Rust Rare Coin, Inc. January, 2009

PRICE TRENDS (New York closes)

IN OUR OPINION. . . .

We hope you all had a wonderful holiday season. As we start the New Year many challenges still face us—both with the dollar and with the world economy. There will be many changes coming with the new president. We will all be watching with interest as to what those changes will be and how they will affect us each individually. It is safe to say that those who have diversified their portfolio with a portion of hard assets have weathered this storm much better than those who did not.

The premiums on bullion items are still significant, and even though we are seeing some slight easing in those premiums, availability of product still remains tight. We feel that the markets in 2009 will still remain very volatile. The current pressures on mining we feel will affect the market supplies, in some cases, significantly.

We continue to remind you to properly structure your portfolio. Get yourself better balanced in 2009. We look forward to serving you and helping you understand the changes in the market as we go through this recessionary period.

MARKET FOCUS, EMERGING TRENDS

James Steel, Analyst, HSBC Global Research

Gold prices recovered from an early sell-off. A gradual comeback by the EUR following early weakness helped push gold higher. Gold also was supported by a continuing rally by the base metals. Weakness in US bond prices signaled a revival in investor risk appetite, according to the financial media, including Reuters, and this helped support gold prices, in our opinion. Discussion in the capital markets about the likelihood of an even greater-than-anticipated US fiscal stimulus program by the incoming Obama administration triggered concerns about issuance of more government debt, according to news services, including the Financial Times. Investors who were willing to increase their risk tolerance shied away from buying US Treasuries and turned to gold. Newly released minutes of the last Federal Open Market Committee meeting showed that the Federal Reserve policy makers perceived a significant risk that inflation would decline and remain at low levels for the medium term. The perception that inflation would remain low may have helped raise investors’ risk tolerance. A continuing rally by base metals also lent support to the notion that commodity prices had become oversold, which also helped support gold prices, we believe. In our view, deflationary pressures in both developed and emerging economies have the power to undermine gold prices.

Euro-zone inflation has dropped to its lowest levels in more than two years. Annual inflation in the euro zone fell from 2.1% in November to 1.6% in December, according to an early estimate by Eurostate, the European Union’s statistical office. Reuters, Bloomberg, and other financial media commented that the drop in inflation theoretically gives the European Central Bank plenty of latitude to cut interest rates, should it wish to do so. The prospect that inflation may fall further in the euro zone is taken seriously by policy makers.

An ECB governing council member, Vitor Constancio, said the bank should cut interest rates pre-emptively to avoid having inflation fall far below 2%. According to a Reuters news report, Mr. Constanciao said that European governments need to use budget policies to boost demand. He said he did not expect Europe to enter into outright deflation or depression. Although Mr. Constancio rejected the idea that the euro zone will fall into deflation, he was nonetheless mindful of the likelihood of falling inflation. Falling inflation rates, according to traditional monetary theory are a negative for gold prices.

Gold may also come under selling pressure by funds that track the commodity indices. The Dow Jones-AIG Commodity Index and the S&P GSCI Commodity Index are due to reweight their commodity indices this month. Market chatter implies that both may lower their gold weightings, which could trigger bullion sales by the funds tracking the indices. The reweighting of the Dow Jones-AIG Commodity Index will run from 9-15 January. The S&P GSCI Commodity Index will rebalance its index between 8 and 14 January.

China is the second largest auto market in the world and until the middle of last year, robust demand acted as a counterweight to the decline in auto sales in North America and elsewhere. Platinum group metals (PGMs) were supported by news that the Chinese government plans to support its domestic auto industry. Government policy is to maintain a 10% average growth rate in auto sales this year. However, officials at the China Association of Automobile Manufacturers are on record as saying that without government support in the form of lower sales taxes on autos, a 10% growth rate is unlikely this year. Bloomberg reported that the State Council is expected to announce reductions in car sales taxes, as well as incentives for development of clean-fuel cars. Chinese passenger car sales in November fell 12% from a year earlier, according to the Chinese Automotive Association; this marked a sharp decline from a 20% year-over-year sales increase in January 2008. JD Power and Associates, an auto consultancy, said it is still predicting that passenger car sales in China this year will be flat at 5.8m units. Data from the China Association of Automobile Manufacturers showed Chinese auto demand had its weakest growth rate in a decade in 2008, increasing just 7.3%. (The year started off in January 2008 with sales in excess of 20% year-on-year.) Preliminary figures for December show an 8% year–on-year decline in sales.

