Reasons To Own Gold
1. Gold will re-establish its true historic role as money
The true role of gold in society was succinctly described in 1912 by the renowned American financier J.P. Morgan when he declared that “Gold is money and nothing else”. Unfortunately, the U.S. Federal Reserve was created the very next year and due to its unrelenting war against the yellow metal, Morgan’s timeless wisdom is often dismissed for long periods of time (1980- 2000 representing an obvious example). The immutable truth, however, is that every pure fiat currency system in world history has ended in ruins. With what is transpiring globally today, the current experiment with paper money is headed for the same sad end, ensuring yet again gold’s re-emergence as the world’s real currency.
2. The inevitability of a collapse in the world’s reserve currency, the US Dollar
The U.S. dollar has dominated as the world’s reserve currency since the Bretton Woods Accord in 1944 and, as such, anchors the world monetary system. Regrettably, the U.S. has totally abused this privilege and, as a result, is undoubtedly fated to lose this status. The U.S. has long since passed “the point of no return” with funded debt now exceeding $17.2 trillion and growing relentlessly. To put this in perspective when Ronald Reagan became U.S. President in January 1981, the country’s federal debt, accumulated in just under 200 years, was $960 billion. Nevertheless, this just represents the tip of the iceberg, as unfunded liabilities are now at least four times the funded debt and, in addition, there are off balance sheet obligations which are also in the trillions. The issue of the debt limit is up for discussion again in early 2014 and is sure to focus more attention on this totally untenable situation.
3. The US Government can no longer fund its budget deficit in the market and must resort to extensive monetization
The U.S. can no longer count on its citizens, financial institutions and foreign governments to fund its bloated deficit. The Chinese who have been large buyers of U.S. government debt for years have become openly critical of the U.S. financial scene and are now looking for different avenues to reduce their exposure to the U.S. dollar. Japan has been another very large buyer of U.S. Treasuries but they are now so consumed with their own intractable problems that their capacity to absorb large quantities of U.S. debt has been impaired. In reality, there are simply not enough available savings in the system to constantly fund massive U.S. government deficits. Accordingly, the U.S. Federal Reserve has been forced to step into the breach and fund a significant portion of the new debt. This activity, politely called quantitative easing and currently running at $65 billion per month, is fated to intensify if a financial implosion is to be averted. The fact that the Fed now owns roughly one-third of the publicly held U.S. federal debt should serve as a clear warning as to where this is all headed.
4. No other significant currency in the world offers any refuge
There is no other currency in the world that at this stage offers a legitimate haven. The European situation is desperate and although extensive monetization by the European Central Bank may buy more time, there is a very real possibility the Euro Zone and its common currency, the Euro, may dissolve at some point in the future. The Swiss have tied their currency to the Euro and the U.K., with its greatly diminished status, has seen the pound become a bit player on the world stage. Japan, in a phrase, is an impending disaster. Abenomics is fated to destroy the yen and, by extension, the massive Japanese bond market. The xenophobic, shrinking and aging Japanese populace is going to suffer grievously as a result. China has plans to become the world’s next reserve currency but its out-of-control debt issuance and restive population will postpone its ascension to that role. Every single one of the world’s currencies is seriously flawed and this situation is only going to get worse.
5. The destruction of government balance sheets, the basic insolvency of the banking system and the widespread adoption of quantitative easing and zero-based interest rate policies are collectively laying the foundation for hyperinflation
As the result of the global financial crisis which enveloped the world between late 2007 and early 2009, the world’s governments were forced to step in aggressively to bail out their banking systems while also attempting to prop up demand in the private sector. Unfortunately, the inevitable outcome of this was the destruction of the balance sheets of most western governments, a process which is ongoing today. To combat the massive budget deficits, widespread quantitative easing (i.e. unrestrained money creation) was employed. That policy, in conjunction with zero-based interest rates, now appears mandatory to stave off a renewed financial and economic collapse. Historically, the result of these activities has always been the destruction of the currency. In that event, hyperinflation is a very real threat.
6. The ticking derivative time bomb becomes more dangerous with the passage of time
Despite escalating concern about the risks inherent in the whole derivative scene, the amounts outstanding continue to escalate. The Bank of International Settlements has changed the accounting methods to obscure this fact but, in the absence of this sleight of hand, the amount outstanding would now be accurately reported as being well in excess of a quadrillion dollars. In truth, the number has to keep growing to hide the losses on many existing derivatives that pollute the global banking system’s balance sheets. It would be well to remember that knowledgeable financial insiders have referred to these instruments as “financial weapons of mass destruction”. They haven’t detonated yet but odds are they will.
