Gold Investing Handbook

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Mourtaza Asad-Syed
To Gabrielle, David and Sarah, my three golden nuggets.
Mourtaza Asad-Syed
Foreword
Writing a book on gold in 2014 feels like writing Dow 36000!

in 2001 after the market had crashed. Of course, market moves
during the past decade provided a strong motive to look in detail
at the barbaric relic, remove misconceptions and present the
analysis to a large audience. Rather, the genesis of this treatise
traces back to a discussion in 2009 between an Indian-born economic geologist and a Swiss-based investment strategist. Simply
put, a gathering of a father and his son.
The love for gold has been universal except with economists. It
has appealed to human beings irrespective of their origin, color,
race, religion, and sex. This book does not provide any justification for the use or the value of gold; the study here, rather gives
an understanding as to role of gold in society and focuses in how
its price is set, even if it often generates seemingly irrational behavior. Indeed, irrational behavior is often denounced by the
economists, who tend to see gold as being useless and unproductive, creating no value, generating no income and even being
simply barbaric. We believe and will demonstrate that there is
much more value in gold, which might be one of the very last,
rationally priced financial assets.
We took pleasure in bringing a unique perspective on gold investing. Indeed, this work should contrast with many existing
books relating to gold investing, because
It presents an analytical framework for gold valuation,
It details winning investment strategies, and
It keeps a non-US centric international perspective.
On the contrary, most common approaches are done for USbased investors with a pure USD reference, and they often fail to
rationalize gold investing into a testable framework. As a result,
gold prices are explained by anecdotal and un-testable random
factors such as psychology, one-time events, chartist techniques,
etc. This lack of rigor in the field of gold investing has open a void
Mourtaza Asad-Syed
Gold investing handbook
for dubious rationale, most often flirting with conspiracy theories, which in the end absurdly justifies purchasing gold at any
prices...
This book is presented in four distinct sections. The first part
presents the context of rising global liabilities that questions the
resilience of traditional safe assets and highlights the current
relevance of gold investing. In short, slow-to-moderate growth is
largely supported by active public policies, generating large public deficits and negative real rates from easy monetary policies.
By itself this backdrop is conducive to a medium term appreciation of gold. Moreover, there are growing tail risks when considering all options. Indeed, it is also possible that governments
will renege on their obligations. With the risk of being provocative there is a distinct possibility that the US Treasury could default1 towards foreign creditors in the coming decades, with gold
an undisputed hedge against it.
The second section explains the dynamics of gold prices. Gold
prices are set simultaneously on three separate markets:
1. The commodity market,
2. The currency market, and
3. The financial assets market, because its value is also defined as an asset relative to main asset classes.
We believe that the currency market matters the most because
gold is first and foremost a mean of exchange and a store of
value, which lends credence to John-Pierpont Morgans blunt
view that Gold is money, the rest is credit!
The third section of the book is pragmatic, focusing on investment opportunities derived from this unique asset. Practical examples of successful investing are presented with simple
prediction-free frameworks for asset allocation, tactical, trading
and relative value investments. Then, major instruments for gold
investing are listed and it concludes with a professional investors perspective.
The fourth and last section of the book is mostly descriptive
and deals with the characteristics of gold. Gold is defined and described here from multiple angles: metallic, mineralogical, geologic, historic, social, economic and financial, enumerating its
1
Defaults is here be defined as the failure to meet the legal obligations and/or conditions of a loan, nor the failure of a government to repay its debt
Mourtaza Asad-Syed

conventional and modern day uses. The numerous facets of gold
help understand its place in society through time and geographies with some amazing facts.
The author sincerely hopes that amateur geologists, journalists,
economists, analysts, traders, portfolio managers, institutional
investors, retail investors and men and women fancying gold,
should all find their subject of interest in some part of this work.
To close, here is the best definition of gold: An ounce of which
provides a perpetual and universal insurance to acquire a year of
subsistence.
Mourtaza Asad-Syed
Content
Mourtaza Asad-Syed
1. Gold in a world of liabilities
Golds ability to protect wealth from government confiscation

or spoliation makes it imperative to examine gold investing
over the next ten years. During the past ten years, gold rallied
against major currencies as real rates declined and remained
low. Given current levels, real rates cannot go much lower, and
hence cannot provide support to a gold rally of similar magnitude as in the past decade. While gold has declined in 2013 by
26 percent and may not have strong absolute performance
ahead, we nonetheless see potential for gold to perform well
against OECD government bonds. In the coming ten years, excess public debt in the Eurozone, Japan, the UK and the US will
translate into capital losses on private savings. Indeed, the only
feasible end game for public debt sustainability is a forced
transfer of the capital loss burden to households or to foreigners.
Gold investing is often anchored on distrust of government, because governments abuse their right to print money. Currently,
economists are worried about deflation, but many long-term investors are already speculating on inflation or even hyperinflation, and while these are legitimate risks, a savvy investor needs
to consider another risk that has not been highlighted in previous discussions: Spoliation! Namely, the effective plundering of
foreign holders of US assets and European pensioners! The starting point of these man-made-disasters is the dire state of OECD
public finances. Indeed, the state of public finance and the foreseeable patterns for government liabilities are unsustainable
around the globe, and this imbalance clearly opens the door for
unorthodox policies that could well impair investors.
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11
Dire public finances in the Eurozone, Japan, the UK

and the US
Following the credit crisis of 2008, public debt across the OECD
expanded massively to substitute for private sector deleveraging
in an attempt to soften the economic recession. This would be
sound policy if public finances were not already impaired by offbalance sheet unfunded liabilities caused by pension obligations
and other benefits (such as health coverage) for a cohort that is
benefiting from an unprecedented increase in life expectancy,
not offset by adequate population growth. Given the severely impacted public finance situation, adding additional debt is effectively kicking the can down the road to a future generation.
There are three ways for the government to reverse the course
of the public debt spiral:
A growth strategy: Induce growth to dilute the debt-toGDP ratio with higher revenues,
A monetary erosion/inflation strategy: Create inflation,
to erode the nominal value of existing debt
A write-off/default strategy: Use default or restructuring
to cancel or reduce the obligations promised either to its
citizens or foreign creditors
So far, Anglo-Saxon countries, chiefly the US, are aiming at the
growth strategy, pushing for a super easy policy-mix.(i.e. fiscal and
monetary policies) Continental Europe is pushing peripheral Euro
countries to default on obligations to their citizens in the form of
austerity policies that reduce the benefits received by citizens. No
explicit strategy was discernible for Japan, until the recent change in
Bank of Japan (BOJ) leadership and Prime Minister Abes economic
program that one might broadly categorize as their pursing a credible
growth or even an inflation strategy.
Growth strategy: a risky dream

