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  1. 374 Posts.
    12:26a ET Friday, February 21, 2003

    Dear Friend of GATA and Gold:

    Our friends at Au Capital in Maryland, Hans
    Kahn and Dan Tessler, have generously
    consented to our sharing with you their
    February 11 report, which includes some
    compelling observations on the gold market
    and our favorite "barbarous relic," as well
    as favorable references to GATA and its
    consultants, Frank Veneroso and Reg Howe.

    Here's a lovely excerpt:

    "We think that prudent, mainstream investors
    gradually will relearn history's lesson that
    gold is what money ought to be. Gold is no
    one's liability, an asset that is produced by
    work, not by credit; it is liquid, scarce,
    divisible, anonymous, portable, dense, and
    nearly indestructible. Call it a barbarous
    relic for a barbarous world."

    The report is appended here with thanks.

    CHRIS POWELL, Secretary/Treasurer
    Gold Anti-Trust Action Committee Inc.

    * * *


    To Our Limited Partners:

    We completed ten full years of operation with
    gains of 12.7 percent in the fourth quarter
    and 111.5 percent in all of 2002. Our
    quarterly and longer-term returns for steady-
    state investors are shown below. Individual
    results vary depending upon the timing of
    investments. Your individual account
    statement and partnership financial
    statements are enclosed, subject to audit and

    We formed Au Capital 10 years ago to provide
    an inexpensive, long-term call on the price
    of gold bullion as "insurance" against
    systemic risk to the values of financial
    assets. We earned nearly 10 percent
    compounded annually although no systemic
    failure occurred during the decade and the
    values of gold bullion and large-
    capitalization gold stocks changed little on
    balance. This ranks among the very best long-
    term returns in Lipper's universe of publicly
    traded funds, without regard to specialty. We
    tripled the average return among the gold-
    oriented funds, and beat the total return of
    the leading gold fund by 40 percent. We also
    exceeded the average returns of all S&P 500
    Index funds by nearly a full percentage point
    per annum, despite the enormous inflation in
    equity prices that occurred during the middle
    years. A $10,000 investment in Au Capital in
    December 1992 grew to $25,614 over the
    decade, as compared with $15,140 in the
    average gold-oriented fund and $23,520 in the
    average S&P 500 Index fund.

    Our performance was volatile from one quarter
    to the next but it trended clearly over
    longer periods. Our first four years were
    generally up, the next four generally down,
    and the last two up. We gained more than 100
    percent in both 1993 and 2002. Our worst
    yearly loss was 34 percent in 1997. Overall,
    we gained in six of 10 years but only 17 of
    40 quarters. The S&P index also rose in six
    years of 10, but with less volatility, a
    difference that reflects the pronounced
    emotional content that can move gold-related
    markets in the short term.

    Gold bullion and related assets were widely
    disparaged by investors when we began. Gold
    was generally thought to have become a
    consumer commodity with steady demand that
    was overmatched by new production and
    prospectively endless sales by central banks.
    Gold had lost its monetary appeal to western
    investors and bankers. It was widely
    ridiculed as the "barbarous relic" of J.M.

    In contrast, we believed for two reasons that
    gold and related assets were historically
    cheap. First, supply/demand fundamentals were
    improving in ways that had not been
    recognized. Second, 5,000 years of history
    assured us that investors eventually would
    rediscover the monetary character of gold in
    a dangerous, paper-intensive world.

    Most of our return over the past decade
    resulted from the further improvement and
    spreading recognition of the commodity
    fundamentals that we saw at the outset.
    Investors by now generally understand that
    gold demand chronically exceeds production;
    that consumer demand, the largest component,
    is growing with Asian incomes; and that gold
    production has peaked and likely will decline
    for some years as a result of diminished
    exploration and development during years of
    low prices.

    How was excess demand satisfied for so many
    years without substantially increasing gold
    prices? The answer to that question is a
    principal reason for our view that the
    commodity fundamentals of gold are still far
    more favorable than generally recognized.

    Briefly, central banks met the excess demand
    from official bullion reserves, by selling
    significant volumes outright and by lending
    even more through financial intermediaries to
    producers and speculators. Producers and
    speculators in turn sold the borrowed metal,
    and physically delivered it, in order to
    hedge future production, finance investment
    or earn the spread between market interest
    and low gold-lease rates. As a result,
    producers, banks, and speculators in the
    aggregate are obligated to return much
    borrowed gold that now dangles from Indian
    and Chinese earlobes. Estimates of that short
    position range up to six years' mine
    production and nearly half of nominal
    worldwide central bank reserves.

    Research by Reginald Howe and Frank Veneroso
    increasingly supports the circumstantial case
    that the Gold Anti-Trust Action Committee has
    made for the high-end estimates.

    In any case, it seems clear that there is a
    short position that amounts to a large,
    possibly unmanageable multiple of normal
    demand. The resulting market imbalance, in
    our view, eventually must be cleared at
    substantially higher prices.

