Solid Gold Reasons to Own Gold
by
Gary North
by Gary North
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
- 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
Copyright
© 2004 LewRockwell.com
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