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r Portfolio Diversification Myths: Why Pension Funds Need to Rethink Their ion is Outperforming Mining Stocks Gold is Money Ensuring the Quality of x Myths about Gold Platinum: Dark Horse, Bright Future Precious Metals: onceptions 2004 Empire Club Investment Outlook 2003 President’s Message
ARTICLES10TH ANNIVERSARY BOOK OF Ten Years of Articles and Outlooks
Nick Barisheff
I n t r o d u c t i o n
We are pleased to present a collection of 15 articles and outlooks by
Nick Barisheff, president and CEO of Bullion Management Group Inc.
The articles were previously published in magazines or periodicals, or
delivered as speeches. Nick has been a regular contributor to magazines
like Resource World, Investor’s Digest and Benefits and Pensions
Monitor. In addition, he has spoken at the prestigious Empire Club
Outlook luncheon for the past five years consecutively. His most recent
address is included in the collection.
These commentaries cover a wide range of topics, from how to buy and
store precious metals to why precious metals will continue rising in price
for years to come. With something for everyone, from those just beginning
to plan their future to the most sophisticated market expert, Tenth
Anniversary Book of Articles deserves a place on every investor’s bookshelf.
Ta b l e o f Con t e n t s
Annual Report President’s Message | March 2004 7
Gold Myths and Misconceptions | October 2004 11
2005 Outlook for Gold | January 2005 19
General Motors, the Stock Market and Gold | April 2005 27
Precious Metals: Critical Diversifier | November 2006 35
Platinum: Dark Horse, Bright Future | March 2007 41
Six Myths About Gold | November 2008 51
2004‐2009 Pompous Prognosticators Revisited | July 2009 59
Ensuring the Quality of Precious Metals Purchases| December 2009 63
Gold is Money | March 2010 67
Why Bullion is Outperforming Mining Stocks | July 2010 77
Three Dominant Factors Will Impact Precious Metals | April 2011 85
Portfolio Diversification Myths | May 2011 103
Gold and Fiat Currency: Forty Years Later | August 2011 109
Why Rising Debt Will Lead to $10,000 Gold | January 2012 113
2 0 0 3 Annu a l R e p o r t :
P r e s i d e n t ’ s Me s s a g e
M a r c h 2 0 0 4
The concept of The Millennium BullionFund was formed in 1997 when
my own research led me to the conclusion that equity markets were
forming a bubble, and that economic conditions were about to
deteriorate. My research indicated that the next bull market would be
in commodities, and particularly in precious metals. Throughout my
30‐year career in the investment business, I have always maintained
that precious metals are a vital component of an investment portfolio.
However, the investment form had to be actual physical bullion, not a
paper derivative such as a futures contract, or an equity interest in a
mining company. Although investments in commodity futures and
mining stocks were available both directly and through mutual funds,
there was no cost‐effective, convenient way for Canadians to purchase
and hold gold, silver and platinum bullion. Moreover, bullion could
not be held in RRSPs or other registered plans.
After further legal research and three long years of negotiations with
the Ontario Securities Commission, The Millennium BullionFund�
received approval for Ontario in January 2002, and after further
negotiations with the remaining provinces and territories, it received
complete Canadian approval in May 2003. For the first time, Canadians
could now fully diversify their portfolios and hold gold, silver and
platinum bullion in their RRSPs.
The Fund’s structure echoes the unique characteristics of bullion.
Unlike traditional financial assets, the value of bullion can never
8 10th Anniversary Book of Articles
decline to zero. Unlike bonds, bullion is not someone else’s liability,
and unlike stocks its value is not based on anyone’s promise of
performance. In order to maintain these unique characteristics, the
Fund was structured with a fixed investment policy of purchasing
equal amounts of each metal. As a result, unit prices are primarily a
function of bullion prices alone, and do not depend on the trading skills
of a portfolio manager. The Fund’s mandate does not allow it to
employ any hedging, or to lease its bullion holdings. The legal
structure of an open‐end mutual fund trust ensures that liquidity is
equal to that of the bullion itself, and that no third party can have any
claim against Fund assets. Because units are priced at Net Asset Value
on a daily basis, no premiums or discounts can impact their value.
The importance of holding precious metals in an investment portfolio
has been largely forgotten during the equity bull market of the past
twenty years. Traditional asset allocation theory, as represented by the
investment pyramid, advocates higher risk, less liquid assets at the top,
with lower risk, more liquid assets at the bottom. Typically, precious
metals and commodities are placed at the top of the pyramid, while
cash equivalents are at the base. While placing commodity futures
contracts at the top of the pyramid is appropriate, fully allocated
physical bullion should form the foundation of the pyramid. For 3,000
years precious metals have been the most liquid, universal form of
money throughout the world. They still are.
An effectively diversified portfolio should contain at least five percent
in physical bullion at all times. Futures contracts, options and mining
equities belong in a different asset class, with percentage holdings
based on individual investor objectives and risk tolerance. Unallocated
bullion, like pool accounts and certificates, can form part of a portfolio’s
cash component, but would not form the foundation.
This asset allocation model benefits the investor because precious
metals have an inverse relationship to other assets, like stocks and
bonds. Holding bullion reduces portfolio volatility and improves
returns during normal market conditions. During periods of economic
stress bullion acts as portfolio insurance, growing in value and
effectively offsetting losses in other asset classes. For added protection
in turbulent economic times, bullion allocation should be increased to
at least 10 – 20 percent.
9
Diversification is just as important within the Fund as for individual
investors. Internal diversification is achieved by holding not just one
precious metal, but all three. Gold, silver and platinum each have
unique characteristics, and share dual roles as both industrial
commodities and monetary assets. The Fund’s investment mandate
requires it to invest equally in each metal.
This strategy reduces volatility within the Fund because the metals are
valued for different attributes: gold primarily as money; silver as money
and as a commodity; platinum primarily as a commodity. During
economic expansions, commodity demand for silver and platinum will
likely be greater than for gold. During economic downturns, monetary
demand for gold and silver will increase. Because two‐thirds of the
Fund’s holdings will perform well regardless of economic trends,
volatility is minimized and long‐term returns are maximized.
Owning units of The Millennium BullionFund provides all the
advantages of holding physical precious metals in a registered plan,
with the added value of cost‐effective purchasing, insurance and
storage. This provides investors with one of the best wealth protection
strategies available. As an added benefit, there is every indication that
we are in the early stages of a long‐term precious metals bull market
that could result in tremendous gains for unitholders.
2003 Annual Report: President ’ s Message
Go l d My t h s a n d Mi s c o n c e p t i o n s
O c t o b e r 2 0 0 4
Gold. Casually mention the word to a group of investment‐minded
friends and colleagues and watch as it inspires a visceral reaction, since
people either love gold or hate it; there arenʹt many who feel ambivalent
toward it. Those who love it realize that gold has been the ultimate
store of wealth for over 3,000 years, while various paper currencies
have come and gone. Those who hate it maintain that gold is an archaic
relic, no longer relevant in a world where the majority of business
transactions are carried out with a few clicks on a computer keyboard,
and money is nothing more than a digital entry on a computer.
Or is the antagonism toward gold because they realize that a rising
gold price makes them uncomfortable? Subconsciously the disbelievers
may sense that a rising gold price is like an economic barometer
forewarning of a coming financial storm.
Since 1971, when Richard Nixon ended convertibility of the US dollar
into gold, various myths and misconceptions have been circulating,
influencing peopleʹs opinions and resulting in a number of unfounded
myths that have dogged the yellow metal.
MYTH: GOLD IS HIGHLY SPECULATIVE!
The importance of holding precious metals in an investment portfolio
has been largely forgotten during the equity bull market of the past
twenty years. Holding precious metals in a portfolio can provide three
distinct benefits: speculative gains, hedging and wealth preservation.
12 10th Anniversary Book of Articles
However, many investors and their advisors focus only on the
speculative aspect and treat gold as if it was an industrial commodity
like copper or zinc.
Traditional asset allocation theory, as represented by the investment
pyramid, advocates higher risk, less liquid assets at the top, with lower
risk, more liquid assets at the bottom. Typically, precious metals and
commodities are placed at the top of the pyramid, while cash
equivalents are at the base. While placing commodity futures contracts,
options and exploration junior mining companies at the top of the
pyramid is appropriate, fully allocated physical bullion should form the
foundation, or base.
While futures contracts, options and mining equities can provide
leveraged speculative opportunities, they belong in a different asset
class along with percentage holdings based on individual investor
objectives and risk tolerance. They also carry much higher risks, and
have been known to decline to zero. Unallocated bullion, like pool
accounts and certificates, can form part of a portfolioʹs cash component,
but should not form the foundation as they may become illiquid and, in
certain circumstances, could lose their value completely. Fully
allocated, segregated bullion is not someone elseʹs promise of
performance, nor is it anyone elseʹs liability. It cannot decline to zero.
An effectively diversified portfolio should contain at least five percent
in physical bullion held on a fully allocated, segregated basis at
all times. This asset allocation model provides effective hedging,
benefiting the investor because precious metals have a negative
correlation, or inverse relationship, to traditional financial assets like
stocks and bonds. Holding bullion reduces portfolio volatility and
improves returns during normal market conditions. During periods of
economic stress, bullion acts as portfolio insurance, growing in value
and effectively offsetting losses in the other asset classes. For added
protection in turbulent economic times, bullion allocation should be
increased to 10 ‐ 20 percent.
MYTH - CENTRAL BANKS NO LONGER NEED TO HOLD GOLD AND HAVE SOLD OFF THEIR HOLDINGS!
The Central Bank of Canada has ignored thousands of years of
monetary history and bought into the archaic relic view, and has sold off
nearly all the gold it held in its foreign exchange reserves. From a peak
13
of 1,023 tonnes in 1965, Canada now holds only 100,000 ounces of gold
valued at $45 million. This places it in 77st place, below third‐world
developing countries such as Bangladesh, Guatemala and Tunisia.
This sell off has contributed to an impression within Canada that other
central banks are also divesting themselves of gold, but statistics
compiled by the World Gold Council show that official global reserve
holdings of 36,575 tonnes in 1971 have declined by only 0.4 percent
annually to 31,736 tonnes in July, 2004. Gold sales by Canada,
Australia, Britain and Switzerland, among others, were offset by gold
purchases in France, Germany, Japan, China and Taiwan. Recently
Argentina has been buying 10 ‐ 12 tonnes per month to shore up the
value of its currency.
The Bank of England also accepted the archaic relic label, sold half of
its gold reserves at the very bottom of market, and purchased
interest‐bearing US treasury bills. Since then, the US dollar has lost
about 30 percent against the British pound, while gold has increased by
approximately 30 percent in British pounds. Gold and silver have
successful 3000‐year track records as portable stores of wealth, whereas
paper money does not. Although the US dollar is considered by
many to be the most stable currency, it has lost approximately
80 percent of its purchasing power since gold convertibility was
eliminated in 1971.
MYTH - GOLD IS NOT A GOOD INVESTMENT!
Although fully allocated gold bullion is not an investment per se, its
long‐term performance has been more than commensurate with risk.
Goldʹs decline from its 1980 peak is often cited to support the poor
investment performance myth but, when measured from a cyclical
peak, any investment will take many years to break even. The DOW
did not recover to its 1929 high until 1954. By that time, many of its
original stocks had completely disappeared and were replaced by
alternatives. Fifteen years following the peak of Japanʹs NIKKEI, it has
only achieved approximately 25 percent of that peak.
In fact, on a cumulative basis since 1971, gold has outperformed the
DOW. Goldʹs rise from $35 per ounce in 1971 to its recent $415 level
amounts to a 1,086 percent increase versus the DOWʹs 1,046 percent
increase from 868 to 9,950 today. In the past four years, goldʹs
performance has dramatically outperformed that of equities. While
Gold Myths and Misconceptions
14 10th Anniversary Book of Articles
gold has increased 63 percent, the DOW has lost 13 percent and the
tech‐heavy NASDAQ is down 62 percent.
As for the future, gold is poised to outperform equities. The DOW:gold
ratio has averaged 10:1, peaking at 44:1 in 2000. Today, the ratio has
dropped to 24:1 and has decisively broken below the 200‐day moving
average. A number of respected analysts expect to see a 1:1 DOW:gold
ratio, as occurred in 1980 and in 1935. The only question that remains is
will the ratio be 1:1 at 6,000, 4,000 or 1,000?
MYTH - PRECIOUS METALS ARE TOO VOLATILE!
The myth that gold is volatile simply does not stand up to scrutiny.
While mining stocks, particularly junior exploration companies, are
highly volatile, gold bullion is not. According to a study by the World
Gold Council, the volatility of the DOW during the past ten years has
been 16.13 percent as compared to 12.55 percent for gold.
The volatility of mining stocks, particularly during bull market cycles,
can afford tremendous trading profits. It is critical to have either a
knowledgeable advisor or to become proficient in technical analysis.
Some traders use trading profits to augment their bullion holdings.
MYTH - MINING STOCKS AND BULLION ARE EQUALLY EFFECTIVE AS PORTFOLIO HEDGES!
One of the most prevalent misconceptions is that holding gold mining
stocks is preferable to owning bullion. However, the decision between
gold mining stocks and bullion is not an either/or decision. Each asset
has a different place in the investment pyramid, representing different
objectives and different risk/reward relationships. Fully allocated
bullion is used for long‐term wealth preservation because it maintains
its purchasing power and also acts as a hedge against economic crises.
Mining stocks, precious metals mutual funds, futures contracts and
options are used for both speculation and investment during bull
market cycles, but are subject to market, management, financial, labour,
geopolitical, environmental and hedging risks.
Another misconception is that bullion is positively correlated to mining
stocks with both rising and falling in unison it is not. In the crash of
1929, Homestake Mining, the largest and oldest gold producer in North
America, initially declined with the rest of the equity market, but
recovered while equities continued down. Unless investors were both
15
knowledgeable and had staying power during that time, a hedge using
mining stocks would have failed. In the crash of 1987, mining stocks
declined more than general equities. Bullion, however, maintained a
positive position with less than 20 percent volatility.
During bull markets, mining stocks initially tend to outperform bullion.
However, as the bull market progresses, bullion tends to outperform
mining stocks. In the 1970s, Homestake achieved a 900 percent increase,
whereas gold more than doubled that level at 2,300 percent. When a
rising gold price signals a non‐confidence vote in the countryʹs fiat
currency, the flight to its safe haven status can result in dramatic gains.
MYTH - MINING STOCKS ARE MORE LIQUID THAN BULLION!
The belief that mining stocks offer superior liquidity over bullion is
another popular misconception. Total aboveground gold is estimated
at $1.7 trillion. On an average day, a net of $6 billion of physical gold is
traded among the members of the London Bullion Market Association
in London alone. This does not include gold futures trades on the
commodities exchanges, or retail investment purchases, or jewelry. On
the other hand, the total market capitalization of all global mining
stocks is less than $150 billion. The most liquid and largest gold‐
producing company in the world is Newmont, with a market
capitalization of about USD$20 billion. It trades about $200 million
shares per day, representing a turnover of about one percent of its
market cap. Even if this turnover rate is applied to all mining stocks it
would equate to about $1.5 billion, or one‐quarter of the gold bullion
traded in London alone.
In addition to higher liquidity due to higher market size and higher
trading volume, gold bullion is accepted as payment globally, whereas
a mining stock certificate would have little if any value in many parts of
the world. There is a difference between liquidity and convenience in
purchasing the investment. The purchase of physical bullion may be
somewhat time‐consuming and inconvenient for a retail investor
compared to placing a trade for mining stocks. However, as the
precious metals bull market progresses, new investment vehicles will
come to market that will provide equal convenience for purchasing
bullion as is currently available for mining stocks.
Gold Myths and Misconceptions
16 10th Anniversary Book of Articles
MYTH - THE PRICE OF GOLD AND SILVER HAS BEEN IN DECLINE DUE TO LACK OF DEMAND!
With all the attention on the latest high‐tech stocks, the price declines in
gold have been attributed to lack of demand. Surprisingly though,
gold, has experienced supply deficits for more than a decade
amounting to over 22,000 tonnes.
How can the price of a commodity decline in the presence of a
supply deficit?
Basic economics tells us that a supply deficit causes prices to rise, but
that hasnʹt happened in the case of precious metals. The fanfare that
always accompanies central banks sales gives the impression that these
sales have made up the deficits. However, net central bank sales only
account for a small part of the deficit. The balance of the deficit has
been made up through the practice of leasing, creating an artificial
supply that acts to suppress prices.
Central banks lease out gold to bullion banks at low interest rates.
Bullion banks, in turn, lease the gold to mining companies and hedge
funds that sell the bullion and invest the proceeds in higher yielding
investments. Calling this practice leasing is a major misnomer. In the
case of the mining companies, it is more accurate to refer the practice as
covered short selling and in the case of the hedge funds, it should be
called naked short selling. In both cases, the artificial supply that
suppresses prices will be a major contributor to the coming price
increases as these entities are forced to buy bullion at market price to
mitigate escalating losses and cover their short positions.
Although there is some controversy about the total amount of leased
gold, the estimates are between 192 million and 800 million ounces.
Any sharp price rise in either metal will have a slingshot effect, caused
by a massive short‐covering demand that cannot be filled with even
several yearsʹ worth of mine production. This will greatly magnify any
increased investor demand and put extreme upward pressure on prices.
For 3,000 years precious metals have maintained their purchasing power
and have been the most liquid, universal form of money throughout the
world. Since 1971, both the Canadian and US dollar have lost
approximately 80 percent of their purchasing power while gold has
enjoyed an increase. In 1971, for example, a new car could be purchased
17
for $3,500 (100 ounces of gold) and a starter house in the suburbs for
$35,000 (1,000 ounces of gold). Today, 100 ounces would buy two new
cars and 1,000 ounces would buy two houses or an estate in the country.
If investors take the time to examine why they have a negative bias
towards gold, and can accept that what they believe to be true may be
myth or misconception, even the naysayers may realize the important
contribution precious metals can make to a portfolio and how they can
both increase and preserve their wealth in the coming decade.
