by Gary North
In the October, 2001, issue of my subscription-based newsletter, Remnant Review, I began promoting gold. I was persuaded that the long decline, 1980—2001, was over. I was also convinced that the best way to make money was in North American gold shares. Those who took my advice have made well over 100% on their money.
In the opening paragraph of the November 21, 2003, issue of Remnant Review, I wrote this:
Those of you who have followed my advice on gold since 2001 are way ahead financially. But gold's price seems to have gotten stalled in the 390's. This may be because of increased central bank leasing. It may be because people who hold gold really don't think it will stay above $400, so they sell. My view is that the dollar has not yet begun to fall to the extent that the balance of payments deficit indicates that it should. So, I still recommend that people be heavy investors in gold.
One of the factors that persuaded me in 1991 that gold had hit bottom was a report issued by some woebegone gold broker. He wailed that he had had enough. For over two decades, gold's price had fallen, and he was not going to promote it as an investment any longer. Gold was finished! On the contrary, he was finished. That's the kind of announcement that marks the absolute bottom of a market.
Then there was the ad campaign, disguised as an investment strategy, issued by long-term gold coin company, Blanchard & Co. By then, Jim Blanchard was dead and gone. I wrote the following in the February 15, 2002, issue of Remnant Review.
With gold moving up the way it has, you now know why I asked Sam Parks four months ago to start writing a column on North American gold shares. I wanted to get you back in early. I hope you did. If not, it's time. The boom has begun.
The classic sign of an imminent bull market for anything is when old-time sellers and advocates of the item bail out. They tell their clients or disciples, "It's all over. Change direction. Sell." The following news has come as a surprise to us old-time gold bugs. Blanchard Co. coins, one of the two most widely known retail sellers of gold coins in the United States (along with Jim Cook's Investment Rarities), has made an about-face. It has done what no company is ever supposed to do: it has publicly abandoned its USP — its unique selling proposition. This is the marketing equivalent of Jimmy Dean going kosher.
I first spoke at a Blanchard conference in 1974. Always, the Blanchard organization has been pro-gold. But then Jim Blanchard sold Blanchard coins. With one utterly bizarre ad campaign, this company has tossed out the original Blanchard position on gold. You will probably see this ad. In case you should be tempted to believe the ad, let me go over its main arguments. Blanchard has a lot of money — this week, anyway — to promote its new message. So, these ideas may spread into the hard-money camp. Here is the new message:
Gold bullion is no longer a hedge against inflation, devaluation of the dollar or falling stock prices. It is no longer a store of value. The very idea of gold's intrinsic value — value that is not dependent upon the actions or promises of any government — is publicly questioned by senior central bankers and by the heads of major financial institutions. Perhaps most importantly, gold is no longer insurance against economic, monetary and political crises, including war, that diminish the value of financial assets.
Note: this page is now gone. It was still on-line in December, 2003. Fortunately, you can still find it on Archive.org.
I cannot recall any comparable instance where an old-line company in any industry made this radical a switch of its public positioning without warning. It is one thing to emphasize a new product line — risky, but not suicidal. But to revamp a company's entire philosophy overnight is a textbook case of what not to do. Whoever is running Blanchard today has bet the farm on a falling price for gold. A stable price won't do it. The ad copy writer calls today's gold price a bear trap.
Gold bullion is caught in a bear trap. If the price of gold goes up, the institutions and corporations that have the most money, the most gold, the most information about gold and the most ability to influence gold's price, lose money. Recent events have proved that those institutions and corporations have the power to slam the brakes on any increase in the price of gold, no matter how compelling the macroeconomic story behind the increase might be.
The final sentence is of course true. "Recent events have proved that those institutions and corporations have the power to slam the brakes on any increase in the price of gold, no matter how compelling the macroeconomic story behind the increase might be." So have events over the last 22 years. Central bankers always possess this power, and they have exercised it on occasion in the past. So, what has changed recently? This: Blanchard's marketing strategy.
I went on to offer evidence that the ad was categorically wrong. I concluded:
If price deflation really is coming, despite monetary inflation, gold could fall. But I think today's monetary inflation will secure the U.S. economy against a price-deflationary scenario. The other major negative factor, another series of unexpected gold sales by central banks, is increasingly unlikely. They are running out of gold, despite the statistics on unchanging official reserves. They can sell gold reserves again, but at some point, the game must end. We are closer to the end than five years ago, when the gold-leasing strategy was adopted.
