A New Chapter for Gold

[sjk]

This could very well be the start of something very big!

Regards,

A New Chapter for Gold

The general meltdown in credit is the ideal macroeconomic scenario to launch gold into all time high territory. While those same conditions have been disruptive for gold and gold shares in the short term as investors sell whatever they can to meet margin calls, it is important to understand that this is a necessary passage to higher ground. Gold must shed the perception of recent years that it is just another “run of the mill” tangible asset and emerge as the premier way to escape financial havoc.

Government spokesmen and analysts who say the economy remains strong and, therefore, no extreme measures are called for, are looking at coincident indicators. If they believe what they are saying, they are either complacent or ignorant of the laws of basic economics. Whatever happened to economic forecasting? It is credit, and credit alone, that makes the economic world turn. Shrinking credit is a bad omen for future economic activity. A soft economy or, more likely, a recession in an election year, is a recipe for gold well above $1000. It is ludicrous to think that a rate cut here and there or daily injections of liquidity by the Fed will make any difference. This market-induced tightening of credit is a deflationary threat to asset values that will prove to be long lived and resistant to traditional policy measures.

In short, the rationale for a commitment to the gold sector is supported by a meltdown in credit. While it seems that the fuse has been lit for gold, the duration of the burn is unknowable. We must wait for investors to connect the dots. Discomfort with the sell off in gold and gold shares will probably be short lived, but only time will tell. Historically, tests such as these shake out weak hands ahead of significant advances. It is encouraging that the bullion holdings of global gold ETF’s (Exchange Traded Funds) have quietly climbed to all time highs during this crisis. This has happened against a backdrop of high profile panic liquidations by hedge funds, proprietary trading desks, and COMEX speculators. Gold has, therefore, been very well bid during the recent market panic and it appears that weak hands (leveraged momentum players) have been flushed out.

Within the space of a few months, the mode of the financial markets has shifted from greed to fear. Just as irrational extremes in greed were necessary to set the stage for the emergence of fear, investor appetite for risk is unlikely to return until all phobias have been exhausted. The psychic energy of crowd emotion is too powerful for central bank or government actions to harness or redirect. Attestations of public officials as to the underlying health and strength of the economy seem hollow and unconvincing. The danger of markets driven by the desire for safety is not limited to the damage they inflict on financial asset values. It extends to the impact on the real economy. Recognition of this potential is what can and will panic public policy makers.

This credit crunch is the most serious financial market event since the 1970’s bear market, and perhaps the depression. The NASDAQ crash was mere foreplay by comparison. The internet bubble was just a playground for high rolling investors. Housing has deep roots in everyman’s and every politician’s psyche. It is a sacred cow. The prospect of declining values, foreclosures, and hard times for American homeowners could put Iraq on the back pages. The potential for collateral damage far exceeds the troubles of those foolhardy investors brought down by the internet bubble.

The political and economic ramifications extend beyond US borders. America has been busily exporting risk to unsuspecting foreign investors. According to Kyle Bass of Hayman Capital Partners in a letter of July 30, 2007, most of the bad mortgage debt issued since 2003 was purchased by foreign investors who had vast pools of dollar liquidity to recycle, and had insatiable and indiscriminate appetites for any dollar denominated instruments. He concludes: “I think the world is going to begin to decouple from the US and realize that currency appreciation coupled with the globe’s best growth is an attractive alternative to fraudulent ratings, US dollar depreciation, and financial interventions used to export risk.”

There is no politically viable way to counter the threat of general insolvency, other than to devalue debt burdens through inflation. As this dilemma becomes increasingly apparent, I expect that money will flow into the gold sector at an unprecedented clip. The Fed will have to cut interest rates, expand its balance sheet and start to print money. So will other governments, at first reluctantly, and then they all will try to outdo each other. It will come as no surprise when politicians also get into the act with deficit spending measures and debt relief proposals.

The page has turned for gold. In the previous chapter, the metal was just another hard asset and a laggard at that. It was outperformed by base metals, energy and all manner of tangible assets. It was an also ran and an afterthought in the commodities derby driven by the expectation of unstoppable growth in the emerging sectors of the global economy. In the current chapter, I expect gold to outdistance its tangible brethren as its unique monetary traits become more widely understood. Unlike dollars, euros or yen, it cannot be printed. In comparison to these suspect contenders for safety seeking capital, it is scarce and difficult to produce. Companies who mine the metal have nothing but complaints about rising costs and barriers to building new mines. Despite the eight year advance in gold prices, mine production continues to stagnate and returns on capital are mediocre at best.

