And finally, you, the delegates – thank you for your continuing support and interest, and, in some cases recently, your patience, while we sorted out the previous arrangements for Shanghai.

And now it gives me the greatest pleasure to welcome Mrs Theresa Maury, the Vice Mayor of Lisbon, who has very kindly agreed to extend a formal welcome to us to this fair city.

Good morning Ladies and Gentlemen, and many thanks to Teresa Maury for those warm words of welcome to Lisbon – I can assure you that we are very happy to be here.

This is only the fourth time that the LBMA has organized its own full -scale conference, and I am pleased to be able to say that these ‘by the Industry for the Industry’ events have rapidly become THE forum to discuss a broad range of precious metals interests. I am sure you will find the papers that you hear over the next couple of days both interesting and thought provoking, and a stimulus for lively discussion in the various coffee breaks and other social events that will punctuate our program.

At this point I should tell you that we nearly did not have a conference this year. Originally we had planned to be in China, but as a result of the deadly SARS virus, our plans have been somewhat in a state of flux. However, providing conditions are favourable it is certainly our intention to hold our 2004 event in Shanghai.

One of the problems of organising successful conferences is that you have a high level of demand for places – Indeed, despite the current travel difficulties, we still have over 250 delegates here with us in Portugal and I would particularly like to thank those that have travelled great distances to participate in the various sessions on offer and to make a valuable contribution to these proceedings.

Stewart Murray and his colleagues on the LBMA executive - Susanne Capano, our Public Relations officer & Editor of The Alchemist, along with Cherry Hart and Andrea Smith and not forgetting Maggie Nash, our intrepid conference co-ordinator - have done an excellent job in switching venues at incredibly short notice whilst, still managing to provide an excellent program and superb location. In that context I would also like to thank Banco de Portugal for their support and encouragement in the organisation of this event and I am delighted to say that Jose de Matos the Deputy Governor of the bank will be addressing you in a few mins.

Since we were last together at our 2002 conference in San Francisco, market trends have largely remained constant. We continue to see a focus on producer de-hedging, and increasing opportunities for investment demand - especially in the current low interest rate environment. We will therefore be examining these areas, among others, in greater detail over the course of the next two days. Whilst, the recent Middle East conflict has undoubtedly had some short-term effect on prices and volatility, the global economic situation is the main driver for overall levels of activity. However, the LBMA does not exist to promote any one specific area of our Industry – rather, it acts as a facilitator to the market as a whole, and thus provides an environment for interested parties to participate in the markets that which we operate, should they of course wish to do so.

An example of this being the recent translation of our ‘Guide to The London Bullion Market’ into both Italian and Chinese, with hopefully others to follow.

The LBMA and its members are very active between conferences and have a number of other key roles to play. You will be aware of course that five of the Market Making members of the Association constitute the London Gold Fixing and three of these are responsible for the Silver Fixing each day. The LBMA itself is responsible for monitoring another extremely important benchmark – the Forward Rates available on GOFO and contributed by all of the Market Making members. Similar forward indicators for silver are also monitored by the LBMA executive.

The Association maintains and updates existing documentation and is also helping to introduce new initiatives. I would like to touch on just two of these this morning. Firstly, we held a seminar in India earlier this year, which was attended by more than 150 interested parties to look at the experiences of other markets during liberalisation and the different models that have subsequently been introduced. The upshot of two days of first rate presentations and discussions was that we came up with a series of recommendations for review by the RBI and the various ministries concerned. It was therefore gratifying to see that not long after our event the Indian authorities announced a further liberalisation of their market.

I am therefore very pleased to see that on our agenda today, we have a contribution from India presenting the ideas of a number of participants on the establishment of a new bullion futures market there. This is just the kind of cross-fertilisation that the LBMA is here to provide. Additionally, the Indian Banks and Traders are forming their own Trade Association, along similar lines to the LBMA model, already used with great effect in Turkey, which will help to ensure a co-ordinated approach to market development and regulation in future years.

Indeed it is in regions such as India, China, Dubai and Russia where I see the greatest opportunity for the LBMA to assist with the development of global bullion markets thus helping to ensure longer-term opportunities for all in the coming years.

Secondly one of the LBMA’s primary roles is the maintenance of The Good Delivery Lists that form the core of Loco London Good Delivery. We take our duty of care for this list extremely seriously, as any company that has gone through the exhaustive process of testing in order to be admitted will know.

As we reported last year, we have decided to go a step further than merely testing applicants for admission. We are going to introduce a form of proactive monitoring for those companies on the list as a way of ensuring that standards are maintained. An essential part of the new system is an expansion of the panel of Referees. During the past year, we have been working with a number of refiners who have been invited to apply for Referee status to ensure that they comply with the very highest standards of assaying gold and silver. In this regard I am pleased to announce that Tanaka & co. are the first of these to qualify and join our existing panel of Referees and I am sure it will not be long before there are further additions.

This has not been a trivial exercise - In fact, it has generated a huge amount of work both for the refiners concerned and on our side, the Physical Committee and the Executive. The data we have amassed in the process will not only allow us to be very confident about what is achievable by assayers in practical terms, but it will help us to guide future applications for Good Delivery. It will also help existing members of the Lists to improve the precision and accuracy of their assaying – something that is of vital importance to the whole market.

The LBMA is rightly proud of its trading model with its twin pillars of the Good Delivery system and the loco-London Clearing Service. Together, these constitute key elements of an efficient and robust wholesale market place and enable the market for London’s products and services to be truly global.

Although the Good Delivery system has always reflected the international nature of the LBMA, the growing globalisation of the precious metal markets has led to the need for an increasingly International LBMA – Maybe we should look at a possible name change to the ‘I’BMA! I would particularly like to acknowledge the role played by my predecessor as Chairman, Martin Stokes, in this area. During his period in office, the Association introduced the International Associate category and then modified the geographical constraints that previously restricted membership to companies based in the United Kingdom.

I am delighted to be able to report that as now we have 33 Associates in 17 different countries, and Full Members in France, Luxembourg, Germany and Australia. This was accomplished without sacrificing the high standards that have always been required of our members. But in spite of our more global approach in recent years, the centre of gravity of the OTC bullion market is very much London. We are especially pleased that both the FSA, our regulator, and the BofE sit as observers at our monthly Management Committee meetings, and that Sir Edward George was our guest of honor at our most recent biennial dinner in October of last year. As Sir Edward is stepping down as Governor in the coming weeks I would like to take this opportunity to publicly thank him for all the support that he has provided to our Industry over recent years and to wish him well in his retirement.

One idea mentioned last year that unfortunately has not come to pass this year is the Bullion Market Forum we had hoped to hold following the Conference. This was planned to give executives from exchanges and other bullion markets around the world a chance to meet and discuss topics of mutual interest and concern. Unfortunately, due to the SARS outbreak, none of the exchanges in the Far East were able to attend, but we are confident that there is sufficient interest in the idea to make it a feature of our next Conference.

On behalf of the Management Committee of the LBMA and the Public Affairs Committee – headed by Kamal Naqvi and responsible for conference content - I would like to express our thanks to all the speakers, the session chairmen and you the audience for your participation in this conference.

I should add at this juncture that in addition to questions from the floor we would be happy to receive written questions for the various sessions and also for the final panel discussion tomorrow.

It now gives me great pleasure to introduce to you Mr. Jose de Matos the Deputy Governor of Banco de Portugal. I am very grateful to him for stepping in at such short notice to give us the keynote speech today.

The peculiarity of gold lies in its being both financial and a commodity which obeys supply and demand rules and has its production cost.

Gold is not influenced by direct economic policy of any country. That is why its position can’t suffer from inflation in the country where the currency is used as a reserve one.

The gold assets are also used for diversification. So, the reserves formed by securities of foreign countries are most vulnerable in case governments of those countries impose administrative measures (such as deposits freezing, debt-payment moratorium, etc). Gold is by far better protected and may be used in case of need.

We consider that the monetary constituent of gold will undoubtedly last in the immediate future. Keeping large amount in precious metals does not pay when the economy is steadily developing: money must work. However, in case of a slightest instability or financial crisis the prices for gold immediately go up. This is the case now.

The true grounds underlying a decrease in prices for gold that we have witnessed in past years are quite justified from the point of view of supply and demand. The main reason is that the former role of gold as a stability guarantor was assigned to the US Dollar. Under such conditions a number of central banks in developed countries had to diminish their gold reserves, and a natural reaction in the market was a decrease in price. But the day came when belief in Dollar was shaken, which turned into a crucial moment in the gold price trend.

Just a while back, some analysts had given up on gold for lost as a means of saving and accumulation. But present time trends have made many of them change their mind. Slow pace of world economy recovery after recession, uncertainty about economic perspectives, Dollar problems, and war in Iraq – all this made investors to look for a more reliable investment medium than stock markets.

The gold boom in the world market will last until the economic and political situation in the world is stabilized, until markets are steady and until the US Federal Reserve starts to raise its base interest rate.

And yet, we consider it possible, that in a long-term perspective the investment appeal of gold will be descending. At the same time we will witness a quite steady growth of demand for gold on the part of electronic, medical and motorcar industries. Demand for gold will be making a steady headway as the high-tech sector is advancing. And the gold price level will be developed on the basis of production costs and demand on the part of industries.

Proceeding from the aforesaid, at present the National Bank of the Republic of Kazakhstan does not plan any major gold sales, and quite the contrary, several tonnes of gold will be bought from the domestic market each year.

Operations with Gold carried out by the National Bank of Kazakhstan

The 16-18 % share of gold in the total gold and exchange currency reserves of the National Bank of Kazakhstan is quite stable.

The structure of the gold and foreign currency assets portfolio of the National Bank has been changed during the period of 2000-2002, and the share of foreign currency components significantly increased while the share of gold was brought down.

The strategy of managing the portfolio of the total gold and exchange currency reserves of the National Bank was aimed at increasing activity in gold reserves managing, extending the range of operations with gold both in domestic and international markets, as well as increasing profitability of those operations. The total amount of gold within the foreign reserves of the Bank is the equivalent of more than USD 600 mln. (53 tonnes); 70 % of the reserves are allocated abroad as fixed-period deposits, being the main gold operating instrument of the National Bank. Besides, different operations are carried out including swap arrangements, options, etc. It is necessary to note that due to the significant gold price increase in the beginning of 2003, the National Bank of Kazakhstan has carried out hedge transactions for around 50 % of the gold reserve thus protecting from eventual price drop till the end of 2003. Such transactions are made both in the gold market, and in the commodity exchanges (NYMEX). Replenishments of the National Bank gold reserves are mostly done through buying gold from domestic gold producers.

The decline in volumes of gold acquisition in 2002 was connected with the problems in Tax legislation.

Gold Production

More than 142.000 tonnes of gold have been mined throughout the human history.

The world production of gold in 2002 comprised 2.543 tonnes, having decreased by 2 % as compared with 2001. The drop in production has taken place for the first time since 1995, but it is expected that in 2003 the production of gold should rise. The production cost of gold according to preliminary estimates is USD 176 1.

As far as the gold production in Kazakhstan is concerned, before the break-up of the Soviet Union, Kazakhstan had a yearly output of 20 tonnes of gold. A significant part of the ore primary processing and gold refining was performed by Kazakhstani companies abroad – mostly in Russia. After the collapse of the Soviet Union and disintegration of traditional trade and economic ties, due to poor technical equipment of enterprises, imperfection of technologies, state budget deficit and other reasons, the production of gold has dramatically dropped from 29 tonnes in 1989 to 9,5 tonnes in 1997. The state has ceased financing the gold-mining industry. However, under the conditions of developing a market economy and a crisis in the mining industry, in order to liberalize the market of precious metals, in July 1995 the President of the Republic of Kazakhstan signed a Decree (valid as law) “On the State Regulation of Relations Connected with Precious Metals and Precious Stones”. This was the first step in liberalizing the market of precious metals in Kazakhstan.

