Sub-Industry Outlook

Our fundamental outlook for the gold sub-industry for the next 12 months is positive. Based on our expectation for increased production and a further rise in the gold price, we look for another increase in sales and earnings for this group.

While the price of gold has been rising steadily since 2001 and is likely to reach its highest average level ever in 2010, we believe that the price will rise again in 2011, for several reasons.

First, we believe short-term interest rates will remain at low levels. Notwithstanding a continuation of the economic recovery and a forecast rise in the Core Consumer Price Index, we believe it is unlikely that the Federal Reserve will raise short-term interest rates significantly given our forecast for an average unemployment rate of 9.5% in 2011, versus 2010's estimated unemployment rate of 9.7%. Low short-term interest rates reduce the opportunity cost of holding gold as an investment.

Second, despite the higher gold price, global mine production has been declining for over a decade. The low level of gold prices in the late 1990s led to a drop in exploration and large new discoveries. According to data compiled by Gold Fields Minerals Service, a U.K.-based metals consulting firm and publisher, global mine output has been in a downtrend since 1999. We believe that production will remain stagnant for the next several years, as old mines are becoming depleted and are not being replaced to the extent needed to lift output. We also note the lack of discoveries of large new deposits. This, combined with rising investment demand, should cause the chronic gap between production and consumption of gold to widen further, in our view, helping lift the gold price. Partly offsetting this is an expected increase in the supply of gold scrap.

Third, we expect that greater volatility of the major world currencies will boost demand for gold as a monetary reserve asset. Also, we believe that China and other countries that hold a large portion of their foreign exchange reserves in U.S. dollars will ultimately diversify out of the dollar and into other currencies and gold. Finally, we think that gold will rise in all currencies due to the implementation of quantitative easing by governments throughout the world.

Year to date to October 1, the S&P Gold Index rose 34.6%, versus a 3.6% gain in the S&P 1500 Composite Index, a 4.1% advance in the S&P 500 Materials Index, and a 20% increase in spot gold. In 2009, the sub-industry index rose 16.2%, versus a 24.3% advance in the S&P 1500, a 46.4% increase in the S&P 500 Materials Index, and a 24.4% rise in spot gold.

--Leo Larkin