Another “Gold Rush” is underway, but unlike the original ’49ers mad dash that took prospectors to California for wealth discovery, the new ’09ers gold rush is for wealth preservation.
Now that the dollar is losing its global appeal as a reserve currency and gold has become a safe haven for investors, there is a new meaning for the term “golden parachute.” But what is the long-term future of this precious metal, and why does it matter to businesses and individuals?
At the moment, gold matters a great deal because it has become a more coveted investment due to its protective value against hyperinflation, which many believe will soon return with a vengeance because governments around the world are trying to stimulate their economies by printing money.
Institutional investors are finding safety in gold after enduring massive investment portfolio losses during the past nine months, and individual investors may soon follow suit.
Growth in the global money supply is not only viewed as inflationary, it has resulted in declining confidence in paper currency, particularly the dollar. “There is a lot of inflation being unleashed, not just by the U.S. government, but by governments worldwide,” said business speaker Robert Ian, founder of Robert Ian Productions and author of How to Identify, Master, and Conquer Change.
“I mean, the printing presses are cranking in just about every country, so the price of gold will likely go up dramatically.”
There is talk of an eventual loss of the U.S. dollar as the world’s reserve currency, and talk of gold reasserting itself as sort of a hidden (though not for long) global currency.
It’s not idle talk. Jim Sinclair, one of the world’s top commodity experts, has said the price of gold, which reached nearly $1,000 per ounce earlier this year, is going higher; that lends support to the belief that gold will become part of a new international currency system.
Given what’s unfolding in economies around the world, Ian could not agree more. “Whether it’s the U.S. that does it, whether it’s China that backs theirs, or whether it’s this international currency that you’re hearing the treasury secretary [Tim Geithner] and others allude to, that may occur,” Ian said. “In my opinion, you’ll see some kind of a gold component to restore the confidence that paper currencies or currencies in general must have. Confidence worldwide is shattered right now.”
According to Jim Essence, owner of Jim’s Coins and Stamps in Madison, one of gold’s advantages is that it’s a tangible asset. At his store, gold bullion coins are sold, including American Gold Eagles, which are comprised of 91.67% gold, the equivalent of 22-karat gold. They contain one ounce of pure gold, so their total weight is a little more than one ounce, and they are sold for their metal content rather than their numismatic value.
The store also sells Gold Maple Leafs from Canada (pure gold), Chinese Gold Pandas (pure gold), and Gold Krugerrands from South Africa, which have the same gold composition as American Gold Eagles. Gold also is sold in one-ounce bars and 10-ounce bars, but generally the most popular are the Gold Eagles, the Gold Maple Leafs, the Gold Krugerrands, and the one-ounce gold bars. (With jewelry, the level of purity depends on the karat; 10-karat gold, for example, refers to 41% pure gold; 14-karat gold is 58% pure gold; 18-karat is 75% pure gold.)
“In uncertain times, a lot of people are including gold in their portfolio because gold is up, and for the last 3,000 years it’s been a store of wealth,” Essence said. “It’s something that people go to, it’s easy to store, and it’s something physical that you actually have, unlike other commodities where it’s on a futures market or you’re buying an ETF (Exchange Traded Fund), where you’re buying a piece of paper that says you have ownership of something. As we’ve seen with these pieces of paper, they don’t always turn out to be what the papers say they are.”
Brent Lindell, a financial advisor with Savant Capital Management, is somewhat skeptical about whether gold can build on its current momentum, but he acknowledges its value as a means of diversification. “If you look at some of the patterns out there, one of the things you see as a trend line is that it’s a great diversification asset,” Lindell said. “Commodities as a whole versus stocks versus bonds, you get a zig when the other is zagging.”
Solid Gold
Since 2000 alone, gold has appreciated approximately 20 percent per year, even during this past year when people lost significant portions of their retirement savings. While the gold standard was abandoned in the 1930s, the monetary system was linked to gold until 1971, when President Richard Nixon completely severed it, making the dollar a free-floating currency. Throughout history, Ian said most purely paper currencies haven’t lasted more than 40 years. “We’re in our 38th year right now of a purely paper currency, so the days may very well be numbered for the dollar as we know it,” he stated.
Gold’s primary use is to store wealth. In this environment, that’s good enough for investors, especially if the price of gold keeps gaining in value. The price of gold, which is measured in dollars per ounce, has risen from about $250 per ounce in 2000 to its present level ($931 per ounce as of June 15). Although the price of gold declined in June, many believe it’s heading much higher, as estimates of $3,000 to $5,000 per ounce are now thought by some to be on the conservative side.