In accordance with the programme of the government, a number of arrangements were made for developing the gold production. It is quite evident that one of priority tasks for Kazakhstan is to develop and strengthen the source of raw materials for the gold-mining industry. According to preliminary estimates, a large amount of expenses is needed for achieving the set volumes of exploration and mining works, for extraction of prospected resources. Such financing can be done mostly through attracting investments. A really working variant in this case is considered to be expanding the production at the sites which are most attractive for investors, by means of establishing mixed capital companies with the participation of Kazakhstani and foreign capital.

As is well known, Kazakhstan is one of the world’s leaders in gold resources, ranking ninth in prospected reserves of 1.900 tonnes. Kazakhstan also ranks fourth in the contents of gold in the ore (average gold grade of 6,73 grams per tonne).

At present, the market of precious metals in Kazakhstan is most perspective and progressive in respect of legislation. The legislative basis helped to attract investments of foreign and domestic companies and commercial banks. This contributed to an active involvement of commercial banks into financing the gold production, increasing volumes of operations with precious metals. An active introduction of new technologies in the gold mining and production has started. At present, the investments of domestic commercial banks constitute the main part of total investments in the gold industry of Kazakhstan.

The share of foreign companies in the gold industry development is 40% of the total number of companies operating in this sector. Modernisation of a number of concentrating plants has been carried out with the participation of Kazkahstani and foreign companies, as well as installation of the plants producing gold doré and cathode gold.

As a result, the production of precious metals in Kazakhstan is gradually increasing.

The basis of the gold mining industry (68%) are the gold fields (Vasilkovskoye Gold Mine, Bakylchik Mine, Akbakay Mine, Suzdal Mine, and others), one third of all gold reserves are located in complex poly-metallic deposits (Ridder-Sokolskoye, Novo-Leninogorskoye, Bozshchakolskoye, and others). A growth in the production of refined precious stones has been marked. In 2005, 25 tonnes of refined gold is planned for production, and 940 tonnes of silver.

An active introduction of new technologies in the gold mining and production has started. The fact is worth noting that the National Bank of Kazkahstan has come forward as the initiator and an active participant of the first in Kazakhstan syndicated loan for development of the gold mining companies. Undoubtedly, such steps in financing gold mining companies will positively influence the rise of gold production and overall growth of industries in Kazakhstan.

Commercial banks have become the main crediting source for financing the precious metal producing companies. Investments into the mining and production of precious metals are increasing. The banks are expanding their presence in the market. Sales of those metals in the foreign market are done by means of a range of banking instruments (forward transactions,

spot sales, swap, etc.). At the same time, Kazakhstan gets stable currency receipts, and taxable base is growing.

During the years of independence, an own production of refined precious metals has been established in Kazakhstan. The refined precious metals of the Open Joint Stock Company “Kazzinc” obtained the recognition of the LBMA and possess the “Good Delivery” status.

The first refined gold bullion was accepted by the State Depository on January 7, 1992. From 1992 to 1996, annually 10 – 14 tonnes of refined gold entered the State Depository, and 500 – 600 tonnes of refined silver bars.

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 utilization 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.

a) 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 USD 155 Bio and PGGM 50bn USD, and gold is 2.25% of the index, that represents implied exposure to gold of approx 275 koz for ABP and 135 koz 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.

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 5 major commodity groups weighted as shown in the figure below, 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 8 person Policy Committee including members from PGGM, GIC, The Harvard Business School, The Chicago Mercantile Exchange, 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, -32% in 2002)
• Negative correlation with stocks and bonds imply that even a small allocation to commodities will reduce portfolio volatility (see efficiency frontier)
• Commodities perform best when other assets perform worst (“hostile markets”)
• Strategy implementation: mainly via swaps, structured notes or futures

b) 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 (summarize Steve Strongin’s piece published in 1994)

• 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) are a clear case of interaction between the gold price and underlying gold producer equities.

• Target = maximize shareholder’s equity
• Highly fragmented industry (room for M&A)
• Hedgers vs Non-hedgers show different upside to gold price
• Non-hedgers acquire hedgers = buy-backs = higher gold price = higher valuations.
• Increasing pressure on hedgers to buy-back too…

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

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:

• 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.

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 apologize 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, synthesized 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.

This is the list of commodities which 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.

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.

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:

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.

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.

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 interest of brevity I ask you to accept these figures as they are. The results are similar to the earlier method of volatility calculation, but show that silver is less volatile than gold.

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.

To summarize 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 tradability. 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. On the right-hand panel of the display you can see the three elements of a supply sufficiency forecast: production, consumption, and stocks. On the left-hand panel, you can see 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. Notice that it 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 of a 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 7019 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 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.

Here’s 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 summarize: 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.

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. This graph 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. In fact, gold may be even more useful that 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 chart on this page 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 capitalization 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 “no sale” statements or ‘limited sale agreements and ten thousand 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 capitalization 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 investible universe. Only a very small change by asset allocaters would have a profound impact on gold demand, and thus the price.

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.

Looking at retail investment demand, a proxy for the private investor, and 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.

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 has 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 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 that one held 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

This report will focus on the following issues:

1. Examination of the prospect and variants of development of Russian gold mining industry in the global context;
2. Introduction of the closed joint stock company “Gold Mining Company “Polyus” and strategy of its development.

SECTION 1: Russia and Global Gold Mining Industry

The Russian gold mining industry has a history of over 300 years. The first gold bullion was poured following metallurgical processing of complex ores at Nerchinsky mines in 1702.

About 16.2 thousand tonnes of gold have been mined in the Russian Empire, Soviet Union and Russian Federation, approximately 11.3 percent of total amount of gold which has been produced historically (about 143.2 thousand tonnes).

In contrast to other countries, Russia has very specific raw materials sources: about 70% of gold has been mined from the alluvial deposits, 23% from hard rock ones, 7% fell at composite deposits. At the same time all over the world gold is now extracted from hard rock and composite deposits.

Until recently, gold mining in Russia has been a completely state monopolised industry. During the 90s, the process of privatisation, mergers and redistribution of mining companies began.

The rapid reorganisation and privatisation of the Soviet gold mining industry initially resulted in the breakdown of large production association into more than 600 small, poorly equipped alluvial producers with an annual production of the first hundred kilos of gold. This disintegration of the industry had a long term negative effect: small producers had no access to long-term financial resources, sharp decrease in investments became an obstacle in the way of development of hard rock deposits.

The sharp devaluation of national currency in 1998 and lack of effective investment instruments fuelled interest of Russian banks to funding alluvial gold production. Increased activity of national banks resulted in increase of gold production.

The correlation between placers and alluvial deposits began to change in the middle of 90-s. The increase of production costs and taxes led to the situation, when the profitable share of alluvial deposits reduced to 60% of balance reserves. Nevertheless, the experts believe, that the potential of alluvial deposits in Russia can provide the extraction of 60-70 tonnes of gold annually during the period of 10-15 years. This period would be enough for the re-orientation of gold mining industry to the hard rock deposits.

As regards the allocation of gold mining in the Russian territories, the most productive region is Magadan (33.5 tonnes in 2002), Krasnoyarsk Territory (29.3 tonnes), Yakutia (17.5 tonnes), Irkutsk Territory (16.3 tonnes), Khabarovsk Territory (15.3 tonnes) and Amur region (12.7 tonnes).

SECTION 2: The Current State of Gold Mining Industry in Russia

Today the world gold mining industry faces the following long-term challenges:

• The reserve depletion and absence of new perspective and highly remunerative deposits
• The increase of financial resources’ cost because of negative attitude of public opinion to the gold mining sector
• The decrease of countries and provinces which welcome large scale gold mining operations
• Fears of political and social instability in the leading gold producing regions.

• With improved macroeconomic and political conditions, Russia again joined the group of five first-rate gold producing countries
• This trend will have a long term effect if supported by strong gold price increase and commencement of new mines
• Experts believe that Russia’s resource potential can enable annual production of about 300 tonnes of gold (9.6 MOz)
• Today Russia has highly skilled labor potential and advanced technology of mining and processing of gold ore
• Stable increase of extraction volume.

Russia is among few countries that have stably increased gold mining during the last four years. In 2002 the production of gold increased by 21.1% up to 158.7 tonnes. About 35 tonnes of gold are consumed for the needs of jewellery. Gold is used in electronics. Besides that, gold is an important export article: the Russian banks sell abroad more than 60 tonnes per annum.

The increase of extraction is attributed primarily to launch of several new hard rock projects.

The unique resource potential
The largest deposit in Eurasia, Sukhoy Log, (398 million tonnes, average contents 2.6 g per ton, reserves – 1100 tonnes) is still unavailable for development. This deposit can provide an additional 30 tonnes of gold annually and will be among the world’s largest gold operations.
The principal modernization of the deposit Natalka which is licensed to the joint-stock company “Rudnik Imeni Matrosova”, (reserves are 243 million tonnes, average contents is 2.85 g per ton, probable reserves are 1000 tonnes or more), will provide the increase of output by 24 tonnes a year.

Aldan group of deposits Kuranakh (240 tonnes, average contents is 2 g per tonne).

The development of such deposits as Sukhoy Log and Mayskoye will replenish alluvial reserves and help Russia to obtain a leading position in the global gold mining industry.

• The improvement of investment climate

• The consolidation of the industry

• Positive public perception and personnel potential

SECTION 3: Prospects for Gold Mining in Russia
The formation of world standard mining company
Russia’s extremely favourable competitive position in today’s world markets can only be preserved by:

• Setting world class deposits – Sukhoy Log, Natalka, Aldan Group – into industrial operation
  
• Executing effective exploration programmes and replenishing gold reserves
  
• Financing prospective research efforts
  
• Having available a skilled and well-trained labour force.

• Output of gold came to 25 000 tonnes in 2002. Together with “Norilsk Nickel”, it was 29,600 tonnes
• Revenues amounted $250 million a year
• The complex, which is able to process the refractory gold-sulfide ores by means of bio-leaching, has been constructed for the first time in Russia
• The company self-finances exploration works and has in-house geological service
• In common with the main shareholder, Norilsk Nickel, Polyus has enough financial resources to develop large gold deposits.

• To preserve and strengthen its leading positions in the Russian gold mining
• To maintain high profitability of production
• To form a horizontal integrated gold mining company
• To provide long-term competitive advantages
• To become one of the world’s largest mining companies.
  

• To increase economic output up to 100 tonnes of gold within 4-5 years
• To increase the reserve base up to 2 thousand tonnes in 2-3 years
• To construct 3-4 new mining complexes.

• Further development of the Olimpiada deposit and increasing the processing facility
• Acquisition of perspective gold mining companies and promising exploration licenses
• Participation in tenders and auctions for the subsoil use
• Development and accomplishment of an effective exploration programme.

• Increase and diversify the company’s reserve base; to secure control over the deposits of long-term importance for the gold mining industry in Russia
• Eliminate the company’s dependence on conditions and peculiarities of one deposit exploitation
• Entry into new regions, creating a platform for further corporation development on a countrywide scale
• Secure leading position in process of gold mining consolidation
• Position the company in the world market as one of the largest gold producer in Eurasia.

• Approximately $1 billion will be invested in their development
• They will be run by a first-rate company armed with necessary manpower, financial and technical resources
• Short term speculation and change of owners will be impossible
• three new world standard mining complexes will be constructed in a timely manner
• Putting the largest Russian deposits into operation will raise Russia’s output of gold to 230 tonnes.

• Gold is still playing its special “reserve” or “stabilising” role in the world economy
• The Russian gold mining industry is restoring its formerly lost competitive position and is becoming one of the mostly inviting and dynamically developing industries within the world mining community
• New stage of industry development is connected with the consolidation of companies, projects and the foundation of large national gold mining companies of world class level
• Large national mining companies only will let Russia preserve its competitive advantages and solve new tasks, such as geological subsoil study, R and D work and manpower training.

• Canada has seen an exodus of exploration and development capital to developing countries in Latin America, Africa and Asia – as well as to Australia. Canada still has a fairly good exploration endowment, particularly in the Canadian Shield. But the taxes from two levels of government remains a hurdle, as does the increasingly complex regulatory environment.
• In the U.S it is becoming increasingly difficult to bring on new mining projects. Nevada and Alaska remain the best jurisdictions. They have good exploration potential around existing operations such as our Cortez mine, but permitting can be a long and tedious process.
• Australia has excellent exploration potential – particularly in Western Australia – and a competitive fiscal and regulatory environment. The challenge will be whether enough can be found to replace what is being produced.
  
