Prepared by AIC Investment Advisors, Inc.

The World Gold Council recently issued its quarterly report, Gold Demand Trends which reviews gold demand throughout the world. Readers should find that demand for gold is not collapsing world-wide as recent price trends would make one believe. In fact, demand is skyrocketing in some areas of the world. A review of the following commentary should be helpful in placing recent gold price trends, in U.S. Dollars, in perspective.

The third quarter of 1997 witnessed record demand for gold totaling 705.3 tonnes (22,657,762 ounces), an increase of 6.0% from third quarter 1996 demand. On an annualized basis, third quarter demand was 90.63 million ounces. The developing markets, which include Asia, the Middle East and India and Brazil and Mexico, continued to report large increases in demand in the aggregate. Demand from developing markets accounted for 512.6 tonnes and represented 73.0% of total world demand. Third-quarter 1997 demand from developing nations was 10.0% higher than that recorded for the third quarter of 1996. On a year-to-date basis, demand was 17.0% higher than that recorded during the first nine months of 1996. In developed markets, which account for slightly more than one-quarter of total world demand, the takedown during the third quarter declined 2.0% from the 1996 quarter.

Demand in Asia sharply lower during the latest quarter as the currency turmoil and lower equity prices took its toll on gold demand. Total demand from this region was 141.2 tonnes during the third quarter, down from 18 1.0 tonnes for the comparable 1996 quarter, a decline of 22.0%. The fall off in demand in the region reflected the economic retrenchments and currency woes being experienced by the tiger economies of South East Asia. While new demand in the area dropped off, no doubt there was selling present from holders of the yellow metal. This suggests that the total demand may have remained reasonably high, but that a portion of supplies to market was met by sales from gold investors selling positions to meet liquidity needs. It is interesting to note (as the accompanying chart shows) that gold prices in domestic currencies did not decrease during the currency devaluations and equity market collapses that occurred in the region. As a store-of-value,gold performed its historical function as expected for local people that owned the metal.

Demand in North Asia, which encompasses Taiwan and Hong Kong, increased 21.0% during the latest quarter, reflecting the ongoing recoveries in these areas. Year-to-date, demand in the Asian region is down 2.0% from the comparable 1996 period.

Perhaps the brightest spot in world gold demand comes from the Middle East and India. The Middle East includes Turkey and the Gulf States. Demand from this region reached a record 343.9 tonnes during the third quarter, an increase of 30.0% from the third quarter of 1996. Year-to-date, gold off-take from the region is up a whopping 33.0%. India is now the world's largest consumer of gold. Gold demand in the latest quarter reached a record 189.8 tonnes which compares to consumption of 120.1 tonnes in the third quarter of 1996–an increase of 58.0%. In 1996, Indian demand totaled 508 tonnes compared to the U.S. demand of 345 tonnes. During the first nine months of 1997, India took down 535 tonnes of gold, 44% higher than demand during the first nine months of 1996. Year-to-date, consumption in India is approximately double that of the U.S., the second largest consumer of gold.

Among the factors accounting for the rapid rise in Indian demand are several that should be positive for continued growth in demand in the years ahead. The Indian government has elected to enact reforms in the gold market. In October, the government allowed all authorized agencies to import gold under what is termed an Open General License which allows appointed agencies to import unlimited amounts for sale on the local market after payment of a 5.0% import duty. This reform is expected to reduce the gold premium from a level of 15% to a range of 7% to 8%. Reflecting these changes, quarterly demand in 1997 is approximately double the level of quarterly consumption recorded in 1996. Taken together, the reforms instituted in India are expected to lead to higher demand over the longer term.

Brazil and Mexico are relatively small consumers of gold compared to other developing nation regions. Total demand was reported at 27.5 tonnes during the third quarter, an increase of 22% from the comparable 1996 quarter. Year-to-date, demand was 19% higher than that recorded in the first nine months of 1996. Jewelry demand consumed 20 tonnes and investment demand accounted for 7.5 tonnes.

In the developed nations, demand was down 2.0% for the third quarter and down a similar 2.0% on a year-to-date basis from the first nine months of 1996. Demand was 192.7 tonnes during the third quarter. Marginal growth in jewelry demand in Europe and the U.S. was offset by lower demand in Japan where a weak economy continues to impact gold sales. Some improvement was recorded in investment demand for U.S. bullion coins. Investment demand increased to 21.1 tonnes largely as the result of bullion coin sales in North America. Investment demand in Europe and Japan remain modest as economic conditions remain stringent.

Despite seemingly endless reports of impending sales from gold reserves held by central banks and international monetary authorities, little actual gold has changed hands. The International Monetary Fund reported that the official gold holdings of all nations totaled 34,493.4 tonnes (1.108 billion ounces) at the end of 1996. Official reserves at the end of August 1997 were estimated at 34,138.52 tonnes–a decrease of 354.5 tonnes, or 1.03%, from year end. In the words of George Milling- Stanley, the gold market analyst for the World Gold Council, “There has, in fact, been no great wave of central bank sales in recent months, or even years. But the fear is there. It may be that a bit more clarity from the world's central banks about their actions, and especially their intentions, with regard to their gold reserves, would help to improve the climate–and the gold price.”

