Welcome to the February edition of my monthly Gold Report.
January saw an end to gold's recent malaise as the bull finally righted itself, running on the news that the Federal Reserve will continue its pro-inflation dollar expansion until at least 2014. Gold finished more than $146 higher (9.1%) than where it started, closing out the month at $1,744. The yellow metal looks ready to break the important psychological barrier of $2,000/oz by the end of this year, as the glimmers of recovery hopes fade from the headlines and the Fed responds by deepening its failed policies. Silver prices also rebounded, finishing 16.7% higher for the month at $33.60.
This month, I'm very pleased to present an interview I conducted with James Rickards, whose first book, Currency Wars: The Making of the Next Global Crisis, is opening a national dialogue on the major threats we face from competitive devaluation. James is a sound-money guy like me and agrees that the only sustainable way out of these currency wars is a gold standard. But he also knows how the policymakers inside the Beltway think, and I believe this perspective is very valuable to gold-buyers.
In keeping with the geopolitical perspective this month, Marin Katusa of Casey Research offers a provocative view on what he considers the real rationale behind the United States' foreign policy stance toward Iran. As always, if you want the truth, you have to follow the money.
Meanwhile, Mark Motive of Plan B Economics explains what happened to our safe-haven asset during the 2008 crisis and how it is likely to behave in the next crisis.
Finally, guest author Andre Sharon, an economist, gold expert, and friend of Euro Pacific, takes us through his own history starting as an academic skeptical of gold and ending up a major proponent of using the yellow metal in commerce.
With the announcement that the Fed's printing press will run non-stop for the next two years, now's the time to swap out your dollar-based assets for the safe haven of gold and silver. Call my precious metals specialists at 888-GOLD-160 to start the conversation.
Euro Pacific Metals, LLC
|PETER SCHIFF SPEAKS TO JAMES RICKARDS, AUTHOR OF CURRENCY WARS|
Though much has happened in the gold market this month - notably, a Fed pledge that has awakened the sleeping bull - we wanted to take a step back and shed some light on what is fundamentally driving the precious metals market today.
A Wall Street pro named James Rickards recently released his first book, Currency Wars: The Making of the Next Global Crisis
, and it's creating a buzz. Our own Peter Schiff often talks about competitive devaluation of currencies as the main driver behind our gold and silver investments. Recently, Peter sat down with James to get his perspective on what's behind these currency wars, and find out what he recommends investors do to preserve their wealth through this tumultuous time.
Peter Schiff: You portray recent monetary history as a series of currency wars - the first being 1921-1936, the second being 1967-1987, and the third going on right now. This seems accurate to me. In fact, my father got involved in economics because he saw the fallout of what you would call Currency War II, back in the '60s. What differentiates each of these wars, and what is most significant about the current one?
James Rickards: Currency wars are characterized by successive competitive devaluations by major economies of their currencies against the currencies of their trading partners in an effort to steal growth from those trading partners.
While all currency wars have this much in common, they can occur in dissimilar economic climates and can take different paths. Currency War I (1921-1936) was dominated by a deflationary dynamic, while Currency War II (1967-1987) was dominated by inflation. Also, CWI ended in the disaster of World War II, while CWII was brought in for a soft landing, after a very bumpy ride, with the Plaza Accords of 1985 and the Louvre Accords of 1987.
What the first two currency wars had in common, apart from the devaluations, was the destruction of wealth resulting from an absence of price stability or an economic anchor.
Interestingly, Currency War III, which began in 2010, is really a tug-of-war between the natural deflation coming from the depression that began in 2007 and policy-induced inflation coming from Fed easing. The deflationary and inflationary vectors are fighting each other to a standstill for the time being, but the situation is highly unstable and will "tip" into one or the other sooner rather than later. Inflation bordering on hyperinflation seems like the more likely outcome at the moment because of the Fed's attitude of "whatever it takes" in terms of money-printing; however, deflation cannot be ruled out if the Fed throws in the towel in the face of political opposition.
Peter: You and I agree that the dollar is on the road to ruin, and we both have made some drastic forecasts about what the government might do in the face of the dollar collapse. How might this scenario play out in your view?
James: The dollar is not necessarily on the road to ruin, but that outcome does seem highly likely at the moment. There is still time to pull back from the brink, but it requires a specific set of policies: breaking up big banks, banning derivatives, raising interest rates to make the US a magnet for capital, cutting government spending, eliminating capital gains and corporate income taxes, going to a personal flat tax, and reducing regulation on job-creating businesses. However, the likelihood of these policies being put in place seems remote - so the dollar collapse scenario must be considered.
Few Americans are aware of the International Economic Emergency Powers Act (IEEPA)... it gives any US president dictatorial powers to freeze accounts, seize assets, nationalize banks, and take other radical steps to fight economic collapse in the name of national security. Given these powers, one could see a set of actions including seizure of the 6,000 tons of foreign gold stored at the Federal Reserve Bank of New York which, when combined with Washington's existing hoard of 8,000 tons, would leave the US as a gold superpower in a position to dictate the shape of the international monetary system going forward, as it did at Bretton Woods in 1944.
