THE OUTLOOK FOR FREE MARKET GOLD

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85T00875R001700040008-8
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 20
• Document Creation Date: December 20, 2016
• Document Release Date: March 28, 2006
• Sequence Number: 8
• Publication Date: August 1, 1972
• Content Type: IM

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Confidential
v
DIRECTORATE OF
INTELLIGENCE
~nt~lligence Memorandum
International Finance Series
The Outlook for Free Market Gold
Confidential
ER .T.M 72-125
August 1972
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CENTR "~L INTELLIGENCE AGENCY
Directorate of Intelligence
August 1972
INTELLIGENCE 11~iEMORANDUM
THE OUTLOOK FOR FREE MARKET GOLD
Summary
1. Free World basic (non-speculative) private demand~l ~ nor gold
caught up with the supply of newly mined gold at the official price of
$35 an ounce in the mid-1960s, exceeded production by 15% in 1970,
and now probably is at least 30% greater. In 1970, basic gold demand totaled
about 1,480 metric tons, compared with only about 1,290 tons of new
gold production. This 190-ton supply shortfall -plus 245 tons added to
official reserves -was met by drawing down most of the remaining portion
of the speculative overhang that accu;~nulated during the 1967-68 rush on
gold. About 55% of total basic demand occurred in the developed
countries -nearly all for commercial purposes. The remainder was added
to gold hoards in the less developed countries.
2. The gap between basic demand and supply may temporarily
narrow in 1973, but will widen in the following years. Basic demand is
expected to grow about 3%-4% annually in quantity terms based on
estimated annual growth rates of some 5% for industrially developed
countries and about 1% for the less developed countries. The annual average
supply of newly mined gold, however, is not likely to expand over the
coming years, although supply in 1973 probably will be somewhat higher
than 1972's unusually low level.
1. The terms consumption and demand, although similar in connotation, have distinct
meanings as applied in this memorandum. In all cases, consumption refers to actual
tonnages of gold absorbed. ?emand, however, i~ intended to describe those tonnages
of gold that potential gold consumers would wish to acquire if the price of gold remained
constant.
Note: This memorandum was prepared by the Office of Economic
Research.
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3. These supply and demand trends are exerting considerable upward
p~~ssure on free market prices Moreover, South Africa may withhold
sufficient gold from the free market this year to drive the average 1972
price up close to US $60 per troy ounce -excluding speculation -should
the Soviet Union continue to sell only moderate amounts of gold on the
free market. The price of gold could temporarily fall ;n 1973, speculative
considerations permitting, perhaps below $SS an ounce. However, in
subsequent years, the free market price probably will increase about 8%-10%
a year on the average; about one-half will result from an increase in basic
demand against a relatively constant supply and the balance from worldwide
inflationary pressures. As a result, the annual average price of gold should
be in the range of $60-$65 an ounce in the mid-1970s, even excluding
speculative influences.
Background
4. For centuries, gold has Y~eer. sought as a store of value against
currency debasement, for display because of its aesthetic characteristics,
and more recently, also for industrial applications owing to its unique
physical properties. From the early 19th century until the mid-1960s, supply
far exceeded private demand at a price fixe3 by international agreement -
$20.67 per troy ounce prior to 1934 and $35 per troy ounce afterwards.
The large residual quantities absorbed by monetary users form the
foundation of the gold bullion standard that prevailed from the end of
the last century until 1933 anal of the gold exchange standard that was
adopted thereaf' ar.
S. In the mid-1960s, non-monetary demand overtook supply for the
first time at $3S an ounce. This largely reflected a sustained rise in
commercial and hoarding demand in the face of constant annual production
of newly mined gold, although it was abetted by such transitory events
as the virtual suspension of Soviet gold sales after 1965 and speculation
(see Table 1). It was a speculative rush from currencies into gold following
the devaluation of sterling in November 1967 that provided the final impetus
for a fundamental overhaul' of the international gold market in 1l4arch 1968.