The growth strategy is the most seductive and the least painful
for citizens, creditors, and politicians. This high return strategy
is also high risk because if it fails, the country is stuck with an
even larger public debt (left by active fiscal policy) and has no
monetary lever left. In the US (and the UK), monetary authorities
have even jumped into vigorous monetization of public debt, in
the name of quantitative easing (QE). Historical experience has
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shown that monetary misconduct is usually perpetrated for fiscal motives and leads to inflation (or hyper-inflation). Once central banks have locked short-term rates at zero percent and
suppressed the entire yield curve below 2%, loaded their balance sheets with Treasury bonds and become recurrent buyers,
and provided commercial banks with immense liquidity facilities for any eligible collateral, it will be very hard for them to reverse course! These actions put overall economic activity at high
risk and threaten the refinancing abilities of their own government. Recently, even an orthodox central bank such as the European Central Bank (ECB) had to reverse course in the wake of
the government debt crisis, and had to decrease rates and even
commit to buying government debt. Interestingly, it was the
ECBs own tight policy in 2008-2011 that worsened Eurozone
peripheral financing conditions and endangered the solvency of
the weakest. In the end, when the solvency of a government is at
stake, notions of central bank independence or restricting them
to a solely inflation mandate is more theoretical than anything
else, and even the ever conservative Germans had to swallow the
broadened mandate of the ECB!
(Hyper) Inflation: a rampant nightmare

We explain below why inflation does not represent a government strategy per se, but could become an unintended consequence if the growth strategy fails.
An inflation strategy is not politically viable. Most of the inflation impact is domestic, especially for a country that is quite
closed, like the US. External impact usually comes in lieu of a decline in exchange rates, but often only over the medium term.
Domestic impact manifests itself either in a price-wage increase
spiral, as rising cost of living can transmit into salary increase or
simply loss of purchasing power when wages fail to match the
inflation increase. Inflation above 5% to 10% is very unpopular,
especially within the older cohorts who have little hope for future wage increases and are focused primarily on maintaining
the standard of living during retirement. Rising or simply high
inflation is among the worst enemies for any political incumbent.
Indeed even more than rising unemployment an inflationary
environment has sealed the fate of most unfortunate political
leaders of the 1970s in the OECD (Carter, Heath, Wilson, Callaghan, Giscard dEstaing, Andreotti), and still dictates the winner in elections in emerging markets, in Latin America
Mourtaza Asad-Syed
13
especially. Within developed countries, only military casualties

have a greater effect on the popular vote2. In most cases, inflation
is associated with impoverishment within the working class because it translates most into relative loss of purchasing power,
and is perceived as a tax, since most blame government action
(or inaction) for any rise in inflation. Any inflationary strategy to
lower a debt overhang would carry high political risk, and would
deter any public leader from pursuing this approach. It is no surprise to see that inflation is lowest in countries where leaders
are more accountable to their people (i.e., the more democratic
regimes). This is quite explicit in Figure 1.1 which demonstrates
average inflation by political regime as defined by The Economist. In 2010, countries with full democracy (Sweden, Norway,
UK) experienced an average inflation of 2.2%, while authoritarian countries (Nigeria, China, Azerbaijan) had on average
7.4% inflation. As a political choice, inflation will not be favored
by any OECD government.
Figure 1.1: Inflation by political regime
7.4
7.1
5.1
2.2
53
33
52
26
Authoritarian
Hybrid regime
Flawed democracy
Full democracy
Average Inflation
Number of countries
Source: The Economist, World Bank, Wikipedia, Authors calculations, Data as of 2011
A burst of inflation will not dilute the debt level as much as

expected. During increasing inflation, even with a lax central
bank that does not increase short rates, the yield curve tends to
2
14
See Bread and Peace model by Douglas Hibbs - University of Gothenberg
Mourtaza Asad-Syed

steepen with rising long-term rates. The term premium then increases, and stays higher for a while, often at least long enough
to match the average public debt maturity, which means that the
entire debt will end up being refinanced at a higher cost. As a
result, during high inflation periods, long-term real rates are
rarely negative and any gain from the dilution of debt by higher
nominal GDP is offset by higher interest rates. Active quantitative easing from central bank could maintain a depressed longterm rate and contain increasing debt service, but this would
need large amount of purchases at the issuance (primary market), which would breach all rules of sound monetary policy, and
open the door for monetization and absolute loss of confidence
in the currency. The other issue with generating such inflation is
the side-effect on agents that have liabilities linked to inflation.
For instance in the US, the Treasury issued USD800 billion of inflation-linked bonds, and these bonds would not benefit from
such policies, but it amounts only to 5% of total debt outstanding. Second, US Social Security has defined benefit obligations to
future pensioners, linked to inflation, worth trillions of dollars
that is guaranteed by the government. The Social Security Trust
Funds current fund is about USD3 trillion (highly invested in
Treasury bonds), which is about 20% of public debt. Therefore
the impact of inflation would be null in terms of reducing the
burden of the government towards the beneficiaries. The private
sector too, has liabilities linked to inflation, which could create
more distress and distortions than it cures. For instance, UK public sector pensioners are protected against inflation, whereas
private sector pensions scheme have inflation caps.
Inflation is not in the DNA of Anglo-Saxon (free-market)
countries. Market-friendly or capitalist countries such as the US
and the UK do not favor inflation for philosophical reasons,
mostly because it usually erodes value for owners of capital and
forces redistribution of wealth, or at least equalization. It can
also be argued that inflation is a consequence of redistribution
policies not the cause. Indeed, social spending and welfare used
to have a high multiplier effect on aggregate demand, which
would lead to upward price pressures. Regardless of causation,
it confirms the notion that inflation is related to a crucial social
and political choice. Historical data displayed in Figure 1.2 (Inflation & income concentration) shows that in the US, inflation
patterns play a significant role in income distribution, second
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15
only to taxation3. As for advanced economies; high inflation has

been experienced more in continental countries, such as Germany, Italy, France and even Japan. It is surprising to see that no
Anglo-Saxon dominions (Australia, Canada, New Zealand, and
South Africa) have experienced hyperinflation or simply very
high inflation, when major European ones have experienced
multiple inflationary bursts. One conclusion from Bernholz
(2003), and highlighted in Figure 1.3, is that hyperinflation happens only in regulated (e.g. centrally planned) economies. Freemarket economies might be prone to financial bubbles, crises
and deflation, but they seem immune to hyperinflation risks.
Figure 1.2: US inflation and income concentration
22
22
20
15
14
13
11
11
10
10
7
5
1
4
3
1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
Top 1% share of national income (%)
Inflation (%, 5-year CAGR)
Source: Piketty & Saez, US Bureau of Economic Analysis, Authors calculations
16
"The Effect of Marginal Tax Rates on Income: A Panel Study of 'Bracket Creep'" Emmanuel Saez, Journal of Public Economics, 87, 2003, 1231-1258
Mourtaza Asad-Syed