• And finally, South Africa is facing cost pressure from a strong rand and rising labour costs. As well, the recent Mineral Bill, and in particular the proposed Money Bill, is harming the investment climate. If current royalty proposals are implemented without modification, investment capital for new development is unlikely to be available. It could put the country’s strategy to attract foreign investment at risk.

I am delighted to be with you this afternoon and I thank the organisers for the opportunity given to me to address this Conference.

In the larger context of economic reform and liberalised policies towards capital account convertibility, the Indian government and Central Bank are seriously examining a number of policy initiative relating to gold.

I start with a brief account of India’s position in the global gold economy.

The total gold stock in India is estimated to be around 13,000 tonnes plus, which is over 8% of total gold and over 65% of our GDP. Against this our share of land is at 2.4% and GDP of less than 2%. The share of mining and production of gold is insignificant. Our share of gold demand is pegged at 20% + of global demand. This needs to be viewed against our share of world trade, which is around 1%. Contrary to the general belief that demand for gold slows down with economic development, the domestic demand continues to grow and touched 800 tonnes in 2001-2002.

We are biggest consumer of silver too. The major share of demand for silver is emerging in rural areas. The key demand drivers are agriculture and in turn, a good monsoon.

From 1997 onwards, the bulk of gold and silver in the country has been imported by authorised banks and four canalising agencies.

What’s surprising is that notwithstanding India’s prominent position in investment and consumption of gold the world trading of gold is concentrated in the USA, UK, Japan, Switzerland etc. India does not figure among them. There are reasons for this. However, as stated, our government is aware of these issues and is very keen to develop India as a major bullion trading hub.

Let me brief you about the reforms happening on the gold front. One of the most significant policy announcements has been the lifting of the ban on futures trading of gold and silver in India. This follows the Central Bank permitting authorised banks to trade in gold futures and options, and banks in India are expected to commence trading in these products in the very near future.

The use of gold purely as a financial product is non-existent in India – however, gold in whatever form, including jewellery, is considered and treated as a hybrid investment. A survey conducted by Securities and Exchange Board of India has revealed that gold continues to remain the second most preferred option of investment after bank deposits and ahead of equities and fixed income securities.

Who invests in gold? It’s not only the preferred form of wealth for Indian women and used as a hedge against inflation. The average Indian family – including the middle as well as affluent classes – creates demand for gold.

With the equities market not doing so well, people do realise the benefit of using gold investment as a risk diversifier. The slowdown if any in urban demand has been more than offset by prosperity in the rural and semi-urban areas. In new generations there is a distinct preference for treating gold merely as a financial product and have an ease of trading similar to equities, including holding gold in electronic or paper form. I firmly believe that with the ability to trade gold in an exchange accompanied by assaying and custodial services, gold in India would see increased demand from this segment, which as of now is unable to invest in gold as a financial product on account of the unavailability of these facilities.

The need is being felt for a fully integrated policy on gold covering trading, jewellery export, investment, refining, testing, custodial services etc. At the government level the management of demand and supply of gold as a tool for fiscal policy and exchange rate management and in the recent times, the use of gold as a financial instrument – especially the mobilisation of domestic gold has attracted attention. One step of utmost significance in this direction has been lifting of the ban on futures trading in gold and silver. Options trading is also likely to be permitted shortly on exchanges.

Its natural to expect the development of a bullion futures and options market in India once it comes into existence. Prior to the ban in futures trading in 1962, there was an active gold and silver futures market in India. Apart from it being largest physical market of gold with retail participation and adequate speculative interest, there are well-established foundations and practices for futures trading that could be built upon. The domestic market is not only fully aligned with global markets but offers distinct advantage as convenient time zone. An efficient and freely tradable exchange in India would attract business from South East Asia, Australia, Tokyo, London and New York due to its convenient time zone position.

There are some concerns too, mostly on infrastructure side. The requirements for a vibrant futures market are not yet being fully in place. These are mainly in areas of good refineries, efficient warehouses, assayers etc. However, far from being a handicap, this throws up immense opportunities to global players to set up these facilities in India either by way of fully owned subsidiary or through a joint venture with domestic partner. We do assure you of all the assistance in this regard. Apart from setting up facilities as above, the refineries, global funds, market makers, traders, bullion banks etc would be able to directly participate in the Indian market through the platform of exchange.

As a prelude to the opening of a bullion market, the government of India has allowed an ICICI Bank-led consortium to set up a nationwide online commodity exchange.

This exchange is jointly promoted by ICICI Bank, the second largest bank in country, the National Stock Exchange, one of the top 5 exchanges in the world, the National Bank for Agriculture and Rural Development (NABARD), apex bank in the agriculture sector and is fully government-owned and the Central Bank and Life Insurance Corporation of India, owned by the government and the largest provider of life insurance products. All are equal stakeholders in the new venture. This consortium brings together the institutions building expertise, nationwide reach and acceptance.

Our plans are to set up an exchange of international standards there by bringing global strengths and best practices into the domestic market. The exchange has already been registered as a separate corporate entity in the name and style of the National Commodity and Derivatives Exchange Ltd i.e. NCDEX.

Our plans are to go operational by October 2003. A future contracts in gold and silver of up to three months maturity would be introduced to begin with. Options trading is likely to be added in the near future. We are also working towards moving from a cash market to an exchange platform. The discussions in this regard have already been initiated with the central bank. The exchange apart from putting up reliable clearing and settlement systems would be guaranteeing the settlement of trades.

Commodity futures trading – including bullion – is regulated by the Forward Market Commission under the Ministry of Consumer Affairs and Civil Supplies, whereas the equities and debt markets are being regulated by Securities and Exchange Board of India (SEBI). The domestic banks’ participation in the bullion market is overseen by the country’s central bank. With a view to integrate the commodity futures market with the rest of the financial market, a task force has been set up to work towards bringing these markets under a single regulator.

Our vision is to set up an exchange of global ranking wherein global participants such as financial institutional investors, mutual funds, bullion banks and refineries can easily participate either by setting up a 100% subsidiary or by getting themselves registered with the central bank. These entities can also consider setting up joint ventures with domestic players particularly in area of refining, assaying and custodial services. Some entities from South East Asia have already evinced interest in this regard.

With recent reforms and more policy changes in the offing, we firmly believe that NCDEX is going to be the place of future for futures trading in bullion.

A very good morning to you all and thank you to the LBMA for inviting me to speak on hedging and derivatives. The change of venue from Shanghai to Lisbon fortunately does not change the content of my speech, although I am rather puzzled as to why SARS has caused such a stir. In the South African context, SARS stands for “South African Revenue Services”, and I have grown up being plagued by the SARS virus in the form of the dreaded taxman and accountants.

And it is indeed the taxman in the form of a financial authority who is the villain of this particular piece, as I will later demonstrate, for it is he who has probably had some of the most direct bearing on the way hedging has evolved in the past 3 years.

But before going into the reasons behind what has become known as the dehedging phenomenon, let me quickly update you on the very latest numbers, a data series literally hot off the press.

Our Gold Hedge Indicator, the industry benchmark collated by Ted Reeve of Haliburton Mineral Services and sponsored by NM Rothschild, indicates that for the first quarter of 2003 the hedge book shrank by a further 5%. Putting this into context this chart shows what has been happening over the past few years. We run with the net delta calculation, since this gives the market a more accurate picture of the real impact the hedge book has on the market, as opposed to the committed ounce figure, which can overstate the true situation. As one then would expect with the committed ounces, the decline is more pronounced because this does not take into account the effect of the net deltas associated with option positions. Regardless of how you might to elect to measure the level of overall hedging, the message is the same; the hedge book on a global basis has been declining and my intention today is to explore some of the reasons for this.

First and foremost there is the price. Hedging and price risk management in general from the gold producers’ point of view has been conducted mainly in a climate of declining prices. Of all audiences, this is one I do not need to remind of the prolonged bear market that we have all endured. The cause and effect of this bear market and the role that hedging has played has been subject to endless debate and it is not my intention to revisit this here today.

But this next chart shows the monthly dollar gold prices from 1987 onwards. It was against the background of these persistently declining gold prices that the majority of the global hedge book was established. This stands to reason. Why would a producer elect to lock in prices through forward sales or put in cap and floor prices in a bull market? In May of 2000, however, the direction of the gold price at last turned around and this forced the miners to rethink their derivative philosophies. Hedging into a rising market obviously made little sense but more than that, the miners began to review their existing positions and hence brought about the change in the direction of total hedging.

The next important issue was undoubtedly the decline in interest rates which had the impact of reducing the contango to be earned by the miners.

Unlike base metals, which can and frequently do lapse into steep and prolonged backwardations, the ready availability of gold market liquidity means that, except on very rare occasions, gold remains in contango, and the earning of that contango was a prime reason for hedging in the first place. But when the contango falls to the low levels seen in the past three years, there is not much incentive for the miners to hedge and this development triggered a rethink.

Then of course there is the shareholder and his perception of hedging. Over the years there has been a gradual but persistent and noticeable shift in sentiment away from being largely pro-hedging to questioning closely the role hedging ought to play –if any - in a company’s overall strategy. I believe that three landmark events led to this change of heart on the part of the shareholder. Chronologically these had an incremental effect on thinking:

First came the European Gold Agreement in September 1999, which for a very short period of time disrupted the lending market and caused lease rates to spike. The backwardation that resulted was indeed very short lived but it did expose the vulnerabilities of a small number of hedge books via their more exotic and volatile derivative products. The fallout seen in specifically two companies is well known to this audience and there is no need to pick over old wounds. But the resultant media attention and in some cases the direct impact this had on share prices and the shareholders’ investment brought the whole issue to the fore and to the attention of the private and institutional investment communities alike. I like to think of it as three out of the seven veils being lifted – probably forever.

Second came FAS133 and the requirement that derivative reporting become substantially fuller and more transparent. I am going to return to this later in my paper. FAS133 effectively lifted another three of the seven veils and on the back of the fact that shareholders were already starting to feel a bit vulnerable with respect to hedging, their degree of discomfort was further heightened when the intricacies and size of the many of the hedge books were revealed in the public accounts. Someone said to me: “it’s like knowing that you have a reptile behind your sofa in your living room. It’s in the back of your mind all the time but because you actually don’t see it, you decide that you can live with it - until you actually see the thing and note that it might be venomous and larger than you thought. Suddenly you cannot ignore it any more.”

No wonder one financial executive bemoaned the fact that at equity road shows he was obliged to spend 40 of his allocated 45 minutes defending the hedge book as opposed to getting to say what he really wanted to convey about the growth and prospects for the company. As I already mentioned, I will return to FAS133 in a minute since the impact that this has had on how shareholders view hedging is in fact somewhat more complicated over and above the question of transparency and reporting.

And finally, came the recent but long awaited price increase in which shareholders have rather understandably wanted and indeed expected to participate. Loss of potential upside participation has always been a major complaint levied by the shareholders against a large hedge book and here, right before their eyes, in their opinion, their worst nightmare was played out.

And now back to the SARS virus and the accounting nightmare.
In my research completed for the WGC in August 2000 on the subject of derivatives, FAS133 was still on the horizon and yet to be implemented. It was therefore too early to comment on the effects that it might have on the hedge book. Acutely aware of the looming situation, however, I wrote in the summary:

“The introduction of the new FAS133…accounting system is certainly going to influence future hedging decisions, primarily with respect to the choice of product and the degree of expected disclosure which will render the intricacies of the hedge book substantially more visible. Product choice will be influenced by the way in which a derivative is defined for accounting purposes.”

Well, three years after FAS’ implementation, it is interesting to see how things have unfolded and in many instances, unfolded they certainly have with a number of knock on effects.

First FAS 133 in a nutshell:

It represents the culmination of a decade’s worth of work on the part primarily of the Financial Accounting Standards Board in an attempt to establish generally accepted accounting practises. The emphasis was on US based companies or affiliates but in practise the impact has been global. With simplicity not it’s strongest point, FAS133 essentially is a halfway compromise falling short of full fair value accounting (which ultimately must be the goal) but having moved a long way from its predecessor dating back to before the 1980s. Earlier accounting norms focused on the commodity or the currency in question. FAS 133 focuses on derivatives no matter how they are used or to what they are applied. Derivatives being what they are, this of course has begged the complex question of definition.