Ian believes the flood of dollar bills is likely to create the last great bubble, in this case a gold, silver, and commodities bubble. As he explains, the supply of dollars (trillions of dollars) is “going ballistic,” while the gold mining supply is declining by about 5% to 7% annually. With the supply of dollars going up and the supply of gold production (in ounces) going down, he said the price of gold has to go up. “The law of supply and demand says the price of gold can only go up in that scenario,” Ian said.
Ian does not think this is going to happen overnight, but “over the next 24 to 36 months, the price of gold will have dramatic staying power, and it could actually go on a little longer than that.”
In addition, Ian said the price of gold is at or below the cost of production, as mining companies make “peanuts in profit.” This means an investment in gold already is hedged to the downside, so gold over the medium to long term can’t go down significantly. With massive inflation being unleashed, Ian believes the price of gold is likely to go up dramatically.
“I don’t think there are a lot of investment profiles that have the really good picture that gold does, which is little downside risk and massive upside,” he said.
Ian said gold cannot accurately be measured or predicted by the Consumer Price Index. In his view, the CPI is “bogus” because its measurements have been revised over the last several decades. In 1995, the gold price was about $400 per ounce and the money supply was about $4 trillion. Today, the money supply is about $17 trillion and climbing. This should put the price of gold at around $1,700 per ounce, he said.
However, the government’s unfunded liabilities and debts, which is money that will have to be created to pay the obligations, are almost $100 trillion. Said Ian: “I think it puts the future price of gold at over $10,000 an ounce, assuming that they stop printing money today, which I don’t think they will do. I think we are on the road to hyperinflation. I think it will appear this year, and there are a lot of supporting reasons for that.”
For a long time, Essence said people have thought the futures market was shorting gold and silver significantly because it’s in the best interests of the currencies of the world to keep gold low. That’s because people will continue to buy into the notion that paper currency, or currency in general, is worth something, when it’s not backed by anything but government promises.
“If gold becomes more and more valuable in relation to these currencies, the currencies become less and less valuable and people’s faith in them diminishes,” Essence said. “A lot of people have been thinking that, and actually the markets have started to reflect that.”
According to Essence, some people in the futures market are starting to demand the immediate delivery of silver, and in some cases gold. “It’s called the ‘backwardation’ of the market, where the price of getting something immediately is more than getting it in the future,” he explained. “Generally, in the futures market, if you get something in the future, it costs less. Silver has gone into backwardation in that securing the physical item has become a premium, and we’ve seen that in our store as well.”
While gold may now be thought of as a savings account that is immune to inflation, how much longer will investors be making deposits? Does gold have staying power, or is the current interest in gold an example of trendy nonsense — a case of investors looking for experts to lead them around by the nose?
Ian said the price of gold has been artificially suppressed by Central Banks dishoarding (selling) their stocks. Without this dishoarding, he said there would be a deficit of 1,500 tons or more per year between supply and demand. Now that Central Bank selling has nearly stopped and China, Russia, and Venezuela are buying, he wonders what will happen when the deficit between supply and demand is no longer filled.
China might be the global 800-pound gorilla when it comes to the future of gold. No foreign nation has expressed more disdain for the direction of U.S. fiscal policy; due to the flood of dollars, China has given strong signals of its waning interest in buying more U.S. debt. In fact, China has already started to scale back on the amount of U.S. debt that it’s buying, despite pleading from Geithner to not diversify out of their dollars too fast or too much.
“China has been rattling its sword now for several months, talking about an international currency, talking about the possibility of some sort of gold backing to a currency, so I think we’re going to see some sort of rapid development,” Ian said. “I think things can change overnight and surprise people, and I think being aware of this is very important.”
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Golden Insurance
A recent report in Bloomberg said the Milwaukee-based Northwestern Mutual Life Insurance Co. has purchased $400 million worth of gold, the first investment that company has made in gold in 152 years. The large life insurance, investment, and hedge fund companies have seen their portfolios decline markedly in the past nine months, and they are looking to gold as a way of preserving wealth.
In the Bloomberg article, Northwestern Mutual CEO Edward Zore said he expected gold to go up anywhere from two to five times its present value, which would elevate it to between $2,000 and $5,000. When IB contacted the company, a spokesman declined further comment.
That raises the possibility that other Wisconsin insurers, including American Family Insurance, a property-casualty insurer that is one of Dane County’s largest employers, might follow Northwestern Mutual’s lead. American Family spokesman Steve Wittwer said the company would not publicly discuss its investment strategy.