Figure 1.3: Hyperinflation episodes over the past century
Country
Year(s)
High
inflation
per month %
Country
Year(s)
Highest inflation
per month %
Argentina
1989/90
196.6
Hungary
1945/46
1.295
Armenia
1993/94
438.04
Kazakhstan
1994
57
Austria
1921/22
124.27
Kyrgyzstan
1992
157
Azerbaijan
1991/94
118.09
Nicaragua
1986/89
126.62
Belarus
1994
53.4
Peru
1988/90
114.14
Bolivia
1984/86
120.39
Poland
1921/24
187.54
Brazil
1989/93
84.32
Poland
1989/90
77.33
Bulgaria
1997
242.7
Serbia
1992/94
309000000
China
1947/49
4208.73
Soviet Union
1922/24
278.72
Congo (Zaire)
1991/94
225
Taiwan
1945/49
398.73
France
1789/96
143.26
Tajikistan
1995
78.1
Georgia
1993/94
196.72
Turkmenistan
1993/96
62.5
Germany
1920/23
29525.71
Ukraine
1992/94
249
Greece
1942/45
11288
Yugoslavia
1990
58.82
Hungary
1923/24
82.18
Zimbabwe
2008/09
6.5 *1021
Source: Bernholz (2003), Wikipedia
As a result, an inflation strategy could largely materialize involuntarily. One can argue that unanticipated inflation could still become an issue in the US (and the UK!), in the form of unintended
consequences of current monetary easing. Indeed, it is very likely
current experiments in monetary policies will prove hard to reverse, especially in the wake of current over-confidence of policymakers. In the case of uncontrolled inflation, gold would have a
great future! The UK is the most vulnerable country for that situation, where the Bank of England (BoE) could at some point open
the Pandora box of inflation, with its aggressive monetization in
a context of declining productivity and current account deficits. By mimicking the US, the UK seems to have neglected the
fact that it does not have a major reserve currency. With a deterioration of the currency and the standard of living, its own
citizens could themselves be tempted to flee their own currency, without any natural external buyers!
Mourtaza Asad-Syed
17
Write-off and spoliation: Dj vu

Is there truly a clear path to a write-off strategy? When one
considers the similarities between the balance sheet of United
States of America and General Motors (in 2008) in terms of total debt, unfunded liabilities, persistent need for funding, conflict of interests and the way creditors were ultimately treated,
any foreign holder of US treasury securities should be afraid.
Given the past behavior of the US to preserve its own interests
above all principles, it is hard to expect this country to play by
the rules and comply with its obligations to foreign creditors if
this requires any painful sacrifice for its population (and voters!). In his 2004 book, Colossus, The Price of American Empire, historian Niall Ferguson presents a defining feature of
the US: It is not a country like any other. It is an Empire! While
powerful abroad, with its unsurpassed military might, the US
has the typical Achilles heel of any empire: the need for external financing. The Chinese, Japanese and Europeans have been
willing to purchase American Treasury notes and bonds to finance this expensive military hegemony. While he sees inflation as the likely exit to dilute debt, and he discards debt
default, we see it otherwise. Indeed, we challenge the view that
the US will not default because its debt is denominated in its
own currency. In fact, the US public sector has defaulted several times in the past, in one way or another, and clearly at the
expenses of some less powerful entities. Since Independence,
a default has occurred about every 50 years. And the last time,
the US declined to comply with its obligations towards creditors was in 1971, just 42 years ago!
A selective US default is on the cards because it is possible,
profitable and is consistent with US conduct. The write-off
strategy carries many benefits for the US, regardless of the
negative impact overseas. Since America became the dominant
power of the western world after the two World Wars, it has
always played by its own rules. It drafted major world regulations, but surprisingly the country has a strong record of not
applying them and not ratifying them, especially in the recent
past. The US has managed unilaterally its special status, even
outside the field of finance and economics. For instance, it supported the International Court of Justice for war criminals, but
in the end the institution can try anyone in the world except
Americans. The US did not ratify the Anti-Ballistic Missile
(ABM) Treaty, the Kyoto protocol on carbon emissions, or the
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Ottawa treaty on banning anti-personnel mines. The US agriculture policy stance was also one of the major causes of the
collapse of the World Trade Organization (WTO) Doha round,
because America preferred protecting its cotton industry
among others- at the expense of broader agreements on global
trade. We see the same behavior on banking, where the US is
now deciding to delay the application on Basel III, which
makes efforts of Europeans -including the Swiss- useless,
when they are pushing hard on their own banks. The issue is
that it is well known that large banks are interconnected and
that the failure of one can impact many others even in other
regions. For other countries, having the US relax the standards
on risk and capital requirements is like insulating the roof
when someone has left the windows open.
America has defaulted often. Harvard academics Reinhart and
Rogoff (2010)4 show how some countries repeatedly default, while
others do not. Greece had such a record, that recent events should
come as a surprise only to ignorant of history They consider
only two US government defaults, and two state defaults since Independence. Nevertheless, when using a more accurate and
broader definition of government default that includes any occasion when the US government (Federal or State) did not fulfill its
financial obligation towards its creditors (i.e., when creditors lost
money!), we count seven defaults! The list is provided below, and
includes the liability on which the government defaulted, bonds or
currency.
1779: The continental currency default (Currency)
1790: The Continental bonds default (Bonds)
1841: 9-State defaults (Bonds)
1862: The Greenback default (Currency)
1873: 10-State defaults (Bonds)
1933: The Liberty bond default (Currency)
1971: The gold standard default (Currency)
1979: Debt ceiling default on treasury bills (Bonds)
The US only defaulted twice on its Federal debt, in 1790 (Continental bonds), and in 1979. The latter was quite a non-event,
Carmen M. Reinhart & Kenneth S. Rogoff, This Time is Different: Eight-Centuries of Financial Folly, Princeton, NJ, Princeton University Press, 2009
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19
as it was mostly a technical default on its Treasury bills payments, delayed by a couple of days. In fact, we consider 1933
and 1971 much more critical defaults than 1979, but they technically affected the currency, not the bond repayment in nominal terms. These two cases will help elaborate further as to
what could be the roadmap for the next default. From the defaults listed above, we see that at a Federal level, the US defaults on its currency more often than on its debt, and that
currency defaults do not always mean inflation/hyperinflation.
In 1779 and 1862, the US defaulted on a currency it created to
raise financing. Both currencies created for same purpose
(military expenditures) ended the same way, they lost their
value and in the end were redeemable to the Treasury at a fraction of the issued parity, or not at all.
In 1933, the US retracted its commitment to redeem bondholders in gold, or in gold-equivalent. Instead, it devalued its currency by 40% and repaid its bonds exclusively in paper
currency. With all due respect to Carmen Reinhart and Kenneth Rogoff or any other academic citing no external defaults
for the US during the Depression, this was a clear default, when
any foreign investor at a time of the Gold Standard would take
a 40%-haircut! US debt at the time was about USD22 billion
(USD360 billion in 2010 terms), representing 37% of GDP.
This would amount to USD6000 billion relative to todays GDP,
and a 40%-haircut would be quite a huge figure: USD 2.4 trillion!
1971 is the classic case of US unilaterally deciding to forego its
obligations, especially towards foreigners that had been financing its twin deficits for a decade, with the explicit guarantee that the US dollar was as good as gold. The Great Society
programs and the Vietnam War were expensive, public deficits
were growing, while the current account deteriorated as relatively high inflation led to a loss of competitiveness relative to
the Japanese and Germans, whose currencies were not revalued. In the end, foreigners simply lost their right to gold, overnight, mostly because they asked for it. At the time, foreigners
held about USD85 billion (USD460 billion in 2012 terms or
USD1100 billion relative to todays GDP), which were devalued
by about 10-20% depending on the base currency (Swiss and
Germans were hit the hardest). More than money, they lost
their gold. These USD85 billion worth of holdings should have
20
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given owners a right to 75,000 metric tonnes (MT) in gold, a
claim to 86% of total gold available at that time! In orders of
magnitude, this would be about USD4 trillion at todays gold
prices (compared to USD690 billion obtained from these
USD85 billion placed on money markets) or USD7.5 trillion at
todays share of world gold value. This amount is dramatic
compared to the current non-resident holdings of US treasuries. The recent US response to German officials asking to repatriate their gold in custody at the Federal Reserve Bank of
New York is additional evidence of the US being an abusive
custodian. It also provides additional fodder for conspiracy
theory addicts! Indeed, if the US needs six to seven years to
hand over to Germany its gold reserves, one can see the fascination with the view that: They do not have it anymore! There
is simply no more gold in the vault! 5
This historical analogy makes us believe that if the US needs to
be relieved from its debt or at least part of it, the country will
go the route it has successfully experimented with in the past,
through currency and at the expenses of non-residents. Foreigners are by definition non-voting, which makes them particularly vulnerable.
Today, the US is liable to the tune of USD12.4 trillion in the
form of marketable securities to the rest of the world, 70% of
which is made of debt, the rest being equities and mutual
funds. Non-residents own USD4.8 trillion in federal debt
(about a third of federal debt); they also own a substantial
chunk of public-sector debt guaranteed by government (of
about USD1 trillion in agency bonds) and about USD3 trillion
in corporate debt.
Since current liabilities to foreigners are very significant, the
incentive for the Treasury to write-off this debt is obvious. We
see a couple of scenario for the US to dismiss its current promise of paying back its creditors:
Simple default: deciding to pay only part of its bonds
(e.g., 80-90% on the dollar of each bond issued). This
To add to confusion and raise further doubt on US gold position, it is worth noticing
that the US Federal Reserve Board is often credited to own 8,100 tons of gold
(USD11billion in the balance sheet valued at USD42/oz.). In fact, the Fed does not own
any gold to back its currency; it only owns a claim on gold held by the US Treasury, via
gold certificates. It is the Treasury that owns the eight thousand tons since 1934, and
the Federal Reserves gold certificates are as good (or as bad!) as Treasury bonds!
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21
would bring significant disruptions especially domestically within US banks.