The definition of whether or not a product is a pure hedge or a speculative instrument for accounting purposes has without question affected the mining industry’s choice of product. Inevitably, the very process of definition has not been without considerable debate revealing a world not conveniently separated clearly into black and white but one displaying many, many shades of grey. The result has been a continued move towards more basic products, such as forwards, which can be categorically defined as a hedge in the pure sense and therefore their accounting treatment has remained largely unaffected. Where a product is defined as a speculative one or a non-hedge the experience has been different. Take the writing of calls for example. Defined as speculative these options have to be marked to market at birth and then brought into the quarterly reported income statement. Thus in any quarter or reporting period, the derivative is either above or below the water, giving rise to volatility in the earnings throughout the option life. As the FAS133.com website says, “…Even if the option hedge is perfectly effective at limiting the company’s downside risk with respect to future cash flows, the cost of the hedge…can become a source of undue volatility.” The result is simple: with this kind of potential impact on earnings, fewer miners have been writing calls. But even the simple definition of writing calls appears to be fraught with difficulties and these products can be treated for accounting purposes as a forward sale provided the hedger undertakes to deliver into the option if called.

Another problem highlighted by the hedgers is that marking products to market on a quarterly basis only serves to focus the world’s attention on the latest set of financial results, a problem already encountered in not just the gold industry. As another miner said: “The preoccupation with the latest quarterlies with marked to market values that are the result of static measures frozen in time does nothing to bring about a better appreciation of the long term wisdom of a well managed hedge book.” Certainly options that in one quarter can be out of the money and thus show a large negative mark to market, over the full life of the option cannot do a hedge book proud – no matter how well structured or managed that book might be.

The reaction to this was predictable. Neither company management (CFOs and CEOs) nor equity markets like earnings surprises at quarterly results presentations. This in turn implies that risk management advisors are now charged with the brief of reducing the volatility generated by hedge products. But the impact this volatility has is a lot more complex and potentially more serious than merely causing some periodic discomfort some quarters. A knock in earnings in any reporting period can in fact result a breach in loan covenants through the erosion of the company’s equity value, the consequences of the company being financially very serious. Ironically this can happen just when the company is actually doing well on other fronts with the unhedged production and reserves rising in value with a rising gold price.

But there are day-to-day issues as well. The major affect of FAS133 from a hedger’s point of view is that it limits the flexibility with which an existing book can be restructured. The extent to which a miner might see the benefits of restructuring is often negated by the accountants who maintain the way the hedges are put through in the income statements remains virtually unchanged. Once a non-hedge product has been introduced into a hedge book, it can leave a sort of permanent accounting footprint irrespective of the way it might be altered in the future. Now when does this occur? If a hedge is restructured via the original counterparty, then in general this problem does not develop assuming of course that valuation changes are fully reflected up to the date of the restructure. But if a hedge originally undertaken with one counterparty is then restructured with another bank then there is no accounting offset permitted and the miner has to report the gross level of hedging which of course leaves the footprint.

This, according the mining industry, greatly limits what they do with whom and complicates rather than simplifies how the miners convey this to the shareholder and how the shareholder appreciates the overall price risk management programme. As one treasurer said: “ Hedging is an already complex concept to get across to shareholders in a cogent and unemotive way that places the rationale into perspective. Superimpose on these the apparently not particularly rational intricacies of the accounting mist and the situation becomes as clear as mud on a foggy day. This does nothing to enhance our ability get across to the shareholder the benefits of the hedge or indeed the wisdom of restructuring to accommodate changing market circumstance. Of course we then play hostage to fortune with respect to comments from our non-hedging colleagues.”

What all this does is highlight the difficulties faced by equity analysts when they have to complete company results comparisons. This is no longer a concern about how to fairly compare hedged against non-hedged producers. It is now a lot more complex than that. It is more an intricate question of appreciating in full the structure of the hedge book, what is defined as hedges and are thus off balance sheet and what are speculative products that introduce the volatility into the income statements and how all this compares with other hedge books and results.

One final point to note that I have already alluded to is that the implementation of these accounting practices is an ongoing process, part of an evolutionary progression. The next step is certainly the intention to include all risk management products into the fair value accounting net, irrespective of their current hedge or non-hedge status. This will imply that all hedging will have to go through the incomes statements. The downside is: expect more of what the miners have been bemoaning with respect to income statement volatility. The upside however will be in the fact that any debate as to product definition will be ironed out the system, circumventing the time consuming debates that have characterised the past three years. It also will automatically allow equity analysts a shot at genuinely fair comparisons.

In my 2000 report I included some rather caustic comments from the mining industry on the subject of the accounting standards.

“The authorities are removing the incentive to mine.” was one and which with hindsight probably should have read “The authorities are removing the incentive to hedge.” Another comment was: “FAS 133 is poorly prepared and in general is unreasonable”. This complaint obviously came from the heart but it was said just as FAS was beginning to impact and we can expect more to come. Regardless of how the miners feel about FAS133 they are not alone since FAS133 is affecting almost every business that might make use of derivatives, from producers of commodities right through to hedge funds, from banks through to traders – in short both users and creators of derivatives are being affected. FAS133 is here to stay and we can only expect accounting standards to become more onerous and encompassing in the years to come.

Thus overall, the hedger has not had an easy life of late. Higher gold prices, lower contangos, onerous accounting standards and in some cases grumpy shareholders – not exactly the recipe for blissful existence. Is it any wonder that we have seen a persistent decline in hedging? And to add insult to injury those producers who have actively reduced their book, a process which certainly has been supportive of the price, have received no credit for this course of action. They have been criticised for years for their hedging policies and then when they unwind them, no one bothers to acknowledge their effect on the market.

But what of the future? In this current price and contango regime we would expect more of the same but there must come a stage when the rate of decline slows and we are left, all other parameters being equal, with a core level of price risk management. On a delta hedge basis the hedge book since June 2001 was contracted from a fraction under 99 million ounces to a little over 77 million ounces, a difference of 21.6 million ounces. This equates to a decline of 673 tonnes or almost twice South African gold production at 2002 levels. Looking at this slightly differently, this 637 tonnes is actually demand, it is gold coming off the market. This begs the question: what other source of demand is going fill the vacuum if and indeed when the dehedging phenomenon has run its course?

John Maynard Keynes once wryly observed that it is better to be roughly right than precisely wrong. We live in an age of unparalleled computing power and significant innovation in complex mathematics and risk management techniques – yet why have so many people lost so much money, particularly in equities, over the past few years?

Of course, it has not just been the individual investor, who has suffered, but also the big institutions and professionals, despite their access to large resources to tackle financial risk. The whole business premise of the risk management industry is predicated on reducing exposures and losses, and helping investors, fund managers and executives in banking and insurance avoid these problems. Has the financial world been chasing rainbows by believing that mathematical models can contain risk, and are we all guilty of putting too much faith in these ideas? As a result have we fallen into Keynes’ trap and lost sight of being roughly right, and instead have ended up being evermore precisely wrong?

It would seem that recent equity market events (To take a familiar and painful example) may seriously bring into doubt the usefulness of some quantative risk techniques – or at the very least force us to put a significant caveat on their ability to contain losses. The desire for precise measurement and the human need for certainty and control have not lead to fewer losses. Perhaps instead of endlessly fine tuning mathematical models we should be directing our efforts into other areas and methods.

In very broad terms we can divide financial risk in to three “P’s” – being Price, Probability and Psychology. The area of pricing (by this I mean issues such as spread, liquidity, access to accurate and timely data etc.) is well understood and usually properly addressed by most players in the market. It is in the second area where much of the current focus is centred. There is now much emphasis on probability; constructing risk models, defining risk measurement regimes, and understanding potential non-linear relationships in time series data etc. This area has been bombarded by huge spending, significant computing power, and not least of all a large amount of high level brain power – but the ‘breakthrough’ to understanding, containing and mastering risk still seems to be tantalisingly just beyond our grasp. Perhaps it’s time to focus more on the third ‘P’ of psychology.

The very word psychology often conjures up images of ‘New Age’ mumbo jumbo and woolly thinking. In fact the science of behavioural finance is very respectable (A leading exponent won last years Nobel prize for economics) and has been around in some circles of financial thinking for a good while. It is however still very early days and we have yet to develop a proper language to articulate and fully develop its ideas.

Perhaps the current bear market in equities will spur renewed thinking, and see attempts to create ‘soft metrics’ type products that will attempt to define and understand the way we make decisions in the market place. Because it is the decision making process (or often the lack thereof) that really determines how we cope with financial risk. Examples of this new language will need to include ideas such as:

False Confirmation
We tend to overestimate the extent to which others share our views, beliefs, and experiences—this is the so-called false consensus effect. Some examples of this are:

Confirmation Bias: We have a tendency to seek out opinions and facts that support our own beliefs and hypotheses

Selective Recall: We have a habit of remembering only facts and experiences that reinforce our assumptions

Biased Evaluation: We are swift to accept evidence that supports our hypotheses, while contradictory evidence is subjected to overly rigorous evaluation, and almost certain rejection.

Investor Overconfidence
Our minds are wired to make us feel overconfident. We are taught from an early age to be confident and that we have to persist in life to succeed. Whilst this may be a good motto in many walks of life – in investment and trading it can be financially ruinous.

We are particularly overconfident of our ability to make accurate estimates. And equally, research shows we are very impressed by seemingly accurate predictions made by ‘experts’ and gurus. A good example of this is the spurious accuracy often offered by chartists when predicting future market price moves (“Gold will find strong support at 324.40”). Also the claims made by some financial software companies about their ‘secret trading systems’, who habitually make grandiose and at the same time minutely accurate claims (“84.7% of the signals were winners!”).

We also tend to be overconfident in our own abilities. People nearly always rank themselves ‘above-average’ when asked to assess their own skills compared to their peer group. Related to this overconfidence is the problem of over-optimism. We all tend to be optimistic, and our performance and investment forecasts tend toward the rosier end of the spectrum. These twin problems of overconfidence and over-optimism can have dangerous consequences when it comes to making investment strategies. Our market strategies are usually based on future estimates, but are often unrealistically precise and overly optimistic about what are essentially inherently uncertain future outcomes.

Status Quo
In one well-known experiment, a group of undergraduates were asked how they would invest a hypothetical inheritance. One group received a million dollars in low-risk, low-return bonds and typically chose to leave most of the investments alone. The second group were told their million dollars was in higher-risk securities—and they also left most of the money in these positions.

What determined the students’ allocation in this experiment was the initial allocation, not their risk preference. People would rather leave things as they are. (There is an element of blame shifting in this behaviour of course).

A possible explanation for this status quo bias is an aversion to taking a loss—people are more concerned about the risk of loss than they are excited by the prospect of gain. Paradoxically this can be part of the reason we hold on to poor performing investments (see also Sunk Loss Bias below).

The students’ fear of switching into securities that might end up losing value prevented them from making the rational choice; rebalancing and adjusting their portfolios.

The status quo bias and an aversion to loss contribute to poor investment decisions; in particular they make investors reluctant to dispose of failing investments and bad trading positions.

These phenomena also make it hard for investors to shift their asset allocations. For example before the current equity bear market, the UK insurer Prudential decided that equities were overvalued and made the wise decision to rebalance its fund toward bonds. Many other UK life insurers, unwilling to break with the status quo, stuck with their high equity weightings and have suffered more severe losses, and as a consequence reductions in their solvency ratios.

Sunk Loss Bias
Another problem about our market behaviour centres around context and circumstance; framing is the more scientific term used by followers of behavioural finance. Chief amongst these issues is regret and sunk loss bias.

It appears that when faced with a loss it is not just the monetary aspect that pains us, but it is the fact we have to acknowledge responsibility for the loss. This regret is a powerful block for many trying to control their losses; it can be an almost impossible hurdle for some, and is very debilitating in financial trading given that we have to control and cut our losses on a continuous basis.