The gloomy outlook for auto sales is a negative for both platinum and palladium demand and helps explain recent price weakness, we believe. Without a recovery in Chinese demand, the PGMs will be hard pressed to rally. In years past, the tone of the Detroit Auto Show, which has just opened, gave an indication of North American auto sales. This year, according to PricewaterhouseCoopers’ Automotive Institute in Detroit, the number of new models is down from last year, with the emphasis on green technology and lighter, more fuel efficient vehicles. This implies reduced PGM demand for autocatalysts.

We believe the fact that the Fed is contemplating adopting inflation targeting is a signal of the growing deflation risk. Deflation fears help explain the decline in gold prices since the beginning of the year. Core inflation has dropped from a growth rate of over 2% year-on-year at the beginning of 2008, to below 0.5% year-on-year, by end-2008. Furthermore, a number of recent consumer and business surveys, as well as the shape of the yield curve, imply falling inflationary expectations. The Fed has made no announcement on changing to inflation targeting and for as long as the current deflationary psychology persists, gold is likely to remain under pressure. Should the Fed change its longstanding policy and adopt inflation targeting, however, we would expect the ensuing commitment by the Fed to raise inflation to also support gold prices.

At the annual Bank of International Settlements meeting, Jean Claude Trichet, the European Central Bank President, who chaired talks on the world economy said the central bankers of the world’s major economies look forward to a recovery in 2010 based on low oil prices, increased government spending and accommodative monetary policies. The global economy would likely remain under strain this year, he said. This supports our view that sluggish global economic activity and the threat of deflation will make it difficult for gold prices to rally this year.

The decline in commodity prices is deflationary and bearish for gold prices. Oil prices fell despite the fact that OPEC still contracted 400,000 barrels per day in December. The cartel is actively reducing production, and for the first time in many quarters, it is producing at quota levels. OPEC is due to cut output further this month by 2.2 million barrels per day, starting January 1 according to the December agreement. Saudi Arabia, according to an article in Reuters, may even produce below quota in a bid to rally prices. The persistence of weak oil prices is evidence of a slowing global economy and deflation and is therefore negative for gold, we believe.

The discouraging employment release helped drag oil prices lower, according to Bloomberg. Another potential source of weakness for gold is oil prices. Should oil prices fall further, the deflationary implications may begin to weigh on gold, we believe.

President elect Barack Obama has called for Congress to pass his spending program swiftly. This by definition would increase the supply of government debt issues considerably and play a part in USD weakness, according to Reuters, and therefore gold’s strength. Calls for even greater government spending, should they occur, may boost gold in the short term, we believe.

 

SILVER

Silver prices are expected to rally in the short term as investor interest returns, according to Philip Klapwijk, Chairman of GFMS Limited. Speaking in November at the annual New York Silver Dinner, Klapwijk presented GFMS’s Interim Silver Market Review. Highlights of the Review include:

• Fabrication demand is projected to rise 1% this year. For jewelry, many consumers are buying silver at gold’s expense. Indian demand has also surged in recent months on lower local silver prices.
• Mine production is forecast to rise about 5 million ounces (171 tons) or just under 1% this year.
• Increasing mine supply should be offset by lower scrap supply and government sales.
• A rebound in investment is expected within the next few months in contrast to a weaker 2007 and should drive the silver price higher again. Demand for silver backed ETFs and, especially, bullion coins has grown.

For the first ten months of 2008, the silver price averaged $15.93, up 21% year-on-year, and will remain volatile in 2009.

Mine production remains by far the largest component of silver supply, normally accounting for around two-thirds of the total (last year was higher at 75%). However, mine production is not the sole source; the others being scrap, disinvestment, government sales and producer hedging.

“Old” scrap is the silver that returns to the market when recovered from manufactured goods. This could include old jewelry, photographic chemicals, even discarded computers. However, it excludes silver that is returned untransformed by the manufacturing process or that never becomes an end product—so called “process scrap”. Old scrap normally makes up a little over a fifth of total supply.

Disinvestment and government sales are similar in that both comprise the return to the market of old bars and coins by the private sector and governments. These sources may not add to supply every year on a net basis. In some years, individuals have been net investors (as was the case in 2007) and governments have been net buyers.

The final, though normally minor, component of supply is producer hedging or the early sale by mining companies of future production. Hedging may also not appear every year on the supply side on a net basis as it can form part of demand as de-hedging (as occurred last year).

GOLD

After briefly testing levels of above $US$950/oz early in the quarter, the gold price fell back to levels of under $800/oz. Nevertheless the average for the quarter, at $872/oz, was 28% higher than Q3 2007’s $680/oz, reflecting an acceptance by consumers of a higher price floor.

