CPM Group Precious Metals and Commodities Research, Consulting, and Merchant Banking

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1 CPM Group Precious Metals and Commodities Research, Consulting, and Merchant Banking Dear Gold Mining Executive: Over the past few months has been asked by executives at several gold mining companies that are clients of ours about the price implications of rising jewelry and/or investment demand for gold. As it has been explained to us by several gold producers, the gold mining industry is being asked to spend large amounts of scarce financial resources to promote gold use in jewelry. The marketing people behind this promotional effort are said to be telling producers that only by stimulating gold jewelry demand can producers ever hope to see gold prices rise. While it is a noble and worthy effort for producers to promote gold jewelry, mining industry executives must understand that it is impossible to drive gold prices significantly higher on a sustained basis with jewelry demand. Gold prices never will rise significantly due to growth in jewelry demand. This reflects the basic nature of jewelry demand, which is negatively correlated to gold prices. The chart on the next page shows how strongly gold jewelry demand has risen over the past two decades. Yet gold prices have not risen commensurately. In fact, the reverse is true. One of the reasons why gold jewelry demand has risen strongly over the past 15 years or so has been the steady decline in gold prices. You see, jewelry demand does not exert a strong influence on gold prices, but gold prices have an significant effect on jewelry demand. As prices have fallen, the lower gold price has stimulated jewelry use of gold. If prices ever were to rise, you would see the reverse function immediately kick in. (Another reason for the strong increase in jewelry demand over the past 15 years was the removal of barriers to gold jewelry ownership in China, India, Pakistan and other markets, a deregulatory process that (a) now is largely behind the market and (b) from here forward is likely to work against gold demand, by opening other alternative purchases for consumers in these developing markets.) The statistical relationship between jewelry demand and gold prices is That indicates the high degree to which gold jewelry demand has risen as prices have fallen, and the degree to which one would expect jewelry demand to decline should gold prices rise again. The World Gold Council reported in November 1999 that the average price elasticity worldwide was 0.8, concluding that gold price changes heavily affect jewelry demand. A 10% rise in gold prices thus would be expected to shave 8% off of world total jewelry demand. In contrast, the correlation between gold prices and investment demand is Broad Street, 37th Floor New York, NY USA telefax Jchristian@cpmgroup.com

2 Page 2 of 5 Gold Jewelry Demand and Gold Prices 100 Gold Price Percent Change 100% Gold (right scale) Gold Jewelry Demand 90% 80% 70% 60% 50% 60 40% 50 30% 40 % 10% 30 0% -10% -% p -30% The key point is that gold jewelry demand is price elastic. As prices fall, jewelry demand rises. Should prices ever begin to rise, jewelry demand will fall, and fall sharply. It s that simple. This already is visible in the two key markets of India and Italy. Rupee gold prices rose 4.6% last year. Legal imports fell % in the first seven months of the year, and consumer demand for gold jewelry is estimated to have declined 9.0% for the full year. In Italy much the same pattern has occurred, with demand declining an estimated 8.0% in 00 as lira and euro gold prices rose. These two markets are highlighted in this letter s appendices. There are several reasons for this. Higher prices lead manufacturers to reduce the per unit gold use, to keep jewelry pieces affordable. Consumers reject higher priced gold jewelry. The idea of convincing gold producers that jewelry demand growth is the key to higher metal prices has happened before. In , as gold prices approached their cyclical lows of that period, the World Gold Council and marketing groups then associated with it tried to convince gold producers that they should focus on promoting gold jewelry, and that gold jewelry demand growth alone could push gold prices higher. Since that time gold demand in jewelry has risen 36.8%, and prices have languished. The simple truth of the gold market is that it is investment demand that drives gold prices higher. If investors buy gold, prices rise. Investment demand has a positive correlation to gold prices: Investors continue to buy in rising markets, even as jewelry consumers pull back from gold.

3 Page 3 of 5 You may be familiar with the body of research that has published over the past years. These unbiased studies have shown repeatedly that investment demand is the key component to rising and falling gold prices. If gold were simply a commodity today, its price would be much higher than it is. It is expressly because gold is a financial asset, competing with U.S. Treasuries, stocks, the U.S. dollar, and other investment products, that gold prices are as weak as they are today. Gold is a financial and investment asset. Approximately 99% of the gold trades made every day and every year are made for speculative and investment purposes, and are not related to mine output, central bank sales, scrap recovery, or jewelry demand. If you want to help the gold price rise, you need to focus on its intrinsic and key nature as a financial asset. (As an aside, it is also expressly a reflection of gold s role as a financial asset that the ratio of gold derivatives to physical supply are as high as they are. The gold ratios are in line with those of other financial assets, such as stocks, bonds, and currencies. They are not similar to the ratios in other commodities markets expressly because, unlike oil, copper, and coffee, gold is much more than just a commodity. Those who will tell you that the high ratio in the gold market is prima facie evidence of a conspiracy to control gold prices completely miss the point. They simply do not understand the gold market.) I do not want to discourage producers from promoting the use of gold in jewelry. I have spent much of the past 22 years berating producers for not actively marketing their product. That said, producers should understand what they are doing, and the likely consequences. And they should understand from the outset that they can double the use of gold in jewelry again over the next 15 years, and it will have no substantial lasting upward influence on gold prices. In contrast, increases in investment demand for physical gold can have immediate and dramatic effects on gold prices. I would gladly discuss gold jewelry and investment demand, and what our opinion regarding suitable promotional programs for mining companies, further with you and anyone else who wishes to discuss this topic, and I welcome your comments and reactions to the contents of this letter. Sincerely, "jeff christian" Jeffrey M. Christian Managing Director

4 Page 4 of 5 Indian Gold Prices and Gold Jewelry Demand Indian jewelry demand rose sharply in the middle of the 1990s, in response to many factors. One was the removal of import bans and the legalization of the importation of gold. This, coupled with strong income growth, helped boost demand for gold jewelry. This chart somewhat distorts trends during that time, additionally, because the gold price shown here is the international price converted into rupees. In reality, gold prices in the Indian market had been inflated for decades due to the illegality of imports and exports, which created a premium price for gold in India. As the government removed these bans, the Indian domestic price actually fell. More important relative to our discussion, you can see that the demand for gold in jewelry form has declined for the past two years. One factor behind this decline has been the rise in gold prices in rupees (the Indian market now tracks international prices much more closely). Another has been a shift in consumer preferences away from jewelry toward electronic goods, computers, cell phones, automobiles, and other consumer luxury items. 26 Rupees/Ounce 14, Rupee Gold Price(right scale) 13, Indian Jewelry Demand 13,000 12,500 12, , p 11,000

5 Page 5 of 5 Italian Gold Prices and Gold Jewelry Demand There is no magic here. When lira-denominated gold prices fell in the 1980s, gold demand in jewelry rose in Italy. When prices rose, demand growth leveled off, and recently has declined. 22 Lira/Ounce 650, Lira Gold Price(right scale) 600, , Italian Jewelry Demand 500, , p 400,000