Inflation specter has some investors pining for gold
By John Parry and Pedro da Costa, Reuters; February 6 2009

http://uk.reuters.com/article/ousiv/idUKTRE5155N120090206?sp=true

Unease over a surge in U.S. government borrowing has some analysts
nervous that, even as the immediate threat of deflation looms,
hyperinflation on a global scale may be the eventual result. They also
note that, given the predominant risk of deflation, policy-makers have
little choice but to flood the financial system with money… This year
alone, analysts expect the U.S. government to issue some $2 trillion of
debt on top of the nearly $6 trillion of Treasuries outstanding. Some
have begun calling even this startling estimate conservative… “It is
hard to understand why the dollar should continue to demand respect,”
said Tom Sowanick, chief investment officer at Clearbrook Financial LLC
in Princeton, New Jersey. “We are in a much different geopolitical
environment than 10 years ago or 20 years ago, with the U.S. being the
largest debtor nation and China being the largest creditor nation.”
Dollar bulls note that, in the case of the United States, an actual
default — i.e., a missed payment — is highly unlikely. Given the
dollar’s status as the world’s leading reserve currency, the U.S.
government could simply print unlimited quantities of money to repay
its creditors… “That sovereigns don’t default because they can print
money is technically true, but the big question is whether the money is
worth anything,” said Jay Mueller, senior portfolio manager with Wells
Capital Management… …the vulnerability of the U.S. currency has
some experts recommending investors hold at least some gold in their
portfolio. In previous periods of high inflation, such as the
post-World War One years in Germany’s Weimar Republic, precious metals
are among a handful of hard assets that have been able to conserve
their worth. Spot gold has rebounded from a recent low in November
around $710 per ounce to $914 on Thursday, a 29 percent rise… Indeed,
its latest jump was triggered in part by massive government debt
issuance, which some say threatens to undermine the value of the paper
it is printed on.

USAGOLD Comment: It’s one thing for mere analysts and
the rest of us mere mortals to play fast and loose with predictions
and/or talk of imminent or inevitable “hyperinflation” of a national
currency, but surely you will NEVER hear open talk of that destructive
monetary specter from a public official. Right? Right??! (Brace
yourself for the following…)

Peter,
Enjoy your site very much,

Regarding gold as a safe haven:

I can see the benefits of being in gold when dollar values are crumbling, but gold does not pay dividends or interest. (although nor does cash at the moment)
Therefore the only way to realize any gains is to sell the gold in the future, ie you can’t sit on it forever.
When you look at the gold price chart for the last decade, it almost mirrors the stock market indices.
This makes me think that a lot of the “safe haven” pricing was factored into gold during the period when the stock markets were on the exponential, (suicidal) rise, and I am worried at how much upside is left.

There will be the problem in the future of selling the stuff at the right time and the right price. It is almost impossible to buy physical gold now and it may be just as hard to liquidate your stake in the future, just when you need it most to buy back into the markets.
How rapidly do you think the price of gold will fall when confidence again returns to the equities market? Who will be the buyers in that market?

On the other hand, the share market currently offers some very good bargains. The low cost of shares in many companies which are still doing good business, but have been oversold, has lifted their returns to exceptional values.

Reading your assessment of the future value of the dollar, yes, gold does look good against hoarding cash, but how does it compare to a carefully selected portfolio of shares?

I believe the long term future must lie in equities.
In my view therefore, the choices are:

1. Get in to equities now, but choose carefully. Hope that your companies continue to perform, pay dividends and share prices are at or near the bottom. You are immediately where you eventually want to be.
2. Sit on cash, and hope that it doesn’t devalue too much until you make your move. Your timing needs to be good. You are though, one step (many transactions) away from where you want to be.
3. Invest in bullion to guard against the dollar devaluation. When the time comes to make your move, your timing needs to be good, twice. You are two steps away from where you want to be.

In times like this when things are happening fast, cutting out each step can put you ahead of the mob, which is a desirable place to be, is it not?
These are the sort of thoughts that have held me back from investing in bullion and may also be holding back many others.

Any comments?

Thanks and cheers,
Keijo

Your assumption is that shares will prove a good long term investment. Warren Buffett says not in his 1999 presentation to an elite group as detailed in the ‘Snowball’ biography – he sees equities moving nowhere over a 16-20 year period. Has he forgotten this recently? Well I suppose he is playing a crash situation to find value.

However, my own view is that the Dow’s fall is not done, and the index is heading to 4,000. By then gold should be up around $4,000 an ounce. Where is the confidence to produce a recovery before that?

