-- Posted Friday, 26 November 2004 | Digg This Article
Over a year ago, in September, 2003, John Embry published an article, "15 Reasons to Own Gold." Mr. Embry is an investment strategist with the Sprott Gold & Precious Metals Fund. As such, I suppose he is not a disinterested observer. But I am sufficiently impressed with his arguments that I think I should pass them along.
What is amazing is that this appeared over a year ago. What he said then is more relevant today. The dollar is lower. Gold is higher.
I will add some thoughts after his article.
1. Global Currency Debasement:
The US dollar is fundamentally & technically very weak and should fall dramatically. However, other countries are very reluctant to see their currencies appreciate and are resisting the fall of the US dollar. Thus, we are in the early stages of a massive global currency debasement which will see tangibles, and most particularly gold, rise significantly in price.
2. Investment Demand for Gold is Accelerating:
When the crowd recognizes what is unfolding, they will seek an alternative to paper currencies and financial assets and this will create an enormous investment demand for gold. To facilitate this demand, a number of new vehicles like Central Gold Trust and gold Exchange Traded Funds (Elf’s) are being created.
3. Alarming Financial Deterioration in the US:
In the space of two years, the federal government budget surplus has been transformed into a yawning deficit, which will persist as far as the eye can see. At the same time, the current account deficit has reached levels which have portended currency collapse in virtually every other instance in history.
4. Negative Real Interest Rates in Reserve Currency (US dollar):
To combat the deteriorating financial conditions in the US, interest rates have been dropped to rock bottom levels, real interest rates are now negative and, according to statements from the Fed spokesmen, are expected to remain so for some time. There has been a very strong historical relationship between negative real interest rates and stronger gold prices.
5. Dramatic Increases in Money Supply in the US and Other Nations:
US authorities are terrified about the prospects for deflation given the unprecedented debt burden at all levels of society in the US. Fed Governor Ben Bernanke is on record as saying the Fed has a printing press and will use it to combat deflation if necessary. Other nations are following in the US’s footsteps and global money supply is accelerating. This is very gold friendly.
6. Existence of a Huge and Growing Gap between Mine Supply and Traditional Demand:
Gold mine supply is roughly 2500 tonnes per annum and traditional demand (jewelry, industrial users, etc.) has exceeded this by a considerable margin for a number of years. Some of this gap has been filled by recycled scrap but central bank gold has been the primary source of above-ground supply.
7. Mine Supply is Anticipated to Decline in the next Three to Four Years:
Even if traditional demand continues to erode due to ongoing worldwide economic weakness, the supply-demand imbalance is expected to persist due to a decline in mine supply. Mine supply will contract in the next several years, irrespective of gold prices, due to a dearth of exploration in the post Bre-X era, a shift away from high grading which was necessary for survival in the sub-economic gold price environment of the past five years and the natural exhaustion of existing mines.
8. Large Short Positions:
To fill the gap between mine supply and demand, central bank gold has been mobilized primarily through the leasing mechanism, which facilitated producer hedging and financial speculation. Strong evidence suggests that between 10,000 and 16,000 tonnes (30–50% of all central bank gold) is currently in the market. This is owed to the central banks by the bullion banks, which are the counter party in the transactions.
9. Low Interest Rates Discourage Hedging:
Rates are low and falling. With low rates, there isn’t sufficient contango to create higher prices in the out years. Thus there is little incentive to hedge, and gold producers are not only not hedging, they are reducing their existing hedge positions, thus removing gold from the market.
10. Rising Gold Prices and Low Interest Rates Discourage Financial Speculation on the Short Side:
When gold prices were continuously falling and financial speculators could access central bank gold at a minimal leasing rate (0.5–1% per annum), sell it and reinvest the proceeds in a high yielding bond or Treasury bill, the trade was viewed as a lay up. Everyone did it and now there are numerous stale short positions. However, these trades now make no sense with a rising gold price and declining interest rates.
11. The Central Banks are Nearing an Inflection Point when they will be Reluctant to Provide more Gold to the Market:
The central banks have supplied too much already via the leasing mechanism. In addition, Far Eastern central banks who are accumulating enormous quantities of US dollars are rumored to be buyers of gold to diversify away from the US dollar.
12. Gold is Increasing in Popularity:
Gold is seen in a much more positive light in countries beginning to come to the forefront on the world scene. Prominent developing countries such as China, India and Russia have been accumulating gold. In fact, China with its 1.3 billion people recently established a National Gold Exchange and relaxed control over the asset. Demand in China is expected to rise sharply and could reach 500 tonnes in the next few years.
13. Gold as Money is Gaining Credence:
Islamic nations are investigating a currency backed by gold (the Gold Dinar), the new President of Argentina proposed, during his campaign, a gold backed peso as an antidote for the financial catastrophe which his country has experienced and Russia is talking about a fully convertible currency with gold backing.
14. Rising Geopolitical Tensions:
The deteriorating conditions in the Middle East, the US occupation of Iraq, the nuclear ambitions of North Korea and the growing conflict between the US and China due to China’s refusal to allow its currency to appreciate against the US dollar headline the geopolitical issues, which could explode at anytime. A fearful public has a tendency to gravitate towards gold.
