Rust Rare Coin, Inc. May/June, 2008

PRICE TRENDS

IN OUR OPINION. . . .

The precious metals market looks to be right in the middle of the correction that we have talked about and expected for the last few months. As many of you who follow the investment markets know, precious metals, as well as most other commodities, are presently in a healthy, bullish market. Some of those higher commodity prices, especially oil, will affect a wide range of consumer products in the coming months. The products being produced right now are for consumption this fall. That’s when the higher prices will really show up. Consequently, inflation concerns continue to grow. Even with aggressive interest rate cuts by the Fed, the dollar still seems to be on fragile ground.

If you have been waiting for this market correction, but have not taken advantage of it yet, you may want to do so soon. We feel that the market has been stabilizing the last few weeks and is now starting to show signs of growth again.

We will continue to monitor the changes in the dollar and oil. Precious metals seem to be caught in the middle of their tug-of-war. As oil goes up, metals strengthen and inflationary concerns increase. Major players are now investing in oil which drives the market up even more. As oil goes up, the dollar generally weakens. The Fed is trying desperately to support the dollar with elections just around the corner.

Generally during the summer investment strategy is not at the forefront, but with all the changes going on, we encourage you to keep abreast of what is going on. We certainly will, and will try to keep you informed.

If you have questions or need help with your investment portfolio, don’t hesitate to contact your friends to Rust Rare Coin, Inc.

We hope you all have an enjoyable and safe Memorial Day weekend.

MARKET FOCUS, EMERGING TRENDS

James Steel, Analyst, HSBC Global Research

Gold prices have been dominated by the credit crisis and its impact on the US dollar for nearly nine months. To the degree that the dollar weakened in response to the credit crunch and because of aggressive Fed easing since the beginning of the credit crisis last August, it stands to reason that a pause in the Fed’s casing cycle could strengthen the dollar and by extension pressure gold. The possibility that the rate cutting cycle is not yet over weakens the dollar and boosts gold prices. The Fed, by leaving open the option of cutting rates in June, has removed a plank in the recent gold sell off. That being said, the Fed did at least hint of the possibility that it would pause its rate cutting.

HSBC currency analyst, Bob Lynch, points out two factors that support the notion that the Fed is willing to pause in its rate cutting. First, despite the improvement in core inflation the Fed stated that commodity prices are very high and are boosting inflationary expectations. Second, the Fed removed the “downside risks to growth” warning, which had been in several previous statements, from the clause pertaining to the Fed’s commitment to maintaining growth and price stability. That leads Mr. Lynch to conclude that unless the economy or financial markets perform even worse than expected, the market will see the Fed as being on hold, at least for now.

What does this mean for gold prices? Despite the fact that the Fed statement is rather ambiguous and that the dollar weakened on its release, HSBC currency analysts do not necessarily view the statement as bearish for the dollar and therefore is not necessarily bullish for gold, despite the initial bullion rally.

The prospect of higher inflation, particularly from higher oil and food prices, as it elicits a policy response from the US Federal Reserve may be pushing gold prices lower. Christian Noyer, a European Central Bank governor, said on 12 May that a mix of soaring commodity prices and “permissive” monetary policy in some countries with dollar pegs could trigger an inflationary spiral that would hurt poor nations most.

These comments were similar to HSBC chief economist Stephen King’s view that easy US monetary policies are stoking inflationary pressures in countries that maintain a link to the USD. Also on the theme of inflation, San Francisco Fed President, Janet Yellen said on 13 May that a return to 1970s style inflation was unacceptable to the Fed. Gold prices reached their highs in real terms during stagflation in January 1980, hitting a high of USD 850/oz or USD 2,000/oz in inflation adjusted terms. Looked at another way, if the economic conditions that ushered in record-high gold prices in 1980 are not allowed to take root now, and according to Janet Yellen, they will not, then we believe that gold prices will not revisit those levels, either.