6. In less than four months after sterling's devaluation, seven major
central banks of the Golc1 PooltZ> lost nearly 2,500 tons of gold (valued
2. The pool's membership included the Central banks of :he United States, the United
Kingdom, West Gerr.:eny, the, Netherlands, Belgium, Italy, and Switzerland (France had
withdrawn in 1967).
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Table 1
Gold: Free World Supply and Dema:~d
Metric Tons
Year
New
Production
Sales by
Communist
Countries
Additions
To Monetary
Stock
Net
PrivatE
s
Purchases
_
1950
19
755
--
288
.
467
51
19
733
--
235
498
52
1
7~5
--
205
550
953
1
755
67
404
418
954
1
795
67
595
267
955
835
67
591
311
1956
1
8'71
133
435
569
957
1
906
231
614
523
958
1
933
196
605
524
959
1
1,000
266
671
595
960
1,049
177
262
964
1961
1
1,080
266
538
gOg
962
19
1,156
178
329
1 005
1
63
1
1,205
489
729
965
964
19
1,250
400
631
1,019
65
1,280
355
196
1,439
1966
1
1,285
-67
-40
1,258
967
1
1,250
-5
-1,404
2,649
968
1
1,262
-29
-623
1,856
969
1,262
-15
97
1,150
1970
1
1,289
--
245
1,044
971.
1,250
50
-50
1,350
at $2.8 billion). Finally, on 17 March 1968, in conjunction with the'
International Monetary Fund (IMF), these central bar..ks inaugurated a
two-tier marketing arrangmant whereby monetary ,old transactions at a
fixed price were segregated from private gold transactions at prices
determined by market forces. As a result of this arrangment, which was
supplemented by an agreement between South Africa and the IMF in
December 1969, monetary gold stocks were to remain essentiali;~ unchanged
and all newly mined gold was to be sold on the free .market `?~ private
buyers except on certain occasions.~ I
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21. Under this assumption for price elasticity, in `.he course of 1971,
when the quantity supplied dropped 9% and basis demand at constant prices
probably increased by about 3% to 4%, the price would have be?n expected
to rise to about an average of $40 per ounce or to $43 an ounce by year's
end, excluding speculative factors. Actual prices rose to just under $44 an
ounce in December 1971, with the small difference easily attributable to
speculative demand.
22. In January-July 1972, the free market price soared above $60
an ounce, at times nearing $70 an ounce as a result of the combined effects
of the Smithsonian currency realignment of December 1971, short-curt
supply restrictions, and speculative demand. During the first month of the
year the price rose sharply to about $48 an ounce. This increase of $4
an ounce largely reflected the devaluation of the dollar in relation to other
major currencies. On the average the gold price in terms of these currencies
changed little. A drop in South African sales to' the free market has caused
a further rise in prices. South Africa sold 20% less to the free market during
the first half of 1972 than during the comparable period of 1971 because
of lower production and increased national reserves. A considerably
improved trade balance and continued capital inflows enabled Pretoria to
increase its reserves by $320 million, of which $60 million was in gold.
During the second quarter of 1972 the decline in sales was more than
one-third, which reduced the total free market gold supply by about 25%.
Basic demand continued to grow, and this would have raised the price of
gold to around $60 an ounce, in the absence of speculation. In aa:iition,
large increases in speculative domand have followed the current rumors that
the newly established official gold price - $38 an ounce -may have to
be doubled or tripled.
Prospects
23. A continued upward trend in prices is inevitable through at least
the mid-1970s. We project that price increases tivill average 8%-10% annually
through 1971-75 on the asumptions .:f (a) a 3%?4% annual growth of basic
demand, (b) a likely 4% rate of worldwide inflation, and (c) relatively
constant new supplies except for a ten',porary drop this year. A little more
than one-half of this projected price increase will result from increases in
basic demand and the rest from inflation. Excluding speculative effects,
the average free market gold price will likely be between $60 and $65
an ounce in 1975.~8> Under the same assumptions the basic price wos:id
8. This estimate incorporates the effects of the Smithsonian realignment of exchange
rates on gold's dollar price.
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exceed $90 an ounce by 1980, but for t'tis longe~ period tl~e supl:~ly
projection becomes much more uncertain, as there would be time for urger
investments in gold mining in response to higher prices to bear fruit.