Gold Myths and Misconceptions
Th e Ou t l o o k f o r Go l d i n 2 0 0 5
J a n u a r y 2 0 0 5
As Presented at the 2005 Empire Club’s
Annual Investment Outlook—January 6th, 2005
It’s January, the beginning of a new year, and the time when
economists, analysts and even astrologers like to prognosticate about
what lies in store for the next 12 months.
With respect to gold, opinions on the price vary from $400 to $500
dollars per ounce for 2005. These opinions presume that current
conditions will remain relatively stable, and if they do the $400 ‐ $500
range is reasonable. Since the range is quite broad, a review of some
history, and an examination of some current trends may be helpful in
gaining additional insights.
First, it is important to realize that the 70% rise in the price of gold since
2001 is not because of any supply/demand imbalance, as an industrial
commodity. Merely speculating on the price of gold ignores its other
benefits and relegates it to a commodity with no more stature than
copper or pork bellies. But gold has an important monetary role,
as confirmed by the billion ounces still held by Central Banks, and by
the clearing turnover of $6 billion daily by members of the London
Bullion Market Association.
Although various paper proxies and gold derivatives can provide
trading opportunities, they may not provide the wealth preservation
and hedging benefits of bullion itself. In order to achieve these benefits,
gold holdings must be in the form of fully allocated, segregated bullion
20 10th Anniversary Book of Articles
with reliable custodial arrangements. Since mining shares and other
gold proxies are either someone else’s liability or promise of
performance, they may not provide these benefits at a time when they
are needed most.
Wealth preservation has been an attribute of gold bullion, and it is the
reason gold has functioned as money for over 3,000 years. Although
gold prices in local currencies may have fluctuated during both
inflationary and deflationary periods, gold has maintained or even
increased its purchasing power in both instances.
Gold’s ability to preserve purchasing power was discussed in detail in
an essay written in 1966 by none other than Allan Greenspan, entitled
Gold and Economic Freedom.
We have all heard that you could always buy a man’s suit with an ounce
of gold. I can remember that in 1971, the price of a basic car was about
$2,500, or 71 ounces of gold. Since then, the dollar price of the car has
increased 5‐fold to $14,000, but for the same 71 ounces of gold, you can
now buy two cars. This relationship holds true for real estate, oil, and
the number of ounces to purchase the DOW, where the cost in gold
ounces has either remained the same or decreased over the last 30 years.
The same cannot be said for paper currencies. Throughout history,
currencies have come and gone as they were inflated away by
emperors, kings and politicians. Since 1971, when the US abandoned
gold convertibility, the purchasing power of both the Canadian and the
US dollar has declined by over 80% due to inflation.
Because of wealth preservation and hedging benefits, gold bullion
cannot be viewed like other portfolio holdings.
The hedging benefits of bullion are achieved because gold is negatively
correlated to traditional financial assets such as stocks and bonds.
These hedging benefits become particularly pronounced during periods
of economic stress. When you compare how poorly stocks, bonds,
real estate and currency performed relative to gold during recent
currency crises in Russia, South East Asia and Argentina, these benefits
become apparent.
The old Wall Street saying ‐ “Put ten percent of your money in gold and
hope it doesn’t work”, is particularly applicable today.
21
Often when I mention this saying I am asked what it means. Why would
you hope it doesn’t work? Aren’t you in the precious metals business?
Over the long term, a portfolio allocation of at least 10% to physical
bullion reduces overall volatility, improves returns and provides a form
of portfolio insurance. With our investment portfolios, we would all like
to maintain an optimistic outlook, hoping that the economy will
continue growing and our investments continue appreciating. However,
since financial markets are cyclical, it is only prudent to maintain some
portfolio insurance, in the form of bullion, in case markets move against
us. Even though we pay for house insurance year after year, we would
still rather that our house does not actually burn down.
Unlike traditional insurance or other hedging strategies, bullion is an
asset rather than an expense. It has a price floor approximately equal to
the cost of mining it. Unlike stocks and financial derivatives, the value
of bullion cannot decline to zero.
Because of the recent equity rally, many investors feel that the worst is
over and there is no longer a need to diversify and hedge. However, an
increasing gold price is like a financial barometer warning of an
impending storm.
Is the storm over, or are we actually in the eye of a hurricane?
Leaving aside the impact of natural disasters, terrorist attacks and wars,
are the economic conditions that have contributed to a rising gold price
still relevant as we go forward into 2005 and beyond?
Are the financial vulnerabilities arising from a mortgage‐induced
realestate bubble still present? Are the concerns expressed by both
Warren Buffett and Alan Greenspan about the $200 trillion of
derivatives exposure still present? By historical measures, are equity
markets fairly valued? Will the looming peak in oil production and
increasing global demand cause a continuous rise in the price of oil,
thus impacting global economies and industrialized societies?
But the worst threat of all comes from the continuous increases in the
money supply through the expansion of credit, at all levels. Simply
put, there is an ever‐increasing amount of paper money chasing a
limited supply of physical bullion. Unless corrected, the inflationary
growth of the money supply, federal budget deficit, trade deficit and
The Outlook for Gold in 2005
22 10th Anniversary Book of Articles
current account deficit will cause the US dollar to plunge in value while
the gold price climbs. In looking forward to 2005 and beyond, we need
to determine whether it is realistic to expect that this credit growth will
be stopped or even reduced.
Today, the annual increases in the US federal budget deficit are greater
than the total federal government debt was in 1971. This is an alarming
trend. Even during reported budget surpluses in 1998 and 1999, total
government debt still grew year after year to the current level of
$7 trillion. The US is now paying over $300 billion in interest to holders
of federal debt. If this rate of increase continues, eventually annual tax
revenues will not be enough to even service interest costs.
Notwithstanding that the US Dollar Index has declined by over 35%,
the trade deficit grew to a staggering $600 billion in 2004, and now
totals nearly $5 trillion cumulatively. The phenomenon of a growing
trade deficit during a currency decline is without historical precedent.
We don’t have to look far to find the reason for this anomaly. Since the
US has outsourced a great deal of its manufacturing and is dependent
on commodity and energy imports, the trade deficit has become an
ongoing systemic problem. For the past 60 years the US has enjoyed
special privileges because of the dollar’s reserve status and the
willingness of foreigners to invest in US dollar assets.
The US Current Account deficit now stands at over $650 billion, and
represents about 6% of GDP. But what has this got to do with the price
of gold? This ratio is the highest since 1929. Most economists consider
5% a critical level for current account deficit/GDP ratios. In the past,
when third‐world countries reached that level, a currency crisis followed.
COULD THE US BE THE NEXT ARGENTINA?
This credit expansion has led to a total US debt of $34 trillion ‐ over
300% of GDP ‐ the highest level in history. In addition, we need to add
$55 trillion in unfunded pension liabilities and Medicare obligations.
In all, this mountain of debt requires that the US borrows about
$80 million per hour, and absorbs over 80% of the world’s savings.
Here is a startling fact – it now takes $7 of new debt for every
$1 increase in GDP. How much confidence would you have in a
corporation that needed to borrow $7 annually just to increase its gross
revenues by a dollar? Clearly this can not go on much longer.
23
No wonder Alan Greenspan recently warned that “foreigners’ appetite to
continue to invest in the US may not be adequate to fully sustain the expected
growth in the net indebtedness of the US”.
Translated into English, his statement means that eventually foreign
investors will stop lending the US any more money.
No one knows for certain when that day will come. It may be next
week, or several years from now. You may think that it can not happen
in the US, but history gives us numerous examples of excess debt
leading to a currency collapse. Unless there is the political will to
reduce or eliminate the current mountain of debt, the day of reckoning
must eventually come. The longer it is postponed, the worse it will
ultimately be. Since politicians are not known for their ability to control
their spending and are not elected on platforms that propose
unpleasant financial medicine, it is difficult to imagine that the steps
necessary to fix the problem will be taken.
Canadians need to pay attention to these issues as well. While I have
focused on increases in the US money supply, you may be surprised to
know that the Canadian money supply has risen at twice the rate of the
US. Because of the fractional reserve banking system and global fiat
currencies, the US has exported credit bubbles to the countries that run
a trade surplus with it. In Canada, we are particularly vulnerable to the
state of the US economy and its monetary policy. We depend on the US
to buy our exports, and US dollars represent 50% of our currency
reserves. Canada is now the only G8 country without any gold bullion
to back its currency.
Bearing this in mind, is it likely that the Canadian dollar will maintain
its recent gains against the US dollar?
Up to this point, we have simply assumed a continuation of current
conditions. Maybe the US and the global economy will “muddle
through”, and business will continue as usual. But is it really prudent
to maintain a long‐only bias in your portfolio and assume that the
longest‐running bull market in history will continue for another
20 years? After all, markets are cyclical ‐ not linear. A 10% allocation to
bullion for its hedging and wealth preservation benefits seems more
than justified.
The Outlook for Gold in 2005
24 10th Anniversary Book of Articles
However, if one of the previously mentioned vulnerabilities
experiences a trigger event, then bullion may provide impressive
capital gains over and above hedging.
Since February 2002, the US Dollar Index has declined 35%, wiping out
$3 trillion for foreign investors. If the dollar continues to decline, the day
will come when the world will no longer be willing to increase their
US dollar holdings. The US Federal Reserve will then be faced with a
no‐win situation: increase interest rates dramatically, or let the dollar fall.
If foreign investors get nervous and start selling some of their 10 trillion
dollars’ worth of US dollar holdings, it may create a descending spiral
of further dollar declines coupled with financial asset declines. If that
happens, the line between hedging and capital appreciation will
become blurred. In the 1970’s, a loss of confidence resulted in the
US dollar declining 70% in German marks and Swiss francs. Gold,
however, experienced a 2,300% increase.
Historically, a reliable indicator for the trend direction of gold and
equities is the DOW:Gold ratio. When the ratio increases, it is a good
time to be overweight equities and when it declines, it is better to be
overweight gold. The ratio was 1:1 in 1935. In 1980, when gold was
$850 and the DOW was 925, it again approached to 1:1. The ratio
peaked at 43:1 in 2001, but has steadily declined to its current level of
25:1. Richard Russell, publisher of the DOW Theory Letter since 1958,
predicts that the DOW:Gold ratio will once again be 1:1. The question
is, will both gold and the DOW be at… 1000, 2000, or 5000?
As far‐fetched as these possibilities may sound today, they may in fact
come to pass. In 1989, investors would have found it hard to imagine
the 80% decline in Japanese equities that ensued over the next 13 years.
Equally difficult to foresee in the early 80’s, when the NASDAQ
was 400, was its rise to 5000. In 1971, when gold was $35 an ounce,
no one imagined the 23‐fold increase that gold would experience over
the next nine years.
We now appear to be entering the second leg of the precious metals
bull market, a time when institutions and hedge funds are beginning to
invest in physical bullion. Because of the tremendous market‐size
disparity between financial assets and precious metals, bullion prices
would rise dramatically if a minute percentage of global investors
allocate 10% to bullion.
25
While there is $50 trillion in global financial assets, there is less than
$1.5 trillion in above‐ground gold, less than $1 billion in above‐ground
silver and practically no above‐ground platinum.
Eventually there may even be shortages. You can not simply print
more bullion to meet demand. New mines take 5 – 10 years to bring
into production.
In 2005 whether the price of gold will be $400 or $500 does not really
matter. Would it have mattered whether you bought the NASDAQ at
400 or 500 in the mid‐80’s?
It is only important that you did not buy at 5,000.
No matter what the price turns out to be in 2005, it is still wise to put
10% of your money into gold… and hope it does not work.
The Outlook for Gold in 2005
Gen e r a l Mo t o r s ,
t h e S t o c k Ma r k e t a n d Go l d
A p r i l 2 0 0 5
If the saying “As goes General Motors so goes America” holds true then
it doesn’t look very good for America or for the stock market.
In a March 16th profit warning GM announced that significant
weakness in the North American automotive business would lead to a
loss in the first quarter and full yearʹs earnings would amount to just
one fifth on the companyʹs December 2004 expectations.
This stunning revelation caught many people by surprise and
prompted investors to drive down GM’s share price 10% in that one
day. GM’s share price is down 44% from a 52‐week high of US$50.04 to
its current low of $29.37. From itʹs market high of $93, in May 2000,
GM shares have lost 69% of their value. This indicates that GM is in
serious trouble and may prove to be an important turning point for the
entire stock market.
What does GM’s financial vulnerabilities tell us about the future of the
stock market and the price of gold?
While most people think of GM as a car company 80% of its 2004
earnings came from GMAC, its financial division. While the auto
divisions posted losses the finance division provided all of the profits.
GMAC doesnʹt just do auto financing; in fact the majority comes from
consumer credit, insurance and mortgage financing. This division
provided GM with most of its profitability. Just as with GM, the
financial industry was responsible for 50% of corporate profitability in
28 10th Anniversary Book of Articles
the US. With rising interest rates and the prospect of increasing defaults
by overleveraged consumers this is likely to change dramatically in the
near future.
This financing activity is clearly masking the problems plaguing its
automotive operations. Apart from competitive market factors for car
sales, foreign competition, rising commodity and labour costs, and
rising oil prices, the areas of greatest concern are GMʹs underfunded
pension liabilities and corporate debt. In 2003, GM faced the largest
pension fund shortfall of any US corporation ‐ $25 billion, requiring it
to float an extraordinary $17.6 billion bond issue, bringing its long term
debt to over $300 billion. This still left GM with a deficit of over
$50 billion in its health care fund. The magnitude of this becomes more
apparent when you consider that GMʹs market capitalization is now
just $16.6 billion.
GMʹs pension woes are not likely to improve. In a report for The Detroit
News Auto Insider Ed Garsten states that GM currently provides health
and income benefits to 461,500 retirees and their surviving spouses. As
of October 2004 GM retirees and their dependents outnumbered the
company’s active workforce by three‐to‐one. This imbalance will
continue to grow as more and more retirees are supported by fewer
and fewer workers.
GM’s employment and pension woes are not isolated issues restricted to
its corporate boardrooms. GM’s problems point to and underscore greater
systemic issues that could one day choke the life out of tomorrow’s
capital markets and cause havoc for the West’s financial system.
Pension underfunding is a global problem that is particularly
pronounced in the US due to the underfunding of Social Security. In
2004, the US Federal government posted the highest budget deficit in
history‐ $412 billion. However, its total indebtedness rose by
$11 trillion to $46 trillion largely due to underfunded social security
and Medicaid obligations. The magnitude of this liability comes into
focus when one considers that the 2004 annual increase is equal to the
entire GDP of the whole country. It translates into $350,000 per worker
and since both couples work in most families, this represents a $700,000
liability per family.
29
In 2003, 70% of US corporate pension plans were underfunded by
$278 billion with estimates for 2004 exceeding $400 billion. The Pension
Benefits Guarantee Corporation, that insures the pensions of over
44 million American workers, incurred a record net loss of $12 billion in
2004 increasing its liabilities to $62 billion on $39 billion in assets,
resulting in a deficit of $23.3 billion. The CATO Institute, a policy
research group estimates that the agencyʹs shortfall may top $50 billion
in the next ten years. If the economy experiences a decline due to rising
interest rates or rising oil prices the number of corporate bankruptcies
could increase dramatically. Given the precarious financial position of
GM, it could be one of them.
During the ‘90s bull market most pension plans were in surplus.
Companies were able to add surpluses to their operating income
thereby distorting price/ earnings ratios. After the market decline in
2000 many defined benefits plans became underfunded. Today, the
picture is still distorted as pension funding obligations are based on
overly optimistic portfolio returns, resulting in a much higher level of
underfunding than is being reported.
As an example, prior to its bankruptcy, Bethlehem steel reported
that its plan was 84% funded when in fact it was only 45% funded.
This resulted in a $4.3 billion liability that the Pension Benefits
Guarantee Corporation had to assume. Robert S. Miller, Chairman and
CEO of Bethlehem Steel told Bloomberg News: “I hope other
companies are ready for this, because many of them, including some
automakers, aren’t going to be able to outrun their pension liabilities.
At some point, the great sucking sound of pension and health care
liabilities just overwhelms your ability to raise capital or invest in new
plants or equipment.”
Like many other members of the S&P 500, GM projects an expected rate
of return of 9% on its pension assets. Such exceedingly optimistic
assumptions served to increase GMʹs operating profit by $8.7 billion in
2001 and $8.1 billion in 2002 even though pension assets posted losses
of $5.3 billion in 2001 and $5.4 billion in 2002.
These pension liabilities may ultimately cause a decline in the entire
stock market. Since 360 of the S&P 500 companies have defined
benefits pension plans these obligations will negatively impact earnings
as more profits will have to be diverted to pension plans. As lowered
General Motors, the Stock Market and Gold
30 10th Anniversary Book of Articles
profits negatively impact share prices these will, in turn, result in greater
pension deficits due to the fact that these company’s pension portfolios
are invested in each other’s stocks. This can become a descending spiral
of pension deficits, leading to reduced earnings that in turn lead to
lower stock prices, that lead to even greater pension deficits.
With the stock market starting to trend down, long term bonds yielding
under 5% and treasury bill yielding 2.7% it is hard to imagine how an
assumption for a 9% rate of return can be achieved without adding
significant risk. Rather than improve, the situation is likely to get much
worse. By 2011 approximately 100 million US workers or roughly the
entire population of Japan will have retired from the workforce.
Economists agree that this event will have marked consequences for
both the US economy and its capital markets. Unfortunately,
economists also agree that the effects of this massive retirement wave
will be for the most part negative.
In addition to the pension and health care liabilities GM’s debt is also of
concern and is symptomatic of the high consumer, corporate and
government debt levels. US corporate debt grew to new highs of over
$9 trillion, representing 84 percent of GDP. These high debt levels are
significant when you consider that the Federal Reserve has stated it
intends to continue to raise interest rates, and that equity markets are
overvalued by all traditional measures. The combination of decreasing
consumer spending and increased debt service costs will ultimately
translate into slower growth, a contraction in earnings and reduced
profit margins. This will all translate into declines in stock prices.