Our March 5, 2007 Website article “Today’s Avalanche Forecast.” concluded: “Nothing would be more congenial for gold than a global recession and a liquidity squeeze, which few anticipate. Forgetting timing and immediate causes, however, what is the likelihood of such an event in the next few years? Has the modern Fed gained such mastery over the economic system that it just can’t happen? The tight credit spreads of today are indicative of investor complacency and explain why the appeal of gold is lost on so many. Let’s see whether that complacency continues when the unexpected leads to mushrooming credit defaults and a meltdown in asset values.”

As of this writing, credit spreads have widened but they have not approached the post NASDAQ level of stress. (See chart below.) Only time will tell whether the current meltdown has been successfully contained by liquidity injections by the Fed. It would be surprising to us if this were the case, but it is possible that this is just another mini panic that will blow over as quickly as it appeared.

However, there are a number of reasons to think that the current credit meltdown is more serious and pervasive than the NASDAQ crash. The magnitude of the dollar overhang is far greater than in 2000. Geopolitical concerns are heightened relative to 2000. The psychic impact of the dot com bust was bad, but not as potentially pervasive as declining house prices. A simultaneous decline in house prices and financial assets is a double whammy that we haven’t seen post WW II. As in the dot com bust, liquidity has dried up (and we don’t know for how long), but it is doubtful that the leverage employed by institutions, hedge funds, and consumers was on the same scale back then. Finally, the extent of the damage in 2000 was readily apparent on a timely basis. Given the complex credit and derivative structures that now are prevalent, the process of discovering where one stands could be more protracted.

If gold investors are squirming these days, what about the overleveraged quant hedge fund geniuses who were instrumental in bringing all of this about? Warren Buffett said that finance is too important to be left to really, really smart people. Gold may be simplistic, but it is understandable to most ordinary folks. If you are not a worried investor these days, you must be a Nobel Laureate. At least gold is a viable strategy to address global credit concerns, and based on historical precedent, it should prove rewarding. Should gold begin to trade in earnest above $700, gold mining shares should also revive and head towards new highs.

John Hathaway
Portfolio Manager and Senior Managing Director
© Tocqueville Asset Management L.P.
August 29, 2007

[one_muggle]

Or not.
Warren Buffet also said that gold was non-productive in 1998 at Harvard: “It gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”

I suggest that you might not want to quote the oracle the next time you try to sell educated people gold. Some of us read.

-one muggle

[HereWeGo]

That’s not really true. Jewelry dominates gold demand these days. Investment demand and hording is only mildly stronger than industrial demand.

Here’s a good link

[partypup]

I think the fact that countless civilizations (many more advanced than ours) saw the value and utility in gold impresses me much more than musings from the Oracle of Omaha. Ten thousand years ago, gold was seen as the ultimate store value, and no one had ever heard of Berkshire Hathaway. Ten thousand years from now, gold will still be here — and I doubt very much that anyone will remember who the hell Warren Buffet or Berkshire Hathaway were. Some of us know history.

[rseiser]

Oh, and by the way, my friend had a personal conversation with Warren Buffett. Buffett asked him how his investments were doing, and my friend answered: “I have a lot of investments outside the dollar, mostly precious metals”. And Buffett said “That’s very good, I also like them, and especially …”. That was about two years ago.

Sure, it’s true that using gold as a backing for liquid short-term money, or for preserving of long-term purchasing power, seems like a waste. But hey, using paper backed by nothing, and that is losing value faster than inflation is even more ridiculous.
Also, we wouldn’t have to talk about this if the politicians of the world were honest (umpf!).
Having some stable medium of exchange or storage is certainly useful for greasing the wheels. Nobody said it has to be the wheels, and that all your savings have to be in gold.

But it is a nice speculation if you look how ridiculous the money-supply gets handled, and how everyone is fooled to take the inflation for “prosperity” (and even pay capital gains tax on that). It’s a simple calculation if you believe in history. Crises come and go, and in the last one gold went to $850 ($6000 in today’s dollars if the dollar loses half its value every decade). Sure, we don’t have a crisis (except liquidity, credit, housing, derivatives) yet, but maybe we get one again. At a tenth of that theoretical peak value I take the risk/reward. (The risk that gold goes down to its mining cost or even below?) I don’t see any other investment where you could make 10x your money if a crisis comes.

