A reply to Ted Butler''s suggestions for GATA

By Bill Murphy, Chairman
Gold Anti-Trust Action Committee Inc.
June 18, 2000

GATA and its friends owe deep thanks to our committee
member, Wayne Wagner of Maryland, who on GATA's behalf
just attended the International Precious Metal's
Institute conference in Williamsburg, Va.

Wayne also has been communicating with the Census
Bureau, Commerce Department, and other government
officials about the U.S. gold trade figures. Already he
has gotten a Census Bureau official to say that
something is seriously wrong about those figures, and
an investigation is now under way.

At the International Precious Metals Institute
conference Wayne publicized the quot;Gold Derivative
Banking Crisisquot; report's availability at the
www.GATA.org Internet site and presented GATA's views
about why the price of gold has been so low for so
long.

One of the speakers at the conference was an economist
from the Federal Reserve Board, Dale Henderson. The
following is a Bloomberg report of what Henderson said,
along with some remarks from New York Gov. George
Pataki:

* * *

Central Banks Have Little Need
for Gold, Fed Economist Says

By Claudia Carpenter

Williamsburg, Virginia, June 12 (Bloomberg) -- The
world's central banks have little need to maintain
reserves of gold, which has lost almost a third of its
value in the past four years, according to a U.S.
Federal Reserve economist.

quot;The role of central bank gold is diminishing,quot; Dale
Henderson, an international economist at the Fed, told
an International Precious Metals Institute conference
in Williamsburg, Va. Banks should sell gold
reserves because quot;the benefits outweigh the costs of
selling,quot; he said.

The United States, the world's largest gold holder with
262 million ounces -- mostly at Fort Knox, Ky. -- has
been the biggest loser by not joining other countries
in selling bullion reserves, Henderson said. Gold
futures are trading at about $290 an ounce in New York,
down from $420 in January 1996.

A Federal Reserve report last month prepared by
Henderson urged a speed-up of central bank bullion
sales and a slowdown of mining to benefit both
individual countries and users of the metal, such as
jewelers.

Central banks at the end of last year held about 33,490
tons of gold in their vaults -- enough to keep the
jewelry industry supplied for 11 years, according to
the International Monetary Fund. Jewelers are the
biggest users of gold, accounting for more than 80
percent of demand.

In the past decade, central banks in countries
including Switzerland, the United Kingdom, Belgium, the
Netherlands, Australia, Canada, and Malaysia have sold
gold from their reserves.

Mining for gold is going to get more costly in coming
years because of more stringent environmental laws, New
York Governor George Pataki told conferees yesterday in
a speech on politics and the environment.

quot;I'm not saying that the mining industry should shut
down,quot; Pataki said. quot;All I'm saying is it's going to
get more costly to mine, because the environment won't
stand for the mining practices of the past.quot;

Governments would benefit from the sale of their gold
bullion reserves by receiving interest payments from
bonds or other assets they could buy with the proceeds,
Henderson said. Jewelers and other users would gain
from the reduction in prices resulting from the sales.

An immediate sale of all central bank gold would result
in a drop in gold prices of $75 an ounce, Henderson
told the conference. That would cost mining companies
$133 billion in lost revenue.

If central banks wait 20 years to sell their gold, the
benefits to them and users would drop to $235 billion
from the $340 billion they would get for selling it
now, according to the Fed study. It was prepared in
conjunction with economists from the University of
Michigan, the University of Chicago, and Amherst
College.

* * *

Below is Wayne's report to GATA about Henderson's
remarks:

* * *

By Wayne Wagner

On this first full day of the conference, everyone was
treated to a free lunch, compliments of NYMEX. Before
the conference I thought this would be the Big Event
for GATA, for the luncheon speaker would be Dale
Henderson of the Federal Reserve. He would present to
the conference his controversial study, quot;Central Bank
Gold Reserve Management: Benefit of Expediting
Government Gold Sales.quot;

This took some courage on Henderson's part. I once read
that about three years ago when he spoke on this topic
the audience of grown men and women pelted him with
wadded paper napkins. I didn't believe this story but
somebody at the conference told me he was there and
that it was all true. I resolved to be assertive yet
polite in case of any sharp confrontation. After all,
Bill, you have always said that it is the truth that
serves GATA best.