HAS THE GAME ENDED?
With gold above $500, should we conclude that the central banks' gold leasing strategy has ended? I don't think so. The interest rate at which gold bullion "banks" can borrow gold, sell it to the public, and invest the money at higher rates than they are paying to borrow the gold, indicates that the game is still going on. If you were one of the favored few, you could borrow gold at 0.14 of a percent per annum.
To see today's rate, click the button, "Leases."
This low rate indicates that there is some worry about borrowing gold, for the debtors must repay in gold, or so the contracts say. This assumes that central banks won't keep rolling over the contracts, year after year. They will, of course. They have no choice. In a true gold rush, the borrowing bullion banks will not be able to afford to deliver physical gold to central banks. It has been sold, and any attempt to buy back large quantities would blow the price of gold through the roof. So, if central banks press the bullion banks, the bullion banks will declare bankruptcy. That would force the central banks to take the leased gold off of their official books. Leased gold is counted as gold in the vault. The central bankers are not about to admit officially to their respective governments that they have sold the reserves to the favored bullion banks at a piddly 0.14% per annum.
Why is the rate low? Because central banks are competing for the right to lease their gold, and the number of takers has fallen. The bullion banks know that being short gold — legally having to return physical gold in the future — is getting more risky. Interest rates have fallen worldwide, so the profits from the carry trade — borrowing from a government-subsidized central bank and lending money to the public — have declined. The risk-reward ratio is getting heavier on the risk side. Demand for borrowed gold has fallen, so the price of borrowed gold has fallen.
The game has slowed, but it has not ended. The gold lease market is still a price-reducing factor in the gold market. There are still well-heeled speculators who are willing to borrow gold, sell it, and invest the proceeds. But enthusiasm has waned, as reflected in the fall of the interest rate demanded.
Central banks continue to get rid of their enormous hoards of gold. The leasing program is a disguised gold sale program. The central banks are returning gold bullion to the great-grandchildren of the victims whose gold was confiscated by the banks in 1914, when World War I broke out, and in 1933, when Franklin Roosevelt unilaterally made it illegal for Americans to own gold bullion. Gold is being de-monetized even further.
IS THIS A TURNING POINT?
With gold breaking the $500 barrier, some gold bugs and other odd-ball forecasters will tell their clients that gold is in a new bull market. Well, gold has been in a bull market for over three years. The $500 barrier has little to do with this.
The buyers of investment gold are still few and far between. The memory of the two decades of falling prices, coupled with bear trap rallies that were heralded as new bull markets, has driven most investors out of the gold market. Gold coin investors still have only a handful of brokers to call. But you can still get through after three rings.
The people who are driving up gold's price are not little people who buy a few gold coins. The big players are jewelry fabricators, industrial users, and (maybe) a few central banks that are quietly adding to their holdings. China is the #1 suspect. But, at this stage of the gold boom, large investors are either absent or else buying for their accounts quietly. We have not begun to see a gold boom.
When you start receiving direct-mail flyers on the gold boom, then the boom will be well established. Today, these flyers are inserts in existing newsletters, which are dying off as their subscribers die off. These inserts reach few potential buyers.
The mainstream investment houses are not actively promoting gold. When three or four large brokerage houses start offering gold bullion mutual funds that are comparable economically, though perhaps not legally, to the tiny Central Fund of Canada, we will know that the boom has reached midpoint.
You do not hear people asking how high Microsoft's shares will go. They assume that the price will rise forever, or at least until two weeks after they retire and sell their shares. You may hear predictions about the top of the Dow Jones Industrial Average, but not too many. This is because the hypesters who proclaimed Dow 36,000 have tarnished the Dow forecasting business, an outcome which was one of the positive aspects of the Dow's fall from its peak of just under 12,000 in 2000.
Then why does anyone announce gold's top at a particular price? I think it's mainly to confirm his readers that he thinks the price per ounce will rise. One large number is as good as any other.
Anything over $3,000 is basically a forecast of the collapse of the dollar.