7. Investment demand for physical gold is exploding as investors increasingly realize that there is no palatable solution to the world’s financial issues
There has been a remarkable disconnect between the paper gold market, which has seen the gold price decline by roughly 28% in 2013 and the demand for physical gold, which exploded to record levels, particularly in China and the Middle East. In a rational world, one would expect that a sharp fall in price would correlate with noticeable demand weakness but that has not been the case. Very simply, western governments and their respective central banks, in concert with the bullion banks, have orchestrated a vicious takedown of the gold price in a last ditch attempt to protect their failing fiat currency system and this has triggered a buying frenzy in the physical market. Considerable amounts of western central bank gold have clandestinely entered the market and the ETF’s have been hollowed out to facilitate the paper takedown but this operation has a limited shelf life. Thus, the robust bull market in gold that began just after the turn of the century has merely undergone a sharp correction that has absolutely nothing to do with the real fundamentals. Those who understand the true state of the market have been taking advantage of this fire sale. However, virtually all conventional institutions and the average citizen remain totally oblivious to gold’s attractions. When the next leg of the global financial crisis arrives, and it is imminent, more financial assets will come under severe downward pressure. This should spark an exponential increase in investment demand for the true safe haven, gold.
8. The physical demand charge is being led by China
This is highly significant because China, the world’s most heavily populated country, is growing more rapidly than every other country of significance and has a deep cultural affinity for gold. In addition, there are recurrent rumors that China in its bid to be the provider of the world’s next reserve currency fully intends to back it with gold. The virtual explosion of gold imports into China via Hong Kong has been impressive and is currently running at an annual rate of well in excess of 1000 tonnes which represents roughly 50% of world mine production outside China. There are also wellfounded rumors of large additional unreported amounts of gold entering China as well. India, the world’s second most populous country, had been the world’s largest importer of gold until 2013 when onerous taxes and other impediments have sharply reduced flows into the country. However, smuggling is picking up rapidly and Indian demand is expected to rebound sharply.
9. Growing recognition that many paper gold products do not have the physical gold backing that is alleged
A considerable proportion of the growth in investment demand for gold has been absorbed by a proliferation of new paper gold vehicles. However, it is becoming increasingly evident to all and sundry that the vast majority of these products are nothing more than another manifestation of “fractional banking” with the gold price being replicated by the utilization of derivatives with little or no physical backing. This criticism would apply to gold futures, many gold ETF’s, gold pooled accounts, gold certificates and even allocated gold accounts within the banking system. The latter disgrace came to light in early 2013 when ABN AMRO, a large Dutch bank, failed to provide its clients’ physical gold on demand and would only offer a cash settlement. In reality, this is an epic Ponzi scheme and its ultimate demise is going to be something to behold. The irony is that when the majority of paper gold holders discover that what they have ultimately doesn’t protect them from the ravages of classic monetary debasement, it will be at the exact time that they require that protection. It will trigger a frantic scramble for physical gold. Fortunately, there are a few traded paper vehicles with fully allocated gold backing and the Sprott Physical Gold Trust is one of them.
10. Mine supply will not rise in the foreseeable future and is much more likely to decline precipitously
Despite gold prices surging from just over $250 per oz. at the outset of the new century to a high of $1,900 in 2011, mine production began to stagnate, prompting observations about peak gold production from industry insiders. This is certainly not unprecedented as mine supply actually fell during the 1970’s when gold rose from $35 per oz. to a peak of $850. Now, much of the high grade easily accessible gold in the earth’s crust has already been mined and the boom in open pit mining which spurred production in the 1980’s and 1990’s is essentially over. However, what has transpired since the peak price of 2011, (with gold at one point falling over 37.5% from that $1,900 price), has totally traumatized the industry and severely undermined both exploration and new mine development. It is now a virtual certainty that mine production will fall sharply in the next five years, irrespective of how high the gold price may rise in that time frame.
11. Central banks have collectively reached an inflexion point where they no longer will be in a position to supply the gold necessary to keep the market in equilibrium
Western central banks, which have supplied massive quantities of gold to the market for two decades, really stepped up their efforts in 2013 in a last desperate attempt to suppress the price while simultaneously meeting burgeoning physical demand. This stupidity has occurred before. During the 1960’s, in the era of the London Gold Pool, western central banks expended over 100 million ounces in a futile attempt to hold gold at the official $35 price. The whole world knows how that worked out as gold appreciated nearly 25 fold in the next decade. That undertaking was at least overt. This time it has been anything but with thousands upon thousands of tonnes being mobilized through covert swaps and leases with the whole exercise being obscured by opaque accounting endorsed by the I.M.F. As a result, available western central bank inventories are believed to be reaching dangerously low levels and their ability to interfere in the market may soon be a thing of the past.