Forward selling by the large mining companies and hedge selling by major producing interests, together with the continued threat of central bank selling, have combined to drive the dollar gold price lower. This combination of depressants will likely continue to have a negative impact on the dollar gold price as long as gold holders become discouraged and liquidate positions. At the present price, the total gold holdings of all the central banks and international financial organizations of the world total 1,096,700,000 fine ounces and are worth about $312.56 billion with gold at $285 per ounce. In relation to just the recent bail-outs of South Korea (estimated to cost $60.0 billion), Thailand (another $40.0 billion), and other tiger countries whose economies are in chaos, the sum of $312 billion seems rather under whelming, to say the least.

Because the dollar is the reserve currency of the world at this time, demand for the dollar increases during times of uncertainty. Few central bankers wish to purchase and hold gold with the major holders (U.S. and European central banks) threatening to sell gold and drive the price lower. These threats are being constantly brandied about by the establishment press. The risk to their creditability is too great and the action would also gain the wrath of the major central bankers of the world and that of the official international financial institutions, such as the World Bank and the International Monetary Fund which carry forward the work of the globalists' interests. To further their aims of buttressing the dollar as the world's reserve unit of account, there are rumors of forward sales from the official sector. Meanwhile, there has been increased central bank lending of gold to speculators whose sales tend to drive the price lower still. As Mr. Milling-Stanley comments, “Central bank gold is also used to finance short sales by speculators. And, of course, the gold borrowed by the bullion dealing community to finance speculator short selling is sold into the market immediately, increasing the physical supply and exerting downward pressure on the price.”

The net result of all this activity by hedge funds and producer forward selling is to increase the supply of paper gold to the market and depress the price of the metal. This manipulative action has had the desired effect to date. However, the distortions to supply, demand and prices will of course, be reckoned with in the fullness of time. When lower prices results in smaller supplies of gold to the market, larger and larger sales from central bank reserves will be necessary to depress prices. Lower prices will encourage accumulations of the metal at attractive prices by those who know the futility of holding fiat currencies as a store-of-value assets. In the end, the actual supply of the physical metal to the market will diminish to such an extent that the price can no longer be manipulated. This period of time in the history of gold can be compared to the January 1975 to August 1976 period when the dollar gold price decreased from near $200 per ounce on December 31, 1976 to $103 in August 1976. From that point forward, the dollar price moved erratically higher. The price moved higher even in the face of U.S. Treasury gold auctions and auctions by the International Monetary Fund. The price moved relentlessly higher to a climatic peak of $850 per ounce in January 1980. Similar price action will occur again in the future. When, we do not pretend to know nor to be able to project the timing with any useful degree of accuracy. The spark for the upward move will be an actual physical shortage of the metal on world markets in the face of ever increasing demand. At the present time, demand is increasing at a rate in excess of 11% per annum. Fabrication and hoarding demand, at recent growth rates, could total 3,855 tonnes in 1997. New mine production will total 2,346 tonnes resulting in a shortfall of approximately 1,500 tonnes in 1997. This shortfall must be made up from official sector sales and old-gold scrap. Scrappage might total 650 tonnes if recent rates of scrappage continue. This leaves a net shortfall of about 850 tonnes of the physical metal. This amount must be delivered to the market from central bank reserves or IMF reserves to prevent the price from skyrocketing. We suspect that the actual amount required to depress the gold price will increase dramatically as the futility of this exercise becomes better understood by millions of people around the world. The route will resemble what appears to be getting underway in the silver market where a shortage of the physical metal is now occurring. Shortages of silver needed for production cannot be offset by the promises of speculators to deliver 10,000 ounces at some future time. The metal is need now! In the silver market, the piper is now in the process of collecting his silver from the short sellers. The short sellers are in the painful position of attempting to purchase silver in a market wherein the physical metal is in short supply at existing prices. The soaring silver price on December 10 suggests that the cost of honoring the pledge to deliver the metal will be somewhat higher than the short sellers had initially expected.

Investors might well ask, is there a light at the end of this tunnel? The answer is yes. Within the next few years if current trends in demand and supply continue (and there is no reason to believe that deviations from recent trends will be significant), the shortfall in gold to the market will approach 3,500 tonnes per annum. This shortfall would be equal to 10%, or perhaps more, of the official gold reserves of all the world's central banks and international financial organizations. From that point forward, the panic to obtain the physical metal will intensify, and the price will begin to reflect this hoarding activity. Promises to deliver the metal will come into disrepute with the first delivery failure by a major short seller. From that point forward, the market will take command and the price will be determined by realities of supply and demand. Manipulation and rumor, as market factors, will become less significant in the market.

As the close of 1997 draws near, a review of AIC's trend-cycle analyses of the dollar gold price, the S&P 500 index and the NASDAQ Composite index. To place price movements in perspective, we also show the S&P 500 stock in 1955 dollars, i.e., adjusted for the change in the dollar gold price. The rate-of-change in trend-cycle curve (double line) on the following charts illustrates the rate at which the price is increasing or decreasing. For example, if the line is below the 100 level and rising, this indicates that price is declining at a slower rate. If the line is above the 100 level and rising, it means that the price is rising at an increasing rate. We caution readers that our trend-cycle charts should not be used for “trading purposes.”