Selective default though a new currency issuance: deciding to pay only domestic investors, and creating a
different currency to pay foreign creditors. Using the
1971 roadmap, we see similarities between the current
USD and 1971 gold reserves, and current US Treasuries
with 1971 USD reserves. The case for an international
dollar to redeem debt held by non-residents would
make sense, in the case of fear of inflation from excess
money supply and increasing velocity after successive
quantitative easing. To prevent this mass of dollars accumulated outside the US (50% of money supply) coming home and thereby inflating prices, such a new
currency would not be allowed to be freely tradable domestically in the US, or at least it ought to be fully distinct from the original USD. Quite quickly, the value of
the international dollar would fall below parity vs. USD.
Foreign investors, who thought they had USD when
holding US Treasuries, would quickly realize who is
supporting the cost of public deleveraging, without any
recourse. This would be close to the platinum coin
gimmick6, which drew media attention in 2012. In essence, it is also fiat currency to repay debt, with no inflationary cost, only reputational cost. The similarities
with 1971, as highlighted in Figure 1.4, are striking:
i) some export-driven countries are once again maintaining a cheap currency thanks to artificial measures
(i.e., fixed exchange rates, with ballooning official reserves); ii) foreign central bank assets are again being
custodied at the Fed (gold in 1971, and US treasury
bonds, which never left the country, even when German, Japanese and, more recently, the Chinese bought
them!); and iii) the US again cannot deliver on promises if creditors ask to be repaid (or simply if they let
their bond expire without rolling them).
22
In the US, only the Federal Reserve has the right to issue currency, at the exception of
the Treasury that has the right to issue commemorative coins in any denomination.
The idea for reducing debt was for the US government (Treasury) to repay debt with
such a coin issued at the value of 1 trillion. For instance, the treasury would repay the
trillions of US government bonds purchased by the Federal Reserve, with 2 or 3 of such
coins.
Mourtaza Asad-Syed

Figure 1.4: Historical comparison of US financial position 1971-2012
Items
Total debt
(private + public
sector debt)
External position
(% GDP)
Public debt
(% GDP)
Amount of foreign
claims on US government (USD)
as a % of GDP
Gold equivalent
(MT)
Alternative reserve
currency
Currency-exchange
rate dispute
Current account
balance
Undervalued currencies targeted by
the US
US Solvency ratio
on liabilities
Main nation creditors
Main type of creditors
Main custodian of
final claim
Reserve currency
Type of foreign
claim to the US
government
Ultimate currency
owed to foreigners
Ultimate backing of
external liabilities
External investor
common belief
Event (historical &
possible)
Outcome (historical
& possible)
1971
150%
2012
350%
Comparison
Worse
Creditor (>0)
Debtor (-15%)
Worse
36%
104%
Worse
USD 85 billion
(2012
USD 482 billion)
8%
7561.1
USD 4.3 trillion
Similar
27%
8367.3
Worse
Similar
DEM, JPY,
FRF, GBP, CHF
Yes
Gold, EUR,
JPY, CNY
Yes
Similar
Deficit (largest in the

world)
DEM, JPY
Deficit (largest in the

world)
CNY, Asian FX, JPY
Similar
Over-extended by 1:5
Over-extended by 1:2
(2 years of tax
receipts)
Chinese, Japanese
Similar
Similar
Currency
Official institutions
(Central banks)
Federal Reserve of
New York
US Treasury
bonds/USD
Treasury bonds
Gold
USD
Different
US Gold reserves
US tax receipts
Different
USD is the reserve

proxy for Gold as it is
'as good as gold'
US suspended the convertibility of USD to
gold
US Treasuries are the

reserve tender of the
USD currency
US Treasury suspends
redemption of US
bonds with USD, but
pays instead in International-Dollar
USD squeeze? Any
large USD gain would
prove unsustainable
after 2-3 years
Similar
European, Japanese
Official institutions
(Central banks)
Federal Reserve of
New York, Fort Knox
USD/Gold
Gold squeeze, with

gold gaining 2000% in
10-year
Similar
Similar
Similar
Similar
Different
Different
Source: US Treasury, IMF, Federal Reserve, Bloomberg
Mourtaza Asad-Syed
23
Punitive taxation. Governments are sovereign on their tax regulation, and thus have complete discretion on the tax treatment
of US assets (securities, real estate, etc) held by foreigners, and
very likely on the inheritance tax. The recent Foreign Account
Tax Compliance Act (FATCA) regulation is going to make increased taxation easier and broader. It is the ideal Trojan horse
for the US to gather worldwide information and transform any
international financial institutions into US tax collectors.
FATCA, a Trojan horse: Spoliation and expropriation mostly
comes from changes in regulation and taxation. In that respect, the recent tax regulation introduced by Americas Internal Revenue Services (IRS) regarding foreign accounts of US
persons is to be monitored closely by foreign investors.
FATCA will increase the amount of information required by
the IRS, largely on non-US persons (information on US persons were already provided under previous agreements), and
will turn any financial institution into an IRS-correspondent.
It will be almost impossible for any major financial firm to refuse cooperation with the IRS as non-FATCA compliant financial institutions will be almost unable to deal with FATCAcompliant institutions. This framework, once all financial
firms are included, will be a fantastic tool for the IRS to monitor all beneficial owners of US securities throughout the
world, even non-US persons, and to eventually tax them. NonFATCA compliant institutions could be forced to incur a 30%
withholding tax on their assets linked to the US, if they enter
into any business with any FATCA-compliant firm. FATCA is
seen as targeting the US persons overseas, but this view is
misleading. Regulations and enforcements on fiscal treatments of US persons are largely quite well in place, FATCA is
unnecessary for that purpose. It would be consistent with the
level of complexity required by FATCA that it aims at other
sources of tax revenues, mostly non-resident holding US assets. If not, that would be a very sorry situation, where bureaucracy would have generate tremendous hassle; for no one
to benefit!
The European path to default