I just decided to search for a few junior/intermediate gold producers (also as speculation if you want). I hope I will find some that have really good reserves, and are well leveraged to the price of gold. I will double check them with Doody, Moriarty, Puplava if they have honest guys at the helm…
Will report back if I find some.

[Anonymous]

A Gold Fund that I have been pretty happy with for the past three years is Franklin’s (FRGOX.) They own all the biggies and some juniors, too. I bought it cheap enough to where I can sorta “trade around” it, selling fractionally on spikes and buying dips. A junior that some hot shots that I talk to love is GSS. Its chart looks awful and I wouldn’t buy it until it trys to stabilize, if at all, but you may wanna have a look or put it on your radar.

[one_muggle]

Oh, and by the way, my friend had a personal conversation with Warren Buffett. Buffett asked him how his investments were doing, and my friend answered: “I have a lot of investments outside the dollar, mostly precious metals”. And Buffett said “That’s very good, I also like them, and especially …”. That was about two years ago.

Sure, but he bought mine stocks, not the gold.

Crises come and go, and in the last one gold went to $850 ($6000 in today’s dollars if the dollar loses half its value every decade).
Now you’ve convinced me. Since gold has had a massively negative return from your $850 ($6000 in today’s, as you say) down to the $600’s in today’s dollars, now it must be a good time to buy gold.
Tootsie roll has had almost 300% returns over the same period, and in really bad times you can actually eat a Tootsie roll. 8^)

Good luck with your gold ventures (really), but when they are pumping out commercials for buying gold on every medium known to man–you are probably getting to the party late. And unlike google, which might also be overavalued, gold cannot earn its way back to its purchase price. When you would have been better off putting your money in your mattress rather than buy gold at $850, doesn’t that make you a wee bit wary today?

-one muggle

[rseiser]

Can’t make money unless you buy when something dropped and sell it after it goes up. Has worked for 3000 years, but you probably think we are in a new era where gold is useless and will drop and drop and drop. Maybe you should check out the story about the Austrian economists and their gold prediction when gold became unlinked from the dollar in 1971.

Believing that the world has changed is the same like everyone telling that wheat prices should go down since it can always be produced more efficiently and because the prices have languished for years. Marc Faber pointed out two years ago that agricultural commodities were historically cheap and a good trade. Yes, nothing is guaranteed, but closing your eyes to what markets do is not a good risk/reward either. So he was definitely rewarded for his stance. See chart.

[Anonymous]

but when they are pumping out commercials for buying gold on every medium known to man–you are probably getting to the party late.

I have to agree with this. Every blog, if only semi-contrarian, has tons upon tons of ads for some gold shop or another. I get tons of junk mail advertising gold mining stocks or some sort of gold bourse.

I only see gold as a good thing for trading its volatility (though there are many stocks that are much more volatile anyway) or if the dollar truly eats crap. In that case, yeah, gold would be incredible.

[one_muggle]

where gold is useless

Never said it was useless, but thanks for explaining buy low, sell high, I’d missed that one. Never predicted it would keep dropping either–just don’t see it worth the risk versus likely continued gains/ Never said the world had changed.
Speaking of history, the price of gold has historically increased about 7-8%, do you think the world has changed? Its several year run-up has just about put it back to its price during the last stagflation craze in the late 70’s. As prices go up, they dig more out of the ground, price goes down. Last analysis I saw was about $350-400 to dig it out, that is some incentive to dig up more as prices top $600.

Wheat was cheap a few ago… great, what’s your point?
Gold is either a hedge against inflation or speculation based upon increasing hordes upon hordes of inexperienced investors thinking that they’ve outsmarted the market. The only people that I expect to see see beating market returns with gold over the last ~10yrs are gold salesmen.
If gold was rising (in dollars) mainly because of US inflation, I might buy into your idea. But check gold versus almost every major currency, it’s way up. The last time gold ran up in anticipation of worldwide inflation, it proceeded to drop back to its historic return, losing about half its price. This is likely to occur again, unless, as you are fond of saying, the world has changed.