    The second aspect of our initial rationale
    was our belief that the traditional regard of
    investors for the monetary character of gold
    eventually would be renewed. That renewal
    seems to have begun last year with the
    spreading perception of rising, intertwined,
    long-term geopolitical and financial system
    risks. It has not yet contributed materially
    to our returns, but we expect it to
    strengthen over time and to substantially
    boost investment demand for gold and related
    asset values.

    We think that prudent, mainstream investors
    gradually will relearn history's lesson that
    gold is what money ought to be. Gold is no-
    one's liability, an asset that is produced by
    work, not by credit; it is liquid, scarce,
    divisible, anonymous, portable, dense, and
    nearly indestructible. Call it a barbarous
    relic for a barbarous world.

    The U.S. dollar has been the symbol of world
    order, and the U.S. economy has been its
    foundation, for five generations. Both the
    dollar and the economy are fundamentally sick
    today. We have had essentially one
    irresponsible monetary policy since 1987 -- a
    policy of "more" -- that has increased the
    broad money supply 8 percent compounded
    annually for the past 10 years and 10 percent
    per annum for the last five. With brief
    exceptions, short-term interest rates have
    been maintained below market; they now
    provide a minus 2 percent return after taxes
    and inflation.

    Like a force-fed goose whose diseased liver
    is prized as foies gras, our economy
    processed this unstinting expansion of
    liquidity and attendant credit into diseased
    growth. Consumption generates 90 percent of
    income growth and represents 70 percent of
    economic activity. About $5 in new debt
    lately has been needed to generate $1 in
    income growth. The expansion of business
    investment that has now collapsed was largely
    illusory, based on the statistical mischief
    known as hedonic pricing; the rest was
    financed in excessively liquid capital
    markets that lacked productive outlets.

    Although much of the air has left the equity
    bubble, our much larger bond, mortgage and
    securitized debt markets have only continued
    to expand at increasing, and increasingly
    dangerous, rates. Domestic savings rates have
    increased slightly in the past year but
    continue near record lows, while our record
    and growing trade deficits consume 80 percent
    of the gross savings of the rest of the

    There is chapter and verse to detail and
    expand upon these concerns, but you get the
    point: conditions economic and financial are
    extremely unbalanced and possibly
    unsustainable. "More" is still the only
    policy response: lower interest rates to
    foster more consumption and less saving, plus
    a guns-and-butter swing from last year's $6
    trillion projected 10-year budget surplus to
    this year's $2 trillion projected deficit.

    Meanwhile, investors increasingly overcome
    their inertia to consider alternatives to
    dollar dependency. There aren't many. All
    major economies are weak, at best. All major
    currencies are in reflation mode. The
    Norwegian kroner is interesting but small,
    like other commodity-based currencies. The
    Chinese remnimbi is undervalued but
    unconvertible and dollar-pegged.

    This kind of thinking leads directly to
    commodities, particularly gold, as we have
    seen in the past two years.

    Bullion supporters often are accused of
    lunacy -- goldbuggery, some call it -- when
    discussing risks of this order. Trust us: we
    know lunatics; lunatics are friends of ours;
    lunatics are not us. We believe that the U.S.
    is still the biggest kid on the block and
    that we will prevail over whatever comes.

    But the risks are real. Osama bin Laden,
    Saddam Hussein, Kim Jong Il, George W. Bush
    and Tony Blair are all gunning for the Clint
    Eastwood Lifetime Achievement Award. At the
    same time, accumulated financial excesses
    have created the most vulnerable financial
    structure and the weakest economic
    environment that the world has seen since
    1930. Instability and disunity have escalated
    dramatically just as risks to economic and
    physical security increasingly require the

    For what it's worth, for example, we'd guess
    that during the protracted efforts toward
    consensus -- notice that "Chirac" rhymes with
    "Iraq" -- the bulk of Iraq's biological and
    chemical weapons have been relocated to Syria
    and Lebanon, where they are even more likely
    to end up with terrorists.
    A barbarous world can have its humorous
    moments, as when the duct tape futures market
    tumbles suddenly into backwardation. Or CNN
    spotlights "chapel in a box," a new emergency
    tool-kit that may or may not include a
    collection plate. Or the United Nations picks
    Libya to chair its Commission on Human Rights
    and Iraq to grace its Commission on

    But it is dark humor today because it is
    increasingly clear that the world order is in
    fundamental jeopardy.

    The discomfort that that fact induces is the
    primary spur to the gradually increasing
    investment demand for non-financial assets,
    including gold, and the second reason that we
    believe a secular bull market in such assets
    has begun.

    For the next decade, as for the last, we
    anticipate continuing and occasionally severe
    volatility, with a generally upward bias, in
    our markets. The principal short-term risk,
    we think, is a substantial and involuntary
    rise in U.S. inflation and interest rates
    brought about by a dramatic additional fall
    in the dollar's exchange value. A credit
    squeeze and a rapid fall across the spectrum
    of asset values could accompany this
    surprise, despite the authorities' best
    efforts to avoid it.

    We would expect gold to decline at first,
    recover soon after and then move to new highs
    relative to other assets. Time will tell.

    With every good wish,

    Hans H. Kahn and Daniel Tessler
    Au Capital LP
    Suite 337
    4938 Hampden Lane
    Bethesda, Maryland 20814
    [email protected]

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