It is axiomatic that we have to keep our losses under control, but for many the pain and regret (perhaps even shame?) is just too great. This is how small losses get larger, why investors often try to average a loss by actually increasing their position in an adverse market, and how large company and government projects often spiral out of budgetary control. Perhaps the British government’s experience with the Millennium Dome is an example par excellence of the sort of fiasco that can result from not getting out of bad decisions. This behaviour is sometimes called sunk cost bias, and really refers to the problem of throwing good money after bad.

Conclusion
Mathematical models are simply unable to capture these factors and emotions. Financial markets are not a neat definable problem that can be solved by a clever model. They are dynamic in their characteristics, and so static models and systems whether for risk measurement or prediction of future outcomes can never be consistently successful. It is time for us to look for new tools and approaches to improve our understanding and decision-making in finance.

This morning I would like to talk about the role of the Bank of England in the gold market. One element of that is our management, on behalf of the Government, of the UK’s official gold reserves, and I’ll be saying a little about that. But I will be saying more about other aspects of our involvement in the gold market that may be less familiar to some people in the audience here. In particular I will describe the Bank’s provision of custodial and account management services to central banks and to commercial firms active in the London market, reflecting our role in seeking to ensure the efficiency and effectiveness of the UK financial sector. And I will explain the Bank’s contribution to the self-regulation of the wholesale gold market. In all these areas we cooperate closely with the LBMA, and I shall explain how that relationship functions.

First, then, the official reserves. The UK is a little unusual, although certainly not unique, in that the official reserves of foreign currency and gold are held on the balance sheet of the Government rather than of the central bank. The Bank of England’s role is to manage the reserves portfolio, embracing both foreign currency assets and liabilities, on behalf of the Government, or more specifically the Treasury, our Finance Ministry. We do that according to a Remit which they set for us each year. Strategic decisions about the reserves portfolio, such as high-level asset allocation, are taken by the Treasury. The Bank provides analysis and advice to assist the Treasury in making these decisions; we implement the decisions that the Treasury makes; and we manage the reserves on a day to day basis. I should add that in recent years the Bank’s management of the official gold reserves has also taken place within the framework of the 1999 Central Bank Agreement on Gold, with which I imagine you all to be familiar.

In the context of gold, the most significant strategic move of recent years was clearly the Government’s decision to reduce the holdings of gold in the reserves by just over half as a portfolio diversification measure. This was achieved through the series of auctions that the Bank conducted between 1999 and last year. Now, this is a subject that has already been subject to a considerable amount of comment and analysis, and I don’t propose to add much to that here. The Treasury have produced a very comprehensive Review of the gold sales programme, which is available on their website, and if any of you has residual questions about the programme I am sure you will be able to find the answers there. The UK remains a significant holder of gold: we have around 315 tonnes, worth $3½ billion at the current price, making us, still, amongst the largest twenty official holders.

Like many other central banks, whether or not they have the reserves on their own balance sheet, our day-to-day management of the gold holdings in the reserves is aimed at achieving a return on them, by lending a portion to the market. As is increasingly common amongst central banks, we have a strategic benchmark for this gold lending portfolio, in our case set by the Treasury. The Bank is able, subject to market and credit risk limits, to adjust the maturity distribution of the actual portfolio, relative to that of the benchmark, in search of additional returns. The return on the actual portfolio relative to the benchmark measures the value that the Bank has been able to add by this ‘active management’.

Recently, of course, gold lending rates have been extremely low. Commentators seem to be in broad agreement as to why that is. There is a low interest rate environment globally, and one might expect that to influence interest rates on gold. But there are also factors specific to the gold market. In particular, much, although not all, gold lending ultimately facilitates the hedging by gold producers of their future output. And, as is well known, producer hedge books have become smaller recently.

Over the past couple of years, a number of central banks have withdrawn some of their gold from the lending market. Gold Fields Mineral Services estimate that outstanding lending by the official sector was 266 tonnes lower at the end of 2002 than it had been a year earlier. In reality this just reflects lower demand from the ultimate borrowers, communicated via the interest rate. In the context of short-term rates in the single digit basis points one might perhaps have expected official lending to fall further, when allowance is made for the compensation necessary to take account of credit risk and transaction costs.

I have spoken so far about the Bank of England’s role as Agent for the Treasury in managing the official gold reserves. I would like to move on now to the broader market in London and the Bank’s role in it.

Comparative international data on turnover in the wholesale gold market are sparse, but London is generally considered to be the most significant centre for spot and forward purchases and sales, Over-The-Counter gold derivatives, and, in particular, for gold lending.

What is the Bank of England’s place in this? First, we are a very significant custodian of physical gold. Primarily this is gold that belongs to other central banks, but we also store gold in our vaults on behalf of a number of commercial firms that are active in the market. In fact, most of the gold we store is not our own. We are certainly not unique amongst central banks in this custodial role. Most notably, the US Federal Reserve also offers this service to other central banks, although not to private sector institutions. The Fed has the advantage of being located on bedrock so it is able to pile its holdings up to the ceiling. We are stuck with London clay, so we are limited to a certain number of bars per pallet!

And there are of course many commercial firms providing vaulting facilities, in London and elsewhere around the world. Most often, however, commercial bank storage services are conducted on an un-allocated basis. This means, as many of you will be aware, that the owner has a claim on the commercial bank where it is held for a certain amount of gold, but does not have title to specific bars.

What the Bank provides is an account management service on an allocated basis. That means that those holding gold at the Bank, particularly other central banks, have the reassurance of knowing that they have title to specific bars; but they are also able to mobilise those gold holdings conveniently by making or receiving so-called ‘electronic book entry transfers’ between their account at the Bank and the account of their counterparty. Such a transfer does not require gold to be physically moved within the Bank’s vaults; rather, title to the bars in question is transferred within the Bank’s IT systems. We are probably unique in offering this kind of account management service on the scale that we do, and to a large number both of central bank and private sector participants in the market. The significance of this facility is that it provides an important element of the infrastructure that brings market participants together.

This system is one that has grown up organically over a long period of time, and very much in response to representations from our central bank customers and from the London market itself. It has no doubt been a factor in London maintaining its position as the most significant international centre in the wholesale gold market. However, other factors have, I am sure, been even more significant. In particular the establishment, and promotion by the LBMA, of London Good Delivery standards, has been crucial. Many aspects of the wholesale market could not exist in the absence of the fungibility and general acceptability of different bars within the London clearing system. Such is the confidence in this market standard that the term London Good Delivery is recognised and respected world-wide.

A further activity, one that grew out of the Bank’s custodial role, is that we are prepared to accept gold deposits from other central banks, which we lend on to the market in our own name, at a margin to reflect the cost and credit risk incurred. Our central bank customers thereby gain the convenience of being able to generate a return on part of their gold holdings, whilst only having to manage a single front and back office relationship. The assets and liabilities denominated in gold on the Bank’s own balance sheet derive entirely from this borrowing and lending activity. Since we publish these figures on our website each month in accordance with the IMF’s disclosure standards, anyone who is interested may track this business from there. At end-April it totalled around forty-five tonnes, reflecting the current interest rate environment. It has been above one hundred tonnes in the past.

We are happy that we have been in a position to assist the development of the market in these ways, but we are not wholly selfless! We do charge fees for the facilities we provide. More broadly these activities reflect the Bank’s role in seeking to ensure the effectiveness of the UK’s financial services, which we do in part by supporting the development of an efficient financial infrastructure.

Finally, I would like to say a word about the Bank’s role in the regulation of the gold market in the UK. This is, in fact, a very limited one. Since the establishment of the Financial Services Authority in 1998, it has been the regulator of individual institutions. The wholesale bullion market is considered to be an inter-professional market, or, in the distinctive parlance of the UK regulatory framework, a ‘non-investment products’ market. This means that, in general, the principle of caveat emptor applies and the market is expected to be self-regulating. The same is true, as it should be, of the foreign exchange and cash money markets in the UK.

As has always been the case, the Bank of England contributes to the self-regulation of all these markets. Nowadays we do that by facilitating the production of the Non-Investment Products Code, known by its acronym, the NIPs Code. This is a code of good practice for participants in these wholesale, over-the-counter markets, covering such things as dealing procedures and conventions. It provides a framework for market participants to gauge what is, and what is not, reasonable and professional conduct. The NIPs Code is produced and maintained jointly by the London Foreign Exchange Joint Standing Committee, for which the Bank of England provides a Chairman and a secretariat; by the Money Markets Liaison Group, for which we provide a similar service; and by the Management Committee of the LBMA. The Financial Services Authority has also participated in the development of the Code and says that it expects the management of authorised firms to take due account of it. The LBMA has endorsed the NIPs Code on behalf of the bullion market, and is consulted on all proposed changes to the Code.

In fact it should be apparent from much that I have said that the Bank works very closely with the LBMA in a variety of contexts. Representatives of the Bank are invited to attend meetings of the Management and Physical Committees of the LBMA as observers, and beyond that we have a very close ongoing working relationship. It seems to us that the LBMA and its participant firms do an excellent job of promoting the bullion markets, increasingly at a global level rather than solely in London, and it has been a great pleasure for me to be able to speak at the LBMA’s annual conference today.

Good morning ladies and gentlemen. Before beginning my paper I would first like to thank the LBMA for giving me the opportunity to present this morning.

My paper this morning concerns Russian stocks of platinum and palladium. As many in the audience will know, Russia’s precious metals production, consumption and inventory levels are state secrets and nowhere is Churchill’s description of Russia as a “a riddle wrapped in a mystery inside an enigma” more apt than when discussing the local precious metals markets. As such, my paper this morning will inevitably rely on more inferences, estimations and assumptions than other papers presented here. Nevertheless, we believe that we have been able to draw together a broadly accurate picture of Russian production, consumption and trade in the platinum group metals.

My paper today will be broadly divided into three sections – past, present and future. With respect to the past, in the 1970s and 1980s Russia accumulated significant stockpiles of both platinum and palladium. This was followed by aggressive destocking in the 1990s after the collapse of the old Soviet Union and the need for the new Russian government to generate badly needed foreign exchange. Confusion over the granting of export quotas and licences became the norm. At present, as we will argue, Russian stocks of platinum have been largely depleted, although significant socks of palladium – possibly as much as 10-12Moz remain. Into the future, we expect the platinum market to remain very tight, with the industry needing all the platinum Russia can produce. Any stockpiling of platinum by the Russians could generate significant spikes in prices given the dearth of metal available to consumers. However, with the fundamentals of the palladium market continuing to deteriorate Norilsk and the Russian government will be in an increasingly difficult position and could be forced to finance ever-increasing inventories of unsold metal.

Before examining in more detail the trends in Russian PGM stocks, I think it would be useful to briefly describe Russia’s PGM production facilities. These are shown in the attached map. Russia’s annual production of platinum is approximately 950,000oz we believe, of which Norilsk Nickel accounts for roughly 800,000oz and the Siberian producers Kondyor and Koryak the balance of 150,000oz. Norilsk Nickel accounts for all of Russia’s 2.8Moz annual palladium production. Norilsk’s production facilities are divided between the Kola and the Taimyr peninsulas. The core assets of the company reside in, or near, the city of Norilsk. At Norilsk the company operates eight mines, a primary smelter and two refineries, together with a slimes shop that sends raw materials to the Krasnoyarsk and Prioksk precious metals refineries. On the Kola peninsula Norilsk’s production facilities include the Pechenganickel and Severonikel combines.

Turning first to platinum, the following chart shows the historic level of Russian production and exports. As I mentioned earlier, the common perception has it that Russian production of platinum group metals is a state secret and this is certainly the case. However, in the past the Russians have occasionally disclosed historic production data. This has not always been deliberate. In the late 1980s, for example, Russian platinum production levels were disclosed in the draft prospectus for a Eurobond issue, the data was strangely omitted from the final document. This, together with other data we have been able to assimilate, has formed the basis of the production levels shown in the chart.