GM’s total consolidated debt was $301 billion on December 31, 2004.
To put this into perspective this is almost as large as Canada’s entire
Federal Debt of about $363 billion. It is larger than the value of the US
gold reserves of 512 million ounces, worth about $217 billion at
$425/ounce gold.
GM is a benchmark bond issuer, being the world’s third largest
corporate borrower with $114 billion in outstanding bonds. Much of
that debt may soon fall below investment grade status among the most
influential credit rating agencies, relegating the once venerable GM to
“junk bond” status. Since the recent announcement the yield on GM’s
euro denominated bonds have soared to 9.59%. Fitch Ratings recently
31
lowered its ranking on GM to one step above junk, while Moody’s said
that it may lower its rating to one step above junk or high yield status.
Dominion Bond Rating service had lowered its rating on GM last week
to two levels above junk status with a negative bias. What will happen
to global bond markets if GM’s bonds go into default?
With borrowing costs surging to their highest level in almost two years,
increasing pension shortfalls, declining auto sales, reduced credit
demand and increasing default risk the earnings picture looks bleak for
both the auto and financing divisions. Instead of a $2 billion positive
cash flow for 2005 GM now projects a $2 billion cash shortfall.
GM’s troubles have immediate ramifications for today’s stock markets.
This is due to the size of GM, its role in the North American economy
and the place it enjoys on its representative index. General Motors
Corporation is one of the 30 “blue chip” companies that comprise the
Dow Jones industrial Average. These 30 companies represent just two
percent of all listings on the stock exchange, but account for 25% of the
daily trading volume of the New York Stock Exchange.
The popular belief that a diversified portfolio of stocks and bonds will
provide long‐term capital preservation and growth is simply not true
during bear markets or during periods of rising interest rates. For full
diversification, portfolios need an allocation to tangible assets,
including precious metals in order to provide negative correlation to
financial assets, and to offset any declines. While North American
investors have participated in the longest and highest equity bull
market ever during the past twenty years, it is important to understand
that this period was not the norm ‐ nor is it likely to be repeated over
the next twenty years. Today, most investment portfolios are not fully
diversified and are at risk of capital loss.
A secular bear market could last for a decade and wipe out any gains
achieved during the bull market. The 1920s bull market took the Dow
from 66 in 1921 to 381 by September 1929, and the ensuing decline took
it down 89% to 41. The current bull market started in 1982 at 777 and
reached a peak of 11,750 in January 2000. The rally in 2003 is typical of
a bear market rally similar to the 1930 rally in the US, and the 1980 rally
in the Japanese Nikkei Index. Will this bear market repeat what
previous secular bear markets have done? Will the ensuing decline
take the Dow below 777?
General Motors, the Stock Market and Gold
32 10th Anniversary Book of Articles
If a secular bear market is coupled with rising interest rates then GM’s
pension problems, as well as the pension problems of many of the
S&P 500 corporations, could lead to insolvency. GM’s pension plan has
a traditional split of 55%‐60% equities, 30%‐35% bonds and 10%‐15%
other assets. There is no mention of any allocation to precious metals
to provide portfolio insurance and to help offset losses that these
assets may suffer.
While many retail investors and pension fund managers believe in
the buy‐and‐hold strategy, it does not work during a bear market.
Many of the baby‐boom generation will not live long enough to even
break even on their investments during the coming bear market.
Many corporations with underfunded pension liabilities may face
bankruptcy long before this strategy delivers the necessary returns to
fund their pension obligations. Investors in the Dow of 1929 had to
wait 30 years just to break even in inflation‐adjusted terms. Japanese
investors who held stocks in the Nikkei are still down 71 percent,
15 years after the 1990 high.
Rather than buying and holding, investors need to consider the benefits
of reallocating portfolio holdings during cyclical trend changes. Apart
from the fundamental vulnerabilities for traditional financial assets,
it is important to understand the cyclical nature of markets. As asset
classes move through individual bull and bear phases, investors should
adjust portfolio allocations in order to maximize long‐term growth. A
portfolio overweight in a bear‐phase asset class can result in huge
losses requiring decades to recover from.
With respect to equities and precious metals, an important indicator for
portfolio adjustments is the Dow:Gold ratio. An increasing ratio, such
as that experienced from 1921 to 1929, from 1933 to 1968 and from 1982
to 2000, indicate that portfolios should be overweight in equities.
Declining ratios, such as those experienced from 1929 to 1933, 1971 to
1980 and 2000 onward, indicate that portfolios should be overweight in
gold. In 1933 and 1980 the ratio came close to 1:1, while in 2000 it
reached its highest level of 43:1. Since then, it has declined to 25:1 and
is trending lower. This indicator suggests that since March 2000
investors should have been allocating higher percentages to precious
metals and smaller percentages to equities. Will this ratio again be 1:1,
as the bear market in equities continues and the value of gold increases?
33
As the outlook for financial assets deteriorates, the importance of a fully
diversified portfolio with an overweight position in precious metals
will become increasingly more critical. Although no one knows for
certain the impact of rising oil prices, the risks posed by derivatives and
high debt levels, and the threats posed by overvalued equity and real
estate markets, there is more than enough justification to consider an
overweight position in bullion. Apart from a portfolio allocation of
5 percent in bullion during all market conditions, an overweight
position of at least 10 percent is essential today.
General Motors, the Stock Market and Gold
P r e c i o u s Me t a l s :
C r i t i c a l D i v e r s i f i e r
N o v e m b e r 2 0 0 6
Gold is on the rise. It recently surpassed $630 per ounce, an increase of
more than 145% from its low of $254. As of mid‐2005, it has increased
approximately 30% in all currencies, and is no longer simply reflecting
US‐dollar weakness. Media coverage attributes these increases to
supply shortfalls, geopolitical concerns, rising oil prices, inflation fears
and US financial imbalances. The reports typically focus on trading
implications, since most investors and analysts think of gold as a short‐
term speculative trade in an industrial commodity. Platinum and silver
have both outperformed gold since 2000, but they have received little
attention. There is, however, an important reason why investors should
pay attention to precious metals: strategic asset allocation.
Strategic asset allocation ensures a fully diversified investment
portfolio by properly balancing asset classes of different correlations in
order to maximize returns and minimize risk. While many investors
believe their portfolios are diversified, they typically contain only three
asset classes ‐ stocks, bonds and cash. Real estate, commodities,
precious metals and collectibles rarely form part of most investorsʹ
portfolios. Containing only three asset classes out of seven, such
portfolios are clearly not adequately diversified. Precious metals
provide effective diversification and improve returns, while at the same
time reducing volatility during both bear and bull markets. The old
Wall Street saying, ʺPut 10% of your money into gold and hope it
doesnʹt work,ʺ still holds true today.
36 10th Anniversary Book of Articles
The validity of this old adage was recently confirmed in a June 2005
study carried out by Ibbotson Associates. Bullion Management Services
Inc. commissioned the study, entitled ʺPortfolio Diversification with
Gold, Silver and Platinum.ʺ Rather than examine the fundamental
reasons behind the current bull market in commodities, it addresses the
fact that relatively little research has been done on the role of precious
metals in strategic asset allocation. Particular attention was spent on the
correlations of precious metals with traditional asset classes, and how
this relates to diversification. Importantly, the Ibbotson study did not
take into account the various drivers currently contributing to rising
prices. Instead, it used current (low) CPI statistics, and projected a
continuance of similar performance for equity and bond markets.
Low correlations between asset classes are the basis for diversification.
Many investors believe their portfolios are diversified if they contain a
mix of stocks, bonds and cash. Unfortunately, correlations between
traditional asset classes have been on the rise resulting in portfolios that
are not adequately diversified. From 1926 to 1969, the correlation
between annual total returns for US stocks and bonds was an attractive ‐
0.02. Recently, US stock and bond market correlations have increased.
This tendency is reflected in the 10‐year rolling correlations from 1970
through 2004 that ranged from ‐0.03 to 0.80. The uncertain diversification
benefit, in combination with attractive returns observed in other asset
classes, drives the vigor with which opportunities in non‐traditional (or
alternative) asset classes have been pursued in recent years. The primary
method for improving the risk‐return characteristics of the efficient
frontier is to expand the opportunity set of available asset classes.
Ibbotsonʹs study examined a 33‐year time period from February 1971 to
December 2004. While there is data available for gold and silver that
predates 1970, it is less pertinent because the US dollar was still
convertible to gold at that time, and the price of gold was fixed. After
US President Richard Nixon closed the gold window on August 15,
1971, the price of gold was allowed to float.
Although there is some debate on what constitutes an asset class, it is
generally agreed that there are capital assets such as stocks, bonds and
real estate, consumable assets such as commodities and store‐of‐value
assets such as currency and fine art. The fact that precious metals are
both consumable assets and store‐of‐value assets is not well understood
by the investment community. While the three constituents are all
37
precious metals, gold and silver have a long history as monetary assets
and are often viewed as a safe harbor during times of crisis or high
inflation. Conversely, during an economic expansion, the commodity
demand for silver and platinum is thought to increase.
Since an investment in mining stocks does not provide a direct
exposure to precious metals, the study focuses on a direct, physical
investment in an equally weighted portfolio or composite of gold, silver
and platinum bullion. Ibbotson constructed an equally weighted
composite index using gold, silver and platinum bullion, and referred
to it as the Spot Precious Metals Index (SPMI). Ibbotson used this Index
as a proxy for the precious metals asset class.
Over the entire 33‐year period, the three equity asset classes outperformed
the other asset classes. The overall performance of the SPMI was closer to
that of the fixed income asset classes. The SPMI outperformed both cash
and inflation. For over 11 years (May 1973 to August 1984) the SPMI was
the top‐performing asset class, with the longest run of any of the asset
classes. During the low inflation period, the SPMI had the lowest
compounded annual return. During the high inflation period, the
compounded annual inflation rate was 8.62%, and the SPMI had the
highest compounded annual return of 20.83%. For the period studied,
precious metals provided a substantial hedge against inflation.
While the standard deviation of the SPMI is quite high in isolation,
according to modern portfolio theory it is the interaction of asset classes
with each other that provides diversification. Of the 33 years of annual
data, there were nine years during which US large‐cap stocks had
negative returns. During these nine years, the SPMI had the highest
average arithmetic return.
Of the 33 years of annual data studied, there were six years that the
equally weighted portfolio of traditional asset classes had negative
returns. The average arithmetic return of the portfolio of equally
weighted traditional asset classes for these six years was negative 3.5%.
For the same six years, the average arithmetic return of the SPMI was a
positive 13.4%. Precious metals provided positive returns when they
were needed most.
Of the seven asset classes, precious metals is the only one with a
negative average correlation to the other asset classes. It is also worth
noting that, excluding cash, precious metals is the only asset class with
Precious Metals: Critical Diversifier
38 10th Anniversary Book of Articles
a positive correlation coefficient with inflation, which is further
evidence that precious metals act as a hedge against inflation.
HISTORICAL CORRELATIONS (1972 - 2004)
The historical efficient frontier with precious metals is superior to the
historical efficient frontier without precious metals. With the exclusion
of the maximum return asset allocation, including precious metals in
the opportunity set improved the risk‐return tradeoff over the entire
historical efficient frontier. Importantly, the allocation to precious
metals does not come at the expense of any single asset class, but rather
it comes from a reduction in several asset classes. This suggests that the
unique risk/reward profile of precious metals makes them a useful
diversification tool in strategic asset allocation.
Based on the historical efficient frontiers, Ibbotson found that including
precious metals moderately improved the efficient frontier. Allocations
ranged from approximately 0% to 9%. Based on the forward‐looking
resampled efficient frontiers, asset allocations that include precious
metals have better risk‐adjusted performance (as measured by Sharpe
39
ratio) than asset allocations without precious metals. Investors can
potentially improve the reward/reward ratio in conservative, moderate,
and aggressive asset allocations by including precious metals with
allocations of 7.1%, 12.5%, and 15.7%, respectively. These results
suggest that including precious metals in an asset allocation may
increase expected returns and reduce portfolio risk.
ASSET ALLOCATIONS
While there are many paper proxies for precious metals that can
provide trading opportunities during a bull market, the hedging
benefits and protection against Fat‐Tail events such as a currency crises
or derivatives accident may only be available if actual bullion is held.
Many precious metals investments are simply counter‐party liabilities
and not an actual investment in bullion. In the event of a counter‐party
default, the benefits of bullion may not be realized at exactly the time
when they are needed most. From a strategic asset allocation point of
view, therefore, it is critical that fully allocated, segregated and insured
gold, silver and platinum bullion is held.
Precious Metals: Critical Diversifier
P l a t i n um :
Da r k Ho r s e , B r i g h t F u t u r e
M a r c h 2 0 0 7
As president of The Millennium BullionFund, I am often asked, ʺWhy
does the Fund hold platinum? Why not just gold and silver?ʺ
Platinum provides a number of benefits to investment portfolios.
Including all three precious metals means portfolios can achieve full
diversification within the precious metal group and experience reduced
volatility, thereby improving overall performance. Although there are
other precious metals such as palladium, rodium and iridium, only
gold, silver and platinum have dual roles as monetary assets as well as
industrial commodities.
While many investors think of precious metals as merely commodities,
their monetary roles can at times be the driving force for price
increases. While gold and silver have been used as money for over 3000
years, platinum is a relative newcomer. The first platinum coins were
issued in Russia in 1828. Over the next 18 years, the Russian
government minted over 500,000 ounces of platinum and introduced to
the notion that platinum was not just a commodity but, like gold, also a
store of value. Today most mints offer gold, silver and platinum coins.
All three metals have the necessary attributes to function as money.
Platinumʹs name comes from the Spanish expression for ʺlittle silverʺ.
The Conquistadors first introduced platinum to Europe when they
brought it back, along with plundered gold and silver, from the New
World. During the nineteenth century platinum became much sought‐
after for jewellery, and was the metal of choice for many royal houses.
42 10th Anniversary Book of Articles
Platinum is the rarest of the precious metals and its price reflects this.
It takes a massive amount of ore ‐ approximately 10 tonnes ‐ to produce
a single ounce of platinum, and the extraction and refining processes
are both costly and time consuming. Excavating ten tonnes of ore takes
6 months of labour‐intensive mining, often in dangerous conditions at
mines that can be several miles deep.
Total annual world production is about 7 million ounces, a mere 10% of
the worldʹs annual gold production of 76 million ounces, and less than
1% of the worldʹs annual silver production of 416 million ounces. All
the gold ever mined would fill an area the size of a 3‐metre high tennis
court, while all the platinum ever mined would hardly fill 25 cubic feet,
or the size of a crate used to ship automobiles.
While the media is starting to notice that gold and silver have jumped
to new 25‐year highs, there has been little or no mention of platinum,
even though its rise has been even more spectacular. On November 21,
2006 platinum soared to an intra‐day high of $1,350 per ounce,
smashing through its previous all‐time high of $1,070 reached in 1980.
In contrast, the previous highs attained by gold and silver ($850 and
$50 respectively) are still some way off. Also largely ignored is the fact
that platinumʹs percentage increase of 190% from the beginning of 2000
has surpassed silverʹs 150% rise and goldʹs 120% rise. Surprisingly,
there is little or no mention of platinum prices in the mainstream press.
43
Even though platinum has surpassed its 1980 high in nominal terms, it
still has a long way to go before reaching its inflation‐adjusted high of
$2,630. Since demand for platinum applications keeps growing while
mine supply remains relatively fixed, the price of platinum is likely to
exceed that inflation‐adjusted high.
Platinum: Dark Horse, Bright Future
44 10th Anniversary Book of Articles
The quiet bull market in all three precious metals ‐ gold, silver and
platinum ‐ is important to investors. A portfolio cannot be fully
diversified if it only contains a mix of stocks, bonds and cash because,
since 1969, stock and bond correlations have been increasing. Precious
metals are the most negatively correlated asset class to traditional
financial assets such as stocks and bonds. When they fall, precious
metals tend to rise and vice versa, so precious metals act like portfolio
insurance. Today, every portfolio benefits from an allocation of at least
5% to precious metals in order to reduce volatility and risk.
LIMITED SOURCES OF SUPPLY
Platinum is in a secular bull market strongly supported by
supply/demand fundamentals. Supply is limited and hard to excavate.
Total world reserves that can be economically mined are estimated at
3.5 billion ounces by the US Geological Survey. Unlike all other metals
and oil, platinum deposits are limited to only two main areas of the
world. Due to the distinctive characteristics of platinum deposits,
geologists consider it unlikely that significant new resources will be
found. South Africa and Russia are the richest sources, with South
Africa accounting for about 78% of total annual world production, and
63% of the worldʹs reserves. Russia accounts for about 13% of total
annual world production. North and South America are less important
sources. Unlike gold, there are no large above‐ground supplies of
45
platinum. Any interruption of mine production, because of political
instability or labour turmoil, for instance, would catapult the price into
orbit. The cost of mining in South Africa has climbed recently because
of strength in the rand, and the increased cost of oil. Russian
production suffered during the transition period before and after the
collapse of the Soviet Union, but new investment in modern plants and
equipment could dramatically boost output.
In 2006, total mine supply was 7 million ounces, with South Africa
producing 5.4 million ounces and Russia 895,000 ounces. While North
America produced 365,000 ounces, it consumed 1,085,000 ounces. Since
1997 demand has exceeded mine supply by 8,285 million ounces,
resulting in above‐ ground stocks being depleted by 2,590 million ounces
during the period. Recycling provided another 5,695 million ounces.
INELASTIC DEMAND
Demand for platinum has increased from about 2.6 million ounces in
1975 to 7 million ounces today. Unlike gold, over 50% of the platinum
produced is consumed (destroyed) in industrial applications. Platinum
is indispensable for many industrial uses because of its unique physical
and chemical characteristics, which make it suitable for many different
applications. Platinumʹs catalytic properties, inertness, durability,
electrical conductivity, and high melting point are useful in a variety of
Platinum: Dark Horse, Bright Future
46 10th Anniversary Book of Articles
industrial applications, while its rarity, strength, and beauty make it a
popular choice for jewellery. Demand for platinum is inextricably
linked to economic growth, so future demand from emerging
economies will likely challenge current production capacity.