My hesitation to predict the collapse of the dollar is my doubt regarding the currency that would replace it if it really did collapse. The euro is the main candidate, but it is a fiat currency, too. It can be reduced in value by the same tried and true central bank policies that have reduced the dollar's purchasing power by over 95% since 1913.
The international currency system is like a group of drunks staggering home after a night at the pub. They hold each other up. If one of them really got sober and stood tall, the others would pull him down by sheer inertia.
In marketing terms, if holders of dollars all decided to exchange dollars for one currency, that currency would rise in its dollar-denominated value to such an extent that the nation's exporters would be ruined. America is the world's mouth. There are too many exporters trying to feed it. Of course, the day will come when the world's mouth will become the world's alimentary canal. American companies and governments will start paying off their creditors in dollars of rapidly declining purchasing power. But when it comes to declining purchasing power, the world's other central banks can play the game, too.
Gold bullion as an inflation hedge will continue to do well, but it is unlikely to become the world's currency that replaces the dollar. If it did, then gold's price really would go ballistic. A $10,000 or $20,000 gold price would be reasonable. But there will always be other central banks working to replace the dollar with their currencies, thereby keeping gold out of the currency markets.
The price of gold at $10,000+ would indicate a severe international monetary crisis: a run on all currencies, not just the dollar. That would indicate a complete shift in public opinion back to a commodity monetary standard. It would be accompanied by a breakdown of the division of labor. Gold at $10,000 would produce an economy in which gold holders would face falling income from their businesses and other income-generating sources. Anyone who predicts $10,000 gold is predicting a breakdown so severe that his life is at risk.
DON'T GET STAMPEDED
Gold is a solid investment in more ways than one. But it should be regarded by investors as supplemental. It is like a government's Treasury Department asset. It is better to have that asset in a time of inflation than it is to have other nation's bonds, but citizens of a nation whose treasury that has only gold in reserve would be at risk in a worldwide breakdown. It is much better for a nation to have an empty treasury and no debt outstanding than it is for it to have a treasury with a pile of gold. A war will deplete a gold hoard very fast. So will a depression, when tax receipts fall. What a nation needs is productivity and a highly developed division of labor. That's what people need, too.
Most investors have so little gold in their portfolios that they probably could use a little hype from gold brokers. But when the hype is everywhere, it will be time to switch to other assets. That is years away, I think.
Because most investors buy only when stampeded, most investors lose. They buy high and sell low. I am writing for people who have heard about gold, who may even have bought a few coins (but probably not), and who are telling themselves, "If gold ever drops to $495, I'll buy more." They won't. If the opportunity ever presents itself, they will wait until it falls to $475.
It's better to buy when you feel that it's the last train out, but only if you are in a small group. When millions of people have heard the story of gold and who think it's the last train out, it will be time to invest in something more conventional.
I realize that by refusing to hype gold, I am encouraging you to play Scarlett O'Hara: "Fiddle-dee-dee. I'll think about it tomorrow." I am asking you to think like a thoughtful Southern plantation owner in 1859, who sold his family's land and his slaves for gold the day after the court hanged John Brown for treason, and then put his money on deposit in several English banks. It's not that you would have trusted in gold in 1859. It's that you would have trusted the American political system even less. You would have been looking to buy half a dozen plantations in, say, 1867. But you also would have been willing to forego a big profit in gold if you had been able to avoid the war.
Of course, no self-respecting plantation owner would have done that in 1859. This indicates that too much self-respect can ruin the plans of the best of us. If you live in a country in which theft has become a way of life — "Thou shalt not steal, except by majority vote" — don't tie your self-respect to the wisdom of the government's policy-makers, including its central bankers.
Gold above $500 is more of an alarm bell than a turning point. The turning point for gold happened over two years ago, before 9-11. Gold over $500 is a small headline on the business page. But it's more significant than a headline in a small-circulation newsletter.
[Note: I published this report, except for changes in the price of gold and the gold leasing rate — today, half of what it was when I wrote this — in Gary North's Reality Check for December 2, 2003. That issue was titled, "With Gold Over $400." I republish it here for a reason: to remind procrastinators in 2003 not to procrastinate in 2006.]
January 11, 2006
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