"This is the biggest debt bubble in history. Each time deflationary forces re-assert themselves, offsetting inflationary forces (monetary stimulus in some form) have to be correspondingly more aggressive to keep systemic failure at bay. The avoidance of a typical deflationary resolution of this long wave is incubating a coming wave of inflation. This will not be the conventional 'demand pull' inflation understood by most economists. The end game is an inflationary/currency crisis, dislocation across credit and derivative markets, and the transition to a new monetary system, with a new reserve currency replacing the dollar. This makes gold and silver the 'go-to' assets for capital preservation."
Paul Mylchreest, Thuder Road Report
By Michael J. Kosares
Around this time each year we like to remind our clientele that the real rate return should be one of the most important factors influencing the way you handles your savings. The real rate of return -- yield minus the inflation rate -- governs the flow of international capital into various investment vehicles. It also influences the way private investors employ their capital. When interest rates go above the inflation rate, like they did in the 1980s, the incentive is to save in the form of government and commercial bonds and bank savings deposits. When interest rates stay below the inflation rate, as they have for most of the last decade, the incentive is to save in the form of gold and other hard assets.
USAGOLD clients consistently cite the low yield on bonds, money markets and bank deposits as a top reason for buying gold. Over the past decade these clients have been amply rewarded as illustrated in our first table showing the real rate of return on gold coins and bullion. Though we could have used the Labor Department's version of the inflation rate, we opted instead to use the inflation rate as calculated by Shadow Government Statistics (SGS) -- a much higher inflation rate and one we believe closer to reality. Had we used the Labor Department's stats, the real rate of return would have been significantly higher. Using the more conservative SGS inflation rate, gold's real rate of return averages just under 7% annually over the ten year period -- a very strong return on savings in an era when just staying even is considered to be a favorable outcome. Impressively a $100,000 gold coin purchase in 2003 would be worth $186,000 in real terms today.
However, for the saver interested in the real bottom line, the opportunity loss associated with paper instruments needs to be blended into the equation. The second table provides the real rate of return on bank certificates of deposits over the past decade. It is not a pretty picture. A $100,000 CD taken out in 2003 would be worth just under $47,000 with inflation taken into account -- a nearly $139,000 swing in real net worth between the two instruments.
The Savings Trap There is another, largely hidden danger for those who save in the form of paper assets. Over the past four years, according to a recent Financial Times article, safe-haven investors poured $2 trillion into various fixed income funds and only $400 billion into stocks. Presumably this migration of capital has to do with the perceived risks in the stock market most notably the presence of computer-based traders who can spike the markets downward in a matter of seconds. The Financial Times points out though that bonds might offer "a false sense of security" particularly if inflation and interest rates rise. "Consider," says FT, "$1 million invested in 10-year Treasuries. The asset manager, MFS, calculates that if bond yields rise from 1.75 per cent to their long-term average of 5 per cent by the end of 2017, adjusted for inflation the investment will be worth just $690,000 in today's money, a real loss of about 7% per year." (Interesting that the inflation adjusted 7% real loss in 10-year Treasuries equals the annual real gain in gold over the past ten years.)
Storing wealth in largely mismanaged paper currencies can become something of savings trap offering low yields at potentially high risk -- not a good combination for the conservative investor. None of this, it needs to be said, is meant as advice to drain your savings from the banking system. Rather, it is to illustrate graphically the power of a proper diversification. It doesn't take a PhD in economics to see that in the senario outlined above the overall loss would be over 30%. Keep in mind too that this loss is calculated using the inflation rate posted by the federal government, not the SGS rate which in some years has been three times the government published rate. In other words, when calculated at the real rate of return using 1980 Labor Department methodology, the loss would be substantially more.
The Saving Grace I am often asked if I think gold will continue to perform as it has over the past decade. The short answer is that the odds favor a continuation of the current secular bull market as long as the conditions that created it persist. Those who put an arbitrary top to the price without taking into consideration the effects of monetary policy, particularly money printing, leave the bulk of the analysis on the table.
In post World War I Germany, for example, a 20-mark gold coin purchased the equivalent of twenty marks worth of goods and services in the marketplace. At the end of the nightmare German inflation in 1924, that same 20-mark gold coin (weighing roughly one-quarter troy ounces) provided the purchasing power of 14,520,000,000,000 paper marks. Those who track the nominal value of gold by itself take their eye off the prize. The investor who failed to recognize the forces driving the 1920s German gold market and took a nominal profit before the situation was remedied might very well have still lost his or her savings as the inflationary debacle moved to the next level.
At the same time, do not be fooled by the low real rates of return on gold over the past two years. Much of that lower return has had to do with weak end of year performances that obscure the higher prices achieved during the course of the preceding months. At the end of 2011 gold dropped by about $200 per ounce. It made up that drop in January, 2012. The end of year correction in 2011 was treated by many as a buying opportunity. Likewise the strong surge in gold coin demand immediately after the November, 2012 election serves as reminder that underlying demand remains strong and perhaps as a portent to what lies ahead in 2013.
For the most part, gold demand among investors globally has been driven by extremely low rates, central bank money printing (aka quantitative easing) and concerns about the relative safety of currency-based instruments including stocks and bonds. With the Federal Reserve and other central banks promising to keep rates low for the foreseeable future, the core driver to the bull market -- a strong real rate of return -- is likely to remain in place for years to come.
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