Peter: You write in your book that it's possible that President Obama may call for a return to a pseudo-gold standard. That seems far-fetched to me. Why would a bunch of pro-inflation Keynesians in Washington voluntarily restrict their ability to print new money? Wouldn't such a program require the government to default on its bonds?
James: My forecast does not pertain specifically to President Obama, but to any president faced with economic catastrophe. I agree that a typically Keynesian administration will not go to the gold standard easily or willingly. I only suggest that they may have no choice but to go to a gold standard in the face of a complete collapse of confidence in the dollar. It would be a gold standard of last resort, at a much higher price - perhaps $7,000 per ounce or higher.
This is similar to what President Roosevelt did in 1933 when he outlawed private gold ownership but then proceeded to increase the price 75% in the middle of the worst sustained period of deflation in U.S. history.
Peter: You also write that you were asked by the Department of Defense to teach them to attack other countries using monetary policy. Do you believe there has a been an deliberate attempt to rack up as much public debt as possible - from the Chinese, in particular - and then strategically default through inflation?
James: I do not believe there has been a deliberate plot to rack up debt for the strategic purpose of default; however, something like that has resulted anyway.
Conventional wisdom is that China has the US over a barrel because it holds more than $2 trillion of US dollar-denominated debt, which it could dump at any time. In fact, the US has China over a barrel because it can freeze Chinese accounts in the face of any attempted dumping and substantially devalue the worth of the money we owe the Chinese. The Chinese themselves have been slow to realize this. In hindsight, their greatest blunder will turn out to be trusting the US to maintain the value of its currency.
Peter: In your book, you lay out four possible results from the present currency war. Please briefly describe these and which one do you feel is most likely and why.
James: Yes, I lay out four scenarios, which I call "The Four Horsemen of the Dollar Apocalypse."
The first case is a world of multiple reserve currencies with the dollar being just one among several. This is the preferred solution of academics. I call it the "Kumbaya Solution" because it assumes all of the currencies will get along fine with each other. In fact, however, instead of one central bank behaving badly, we will have many.
The second case is world money in the form of Special Drawing Rights (SDRs). This is the preferred solution of global elites. The foundation for this has already been laid and the plumbing is already in place. The International Monetary Fund (IMF) would have its own printing press under the unaccountable control of the G20. This would reduce the dollar to the role of a local currency, as all important international transfers would be denominated in SDRs.
The third case is a return to the gold standard. This would have to be done at a much higher price to avoid the deflationary blunder of the 1920s, when nations returned to gold at an old parity that could not be sustained without massive deflation due to all of the money-printing in the meantime. I suggest a price of $7,000 per ounce for the new parity.
My final case is chaos and a resort to emergency economic powers. I consider this the most likely because of a combination of denial, delay, and wishful thinking on the part of the monetary elites.
Peter: What do you see as Washington's end-game for the present currency war? What is their best-case scenario?
James: Washington's best-case scenario is that banks gradually heal by making leveraged profits on the spreads between low-cost deposits and safe government bonds. These profits are then a cushion to absorb losses on bad assets and, eventually, the system becomes healthy again and can start the lending-and-spending game over again.
I view this as unlikely because the debts are so great, the time needed so long, and the deflationary forces so strong that the banks will not recover before the needed money-printing drives the system over a cliff - through a loss of confidence in the dollar and other paper currencies.
Peter: I don't think this scenario is likely either, but say it were... would it be healthy for the American economy to have to carry all these zombie banks that depend on subsidies for survival? Wouldn't it be better to just let the toxic assets and toxic banks flush out of the system?
James: I agree completely. There's a model for this in the 1919-1920 depression, when the US government actually ran a balanced budget and the private sector was left to clean up the mess. The depression was over in 18 months and the US then set out on one of its strongest decades of growth ever. Today, in contrast, we have the government intervening everywhere, with the result that we should expect the current depression to last for years - possibly a decade.
Peter: How long do you think Currency War III will last?
James: History shows that Currency War I lasted 15 years and Currency War II lasted 20 years. There is no reason to believe that Currency War III will be brief. It's difficult to say, but it should last 5 years at least, possibly much longer.
Peter: From my perspective, what is unique about a currency war is that the object is to inflict damage on yourself, and the country often described as the winner is actually the biggest loser, because they've devalued their currency the most. Which currency do you think will come out of this war the strongest?
James: I expect Europe and the euro will emerge the strongest after this currency war by doing the most to maintain the value of its currency while focusing on economic fundamentals, rather than quick fixes through devaluation. This is because the US and China are both currency manipulators out to reduce the value of their currencies. In the zero-sum world of currency wars, if the dollar and yuan are both down or flat, the euro must be going up. This is why the euro has not acted in accord with market expectations of its collapse.