-one muggle

[rseiser]

All good points, I was only harping on your criticism that the real price of gold dropped ten times since 1980. Yes, that is true, and that’s why it is at a good price now.

I am not forcing you to buy it, but consider your own math. 7-8% annual increase because of inflation, I agree perfectly, that’s a double every decade. Of course, you have to use long time frames and not just a decade. $50 fair value in 1970 before the boom would be 16x$50=$800 in 2010. $850 in 1980 after the boom would be 8x$850=$6800 in 2010. So a range of reasonable historical assumption would be $800-$6800 for 2010. Or $1600-$13600 for 2020. For me gold is still cheap right now. For you maybe not. Maybe for you, bonds, stocks, or real-estate might seem cheap.

$350-$400 cost is not a correct number to look at. That might be an average cash cost for some mining companies but not when you include general and administrative expenses. Most mining companies at the margin (what counts in economics) are struggling to break even. It is also a production issue. If there is more investment demand, it will take years to up production, and gold can trade five times above the cash cost. Kind of like oil at $70, even though some oil companies get it out of the ground for $10.

[Anonymous]

If jewelry dominates gold demand then its price will correlate positively with economic cycles, not inversely.

If there is a global recession, people will sell it and some will melt the jewelry for cash to buy necessities.

[Anonymous]

Ten thousand years ago, cattle were seen as the ultimate indication of value. You can eat them, and you can breed them.

If you want a physical currency, oil is it, not gold.

Gold is being mined out of the ground, and goes into vaults.

Oil is being mined out of the ground, and is burnt into CO2.

There is plenty of gold left in the ground. There isn’t plenty of oil left.

[Bubblesitter]

Please note, the following are just some of my personal comments on gold. I am not an investment adviser. I do hear alot of confusion about gold in general.

I believe one of the best ways to invest in gold is thru an ETF such as Streetracks GLD or iShares IAU. Commodity ETFs are listed on the stock exchanges and offer investors
exposure in the underlying commodity such as gold without taking physical delivery. Gold ETFs buy a matching amount of gold from the market to keep in bank vaults. You buy the share at typically 1/10 the spot price.

I feel that all these other gold offers are waste of money, e.g. gold coins come with high fees, it also costs money to insure.

Please don’t go crazy with gold, I’m personally keeping it less than 15-20% of my portfolio. Be careful, gold does has volatility, as we have seen in recent weeks. I’m keeping only as a long term hedge against dollar depreciation.

Gold prices has actually dropped in recent weeks as investors have covered losses and many feel that demand for gold will decrease as we may go into recession. Industrial use of gold is still a big gold user, e.g. gold plated electronics connectors.

In recent weeks, investors big and small have been liquidating gold to cover margin calls/losses on Wall street, here’s an article on this.

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=ajSEk5FMPqqM

ETFs have made gold an even more liquid asset, more on this on article on “The Street” on how gold has become more correlated with the market in recent years.

http://www.thestreet.com/s/gold-loses-its-value-as-selloff-protection/funds/etftuesday/10376598.html?puc=_cnnmoney&cm_ven=CNNMONEY&cm_cat=Free&cm_pla=Feed&cm_ite=Feed&puc=cnnmoney&

Bubblesitter

[one_muggle]

For me gold is still cheap right now.
It may be, but what concerns me is the “water-cooler” status of gold. As far back as ~2000, scores of friends have been extolling the virtues of gold, and it has had a good run over those years. Yet currently, not one single professional wall street type I know personally or read is bullish on gold. Put together, it strikes me as more hype than investment.

Bubble: I believe one of the best ways to invest in gold is thru an ETF such as Streetracks GLD or iShares IAU
If you’re going to buy gold, I agree.

many feel that demand for gold will decrease as we may go into recession. Industrial use of gold is still a big gold user, e.g. gold plated electronics connectors.
As a pure commodity, I would have to agree. It is gold’s status as the benchmark currency, and hedge against inflation that makes this hard to call.
As far as electronics, this is also true, but currently it is the labor cost that dominates my costs. We do specialized, low volume stuff, so the actual gold costs might be more significant for high volume production, like cell phones–I don’t know. IMHO, if gold were merely an industrial metal, it would trade for far less and be more at the mercy of recessions than it is currently.

-one muggle

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