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WHY WE HAVE LIKED, AND CONTINUE TO LIKE OIL AND GOLD

WHY WE HAVE LIKED, AND CONTINUE TO LIKE OIL AND GOLD

Several years ago, we became bullish on energy and precious metals for our clients. Our bullishness was a creature of long term economic and social events, which will continue to effect the world for at least one generation and probably longer. The most important event is the entry of about one billion new people into the developed world economic system. On top of the generational trend there are shorter-term trends as well. They may be connected to the election cycle in a country, or to seasonal or other cycles, which are a function of local events within an individual country (i.e. changes of government, wars, political instability). We did not become bullish on energy because of terrorism and Middle East tension, although it is a secondary reason to see oil and gold go higher.

There are six billion people on earth, and about one billion live in the parts of the world with somewhat developed economies. They live in Europe, Canada, U.S., Japan and small parts of Asia, South America and Africa.

We became bullish on oil and gold because several years ago we saw that two major population blocks were joining the world economic system. We began to ask how they would make themselves felt. If they were to add 40% of their population to the world economic system; that is, if China and India were successful in lifting only 40% of their people out of subsistence economics into the world economic system, the size of the system would double in a generation. If in twenty years the number of individuals participating in the industrialized world doubled, it would take a 4%+ compound growth rate for the entire world economy to accommodate that growth. The world economic system would grow at 10% in some sectors and at 1% in others. China and India have been growing at about 9% and & 7% respectively.

We saw two possible avenues for their expression in the world economy. This growth would cause big changes in the way the world used resources and the way the world held its wealth.

1. The Southeast countries would collect and use raw materials, especially energy and industrial minerals (i.e. iron ore, coal, copper etc.). In order to create an economic base, raw materials, labor, capital and technological know how were necessary. These countries had labor in excess, they had technological know how, and the developed world was happy to give them capital. What they needed was raw materials to build the economic system.

2. Once assets were acquired as a result of creating and selling products and services they would acquire gold and strong currencies to hold their accumulated assets. They would acquire gold and other precious metals as a store of value to protect their newly acquired wealth. We must remember that India for example has a history of thousands of years of holding their wealth in the form of gold jewelry and gold bullion.

INDIA AND CHINA VIEW GOLD AS A DESIREABLE ASSET

Accumulated wealth can be reinvested in the country. It can also be hoarded to protect a family’s assets or it can be invested for interest. The demand for gold is both for hoarding and for investment. Gold pays no interest, but if it is rising versus, say, the U.S. dollar at 10%, it is better than collecting 4% interest in U.S. dollar bonds. The weakness in the dollar over the last few years, and the policies of the U.S. government have caused China and India to hold a larger proportion of their hoarding and income earning assets in gold and other currencies, and less in U.S. dollars.

These people are very intelligent and their long history has taught them to count on the family, rather than the government for good advice on how to hold on to your assets. They prefer something portable that cannot be debased, manipulated and easily confiscated. Gold represents this type of asset. As their assets grow, their demand for gold grows.

WHY INVESTORS AND SPECULATORS SHIFT BETWEEN GOLD AND CURRENCIES

In our opinion, in the short run, currency speculators look at real interest rate differentials between competing currencies. In the intermediate period, they look at balance of trade figures. In the long run, GDP growth rates and budget deficit figures are of concern. In the case of the U.S. dollar, none of these figures look good. If you monitor these statistics, you know the U.S. dollar and many foreign currencies are not the place to hold assets. Gold is the place. As wealth increases in China and India, we expect a bigger and bigger percentage of assets to be held in gold.

HOW LONG WILL GOLD AND OIL DEMAND RISE?

How industrialized are China and India?

We estimate that about 5 –10% of people in these countries may be approaching middle class living standards. Their objective is 40%. They have a long way to go, and as long as they want to grow, they will consume energy and industrial minerals and they will hold gold and non-U.S. currencies for their savings.