The other reason the euro is strong and getting stronger is because it is backed by 10,000 tons of gold - even more than the US This is a source of strength for the euro.
Peter: You and I both connect the Fed's dollar-printing with the recent revolutions in the Middle East. This is because our inflation is being exported overseas and driving up prices for food and fuel in third-world countries. What do you think will happen domestically when all this inflation comes home to roost?
James: The Fed will allow the inflation to grow in the US because it is the only way out of the non-payable debt.
Initially, American investors will be happy because the inflation will be accompanied by rising stock prices. However, over time, the capital-destroying nature of inflation will become apparent - and markets will collapse. This will look like a replay of the 1970s.
Peter: How long do you think China's elites will put up with the Fed's inflationary agenda before they start dumping their US dollar assets?
James: The Chinese will never "dump" assets because this could cause the US to freeze their accounts. However, the Chinese will shorten the maturity structure of those assets to reduce volatility, diversify assets by reallocating new reserves towards euro and yen, increase their gold holdings, and engage in direct investment in hard assets such as mines, farmland, railroads, etc. All of these developments are happening now and the tempo will increase in future.
Peter: In your view, what is the best way for investors to protect themselves from this crisis?
James: My recommended portfolio is 20% gold, 5% silver, 20% undeveloped land in prime locations with development potential, 15% fine art, and 40% cash. The cash is not a long-term position but does give an investor short-term wealth preservation and optionality to pivot into other asset classes when there is greater visibility.
[Editor's note: Opinions expressed are the interviewee's own and do not represent investment advice from Peter Schiff or Euro Pacific Precious Metals.]
Peter: What, if any, silver lining do you see for us in the future?
James: I continue to have faith in the democratic process and the wisdom of the American people. Through elections, we might be able to change leadership and implement new policies before it's too late.
Failing that, the worst outcomes are all but unavoidable.
We would like to thank James for speaking to us about this topic and educating the public about the dangers of currency wars. We at Euro Pacific Precious Metals believe they represent the greatest threat to investors' financial wellbeing today.
While James and Peter may disagree on some key points, we think he has accurately diagnosed the mentality that may drive the US to a dollar collapse. Unless the US decides to quit the currency wars, investors will continue to be pushed into precious metals and other hard assets. And, as James illustrates, declaring a truce is easier said than done.
James G. Rickards is Senior Managing Director at Tangent Capital Partners LLC , a merchant bank based in New York City, and is Senior Managing Director for Market Intelligence at Omnis, Inc., a technical, professional and scientific consulting firm located in McLean, VA.
Peter Schiff is CEO and Chief Global Strategist of Euro Pacific Precious Metals, a gold and silver coin and bullion dealer offering honest products at competitive prices.
If you would like more information about Euro Pacific Precious Metals, click here or go to our website, www.europacmetals.com. For the fastest service, call
GOLD IN A FINANCIAL CRISIS
by Mark Motive of Plan B Economics
In what can only be called comic timing, the President's latest State of the Union was scheduled back-to-back with the latest Fed policy meeting. One day, the President painted a rosy picture of a nation on the rebound, and the next, the Fed doused it in the bitter acid of economic reality - and proceeded to make an unprecedented pledge to keep rates near-zero for at least another two years! Gold immediately spiked to about $1,710 an ounce on the news.
Over the past 6 months, gold prices oscillated and many investors lost sight of the long-term fundamentals supporting the monetary metal: the western world remains mired in debt, and the easy way for governments to tackle this crisis is to print money and keep interest rates low.
I started investing in gold when I first calculated the inescapable reality of the global debt trap several years ago. I became a gold bull, yet I did not fully understand why gold performs the way it does. At the time, I made the classic assumptions that gold is a hedge against lackluster stock market performance and general financial stress.
While these assumptions can prove true at times, one must dig deeper to understand the primary drivers behind gold's performance - gold's relationship with stock prices and financial stress is merely an indirect side effect. In fact, despite the classic assumptions, the gold price can rise during bullish stock markets and fall during periods of financial stress. Put the assumptions to rest: what really drives gold is the value of fiat currency.
Let's take a look at the major secular trends of the last decade:
Trend 1: January 2003 to December 2007 - Equity Bull Market
Trend 2: January 2008 to March 2009 - Equity Bear Market
S&P 500 lost 52%.
Gold gained 9%. (At the height of the financial crisis, gold lost 16%.)
The US dollar index gained 18%.
Trend 3: March 2009 to April 2011 - Equity Bull Market
As you can see from Trends 1 & 3, gold tends to perform well when the dollar doesn't. Gold is effectively a hard currency, and as a currency, it's a mirror against other currencies. And the same easy-money policies that cause the dollar to lose value and gold prices to rise also tend to cause the stock market to rise. Technically-speaking, inflation has driven real interest rates so low that they are negative, pushing investors away from the dollar and into other assets. Many investors already understand this.