15. Limited Size of the Total Gold Market Provides Tremendous Leverage:
All the physical gold in existence is worth somewhat more than $1 trillion US dollars while the value of all the publicly traded gold companies in the world is less than $100 billion US dollars. When the fundamentals ultimately encourage a strong flow of capital towards gold and gold equities, the trillions upon trillions worth of paper money could propel both to unfathomably high levels.
WAYS TO OWN GOLD
There are many ways to own gold. The best way is to buy a few one-ounce gold coins, preferably American eagles if you’re in the United States, or Canadian maple leaf coins if you’re in Canada. With one-ounce coins, you pay the lowest commission.
The trouble with gold coins is also their advantage: they are in your possession. They can be lost or stolen. They must be mailed back to a coin dealer to sell them for money. There are commissions to pay. But, in a time of national crisis, coins are the best way to hold gold for the small investor.
In a true panic, you will have a problem selling—not because of low demand but the opposite: you won’t be able to get through on the phone. There are probably fewer than 400 full-time retail coin dealers in the country, and most of them are small operations. This number must serve up to a hundred million American families. If one percent of these families ever decide to buy a single one-ounce coin during a panic, the phone lines will jam up.
You can buy gold shares. This is the standard approach of most investors. The problem is, you’re not buying gold. You’re buying a company that says it has gold in the ground. You are also betting on future mining costs, management skills, and the possibility than the company has already sold its output for a fixed price.
You can buy small gold units (grams) at a company like GoldMoney, which holds the gold in a bonded warehouse outside the United States. GoldMoney uses a warehouse in London. Using digital accounts is convenient. Commissions are low. Transactions are easy. You can take delivery of your gold. You must pay storage fees, which is evidence that your gold is really there. There are no free lunches and no free vaults.
There is a fund, the Central Fund of Canada, that holds mostly gold and some silver bullion. The prices of the two metals move in tandem most of the time. Owning shares of this fund is a surrogate for owning physical gold.
Recently, a new firm has been approved by the Securities & Exchange Commission to trade in units of gold as low as a tenth-ounce: streetTracks Gold Trust (GLD). This firm is part of the World Gold Council. It is receiving considerable publicity. It is likely that Americans who are looking for an easy way to participate in the rising price of gold will use this firm. If the firm becomes profitable, there will be imitators.
Always remember: if there is no proof of physical possession of gold, and if there are no storage charges for gold held in reserve, then you may be trading a futures contract, which is a promise to pay gold on demand. Promises to pay are never as reliable as gold in hand. Third-party verification of gold held against receipts issued for gold becomes important.
I think an electronic approach to holding gold is the wave of the future. There will come a day when banks and other financial services companies will offer these services. But that change will require a few currency crises that will catch the attention of people with money.
You should ask yourself what you are hedging against. Answers include the 15 reasons in the report, plus these more specific ones:
- Dollar inflation/depreciation
- Terrorist attack on the U.S.
- Crisis in the bank payments system (cascading defaults)
Retirement
- Capital gains taxation rather than ordinary income taxation
- Speculation: Asians may start buying gold
You should also ask yourself this question: "What do I intend to do with my gold?" Answers include these:
- Hold it as a speculation: buy low, sell high
- Hold it as a way to pass down wealth to my heirs
- Hold it as a way to hedge against a monetary disaster
- Hold it as a way to avoid paper trails
WHAT IS THE DOWNSIDE RISK?
The standard ones are these:
- Net central bank sales of gold to public
- Recession reduces price inflation
- Recession reduces demand for commodities
- Asians turn out to love paper money more than gold
- Government outlaws gold for Americans
- Gold-owning Americans actually obey the government
The political pressure is very strong to keep a higher price of gold from identifying reduced confidence in the dollar. We have seen the government take steps to push down gold’s price. But the government also sells gold coins. It maintains the official position that gold is not relevant for monetary affairs. To outlaw gold would be to admit that gold is relevant. This might turn into a gold-buying panic. Because Americans can easily buy and sell gold on the Web, there are ways for people to evade the law.
A worldwide recession is possible if China suffers a major recession. China at some point will have to go through a recession because of today’s inflationary policies. But the question is: When? Gold may fall 30% from $700 an ounce. If you have no gold, it’s not wise to bet the farm on a fall in price. Besides, if gold falls, you’ll probably think, "It’s going to fall even more. I had better wait."
CONCLUSION
People postpone doing what they don’t really want to do. They don’t want to take action that implies that the present system is shaky, that the government is following policies that will debase the currency, and that there is no way for the government to preserve the purchasing power of the dollar by anything other than ceasing all monetary expansion, which the Federal Reserve System never does.
I suggest that you re-think all of the reasons you have come up with for not buying gold. See if they still make sense in the light on the 2003 article at the beginning of this report.
November 24, 2004
Gary North [send him mail] is the author of Mises on Money. Visit http://www.freebooks.com.
-- Posted Friday, 26 November 2004 | Digg This Article