We estimate Russian platinum production this year will be about 950,000oz. This is considerably higher than the levels seen in the early 1990s, but still below the highs of the late 1980s when Russian output topped 1Moz. Russian platinum consumption, which was considerable in the 1970s and early 1980s collapsed to nothing, leaving all of the production available for export. During the 1970s and 1980s Russian exports were significantly below Russian production levels, leading to an increase in domestic stockpiles. This stockpiling of inventory was reversed in the 1990s, depressing the international market.

With respect to palladium, Norilsk Nickel is Russia’s sole producer of the metal, with annual production around 2.8-2.9Moz. Until 1993 exports were considerably lower than annual output, leading to an ongoing increase in inventories of unsold metal. However, 1993 marked a sea change in Russia’s attitude to palladium exports, with the beginnings of a massive dumping of metal onto the international markets. At the peak, exports exceeded production by over 3Moz in 1998.

The change in the early 1990s from stockpiling to aggressive destocking was a direct result of the need of the government’s budget financing requirements. The Finance Ministry, through its subsidiary Gokhran, controlled most of the platinum and palladium inventories held by the Russian government. Some of the inventory was sold directly to the Western markets through Almazjuvelirexport (Almaz), the official Russian export agency.

The Finance Ministry also sold metal to the Central Bank in exchange for roubles to cover monthly budget deficits. In doing so, the Russian Central Bank accumulated an inventory position separate to that controlled by the Finance Ministry. The Central Bank tried to negotiate some palladium swaps in the earlier years, but did not succeed until 1999. Any profits from such transactions could be retained by the Central Bank for twelve months, and then half of which had to be repaid to the state treasury. Sales from Norilsk were also handled by Almaz, although export quotas and licences were only granted on an annual basis, at least that is until 1998 when a 10 year quota for palladium exports was granted.

However, with export quotas and licences still needing to be passed by the Duma, the Finance Ministry and the president, a complex web of interdependency and rivalry developed. This resulted in repeated disruptions to exports on an annual basis, culminating in the farce of “Clause 19” that resulted in severe disruptions to shipments in 1999. In turn, with the Western markets increasingly reliant on Russian material, platinum and palladium prices became increasingly volatile.

So much for the past, but where does that leave Russian platinum and palladium inventories at the moment? With respect to platinum, we believe that Russian stocks have now largely been depleted, and that at most a residual stockpile of maybe 2-300,000oz remains in the hands of the Russian government. In this respect it should be noted that despite the high level of platinum prices in the last two years, Russian platinum sales have been broadly in line with underlying production levels. Even the high platinum lease rates seen at times over recent months has failed to attract any significant lending activity, again suggesting that Russian platinum stocks have been drawn down to minimum acceptable levels.

With respect to palladium, however, a different story emerges. Between 1993 and 2001 we estimate that approximately 18Moz of palladium were sold from Russian stocks onto the Western markets. However, this still left a remaining inventory overhang of approximately 9-10Moz we believe. This accords with comments made by Valery Rudakov of Gokhran in 2000 that Central Bank stocks of palladium were 2-300t (6-10Moz).

In August 2001 Norilsk took the unusual step of declaring that it had suspended sales of palladium into the spot market, as a response to the slump in palladium prices. Having peaked at almost USD1,100/oz in February 2001 palladium prices slumped to what was then a two year low of under USD400/oz. The announcement helped temporarily to boost sentiment in the palladium market, after which prices continued their almost unrelenting decline. Since August 2001 we believe that Russian palladium stocks have risen by almost 2Moz, taking aggregate inventories to around 11-12Moz.

Much of the 2Moz of inventory that Norilsk has accumulated in the last two years have already been committed. Last year Norilsk used somewhere between 1-1.5Moz to repay a loan from the Ministry of Finance dating back to 1994, transferring the metal to the state treasury Gokhran. In addition, Norilsk has shipped 877,000oz of palladium to London against part payment of the share purchase of Stillwater Mining, announced late last year. These two transactions should eliminate Norilsk’s existing inventory. The Finance Ministry has little material, with the exception of the metal it received from Norilsk. The bulk of the palladium stocks in Russia still under the control of the Central Bank, we believe.

So much for the past and the present, what about the future? The starting point has to be an examination of the future output of PGMs in Russia. Earlier this year Norilsk published its “Strategy until 2015”, which replaces the pre-existing “Development Plan to 2010”. The new strategy us based on four principles, namely adjusting metal production in line with expected market demand, increasing the efficiency of production and recovery rates, ensuring the sustainability and cost efficiency of the company’s operations and finally addressing the environmental impact of the company’s operations.

With respect to metal output, it is impossible to manage mine output such that production of nickel, copper, platinum and palladium are all at optimum levels. Norilsk appears to be targeting nickel production, by raising output of cuprous ores. This should leave output of PGMs roughly stable. Given the widely held belief that the fundamentals of the nickel market are the strongest of any of the base metals, Norilsk’s strategy seems to be to operate as a nickel mine, with production of copper and PGMs effectively as a by-product.

Keeping platinum production flat and with little if any inventory to act as a ‘safety valve’ the platinum market remains vulnerable to the possibility of damaging price spikes, we believe given the underlying strength of the market fundamentals. The platinum market has been in deficit in five of the last six years as good demand from the autocatalyst and jewellery sectors has outpaced rising mine production. We see little reason for this to change. Offtake from the auto industry remains strong, notwithstanding the current price differential between platinum and palladium which is encouraging car manufacturers to substitute the cheaper metal where possible. Jewellery demand in China also remains firm, with huge potential gains to be made if future marketing campaigns are as successful as past. On the supply side the South African producers have struggled to meet ambitious production targets. With industry stocks of platinum having been drawn down there is a real possibility of the platinum price spiking higher over the coming months. Although the all time highs of over USD1,000/oz are probably out of reach a return to the 23 year high of USD710/oz. Seen earlier this year is a possibility, if not probability.

The opposite is, unfortunately, true of the palladium market, where the fundamentals of the market look almost unreservedly grim, even allowing for a switch from platinum into palladium in the autocatalyst sector. We expect the market to move into structural oversupply, with ongoing downward pressure on prices as a result. On the demand side, offtake from the electronics sector has collapsed to only a third of the level enjoyed two years ago, while in the auto sector ongoing destocking by the car companies will depress purchases. On the supply side, the output of by-product palladium in South Africa is rising sharply as the producers raise output form the UG2 reef, while a huge surge in scrap supplies appears imminent. Price risks remain on the downside.

Indeed, we believe that the only way for the palladium market to remain in balance is for the Russians to accrue an ever-increasing stockpile of palladium. We estimate that the Russians would need to stockpile somewhere between 1-1.5Moz of production annually over the coming years to keep the palladium market in balance. This is in sharp contrast to the 1990s, when the market required significant deliveries of metal from Russian stockpiles. Our base case scenario assumes that the Russians stockpile roughly half of this, leaving the market in ongoing oversupply and prices under pressure.

The possibility of the Russians stockpiling over 1Moz each year of palladium is remote we believe, and this view is confirmed by the terms of the proposed deal between Norilsk and Stillwater Mining. The agreement was reached late last year, but still has to be ratified. The principle terms of the transaction are shown in the chart. Briefly, Norilsk Nickel will take a 51% stake in Stillwater for USD100M in cash and 876,000oz of palladium. At the time the deal was announced this was inventory was worth approximately USD241M but has since declined alongside the palladium price to around USD140M at current prices. Norilsk have the option of purchasing a further 10% stake in Stillwater and, although this has to be ratified, Norilsk will ship up to 1Moz of palladium to Stillwater each year to be marketed in North America.

For Stillwater the deal allows the company to shore up its battered balance sheet and provides working capital and access to Norilsk’s technical team. For Norilsk, the deal offers the chance to remove almost 1Moz from inventory and, more importantly, offers access to Stillwater’s distribution network while assuring the car companies of security of supply. The insurance policy is that Norilsk now was access to the Stillwater hedge book. The deal also raises Norilsk’s profile with US investors, which in turn may help raise the rating on the company’s ADR. For the palladium market, however, the sales from Norilsk through Stillwater, together with their sales into Europe and the Far East should ensure the market remains more than adequately supplied with metal for the foreseeable future.

To conclude, Russian policy towards PGM stockpiles changed in the early 1990s as the previous policy of stockbuilding was replaced by one of stock drawdown. We estimate that almost 3Moz of platinum stocks were sold into the international market, leaving stockpiles close to exhaustion. With the underlying supply/demand fundamentals still so strong, and with little industry inventory available, there remains the possibility of a damaging price spike in the platinum market. By contrast, despite palladium sales of more than 15Moz in the 1990s, an overhang of 10-12Moz remains. Moreover, this overhang is rising as Norilsk has suspended sales into the spot market. True Norilsk is managing to sell more metal on a contract basis, but unfortunately, with the fundamentals of supply and demand still so weak, the outlook for palladium prices remains depressed. Palladium looks set to resume its historic role of being a by-product of platinum and should be priced accordingly.

I was delighted to be invited here today to represent Dubai’s growing jewellery trade. In addition our organisation, Damas, I also represent Dubai Gold & Jewellery Group as Chairman. While Damas has 140 retail outlets in the Middle East region, the Gold & Jewellery Group has 450 trade members in Dubai.

The LBMA has done a fine job of ensuring that London continues to meet the needs of the global bullion market. This is the first time that I am able to represent the Trade in Dubai in this annual precious metals conference, and I have to say that the presentations so far have been very informative.

We want Dubai to follow London’s example, and to develop further as a hub for the gold and jewellery industry in the Middle East. The Gold and Jewellery Group Dubai has accomplished a lot since being set up only 8 years ago. Ever since, we have worked on developing Dubai as a jewellery trading hub, with world-class facilities for traders, exporters and investors.

Many of you will already know a lot about Dubai’s reputation for jewellery. To give you an idea about the jewellery import growth, in 1996, we imported 50 tonnes of gold jewellery, and this number increased to over 300 tonnes in 2002. Dubai itself accounts for 80% of gold jewellery sales in the United Arab Emirates.

We often like to say that Dubai sells quality jewellery at the world’s best price. It’s no idle boast. This is possible because of the low import duties imposed by the government. Also, because of the very high volume, suppliers and retailers are able to work on a low margin to keep prices competitive.

There are over 600 outlets in Dubai selling gold and jewellery, including over 275 just in our Gold Souk market area, so that will give you an idea of the density of jewellery shops.

Dubai’s population has always been inclined towards gold, and this was reinforced by the emirate’s historical links with India, which has an extremely high rate of gold ownership. Add to this the fact that has an oil based economy and a high per capita income.

Dubai is a very cosmopolitan place, with over 130 different nationalities, including a large number from the Indian subcontinent. This has bred a very healthy respect for the yellow metal, in its many different karatages and styles.

The city therefore was always destined to have a thriving gold industry, whether it was 18 karat for the European tourists, 21 karat for Arab nationals, or 22 karat for Asians from the Subcontinent.

The city is also the main export/re-export centre for gold and jewellery in the Middle East region. We had some very exciting news recently, confirming that a new terminal would be set up in the heart of town for receiving gold and jewellery. This new one-stop shop makes the whole process of importing and exporting much quicker and more convenient, and less costly. So we are very proud of that new step.

The Group was formed in time for Dubai’s first shopping festival in 1996 to develop the concept further. Together with Dubai’s Economic Department, we re-branded Dubai as the ‘City of Gold’. We found that this was a concept we could own, and we used some exciting promotions to reinforce our messages. In our latest promotion, we gave away one million dirhams in a jewellery-purchase linked raffle.

During the annual shopping festival, we also developed some unique ideas. For example, one year we made the longest gold chain in the world, measuring 4.1 kilometres, and weighing an amazing 200 kg. The record-breaking chain was cut up afterwards and sold to shoppers. In 2000, we created a special heart-shaped locket to celebrate that year’s festival theme

To celebrate the theme of Dubai Shopping Festival (DSF) 2000, ‘To Mother with Love’, a special edition gold locket was brought out with the script ‘ the world’s best mother’, and that really proved to be a great success among residents and tourists.

As a group, we have been also been promoting Dubai regionally and internationally, through participation in events like this, and our own annual conference, which we started in January, and which managed to attract a large number of prominent delegates. Our second conference is this December, so I welcome you to attend.