Approximately 30% of products manufactured today either contain
platinum or use it in production.
CHEMICAL PROCESSING
Platinum is used as a catalytic agent in the processing of nitric acid,
fertilizers, synthetic fibers and a variety of other materials. It can be
recycled following the catalytic process, making demand somewhat
volatile. However, platinum is an essential ingredient for many
catalytic processes and there are few satisfactory substitutes.
ELECTRONICS
New uses for platinum in electronics are discovered almost daily.
Currently, it is used in thermocouple devices that measure temperature
with high accuracy; thin‐film optical coating and temperature systems;
wires and electrical contacts for use in corrosive or high‐voltage
mediums; magnetic coatings for high density hard disk drives and
some of the new optical storage systems.
47
GLASS
Platinum is used extensively in glass production, because its hardness
and high melting point make it ideal for difficult high‐temperature
processes. It is also widely used in fiberglass production. The recent
introduction of glass fiber communications technology is a new and
powerful driver for demand. Although glass production is currently a
relatively small component of total demand, it is a high‐growth area.
PETROLEUM
Crude oil refining is a growth area for platinum, alongside economic
expansion in Asia. While other technologies that perform crude oil
separation do exist, the processes using platinum are the most
environmentally friendly. As new refineries are constructed and older
one are updated, platinum use in petroleum refining will rise accordingly.
JEWELLERY
Platinumʹs scarcity and beauty make it top choice for expensive
jewellery. Its hardness and durability mean it can be used in extremely
pure form, resulting in more secure stone settings. It resists oxidation
and discolouration. Its brilliant luster makes diamonds in particular
more luminous, but also enhances the beauty of all precious stones.
Platinum is hypoallergenic, making it the metal of choice for those who
suffer reactions to other materials.
AUTOMOTIVE CATALYSTS
Platinum, along with palladium, is in great demand by the auto
industry, which soaks up 33% of annual supply. Since 1999 auto
catalyst demand has more than doubled, largely because platinum has
a unique ability to control and remove harmful engine emission by‐
products. The importance of platinum within the auto industry will
continue to grow as governments around the world worlds ecologically
responsible governments demand greater levels of emission control,
and future demand could increase exponentially, along with price.
Diesel engines, already extremely common in Europe and Asia, are
becoming increasingly popular in North America. Currently only
platinum can be used for diesel auto catalysts, and only platinum can
be used in third‐world countries where sulphur levels in the fuel
exceed acceptable limits.
Platinum: Dark Horse, Bright Future
48 10th Anniversary Book of Articles
Diesel cars now account for more than 50% of the market in Europe,
where many models include soot filters that employ platinum as well
as oxidation catalysts. European auto catalyst demand is expected to
increase by 15% to 2.25 million ounces in 2007.
In North America many light diesel trucks will have catalysts fitted for
the first time in 2007, and platinum use in larger trucks is also expected
to increase. Platinum consumption by North American automotive
industries is expected to rise by 5% in 2007 to 1.5 million ounces.
FUEL CELLS
Manufacturers are experimenting with fuel cell power plants for
electric cars, creating a new use for platinum that could substantially
increase demand. Fuel cells use platinum to catalyze a chemical
reaction using hydrogen that creates electrical energy, but generates no
harmful emissions.
INVESTMENT CASE
According to recent data from Platinum Today, the vast majority of
investors ignore precious metals entirely, and hold portfolios that are
not diversified and are therefore exposed to economic downturns,
financial crises and inflation. Of the investors who do have an
allocation to precious metals, most concentrate on gold, while a few
more include silver. Many believe that an allocation to mining stocks
provides the required diversification. Although mining stocks often
track the price of the metals, there are times, such as during the market
decline in 1987, when mining stocks decline by a greater margin than
the broad equity markets even as the price of gold rises. Consider that,
in the 1970s, the price of gold itself outperformed Homestake Mining
49
shares by a factor of two. Few investors have an allocation physical
platinum, the best‐performing precious metal.
Where platinum is concerned, there are few stocks to choose from. The
major producers are South African stocks such as Impala Platinum, and
Anglo‐American Platinum. North American producers such as
Stillwater Mining and North American Palladium are primarily
palladium producers with some by‐product platinum production.
According to a study by Wainwright Economics, a Boston‐based
investment research and strategy firm, platinum is the leading indicator
of inflation. While gold and silver lead inflation by 12 months, platinum
leads by 16 months. This was confirmed in the current bull market
as the rise in platinum prices started in 1999, while gold and silverʹs
rise began in 2001.
According to David Ranson, president of Wainwright Economics,
ʺThe only asset class that is better than gold as an inflation hedge is a
basket that includes silver and platinum.ʺ
Platinum: Dark Horse, Bright Future
S i x My t h s a b o u t Go l d
N o v e m b e r 2 0 0 8
Gold. People either love it or hate it. There aren’t many who feel
ambivalent toward it. Unfortunately, gold is deeply misunderstood by
investors, and that misunderstanding is hurting their portfolio returns.
Many in the investment community trot out the old myths about gold:
that it is a bad investment; that it is very risky; that it is not a good
inflation hedge. But is there anything behind these assertions? If
investors take the time to examine the facts, these commonly held
beliefs simply do not stand up to scrutiny. It is precisely because these
myths have become so prevalent that gold is still undervalued. Once
the general public realizes these beliefs are not valid, the price of gold
will be much higher.
MYTH 1: GOLD IS A BAD INVESTMENT
A frequently cited argument is that since it peaked at $850 per ounce
(all amounts in U.S. dollars unless otherwise noted) in 1980, gold’s
return has been poor compared to the major stock indices. However,
that peak price was a short‐lived, single‐day aberration. Investors who
avoided the mania phase and purchased gold one year earlier in 1979 at
its average price of $306 per ounce also avoided any significant losses
during the subsequent bear market. The performance of different asset
classes varies from cycle to cycle. The previous cycle from 1968 to 1980
saw the Dow Jones Industrial Average remain flat with significant
volatility, while gold increased by 2,300 percent. In the current cycle,
which began in 2002, gold has posted a compounded return of
14 percent, while 15 of the 30 Dow components are negative.
52 10th Anniversary Book of Articles
Many studies compare gold to equities over peri‐ods as far back as the
1700s. But these studies ignore the fact that gold’s price was fixed until
1971. Prior to that time, gold was money and not an investment.
Interestingly, virtually none of the stocks listed in the 1700s still exist
today. Instead, the returns of major indices such as the Dow are boosted
by the removal of bankrupt companies and poor performers, which are
replaced by high performers. Three of the 30 companies that made up
the Dow in 2000 have since been replaced.
From a strategic portfolio allocation viewpoint it is easy to see why
Ibbotson Associates, one of the world’s most highly regarded asset
allocation specialists, determined that holding between 7.1 percent
and 15.7 percent in precious metals bullion reduces portfolio volatility
and improves returns.
MYTH 2: GOLD IS NOT A GOOD INFLATION HEDGE
The arguments against gold as an inflation hedge are usually based on
calculations arising from the intra‐day price spike in 1980. While gold
did not keep up to inflation using daily prices from 1980 to 2002, the
annual average gold price has kept up extremely well since 1971, when
the price was no longer fixed, Figure 1. During the same timeframe, the
U.S. dollar lost about 80 percent of its purchasing power. In fact, all the
world’s major currencies have depreciated by significant amounts due
53
to continuous excessive increases in the money supply. The impact of
this devaluation on real returns is significant.
Conversely, gold has not only maintained its purchasing power but
increased it against all major currencies. It will continue to do so as long
as the world’s central banks keep increasing the money supply by a
greater percentage than their country’s GDP growth.
More importantly, gold maintains its purchasing power not only
during inflationary periods, but also during deflationary periods. An
extensive study, published by Roy Jastram, analyzed the purchasing
power of gold in England and the U.S. from 1560 to 1976. Jastram
concluded that gold held its value remarkably well over time. The
purchasing power of gold and precious metals actually increases
during deflationary periods because other assets decline in price by a
much greater amount than precious metals do.
As central banks continue to accelerate the pace at which money is
printed, inflation will increase, and the purchasing power of paper
currencies will decline. This will result in more and more astute
investors fleeing to the safety of gold. As a con‐sequence, goldʹs price
should rise far in excess of the Consumer Price Index and the true
inflation rate. In order to protect portfolios from rising inflation,
Wainwright Economics concluded that an all‐bond portfolio would
need an 18 percent allocation to gold, silver and platinum, while an
all equity portfolio would need 40 percent just to stay ahead of inflation.
MYTH 3: GOLD IS A RISKY INVESTMENT
Risk means different things to different investors. A pension fund may
perceive risk as a failure to meet its liabilities, whereas an asset
manager may view risk as a failure to meet its benchmark. Most
investors, however, associate risk with a loss of their capital or
underperformance of their investments in comparison to their
expectations. ʹRisk comes from not knowing what you are doingʹ according
to Warren Buffett.
There are many kinds of risk: currency risk, default risk, market risk,
inflation risk, systemic risk, political risk, interest rate risk and liquidity
risk. While all of these apply to financial assets, many do not apply to
gold bullion. Physical bullion is not subject to default risk, liquidity
risk, political risk, inflation risk or interest rate risk. In the rare
Six Myths About Gold
54 10th Anniversary Book of Articles
circumstance of strong currencies, gold may be subject to short‐term
currency risk and, at times, to market risk. Unlike financial assets,
however, gold bullion cannot decline to zero. Gold is the only asset that
can protect wealth from non‐diversifiable systemic risk.
Volatility or standard deviation are often used as measures of risk, and
gold is considered to be quite volatile. However, when annual
compounded returns are plotted against standard deviation, the
individual Dow stocks are all more volatile than gold, and all but two
of the Dow stocks had poorer performance than gold, silver, and
platinum over the past eight years. Figure 2.
Returns are important, but even more important is to compare
risk‐adjusted returns. Clearly, an investment that has higher volatility
may still be attractive if the returns are appropriately higher.
Nobel prize‐winning economist William Sharpe devised the most
commonly used measure of risk‐adjusted performance: the Sharpe
Ratio. This ratio measures the amount of excess return per unit of
volatility. The interpretation of the Sharpe Ratio is straightforward: the
higher the ratio the better.
Bullion is unlikely to suffer underperformance risk in the near future.
Demand for gold, silver and platinum is increasing for both commodity
and monetary attributes, while annual mine production is declining.
55
As the price of oil continues to rise due to production declines and
increased demand, inflation will accelerate. As central banks increase
money supply at accelerating rates, the purchasing power of currencies
will continue to decline. As these two major trends interact with each
other, the price of gold will continue to rise.
MYTH 4: GOLD DOES NOT PAY DIVIDENDS OR INTEREST
The Bank of England used this argument to justify selling half the
countryʹs gold holdings at the bottom of the market in 1998. It wanted a
ʹsafeʹ investment, one that would generate interest, and it chose U.S.
treasury bills. The gold was sold for under $300 per ounce. In the
months following that sale, the price of gold tripled, and the value of
the U.S. dollar lost 30 percent against the British pound. The currency
exchange losses plus the opportunity cost resulted in billions of pounds
in losses, significantly offsetting any interest income the Bank might
have received.
The same is true for bond investors. In an inflationary environment, the
ʹrealʹ or inflation‐adjusted interest rate they receive is often negative.
Gold, like any other asset that sits in a vault, will not earn interest or
dividends, but neither is it at risk. No asset class generates income
unless you give up possession and take the risk of not getting it back.
However, goldʹs capital appreciation is many times greater than the
prevailing interest yields, while not being subject to any of the risks that
interest‐bearing investments are subject to. For a comparative analysis
of holding bonds versus a systematic withdrawal program for BMG
BullionFund units, seewww.bmgbullion.com/bondsvsbullion
MYTH 5: GOLD IS AN ARCHAIC RELIC
Gold is often referred to as an archaic relic with no monetary role in
todayʹs modern digital society. Several facts contradict this view. The
worldʹs central banks still hold 29,000 tonnes of gold in their reserves.
Gold, silver and platinum trade on the currency desks ‐ not the
commodity desks ‐ of the banks and brokerage houses. The turnover
rate of physical gold bullion, between the nine members of the London
Bullion Market Association, currently averages $24 billion per day.
Trading volume is estimated at seven to ten times that amount. Clearly,
gold is still trading in its traditional role as an alternative currency.
Six Myths About Gold
56 10th Anniversary Book of Articles
MYTH 6: MINING STOCKS ARE BETTER INVESTMENTS THAN BULLION
While mining stocks can generate impressive returns during an
uptrend in precious metals prices, they do not always outperform
bullion. It is unfair to compare junior mining companies to bullion
because of the huge disparity in risk. While successful junior miners
can generate impressive returns, over 90 percent of precious metals
discoveries never become productive mines. A better comparison
would be the larger producers. While mining stocks have outperformed
bullion during the early stages of this bull market, gold bullion has
outperformed the major mining indexes since March 2007. Figure 3.
Mining stocks tend to be significantly more volatile and risky than
bullion, and during sharp market declines they tend to follow the broad
equity markets downwards ‐ even if the price of the metal is rising.
During the late stages of the bull market of the 1970ʹs, mining stocks
underperformed bullion. In order to adequately compensate investors
for the higher risk, mining stocks would have to outperform bullion.
CONCLUSION
Investors who take the time to carefully evaluate the benefits of bullion
will realize that these commonly held myths do not hold up to scrutiny.
Those investors stand to reap significant rewards. Investors who
believe these myths are missing out on the opportunity to add an asset
57
class that diversifies portfolios, protects against inflation, and may
provide better returns than traditional assets, such as stocks and bonds.
Under a worst‐case scenario of systemic risk, bullion may be the only
asset that holds its value. As these myths are dispelled and the price of
bullion rises, as many mainstream analysts predict, informed investors
will benefit from purchasing bullion at todayʹs undervalued prices.
When the public at large becomes fully educated with respect to
precious metals, it will bid up the price. Considering that global
financial assets are estimated at over $180 trillion, while total global
above‐ground gold is only $4 trillion (and above‐ground bullion is less
than $1.5 trillion), a massive wealth transfer event is likely to occur. It is
interesting to note that even a 10 percent switch from financial assets
to gold would result in a 450 percent to 1,200 percent increase in the
gold price.
The BMG Special Report: ʺThe Six Biggest Myths About Goldʺ is
required reading for sophisticated investors and advisors. This report
provides a more detailed and technical evaluation of the six myths.
Please visit www.goldmyths.com to download the report.
Six Myths About Gold
2 0 0 4 ‐ 2 0 0 9
P ompo u s P r o g n o s t i c a t o r s R e v i s i t e d
J u l y 2 0 0 9
In 2001, Colin Seymour published an article entitled 1927‐1933 Chart of
Pompous Prognosticators. In it, he documented the many Depression‐
era assurances given by politicians, economists, financial experts and
the media to the public, protesting that everything was fine and there
was nothing to worry about. Meanwhile, the stock market would
decline by 92%, the US dollar would be devalued by 40%, real estate
would drop 30% and unemployment would soar to 25%.
Today, we have a similar situation. Politicians, economists and the
media are assuring the public that everything is fine. But governments
around the world are frantically borrowing trillions of dollars to fund
bailout and stimulus plans, the stock markets have lost over 40% of
their value, real estate over 50%, and unemployment is approaching
10% in most major countries.
2004
1.“The ability of lending institutions to manage the risks associated with
mortgages that have high loan‐to‐value ratios seems to have improved
markedly over the past decade.” – Alan Greenspan [February 2004]
2005
2. “Home sales are coming down from the mountain peak, but they will level out at
a high plateau, a plateau that is higher than previous peaks in the housing cycle.”
– David Lereah, Chief Economist, National Association of Realtors [December 2005]
60 10th Anniversary Book of Articles
2006
“I don’t know, but I think the worst of this may well be over.” – Alan Greenspan, [October 2006]
2007
4. “The fallout in subprime mortgages is ʺgoing to be painful to some lenders,
but it is largely contained.ʺ – Treasury Secretary Henry Paulson [March, 2007]
5. “The impact on the broader economy and financial markets of the problems
in the subprime markets seems likely to be contained.” – Ben Bernanke [March 28, 2007]
6. ʺThis is far and away the strongest global economy Iʹve seen in my business
lifetime.ʺ – Treasury Secretary Henry Paulson [July 12th, 2007]
7. “In todayʹs environment, it is virtually impossible to violate rules.” – Bernie Madoff [November 2007]
61
2008
8. “Over the next few months, existing‐home sales are expected to hold fairly
steady as indicated by pending sales activity, then rise later in the year and
continue to improve in 2009.” – National Association of Realtors [January 2008]
9. “Although recent data suggest that the probability of a recession in 2008 has
increased, CBO does not expect the slowdown in economic growth to be large
enough to register as a recession.” – US Congressional Budget Office [January 2008]
10. “I donʹt think weʹre headed to a recession.” – President George W. Bush [February 2008]
11. “I donʹt anticipate any serious problems of that sort among the large
internationally active banks that make up a very substantial part of our
banking system.” – Ben Bernanke [February 28, 2008]
12. “No! No! No! Bear Stearns is not in trouble.” –Jim Cramer, CNBC commentator [March 2008]
13. “The worst is likely to be behind us.” – Henry Paulson [May 2008]
14. “Despite a recent spike in the nationʹs unemployment rate, the danger that
the economy has fallen into a ʺsubstantial downturnʺ appears to have waned,” – Ben Bernanke [June 9, 2008]
15. “Fannie Mae and Freddie Mac are fundamentally sound. Theyʹre not in
danger of going under.... I think they are in good shape going forward.” – Barney Frank, chairman of the House Financial Services Committee
[July 2008]
16. “We have no plans to insert money into either of those two institutions.”