24. In 1972 the basic price will deviate substantially from the
estimated longer run trend bccause we expect South Africa to sell about
300 fewer tons of gold to the free market this year than last. Excluding
speculation, this she~~ld yield an average price of about $60 an ounce. Free
market price rises in subsequent years should be substantially more gradual
as the flow of newly mined gold to the free market from South Africa
is restored to more normal levels and with the expected resumption of
Soviet gold sales on a larger scale. In fact, the price of gold could temporarily
decline over the next year, speculative considerations aside.
Demand
2S. Basic demand for gold in non-Communist countries is expected
to rise during 1971-75 at an average annual rate of 3% to 4% based on
a projected annual growth rate of about S% or slightly more for the
advanced countries and only about 1% for developing countries. Because
the price elasticity of demand for gold is slightly less than unity, the value
of gold demand increases at about the same rate. Consequently real demand
should increase from 1,480 tons in 1970 to 1,750 tons in 19'5 if the
gold price is constant. With a price elasticity of unity, the value of sales
in current prices will increase to the same extent -from $1.7 billion in
1970 to $2.1 billion in 1975.
26. The basic demand for the developed countries is based heavily
on past trends that have been modified slightly in some instances to reflect
changing conditions (see the Appendix). In accordance with past trends,
a projected S% a,~nuzl average increase for national income should yield
a 5% to 6% annual growth rate for gold in jewelry. Demand in dentistry,
because it is more closely related to population -which is expected to
increase 1% annually in the developed countries -than to income, probably
will rise at the average annual rate of 3%. Finally, industrial applications
of gold, which have risen at least SO% more rapidly than industrial
production in the developed countries over the past 1 S years, are likely
to be somewhat less sensitive to increases in industrial production in coming
years becaus~;: of new techniques which will lower the gold content per
unit of output in the electronics industries. Consequently, an expected 6%
growth rate of industrial production may yield only an 8% rate of increase
for industrial demand for gold.
27. Consumption in less developed countries is more difficult to
forecast because it largely depends on prevailing political and military
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conditions. Estimates range frc m a 2% annual decline to about a 2% ann.~al
increase, with the most likely increase approximat;ly 1%. Our overall
projection is a c~mpesite of ^Aparate estimates for each region. Consumption
in the Near East is expected to continue to decline as : apiii economic
development in that area provides more attractive forms of investment and
as investor sophistication grows. South Asian consumption sh~~uld increase
by only 1% to 3% a year as the growth of rural incomes gi;nerated by
the "green revolution" of recent years decelerates. Far Eastern a~nsumption,
dominated by South Vietnam and Indonesia, is likely 'to be much more
volatile. Vietnam's consumption might increase to perhaps 70 tons a year,
if a high level of uncertainty continues. On the other hand, should stable
conditions be restored to Viet~iam, consumption in 1975 could be on the
order of 20 tons - a normal level for a country with its population and
level of development. In Indonesia, economic conditions are likel;~ to
continue improving, bringing a drop in politically motivated gold purchases.
5'uPP1Y '
28. World gold production is not likely to expand over the next
several years, regardless of free market price behavior. Because a long lead
time is necessary to open a new mine -about three years for a deep level
shaft -South Africa's output through 1975 will be determined by mines
already in operation or under construction. Ry this time, four mines are
expected ~,;ii:?er to be opened or substantially expanded, providing additional
capacity of about 75 tons. At free market prices substantially above the
official price, some older mines scheduled for closure will remain open.
But, although gold mining capacity will increase and the lifespan of existing
mines will be lengthened, their production during this period will be reduced
because the richness of the ores extracted and, consequently, output in
terms of metallic content varies inversely with price.~9~ This decline in
output from existing mines will approximatelS? offset increased output from
new mines. South African production in 1972 is expected to be 8% (about
9. All but one of the seven goldfields are in one geological basin -- the other field
is in a subsidiary basin -- that is characterized by the occurrence of gold in thin reefs
at extremely deep levels -- down to depths in excess of 10,000 feet. The gold is found
in the form of a fine dust intermixed in a conglomerate, and for each metric ton of
conglomerate mined an average of about one-third ounce of gold is obtained. Remo gal
and processing of the conglomerate is the gold industry's bottleneck. The total volume
produced can be varied somewhat, however, by extracting ores with different gold
content. The richness of the ores extracted varies inversely with the price of go13.
