Having spent the past few years doing their best to increase the value of our assets they are becoming increasingly concerned with how to protect the assets that we already have.

- Rob Weinberg, the new head of Institutional Investment at the World Gold Council, making an observation at the Council's 15th annual meeting (May 18th 2001) about the prior day's surprisingly large turn out by nearly 100 fund managers who had come to listen to their case for gold.

He was referring to recent concern expressed by many global pension fund managers whose passively managed (or index tracking) portfolios, the upshot of a 50 year paradigm shift, have turned into a one way bet. It is a candid analysis of the global investment environment, and surprisingly bullish for gold.

In the analysis, he hones in on a recent report published, no… not by Professor Nuberger, but by Graham Birch of Merrill Lynch Investment Managers, who is responsible for the management of the sole remaining gold fund in the UK. Mr. Birch points out that in addition to the enormous growth in passively managed, indexed funds from 1995 through 2000, many of the actively managed funds have also adopted stringent, index related benchmarks. Importantly, Graham notes that gold does not feature in any of the major indices or benchmarks. In other words it is being ignored (italics are Rob Weinberg's words).

Mr. Weinberg simultaneously discusses the likelihood that the global financial environment is in the "throes of another paradigm shift" - where earnings may no longer outpace the rate of global inflation, for instance, and where long run investment returns regress to their mean. And if so, does gold have a place in the world of portfolio risk management?

We only object with one sentence in the 4 page report… you'll spot it… it sticks out like a very sore thumb. Otherwise, it is quite bullish (for gold prices).

But wow!! How many passively managed global pension funds, which have little or no gold in their portfolios, are there? We've heard reports of fund buying for several days now. Is this only the beginning? Probably yes!

Goldenbar Subscriber Question:

My neighbor trades foreign currencies. He says the Dollar will not crack for the simple reason that no one wants the Euro or the Yen as the obvious alternatives. The dollar is the lesser of three evils if you will. Do you think that this is possible or are the (deteriorating) economic factors behind the dollar - low US economic growth, higher inflation, lower interest rates and deficit spending - just too powerful to stop the U.S. Dollar from remaining strong??

Good question, heh? As far as we can tell, our hypothesis has been strengthening, so we do expect to continue to see deterioration in real economic growth, and much higher inflation. Over the past two quarters, the rate of inflation (measured by the implicit price deflator) has outpaced the real rate of growth implicit in the US GDP report. To the extent that the government's inflation data (the CPI, PPI, and the implicit price Deflator) lags reality, as it was designed to, it functions as a fine manager of inflation expectations. In this case, the data is presumably telling a six-month-old story. And since there is reportedly a six-month lag before the effects of a rate cut set into the economy, the first in the series of rate cuts this year will manifest sometime in June. Why, that's this month!

But while the government's figures won't reveal these effects until December some time, we believe that fixed income investors have caught on to the obvious trends. So yes, we see higher US debt market yields, for various other reasons as well.

The question is, what is the Fed gonna do about it? It will have to follow the market, as always. That portends a reversal of monetary policy sometime this year. But higher interest rates need not contract the money supply. In fact, they hardly ever have, by themselves. They can exert an influence on its rate of growth, but there are other factors that affect the rate of growth in money supply, perhaps more today, such as the business cycle or the credit cycle, or maybe even the dollar itself. By credit cycle, we are referring to secular trends in the interaction between borrowers and lenders - and to the extent that the spread between short and long term interest rates allows an incentive for lenders to lend, they will, as much as borrowers want to borrow.

Nonetheless, the multi factor combination of higher nominal interest rates, slower real growth, the subsequent prospect for a surprise decline in government tax receipts, the determination of the current administration to expand outlays over the next two years, and the ultimate correction in equity risk premiums will undeniably raise the probability of a budget imbalance.

To the extent that the dollar's external purchasing power is dependent upon prospective (US) economic performance, the higher inflation rates portend a return to a reliance on fiscal policy - or deficit spending - which spending power may be broadly perceived to have been saved up now, in order to defend the dollar.

However, to the extent that the dollar's foreign (external) purchasing power is reliant on the perception of economic stability, God only seems to know that it cannot deliver. So let's discuss the all-important dollar, which is supposed to be as good as gold, relative to all other currencies.

In the June 1 Subscriber issue of the GIC:

• The battle to contain inflation expectations rages!
• Should the ECB bribe speculators, or reward investors?
• How can we expect market psychology to adjust to a potential reversal in the primary trend of gold prices?
• Perhaps some perspective on how market's have had to accept the unacceptable in the past.
• How does the shifting economic paradigm in our reader's question conflict with the goal of the US Treasury; the strong dollar, which today means the foreign exchange rate? Is it really the lesser of three evils?
• When will Dollar/Gold break down - in other words, when will gold prices bust through the mid $300 handle?