Perceived changes in Fed posture can have a significant impact on gold prices. Within a relatively short time span, it appears the Fed has gone from an accommodative policy to a signaled pause issued at the time of the last Fed rate cut, to the prospect of tightening, as alluded to by Fed President Yellen, as a way to head off commodity price increases. In the same time span, gold has tended to weaken, moving down from its recent highs above $1000/oz to drop below $900/oz.

A tighter monetary policy may not impact commodity prices, but is likely to affect gold prices. Studies of commodity cycles tend to show that monetary policy is often not particularly effective in constraining commodity price increases, partly because commodity prices tend to be impacted by physical events. Oil prices, for example, are likely to be more dependent on OPEC policy than Fed interest-rate action. Gold prices, by comparison with other commodities, are highly sensitive to changes in monetary policy. Gold is not just a simple hedge against inflation; gold prices also react to the monetary response to inflation. Thus, gold prices tend to weaken even during period of moderate inflation if investors perceive monetary policy as inflationary. Conversely, gold prices may decline even if headline inflation looks to be rising, if investors perceive that monetary authorities are ready to respond to inflationary pressures and tighten policy. Fed President Yellen’s comments, plus Fed futures now pricing in their first expectations of higher rates in many months and the jump in bond yields, all bode negatively for gold.

What we find especially interesting, with possible ramifications for gold prices going forward, is a report by the World Trade organization that showed a sharp decline in the rate of world trade growth in 2007 and the expectation this will slow further this year, as financial turmoil and rising commodity prices further depress global economic activity. Based on International Monetary Fund and WTO forecasts, world trade growth could slow to 4.5% this year from 5.5% in 2007 and 8.5% in 2006. The WTO’s chief economist, Patrick Low, said that turmoil in the credit markets and weaker economic activity are taking a toll on world trade, and that trade growth could be much lower this year than the current forecast.

What has this to do with gold? Periods of strong trade growth, according to traditional economic theory, are typically periods of increased globalization, higher productivity, reduced trade barriers, relatively harmonious international relations, free flow of capital across borders, and falling inflation. This is because increases in trade usually lower consumer prices as international competition increases. Expanding international trade is generally a function of higher productivity, which also tends to reduce inflation pressures. Furthermore, lower commodity prices usually, but not always, accompany an expansion in trade. Reduced trade growth typically indicates rising international frictions, increased trade barriers, reduced competition, higher commodity prices, and higher inflation. These factors are typically supportive of gold prices.

 

 

SILVER

In the first three months of 2008 India did not import a single kilogram of silver because of high prices. Banks had about 580 tonnes of silver ordered by Indian traders lying with them for six months, but deliveries were not taken as

prices of local scrap silver were cheaper. Efforts were on to re-export the unsold silver stocks, but prices needed to climb by about another 10% internationally from the current level in order to make that viable. India re-exported 65 to 70 tonnes of silver in the first three months of 2008. India’s total annual silver consumption is estimated at about 3000 tonnes, of which jewelry accounts for about 20% to 30%. Industry uses most of the rest.

The silver exchange-traded fund, iShares, according to the latest data, increased by 1.6 moz to 189.1 moz on May1, despite recent price weakness. Further off-take would likely bolster prices, as this would signal an increase in investor confidence. Interestingly to us, unlike gold, the iShares ETF has not experienced any significant redemptions in the recent sell-off.

 

GOLD

India’s gold imports in the year to March 2008 fell 23.4% from the year before to 592 tonnes as international prices soared. Suresh Hundia, president of the Bombay Bullion Association, said imports in March halved to 27 tonnes from a year ago as buyers stayed away despite a slight drop in prices. “If prices decline further, we may at best see a slight increase in demand and reach the April to June 2006 levels,” he said. India, the world’s largest gold consumer, annually imports between 700 tonnes to 800 tonnes. But the surge in prices has prompted people to sell their old gold jewelry to cash in on profits. “Recycling has increased by 50% to take advantage of the price rise,” Hundia said. The country recycles about 200 tonnes of gold every year. He expected [gold] demand to pick up only if gold prices fell to $750 to $850 an ounce.