You could hedge and buy gold stocks which look both cheaply rated and are leveraged to the gold price.

But bullion is a hedge against systemic collapse of the financial system, and I think that is where we are heading – not a nice cyclical bounce and business as usual. Most of the banks will end up nationalized and amid the chaos that ensues stock markets will plunge and bullion soar as currencies enter a phase of competitive devaluations – which we have already started to see.

At the root of this problem is a black hole in the balance sheet of the banks – and it is way bigger than the $2 trillion of measures announced this week. There will have to be a far bigger creation of money supply and that will be dollar negative and highly gold positive.

I would urge you to reconsider your love affair with equities which has presumably already cost you an arm and a leg – try to keep your remaining limbs! This article explains this well, see:

http://news.goldseek.com/GoldSeek/1234363627.php

Peter,
Thanks for the prompt and comprehensive response.

You presume a little too much however. I don’t have a love affair with equities as I converted most of them to cash quite some time ago. Well before the markets peaked, maybe a little too early but I still have all of my limbs.
Cash is no longer delivering returns and it’s time to chart a new course.
My assumption about shares is based on sound historical data.

Warren Buffet’s comments about equities may be correct, but surely you don’t suggest sitting on a gold investment for 16 to 20 years.
At least shares will pay dividends over that period, even if the underlying value remains unchanged.

The Dow is an average.
Even though the Dow may halve in value, not all shares will do the same. Some will actually increase.

Not all banks have the huge black hole in the balance sheet and not all will be nationalized. The survivors may actually thrive and provide unprecedented returns.

There was a period when you could invest in equities across the board and still do well.
There was a period where a whole generation of investors seriously believed they were savvy traders, when a drover’s dog could have done as well or better.
Those times are well and truly gone.
You just have to work hard at it now to find the nuggets in the gravel (I know, poor metaphor, considering the subject)

I honestly don’t believe we are heading for a systemic collapse of the whole system.

So if that does not happen, think about your earlier comment in the article.
Quote: “But we all know what happens to unsustainable bull markets, they crash. It is thus advisable to have something of an escape plan in this rush to the greenback“
Could also be correct to say:
“But we all know what happens to unsustainable bull markets, they crash. It is thus advisable to have something of an escape plan in this rush to bullion“

Cheers,
Keijo

Keijo does make a good case. Although Zimbabwe is an extreme example now, some years ago, as inflation grew to hyper levels, their stock exchange did provide a hedge against the fiat currency devaluation.

I too went into cash some years ago, and being in South Africa, have been able to get av 10% returns so far on part of my holdings here. It occurs to me that an opportunity to buy Rands whilst hedging the exchange rate would offer returns on cash that Keijo is looking for at least in the short term (I think this is the fabled “carry trade”).

However I am no expert. I do believe though that gold as a monetary unit is the final arbiter. Useful discussion here from Jim Sinclair’s site.

http://online.wsj.com/article/SB123440593696275773.html?mod=googlenews_wsj

And also Jim’s worry about ETFs:

“Dear Editor Dan,

Here is an important piece of research for you.

Find out for me (ASAP) the reported amount of gold every Gold ETF has on the planet as of their last reporting period.

I smell a massive fraud that could easily collapse on a rising price of gold by the failure of the sellers to deliver anything.

The Madoff equation is saying that none of this gold is paper gold on a clearinghouse exchange. It can’t based on its size be real bullion, leaving only toxic paper (OTC derivative) gold.

I believe I know exactly how it is being done and by whom.

It is totally legal but so are OTC derivatives.

Jim

Jim,

I am working on it now. More on what I find out soon…

Regards,
Editor Dan”

Currently Asian currencies have fallen sharply against the Dollar. Take for example the Korean WON which is over 1400 to the Dollar today and not long ago was under 1000 which is a 40% depreciation. The Taiwan Dollar has now also started its descent and is at 34.10 today along with the Thai Baht at over 35 Baht. I think Asian countries which rely on exports will allow their currencies to depreciate over the next month or two to help boost exports.

Local economies here in Asia have been battered by falling exports so I doubt the will allow their currencies to appreciate against the Dollar. The Japanese YEN has been an exception but I think the YEN will drop again. Asian countries rely on exports for growth and with a strong currency they will not be able to compete against their neighboring competitors. With Korea’s WON depreciation, Taiwan has lost its edge in competitiveness for exports unless it allows for devaluation of its currency.