While we started off marketing Dubai as the City of Gold, it has become clear in recent years that gems and other types of jewellery will play a major role in increasing sales. This is not just a regional trend but also an international one, and we need to look at how best we can exploit this to help grow the market.

While gold jewellery will never lose its popularity there is now a demand for more variety, and for the different possibilities that gems offer. For suppliers and retailers, the advantage of diversifying into gems is the fallback when gold prices are high, and consumers are not buying pure gold.

Looking at diamonds in particular, there has been significant growth in the last three years, and in fact in 2001 the GCC became the world’s fourth largest diamond market, after the US, Japan and India, representing a market size of US$1.13 billion, or a sale of 395,000 diamond units.

One of the factors behind this growth was the work done by the Diamond Trading Company in promoting the ‘Every Day Diamonds’ campaign to encourage consumers that diamonds were affordable and could be worn on any occasion.

Of course, one of the most important factors in encouraging diamond sales is assuring consumers of the purity of the diamonds. We have worked hard to make Dubai one of the best places to buy diamonds. The emirate became one of the very few countries in the Middle East to use the Kimberly process. Additionally, we have been working with the International Gemmological Institute and the Diamond High Council to offer a number of diamond courses to our members, thus keeping high retail standards.

We also have very strict controls and checks imposed by our gem material laboratory in Dubai’s Municipality, helping to guarantee the quality of our diamonds.

The DTC research showing the growth in regional diamond sales also gave jewellers a jolt, and encouraged them to spend more on branding and advertising activities for diamonds. The building of diamond brands is undoubtedly the way forward in the Gulf. This new swing in thinking has led to a growth in diamond gemstone branding to appeal to different sectors.

Because of Dubai’s diverse mix of nationalities, there is huge potential to create products for different segments, and this is what some companies have started to recognise and exploit.

Examples are the beautiful Princess diamond collection from Damas itself, which appeals to the European market, using 18 karat white or yellow gold that can be used either as a pendant or a ring. We also launched the Najoom collection for Arab nationals.

Other brands recently launched include Scintilla, Al Mantoorah Nakshaba,and legacy. While Al Mantoorah is focused on the Arab Market, Nakshaba and Legacy appeal to the Indian markets. Even within these categories, there are subdivisions. So for example, Nakshaba is much more modern and trendy while Legacy lives up to its name, and is more grand and traditional.

So, there has been a very noticeable move in the trade towards marketing of diamonds. This applies equally to the visual merchandicing, which has shown a lot of improvement, as traders realise that a good display of branded jewellery & gemstone studded collections can play an important role in pushing sales.

But while some enterprising companies have taken the bull by the horns, there is still a lot more opportunities, and we look forward to new brands and more diamond marketing over the coming years.

On another front, we also look forward to the opportunities that will be presented by the Dubai Metals and Commodities Centre, which will open in the next two years, including a commodities exchange, manufacturing facilities and gold refineries.

Thank you for your time, and I hope that Dubai’s experience was an interesting one for you.

The metal, gold, has experienced more change in the past 100 years to its role, symbolism, access, form, fabrication and trade than it has in the preceding 4500 years. Gold is in a period of flux. Much attention has been given to the problems facing the gold jewellery industry today. On the other hand, there has been very little said about the opportunities and innovative strategies and tactics underway ensuring that gold has a place in the hearts and minds of future generations.

In the not too distant future I see the following events taking place, which will redefine and modernise the gold jewellery category.

Forecast 1: Emergence of the “Fashion Gold” Category
Over 80% of gold production goes into jewellery; today there are four basic categories of gold jewellery:

• Stones-set in gold
• Mass Gold (including chain and “market-goods”)
• Ethnic Gold (including Chuk Kam and Indian Bridal)
• Fine Gold (high-end hand fabricated).

Believe it or not, all four of these different categories of gold jewellery are lumped together and reported as a single category, called “Karat Gold”. It is impossible to determine what share-of-market and share-of-value each category represents to total gold jewellery consumption. In addition, research reveals that these four groupings are missing a big business opportunity.

In response, a new category of gold jewellery is being created to occupy the empty spaces, creating an entirely new genre of plain gold jewellery. The new category is called Fashion Gold and it is defined as:

• 18kt plain gold.
• Outstanding, contemporary and fashionable design, in-synch with fashion seasons.
• Differentiated and made interesting through technologies, fabrication techniques and innovative design processes.
• Branded, but not branded by designer or retailer
• Because Fashion Gold is so different from Mass, Ethnic and Fine Gold, it should not cannibalise existing Karat Gold demand. Instead, Fashion Gold should attract new consumer groups to gold, thus growing the market for gold jewellery overall.

This new category of gold jewellery is made possible today through a combination of:

• Gold Jewellery Designed by Designers, Not Jewellers
• New Technologies Applied to Gold Jewellery
• New Gold Fabrication Techniques

Gold Jewellery Designed by Designers, Not Jewellers
Cross-disciplinary creative collaboration is a growing phenomenon amongst creative communities globally. Graphic designers are designing automobiles, industrial designers are designing textiles, musicians are designing apparel and architects and other designers are designing gold jewellery. This is improving the design of gold jewellery and bringing fresh thinking to the category. In addition to raising the profile of gold jewellery, this is attracting celebrity designers to an industry that has relatively few personalities.

The predominance of amateur and non-professional winners of international jewellery design competitions proves that one doesn’t need to be a jeweller to design gold jewellery. One needs to be a good designer. Jewellery schools around the world recognising this have started separating design from goldsmithing education.

New Technologies Applied to Gold Jewellery
New technologies are being applied to gold jewellery to give gold a new look that consumers desire. New alloys and processes are adding interest, colour, texture and pattern to gold. Conversely, gold components previously used for medicine, science and technology have been rediscovered and are now being used to fabricate jewellery.

New Gold Fabrication Techniques
Many industries are seeing a movement towards combining hand and machine manufacturing, and the gold jewellery industry is no exception. Gold is so versatile virtually anyone can work with it, and as a result new groups of people (who are not goldsmiths or jewellers) are starting to work with gold, from artists to craftspeople. Gold is being knitted, laced, thrown, blown, sewn, snipped, etc. Machine components are hand-manufactured and finished by machine.

Forecast 2: Tidal Wave of Branding
We should soon see the introduction of gold to brands, and brands to gold, which will introduce much needed scale-benefits to the category. The brands that have drawn consumers away from jewellery should soon start to sell gold jewellery; Fashion Gold can be designed specifically for brands, with distinctive use of technologies, techniques and design, for differentiation and brand protection. There are no reasons why jewellery shouldn’t be branded like other sectors. Gone are the days when a “brand” of gold jewellery only meant either a “designer brand” or “retailer brand”. Very soon we should see brands of gold jewellery focussed on product benefits. In addition, ingredient branding is about to catch on in the gold industry with at least seven “gold brands” already registered as trademarks today.

Forecast 3: Shorter NPD Cycles and Time to Market
The surge in retailers using a business model based on “6 weeks from runway to retail” highlights the business opportunity of bringing fashion products faster to the mass market. Due to improved new product development (NPD) cycles, this new genre of retailer offers consumers the latest fashions at low-to-middle price points. Taking cues from Fast Fashion retailers, Fashion Gold should evolve into “Fast Fashion Gold”, synchronised with fashion cycles and seasons. This will be made possible by computer aided design (CAD) and just-in-time manufacturing systems. Procedures and technologies used for inventory management and restocking by apparel retailers should be introduced to the gold jewellery category, improving the capital efficiency of Fashion Gold.

Forecast 4: Innovative New Retail Channels
A key trend in retailing is the shift from shopping malls to off-mall formats such as large scale strip malls, “big-box” stores and boutique department stores. Gold jewellery retailing will also evolve into new off-mall formats with improved retail experiences. Lifestyle retailers, Fast Fashion retailers and Luxury retailers have more inviting environments, better educated sales people, more attractive merchandising, better customer services and more transparent pricing, making them attractive for Fashion Gold. The penetration and presence of these retailers creates a business opportunity for Fashion Gold. We will also see the introduction of Fashion Gold to catalogues, hair salons and, in the next generation, even upmarket vending machines.

Forecast 5: “Diffusion” Merchandising
“Diffusion” is the term used by the fashion industry when an “haute couture” range inspires and drives sales of a “prêt-a-porter” range. The gold jewellery sector is learning that it is strategically sensible to sell a $20,000 item next to a $2,000 item, which is next to a $200 item, providing the products share the same inspiration and family look. Fashion Gold is ideal for this merchandising and pricing strategy, especially because mother and daughter are shopping at the same branded retailers. A new generation of merchandising professionals will emerge, versed in the full product spectrum, shifting industry dominance from the manufacturer to designers and marketers. “Diffusion” supports branding, and branding will support “diffusion”.

Forecast 6: Franchised Gold Category Management
Purchasing scale benefits are the primary driver of consolidation in most retail sectors. Not only will supply chains in the gold jewellery category continue consolidation, but retailers will embrace franchised businesses that will provide complete turnkey out-sourced gold jewellery category management. This would enable smaller players and new entrants to the category to benefit from the scale of benefits of networks that provide best-practice research, intellectual property protection, logistics, matchmaking, marketing, brands, etc.

Forecast 7: Sophisticated Advertising
The primary reason why there are few scale brands in the gold jewellery industry is because the category is under-promoted and naive in its marketing approach. The highly fragmented “Mom & Pop” industry has neither the expertise nor the clout to benefit from advertising. However, the combination of apparel retailers moving into Fashion Gold, and the scale of benefits of franchised category management would result in the introduction of imaginative, targeted and category-enhancing advertising and promotion of gold jewellery.

Forecast 8: More Insightful Consumer Research
Gone are the days of simplistic demographic profiles of gold jewellery consumers. The industry is about to leapfrog into sophisticated consumer research tools and benefit from the outstanding consumer insight of Lifestyle, Fast Fashion and Luxury retail partners. Research on the horizon will assess and identify commonalities in life stages, purchasing motivations and style signals. In addition, while gold has strong “meaning” there are no major gift-giving occasions associated with gold: presenting an opportunity. Consumer insight would drive the introduction of Fashion Gold products for “no occasion and yet all occasions” accompanied by more sophisticated and focussed marketing campaigns.

Forecast 9: Tackling New Consumer Groups
Accessing branded retailers will attract new consumers who previously were not economically attainable. Consumers tend to shop at multiple outlets and are “brand-mixers”, as different brands fill different needs and reflect different facets of one’s personality. Consumers who are not in the market for gold jewellery and have no desire to go into a jewellery store would be confronted with Fashion Gold in their favourite stores, enticing them into the category. This would bring a new wave of young consumers into our cross-hairs, replenishing the consumption of aging gold jewellery buyers.

Forecast 10: Selling-Up Customer Loyalty Programmes
Facilitating “diffusion” strategies, we should see customer loyalty programmes offered by retailers encouraging consumers to “collect” gold products and/or “trade in” their Fashion Gold for a fee. The fine gold content of last year’s Fashion Gold would be put towards a newer, more fashionable and larger Fashion Gold item. At the retail level, products would start to be hallmarked by fine gold content weight in addition to karatage (even in the USA), making manufacturing costs and margins more transparent. As a result of these programmes, consumers buying into brands should accept this, and sales people would become better educated about gold.

These 10 forecasts – my strategic “wish list” for the gold industry -- represent the crest of a tsunami, which is swelling and gaining momentum in the gold jewellery category. This wave of change should have the largest impact yet on the image and desirability of gold, consumer demand for gold and the profitability of the industry as a whole.

In addition, many of the initiatives I see on the horizon are commercial not promotional, creating an opportunity for gold producers to get involved in promoting gold as well as generating tangible shareholder value and meeting goals for return on investment for “exploration”.

I run a company called gold® limited (with operations in Cape Town, Paris, New York, Tokyo). gold® is a progressive gold marketing consultancy and the driving force in the reinvigoration of the gold jewellery category spearheading a number of sweeping initiatives. gold® is infusing the gold jewellery industry with new thinking and ideas...

The 5th Millennium of gold has begun.

Good morning. I have a goal to double the industrial demand for gold over the next decade. Is that just a silly pipedream or could it be a reality? You can probably guess my answer to that question. Today, I want to show you why I believe it is a reality and how it can be achieved.