(Fannie Mae and Freddie Mac) – Henry Paulson, [August 10, 2008]
Pompous Prognosticators Revisited
62 10th Anniversary Book of Articles
17. “My own belief is if we were going to have some sort of big crash or
recession, we probably would have had it by now.” – Canadian Prime Minister Stephen Harper [September 2008]
18. “Weʹre probably somewhere pretty close to a bottom.” – Fund manager Barton Biggs [September 2008]
19. “The fundamentals of our economy are strong.” – US Senator John McCain [September 2008]
20. “We remain committed to examining all strategic alternatives to maximize
shareholder value.” – Lehman Bros. CEO Dick Fuld, before bankruptcy [September 2008]
2009
21. “It’s a huge bull market rally.” – Jim Cramer, CNBC [June 2009]
Just as Seymour’s Pompous Prognostications proved devastating for
those investors who remained complacent due to those false
assurances, today’s investors would be wise to educate themselves on
the real risks and vulnerabilities they face today. In order to preserve
their wealth over the coming years, investors need to make wise,
informed decisions, stop being complacent, and avoid following the
false assurances of politicians and financial experts. With countless
risks and vulnerabilities facing the world, the next 20 years will not be
the same as the last 20 years.
Sources: FederalReserve.gov, BusinessWeek, CNBC.com, Realtor.org, Marketwatch.com, USA Today, Washington Post, Reuters, Associated Press, Bloomberg, BBC.com, TimesOnline.
E n s u r i n g t h e Qu a l i t y o f
P r e c i o u s Me t a l s P u r c h a s e s
D e c e m b e r 2 0 0 9
There have been a number of articles on the Internet about tungsten‐
filled gold bars, as well as fake and counterfeit coins being in
circulation. As precious metals prices continue to rise, there will be
more and more scams involving precious metals that will prey on
individuals trying to save money on the purchase price or storage costs.
This is false economy, as well as a risky approach that could result in a
complete loss of their investment instead of having precious metals
preserve their wealth.
Precious metals do not sell at a discount. Any metals offered at a
discount will either not meet good delivery standards, have illegal
source backgrounds or are to be delivered at a future date. Purchasers
should remember that it is much easier to create fake or counterfeit
coins and bars than it is to create counterfeit paper money. The
potential profitability for criminals is very tempting as tungsten, which
closely matches the density of gold, sells for about $49 per kilogram, a
fraction of the price per ounce for gold. At Bullion Management Group
(ʺBMGʺ), we receive many offers to purchase bullion at a discount, and
simply dismiss all such offers as not being credible. Very low storage
fees are also suspect, as they typically involve pooled accounts that may
not be backed by bullion, or the bullion is leased to third parties.
BMG deals exclusively with ScotiaMocatta, a division of The Bank of
Nova Scotia, for all of its bullion purchases. Records trace bullion
transactions in London back to the 17th century with the formation of
64 10th Anniversary Book of Articles
the oldest original member of the market, Mocatta & Goldsmid, in 1964.
It was, however, the introduction of the London Silver Fixing in 1897
and the London Gold Fixing in 1919 that marked the beginning of the
marketʹs structure and of the co‐operation between members that has
created the marketplace as it is today.
The growth in the number and type of market participants in the early
1980s, combined with the introduction of the Financial Services Act in
1986, brought about the formation of the LBMA in 1987. Mocatta &
Goldsmid was purchased by The Bank of Nova Scotia in 1997.
ScotiaMocatta is one of the eleven market‐making members of the
LBMA while BMG is an associate member of the LBMA.
The rules established by the LBMA mean members can trade bullion
between themselves without concern as to the quality or the purity
of the bars. Daily Turnover, the net difference in trades among LBMA
members, is in excess of US$37 billion for gold and US$5.45 billion
for silver. The actual volume is estimated at 7‐10 times the Daily
Turnover amount.
The LBMA sets the rules for good delivery bars. In January 2004, the
LBMA introduced Proactive Monitoring of the refiners on the
Approved List, an important initiative which further enhances the
reputation of the List and the refiners on it. Prior to the introduction of
Proactive Monitoring, a refiner only had to demonstrate its refining and
assaying ability at the time of its application for admission to the List.
Regular monitoring of those on the List ensures that the stringent
requirements for joining the List continue to be met.
The monitoring system necessitated the appointment of Supervisors (to
witness the dip‐sampling operation that provides samples for testing
by the LBMAʹs Referees). The monitoring operations are carried out
approximately every two months.
If a refiner produces both gold and silver, it is tested for both metals at
the same time. Gold refiners that only produce and sell ʺfour‐ninesʺ
gold may elect to be monitored by assaying a set of reference samples
(ranging in fineness from .995 to. 9999) sent to them by the LBMA.
These samples have been produced and crosschecked to the highest
standards by the panel of Good Delivery Referees.
65
If the LBMA receives a complaint about the quality of bars produced by
a refiner, it investigates the complaint and carries out a bar examination
if necessary. If the complaint appeared justified, the LBMA writes to
the refiner asking it to ʺstand behindʺ its bars by making appropriate
restitution to the customer.
Bars traded by LBMA members are maintained within a ʺChain of
Integrityʺ. This refers to a traceable chain of custody among trusted
trading partners where bullion bars are accepted at face value without
an assay test. COMEX rules specify an official ʺchain of integrityʺ for
COMEX GOLD contracts. The LBMA maintains a list of acceptable
member refineries that meet certain membership requirements and
have passed assay tests. Bullion products from these refineries will
generally be accepted by other members of the LBMA at face value
without further assay testing. However, the LBMAʹs chain of integrity
is purely informal. When purchasing bullion products the face value
can generally be accepted if the product can be shown to have
remained in the custody of a certified bullion repository since its
manufacture by an acceptable refinery.
Responsibility for the regulation of the major participants in the
London bullion market lies with the Financial Services Authority (FSA)
under the Financial Services and Markets Act 2000. Under this Act, all
UK‐based banks, together with other investment firms, are subject to a
range of requirements including capital adequacy, liquidity and
systems and controls.
Introducing bars into the LBMA system requires the sale or deposit of
the bullion with an LBMA member. Documentation may be required in
order to comply with Anti‐Terrorism and Money Laundering legislation
such as FinCen in the USA, NCIS in the UK, JFIV in China and Hong
Kong and FINTRAC in Canada. The identity of the bar owner needs to
be established and confirmed, as well as the source of the bars.
If the documentation and the background checks passed scrutiny, then
all bars coming from outside the Chain of Integrity are re‐assayed and
re‐cast to Good Delivery standards at the cost of the owner. For bars
coming directly from an acceptable refiner, or from another LBMA
member, spot checks are made to confirm weight and purity.
Ensuring the Quality of Precious Metals Purchases
66 10th Anniversary Book of Articles
In some instances, typically bars from ʺDeep Storageʺ from central
banks, bars that meet acceptable purity and weight but that do not meet
Good Delivery Standards for physical appearance are also required to
be recast. The LBMA clarified their position for ʺDeep Storage Barsʺ in
a press release in 2007.
In addition to the checks and balances provided by LBMA and the FSA,
BMG receives sales confirmation documentation for every bar
purchased from ScotiaMocatta. This documentation details the refiner,
the weight to three decimal places and the purity to three decimal
places. In addition, The Bank of Nova Scotia, as Custodian, provides
detailed inventory lists of all the bars held in storage. The physical
inventory is verified annually by KPMG as part of their audit for both
BMG Funds and BMG. These lists, for both the bars and the Funds, are
posted on the BMG website.
As a result, purchasers of either the BMG Funds or the BMG
BullionBars program are assured that all bars purchased meet Good
Delivery Standards.
As a result of these checks and balances it is highly unlikely that fake or
counterfeit bars would ever enter the LBMA Chain of Integrity. Should
it be discovered that a bar did not meet Good Delivery Standards or
was not of the stated purity or weight, The Bank of Nova Scotia and the
LBMA would intervene to correct the situation in order to meet the
representations in their sales documentation.
For more information on purchasing and storing physical bullion
please download our free report at: www.howtobuygoldreport.com.
Go l d i s Mon e y
M a r c h 2 0 1 0
In a speech I recently gave at The Empire Club of Toronto , I referred to
gold as the ʺanti‐currency.ʺ Gold is not and never has been a currency.
Gold is something entirely different and far more valuable. It is money.
CURRENCY VERSUS MONEY
Most investors confuse money and currency, but they are not the same
thing. Money is defined as a medium of exchange, a unit of account and
a store of value. For centuries, money referred to coins made of rare
metals (gold and silver) with intrinsic value, and to notes backed by
precious metals.
Currency, while it is a medium of exchange, is not a store of value. It
only derives its value by arbitrary fiat , government decree and hence
the term “fiat currency”. Paper banknotes represent money but they are
not money. They are simply promissory notes whose long‐term “value”
or purchasing power depends entirely on the fiscal and monetary
discipline of the government that issued them.
And therein lies the problem. In an era of massive fiat currency
expansion by profligate governments across the globe, today’s
currencies are depreciating in value faster than yesterday’s news.
Fortunately for precious metals investors, gold and precious metals
have risen in value, and will continue to rise in value against all
currencies because they have once again resumed their historical role as
stores of value: money.
68 10th Anniversary Book of Articles
THE DECLINE OF THE WORLD’S CURRENCIES
“Currency debasement isn’t a recent phenomenon. For decades,
governments around the world, through their central banks, have been
creating money out of thin air to cover their excessive spending and
mounting debt. Investors have for the most part accepted this subtle
form of taxation, because it seemed to have little personal impact. But
appearances are deceiving. Investors are discovering that the value of
their dollar‐denominated assets has actually declined a staggering
82 percent since 1971 (not coincidentally, the year the US cut its link to
the gold standard). Figure 1 tells the story.
THE MEDIA ARE USING THE WRONG MEASURING STICK
Every day, the media (via currency traders) informs Canadian investors
about the latest price of the Canadian dollar in US dollar terms, while
US investors compare the US dollar to a basket of the world’s major
currencies. But this information gives investors surprisingly little
insight into the true value of their portfolios. If we started measuring
the world’s currencies against money (i.e., gold), investors would be
horrified at the stark decline in the value of all currencies. Most
investors’ portfolios are heavily weighted towards currency‐
denominated financial assets (stocks and bonds), but few realize that
the true value or purchasing power of their portfolios is declining every
single year because of currency depreciation.
69
THE RATE OF CURRENCY DECLINE IS ACCELERATING
Since 1913 (the year the US Federal Reserve was established), the US
dollar has lost over 95 percent of its value. The US and Canadian
dollars have lost 82 percent of their value since 1971, as noted earlier.
But the rate of currency decline is now accelerating.
In the past ten years alone, the US dollar, the Canadian dollar, the UK
pound and the euro have collectively fallen 70 percent in value if
measured in real (currency‐debased) terms. In other words, when they
are priced in terms of gold (Figure 2).
IT’S ALL ABOUT THE (FIAT CURRENCY) MONEY SUPPLY
Not too long ago, all the world’s major currencies were backed by gold
because it was a universally recognized store of value. The gold
standard imposed fiscal and monetary discipline, since each country
had to hold enough gold to equal the amount of money in circulation.
But not any longer. Government spending around the world is
exploding, and (fiat currency) money supply, along with government
debt in the world’s major economies, is exploding along with it. But
nowhere in the world has spending become more out of control than
the US (Figure 3), where the monetary response to last year’s financial
crisis is creating yet another bubble, and this time it will be the bubble
to end all bubbles.
Gold is Money
70 10th Anniversary Book of Articles
COUNTRIES ARE INCREASINGLY AT RISK OF SOVEREIGN DEBT DEFAULT
“In the process of saving a few ‘too big to fail’ corporations and their bond
holders, policymakers are greatly increasing the risk of sovereign defaults.” – Puru Saxena, editor/publisher, Money Matters
The risk of massive and widespread sovereign debt default has never
been higher. “Official” US government debt has soared to 90 percent of
GDP, while multi‐trillion‐dollar budget deficits for the next several
years will send that number soaring. Japan, the world’s second‐largest
economy, was recently put on credit watch. Its debt is twice total GDP,
yet its newly elected government has announced much higher
spending for 2010. The UK’s 2009 budget deficit will be over 14 percent
of GDP, adding to a net debt that will reach 56 percent of GDP this
year, 65 percent in 2010 and 78 percent by 2015.
Spain, Italy and Portugal are facing major fiscal deficits, as is Eastern
Europe. Dubai is billions in debt and its prize jewel, Dubai World, is
bankrupt. Greeceʹs credit rating has been slashed, and its debt is
forecast to reach 130 percent of GDP. And then there is Iceland, whose
debt had exploded to seven times GDP before the global meltdown.
The country’s banking system has now collapsed, its currency is deeply
devalued, its real estate market has imploded and the country is in a
full‐blown economic depression.
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THE INCREDIBLE SHRINKING DOLLAR
As the world’s reserve currency, the US dollar is a proxy for the rest of
the world’s currencies. The dollar’s decline is a direct reflection of
America’s deepening financial troubles, exacerbated by a ravaged
banking system that, by 2010, may see over one thousand banks
insolvent. In 2009, the US incurred a budget deficit of $1.4 trillion, and
its debt rose by $1.9 trillion due to off‐budget expenditures. These off‐
budget expenditures alone were more than the 2008 budget deficit. At
the end of 2009, America’s total debt was over 100 percent of GDP.
In their attempt to reflate the bubble‐driven economy, President Barack
Obama, Fed Chairman Ben Bernanke and Treasury Secretary Tim
Geithner have decided to add to this financial house of cards. Instead of
raising taxes or cutting expenditures, they have decided to borrow their
way out of the problem and have the Fed create money out of thin air,
which will almost certainly create another bubble. This bubble will
make the others pale by comparison and will help destroy the US
dollar. The dollar may be the world’s reserve currency, but China and
other countries are not only questioning its status, but also actively
campaigning for greater use of alternative currencies.
Gold is Money
72 10th Anniversary Book of Articles
INVESTORS ARE DEMANDING REAL MONEY
Where are most investors putting their cash? It should no longer be in
stocks. Key stock indices like the Dow Jones Industrial Average have
been flat to negative in nominal terms since the end of the last century.
But if the Dow is priced in gold (in other words, money) as opposed to
depreciating dollars (in other words, fiat currency), its decline is far
more dramatic. As Figure 4 shows, the Dow:Gold Ratio is not only in a
downtrend, the downtrend is steepening which is a continuing
indicator to move from equities to bullion.
Global creditors who currently hold trillions of dollars’ worth of dollar‐
denominated financial assets are dumping them to preserve their
wealth. That is why gold bullion, along with its precious metals
cousins, silver and platinum bullion, have been consistently keeping
their value against financial assets (Figure 5).
CENTRAL BANKS ARE BUYING GOLD BULLION
India recently bought 200 metric tonnes of gold bullion from the International
Monetary Fund for $6.7 billion. Russia has recently added 120 tonnes of
bullion to its reserves, while China has steadily (and surreptitiously)
increased its gold bullion reserves from 600 tonnes in 2003 to 1,054 tonnes
today. China is even urging its people to put five percent of their savings into
gold and silver because it is so worried about the dollar. And because trillions
73
of dollars of its reserves remain in US dollar‐denominated assets, China’s
central bank will be diversifying into gold for many years to come.
The world’s central banks know that gold is primarily a monetary
asset, not a commodity. That’s why a growing number of them are
quietly diversifying out of US dollars and adding to their 29,000
tonnes of gold reserves.
In its 2010 Precious Metals Outlook, Scotiabank noted that “seeing the
value of the dollar steadily erode must be a nightmare for large US
creditors such as China, Japan, South Korea, Russia, the oil producing
countries and Sovereign Wealth Funds (SWF)...
MAJOR INVESTORS ARE DIVERSIFYING INTO GOLD
It is not just governments that are dumping dollars for bullion. A
rapidly growing number of sovereign wealth funds (including China
Investment Corporation) are participating, as are major institutional
investors. Hedge fund manager John Paulson, who made $3 billion in
2008 by shorting subprime mortgages, recently took a multi‐billion‐
dollar position in gold as a hedge against inflation. Northwestern
Mutual Life Co.’s CEO Edward Zore said his company purchased
$400 million in gold (the first time in its 152‐year history) because “the
downside risk is limited, but the upside is large. We have stocks in our
portfolio that lost 95 percent. Gold is not going down to $90.ʺ
Hedge fund manager David Einhorn, through his Greenlight Capital
fund, has sold gold ETFs in order to invest in longer‐term and lower‐risk
gold bullion because of current US economic policy. Lone Pine Capital
significantly increased its stake in gold this year. Perhaps of even greater
interest to the unwary investor is a survey of US hedge fund managers
by London ‐based Moonrake r Fund Management :
90 percent (20 of the 22) of the hedge fund managers surveyed admitted
they had bought physical gold for personal investment. These
sophisticated investors know something that the average investor
doesn’t: that the global policy response to the financial crisis will not
only devalue the world’s major currencies, it will decimate the US dollar.
“Both China and America are addressing bubbles by creating more bubbles
and we’re just taking advantage of that.” – Lou Jiwei, Chairman, China Investment Corporation
Gold is Money
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MANY INVESTORS STILL VIEW GOLD AS A COMMODITY
Individual investors are not so farsighted – yet. Because most of them
have only experienced one kind of market – a 25‐year bull market in
stocks – many still think gold is just a commodity like copper, zinc or
pork bellies. But gold is far more than that. It has a 3,000 year history as
money; for much of that time, it was the universal medium of exchange
because of its divisibility, portability, rarity, beauty, malleability and
indestructibility. Despite today’s negative sentiment, gold is not a
speculation or a barbaric relic. Gold is money. Gold retains its
purchasing power year after year, as Figure 6 shows.
Forty years ago it took 66 ounces of gold to buy a compact car. Today it
takes only 14 ounces. If you had put your money in gold instead of
dollars, the same car would actually be 79 percent cheaper, because
gold keeps its value. Houses, stocks and virtually every other asset on
earth would also be cheaper if bought with physical gold.
