Rust Rare Coin, Inc. July/August, 2008

PRICE TRENDS

IN OUR OPINION. . . .

The continuing volatile markets that we have seen this year feel more like a roller coaster ride than a commodity chart. On a global perspective there is more and more interest in precious metals. Countries that have long been considered “second world” are becoming players in the international market. For example, China’s economy is expanding, demanding more resources as well as investment opportunities. The Middle East is expanding its metals trading. The probability of India bringing ETFs to that region of the world will only add to the demand and the volatility. Then mix in current global economic and political issues. It shouldn’t be too surprising that we see an extremely active precious metals market.

We feel that fundamentally, metals are still very sound and on an upward trend. However, be aware that in the last few months when commodities have become top-heavy the profit-taking seems to have been greater that we have seen in years past. As long as you are aware of the dips, buying opportunities can be very promising. However, I would advise not watching the market every single day. It could drive you crazy!

MARKET FOCUS, EMERGING TRENDS

James Steel, Analyst, HSBC Global Research

Gold and the other precious metals pushed higher, supported by a weaker US dollar, higher oil prices, and jittery financial markets. The lack of any tangible progress in talks between Iran and six major Western powers, which ended with no agreement, also supported gold prices. US Secretary of State, Condoleeza Rice, said Iran should end its program of nuclear enrichment or face sanctions. UK Prime Minister, Gordon Brown, stated that the UK was determined not to let Iran develop nuclear arms technology. Iran’s top nuclear negotiator, Saeed Jalili, said at the next meeting Iran would not discuss the demand to freeze its sensitive atomic work. A senior but unnamed Iranian official said Iran was ready to respond to any positive US overture but it was unclear whether Washington had decided between diplomacy and force, according to Reuters. Geopolitical concerns supported oil prices and by extension gold prices.

News that some rigs in the Gulf of Mexico had been evacuated as hurricane Dolly approached oil-producing regions of the Gulf further supported oil prices. Should Dolly disrupt oil production and possibly affect land-based refining operations, oil prices could rise and support gold prices also.

Gold has been consistently supported, since last August by financial market concerns. News that American Express had missed earnings estimates by a wider than expected margin, triggered renewed financial market worries, increased investor risk concern and spawned safe haven buying of gold. The prospect of more financial market weakness to come could support gold prices further.

 

SILVER

Benchmark Asset Management plans to launch India’s first exchange traded fund (ETF) tracking silver as part of a strategy to expand its bouquet of passively managed funds. The fund will invest in international silver-backed ETFs. Indian regulations restrict mutual funds from investing in commodities other than gold. But they can invest in global funds tracking any commodity, a path that Benchmark hopes to follow. The fund house filed initial papers with the Securities and Exchange Board of India to launch Silver Benchmark Exchange Traded scheme which will invest at least 90% of its assets in units of overseas mutual funds tracking silver.

 

GOLD

Data out on Monday, July 7 shows a near implosion in Indian gold demand--further evidence that high prices are inhibiting jewelry demand. Customs data showed Indian gold imports in June fell 67.6% year-on-year. Preliminary estimates indicate that India imported 24t of gold in June against 74t a year earlier, said Suresh Hundia, president of Bombay Bullion Association. The monsoon could be a factor in gold demand in the months ahead, Mr. Hundia stated. Traditionally, a good monsoon and bountiful harvest raises income in India’s large agricultural sector, which translates into increased gold demand. Indian gold demand has been weak all year. India imported 131.9t of gold in the first six months of the year against 374t a year earlier. In most recent years, India has accounted for at least 20% of world gold consumption; therefore a pronounced decline in Indian demand could undermine global bullion demand. The rupee has weakened in recent months adding to gold prices in local currency terms. Gold in rupee terms is now close to price levels last seen in March when gold went to USD 1,030/oz. The decline in imports may not entirely reflect lower jewelry demand. Some of the domestic demand for jewelry may be filled by an increase in domestic recycling. High prices may be tempting holders of scrap to dispose of “old gold” and thus add to local supply and do away with the need to import bullion. Eroding physical demand in India as well as other emerging and developed nations will make it increasingly difficult for gold to sustain rallies beyond current prices.

The World Gold Council has issued a paper indicating that the signatories of the Central Bank Gold Agreement have so far sold 297t of the 500t allowed under the agreement in the year up to 26 September. With only a couple of months left to go in the agreement, the signatories have only sold 60% of their allocation. This reluctance of central banks to sell their full quota is also supportive of gold prices.