Gold has unique properties compared to other metals and consequently is used in a myriad of industrial applications, some of which are listed on this slide.

As we can see from the histogram, these applications have provided a steady annual offtake for gold of around 350-400 tonnes, the bulk of which is centred on electronics applications, with dental as the second largest application.

Despite these applications, when we look at the total demand for gold, we see that industrial applications constitute only about 12% of overall annual demand. This is a conspicuously low figure compared with the other precious metals. This comparison suggests that there is scope for increasing the industrial demand for gold. But where is such an increase likely to come from? Let us look at the two main areas of application and the prospects for growing demand in them.

Gold in Electronics
The attributes of high electrical (and thermal) conductivity, coupled with its corrosion and tarnish resistance have long been of relevance in many aspects of electronic circuitry. Applications include conductive pastes, bonding wires, solders and connectors. Where electronic devices need to be of high quality, durable and operate in arduous environments, or in safety-critical applications, gold is the material of choice. However, with the advent of miniaturisation of electronic devices and the tendency to thrift on expensive materials, the growth in gold consumption has not mirrored that in electronics over the last few decades. Increasingly, at the high volume, low-end applications such as consumer electronics, cheaper competing materials with poorer performance tend to dominate.

If we look at the trends in electronics, we see currently a sluggish market in IT and mobile phones although the longer-term prospects are brighter. Certainly, there is growth in automotive electronics, which operate under arduous under-bonnet (hood) conditions, thereby favouring gold usage. However, we should note that gold continues to be under increasing threat from competing materials and in applications such as connectors, the relative price of palladium plays a critical role in materials choice. Cost tends to dominate over performance!

Gold in Dentistry
Turning now to dental applications. Gold is bio-compatible and, along with its other attributes of corrosion resistance and mechanical strength, these have resulted in a long history of use. Today, gold continues to be used for crowns and bridgework, porcelain enamel onlays and inlays, mostly in cast form although electroforms are gaining in popularity.

Most dental alloys are gold alloyed with palladium and/or platinum plus silver and other small additions. There are a myriad of alloys on the market, ranging from low to high gold contents (12 - 90 % gold). The choice of alloy selected tends to be price-driven and hence relative price of gold and palladium influences choice.

We should also note that the countries with the largest dental gold markets are those where the state national health insurance schemes support use of gold materials.

There is no doubt that high gold alloys are technically superior. However, their use is only favoured when palladium and platinum prices are high, as we have seen recently. The position of palladium has reversed and it is now cheaper than gold, so favouring lower gold alloys. On top of this, there is increasing competition from alternative, cheaper materials. If we look at future trends, some long term growth in demand in developing markets such as China is possible, but this may be offset a a gradual decline in the developed markets of Japan and the West, as National health insurance schemes favour the cheaper, alternative materials

Growing gold demand
From these rapid appraisals of the two current market applications, it is fairly safe to conclude that significant growth will not result from current applications for gold. That said, it is worth noting at this point that there have been no new applications for gold for some decades. Gold bonding wire was, perhaps, the last one.

From this, we can also conclude that any substantial growth in demand will only come about the development of new industrial applications for gold.

Why has this situation arisen? Why no new applications? There are a number of related reasons.

Firstly, there is still a strong perception in industry that gold is expensive, probably arising from the price spike in the early 1980s. So when someone has a problem to solve, gold is not usually considered as a candidate material. Added to that, we teach our school children that gold is the most noble of all metals and this has, perhaps, discouraged research into gold in our universities, particularly into gold chemistry. Consequently, new gold science has not emerged. I am sure you do not need me to tell you that the development of new applications for a metal leans on the emergence of new science. No new science – no new applications!

However, that said, there are encouraging signs of change. Firstly, there is a growing recognition that gold is not expensive compared to platinum and its sister metals. We are also seeing a change in the Universities and industrial research centres. Gold chemistry and its related technologies are being investigated to good effect and new areas are emerging, nanotechnology – the science of very small particles – being a good example. Coupled with this, there has been a scientific breakthrough in the field of gold catalysis, about which more shortly.

From our gold industry standpoint, there has been recognition of the importance of stimulating and exploiting gold science and technology.

Gold Catalysis
As many of you will remember from your schooldays, a catalyst is a substance that promotes chemical reactions without being consumed itself. Over 90% of all chemicals are commercially made using catalysts. Until recent times, gold was considered by the catalyst community as the oddball among precious metals in not being very active as a catalyst. Such perceived wisdom was overturned in the late 80s by pioneering work in South Africa and Japan. A momentum of R & D has slowly built up since.

It has been found that when prepared as very small nanoparticles about 5 billionths of a metre in size on an oxide support, gold is not only catalytically very active but for some chemical reactions of importance it is the most active catalyst known. Not only that, but it is active at very low temperatures, which is unusual. Gold catalyses a number of commercially important chemical reactions, including the oxidation of carbon monoxide.

Thus, a number of existing applications open up for gold. However, importantly, a number of new applications also open up, because of its unique low temperature properties. Air conditioning systems in buildings and transport, for example. This includes the removal of odours and toxins, and use in safety applications such as in mines.

The main areas of application are in chemical processing, in pollution control as I have just mentioned, not forgetting automotive pollution applications such as diesel, and in fuel cell technology in the new hydrogen economy.

Perhaps not surprisingly, a number of major companies are taking an interest and patents have been filed by several, as this slide illustrates. Only last year, the first commercial breakthrough was announced by BP Chemicals. A gold alloy catalyst is used in a new process for making vinyl acetate monomer.

An analysis of patent activity shows that chemical processing dominates with pollution control applications in second place. If we assume that the number of patents granted is a measure of commercial activity, then we can see there is an encouraging future for gold catalysts.

Nanotechnology
The science of tiny particles, nanotechnology, is a major activity in the research laboratories around the world. It is based on the fact that the properties on nanoparticles are very different from those of the bulk materials. Gold is a prime candidate material because of its nobleness and resistance to surface oxidation. Commercial applications are already emerging including pregnancy testing kits.

Gold-based nanotechnology offers exciting prospects in a number of fields: microelectronics and micromechanics, medical diagnostics and biosensors, decoration, coatings and sensors, for example. However, the gold offtake potential is more modest than gold catalysts.

Gold Chemistry
I mentioned earlier that gold chemistry is relatively underdeveloped compared to other precious metals. The field of gold organometallic compounds is yielding interesting results in terms of luminescence and medical properties. Luminescent gold compounds have applications in optical materials, sensors and optical electronic devices. Other compounds are showing anti-tumour activity in addition to gold’s known use for the treatment of arthritis. So gold pharmaceuticals are possibly a growing application. Again gold offtake potential in such applications is modest.

Gold in Medicine
Besides its pharmaceutical benefits, gold is demonstrating other medical properties of interest – biocidal activity, radio-opaqueness as well as bio-compatibility which are opening up other applications, such as stents, food and water treatment and a concept known as ‘Pharmacy on a Chip’. An electronic chip which contains microdoses of drugs with a gold envelope is implanted in the body. The microdoses of the drugs can be released by activating the chip. Truly, targeted delivery at the appropriate time.

Doubling Gold Offtake
Returning to my theme of doubling offtake for gold, I show here the growth of the platinum metals usage in automotive pollution control. Gold catalysts also have potential application in this area for diesels and for cold start situations in petrol engined cars. Not at the expense of platinum, I might add! This could be a significant application in terms of offtake.

There are other areas where offtake growth could be significant and I will demonstrate these with some brief case studies:

Case Study 1 Hydrogen fuel processors
There is a major effort to develop the hydrogen economy. President Bush recently announced a $1.2 billion programme in the USA. Fuel cells are central to this strategy and the major players are setting up production facilities. Gold catalysts can play a major role in fuel cell and its associated hydrogen generation technologies. A very simple calculation on fuel cells for cars yields a figure of around 120 tonnes of gold per annum. This is a ballpark figure. A goal in commercialising fuel cell technology is a reduction in capital cost and size and gold scores on these counts too.

Case Study 2 Diesel catalytic converter
I mentioned this application a few seconds ago. We believe gold is preferable to PGMs for this application. Again a simple calculation yields a ballpark figure of 35 tonnes gold per annum.

Case Study 3 Coated Superconductor Tapes
We have recently identified this new application in high temperature oxide superconductors. There is a growing surge of effort to realise their commercialisation for both electrical power transmission and high power magnets for MRI imaging. Gold appears to be technically preferred over silver and other metals as the coating. If found economical too, then a market of around 80 tonnes per annum is calculated for the magnet application alone.

Case Study 4 Propylene Oxide Manufacture
This is an example of chemical processing. Propylene oxide is used in the manufacture of polyurethane plastics and major manufacturers all have gold catalyst patents in this field. Again, calculation for this one chemical intermediate yields an offtake of 15 tonnes per annum. If we find another 6 chemicals to use a gold catalyst, we are approaching 100 tonnes per annum offtake.

Thus, from these examples alone, we can see that if the opportunities for gold are successfully commercialised, then the prospect of an additional 350 tonnes per annum offtake are realistic.

To ensure that they are realised, we must promote them vigorously and make the ‘Case for Gold’ to the industrial community. We also need to ensure new opportunities continue to emerge by encouraging new gold science and technology.

Thus, there are 4 requirements if successful exploitation is to result:

1. Sustain investment in gold R & D to ensure new gold science & technology is discovered and developed
2. Communicate these new discoveries and developments to industry
3. Get commitment from industry to exploit the technology (Make the ‘case for gold’) and
4. An industry ‘champion’ for gold. This is the role of World Gold Council I venture to suggest.

World Gold Council Activities
To ensure new old science emerges, WGC has initiated a programme of support for R & D, known by its acronym, GROW [Gold Research Opportunities Worldwide]. In the 2 years since it commenced, we have 14 projects already underway in 9 countries. Six of these have strong industrial partners, increasing the chance of commercialisation of the results of the work. Several of these projects centre around gold catalyst applications such as fuel cells, but we also embrace nanomaterials, biomedical and materials projects.

As indicated in the previous slides, communication of science to industry is a key task. As this slide shows, we achieve this objective in a number of ways - publication of Gold Bulletin and Catgold News; The technical database on our website went live last August and quickly attained 50,000 visits per month, demonstrating the need! We also present papers at targeted conferences and meet with key players in industry to make the case for gold for particular applications.

A major project this year is the first Gold 2003 conference on new industrial applications for gold. Organised jointly with the Canadian Institute of Mining, Metallurgy & Petroleum and sponsored by gold mining companies, over 140 papers and posters on gold science, technology and applications will be presented. This shows the momentum now generated in gold science & technology.

A significant role we undertake is to identify new opportunities for gold and to encourage exploitation. We also ‘match-make’ scientists with industry and support R & D initiatives. To facilitate commercialisation of gold catalysts, we have recently commissioned a range of gold reference catalysts which enables researchers to benchmark their own experimental results.

Industry Initiatives
Early on, I mentioned industry initiatives. Project AuTEK in South Africa is a gold mining company-led project centred on Mintek R &D laboratories to develop and commercialise new gold technologies. The European Union has sponsored a programme in Europe on gold catalysis worth €1.5 million at a consortium of 8 universities and 4 industrial companies. We also understand an initiative in Canada is under consideration which will emulate Project AuTEK and involve North American gold mining companies. These are truly signs of significant change in our industry!

Conclusions
I hope you have found this interesting and exciting even! There is cause for optimism that several significant new applications for gold could emerge over the next decade and that the current gold offtake for industrial uses could more than double. I believe that this is a realistic expectation, not just a pipedream.

You will now appreciate that this growth in demand will come from new applications for gold, not from existing applications.

We have identified several new opportunities. Gold Catalysis is the prime opportunity ripe for exploitation. Others are in the pipeline.

To turn the pipedream into reality requires sustained support of R & D, a determination to exploit this emerging technology in commercial applications and for commitment by the gold industry, if we are to succeed.

I mentioned our pioneering conference, GOLD 2003 in Vancouver. This is a landmark on our journey towards our goal. I hope to see some of you there!

Thank you.