Dollar gold prices have been on a relatively steady decline since 1988 with only a slight reprieve from 1993 through 1995. Dollar gold prices have since declined more sharply since the start of 1996. Dollar gold prices (London PM fix) averaged $404.74 in February 1996 and have dropped to a monthly average price of $306.57 per ounce in November 1997. Through the first week of December 1997, dollar gold prices are averaging approximately $307 per ounce.

The rate-of-change in trend-cycle (double line) remains below the 100 line indicating that gold prices continue to contract. However, the rate at which gold prices are declining is slowing to some extent. (Remember, this analyses uses a 12-month moving average of a 12-month moving average as base data.) When the rate-of-change in trend-cycle moves through the 100 line in an upward manner, this indicator would project cyclical rising gold prices. Readers will note that the rate-of-change in trend-cycle curve briefly rose above the 100 line in late 1989 as the dollar gold prices increased from the $360 level to just less than the $420 per ounce (monthly average)level. From there, dollar gold prices began to contract and reached an average monthly price of $330 per ounce in early 1993. From this low, gold rose erratically through January 1996. The rate-of-change in trend-cycle curve retreated briefly to below the 100 line in December 1994. From there, the monthly price moved above the $400 per ounce level, to $404.74, in early 1996. Beginning in early 1996, the gold price began a contraction that has yet to run its course. At this time, the rate-of-change in the trend cycle curve is diminishing–a development that would be welcomed by both gold investors and the industry.

AIC's trend-cycle chart of the S&P 500 stock index illustrates the secular advance of stock prices that began in early 1988 and has persisted for nearly a decade. Most noticeable from the accompanying chart is the rapid rise in the S&P 500 index from late 1994 to date. The nominal rise was preceded by a rising rate-of- change in trend-cycle curve (double line) beginning in May 1994. The rate-of-change line peaked in January 1997 at a rate of 102.25 and has since decreased to the 100.59 level through the early December 1997. A careful watch of the rate-of-change in trend-cycle is in order as it approaches the 100 line in a downward direction. At this time, share prices are continuing to advance on a secular basis–however, the rate of increase is diminishing. If the Asian situation worsens, stock prices may already have recorded their highs for this monumental cyclical upturn. At the very least, our trend-cycle chart is telling us that the gains in share prices will likely be much slower in the foreseeable future.

Similar to the Standard & Poor's stock index, the NASDAQ's rate-of-change in trend-cycle curve has remained above the 100 line for most of the past ten years with the exception of the period between November 1989 and October 1990. The drop in this index preceded the 1990- 1991 economic recession (shaded area). From its recovery to above the 100 line during the recession, the NASDAQ Composite has remained above the 100 line. A peak in the rate-of-change in the trend-cycle curve was reached in July 1995 at 102.68. This measure has since fallen back to the 100.58 level through the early part of December 1997.

The NASDAQ remains the most volatile of all the major market indices and reflects the rapid changes in the technology sector of business probably better than any other index. Share price movement in technology issues will most likely remain very volatile as businesses jockey for best position in a rapidly evolving market.

Investment in many technology issues, either by specific stocks or via mutual fund investing, has provided investors with superb returns during this decade. The risk of capital loss and market volatility will remain high.

Since August 15, 1971, when President Nixon closed the gold window, securities and commodities markets have been in turmoil. On that day, the modem world of a wholly fiat dollar was bom. The accompanying twenty-year chart depicts the S&P 500 stock index adjusted for 1955 dollars and the rate-of-change in our trend-cycle curve for the index. The year 1955 was chosen as a base year because an ounce of gold and the Standard & Poor's index both traded at approximately 35 per unit on January 3, 1955. It is assumed for our analysis that equity prices and gold were trading at an equilibrium price, in terms of purchasing power, on January 3, 1955. This hypothesis rests upon the assumption that all the inflating from 1934 forward adequately offsets the dollar devaluation that occurred in 1934 when the dollar/gold exchange ratio was increased from $20.67 per ounce to $35.00.

With relatively minor dips along the way, the S&P 500 index in gold dollars has steadily advanced over the past twenty years. The advance began from a low of 5.75 in January 1980 and recorded its high, to day, of 111.11 through early December 1997. As we go to press, this reached 120 on a daily basis. The rate-of-change in trend-cycle is 100.92 at this time. The conclusion that can be drawn from this chart is that share prices have fully (and then some) adjusted for the dollar debasement of past decades. AIC believes that future rates of increases in equity prices wi II be at rates substantially less than those that younger investors have come to expect from their experiences of recent years. In the future, stock prices will more closely reflect productivity gains and earnings growth.

December 15, 1997Richard F. Maloney

AIC Investment Advisors, Inc.

440 South Street, Pittsfield, Massachusetts

Consensus National Futures and Financial On Line Index

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