Europe sacrificing its own long-term savings. As opposed
to the US, the Eurozone does not have a reserve currency, but
it does not have any recurring foreign financing needs (i.e.,
balanced current account). Its current debt crisis is mostly an
24
Mourtaza Asad-Syed

internal imbalance between southern liabilities and northern
assets. Basically, it was a case of German pensioners financing
Spanish real estate developers that were hoping to sell their
newly built beach condos to the same German retirees! In the
end, the Germans had no intention to retire en masse on the
Costa Brava and the phony scheme went bust! We cannot help
but mention another European circular system due to the
crash: European soccer! How sweet is it to see a Spanish
mega-club, heavily indebted and financed by French, German,
and Dutch pensioners, trouncing continental clubs over the
last decade! Only Spanish (3), Italian (3), English (3) and Portuguese (1) clubs have won the Champions league over the
last ten years. While correlation is not causality, to the casual
observer it seems that financial discipline has clearly not been
a winning soccer strategy lately! By inflating the professional
player market, highly leveraged Mediterranean and English
clubs even downgraded other national championships that
did not follow the player arms race, which then fell out of favor and led to a drop in relative TV rights. What an irony that
in the end, the same German, French, Dutch and Belgian fans,
whose local championships have lost their best players, have
suffered as their clubs have lost their titles (Germans, Dutch
and French clubs clinched 4 titles in the previous 10
years).These same fans even had to pay to watch Spanish and
English matches, and the ultimate irony will be when they will
be asked (or forced) to pay to bail out these clubs! No subprime crisis and no American banks to blame here, just plain
madness made in Europe.
As of today, Portugal, Spain (not to mention Greece) have
90-150% of GDP in public debt, and 90-120% in external position (Assets minus Debt to rest of the world). Figure 1.5
highlights what we call the European Game of Death, and
Figure 1.6 examines the solvency dynamics. The mere service
of this external debt implies that a current account surplus of
2-3% of GDP is needed just to stabilize the external balance.
In the meantime, current cost of public debt (at 4-5% from
yield on most Bonos auctions) requires an equivalent rate of
nominal growth to stabilize the public debt once the primary
deficit has been eliminated! One word comes to mind: Impossible. It is impossible to stabilize external debt with the high
growth required to stabilize the public debt. It is impossible
to stabilize public debt with the growth contraction required
to achieve a 2-3% current account surplus to balance external
Mourtaza Asad-Syed
25
accounts. The Euro currency is a straitjacket, pretty much like

the Gold Standard was for the US during the Great Depression.
Inflationary monetary measures from the ECB, to benefit the
countries in southern Europe, are very unlikely to materialize
given political differences. Also, and far from the obvious,
monetary channels from the ECB to local countries is impaired
(like the Federal Reserve System across US states in the
1930s). No growth strategy will solve the external debt circle.
The end-game is clearly to relieve Spain from its external debt
that is in the form of government bonds due to other Europeans. Such a haircut would be supported mostly by pension
fund of northern European countries that have long-term savings in the form of capitalized asset reserves (Second pillar).
Such redistribution will be much easier than asking for direct
taxpayer contributions to bailout overseas investors. Taking a
silent haircut in German, Dutch, Belgian and French pension
funds is a much more viable political decision for current leaders to solve the debt crisis, especially if the victims will understand the trick played on them only when they will become
pensioners in 15-25 years (1965-1975 cohorts). European
leaders will succeed in a perfect silent robbery. Of course, an
exit from the Euro is a possible alternative, which means
changing EUR-denominated debt owed to other Europeans,
into a local currency. This equates to a monetary default as in
the case of the US (mentioned above), with probable consequences of an increased rate of inflation, a depreciation, and
an ultimate loss for foreigners. There is no need for Spain to
bear the high cost of exiting the Euro, when its northern
neighbors could save the day. This is highly likely, especially
if the Spaniards push hard enough. Spain, Portugal and others
highly indebted countries could seek a Greek outcome;
namely, benefiting from a debt restructuring and, a bailout at
the expense of European banks, insurance companies, pensioners, and even Russian depositors (via their offshore accounts in Cyprus, whose banks invested in Greek bonds)!
26
Mourtaza Asad-Syed

Figure 1.5: European Game of Death
-200%
Danger zone
Net investment position

as a % GDP
-150%
Hun
-100%
Rom Lit
Pol
Est Tur
Slo
Cze Aus
Swe
Fin
Lux
Den
Net
-50%
0%
50%
Por
Ire
Spa
Bul
UK
Fra
Gre
Ita
Ger
Bel
100%
150%
Swi
200%
0%
50%
100%
150%
200%
Public debt
as a % GDP
Source: Eurostat, IMF, Authors calculations, Data of 31 Dec 2012
Figure 1.6: Solvency Dynamics
Current account
as a % GDP
Deficit
Surplus
-15%
Geo
-10%
Tur Ukr
Rom Ice
Por
Pol
Ita
Cro
Fin
Cze Fra
Lit
Bul Est Bel Hun
Slo
Aus
Den
Ger
Swe
Net
Lux
-5%
0%
5%
10%
Danger zone
Swi
Gre
UK
Spa
Ire
15%
4%
2%
0%
-2%
-4%
Surplus
-6%
-8%
-10%
Deficit
Fiscal balance as a
% GDP
Source: Eurostat, IMF, Authors calculations, Data of 31 Dec 2012
The end of the Japanese experiment

Japan all-in. We doubt if Japan, at this stage of population decline (which is already well in place with structural deflationary
impact), will really be able to reach any steady structural growth,
and/or positive inflation target. In case the current attempts by
the government and BOJ fail, it seems inevitable the country will
Mourtaza Asad-Syed
27
converge towards the write-off strategy through a smooth default of its debt versus its own people. Given the high level of
wealth and the domestically-financed nature of the public debt,
Japan will not get into any typical debt crisis (such a balance of
payment crisis). Japanese will sell foreign holdings in Asia, Europe or the US before getting into trouble with their own liabilities. For instance, we could see the smooth write-off in one of
two possible ways: i) turning all fixed-maturity JGB held by the
public (including via life insurance) into perpetual bonds; and ii)
imposing a 100%-inheritance tax on JGBs. This would maintain
the income necessary for pensioners through their life, and erase
most existing public debt over the renewal of a generation. For
instance, the 1950-55 cohort, the largest in size, will slowly expire starting in 2020. In any case, Japan will be interesting to
watch because the country is at the forefront of all structural issues faced by other OECD countries, namely the decline of an advanced economy caused by the aging of its population.
How does this relate to gold?