Ian cites Northwestern Mutual’s investment as proof of gold’s renaissance, but Lindell views it as more of a protective move. “What percentage of that is their overall portfolio?” he asked. “I would guarantee they are not putting too much of a bet in gold as a whole. I would say they are using that as a hedge about what may come, but you know they have more assets out there that are not directed at that spot.
“To a certain extent, it’s the old ‘put it under the mattress’ type of mentality. Gold is the last bastion of safety dating back to the Middle Ages and even prior to that.”
Despite recent economic optimism, Ian isn’t convinced that the U.S. can avoid Japan’s fate. He noted that the Japanese economy hasn’t fully recovered from the recession of the early 1990s; even after years of stimulus spending, Japan is still reeling. “I think we’re headed into a similar situation in terms of the longevity of the problem,” Ian predicted. “There are a lot of things that have to be worked out of the financial system, and I think we are going to be surprised at the downside, both the size and the duration.
“There also are a lot of things that have to get worked out of the economy, and I think that a lot of people are going to look to gold as a means of preserving and possibly increasing the wealth that they do have remaining.”
This includes investing in gold through their traditional retirement vehicles. Ian said upfront that he is not a registered investment adviser, but he predicted that when people can’t afford gold as the price goes up, they are going to buy the next best thing, which is stock in the mining companies that actually produce gold.
There are many large gold-mining or related companies — the two largest in the U.S. are Newmont Mining Corp. and Derrick Corp. — and the industry is consolidating. Ia said the larger companies are buying the mid-tier companies, and the financially sound mid-tier companies are buying the exploration companies that have lost their financing. “So there is more consolidation,” Ian observed, “and I think the largest amount of upside that’s available is in some of the mining stock. They (mining companies) have even more leverage than the metal, itself.”
Ian predicted that people will look for mining stocks or, if they are not familiar with individual companies, they will look for mutual funds that buy across a span of gold-mining companies.
The nations that are rich in gold, and lead in gold production, include the United States, Canada, Mexico, China, and South Africa. There are environmental restrictions on mining, so the mines that are fully permitted and already meet environmental regulations, Ian said, are “going to be the hottest commodities in the next couple of years.
“In the U.S., some mines will have difficulty opening. The cost will be higher, but there are still plenty of mines coming on line because a lot of miners in the past decade have really gone green. They have to hold back tremendous amounts of money for reclamation because there are very strict standards that they have to follow and really, in large part, a lot of the mining industry today does not look anything like the mining industry of even 10 or 20 years ago.”
In any bull market, Ian said there are three phases. The first phase is when the experts and insiders invest. The second phase comes when institutional money is invested, which is what’s happening right now with gold. In the third phase of the bull market, the general public starts to invest. “I think we’re still in the middle of that second phase of the gold bull market because we’ve seen a tremendous amount of large investment firms now finally taking the plunge,” he said.
“I think we have two to three to five years to go on this gold ride. It’s very similar to what happened during the tech boom. At first, it was the insiders like Bill Gates, then a lot of institutional funds, and in about the last four years, it was the general public that really drove that market.
“Whether people do their own financial planning or work with a financial planner, gold is no longer going to be a four-letter word in the financial industry,” Ian predicted. “It’s going to be one that people gravitate to and profit from.”
Essence said a wide cross section of people have come into his store to buy gold, and most just want to put their money into something safer. He said in terms of volume, gold now represents about half of his store’s sales; in 2005, it was about 25%.
He can’t say with any certainty if the rise of gold has staying power. “The previous owners of this store, who still works for us, likes to say that he’s been in the business for 30 years and he’s very confident that it will go up or down in the future,” Essence joked. “But there are a lot of forces that are on the market to increase it. The Chinese are heavily investing. Gold has always been very popular in down economies and as a store of wealth, historically.”
Lindell would not quibble with that, but he views gold as a way to reduce volatility in investment portfolios. He serves one person that is investing in gold and silver right now, but with a nod toward diversity in her portfolio, she doesn’t want too much of it at this point in time.
That’s a good approach for investors who want to create the best rate of return with the least amount of volatility. Gold is a component of that, and it has value in terms of getting some decent returns, but Lindell believes the price of gold is very high. While he acknowledges that hyperinflation could drive up the price of gold, Lindell said putting too much faith in gold would defy the greatest investment lesson of the past several months — the importance of re-evaluating risk tolerance.
“I would be very wary of buying too much of something that is essentially peaking out in price,” he said.