South African gold production has dropped 28.2% in the year from February last year, official data showed. Gold production after seasonal adjustment fell 11.1% in the three months to end with February, with February recording a decrease of 7.7% alone. South Africa’s data shows that gold’s continuing production decline helped pull overall mining output lower. Actual total mining production for February 2008 decreased by 7.3% compared with February 2007, and after seasonal adjustment, total mining production for the three months from December 2007 to February 2008 decreased by 5.2% compared with the previous three months. “The major contributors to the decrease of 5.2% were the production of platinum group metals (PGMs) (-2.3 percentage points) gold (-1.5 percentage points) and diamonds (-1.5 percentage points),” said Statistics South Africa. Shorter-term seasonally adjusted gold sales were, however, up 16.1% at R3.1 billion from December last year to January this year as the gold price rallied to record highs of over $1000 an ounce.

The “once-off” sale of 403 tonnes of gold by the International Monetary Fund to bolster its funds is more than likely to go ahead and is not seen to have much impact on the global gold market, said GFMS chairman, Philip Klapwijk. The IMF, in a well telegraphed move, said it was selling the gold to create an endowment with the profits from the sale, which would be held in a “transparent manner with strong safeguards to ensure they do not add to official sales and avoid a risk of market disruption ,” said managing director Dominique Strauss-Kahn. The gold price barely twitched on the news. Klapwijk continued, “Given that it’s going to be spread over a number of years and the market is used to 500 tonnes or so coming from Central Bank Gold Agreement countries every year, this is not a major dent to sentiment as we can see by the price reaction.”

An important factor accompanying the most recent decline in gold prices is the falloff in gold Exchange Traded Fund demand. The combined World Council sponsored ETFs plus the Barclays iShares comprise the vast bulk of ETF gold holdings globally, and reached a peak of combined off-take of 890 tonnes of gold bullion on 13 March of this year. In just six weeks, the figure has dropped to 805 tonnes as of 30 April. Such steep redemptions in the heretofore firm ETF, should it signal a change in sentiment, may imply further gold losses.

PLATINUM/PALLADIUM

PGM prices fell especially hard at the end of April. In addition to the inherent thinness of the market which often contributes to severe price swings, the platinum and palladium markets may also be impacted by poor US auto sales figures. US auto sales have dropped sharply in recent months, with the latest data for March showing a continuation of this downtrend. Standard & Poor’s in a recent report, estimates US sales will keep sliding, due to US economic problems and the rising cost of fuel for the rest of the year.

While sales outside the US appear steady with continued growth in China, the world’s number two auto market, the weakness in the US is even greater than estimated just a few months ago. GM expects total China car sales to rise about 16% in 2008, after climbing to 6.3 million units in 2007 with the whole auto market, including trucks and buses, to reach 10 million units this year. Thus increases in Chinese demand will largely if not entirely offset losses in the US.

While it is too early to tell with any great precision what impact the downturn in US vehicle sales will have on auto production and hence PGM demand for 2008, the poor showing in the US is weighing on production globally. That being said, the underlying platinum market supply/demand fundamentals remain tight in our view, even assuming a decline in US auto demand and some demand destruction in the jewelry market due to high prices. This is primarily because problems in electricity generation and distribution in South Africa have not been resolved, and furthermore, stands a good chance of negatively impacting mine output further this year. Thus, we believe that while further near term price declines in platinum are entirely possible, platinum prices are likely to recover.

Platinum prices jumped to a two-month high on concern that supplies may fall short of demand as production declines in South Africa, the world’s biggest producer of the metal. Palladium also rose. Power failures have hampered mine output in South Africa, and production in the country may drop 10 to 15 percent this year, RBC Capital markets analyst, Leon Esterhuizen said. Platinum has surged 61% in the past 12 months. The metal is used in jewelry and pollution-control devices in cars. “Given platinum’s strong fundamental backdrop, we maintain a positive outlook for platinum prices,” Barclays Capital said in a report.

Prices have more than doubled in the past three years as demand outpaced supply. Consumption will exceed production by at least 400,000 ounces this year. This year platinum may reach $3000 an ounce “easily” said RBC’s Esterhuizen.