In the wake of this possible outcome, Eurozone and Japanese
pensioners should immediately diversify away from their assets
that their pensions are invested in (Sovereign bonds), and very
likely include gold in the holdings as a default-free asset, especially if they want to secure any inheritance. Indeed, it is amazing
to see how inspirational Enron has been to Eurozone pensions
system! Enron was broke, but managed to look solvent with accounting gimmick that hidden long-term debt and in the meantime it tapped into its employee pension fund to refinance ongoing operations (buying its own stocks and bonds) and stay
afloat at the expense of future liabilities, and at the cost of ruining all Enron retirees.
On the other side of the oceans, looking at the US, there are similarities between US public finances and GM balance sheet as we
mentioned in the introduction, therefore for non-US residents
gold should come in complement to traditional risk-free assets
such as US Treasury bonds for their ability to remain free of
counter-party risk and untouched by unilateral sovereign decisions that has always hurt foreigners.
28
Mourtaza Asad-Syed
2. Valuing gold
Overview
Gold is relatively freely traded in most parts of the world. For
four decades now, its price is fully set on financial markets, after
years of gold being artificially stuck at USD 35/oz. In 1971, the
dissolution of the gold standard brought liberalization of gold
prices, and subsequent liberalization of trading made the gold
market comparable to the market for marketable securities.
Gold gained 1,350% in the 1970s, to eventually reach its all-time
high annual average price of $612.56 per troy ounce in 1980. The
annual average price for gold then ranged from $318 to $478
through the rest of the 1980s. From 1990 through most of 2000,
it ranged from $252 to $385. When adjusted for inflation, current
prices at the time were the lowest they had been since the early
1970s as shown in Figure 2.1. Since then, gold ramped up fourfold to reach an absolute all-time-high at USD1922/oz in September 2011 and has subsequently declined to approximately
USD 1250/oz in November 2013. What forces are behind these
changes in trends? How is the gold price being determined, what
are the drivers, and are there any valuation metrics for gold? An
attempt has been made to answer these questions in this chapter.
Mourtaza Asad-Syed
29
Figure 2.1: Gold price in nominal and real terms (1900-2013)

4096
1024
256
64
16
1900
1920
1940
Gold price ($/oz, log-scale)
1960
1980
2000
2020
Real gold price (2012$/oz, log scale)
Source: Bloomberg, BLS, Authors calculations, Gold prices as of December 2013
Given the historical, universal, monetary usage that we detail in

the last section of the book, Gold can be considered both as a
commodity and as a currency. This dual nature should be taken
into consideration when assessing its price setting mechanism.
Also, given its growing popularity among diversified investors,
we will also look at gold as an asset class in a comprehensive valuation framework.
Analysis of the supply and demand dynamics of the commodity framework reveals that: i) the long-term price is
partly a function of total supply related to long-term mining costs; and ii) the total physical demand has no clear
impact on prices, except for short-term effects, typically
seasonal ones.
In the currency framework, the price of gold typically
quoted in US dollars depends on i) the inverse value of
the US dollar versus other currencies; and ii) the attractiveness of gold as a safe currency versus all other currencies. This framework reveals that interest rates and
inflation are the most critical gold price drivers.
The asset class approach shows that relative attractiveness of gold versus other assets is mainly driven by pessimism, as opposed to equities, which are driven by
optimism of better days ahead. Gold turning points are
signaled by trends in the equity risk premium, which is
the risky assets opportunity cost, especially since 1971.
30
Mourtaza Asad-Syed

This framework helps us inversely link gold with economic growth. Unsurprisingly, gold is the preferred asset
for investors in aging societies as these societies are past
their prime and favor safety and conservation over
growth and creative destruction.
As we will see, the gold price is mostly defined as a currency.
Perspectives of gold as commodity and gold as an asset class also
play an important part in the valuation picture, but remain secondary to the currency perspective.
Indeed, gold transactions of the financial or secondary
market dwarf the commodity or primary market, with
new supply representing only 2% of the total above
ground metal. As a result, its price depends, unlike traditional commodities, more on its value perception than on
supply and demand dynamics of the physical market.
Gold remains very popular in financial discussions, but it remains largely a secondary asset. The entire stock of above
ground gold amounting to about 174,200 metric tons, -i.e. USD
7-8 trillion at current prices- is a relatively small figure as compared to other financial assets such as the total global market
capitalization of bonds, equities and bank deposits (respectively,
USD 100, 55 and 60 trillion). Of this amount, much less is available for trading in the market. About 60 percent or more is embedded in jewelry, dentistry, other industrial applications, and
central bank holdings, leaving no more than 16-20 percent of the
above ground gold or about 0.5% of the total global stock of liquid wealth available for private investment.
Gold as a commodity
Fundamental analysis for gold price determination, from a commodity perspective, naturally involves the study of supply and
demand on the physical market. First, we must assessed the existing stocks because gold being indestructible commodity, it
never disappears and its stock is what is primarily exchanged in
physical markets. Second, demand can be separated in two keys
categories: financial demand (FD) and non-financial demand
(NFD). Third, supply is based on: new supply coming from mining, existing supply returning to market (i.e., scrap) and existing
marketable holdings. To avoid logical pitfalls on causality between prices and quantities, we also study of the price impact of
Mourtaza Asad-Syed
31
changes in supply and demand to validate or invalidate the predictive power of demand and/or supply.
Gold stock
The total gold ever extracted is estimated at 174,200 metric tons.
Being indestructible, and chemically inert, and having been carefully preserved, and conserved, nearly all the gold that has been
mined in the last five millennia is still above ground, 90 percent
of which is more or less locatable, and, in large measure, is either
still in use, retrievable or potentially available for use, and can
be accounted for. The above ground gold stock represents a cube
of 21-meter length, which is the most striking fact to grasp how
scarce gold is. Divided by world population, it means that each
individual can hold no more than 25 grams or about 4 rings as
shown on Figures 2.2 and 2.3.
The 20th century has seen rapid and sustained increases in
world gold production as seen on Figures 2.4. The output from
old and new gold fields has been augmented by the development
in mining methods and equipment and in metallurgical extraction processes, yet future supplies appear quite limited. The
USGS estimates world underground resources of gold at about
100,000 metric tons (only 50,000 of which are economic reserves7). According to these estimates, in 1998, the 50% threshold was crossed with more gold being extracted than still in
recoverable reserves. This would also mean a 60%-increase
from the existing amount and such an increase is typically
reached in 30 years. And in the end -say 2050- when this amount
has been retrieved, total gold would only amount to a cube of 24meter length.
By coincidence, gold per capita, has been quite constant throughout history at about 20-25g per person, as population grew
about as fast as gold was retrieved, as seen on Figure 2.5. Interestingly, this possible end of gold accumulation could almost coincide with the peak of human population. Indeed, United
Nations demographic projections increasingly make mention of
fast-declining fertility rates, and lower-bound estimates of population see a population decline starting in 2050 (while median
scenario expect this for 2100). Of course, both estimates on reserves and population trends at a 50-year horizon are subject to
7
32
Economic reserves are defined as reserves that can be currently accessed at a profit
given current gold price and extraction costs.
Mourtaza Asad-Syed

caution Forecasting is hard, especially about the future! Yogi Berra.
Figure 2.2: 40 Centuries of gold per capita
128
Log-scale
64
32
16
8
4
Total gold inventory/ World population (grams per person)