Dollar demand for gold reached an all time quarterly record of US$32 billion in the third quarter of 2008 as investors around the world sought refuge from the global financial meltdown, and jewelry buyers returned to the market in droves on a lower gold price. This figure was 45% higher than the previous record in Q2 2008. Tonnage demand was also 18% higher than a year earlier

Identifiable investment demand, which incorporates demand for gold through exchange traded funds and bars and coins, was the biggest contributor to overall demand during the quarter, up to US$10.7 billion (382 tonnes), double year earlier levels, according to Gold Demand Trends, released by the World Gold Council.

The figures, compiled independently for WGC by GFMS Limited, show retail investment demand rose 121% to 232 tones in Q3 with strong bar and coin buying reported in Swiss, German and US markets. The quarter also witnessed widespread reports of gold shortages among bullion dealers across the globe as investors searched for a haven. Overall, Q3 saw Europe reach an all time record 51 tonnes of bar and coin buying and France became a net investor in gold for the first time since the early 1980s.

Gold ETFs enjoyed a record quarterly inflow of 150 tonnes in Q3 boosted by extreme levels of economic and financial uncertainty. The peak in inflows occurred in late September, triggered by the collapse of Lehman Brothers and a fear of banking sector failures. Net inflows surged by an unprecedented 111 tonnes during 5 consecutive trading days, equivalent to US$7bn. However, it was net retail investment that drove the improvement in identifiable investment demand, enjoying a 127.0 tonne improvement from 105.1 tonnes to 232.1 tonnes (121%).

As the financial crisis deepened these increases in identifiable investment demand were offset by outflows in “inferred investment.” This was characterized by hedge funds liquidating investment positions in gold as they were forced to raise cash and by institutions liquidating commodity index investments, including gold, as fears of recession deepened. The trend largely reflects gold’s better performance relative to other assets and also explains why the gold price did not perform better during the quarter in the face of very strong demand.

Q3 saw a record US$18bn of consumer demand for gold jewelry with buyers returning to the market on lower price points, around and below US$800, demonstrating the underlying positive sentiment towards gold and its recognition as a store of value. The biggest contributor to the positive trend was India which witnessed a rise of 65% in US$ value or 40 tonnes relative to previous year levels, with the Middle East, Indonesia and China all enjoying rises of more than 40% in value or 10% in tonnage There were however, strong declines in Western markets with the US down 9% in value and 29% in tonnes, and the UK down 5% in value and 26% in tonnes due to the overall decline in the retail market.

James E. Burton, Chief Executive Officer of World Gold Council, commented:

“Gold’s universal role as a store of value has shone through during this quarter helping attract investors and consumers to all forms of gold ownership. The rise in demand for gold bars and coins has been impressive as has the record rise in gold ETF inflows. Perhaps most encouraging is the return to positive jewelry buying which has been absent for several quarters due to the high levels of price volatility.

“Looking forward, given the uncertainty that surrounds the global economy, gold’s safe haven appeal should continue, but so too will the possibility of heightened levels of activity in the speculative side of the gold market, therefore it is too soon to call an end to market volatility.”

Despite a deteriorating global and domestic economic climate, demand in India, the largest market for gold demand, recovered during the third quarter, encouraged by lower gold prices, a good monsoon and the onset of the festive season. At 250 tonnes, total consumer demand was 31% higher than Q3 2007 levels. In value terms demand hit the record quarterly sum of US $5bn.

Demand in Greater China rose 18% to 109 tonnes, the majority of this increase attributable to a strong rise in demand in mainland China.

Jewelry demand in the Middle East, which accounts for more than 90% of total consumer offtake in the region, rebounded in Q3 with tonnage demand up 15% on Q3 2007 and up 47% in dollar terms, hitting a new record of US$2.8bn.

Retail investment demand, while relatively small in size at 7 tonnes, recorded strong growth of 23%, and 57% in dollar terms. In Turkey total Q3 offtake, at 99 tonnes, was up 15% on the levels of a year earlier, with investment demand smashing all previous records to reach 31.7 tonnes.

Industrial and dental demand declined to 104 tones during the quarter 11% down on year-earlier levels. Electronics, the largest component of industrial demand, was hampered by the downturn in the global economy and a lack of confidence within world markets.

Gold supply was down 9.7% on year-earlier levels, largely driven by a significant reduction in central bank sales. Sales under the Central Bank Gold Agreement (CBGA) totaled a provisionally 357 tonnes in the CBGA year ending September 26, the lowest annual figure since the first Agreement was signed in 1999.

PLATINUM

Platinum and palladium fell in New York on concern that demand for the metals from jewelers, carmakers and other users will decline further after December US retail sales dropped twice as much as forecast. Retail sales sank 2.7% from November, a record sixth straight monthly drop. Purchases excluding automobiles slumped 3.1%, and sales for the year slipped 0.1%, the first decline since at least 1992. Most platinum and palladium is consumed in making jewelry and catalytic converters for cars and trucks.