Gold

This is what I wrote about gold a couple of months ago.

Last week’s small correction in gold price offers a nice opportunity to increase exposure to gold mining stocks.

 

New York, November 5 2010.

“With all due respect, US policy is clueless”.

With these words, the German Minister of Finance voices many countries’ irritation around the world.

We have now reached the post-diplomatic language era.

The currency war is in full swing.

It is not like the US is entering this period united in its convictions.

Ron Paul is already preparing the post-Fed era.

Several Fed Directors are disagreeing openly with their boss.

Paul Volcker, the major architect of a 30-year bond market rally, is worried too:

“The thought that you can create a prosperous economy by inflating is an illusion, in my judgment.”

He then adds: ” I thought we’d learned that lesson.”

The world is coping with the mad professor syndrome.

Professor Bernanke is very intelligent.

He is respected.

He has the knowledge.

When the financial meltdown hit the world economies, he had the answer.

Many believe QE1 was needed to get the economic blood flowing again.

Then he had the answer to economic recovery.

This time it did not work.

The expected growth from the massive fiscal and monetary stimuli did not materialize.

Now, a professor – not unlike portfolio managers – does not like to admit being wrong.

So, he doubles down.

He is right.

The world is wrong.

History will vindicate him.

Bernanke is not just another professor.

He is part of what is rapidly becoming the Princeton school of massive intervention.

Let’s call it the Keynesian school on steroids.

Krugman and Bernanke know why Keynesian policies have always failed in the past:

The policy implementations were just too timid.

Buy more gold.

In my early years on Wall Street, M3 numbers were watched very carefully.

The markets were watching the unsupervised Federal Bankers’ actions very carefully.

That was not to their liking, it seems.

So, the Fed stopped publishing M3 numbers in March 2006.

It had grown 142% from 1994 – when the growth started to accelerate – to 2006.

That is an 11.8% compound annual growth.

US per capita output grew at 5.4% annually over that same period.

We learn from the St Louis Fed that since 2006 the USD monetary base has grown by another 134%.

Total public debt has gone up from $8.5 trillion to $13.5 trillion.

And all this has resulted in a 7.6% GDP growth in 4 years.

As Paul Brodsky from QB Asset Management puts it:

“At first this term credit flowed broadly into financial asset markets.

When equity markets blew up in 2000, it flowed into housing.

When that credit finally blew in 2007 there was nowhere for it to go except back to the Fed.”

Gold is not a commodity.

Brodsky is right to claim that gold is a currency.

It has been for a few thousand years.

By contrast, no fiat money has ever survived.

None.

The production gap and velocity of money.

Skeptics of gold as a refuge against fiat money focus on two arguments:

The production gap and the low velocity of money.

History tells us that these are misplaced.

CPI, interest rates and capacity utilization rates were all falling in 1972 as well.

That surely did not prepare us for the infamous stagflation years that followed.

As far as today’s low velocity is concerned, let’s remember that Weimar Germany experienced a deflation in 1920.

It was followed by massive money printing and hyperinflation.

Velocity kicked in once the Germans lost confidence in the government’s ability to pay its huge debt.

At that point, the large amounts of money citizens had hoarded during the short deflation came out of hiding.

It seemingly hit the markets all at once.

Such a scenario may not apply to the US today.

Maybe we will grow out of our problems.

But the day all the money that is being hoarded by consumers and companies today will come out of hiding, velocity will quickly accelerate.

Hopefully not too quickly.

The generation gap.

The final argument for gold is counterintuitive.

With all the ads for gold on the Glenn Beck show, one is tempted to believe that gold price has reached a bubble.

If my taxi driver is buying gold, it must be a sign to short…

However, every time I talk to investors from my generation, I realize they still do not hold gold in their portfolio.

There is still a huge potential demand from investors for whom gold accounts for less than 0.6% of their financial assets.

In 1980, 2.77% was the average.

The Volcker generation has a hard time buying gold.

In the good years gold was rightly viewed as a useless metal.

After all, it does not produce anything and it is hardly used for industrial purposes.

Which is true, but misses the point.

The world monetary system is disintegrating in front of our eyes.

Gold is the only solid currency left before Geithner’s successors and their increasingly assertive counterparts overseas come up with a new Brettonwoods.

To paraphrase Lord Keynes:

When facts change I change my mind too. What do you do sir?

Having ignored gold for most of my professional life, 18 months ago I started buying gold mining stocks.
I plan to increase my exposure from today’s 20% level.

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