Source: Gold Money Foundation, GFMS, US Census Bureau
Figure 2.3: A century of gold per capita
27
26
23
24
23
24
25
23
18
12.0
1.7
2.0
2.5
3.0
1900
1927
1950
1960
in oz/person (grams)
4.0
1974
5.0
1987
6.0
1999
7.0
2012
2050est.
World population (Bil)
Source: Authors calculations
Mourtaza Asad-Syed
33
Figure 2.4: A century of production and reserves

10,000
50%
1,000
log-scale
100%
0%
100
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
Cumulative gold production (% of total disposable gold)
Gold reserves (% of total disposable gold)
Annual world production (in MT, RHS)
Source: Authors calculations, Gold prices as of 31 Dec 2011
Figure 2.5: Population and gold stock have grown at a similar pace
1.8%
1.8%
1.6%
1.4%
1.3%
0.7%
1850-1950
1950-2000
Population growth
2000-2012
Gold stock growth
Source: Gold Money Foundation, US Census Bureau, Authors calculations
Breakdown of gold demand

Change in demand for gold especially change in financial demand is often cited by commentators and analysts as a key
driver of change in prices. Unfortunately, for investors, we find
that physical demands impact on prices is temporary and beyond this short-term effect, it is the demand that is driven by
34
Mourtaza Asad-Syed

prices. Not to the contrary! It is precisely what is seen in historical data over a century in the United States: gold consumption
per capita drops when prices rise and increases when prices fall.
Interestingly, the per capita gold consumption has remained stable over time at 1 ounce per 40 years, independent of rising purchasing power. Therefore, over the long run, population growth
has been the main driver of greater gold demand.
Non-financial demand
Non-financial demand (NFD) represents the lion share of current global demand, with about 76 percent of gold consumed annually, but not in gross transactions dominated by financial
demand as will be described later. Jewelry is the dominant nonfinancial demand category; others account for some 15% of the
NFD as highlighted in Figure 2.6. The next NFD is related to dentistry followed by the electronic industry using 250 tons of gold
for its conductive properties. Evidence across geographies over
a period of time displays similar trends of gold consumption.
Gold demand for jewelry had been strong; amounting to 3250
tons in the late 1990s when gold was less expensive, but declined
by a third, over the last decade as shown in Figure 2.8 and 2.9,
with the increase in the price of gold. Based on this diverging
trend, highlighting the inaccuracies of the popular explanation of
the gold bull market, that the growing Indian middle class appetite for gold is driving prices.
Figure 2.6: Breakdown of total non-financial demand per sector in 2012
Dentistry
2%
Electronics
13%
Others
4%
100% =2,336 MT
Jewellery
81%
Source: World Gold Council
Mourtaza Asad-Syed
35
Jewelry, is negatively affected by high prices, and tends to act as a

price buffer. India is the largest gold jewelry manufacturer and
consumer. It has its own unique cultural, economic and financial
basis. India is also the world's top exporter of jewelry, despite the
fact that gold and gems are often intermediary components of Indian
exports that are not counted as metallic exports but rather are counted
as manufactured goods. India's domestic usage of gold may have
perhaps been a bit overstated as India is nowadays more of a major
jewelry producing platform than a few decades ago, exporting its
jewelry to the US, EU countries, and the Middle East. The majority
of jewelry manufacturing establishments worldwide consist of small
shops and individual artisans. According to the USGS publication,
Gold Fields Mineral Services Ltd. estimated in the early 1990s that
perhaps 2 million goldsmiths were working in India, and 400,000
people employed in the jewelry industry in China.
Figure 2.7: Breakdown of total jewelry demand by country in 2012

100%= 1,908 MT
Rest of world
32%
India
29%
Saudi Arabia
2%
Turkey
4%
U.S
6%
China
27%
Source: World Gold Council
It is the cultural aspects that make India the prime holder of gold
and silver jewelry as shown in Figure 2.7. There are reasons
other than the clichs of Maharajahs jubilees and the mysterious
Maharanis lust for sophisticated jewels8 Gold and precious articles act as secure store of value for Indians, mostly due to the
8
36
Maharaja is a king and Maharani is a queen in South East Asia.
Mourtaza Asad-Syed

absence of a dependable banking system and the lack of trust in
its currency, as India has suffered from inflation in excess of 7%
per annum, and the strict state control over currency convertibility.
Most marriages in India have long been organized weddings
with economic reciprocity where the brides jewels serve as the
dowry to ensure her future. The artifacts are traditionally and
culturally popular, rather essential for a respectable marriage, as
well as a necessity in the rural areas where these ornaments act
as secure savings to dig out in times of need. In the absence of
bank branches, the omnipresent 'mahajan' or 'banya, (local
money lender and merchant), is ever ready to buy or mortgage
these artifacts. Of course, there are cases where many men
marry women only for their jewelry and gold ornaments and
many young women marry rich old men for gold!
Figure 2.8: Annual jewelry demand (MT)
3,000
2,500
2,000
1,500
1,000
500
0
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Source: GFMS, World Gold Council, Bloomberg
Mourtaza Asad-Syed
37
Figure 2.9: World jewelry demand versus real gold price

3,500
2,000
3,000
1,500
2,500
1,000
2,000
500
1,500
0
1990
1995
2000
2005
World jewellery demand (MT)
2010
2015
Real gold price (US$/oz, RHS)
Source: GFMS, Bloomberg, Authors calculations, Gold prices as of 31 Dec 2012
Figure 2.10: U.S. per capita gold consumption and gold price
0.10
2,000
0.08
1,500
0.06
1,000
0.04
500
0.02
0.00
0
1900
1920
1940
1960
Per capita consumption (oz/year)
1980
2000
2020
Real gold price (US$/oz, RHS)
Source: U.S. Geological Survey, US Census, Federal Reserve, Authors calculations, Gold
prices as of 30 April 2013
When prices rise, the NFD declines. This reflects the normal causality of price to demand, in a market where supply is somewhat
rigid and consumers are price takers. This is relevant with NFD
actors given the fragmentation of the buyers (especially in the
jewelry segment). Over the medium to long run (one-year and
beyond), there is no evidence that NFD has driven prices; there
38
Mourtaza Asad-Syed