The real confusion arises when a financial crisis occurs. As we see in Trend 2, while the S&P 500 lost 52%, gold only gained 9%. In fact, during the height of the Lehman Brothers implosion, gold was at one point down 16%.
Again, the real driver behind gold's performance during this example was the US dollar, which gained 18%. At the time, the US seemed to be the safest house in the economic ghetto. When financial shots were fired, investors ran to the perceived safety of the US dollar and US Treasuries.
Gold reflected the dollar's strength by declining in price. Tellingly, gold priced in euros and Canadian dollars declined by far less.
|Source: Plan B Economics, World Gold Council|
This safe-haven role for the dollar will not last forever. In fact, from 1900-2010, the US dollar lost about 95% of its purchasing power. As $120 trillion of unfunded liabilities come knocking at the US Treasury's door, aggressive debt monetization could eventually lead to a hyperinflationary spiral.
While gold price declines during times of financial stress can be worrisome to gold investors, they should remember one thing: the larger the financial calamity, the bigger the monetary response by central banks (i.e. money printing). As shown in the chart above, the Federal Reserve's November '08 response to the crisis sent gold prices skyrocketing in all currencies from their crisis lows.
Investors should look through periods of financial stress with the expectation that central banks are likely to make more announcements like the Fed's latest zero-rate pledge, ultimately sending the price of gold back upward. As long as this gold bull market lasts, every dip in gold caused by temporary spikes in the US dollar is a potential buying opportunity. In fact, gold is now up over 10% from the recent dip caused by financial stress over Europe.
Real interest rates will remain negative for the foreseeable future as the US economy remains burdened with debt. Until the fundamentals change, I believe the long-term bull market for gold remains intact.
Mark Motive is the pen name of a respected business journalist. He is the publisher and chief author of Plan B Economics, the source for market insights overlooked by the mainstream media.
Follow him on Twitter for free eBooks, documentaries and more: @planbeconomics.
WILL IRAN KILL THE PETRODOLLAR?
by Marin Katusa of Casey Research
Editor's Note: Iran and the United States seem to be on a collision course to war. Iran has been taunting the US with naval exercises in the Strait of Hormuz, through which much of the Mideast's oil exports ship, and the US continues to threaten Iran with sanctions over its uranium enrichment program. Casey Research's Marin Katusa offers an edgy, and likely controversial, perspective on US/Iran relations, gold, and oil. While lengthy, we found it thought-provoking and a worthwhile perspective for hard asset investors.
The official line from the United States and European Union is that Tehran must be punished for continuing its efforts to develop a nuclear weapon. The punishment: sanctions on Iran's oil exports, which are meant to isolate Iran and depress the value of its currency to such a point that the country crumbles.
But that strategy doesn't make sense, and the sanctions will not achieve their goals. Iran is far from isolated. Its friends - like India - will stand by the oil-producing nation until the US either backs down or acknowledges the real matter at hand. That matter is the dollar and its role as the global reserve currency.
The short version of the story is that a 1970s deal cemented the US dollar as the only currency that can be used to buy and sell crude oil, and from that monopoly on the all-important oil trade, the US dollar slowly-but-surely became the reserve currency for global trading in most commodities and goods. Massive demand for US dollars ensued, pushing the dollar's value up, up, and away. In addition, countries stored their excess US dollar-savings in US Treasuries, giving the US government a vast pool of credit from which to draw.
We know where that situation led - to a US government suffocating in debt, while its citizens face stubbornly high unemployment, a failed real estate market, record personal-debt burdens, a bloated banking system, and a teetering economy. That is not the picture of a world superpower worthy of the privileges gained from having its currency back global trade. Other countries are starting to see that and are slowly-but-surely moving away from US dollars in their transactions - starting with oil.
If the US dollar loses its position as the global reserve currency, the consequences for America are dire. A major portion of the dollar's valuation stems from its lock on the oil industry - if that monopoly fades, so too will the value of the dollar. Such a major transition in global fiat currency relationships will bode well for some currencies and not so well for others, and the outcomes will be challenging to predict. But there is one outcome that we foresee with near-certainty: gold will rise. Uncertainty about paper money always bodes well for gold, and these are uncertain days indeed.
THE PETRODOLLAR SYSTEM
To explain this situation properly, we have to go back to 1973. That's when President Nixon asked King Faisal of Saudi Arabia to accept only US dollars as payment for oil and invest any excess profits in US Treasury bonds, notes, and bills. In exchange, Nixon pledged to protect Saudi Arabian oil fields from the Soviet Union and other interested nations, such as Iran and Iraq. It was the start of something great for the US, even if the outcome was as artificial as the US real estate bubble. It constituted the foundation for the valuation of the US dollar.