THE MORE INVESTORS LEARN ABOUT BULLION, THE BETTER FOR THEIR PORTFOLIOS
If you are already a bullion investor, now is the time to add to
your portfolio. If you are new to investing in bullion, now is the time to
start dollar‐cost‐averaging into bullion. I encourage investors to learn
as much as they can about bullion and about the markets in general.
A good place to begin is the Learning Centre section of our website
(www.bmgbullion.com). It offers a comprehensive look at the economy,
money, markets and bullion investing, and provides a variety
of thought‐provoking articles written by experts in the field of gold
and precious metals.
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ʺWe have a market‐friendly Fed injecting a lot of liquidity in the system
which will set us up for another bubble economy. Excessive monetary
accommodation just takes us from bubble to bubble to bubble.ʺ – Stephen Roach, chief economist, Morgan Stanley
GOLD IS MONEY
Gold is money because it cannot be created out of thin air by
government decree. Unlike bonds, gold does not represent someone
else’s liability and, unlike stocks, gold does not rely on someone else’s
promise of performance. Gold is money because, unlike currencies,
impatient monetary policymakers cannot change its value. The rising
gold prices we have experienced for the last eight years do not signal a
bull market in precious metals, but rather a vote of decreasing
confidence in the future value of paper currencies.
Currency‐denominated financial assets are a disaster waiting to
happen. The current economic rebound is a mirage, being entirely
dependent on something artificial and unsustainable: massive
government spending. A new crisis is building out of unprecedented
fiscal and monetary mismanagement. Fortunately, smart investors can
protect their wealth from the coming storm. The true level of risk has
not been priced into the markets. The time to shelter your wealth from
the storm is now. And there is no safer investment on earth than
bullion, because bullion is and always will be money.
1Gold Outlook for 2010
Gold is Money
Why Bu l l i o n i s Ou t p e r f o rm i n g
Min i n g S t o c k s
J u l y 2 0 1 0
If the investment choice is between mining stocks and physical bullion,
it is essential to remember that these are different asset classes with
entirely different risk/reward attributes. Mining stocks and bullion
perform quite differently when the global economic environment is in
turmoil, as is the case today. Banking crises, trillion‐dollar deficits and
the accelerating depreciation of many of the world’s major currencies
do not create positive conditions for equity markets, which is why
investors are fleeing to the safety of physical bullion.
BULLION IS A SAFE HAVEN DURING TURBULENT TIMES
This flight to bullion was confirmed during the stagflationary 1970s.
Figure 1 shows that while Homestake Mining, the shares of the largest
North American producer at the time, increased by an impressive 800
percent during the 1970s, physical gold increased by 1,500 percent,
during that same time period. While it is true that many junior mining
companies outperformed both bullion and Homestake in the 1970s,
producing impressive returns for their shareholders, many other
juniors faded into obscurity, resulting in painful losses.
The volatility associated with junior mining companies versus blue chip
producers and physical bullion makes them a purely speculative
choice. However, if you have a high risk tolerance and a good advisor,
then a small allocation to junior mining companies may be appropriate,
especially those with established ounces in the ground. Juniors with a
78 10th Anniversary Book of Articles
new discovery can generate substantial capital gains, but they are still
highly speculative investments and can be very volatile.
BULLION OUTPERFORMS MINING STOCKS DURING FINANCIAL CRISES
While mining stocks can generate impressive returns during an
uptrend in precious metals prices, they do not outperform bullion
during times of crisis, as in the financial meltdown of 2008, for example.
79
Figure 2 shows the relative performance of the XAU mining index
against gold bullion. When global economic conditions deteriorate,
investors inevitably seek a safe haven for their wealth, rather than more
speculative investments. As can be seen in Figure 2, gold maintained its
strength throughout the turmoil, even as financial markets and mining
stocks (as represented by the XAU Index in purple) declined.
Blue chip gold stocks like Goldcorp and Barrick Gold can be good
investments because, unlike juniors, they are less likely to wither away
to nothing and frequently offer dividends. But timing is crucial because
producers can also be quite volatile. Other precious metals investment
options might include mining ETFs which holds a basket of gold
producers, but be prepared for a daily roller coaster ride. Regardless of
the type of investments chosen, every investor’s portfolio should be
diversified with precious metals.
BULLION HELD ITS OWN DURING THE 1987 MARKET CRASH, WHILE MINING STOCKS FELL
During sharp market declines, such as the 1987 stock market crash,
mining stocks tend to become correlated to the broad equity markets
rather than the price of bullion. Figure 3 shows the comparative
performance of mining stocks, gold bullion and the Central Fund of
Canada (CEF), a closed‐end fund that holds gold and silver bullion,
during the crash. As the chart shows, mining stocks declined more than
Why Bullion is Outperforming Mining Stocks
80 10th Anniversary Book of Articles
the Dow even though the price of gold was rising. The exchange‐traded
Central Fund behaved like an equity even though it holds bullion.
While mining stocks have significant appreciation potential beyond the
price of bullion, they are leveraged plays on bullion prices, and like any
form of leverage they carry a variety of risks. In addition to stock
market volatility and deteriorating economic conditions, potential risk
factors include: geopolitical issues, environmental issues, management
skills and performance, business model, financial strength, mine life,
production costs and efficiencies, increases in operating and energy
costs, hedging policies and exploration success.
GOLD BULLION IS NOT AN INVESTMENT
Many investors jump on the gold bandwagon without taking the time
to assess whether they are savers seeking wealth preservation or
speculators seeking capital gains. Mining stocks, especially juniors and
exploration companies, tend to be for speculation, while bullion is
about wealth preservation. But physical bullion should not be viewed
as an investment. An investment is defined as an asset that is expected
to produce earnings or capital appreciation at a later time. Bullion does
not pay dividends, income or interest, and should not be held,
primarily, for capital appreciation. If bullion isn’t an investment, what
is it and why does it continue to rise in price?
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GOLD IS MONEY
Gold is primarily a monetary asset. It has been a universal medium of
exchange and store of value for three thousand years, and it backed
every major world currency until the twentieth century. The reason for
gold’s “rise” to prominence in recent years has little to do with the
metal itself; it is occurring because gold provides the ultimate
protection against economic mismanagement and currency destruction.
In an era of rampant currency creation, gold has resumed its historical
role as money. For a full explanation of this phenomenon, go to: “Gold
is Money” (www.bmgbullion.com/document/682).
THE “CASH” COMPONENT OF EVERY PORTFOLIO
Because gold and other precious metals do not depreciate in the long
term, it should replace the depreciating “cash” component of every
investor’s portfolio. Physical, allocated bullion is the foundation of the
precious metals investment pyramid (Figure 4) and, given current
conditions, it offers more safety and security than government bonds,
T‐bills and other traditional cash components.
GOLD IS THE ANTI-CURRENCY
In an era of fast money and currency destruction, bullion is real money.
Central banks are buying bullion, hedge funds and other institutional
investors are buying bullion. And the world’s largest creditor – China –
is diversifying out of dollars and buying bullion.
“When the price of gold moves, goldʹs price isnʹt moving; rather it is the value
of the currencies in which itʹs priced that is changing.” – John Tamny, Economist, H.C. Wainwright Economics
Most investors’ portfolios are heavily weighted in currency‐
denominated financial assets (stocks and bonds), but few comprehend
the extent of their purchasing power loss. The numbers in Figure 5 may
help put things in perspective: in the past ten years, the US and
Canadian dollars, the UK pound and the euro have, collectively, fallen
more than 70 percent in value if measured in that universal unit of
money, gold. In effect, investor portfolios have lost 70 percent of their
purchasing power. Currency destruction, while it is accelerating, is by
no means a recent event, however. Since 1913 (not coincidentally the
year the US Federal Reserve was formed) the US and Canadian dollars
have lost a staggering 96 percent of their value. Is this trend likely to
come to an end? Not in the foreseeable future.
Why Bullion is Outperforming Mining Stocks
82 10th Anniversary Book of Articles
SOVEREIGN DEBT GROWS, BUT GREECE IS NOT THE PROBLEM
The debt problems in Europe in general, Greece in particular, Japan and
the UK should be of grave concern to all investors. As the crisis widens
and deepens, all currencies are coming under pressure. The US dollar is
rising because it is currently perceived to be the least ugly of an ugly
bunch. But is it? Americaʹs budget deficit (13 percent of GDP) is nearly
identical to that of Greece, and its debt as a percentage of GDP is not far
behind. And America’s problems are one hundred times the size. In
2009, the US incurred a budget deficit of $1.4 trillion, and its debt rose
by $1.9 trillion due to off‐budget expenditures. These off‐budget
expenditures alone were more than the 2008 budget deficit.
At the end of 2009, America’s total debt was approaching 100 percent of
GDP, but most investors are unaware of another, far bigger burden:
trillions of dollars in unfunded liabilities for Social Security, Medicare
and Medicaid. Money the government promised to taxpayers for Social
Security has instead been borrowed for its own use. Money the
government promised to fund future Medicare and Medicaid benefits
and military/government pensions has not been set aside at all. Richard
Fisher, a member of the Federal Open Market Committee, believes total
US debt – including Medicare and Social Security – is over $122 trillion
(Figure 6). This is more than $390,000 for every man, woman and child
in the US, and the number keeps rising.
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“Fiscally, we are in uncharted territory.
Because of this gigantic deficit, our country’s ‘net debt’ is mushrooming...
no one can know the precise level of net debt to GDP at which the United
States will lose its reputation for financial integrity.” - Warren Buffett, Chairman, Berkshire Hathaway
When, not if, interest rates rise from their present near‐zero levels, US
debt payments will soar because every percentage point rise in interest
rates adds an additional $120 billion in interest payments. And if
inflation were to take hold, rates could easily rise to 10 or 15 percent, as
in the 1970s stagflation era. If that were to happen, interest payments
alone would gobble up over 90 percent of government tax revenues.
With this kind of economic future on the horizon, is it any wonder the
US dollar is in irreversible decline?
A MUCH BIGGER CRISIS AWAITS
Current economic conditions are ripe for the onset of another, even
bigger financial crisis. Zero interest rates, trillion‐dollar sovereign debt,
trillion‐dollar bailouts and stimulus spending are almost certain to
result in spiralling inflation, which could lead to a hyperinflationary
depression. Economist John Williams delves into this growing
possibility in his Special Report on Hyperinflation ‐ 2010 update.
(www.shadowstats.com/article/hyperinflation‐2010)
“It is absolutely inevitable that the US will have to ‘default’
on part of its existing liabilities, since the long‐run trajectory of government
borrowing is clearly unsustainable.” - Niall Ferguson, Author, The Ascent of Money
As confidence in fiat currencies continues to decline, gold prices will
rise causing mining stocks to rise as well.
Why Bullion is Outperforming Mining Stocks
84 10th Anniversary Book of Articles
IT’S TIME TO PRESERVE YOUR PORTFOLIO’S PURCHASING POWER
In a world of increasing volatility and uncertainty, precious metals
bullion provides tangible, predictable wealth protection for currency‐
denominated investment portfolios. For the past several years, as
currency creation has reached unprecedented levels, gold, silver and
platinum have resumed their traditional role as a store of wealth. Over
time, purchasing, or adding to, a core holding of physical bullion is a
prudent investment strategy. While a minimum 10 percent allocation is
considered adequate under normal conditions, a much larger allocation
of 20 percent or more is suggested for protection today. If you have not
already done so, now is the time to rethink your investment strategy
and preserve your hard‐earned wealth with physical bullion.
Th r e e Dom i n a n t F a c t o r s Wi l l
Imp a c t P r e c i o u s Me t a l s i n 2 0 1 1
A p r i l 2 0 1 1
As we near the end of the first quarter of 2011, the potential for a
widening of the uprisings in North Africa and the Middle East has
pushed oil prices past the $100 mark. Long before the riots began,
commodity prices had risen to uncomfortable levels, having soared
over 30 percent in a matter of months.
Currency creation by emerging market central banks was, and is, a
major factor behind the rise in oil prices. Egypt’s M2 money supply, for
example, rose 13.3 percent during 2010, while China’s M2 money
supply increased by 17 percent and India’s M3 money supply increased
by 15 percent. When currency creation outpaces GDP growth, too many
artificially created rupees and yuan and pounds and euros chase too
few goods, and price inflation results (Figure 1).
In an economy largely propped up by quantitative easing and money
supply expansion, three dominant factors are likely to impact gold and
precious metals prices in 2011. They are:
Movement away from currencies
Central bank buying
China
86 10th Anniversary Book of Articles
FACTOR 1: MOVEMENT AWAY FROM CURRENCIES
Major currencies, including the US dollar, have been declining in
purchasing power for years, but now the rate of depreciation is
accelerating. Investors are losing confidence in the ability of the world’s
largest economy to lift itself out of its $14 trillion debt. When (not if)
interest rates rise from their artificially low levels, interest paid on the
debt will soar. The Washington Post estimates it will quadruple by
2014. “When governments reach the point where they are borrowing to
pay the interest on their borrowing they are coming dangerously close
to running a sovereign Ponzi scheme,” says economist Nouriel Roubini.
The US is rapidly approaching that point, and investor anxiety is
increasing in concert with the realization that currency creation for
bailout purposes ‐ the knee‐jerk monetary response to the financial
crisis – is no longer a temporary matter. As quantitative easing becomes
institutionalized, the “safe haven” US dollar continues its decline,
sending precious metals prices higher.
The Pe t rodo l l a r Di lemma
As the world’s reserve currency, the US dollar has enjoyed special
status. Since 1973, the dollar has been the only currency in which oil
could be traded, a key reason the US has been able to amass over
$14 trillion in debt. However, the unquestioned status of the dollar is
coming to an end. On November 24, 2010, China and Russia officially
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“quit the dollar” and agreed to use each otherʹs currencies for bilateral
trade—including oil. Official trading on Moscowʹs MICEX Index began
on December 15, 2010. Loss of the petrodollarʹs hegemony would have
a devastating effect on the US, as this is essentially the only reason most
foreign countries need to hold US dollars. Robert B. Zoellick, President
of the World Bank, says the US would be “mistaken” if it continues to
take for granted the dollar’s place as the world’s reserve currency, and
that, “looking forward, there will increasingly be other options to the dollar.”
Mone t i z ing Debt by Demone t i z ing the Dol l a r
The US Federal Reserve is quietly trying to ward off economic disaster
by purchasing hundreds of billions of dollars of US Treasury bonds via
the second stage of its quantitative easing program, QE2. Few investors
seem to care that the Fed is in effect funding the US government; that
QE has created $2 trillion new US dollars out of thin air that debase the
value of existing US dollars; or that QE1 and QE2 have been pumping
liquidity into the equity markets, and thus pushing stock prices to
unrealistic levels. Monetary inflation leads to price inflation, and
today’s rising energy and food costs reflect that fact. Food prices have
political consequences in emerging markets because the cost of food
consumes such a large percentage of income.
Quant i t a t i ve Eas ing i s Globa l
QE programs are also at work outside the US. In October 2010, the Bank
of Japan unveiled its latest program, a 5‐trillion yen ($60.1 billion) fund
to buy assets including government bonds, corporate debt, exchange‐
traded funds and real‐estate investment trusts. Deputy Governor
Kiyohiko Nishimura of the Bank of Japan went out of his way to defend
the Bank’s QE actions. “It is crucial to avoid creating an impression of
the monetization of government debt. Otherwise, purchases may lead
to a substantial and lasting ratcheting‐up of long‐term rates which
would pose a serious problem for economic recovery and the financial
position of the government.”
The 9.0 earthquake and tsunami that rocked Japan in March have dealt
the country’s already struggling economy a potential knockout blow.
At the time of writing, Japan’s central bank had already poured nearly
60 trillion yen ($688 billion) into the economy, but that is just the
beginning of the money creation. Hundreds of trillions more new yen
are expected to be pumped into the economy over the next few months
in an effort to keep it afloat. Japan’s devastation and its efforts to
Three Dominant Factors Will Impact Precious Metals in 2011
88 10th Anniversary Book of Articles
recover are going to add fuel to the currency fire, sending precious
metals prices higher.
QE supporters say that QE currency creation is used to stimulate the
economy, and not used to finance government spending. This is a very
fine line indeed. Richard Fisher, president of the Federal Reserve Bank
of Dallas, doesn’t even bother to draw the line. He puts the blame on
Congress: “The Fed could not monetize the debt if the debt were not
being created by Congress in the first place,” Fisher said recently.
“The Fed does not create government debt; Congress does.” Fisher is
technically correct, but the Fed is and always has been Congress’s
enabler. Without acquiescence from the Fed, America wouldn’t have
been able to sink into its current debt quagmire.
The consequence of this movement away from currencies will be a
decline in real purchasing power. If we examine a 10‐year chart of the
US and Canadian dollars, the British pound, the euro and the yen
(Figure 2), we can see that these currencies have lost between 70 to 80
percent of their purchasing power in terms of gold. In truth, however,
gold is not rising. Currencies are falling in value, or purchasing power.
89
FACTOR 2: CENTRAL BANK BUYING
In 2009, for the first time in 20 years, monetary gold, or central bank
and investment buying, outpaced gold buying for industrial or
jewellery purposes. In 2010 China, Iran, Russia and Indiaʹs central
banks were all significant buyers as they moved cash reserves to gold.
As the flood of cheapening US dollars continues to flow into
developing world economies, emerging market central banks are
converting substantial amounts of their dollars and other paper
currency reserves into gold, partly due to currency‐related fears. In the
third quarter of 2010, Russian central bank gold holdings rose 7 percent
to 756 tonnes. In 2010, the Russian Central Bank bought two‐thirds of
its own gold production. In December we learned that China had
imported 209.7 metric tonnes of gold in the first 10 months of the year, a
500 percent increase over the same period in 2009. This was in addition
to the purchase of its own world‐leading gold production (Figure 3).