is even evidence that prices managed to rise when NFD declined
strongly (Figures 2.9 and 2.10).
Analysts and forecasters would be misled if they explained any
durable changes in gold prices with NFD, especially jewelry. By
extension, any gold forecast based upon projections of NFD is
useless. Rather, industry analysts can consistently forecast jewelry demand and NFD for gold based on its expected price action.
Short-term effects and seasonal patterns
There is one caveat to the notion that there an absence of NFD
impact on gold prices: we do believe NFD can consistently impact prices over short-term (1-month), and this has brought
some significant seasonal patterns in gold prices. The proposed
explanation may be building a thesis on a spurious correlation,
but the consistency of the evidence deserves to be considered.
Timings of festivals and religious calendar reveal a seasonal effect on gold consumption and prices. In fact, since 1984, gold
performs significantly better in the last four months of the year
and in January than in other months as shown in Figure 2.11;
September being its best month, registering prices upward of
3 percent, on an average.
Figure 2.11: Seasonal profile of gold performance
8%
6%
4%
2%
0%
-2%
Jan
Feb
Mar
Apr
May
Jun
Average monthly return since 1980
Jul
Aug
Sep
Oct
Nov
Dec
Cumulative year to date return
Mourtaza Asad-Syed
39
Source: Bloomberg, Authors calculations, Gold prices as of 31 Dec 2012
September marks the end of Indian monsoon period and Indian

agricultural cycle. The harvest having been completed and monetized, the peasants and farmers have money on hand, and they
start converting their cash into gold, given the lack of sound financial savings system, especially in rural areas (i.e., inflation,
unsecure banking system). This season also marks various
Hindu festivals, Durga, Puja, Saraswati Pooja, Dassehra, and Diwali, falling in the period from October to December, which
could also tends to be an auspicious time for weddings. This endand turn-of-the-year also coincides with Christmas and New
Year celebrations in the Anglo Saxon world as well as the Chinese
New Year and leads to an exchange of gifts and presents.
These seasonal occurrences are likely to support the idea that
gold prices can be affected by NFD in South Asia on a short term
basis (1-3 month) during the last quarter of the year (including
January). This end and turn of the year also coincides with
Christmas and New Year celebrations and exchange of gifts and
presents, as well as with the Chinese New Year. This idea was
also tested with the Muslim religious calendar, which would also
tend to push up gold demand, resulting in price hike during the
festivities at the end of the fasting month (Ramadan) and the restart of weddings that follows the month of Ramadan. The changing date of Ramadan across the Julian calendar would therefore
be a test of whether the previous explanations (i.e., religious/seasonal festivities) were spurious about the end/turnof-the-year effect.
The analysis, highlighted in Figure 2.12, shows that prices do increase during the month of Ramadan by about 2 percent. The
other months display a merely 0.3% average increase since
1980. For this statistical test, the Muslim lunar calendar of 354
days, rolling over the solar calendar of 365 days, brings the
month of Ramadan revolving over all the solar months during
the study sample. This out-of-sample test strengthens the case
for seasonal patterns on physical gold demand and its shortterm effect on prices.
40
Mourtaza Asad-Syed

Figure 2.12: Monthly returns of gold since 1980 sorted based
on Ramadan
1.7%
1.0%
0.5%
Month After Ramadan
Ramadan
non - Ramadan
Source: Bloomberg, Authors calculations, Gold prices as of 30 April 2013
Financial Demand
Financial demand (FD) represents only about a quarter of total
physical demand, but thanks to its high volatility, it has remained
the dominant driver of changes in total demand. FD has been
growing and its impact has often been denounced for jacking
up gold prices. Traditionally, FD was dominated by central bank
moves; but recent financial demand has been fueled by investors appetite for commodities, and by increasing supply of gold
tracker funds (such as exchange traded funds), which often use
gold futures and physical backing in their holdings.
Figure 2.13: Breakdown of financial demand in 2012
Comex
1%
ETFs
18%
100% =1,525 MT
Bar and coins

81%
Source: Bloomberg, World Gold Council
Mourtaza Asad-Syed
41
As shown in Figure 2.13, financial demand consists of trackers

funds also known as ETFs; future and derivative instruments
backed by gold (exchanged on the COMEX in New York) and
other private investments, which include gold bars and coins
stored mostly in vaults. The first tracker was launched in 2003
and the demand has rapidly grown to reach almost a quarter of
total FD. More details on trackers are provided in the section on
Investment vehicles in Chapter 3. 'Other investments correspond to the holdings of gold bullion and coins by individuals
and private sector. Central banks are not included because they
were net sellers in 2008, as they have been since 1989, but this
could change with emerging central banks building up positions
on gold, and could reappear in the financial demand calculations.
The financial demand for gold, as compared to non-financial demand, is growing and can be very volatile. Although financial demand constitutes only 29% of the total demand, its highly
volatile behavior makes it potentially a significant driver of gold
prices in the short term.
Financial demand has to take into account the negative impact of
hedging from the gold mining industry, whether in futures or in
options (which act as financial supply that hits the market before
its physical supply). By selling futures or option contracts for delivery of gold at a future date, producers are able to reduce
downside price risks, and in some instances, when the price falls
more than anticipated, actually make a profit from the hedging.
Also, by hedging several years production, producers forego the
possible profit to be made should the gold price rise. For this reason, several producers in the United States and some other countries have been reluctant to hedge.
Gold trackers currently represent in excess of USD100 billion in
capitalization or about 75 million ounces in gold. Exchange
traded funds (ETFs) replicating gold have been very popular
among retail investors, but also with institutional investors. For
instance, John Paulson, the famous hedge fund manager has
heavily invested in gold through the GLD tracker. The evolution
of global gold tracker funds from 2004-2012 is provided in Figure 2.14
42
Mourtaza Asad-Syed

Figure 2.14: Global ETF demand (2004-2012)
ETF holdings in Moz
100
2,000
80
1,500
60
1,000
40
500
20
0
2004
0
2006
2008
2010
2012
Gold trust (SPDR)
Gold bullion securities (Lyxor)
NewGold
iShares gold trust (COMEX)
ZKB gold (SWX)
ETF securities
Julius Baer
Source: Bloomberg, Authors calculation, Gold prices as of 30 April 2013
Given the recent trends, especially in the private financial demand, it is hard to understand the precisely impact financial demand will have on prices. Unlike other categories of buyers of
physical commodities, investors are buying gold in a rising market: higher prices usually trigger more buying as a result of the
herd or momentum effect. Increases (declines) in trading volume on the gold ETF were seen after price increases (decreases).
Therefore, there is no tangible evidence of causality, that financial demand is really behind gold price dynamics, as is often
mentioned in media or research analysis. Popular headlines such
as: Investor rush on gold ETF fuels gold bull market have no empirical backing. In the light of available evidence, the causality
even appears reverse, but given the lack of a significant sample,
we leave this as an open question. It is plausible that an exogenous change in financial demand could impact gold prices by creating a scarcity on the physical market thus pushing price up. We
consider that such an impact is similar to one on any security,
which would remain only temporary and can be classified as a
short-term catalyst. Such short-term perturbations, caused by
behavioral patterns, have often been found in academic research
on equities. We will see in the last part of the book, how investors
can take advantage of it.
Mourtaza Asad-Syed
43
44
Mourtaza Asad-Syed

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To Gabrielle, David and Sarah, my three golden nuggets.

Writing a book on gold in 2014 feels like writing Dow 36000!