By 1975, all of the members of OPEC had agreed to sell their oil only in US dollars. Every oil-importing nation in the world started saving its surplus in US dollars in order to be able to buy oil. With such high demand for dollars, the currency strengthened. Meanwhile, as agreed, oil-exporting nations spent their US dollar surpluses on Treasury securities, providing a new, deep pool of lenders to support US government spending.
The "petrodollar" system was a brilliant political and economic move. It forced the world's oil money to flow through the US federal government, creating ever-growing international demand for both US dollars and US debt, while essentially letting the US pretty much own the world's oil for free, since oil's value would be denominated in a currency that Washington controls and prints. The petrodollar system spread beyond oil; because of it, the majority of international trade is now done in US dollars. That means that from Russia to China, Brazil to South Korea, every country aims to maximize the US-dollar surplus garnered from its export trade to buy oil.
The US has reaped many rewards. As oil usage increased in the 1980s, demand for the US dollar rose with it, lifting the American economy to new heights. A strong US dollar allowed Americans to buy imported goods at a massive discount - the petrodollar system essentially created a subsidy for US consumers at the expense of the rest of the world. Here, finally, the US felt a downside: the availability of cheap imports hit the US manufacturing industry hard, and the disappearance of manufacturing jobs remains one of the biggest challenges in resurrecting the US economy today.
There is another downside, a potential threat now lurking in the shadows. The current value of the US dollar is determined in large part by the fact that oil is sold in US dollars. If that trade shifts to a different currency, countries around the world won't need all their US reserves. The resulting sell-off would weaken the currency dramatically.
So here's an interesting notion... Everybody says the US goes to war to protect its oil supplies, but doesn't it really go to war to ensure the continuation of the petrodollar system?
The Iraq War provides a good example. Until November 2000, no OPEC country had dared to violate the US dollar-pricing rule, and while the dollar remained the strongest currency in the world, there was little reason to challenge the system. But in late 2000, France and a few other EU members convinced Saddam Hussein to defy the petrodollar process and sell Iraq's oil-for-food in euros. In the time between then and the March 2003 US invasion of Iraq, several other nations hinted at their interest in non-dollar oil trading, including Russia, Iran, Indonesia, and Venezuela. In April 2002, Iranian OPEC representative Javad Yarjani was invited to Spain by the EU to deliver a detailed analysis of how all of OPEC might at some point sell its oil to the EU for euros, instead of dollars.
This movement, founded in Iraq, had started to threaten the dominance of the US dollar as the global reserve currency. Shortly thereafter, the US invaded Iraq, ending the oil-for-food program and its euro payment agreement.
There are many other examples of possible US covert influence in halting a movement away from the petrodollar system. In February 2011, Dominique Strauss-Kahn, managing director of the International Monetary Fund (IMF), called for a new world currency to challenge the dominance of the US dollar. Three months later, a maid at the Sofitel New York hotel alleged that Strauss-Kahn sexually assaulted her. Strauss-Kahn was forced out of his role at the IMF within weeks; he has since been cleared of any wrongdoing.
Covert and overt warfare may be costly, but the cost of not protecting the petrodollar system would be far higher. If euros, yen, yuan, rubles, or even straight gold, were generally accepted for oil, the US dollar would quickly become irrelevant, rendering the currency almost worthless. As the rest of the world realizes that there are other options besides the US dollar for global transactions, the US is facing a very significant - and very messy - glitch in its global oil machine.
THE IRANIAN DILEMMA
Iran may be isolated from the United States and Western Europe, but Tehran still has some pretty staunch allies. Iran and Venezuela are advancing $4 billion worth of joint projects, including a bank. India has pledged to continue buying Iranian oil because Tehran has been a great business partner for New Delhi, which struggles to make its payments. Greece opposed the EU sanctions because Iran was one of very few suppliers that had been letting the bankrupt Greeks buy oil on credit. South Korea and Japan are pleading for exemptions from the coming embargoes because they are dependent on Iranian oil. Economic ties between Russia and Iran are getting stronger every year.
Then there's China. Iran's energy resources are a matter of national security for China, as Iran already supplies no less than 15% of China's oil and natural gas. That makes Iran more important to China than Saudi Arabia is to the United States. Don't expect China to heed the US and EU sanctions much - China will find a way around the sanctions in order to protect two-way trade between the nations, which currently stands at $30 billion and is expected to hit $50 billion in 2015. In fact, China will probably gain from the US and EU sanctions on Iran, as it will be able to buy oil and gas from Iran at depressed prices.
So Iran will continue to have friends, and those friends will continue to buy its oil. More importantly, you can bet they won't be paying for that oil with US dollars. Rumors are swirling that India and Iran are at the negotiating table right now, hammering out a deal to trade oil for gold, supported by a few rupees and some yen. Iran is already dumping the dollar in its trade with Russia in favor of rials and rubles. On top of that, consider: India is already using the yuan with China; China and Russia have been trading in rubles and yuan for more than a year; and, Japan and China are moving towards transactions in yen and yuan.