By the third quarter of 2010, Indiaʹs gold imports for the year, both
commercial and private, were 624 tonnes, putting them well over the
previous yearʹs total of 595 tonnes. Fourth quarter purchases could put
Indiaʹs annual total over 750 tonnes.
Three Dominant Factors Will Impact Precious Metals in 2011
90 10th Anniversary Book of Articles
China and Russia need to acquire gold to bring their gold reserves to
outstanding currency ratio closer to that of Western central banks.
Russia needs to acquire at least 1,000 tonnes and China at least 3,000
tonnes to remain on parity with the US. Chinese officials have stated
publicly that China would like to acquire at least 6,000 tonnes.
Unofficially they have stated targets as high as 10,000 tonnes
FACTOR 3: CHINA
Investment demand for gold and silver is soaring, due in part to inflation
fears in many of the emerging economies. A key demand driver is China,
whose massive population and surging economic growth has led to rising
prosperity and a burgeoning middle class with a keen desire to protect their
new‐found wealth. Although the West shares many common economic
principles with the East, because the banking systems are similar, in one area
there is a clear distinction: how Easterners view the role of gold as money.
Western governments fear the rising gold price because it restricts their
ability to create currency. They fear rising silver and platinum prices
because these are harbingers of economic uncertainty and instability. In
the West, governments borrow and encourage their constituents to
follow their example. Banks encourage us to borrow for everything
from vacations to widescreen televisions made in China. They tell us
we are “stimulating” the economy through consumption. Generally
speaking, the investing public in the West sees gold as a wealth‐gaining
asset to be traded like stocks and bonds. This is why Westerners are
constantly fretting about the price of gold in currency terms.
China : A Dif fe ren t At t i tude Towards Gold
The Chinese government, on the other hand, respects gold. This is
evident by the laws they have passed to facilitate mining and private
gold ownership. China currently leads the world in gold production.
The government encourages the public to put 5 percent of their savings
— yes, they encourage saving — into gold. This is significant because
the Chinese can save up to 40 percent of their annual salary.
The campaign appears to be working: In the first two months of 2011,
domestic gold purchases in China jumped to 200 metric tonnes, far
outpacing the previous year. The Chinese see gold as a wealth‐
preserving asset that will weather all seasons. Pierre Lassonde, former
CEO of Newmont Mining, thinks that buying by the Chinese public
will eventually propel gold prices into the stratosphere.
91
Cur rency Wars
Federal Reserve Chairman Ben Bernanke’s $600 billion QE2 program
infuriated the Chinese. It not only debases the value of the $840 billion
in US Treasuries that the Chinese hold, but it also requires them to
debase the yuan, which is pegged to the dollar. This causes inflation,
which is showing up in rising food prices. The ensuing rift between the
US and China may develop into the major gold‐related news story of
2011. Currency wars lead to price wars. We saw the beginning of this in
November 2010, when China began putting price controls on Wal‐Mart.
Although all major countries are participants in this “race to debase”,
the battle between the US and China is the most significant. China has
been financing the US for years through the purchase of US
government securities. In 2010 we saw an alarming decrease in Chinese
US Treasury purchases. This has led to a vicious cycle in which the Fed
has to buy US debt with more currency creation, which leads to more
debt and interest payments for the US taxpayer.
Morgan Stanley Asia Chairman Stephen Roach says the US should
expect “a natural, organic reduction of Chinaʹs buying of dollar‐
denominated assets.” This is troubling news for an already
beleaguered US dollar, as America’s escalating debt will likely
encourage more policy measures that devalue the dollar, further
depreciating China’s US bond portfolios in the coming years.
THREE IRREVERSIBLE TRENDS
In addition to the three immediate factors helping to drive metals prices
higher in 2011 – movement away from currencies, central bank buying
and the China effect – three longer‐term, irreversible trends are at work
that will likely affect the price of gold and currencies for decades.
These three trends are:
Aging Population;
Outsourcing; and
Peak Oil
Trend 1 : The Aging Popu la t i on
The aging population is a result of two things: a populace that is living
longer, and the “pig in a python” effect of a tidal wave of baby boomers,
born between 1946 and 1963, who are beginning to retire (Figure 4).
Three Dominant Factors Will Impact Precious Metals in 2011
92 10th Anniversary Book of Articles
As people age, they spend less and downsize. GDP and tax revenues
are reduced and a much smaller workforce follows the baby boomers,
creating a triple whammy. This problem is universal. In China, it is
further exacerbated by the one‐child‐per‐couple policy. Governments
will have no choice but to create more currency and further debase it.
The baby boomer generation has been the world’s prime socio‐
economic driver for the past 50 years. As they were getting married,
buying houses, having children and starting to invest, the boomers
drove a growth economy. Now, as they approach retirement, the
economy will slow as boomers’ spending habits decline, because they
already own everything they need. So consumer spending, which has
driven the economy for the last number of years, will begin to drop.
Moreover, as they start withdrawing money from the system in terms
of pensions, social security and Medicare, boomer retirees will become
a cost to society. In the US, social security is a giant black hole with
obligations in the order of over $100 trillion. The government is already
spending money that is not in the program. As the baby boomers age,
Medicare obligations are going to be massive.
This will result in a reduction in GDP, a reduction in government
revenues and an increase in government outlays, which will force the
government to borrow more money. At some point, monetization by
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the Fed will go into overdrive because the US will no longer be able to
sell its debt to foreigners. This is not just an American problem,
however. Japan, Russia and many European countries are in the same
boat. As governments race to debase their currency by creating more
and more, the price of precious metals will continue to rise.
Trend 2 : Outsourc ing
Outsourcing has almost entirely destroyed the manufacturing sectors of
many first‐world countries like the US and Canada, and much of
Europe. The Chinese worker who built your iPhone made $287 a
month; this was after a well‐publicized raise. The West simply cannot
compete with these labour costs. The US was the worldʹs largest
manufacturer after WWII, and has driven the worldʹs economy ever
since. However, the dismal US unemployment rate (Figure 5) means
Americans are no long able to buy things with their former gusto. As
factories move offshore, the high unemployment becomes systemic.
Without jobs, the GDP and the tax revenues of the US fall. As the
mountain of federal, state and municipal debt becomes harder to
service, the government will be forced to go even deeper in debt and to
further debase its currency.
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Trend 3 : Peak Oi l
Peak oil is the point at which the maximum rate of global petroleum
extraction is reached, after which the rate of production enters terminal
decline. Peak oil has already been reached in the US, Alaska and the North
Sea (Figure 6). In other words, the era of cheap oil is rapidly coming to a
close. In the next few years, Mexico will become an importer of oil and the
US will lose its third‐largest supplier. America’s fragile, highly indebted
economy relies on this land‐based cheap oil to grow, and it will not easily
withstand the shock of transitioning to more expensive alternatives.
September 2010, a German military think‐tank reported that the
German government was taking the threat of peak oil seriously and was
preparing accordingly. Numerous studies from around the world have
concluded that we are very close to peak oil production, which will be
accelerated due to Gulf drilling bans and unrest in the Middle East.
Even the National Petroleum Council recognizes the end of cheap oil.
In its July 2007 report, “Hard Truths: Facing the Hard Truths about
Energy,” the Council concluded that “hydrocarbon resources are
becoming more difficult to access and challenging to produce [and the]
costs of developing and delivering energy are escalating.”
Peak oil will inevitably lead to uncontrolled inflation on a global scale,
because oil is a vital component in the discovery, delivery,
manufacture, refinement, processing, packaging, distribution, sale and
consumption of virtually every product on Earth.
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According to the International Energy Agency, over the past year the
oil import costs for the 34 countries that make up the Organisation for
Economic Co‐operation and Development soared by $200 billion to
$790 billion. “Oil prices are entering a dangerous zone for the global
economy,” reports Fatih Birol, the IEA’s chief economist. Interestingly,
he made these remarks before the uprisings in North Africa sent oil
prices skyward.
Oil prices are surging (Figure 7), but they could skyrocket over the
coming weeks and months if the uprisings in North Africa spread to
Algeria and Saudi Arabia. Some analysts are predicting $220 per barrel
should Libya and Algeria halt oil production.
As Ambrose Evans‐Pritchard of the Telegraph notes, “A shut‐down in
Libya and Algeria would cut global supply and reduce OPEC spare
capacity to levels comparable with those at the onset of the Gulf War
and worse than during the 2008 spike, when prices hit $147. Both price
shocks preceded a recession in Europe and the US.”
The US is the world’s largest consumer of oil, importing almost
10 million barrels per day. China is now the second‐largest consumer.
Among the top 15 consumers are Japan, Germany, France, Canada,
Italy and the UK. Yet outside of Canada and China (which,
like the US, produces roughly half of its daily consumption and is
Three Dominant Factors Will Impact Precious Metals in 2011
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also the world’s third‐largest producer), none of the others are in
the top 15 for production.
Rising prices as a result of peak oil will hurt the fragile US economy
most, because America currently pays less for oil and gas than any of
the first‐world countries. When added to the effects of the waning
strength of the petrodollar, the results will be devastating.
OUTLOOK FOR PRECIOUS METALS
Gold, silver and platinum prices will continue to rise, driven by a shift
away from depreciating paper currencies and massive economic
growth in China, the world’s second‐largest economy.
Out look fo r Gold
Despite rising prices, overall demand for gold is expected to remain
strong in 2011, building on 9 percent growth in 2010, its highest rate in
a decade (Figure 8).
Investment demand for gold is soaring, and investment in physical bars
surged 56 percent over the past year to reach 713 tonnes. In recent years
the Chinese government has actively encouraged its 1.3 billion citizens
to put a portion of their savings into silver and gold.
China and India are major demand drivers, accounting for over half of
world demand for jewellery, bars and coins. China is poised to overtake
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India as the worldʹs largest consumer of gold, thanks in part to strong
economic growth, but also due to the government’s gold‐centric
policies. Since 2003, China has more than doubled its official gold
reserves, yet even today, gold accounts for only 1.6 percent of the total
reserves held by the People’s Bank of China, China’s equivalent of the
US Federal Reserve. Chinese officials are on record as saying that the
country needs to raise its gold reserves, which are considered
“inadequate” compared with the 8,133 tonnes held by the US and 3,408
tons by Germany. Given the size and scope of China’s central bank, this
bodes well for future gold demand.
India continues to be the largest market for gold, accounting for
approximately 20 percent of world demand. India’s gold imports
surged to 800 metric tonnes in 2010 (compared with 557 tons in 2009)
driven mainly by investment demand. Indian consumers see gold as a
store of value and protection against inflation, which has been surging
over the past several years. Indian investment is traditionally in the
form of jewellery as opposed to gold bars. Jewellery demand rose
67 percent year in 2010, despite rising prices. Gold demand in India has
increased 13 percent per year, on average, during the past decade,
outpacing the country’s real GDP, inflation and population growth by
6 percent, 8 percent and 12 percent respectively.
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Currently, Indians own roughly 18,000 tonnes of aboveground gold, or
approximately half an ounce of gold per person. This is significantly
below consumption in Western markets. Since incomes and wealth
continue to rise in India, there is plenty of scope for additional future
growth. Gold has already surged to new highs in 2011.
Out look fo r Si lve r
Like gold, silver has been money for thousands of years, and was used as
ordinary coinage in both Canada and the US until 1965. Recognized for
its unique attributes as both a monetary and industrial asset, silver is both
a safe haven in the event the economy regresses and a scarce commodity
that will soar if the economy enters an inflationary boom. Despite its
recent price rise, silver remains undervalued compared to gold, and the
recent “backwardation” in the price of silver reinforces this view.
Backwardation occurs when the current or spot price is higher than the
price for future delivery, clearly indicating that there is a silver shortage,
since demand is greatly outpacing the ability of dealers to deliver.
Many factors are pushing silver prices higher today (Figure 9): falling
currencies are raising the likelihood of spiralling inflation; new high‐
tech applications are increasing industrial demand; rising energy costs
are pushing production costs higher; and China, India and other
developing economies are ramping up their silver purchases for
industrial and investment purposes.
The supply/demand characteristics for silver are even more attractive
than for gold.
For many years, the governments of India, China and Russia have been
selling off their stockpiles of silver, but now these countries have
curtailed sales. Silver shortages are the most likely reason. Globally,
demand from the developed world combined with accelerating
demand from the emerging world should continue to stretch the limits
of supply. While it is true that silver is ten times more abundant than
gold, silver has been in supply deficit for many years because much of
it is consumed. Although silver is a critical component in a vast number
of industrial and high‐tech applications, the amount of silver consumed
in each application is generally so small as to make recovery
economically unviable. In addition, investment demand is likely
understated. China, the world’s third‐largest producer of silver,
imported four times as much silver in 2010 than the previous year, and
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demand shows no signs of abating in 2011. Meanwhile, escalating drug
wars in Mexico are threatening to choke off silver production from the
world’s second‐largest producer.
Silver may finally be ready to jettison its title as the “poor man’s gold”.
Regardless of how well or how poorly fundamentals are clearly in
silver’s favour. If the economy shows signs of recovery, industrial and
monetary demand will push prices higher, and if the economy
continues to stagnate or decline, silver will remain firmly in demand as
a store of value. The price of silver, like gold, is simply mirroring the
disarray in the global monetary system. How long can silver prices
keep going up? As long can monetary authorities keep printing
currencies at breakneck speed.
Out look fo r Pla t inum
While gold and silver are often in the news as they jump to new highs,
there is little or no mention of platinum, even though it has been in an
uptrend for ten years.
By year‐end 2010, platinum had reached $1,755 per ounce (Figure 10),
well beyond the $1,070 level reached in 1980, and not far from its
pre‐crisis 2008 high. By any metric, but especially compared to its
precious metals cousins, platinum is considerably undervalued. Beyond
its jewellery and industrial demand, there is increasing investment
Three Dominant Factors Will Impact Precious Metals in 2011
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demand for platinum because platinum, like gold and silver, is a store
of value. But platinum’s supply story is even more dramatic than that
of gold and silver.
Total annual world production of platinum is about 7 million ounces −
a mere 10 percent of the world’s annual gold production of 76 million
ounces, and less than 1 percent of the world’s annual silver production
of 416 million ounces (Figure 11). South Africa supplies about
75 percent of the worldʹs platinum. Platinum is both a monetary and an
industrial metal, so platinum prices are influenced by the price of gold
and silver, as well as by key applications such as catalytic converters for
automobiles. Auto‐catalyst and industrial demand rebounded by
18 percent in 2010.
Demand for industrial uses other than autos rose 30 percent in 2010.
Current platinum prices are limiting production as the industry’s
margin is “barely positive” at these prices, according to BNP Paribas.
In addition, a stronger South African rand and rising energy and wage
costs are pressuring margins and constricting supply.
For these reasons, platinum should be considered a key portfolio
holding, a store of value and an exceptional wealth preservation
vehicle. Supply constraints combined with increasing demand as a
result of rising global inflation should help propel platinum prices
higher in 2011 and beyond, while investors seeking a safe haven will
discover that platinum, along with gold and silver, preserves
purchasing power over the long term, more so now than ever as paper
currencies decline.
GROWING COMPETITION FOR THE WORLD’S GOLD
The three long‐term trends we noted above will have consequences for
years to come, especially in the developed world. The cost of
supporting aging populations whose income is destined to flatten or
decrease can only create a drag on economic growth. Meanwhile, the
ongoing outsourcing of jobs, including skilled labour, will further
hollow out already fragile Western economies. Finally, the end of cheap
oil will create tremendous unpredictability and price uncertainty,
creating exogenous price shocks that will drive food prices to
unprecedented levels.
As we enter 2011, there is little indication that global governments
are any closer to getting their fiscal and monetary houses in order. The
US in particular remains on a spending path of a size and intensity
never before witnessed in human history. As investors lose confidence
in currencies, the worldʹs appetite for the relatively small amount
of available gold will increase.
As a direct result of worldwide debt and currency debasement, more
people will be competing for the world’s available gold, yet fewer
and fewer new deposits are being found. Smaller, lower grade deposits
with none of the “economy of scale” benefits of larger deposits are
being put into production out of desperation. Mine supply has been in
a deficit since 2005.
THE FUTURE OF PRECIOUS METALS
Based on current economic factors, we expect gold prices will end the year
somewhere between $1,700 and $2,000 per ounce. Silver and platinum
prices will experience similar growth based on investor demand.
As safe haven demand accelerates, there will be a transition from the
$200 trillion financial asset market to the $3 trillion aboveground gold
bullion market. Of the $3 trillion aboveground gold bullion, about half
is owned by central banks and half is privately held. (Figure 12)
Three Dominant Factors Will Impact Precious Metals in 2011
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The privately held bullion is largely owned by the world’s richest
families and is not for sale at any price. If the world’s pension funds
and hedge funds decided to move only 5 percent of their assets into
gold and precious metals, which these days seems quite conservative,
gold would trade above $5,000.
The multiple powerful trends identified in this review confirm that we
are in a long‐term precious metals bull market with strong
fundamentals and many positive indicators. In addition, attitudes
about owning bullion have irreversibly changed. Investors are
beginning to understand that precious metals are money. They do not
lose value like currencies, their past is far longer and their future is far
brighter than any currency on Earth.
P o r t f o l i o D i v e r s i f i c a t i o n My t h s
M a y 2 0 1 1
Pension funds across North America are facing record shortfalls.
Research shows that 33% of Canadian pension funds are struggling to
meet liabilities (Figure 1); the Ontario Teachersʹ Pension Plan funding
shortfall, for example, ballooned to $17.1 billion in 2009, despite strong
investment returns.
In the US, public pensions expect a shortfall of $2.5 billion that will force
state and local governments to sell assets and make deep cuts to services.
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When anticipated future payments are taken into account, the amount
reaches a staggering $1.9 trillion. The solution for pension funds is
simple: restructure asset allocation and include precious metals bullion.
FIDUCIARY RESPONSIBILITY AND RETHINKING ASSET ALLOCATION
Pension fund managers have a fiduciary responsibility to meet
liabilities; they use asset allocation to achieve diversification in order to
reduce risk, maximize performance and thus responsibly manage their
funds. To ignore the best‐performing asset class year after year could
conceivably expose managers and trustees to legal liabilities (Figure 2).
