‘To me the gold price takes the form of a very uncomplicated formula, and all you have to do is divide one by ‘n.’ And ‘n’, I’m glad you ask, ‘n’ is the world’s trust in the institution of paper money and in the capacity of people like Ben Bernanke to manage it. So the smaller ‘n’, the bigger the price. One divided by a receding number is the definition of a bull market.
You’ll notice that this had nothing to do with security analysis. This is conceptualizing, brainstorming, nothing to do with price/earnings ratios, other valuation methods like cash flows. It is a proposition or a hypothesis on what is driving the gold market. So the gold market is necessarily a speculative piece of business. It’s not to be confused with the kind of investment that Ben Graham wrote about. Anyway, I happen to be bullish on it, but not for reasons that I can readily defend before a member of the fraternity of chartered financial analysts.’
Jim Grant, of Grants’ Interest Rate Observer, speaking to King World News.
The precious metals both made new highs overnight. Gold is approaching US$1480 while silver is over $42. Yet they produce no earnings. The inert nature of the metals makes them very hard for many investors to comprehend.
To key to working out the allure of gold and silver is to look elsewhere. Watch what their competitors are doing. Who are their competitors? Predominantly the US dollar, the euro and the yen – the world’s major paper currencies.
On Thursday, US Treasury Secretary Tim Geithner – ostensibly the manager of the US dollar – and President Obama were doing the rounds trying to convince everyone of the US’s planned fiscal rectitude. The market wasn’t buying it.
There is a bear market in trust. The ‘n’ as Jim Grant puts it, is diminishing day by day. And it’s not about to change anytime soon.
While the case for gold might seem obvious to some, to others it just doesn’t make sense. A few weeks ago we sent a special email warning of a breakout in the gold price and why it was important to own physical metal, not just a paper claim to it.
Amongst others, we received the following response:
Your Advice to Purchase Gold Metal is a Fatal Error.
I note that you advise investors time and again to purchase physical gold, when it can only lead to a large financial loss. Mr. Bernanke is an expert on the 1930’s depression, and in his address to the National Economist’s Club on Nov 21, 2002, when speaking on deflation, he tells us exactly what he will do when faced with today’s problems.
He says that printing money will always reverse a deflation and outlines 7 measures that he would take. To date he has already taken the first 5 of them. The 6th is monetisation of US debt, initiated in March 2009, and continuing under the term called “quantitative easing” today. Lastly he advocates the Roosevelt solution “by a 40% devaluation of gold (presumably you mean revaluation –ed) — enforced by a programme of gold purchase and domestic money creation”. And here is the problem. On May 31st. 1933 Roosevelt made it illegal to hold gold, and confiscated all gold held at that date at the then rate of $20.67 per oz.
BUT a year later in March 1934, Roosevelt re-valued gold up by 60% to $35.00 per oz. and devalued the dollar by 40%, thus robbing all holders of metallic gold. But that didn’t worry the workers marching down the street tearing the place apart, because they didn’t have money in the bank, or any gold to be stolen. But it paid off a big slab of the government debt, and thus Roosevelt was credited with solving the depression overnight. And with WW2 in 1939, it got rid of the rest of the debt.
So I believe it is very wrong to advise your readers to hold metallic gold as you suggest, and it seems to me that the safest way to hold gold is in the ground.
The old proverb, ‘there are none so blind as those that will not see’ comes to mind here. We’re not trying to be disrespectful. Everyone is entitled to an opinion and that is what makes a market.
The assumption here is that governments worldwide will again make gold ownership illegal, confiscate it and then revalue it against their currencies.
The probability of that happening on a global scale is so small it’s not worth contemplating. Gold is truly an international currency, traded around the world and around the clock. Coordinated confiscation would not be possible.
The 1930s was a very different place, socially, to what it is today. People had trust in government and were mostly compliant in handing over their hoarded gold. Today they have little trust and wouldn’t think about doing it again. Once bitten, twice shy.
And to think that revaluing gold solved the depression overnight is completely ignorant of the facts.
One of the things that made the Depression great in the 1930s was Hoover’s belief that purchasing power (in the hands of the worker) would solve the problems. So he encouraged the maintenance of high wages rates, thinking that a well-paid worker would spend and get the economy going again.
This had the effect of killing profits and locking millions of workers out of the market. Those lucky enough to have a job enjoyed rising real wages (deflation increased the real value of wages) but this came at the expense of very high unemployment rates and falling company profits. That’s why the market continued to fall in the early 1930s.
Roosevelt’s confiscation of gold was a crude attempt at reflation but by this stage the economy had already hit rock bottom. A bounce was inevitable.
And it is wrong to say that the proceeds from the gold theft (let’s call a spade a spade) were used to pay off debt. The $2b gold hoard was used to create the American Stabilisation Fund (created via the Gold Reserve Act of 1934), modelled on the British Equalisation Account established in July 1932.
After abandoning the gold standard, these governments needed a mechanism to control the foreign exchange markets. This was the start of government interference in foreign exchange.
The decision to buy physical gold is not a fatal error. The decision to believe that governments and central banks can fix the problems they helped to create is a fatal conceit.
While owning gold in the ground (via gold mining companies) is one way to get exposure, a diversified portfolio should also have a healthy exposure to physical bullion.
For Daily Reckoning Australia