All those energy trades between Iran and China? They will soon be settled in gold, yuan, and rials. With the Europeans out of the mix, in short order, none of Iran's 2.4 million barrels of oil a day will be traded in petrodollars.
With all this knowledge in hand, it starts to seem pretty reasonable that the real reason tensions are mounting in the Persian Gulf is because the United States is desperate to torpedo this movement away from petrodollars. The shift is being spearheaded by Iran and backed by India, China, and Russia. That is undoubtedly plenty to make Washington anxious enough to seek out an excuse to topple the regime in Iran.
Speaking of that search for an excuse... A team of International Atomic Energy Agency (IAEA) inspectors just visited Iran. The IAEA is supervising all things nuclear in Iran, and it was an IAEA report in November warning that the country was progressing in its ability to make weapons that sparked this latest round of international condemnation against the supposedly near-nuclear state. But after their latest visit, the IAEA's inspectors reported no signs of bomb-making. Oh, and if keeping the world safe from rogue states with nuclear capabilities were the sole motive, why have North Korea and Pakistan been given a pass?
There is another consideration to keep in mind, one that is very important when it comes to making some investment decisions based on this situation: Russia, India, and China - three members of the rising economic powerhouse group known as the BRICs (which also includes Brazil) - are allied with Iran and are major gold producers. If petrodollars go out of vogue and trading in other currencies gets too complicated, they will tap their gold storehouses to keep the crude flowing. Gold always has been and always will be the fallback currency. As mentioned before, when currency relationships start to change and valuations become hard to predict, trading in gold is a tried-and-true failsafe.
2012 might end up being most famous as the year in which the world defected from the US dollar as the global currency of choice. Imagine the rest of the world doing the math and, little by little, doing more business in their own currencies and investing less of their surpluses in US Treasuries. It would constitutes nothing less than a orderly decimation of the dollar.
That may not be a bad thing for the United States government. The country's gargantuan debts can never be repaid as long as the dollar maintains anything close to its current valuation. Given the state of the country, all that's really left supporting the value in the dollar is its global reserve currency status. If that goes and the dollar slides, maybe the US government will be able to repay its debts and start fresh. That new start would come without the privileges and ingrained subsidies to which Americans are so accustomed, but it's amazing that the petrodollar system has lasted this long. It was only a matter of time before something would break it down.
Finally, the big question: How can one profit from this evolving situation? Playing with currencies is always very risky, and with the global game set to shift to significantly, it would require a lot of analysis and a fair bit of luck. The much more reliable way to play the trend is through gold. Gold is the only common currency that is also a physical commodity; and it is always where investors hide from a currency storm. The basic conclusion is that a slow demise of the petrodollar system is bullish for gold and very bearish for the US dollar.
Marin Katusa is the Chief Energy Investment Strategist at Casey Research, and he is senior editor of the highly regarded Casey Energy Opportunities. Try it for $39 per year, with a 3-month money-back guarantee.
EUREKA! WHEN GOLD STRUCK ME
by Andre Sharon
Probably more nonsense has been expended on discussions of gold than on any other investment vehicle. Including by me - until my eureka moment.
THE TWO EXTREMES
On one side are the true believers who become almost fanatical in their devotion. Incas waxed lyrical about gold, calling it "the tears of the sun." Ancient Egyptians called it "the skin of the gods." It has been coveted and sought after from time immemorial at practically any cost, including moral considerations. Lovers symbolically pledge their devotion with it, poets and musicians rhapsodize about it, and most people measure excellence by reference to it.
Gold's detractors are equally passionate about it. Keynes called it a "barbarous relic." Charlie Munger more succinctly called it "stupid." In his latest letter to Berkshire Hathaway shareholders, Warren Buffett was equally dismissive, pointing out that "gold doesn't produce anything." He repeated the familiar observation that "gold 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... Anyone watching from Mars would be scratching their head."
Buffett's observations are correct. Gold is unproductive. It pays no interest. You can't eat or drink it. It may be beautiful, but its industrial uses are limited. It is difficult to value vis-a-vis other assets.
So why did I conclude that the Buffetts of the world, and even my hero Milton Friedman, are wrong with respect to gold?
ARRIVING AT A RESPECT FOR GOLD
In order to understand that question, you must know a bit about me. I am an economist, with a degree in Money and Banking from the London School of Economics. I know all about the gold and gold-exchange standards. I analyzed the gold mining industry from Canada to Australia, and descended into mines a mile deep in South Africa. I became thoroughly familiar with gold's supply and demand components, and with the mines' marginal cost and revenue curves. And like Keynes and Buffett, I pontificated eruditely but cluelessly on the subject of gold's worth, while totally missing the core issue.