I finished my meal quickly and pulled out my copies of
Henderson's 1997 papers. Throughout his presentation,
the people around me would glance over my shoulder as I
followed nearly every chart, table, or graph that
Henderson projected on the movie screen with the
corresponding figure from his 1997 work.

Henderson was introduced to the conference by The CPM
Group's Jeffrey Christian, who voiced the opinion that
misinformation about the state of the precious metals
markets has never been greater than it is today, and
that a great deal of this is because of the
uncertainties of central bank gold policies.

With this ambiguous endorsement, Henderson started his
presentation by saying that these were his views, not
necessarily those of the Federal Reserve, and that he
looks forward to constructive dialogue with others on
this topic. He noted that his views had some support in
John Young's paper, quot;Gold at What Price? The Need for a
Public Debate on the Fate of National Gold Reserves,quot;
published by the Minerals Policy Center.

Some people around me now emitted low growls and
gritted their teeth. One later explained to me that the
Minerals Policy Center is a bunch of quot;enviro-craziesquot;
who argue that gold mining should be stopped on
environmental grounds. Of course THEY would want
governments to sell their gold.

Yet I did meet at least one fellow at the conference
who believed that gold was way OVERPRICED. quot;What other
commodity has a 20-year supply stockpiled in
government warehouses?quot;

quot;Umm, I hear the European Community has a big mountain
of butter...quot; was my feeble reply.

A Belgian analyst sharing the conversation laughed,
adding, quot;Not that big!quot;

Well, if you view gold as just any other commodity,
they might be right. But banks and governments don't.
To them, gold is money.

After comment from various interested parties,
Henderson has updated his study and retitled it,
quot;Benefits of Expanding Gold Sales.quot; (The updated paper
is not available in print.) The pricing model can be
downloaded from the website
www.amherst.edu/jsirons/gold.

Henderson noted that in the three years since the
original paper was published the price of gold had
dropped excessively, mostly because the markets asked,
quot;What is government going to do?quot; The Belgians were
selling, the Dutch were selling, the Asians were
selling, and it looked like the IMF itself would be
next.

Henderson praised the Washington Agreement as a
quot;landmarkquot; in central banking transparency, as CBs
previously had been loath to discuss such matters, but
were now stating their intentions clearly. In his
opinion, the Washington Agreement and British gold
auctions were both examples of quot;good government
behavior.quot; Although gold has had its ups and downs, it
was now trading for $20 more than before the Washington
Agreement was announced.

Henderson continued: Although gold has government uses,
he would not discuss government uses now. His model
focuses on private and industrial uses of gold only;
jewelry, bars, coins, dentistry, and electronics.

Henderson's central theme: If governments sold all
their gold, general welfare and government revenues
would increase, with the greatest benefits going to
those countries whose governments sold first. (Thus,
only something like the Washington Agreement can deal
with the quot;first in linequot; issue.)

Henderson explained that the discrepancy between the
minimum gold price after total sales that he forecast
in his 1997 paper, $309, and the current price, around
$290, was because the extraction costs assumed in the
'97 paper were too high; the recalibrated model assumes
a $250 production cost and a minimum gold price of
$275/ounce.

Public welfare gains are thus not as great (money saved
from the expensive costs of mining). (Also, a key
change I noted is that more entities lose out -- those
who stockpile and use gold, like jewelers, definitely
lose out, where before they broke even.)

