Special Report GOLD - In GOLD We TRUST

Special Report Gold

–

July 2011

In GOLD we TRUST

The foundation of a return to “sound money” has been laidGuilt without atonement? Excessive structural debt suggestsfurther appreciation of goldNegative real interest rates continue to provide gold with aperfect environmentNo reason for “AUROPHOBIA”Adieu “Exorbitant Privilege“Why gold is (still) no bubbleExcursus: the creation of money from the perspective of theAustrian School of EconomicsThe monetary system at the crossroads – on the way to anew gold standard?Gold as portfolio insuranceGold mining shares with historically low valuations

Risk/return prole of gold investments remains very favorable

Next target price at USD 2,000At the end of the parabolic trend phase we expect at leastUSD 2,300/ounce

Special Report Gold

Erste Group Research Page 1

Table of Contents

Page

1. Introduction 22. Guilt without atonement? Excessive structural debt suggests further appreciation of gold 73. Negative real interest rates continue to provide gold with a perfect environment 114. The law of diminishing marginal returns indicates that the level of debt hasreached a saturation point 13Social asymmetries as tinderbox 145. The monetary system at the crossroads – on the way to a new gold standard? 16Is a gold standard deflationary per se? 19Gold and silver as official means of payment vs. “Gresham’s Law“ 216. Regression theorem explains why gold equals money 23Stock-to-flow ratio distinguishes between gold and commodities 237. Gold as portfolio insurance 268. Possible targets for the gold price 299. Why gold is (still) no bubble 3610. History repeats 4311. Adieu “Exorbitant Privilege“ 46US Treasuries: from the risk-free fixed income paper to the risky no-income paper 4712. China on its way to the leading global currency? 50Yuan as leading currency? 5013. Excursus: the creation of money from the perspective of the Austrian School of Economics 5314. Inflation

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rising prices 5515. Demand 57Renaissance of investment demand – institutionals as “elephant in the room“ 59Central banks on the buyers’ side for the first time in two decades 60De-hedging 6316. Supply 6517. Gold mining shares 68Gold mining shares with historically low valuations 7118. Technical analysis of the gold price 74Ratio analysis 79

1) Dow / gold (currently 8.1x)

79

2) Gold / S&P 500 (currently 1.12x)

80

3) Gold / silver (currently 43x)

80

4) Disposable income / gold (currently 26x)

82

5) World Gold Mining index / gold (currently 1.5x)

83

6) Gold / HUI (currently 2.7x)

83

7) Gold / oil (currently 13.6x)

84

8) Home price / gold (currently 173x)

84

Ratio analysis: conclusion

8519. Conclusion 86

Special Report Gold

Erste Group Research Page 2

1. Introduction

The (financial) world is currently long in questions but short in answers. We believethat gold is still one of the few right answers in times of chronic uncertainty.

In what isnow our fifth Gold Report we want to explain why our long-term target of USD 2,300, set forthe first time three years ago, could come out on the conservative side.

Gold is a highly emotional topic.

It seems there are only two opposing fronts here: peoplewho love gold (aka gold bugs), and people who hate it. There are only very few shades of greybetween these two fronts, and people are extremely hesitant to defect from one to the other. Itseems as if we were faced with something like “

aurophobia

“

1

, especially in the financialsector. This pathological fear of, or aggression towards, gold does not seem to exist for anyother commodity. After all, we have not heard of such a profound aversion against copper, wedo not know “bond haters”, nor are militant property bashers a popular concept. We regardourselves as analysts rather than psychotherapists, which is why we do not really want todwell on the reasons for that strong aversion.

Instead we would like to continuesubstantiating with data, historical comparisons, and facts why we believe that goldshould be a central module of the portfolio.+25%, +140%, +460%, +4,322%.

These are the performances since the previous GoldReport, since the first Gold Report, since the beginning of the bull market in 2000, and since1970. Gold set new (nominal) highs last year both in USD and EUR as well as in numerousother currencies. The following chart illustrates the fact that the bull market is intact in bothEUR and USD, but also that we have not seen the trend acceleration yet.

Performance of gold in USD vs. gold in EUR since the most recent Gold Report

1150120012501300135014001450150015501600

0 6 . 2 0 1 0 0 7 . 2 0 1 0 0 8 . 2 0 1 0 0 8 . 2 0 1 0 0 9 . 2 0 1 0 1 0 . 2 0 1 0 1 1 . 2 0 1 0 1 1 . 2 0 1 0 1 2 . 2 0 1 0 0 1 . 2 0 1 1 0 1 . 2 0 1 1 0 2 . 2 0 1 1 0 3 . 2 0 1 1 0 4 . 2 0 1 1 0 4 . 2 0 1 1 0 5 . 2 0 1 1 0 6 . 2 0 1 1

U S D

870890910930950970990101010301050107010901110

E U R

Gold in USD (left scale)Gold in EUR (right scale)

Sources: Datastream, Erste Group Research

“Gold still represents the ultimate form of payment in the world… Fiat money, in extremis, is accepted by nobody. Gold is always accepted

”

Alan Greenspan

2

The past months have shown a clear trend: gold has been more and more regarded asthe purest form of money and increasingly less as a commodity.

It has an internationalcurrency code (XAU

3

), and is still held by the global central banks as a key reserve. Thisunderpins the monetary character of gold. We believe that the current return to a track record

1

“Gold: The Currency of FIRST Resort”, Hinde Capital, June 2010

2

Economic Club of New York, remarks by Chairman Alan Greenspan, December 2002

3

ISO 4217, International Currency Code List

Return to themonetarystatus of gold…Manyquestions,goldenanswers+140% sincethe first GoldReportNo reason for“AUROPHOBIA”