You see, all my education provided less insight than a single conversation I had many years later with the late Dr. Bernard Pacella, then President of the American Psychoanalytic Association. Though he was a quiet and modest man, in the course of our conversation, I soon understood that I was in the presence of an extraordinarily perceptive mind that could see around corners. By the time he was through, I felt that I understood gold for the first time in my life.
Dr. Pacella started by pointing out that the single most powerful force in all of nature is survival. Above all, survival of one's body, and then of the species. By extension, he continued, this involves protection of savings, the fruits of one's toil, and the expectation that there will be a reward for forgoing immediate consumption and gratification. Just as squirrels collect acorns which may sustain them and ensure their survival in the winter, so humans will, if they can, save for enhanced well-being in the future. The medium in which they hold their savings is crucially important: they will not rationally choose a vehicle which is vulnerable to erosion or worse, disappearance.
Here, the significance of gold falls into place. Consider its characteristics:
It is rare, and its quantity is limited. The entire amount extracted from the ground in all of history amounts to 165,000 metric tons. This is equivalent to a cube 20 meters long/deep/wide.
It is difficult and expensive to find, mine, and bring to the surface. It is therefore subject to only small and slow incremental supply.
It is indestructible, homogeneous, and easily reconstituted if diluted or broken up.
It is compact, and therefore permits transportation of a high value in a relatively small space.
It is the only universally used asset that can be instantly converted to cash (even by the world's central banks) that is not someone else's liability.
And, of crucial importance, it is anonymous.
Not one of these attributes is unique to gold. What makes gold unique is that it is the only form of money which combines all of them.
And while its monetary nature makes it difficult to price in the short-run, it also means an investor can count on one thing in the long run: it doesn't change its value - it merely mirrors the erosion in the purchasing power of fiat currency. For example, in the relatively brief 40 years since President Nixon untethered the dollar from its gold anchor, it has shrunk to 18 cents of its previous purchasing power.
So, gold's value is not primarily a question of supply and demand. There is sufficient gold in that above-ground cube to satisfy normal commercial demand for some 65 years.
Instead, gold appreciates when forces are, or are expected to be, at work which would erode returns on savings. The single most significant inverse correlation with the gold price is the real rate of return on savings, i.e. on capital. In that sense, Keynes and Buffett are correct: if one can obtain a positive real rate of return in reward for saving, then buying and holding gold makes no sense. But that is not always possible.
What could potentially erode real rates of return on savings? The answers include not only inflation, but concerns stemming from political and social uncertainty, high taxes, poor legal protection of assets, and war.
The futurologist Herman Kahn once observed that all of humanity believes in gold, but that it takes more to trigger the urge to acquire it in what he characterized as the world's "Northwest Tier," i.e. the Scandinavian countries, the British Isles, and North America. This is not an accident. What these countries have in common is a relatively longer and stronger history of nurturing capital formation - rule of law, financial institutions, democracy, political stability - than the rest of the world.
WHY A GOLD STANDARD IS NECESSARY
At the core of the historical gold standard was this overriding premise: a government in deficit because it was living beyond its means would have to lose gold and accept the pain of economic contraction to cleanse excesses. It was an objective discipline, divorced from political or social considerations. It could not be denied or manipulated by utopian theoreticians, corrupt politicians, lazy bureaucrats, or soft electorates.
Not that the upward economic trajectory was smooth - far from it. A gold standard is far from perfect; given human nature, it is merely the least bad of alternative options, because ultimately its objective discipline involves - indeed, imposes - an honest, and therefore moral, response.
At the simplest level, the fundamental issue is whether following a binge of excess, a society is willing to tolerate the pain of deflation (including bankruptcies, unemployment, workouts, restructurings, and all the rest) or will seek to inflate its way out of its problems. Hayek's and Schumpeter's "creative destruction" versus Keynes' "animal spirits."
ARE WE ENTERING A GOLD STANDARD GENERATION?
A study of history would strongly suggest that these issues are heavily influenced by cyclical generational considerations.
Living in London in the '90s, I witnessed the explosion of emotion that followed the death of Princess Diana. One incident stuck in my mind. A TV camera caught an old biddy wearing unfashionable clothes and sensible shoes watching the proceedings with evident disapproval, while making sarcastic remarks about the mushiness of the crowds. The BBC twit interviewing her remarked, "But Princess Diana said all you really need is love." She shot back, "In my day, we needed Spitfires too!"
She had a point. Further, one could argue that it was precisely the sacrifices of the World War II generation that made possible the softness of their children and grandchildren. Historians remind us that civilizations don't necessarily perish because they have been successfully attacked by superior forces from outside but more likely because they have become frivolous and unserious one the inside.
At present, the confluence of forces which financial markets must contend with include:
A debt-ridden United States in the personal, corporate, and government sectors.