Henderson notes that the model indicates enough money
to compensate miners for their losses, though not
private hoarders. He acknowledges that compensating
miners would be extremely difficult because of the
transnational nature of gold mining; those countries
hoarding gold in vaults are not usually the same
countries that produce the precious yellow; how one
country's taxpayers could be dunned for the lost income
of miners in another country is a mystery to everyone.

Henderson admits the model assumes that governments are
not leasing gold for income, but that's OK because the
United States doesn't lease gold anyway but gains only
by price appreciation. But leasing might be considered
preferable because the government quot;retains ownership.quot;

The floor was now open for questions, and, identifying
myself as GATA's representative, I asked the first one:
quot;Mr. Henderson, I'm pleased that your model has been
updated with more realistic supply data, but why is the
demand function so simple? Why is it assumed that the
entire world behaves the same way, with increase in
population the key factor? Why not break the demand
function down country by country? And why is it pegged
to population and not income?quot;

Henderson supported the idea of breaking the demand
function down country by country as a worthy project.
He said he believes that projecting gold demand by
population rather than by income is more accurate.

George Gero asked Henderson if he didn't think that
eliminating the gold stockpile would reduce the
security of the dollar. Henderson replied that this was
a government use and could be a consideration.

There were other questions but Henderson defended his
work throughout. While the quantitative model could use
refinement, he believed that the qualitative results
were sound and would remain the same.

Seeing that I came to lunch prepared, when the Qamp;A
session ended and everyone else had departed,
Henderson graciously took time to discuss mathematical
particulars with me. We compared the current paper with
the revised version and I voiced my suspicion that with
some additional quot;refinementsquot; -- especially a variable
extraction cost -- the model might show a qualitative
change and indicate a breakeven point, and the price of
gold could drop so low that no net public benefit would
be gained.

Henderson saw no immediate way to counter these
arguments. Admittedly, it would take a computer to do
it. He kindly left me with copies of all his papers
after our tete-a-tete and returned to Washington.

Continuing with Monday morning's Session B: The
Business of Precious Metals, and Bob Lapple, Stillwater
Mining Co., quot;Stillwater Mining: An Updatequot;

Stillwater mines only PGMs, but it is after all a
mining company, and relatively willing to discuss its
plans and financial affairs. Hoping Stillwater's
PGM business could, by analogy, shed light on gold
mining, I attended this session.

Stillwater has an excellent mining property in Montana
and total costs of under $270/ounce in 1999 -- quot;nearly
the price of an ounce of gold.quot; Yet the average
realized price it received for its metal was
$548/ounce. (In any other industry, you'd refer to the
company as quot;a real gold minequot; -- but that would be
confusing and perhaps unhappy term here.)

Lapple referred to cash flow as an issuequot; yet did not
list it as one of the problems to be surmounted, as the
company is in the process of tripling its production.
Of course the capital for such a huge expansion cannot
sensibly be provided out of the cash flow generated by
current production -- Stillwater can't be sure that PGM
prices won't go down sharply before new facilities are
complete. And capital expenditures must be made now,
during the construction of these new facilities, yet
before new production hits the market.

In the Qamp;A session that followed, I asked about
Stillwater's financing arrangements. Did they issue
bonds or sell forwards or deal in the futures markets?
Mr. Lapple replied that Stillwater issued no bonds and
sold no futures -- they have a revolving credit
facility.

This reply perked up my ears. Revolving credit
facilities, which often have a maximum cap and
generally carry a higher interest rate than many other
common arrangements, are in my opinion best used for
quot;swingquot; expenses in a business that has mostly
predictable expenses because of its highly developed
plan.

The next questioner then asked specifically if
palladium sales were sold forwards. The reply was that
Stillwater's policy was to allow hedging up to 50
percent of production: currently the company hedged 30
percent of its production of palladium and 18 percent
of its production in platinum.