PLATINUM

We do not believe the sell off in platinum is fully consistent with the underlying fundamentals. It is possible that recent poor US auto sales figures have undermined the investment demand for platinum. The outlook for global auto demand, despite weakness in the US, remains positive, according to HSBC auto analysts, with increased demand in East Asia, India and the Middle East likely to boost auto vehicle sales and production this year. While a further sell off in platinum prices is possible near term, platinum is likely to recover.

 

CPM Group has recently published its annual review of the platinum group metals markets and concludes that in 2008 the balance between newly refined platinum supplies and fabrication demand is likely to show a reduced surplus of 32,000 ounces this year, down from 358,000 ounces in 2007 and 777,000 ounces in 2006. When coin fabrication is taken into account then this drops to 12,000 ounces, down from 338,000 ounces and 754,000 ounces in 2007 and 2006 respectively.

This, as the group puts it, leaves “no new metal for investors” [which by definition would include coin purchases], although the survey goes on to assert that “Investors are not passive agents in these markets, however, sopping up what fabricators leave for them.” Investors have already added another 202,126 ounces to their ETF platinum holdings in the first four months of this year, along with a couple of thousand ounces in platinum coins and an unknown quantity of physical platinum purchased in over the counter market. This has been a key fact driving prices to their recent high; these trends should be expected to continue over the course of 2008.

On the supply side, CPM is one of the more confident market observers with respect to the impact of power supply problems in South Africa on domestic platinum production this year. The group is looking for a potential decline of 3.3% or 168,000 ounces over the year as a whole, due largely to the problems in the power industry, noting that while some observers are looking for falls of up to 10-12%, the miners themselves have stated that they expect to recoup most of the first-quarter losses over the remainder of the year. This is clearly a matter of some debate within the industry – only time will tell.

While power supply is running at more or less 95% of capacity, the miners have been trying to improve their efficiencies and to turn their operations at close to 100% of the rate at which they were operating when power supplies were at full capacity. Some companies, however, are still reporting that power supplies have not been consistent, and some companies “have and are working to set up their own power generation units.”

On a broader scale within the supply side, CPM points out that of the estimated $10 billion that were allocated in 2007 for exploration expenditures (this figure from Metals Economic Group), just 3% or $299.7 million went towards platinum exploration. The global increase in exploration and mining activity across metals has “led to a scarcity of qualified personnel [and equipment] in all areas of the mining industry.” This is already affecting existing mining operations and the position is expected to worsen in the future. The problem with equipment is hampering exploration and development projects, while costs have increased. The group suggests that mining projects across the board will be under considerable stress over the next several years as a result of intense competition for the necessary infrastructure – be it human or inanimate.

Refined supplies of platinum to the market are projected to fall by 1.4% this year by 109,000 ounces to 7.32 million ounces, with the bulk of the decline coming from South Africa, along with a small decline from Russia. North American output is expected to rise (with this increase to accelerate in 2009 as a result of increased by-product supply for new base metal operations). Secondary supply accounted for 920,000 ounces last year, a 7% increase over 2006, while this year this component could rise by over 8% to a million ounces.

Fabrication demand, by contrast, continues to rise with the global auto production and sales running strong in 2008 which leads to increased usage in emission control catalysts, as well as demand in petroleum refining catalysts. Despite further forecast shrinkage in jewelry demand (albeit a small fall); fabrication demand is expected to grow by 3.2% this year to 7.29 million ounces. The strongest growth is likely to come from chemical and petroleum refining catalysts, which are expected to score a 9.8% increase this year while emission control catalysts are expected to absorb 4% more platinum than they did last year. Jewelry use is expected to fall by almost 6%.

The survey states the fact that platinum end-users have been seeking substitutes for several years by virtue of platinum’s cost and that fabricators have been looking to minimize its use because it is an expensive metal to work with. It is thought possible that the current rise in prices may pressure some of the more price-sensitive consumers out of the market, but the bulk of platinum demand is relatively price-inelastic, especially given that catalysts, which take up approximately 65% of platinum usage, have only limited scope for substitution.

While platinum demand is at risk in several of its uses, none of the potential threats are likely to have any material impact on platinum demand, at least over the short to medium term.

This backdrop sets the scene for the activity in the investment market. CPM suggests that while the supportive underlying fundamentals have definitely contributed to the upward pressure on prices, “it may be investor buying that has had the greatest effect.” Investor attitudes towards platinum have been changing since 2005 and this has made the market relatively more liquid; consequently there is increased investor interest in holding the metals, as well as the fact that commodities as a whole have been receiving increased attention from the investor community. The group estimates that investors, largely institutions, have spent more that $2.2 billion in the platinum bullion market over the past four years.