The traditional view is that three asset classes (stocks, bonds and cash)
are sufficient to achieve diversification. But Figure 3 shows that only
precious metals offer negative correlation to stocks, bonds and cash; a
portfolio that consists of only positively correlated asset classes is not
balanced or diversified.
Portfolio Diversification Myths
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Holding cash for portfolio protection does not work either. Figure 4
shows the dismal performance of five major currencies versus gold
since 2001.
HOW TO INVEST IN BULLION
For wealth preservation and portfolio protection, gold bullion should
form the foundation of an investment portfolio.
Figure 5 shows various investment vehicles based on inherent risk.
During periods of economic uncertainty, wealth preservation is critical
and unnecessary risk should be avoided. The best investment strategy
for long‐term investors seeking low risk with secular growth potential
is unencumbered physical bullion, as illustrated in the Precious Metals
Investment Pyramid.
GOLD IS LOW RISK
A prevailing myth says gold is risky and volatile. In fact, the opposite
is true. Standard deviation, a commonly used measure of risk,
calculates the total risk or variance associated with the expected return.
Using this method to compare gold to every Dow Jones component over
the last decade shows that gold is less volatile and has better
performance. Other methods, the Sharpe Ratio and the Sortino Ratio,
deliver similar results.
THE DOW:GOLD RATIO
The Dow:Gold Ratio measures trend changes in the gold price versus a
basket of stocks as represented by the Dow (Figure 6).
When the Ratio is rising, as in the 1920s, the 1960s and the 1990s, you
should be overweight stocks. When the Ratio is falling, as it did in the
1970s and is doing today, it is time to be overweight gold and precious
metals in portfolios. Currently the ratio is less than 9:1 and falling,
meaning investors should rebalance into gold and precious metals,
which will allow for reduced risk and maximized returns.
AN APPROPRIATE ALLOCATION
Although global pension assets are estimated to be $31.1 trillion, at
present, pension funds allocate virtually no funds to gold (Figure 7).
According to an Ibbotson Associates study, conservative portfolios
require a 7% allocation to gold, and aggressive portfolios require a 16%
– 17% allocation, simply to achieve a balanced, diversified portfolio.
This is known as strategic allocation.
From a tactical allocation standpoint, Wainwright Economics sees gold
as a leading indicator of future inflation. In a high‐inflation
environment, which the ongoing global money printing practically
guarantees, they recommend gold allocations of 17% in a bond portfolio
and 40% in an equity portfolio, just to break even against inflation.
Portfolio Diversification Myths
108 10th Anniversary Book of Articles
While pension funds are far below these recommended levels, the
mindset is beginning to change. Last year, the University of Texas
invested $500 million in gold due to fears of “unstable international
financial markets and the possibility of high inflation.ʺ This trend will
accelerate as the global economic reality we live in becomes more
widely understood.
Globally, financial assets are estimated at over $200 trillion, while total
aboveground gold bullion is a modest $3 trillion (Figure 8). About half
of that is owned by central banks, and half is privately held and not for
sale at any price. When pension funds begin to move into gold, the
price could skyrocket.
Savvy investors and pension fund managers alike can protect their
portfolios and ensure that future liabilities are met by allocating to
precious metals bullion now, while there is still enough supply
available to meet pension fund needs, and the price is reasonable.
Go l d a n d F i a t Cu r r e n c y :
F o r t y Ye a r s L a t e r
A u g u s t 2 0 1 1
ʺIn effect, there is nothing inherently wrong with fiat money,
provided we get perfect authority and god‐like intelligence for kings.ʺ -- Aristotle
Today, Monday, August 15, 2011, marks the 40th anniversary of the US
default on the dollar’s convertibility into gold. It was the world’s de
facto reserve currency and thus began an experiment with a reserve fiat
currency that was doomed to failure before it began, because there has
never been a successful fiat currency in all of history.. August 15, 1971
was just like any other day for most people, and President Nixon’s
unprecedented decision to cut the US dollar’s gold international
convertibility was largely ignored by the public. The majority of
citizens didn’t understand the implications for their financial future.
Contrast that to today, where a historic downgrade of US debt and a
very public $2‐trillion increase of the debt ceiling dominated headlines
and the television news.
Forty years later, it is a tale of contrasts between US dollars and gold.
The US dollar is the world’s reserve currency despite the fact that it is
being issued by the world’s largest debtor nation. Investors around the
world flee to it during times of crisis, despite it continually loses value
through debasement. Gold meanwhile is dismissed as a viable asset,
ignored by most pensions, institutions and asset managers despite
increasing from $35 in 1971 to over $1800 last week.
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It is important to note that on this historic day 40 years ago, the dollar
quietly ceased to be money and instantly became a currency. Money
and currency are often considered as one and the same; however, there
are meaningful and significant differences between the two. While fiat
currencies function well as a medium of exchange and a unit of
account, they fail miserably as a store of value.
The US dollar has lost over 80 percent of its purchasing power
compared to gold in the last decade alone. Gold, however, has endured
as money for over 3,000 years, and maintained its purchasing power
throughout that time, because it meets all of the criteria for money.
To satisfy the functions of money, an item must be a unit of account, a
medium of exchange and a store of value. Gold is all of these things;
it is durable, portable, divisible, consistent, intrinsically valuable and,
of crucial relevance today, it cannot be created by central banks.
Gold is a tangible asset, something that is real and in limited supply, as
opposed to fiat currency, which is merely worthless paper that
governments can produce at will. It is only the promise written on the
paper enforced by a government decree that gives it any value. The
more governments produce, the less value it has.
In light of this, it makes sense to earn currency and then protect its
value through precious metals ownership of gold, silver and platinum.
The current monetary system, which, in its current form, began in 1971,
has two critical features that have profound implications for our
financial future:
1. Fiat currency is created out of debt via the banking system and the
Federal Reserve.
2. The amount of currency created must continually expand.
In May 2006, we wrote August 15, 1971 Inflation Unleashed, and I
direct you to key statistics of just five years ago.
There are limits to debt expansion, and it is my guess that we are now
entering the phase where the compounding of the debt and the loss of
our purchasing power is not only more noticeable, but also about to
become exponential. In three years time, it is quite possible that these
numbers could be double what they are today.
Chris Martenson quotes Dr. Bartlett, an emeritus Professor of Physics at
the University of Colorado, who said, “The greatest shortcoming of the
human race is the inability to understand the exponential function.”
I encourage you to spend eight minutes viewing the presentations
“Exponential Growth” and “Compounding is the Problem” from Chris
Martenson’s “Crash Course”(www.chrismartenson.com/crashcourse).
It puts into context why the only logical conclusion that can be drawn
from the ever‐expanding debt and money supply problems that the
US and other countries are facing is hyperinflation. See John Williams
Hyperinflation Report (www.shadowstats.com/article/hyperinflation‐
special‐report‐2011)
Until governments around the world stop spending beyond their
means, running huge deficits, incurring massive debts and creating
endless amounts of fiat currency, precious metals will continue to rise
and fiat currency values will continue to erode. The best way to protect
portfolios and preserve wealth from this impending crisis is to own
precious metals.
When we consider that total global financial assets are estimated at
over $200 trillion, but total global aboveground gold bullion is a modest
$3 trillion, and only growing by approximately $100 billion a year, we
can see that once a shift towards gold occurs, there will be too much
paper currency chasing too little gold. Of the $3 trillion of aboveground
gold bullion, about half is owned by central banks and half is privately
held. The central banks have been net buyers since 2009, and most of
the privately held gold is not for sale at any price. If only five percent of
the $200 trillion in financial assets were to allocate to gold, there would
be about $10 trillion trying to buy the $1.5 trillion of privately held gold
bullion. Under that scenario the price of gold will trade substantially
higher than the levels today.
There have been suggestions in the media that holding gold is too risky.
It has been called a useless, overvalued relic that pays no interest and is
in a bubble. We heard this same rhetoric when gold was $300, then
$500, $800, $1,000 and last week at $1,800This advice has been costly to
those who listened. In truth, gold is not rising; fiat currencies are falling
and will continue to do so until governments around the world begin to
act responsibly. There is nothing on the horizon to indicate this will
happen any time soon.
Gold and Fiat Currency: Forty Years Later
112 10th Anniversary Book of Articles
It is difficult to predict how the financial mess the major economies of the
world are in will unravel. Some economists believe the increase in money
supply will have an inflationary effect, while others believe the lack of
demand and lack of growth will result in deflation. Federal Reserve
Chairman Ben Bernanke made it quite clear in his famous “helicopter”
speech that there will be no monetary deflation on his watch. Other
historical examples indicate we will end up in a hyperinflation followed
by a deflationary collapse. Recent examples of this have occurred all
over the world. See http://en.wikipedia.org/wiki/Hyperinflation.
The best defense in either eventuality, however, is to hold precious metals.
The lack of understanding in the difference between money and
currencies is so pervasive that even Warren Buffett, who has received
many accolades for his investment track record, has criticized gold in
the past. In a speech to the 1998 Harvard graduating class he said:
“Gold, 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.”
In contrast to this view of gold, fiat currency is nothing more than a
medium of exchange that is susceptible to abuse by the governments
that produce it. Trees are cut down, turned into paper, a number is
written on it and by force it is declared legal tender. It is created out of
thin air, backed by debt, printed without limit and its value decreases as
the amount of printing increases. There has never been a successful
paper currency in history; the longest‐standing currencies, the British
pound and the US dollar, have both lost 99.5 percent of their purchasing
power. Currency completely fails as a store of value. Anyone watching
from Mars would be scratching their head at this, as well.
Perhaps the former chairman of the Federal Reserve, Alan Greenspan,
explained the importance of the gold best when, in 1966, he said, “
In the absence of the gold standard there is no way to protect savings
from confiscation through inflation. There is no safe store of value.”
Forty years after President Nixon ended the dollar’s convertibility to
gold; it seems that Mr. Greenspan was correct.
Why R i s i n g Deb t Wi l l L e a d
t o $ 1 0 , 0 0 0 Go l d
J a n u a r y 2 0 1 2
As Presented at the 2012 Empire Club’s
Annual Investment Outlook—January 5th, 2012
Good afternoon, it’s a pleasure to speak about gold at this Outlook for 2012.
Today, I’d like to focus on one important idea: the direct relationship
between the rising price of gold and the rising levels of government
debt that result in currency debasement. Since we measure investment
performance in currencies a clear understanding of the outlook for
currencies is critical.
In order to understand gold’s relationship, it’s important to understand
that gold is money. It is not simply an industrial commodity like
copper, or zinc. It trades on the currency desks of most major banks—
not on their commodities desks. The turnover at the London Bullion
Market Association is over $37 billion per day, and volume is estimated
at 5‐7 times that amount – clearly, this is not jewellery demand.
The world’s central banks know gold is money: after decades of
modest sales they have become net buyers since 2009. This trend
strengthened in 2010 and gained momentum in 2011. They are buying
gold as a counterbalance to their devaluing currencies.
As money, gold has provided the most stable form of wealth
preservation for over three thousand years – it still does today. Gold
has outperformed all other asset classes since 2002.
114 10th Anniversary Book of Articles
Figure 1 clearly shows that US federal debt (purple) and the price of
gold (gold) are now moving in lockstep. This correlation will likely
continue for the foreseeable future. The red line represents the
repeatedly violated government debt ceilings.
Based on official estimates, America’s debt is projected to reach
$23 trillion in 2015 and, if the correlation remains the same, the
indicated gold price would be $2,600 per ounce. However, if history is
any example, it’s a safe bet that government expenditure estimates will
be greatly exceeded, and the gold price will therefore be much higher.
And it’s not just the US. Most Western economies have reached
unsustainable levels of debt that will be impossible to pay off. It’s worth
noting that the US Federal Reserve, unlike the European Central Bank,
can create currency without restriction. The US dollar has been the
de facto world reserve currency for over half a century; the rest of the
world’s currencies are essentially its derivatives. Whether global debt is
in euros or Special Drawing Rights issued by the IMF, the Fed, and thus
indirectly the US taxpayer, may become the lender of last resort.
There are four possible ways to reduce government debt:
One: Grow out of it through increased productivity and increased
exports. This is highly unlikely, as Western economies, and even China,
are poised for recession.
Two: Introduce strict austerity measures to reduce spending. This has
the unwanted short‐term effect of increasing unemployment and
reducing GDP, resulting in even higher deficits.
Three: Default on the debt. This will make it difficult to raise future
bond issues.
Four: Issue even more debt, and have the central bank in question
simply create whatever amount of currency is needed.
Most politicians will select option four, since few have the political will
to choose austerity, cutbacks and full economic accountability over
simply creating more and more currency. Almost inevitably, they will
choose to postpone the problem and leave it for someone else to deal
with in the future.
Last August, the world watched as the US government struggled to
come to an agreement on raising the debt ceiling, and was forced to
compromise and delegate the final solution to a “super committee”.
Its lack of political will earned the country an immediate downgrade
from the S&P. Then, the hastily convened “super‐committee” failed to
reach a solution.
In Europe, matters were even worse. Greece did try to write off half its
debt, but Germany and France reminded the Greeks that, if they did, no
one would buy their bonds. The British and Irish implemented
austerity measures that raised unemployment and reduced GDP,
resulting in even higher deficits. The Italians watched their bond yields
rise to 7 percent. While the tsunami and related nuclear incident
deflected attention from Japan’s financial problems, it is a temporary
lull, because Japan has the highest debt to GDP ratio of any of the
developed countries.
In order to compensate for slowing growth, governments attempt to
devalue their currencies and thus improve export competitiveness.
This can lead to a global currency war that author and Wall
Street/Washington insider James Rickards discusses in his bestselling
new book, Currency Wars. This process is now well underway.
A recent Congressional Budget Office report predicted the US federal
government’s publicly held debt would top an unsustainable
101 percent of GDP by 2021. Currently, the official US debt is an
Why Rising Debt Will Lead to $10,000 Gold
116 10th Anniversary Book of Articles
astronomical $15 trillion. Yet this is only the current debt. If the US
government used the same accrual accounting principles that public
companies must use, unfunded liabilities like Social Security and
Medicare make the real debt more than $120 trillion. This represents over
$1 million per taxpayer. Obviously, this amount is impossible to repay.
It’s interesting to note that in almost every recorded case of
hyperinflation, the point where inflation exceeds 50 percent a month
was caused by governments trying to compensate for slowing growth
through full‐throttle currency creation. This is exactly what we are
seeing today.
These events gave me the confidence to title my new book $10,000
Gold. The book connects the many trends that will be directly and
indirectly responsible for both the rising debt and the rising gold price
over the next five years. It will be published this year.
To make matters worse, the irreversible macro trends I discussed in last
year’s Empire Club speech are still very much in place today.
These include the added costs of retiring baby boomers, systemic
unemployment due to outsourcing of Western jobs through globalization
and rising oil prices due to peak oil. These irreversible trends will
increase unemployment, lower GDP, reduce tax revenues, increase
deficits further and force governments to borrow even greater amounts.
Governments find themselves between the proverbial rock and a hard
place, as even austerity measures tend to negatively impact GDP.
As GDP falls and debt increases, credit downgrades are likely to follow,
resulting in higher bond yields followed by even greater deficits. This
becomes an unstoppable descending spiral.
Loss of purchasing power against gold continued unabated last year
(Figure 2). The US dollar and the British pound have lost over 80
percent of their purchasing power against gold over the past decade,
and the yen, the euro and the Canadian dollar have lost over 70 percent.
As we remind our clients this is not a typical bull market. Gold is not
rising in value, currencies are losing purchasing power against gold,
and therefore gold can rise as high as currencies can fall. Since
currencies are falling because of increasing debt, gold can rise as high
as government debt can grow.
The sovereign wealth funds as well as the more conservative central
banks will have little choice but to re‐allocate to gold in order to
outpace currency depreciation. This is why some central banks,
particularly those of China and India, accelerated their gold buying in
2011, for a third year in a row, to nearly 500 tonnes—about one‐fifth of
annual mine production.
While central banks have been net purchasers of gold since 2009, the
real game changers will be the pension funds and insurance funds,
which at this point hold only 0.3 percent of their vast assets in gold and
mining shares. Continuing losses and growing pension deficits will
make it mandatory for them to eventually include gold—the one asset
class that is negatively correlated to financial assets such as stocks and
bonds. When this happens, there will be a massive shift from over
$200‐trillion of global financial assets to the less than $2 trillion of
privately held bullion.
In considering where gold will be at the end of 2012, I looked back to
my first Empire Club talk of 2005. I said then that it didn’t really
matter whether gold closed the year at $400 or $500 an ounce—the
trends were in place to ensure it had much further to rise. Seven years
later, we can say the same thing. It doesn’t matter whether gold ends
2012 at $2,000 or $2,500, because gold’s final destination will make
today’s price seem insignificant.
Why Rising Debt Will Lead to $10,000 Gold
118 10th Anniversary Book of Articles
These can be frightening times, but gold always offers hope. We may not
be able to heal the global economic problems of government debt, but
individuals can protect and even increase their wealth through gold
ownership. Gold bullion ownership, not mining shares, ETFs or other
paper proxy forms of ownership, is an insurance policy against
accelerating currency debasement. We use the analogy that ‐ In the case
of fire, would you rather have a real fire extinguisher or a picture of one?
A number of people have approached me recently and said they
wished they had listened five years ago. They feel they have missed
the boat, that it’s too late to buy gold. For those who feel that way, let
me close with a Chinese proverb I discovered last year:
The best time to plant a tree is 20 years ago.
The second best time is today.
Why Rising Debt Will Lead to $10,000 Gold Gold and Fiat Currency: Forty Yea Strategies Three Dominant Factors Will Impact Precious Metals in 2011 W Precious Metals Investments 2004-2009 Pompous Prognosticators Revis Critical Diversifier General Motors, the Stock Market and Gold Gold Myths an
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