Working a given volume of lower grade ores means that in any one year less gold is
produced and profitable reserves are increased. In the long run, therefore, less gold
is left in the ground by the time the mine is closed and thus the mine's lifespan is
considerably lengthened.
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75 tons) less than in 1971. Moreover, production from existing mines should
continue at that level until the mid-197Gs.
29. The condition of South Africa's balance of payments and the
marketing policies of th.e Swiss "Big Three" banks which market most of
South Africa's output~l~~ will continue to yfr,;ct supply conditions. South
Africa, because of potential balance-of-payments surpluses, may withhold
upward of 200 tons of newly mined gold in 1972 and additional amounts
in subsequent years to build up its own gold reserves. Pretoria expects a
balance-of-rayments surplus of about $500 million in 1972 compared with
a $340 million deficit in 1971, mainly as a result of a vastly improved
trade balance.
30. Production by other non-C'ommuni ;t countries will probably
decline or at best remain constant because a substantial share of this output
is a byproduct of other metals production, which is little affected by
changing gold prices. Moreover, gold mine operations everywhere are Beverly
pressed by rising costs. Although rising receipts have somewhat alleviated
th4is squeeze, the basic price trend is probably still tao low to influence
production significantly.
31. Finally, it seems likely that the Soviet Union will resume
large-scale sales. Planned imports of capital equipment and grain are
expected to greatly increase Moscow's hard-currency requirements. With
nearly 1,750 tons of gold reserves, Moscow may now be willing to sell
enough gold at least to offset the expected decline in non-Communist
supplies (150-200 tens annually through the mid-1970s). During the decade,
moreover, the potential for Soviet sales will increase. Preliminary estimates
suggest that annual production should rise from the 1971 lever ~f about
225 tons to 350-400 tons by the mid-1970s.
32. The gold supply in the late 1970s is less predictable. The problem
is not so much a lack of gold deposits but rather whether these deposits
can be profitably mined. Although the prospects that prices will increase
at least as rapidly as costs could lead to a substantial increase in production,
this is by no means certain. An increase in production would have the
effect of dampening price increases. Practically all producers outside South
10. The Big Three Swiss banks -- (1) Union Banks of Switzerland, (2) Swiss Banking
Corporation, and (3) Swiss Credit Bank -- gained the ability to manipulate the gold
market after 1968 when South Africa shifted the bulk of its gold sales from the London
market 4o this consortium.
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Africa depend on government subsidies, and higher prices might result in
lower subsidies. Moreover, the South African government largely determines
the profitability of .its manes through tax policy, and, if dependence on
gold to finance balance-of-payments deficits declines, Pretoria may not
encourage an expansion of its gold industry.
Implications
33. A price increase on the order of that envisioned through the
mid-1970s could threaten an end to the two-tier gold market,, depending
on the shape international monetary reform assumes. If Special Drawing
Rights, or some other new form of international reserve ass;,t, were to gain
sufficient favor among central banks, then part of the nearly 36,000 ions
($44 billion at $38 an ounce) of gold in official coffers could be sold on
the free market. Large-scale sales of gold stock, however, would depress
the free market price and reduce the advantages of further sales.
34. Conversely, rising prices may increase gold's attractiveness as a
reserve asset and encourage same gov~;rnments to purchase free market gold.
This would be the most likely outcome in the absence of restored confidence
in the international monetary system and the viability of alternative reserve
forms. Steadily rising prices could dispel a principal argument against gold
as a reserve asset. If the free gold market price rose steadily, a country's
gold reserves -far from being sterile assets -would indeed increase in
market value. Moreover, a combination of sustained dollar inconvertibility
and a rising gold price would tempt some central banks to dispose of excess
dollar holdings by using them to purchase free market gold.
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