Sounds to me like this was the primary source of
company financing! But I asked only, quot;Isn't there a
risk if Platinum spikes?quot; and received the answer:
quot;Yes, I understand there is a risk, especially in the
gold lately -- but Stillwater assesses its risks to the
benefit of the company.quot;

Later, another analyst pointed out to me that
Stillwater was lucky because it has a sweet deal with
General Motors and has quot;other arrangements.quot;

One of those arrangements was announced that morning:

quot;Montana's state government is issuing tax-exempt bonds
to help Stillwater cover the costs of sewage and waste
disposal. Would that all mining companies could be so
lucky!

Next, Heinz Giegerich discussed the construction of quot;an
interactive Internet-based platform for the marketing
of precious metal containing refining materials.quot; Aha,
this is something I actually had experience with!

Back in the days when I worked in a glass science
laboratory, I destroyed several platinum crucibles
while melting new glass formulations or testing new
materials. The ugly remains were eventually sent to a
refiner where the precious metal was recovered and
credited back to the laboratory to pay for new
crucibles.

Naturally, you want to find a recycler who will give
you the best deal, tailored for your individual needs.
Demet's proposed system would make matching a customer
with a suitable refiner easier, and could accommodate
even small customers.

Yet it sounded as if the system subtly favored Demet's
own refining service over that of its competition. And
one analyst in the room asked if the metal supply in
customers' pooled accounts was allocated or not.
Giegerich's answer was not complete.

If pooled accounts are allocated, then Demet just acts
as a warehouse, and the customer owns his precious
metal. If pooled accounts are nonallocated, then the
precious metal is Demet's asset and the customer
has only a claim on it.

The difference is that if Demet goes bankrupt, the
allocated metal is generally safe; but owners of
unallocated metal will just be among the company's many
creditors, each claiming a share of the firm's
remaining assets -- among them the metal you thought
was your property. Ever since Handy amp; Harmon went
bankrupt, people have been more interested in the
answers to these questions. The Hamp;H bankruptcy has
acted as a catalyst to renew interest in the financing
side of the precious metals industry. Caveat emptor.

George Gero has been a member of the NYMEX since 1966
and boasts of trading the first COMEX gold contract
when gold was re-legalized at the end of 1974. His
speech was titled quot;Conditions in the NYMEX Platinum and
Palladium Exchangesquot; but perhaps should have carried
the subtitle, quot;Why NYMEX is Safe and Why You Should Use
NYMEX vs. the New Electronic Exchanges.quot;

Essentially, Gero says the new proprietary over-the-
counter Internet-based metals markets (like the ones
GM, Goldman Sachs, etc. are trying to create) bill
themselves as more efficient. Yet they will continue to
have limitations, especially counterparty and
collateral issues.

Counterparty risk is more subtle than outright default.
Suppose you do an OTC contract with a big bank you have
confidence in. Now suppose this big institution decides
it wants out of commodities. They may then decide to
sell your contract to a less-reliable institution. Or
the bank may prohibit new positions, letting you, their
once-valued customer, wither away -- and your business
too.

Futures, however, are liquid and centralized without
counterparty risk; the exchange and clearing members
shoulder that. I asked if what happened at TOCOM could
happen at NYMEX. Gero responded that TOCOM traded
one-year forwards that were managed very differently
from NYMEX; at NYMEX a TOCOM-like situation was
impossible because same-day cash settlement is a
requirement, and the quot;contingency fundquot; to handle
prospective defaults is increased with increasing
market risk.

However, if you must settle in metal, he confirms that
you'll need to take delivery with warehouse receipts --
those were the only investors who were able to profit
when platinum spiked 30 percent just hours before
expiration of the April contract this year. (A tip of
the hat to Ted Butler here!)

Gero believes that the planned demutualization of the
NYMEX will generate sufficient capital to finance its
own electronic trading system, with the advantage that
margin requirements can be tailored to individual
customers based on the market risk of a customer's
entire commodities portfolio, not just a specific
contract. But rules to prevent fraud or manipulation
would not be changed by demutualization. Gero's big
worry is too much micro-management by government; he
considers this a hindrance, not protection.