12. Accelerating purchases by eastern central banks
The enormous concentration of U.S. dollars in the reserves of many Asian and Middle Eastern central banks is justifiably burning a hole in their pockets and, with relatively low gold exposure, has motivated them to be aggressive acquirers of gold. China and Russia have been more than vocal about their intentions. India’s central bank purchased some of the IMF’s gold in 2009 and a number of smaller entities such as Thailand, Mongolia and Kazakhstan to name but a few, have been active also. Their purchases and the aforementioned looming end to western central bank liquidation will result in a situation where the world’s central banks collectively will become an important source of demand. This is the antithesis of what has been the case for the last couple of decades. It represents an enormous change, the impact of which should have a very salutary impact on gold prices in future years.
13. Increasing skepticism with respect to US gold reserves
The U.S. has long been, by a considerable margin, the world’s largest central bank holder of gold with a reported position of 8,133 tonnes (worth at a recent gold price of US$1,250 per oz. roughly $325 billion). This sounds substantial, but in reality, it only amounts to exactly five months of U.S. quantitative easing at the present rate and is absolutely dwarfed by funded debt now exceeding $17 trillion. More importantly, there have been recurring rumors that the U.S. has mobilized a considerable portion of these reserves via various swaps and lease arrangements with bullion banks and other nations to aid in the increasingly evident price suppression scheme. These rumors persist because of the absence of an outside audit since the Eisenhower presidency in the 1950’s and the Federal Reserve’s continuing intransigence to allowing one despite repeated requests. Adding fuel to the fire has been the Germans’ recent experience in attempting to repatriate some of their gold held at the New York Fed. They asked for 300 tonnes, a small portion (less than 20%) of the total amount held on their behalf by the New York Fed and remarkably agreed to a seven year delivery schedule. However, all that was delivered in that first year were 5 tonnes which had been re-refined.
14. The ongoing existence of large short positions in gold
Despite dramatic de-hedging in recent years by the gold producers, whose original excessive hedging was ostensibly the primary reason for the proliferation of gold derivatives, the notional value of OTC gold derivatives still remains elevated. This suggests either a major legitimate bet against the rising secular trend of the gold price (highly unlikely despite last year’s orchestrated takedown) or ongoing price suppression by the usual suspects. The existence of large concentrated short positions on the Comex which are dramatically in excess of the physical gold available is telling. If the longs were ever to call for delivery, the shorts’ position would be untenable due to the growing physical shortage of gold throughout the world.
15. Intensified gold price suppression has increased gold’s extreme undervaluation
Despite the constant bad mouthing of gold in the mainstream media, gold is, in fact, dramatically underpriced when measured by any number of relevant metrics (gold price in relation to the ongoing staggering amount of money and credit that continues to be created; gold’s price relative to any number of other commodities, the gold producers’ pathetic returns on capital, etc.). What is particularly revealing is gold’s low exposure in portfolios compared to previous eras. For example, it would take somewhere between a five and ten fold increase to even approach levels achieved at the end of the 70’s. In addition, if gold had merely kept up with the reported rate of U.S. inflation (which, incidentally, is considerably understated) since gold’s previous peak in 1980, it would be trading in the neighbourhood of $2,500.
16. The relatively small size of the gold market
In the past, gold’s small market footprint has actually been negative because it more easily facilitated the price suppression activity. This is about to change dramatically, as gold becomes the asset of choice for more and more investors worldwide for all the aforementioned reasons. All the gold mined since the beginning of time (estimated to be in the area of 170,000 tonnes) is currently worth approximately $7 trillion and the total capitalization of the world’s gold stocks now represents little more than a rounding error following the recent devastation of the sector. When compared to the amount of paper money that could ultimately seek refuge in the world’s eternal money and the companies that mine it, the staggering upside potential becomes apparent.
17. Sentiment has reached levels of historic pessimism
Despite impeccable fundamentals and enormous undervaluation, gold’s counter intuitive price action and a massive campaign by western governments, their central banks and the mainstream media to denigrate the yellow metal, have combined to create a degree of negative sentiment toward the metal that has seldom been approached in the past. This magnitude of negative consensus is generally a precursor to a dramatic upmove.
18. Gold has endured
Gold is indestructible, possesses a high value-to-weight ratio (invaluable for storage and transport), is no one else’s liability (a major advantage when counterparty risk is everywhere), can be easily concealed and, most importantly, has provided protection against the destruction of wealth for centuries.
The fundamentals for gold are unassailable, the positive long term technical picture remains intact and gold is very inexpensive when compared to virtually every other alternative (most particularly, bonds, treasury bills and bank deposits). With continuing currency debasement essentially assured and some form of hyperinflation probable, gold should eventually trade at many multiples of the current price before this bull market, which began thirteen years ago, reaches its end. In fact, it is not inconceivable that, when ultimately viewed in retrospect, this may turn out to be one of the biggest, most enduring bull markets in financial history.