A divided and entitled Europe, so there is no escaping problems in the US by fleeing into the euro.
A world without a strong anchor to set the agenda, leading to uncoordinated policies across countries.
HISTORY AS A GUIDE
The last time the US found itself in a roughly similar situation was in the early '80s. At that time, two forces emerged which turned things around. The first was Ronald Reagan, a revolutionary who cut taxes and wrapped up the Cold War, which allowed the release of enormous resources from the public to the private sector. The second was Fed Chairman Paul Volcker, who broke the back of inflation with double-digit interest rates. It was a very painful period, but real rates of return reappeared, and a new era of prosperity was born. Predictably, gold prices stayed low and steady until macroeconomic troubles returned in force in the early '00s.
THE ONLY CERTAINTY IS UNCERTAINTY
Is the current crisis likely to be resolved in the miraculous fashion of the 1980s? Everybody must draw their own conclusion, based on their assessment of the outlook as well as their own situation and risk tolerance. A total optimist would have zero exposure to gold, a total pessimist a whole lot, and those unsure a small percentage as insurance. I always remember the lesson from my wise colleague... gold is a means to reliably store our wealth, and therefore a means to survival.
Andre Sharon is a professional economist and acknowledged expert on gold, having served as Director of International Research covering gold mining investments at Drexel Burnham Lambert and Director of European Research for Merrill Lynch.
A version of this article was originally published at www.minyanville.com
THIS MONTH IN GOLD
Gold Again Above $1,700 on Fed's Extended Zero-Rate Pledge
Reuters - Gold rallied hard on January 25, climbing 2.5% intraday to above $1,700 an ounce, on news that the Fed is extending its promise to maintain near-zero interest rates until late 2014. The Fed's previous low-rate pledge was set to expire in mid-2013. The rally was gold's biggest intraday gain in four months, and eclipsed the day's modest gains in equities and other commodities. "Ben Bernanke is saying if you keep your money under your mattress, you lose out as the purchasing power of the US currency is being eroded," remarks Axel Merk, the currency expert from Merk Funds. Read full article>>
Gold Proves Safest as Goldman Forecasts Record
Bloomberg - US Treasuries step aside; the world's oldest safe-haven asset is making a comeback. According to the Bloomberg Riskless Return Ranking, gold has outperformed all other commodities over the past five years when adjusted for volatility. The next-best performer has been gold's junior sibling: silver. No surprise, then, that Goldman Sachs likes what it sees in the yellow metal market. The bank forecasts gold futures to climb to $1,940 an ounce in the next twelve months. Read full article>>
China Gold Hoarding Turns More Traders Bullish
Bloomberg - Mainland China imported a record-breaking 85.7 tons of gold bullion via Hong Kong last October. It shattered that record and set a new one in November, importing a whopping 102.8 tons. China recently overtook India to become the world's largest gold-jewelry market. The exploding imports via Hong Kong may also be a sign that the People's Bank of China is looking to further diversify its reserve holdings. "The thing that's caught people's minds is the massive increase in Chinese buying," says Ross Norman , CEO of Sharps Pixley Ltd., a bullion brokerage in London. "Gold has demonstrated time and time again its ability to hold purchasing power." Read full article>>
Sprott Positive on Gold
Reuters - Eric Sprott, the renowned Canadian fund manager, remains positive on precious metals for the coming year. Sprott anticipates gold will rally to $2,000 an ounce and beyond in 2012. Sprott is even more sanguine on silver, which he anticipates will rally to $50 an ounce and beyond. Sprott points to strong physical demand from mainland China and Turkey, where consumers are purchasing specie at record rates, as an important driver of the secular bull market in gold - in addition to the more fundamental litany of concerns about the global economy. Sprott prefers physical bullion as an asset choice, especially in light of the MF Global swindle. Read full article>>
Miners See Gold Hitting $2,000 This Year
TheTelegraph(UK) - The folks digging the yellow metal up out of the ground see rosy times ahead. A survey by accounting giant PricewaterhouseCoopers (PwC) found that a preponderance of gold-mining company executives believe the price of gold will keep increasing in 2012 for a 12th consecutive year. The average prediction from the survey came in around $2,000 an ounce. Accordingly, gold mining companies have increased their price targets for this year by 20%. Miners underestimated their price targets in 2011, predicting the yellow metal would end the year at only $1,500 an ounce. Read full article>>
Roach: Central Banks "Pulling the Wool Over Our Eyes"
Bloomberg - Stephen Roach, a senior executive with Morgan Stanley Asia and a member of the faculty at Yale University, sums up today's economic predicament succinctly in a must-see interview from Davos. "Central bankers right now are trying to pull the wool over our eyes with zero interest rates and this magic called 'quantitative easing.' [...] They have committed to a policy that they then have to up-the-ante on themselves to continue to implement." Of course, when they "up the ante," our purchasing power goes down the drain. See video >>