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.
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AU CAPITAL LP REPORT FOR FEBRUARY 11, 2003
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 adjustment.
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. Keynes.
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 world.
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 opposite.
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 Disarmament.
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 301-469-8080 [email protected]