An All-Season Hedge

Gold is the ultimate dollar hedge. It is the only global currency that is no one’s liability. It is "pure money." As such, gold has always provided a kind of insurance, first and foremost. It is not an investment per se. But when economic uncertainties mount, buying a bit of gold "insurance" can be a terrific investment.

"If gold isn’t a bargain, what is it? It is a hedge," says Jim Grant, editor of Grant’s Interest Rate Observer. "However, in my opinion, it is a hedge bargain. The value of a hedge should vary according to the cost and evidence of the risks being hedged against. In the case of gold, the risks are monetary."

The abandonment of the gold standard in 1971 was a crucial turning point in the U.S. economy, a decision that has been gradually destroying the power of the United States. The excessive printing of currency led directly to the trade deficit, and once the surplus turned, it never went back. It aggravated the condition of the national debt and allowed the Fed unbridled access to printing presses, the condition in which we find ourselves today.

The lesson not yet learned has everything to do with the reasons why the gold standard was so important. We have given control of economic forces over to government tinkering. Ludwig von Mises, noted twentieth-century economist, was a believer in allowing market forces and not government to determine monetary policy:

"Mises argued that because money originated as a market commodity, not by government edict or social contract, it should be returned to the market. Banking should be treated as any other industry in a market economy, and be subject to competition."

In one of his many writings, Mises correctly observed, "The significance of adherence to a metallic-money system lies in the freedom of the value of money from state influence that such a system guarantees."

This is the crux of the monetary struggle of our era. With governments virtually off the gold standard, the market itself is not trusted to set the course of value in the exchange of goods and services. That is why, ultimately, the destruction of the dollar is inevitable. Governments-including the U.S. government along with the Fed-have not yet learned that the economy cannot be controlled.

But as Mises explained, it is not just monetary policy but part of a larger social trend that has brought us to this moment:

"The struggle against gold which is one of the main concerns of all contemporary governments must not be looked upon as an isolated phenomenon. It is but one item in the gigantic process of destruction which is the mark of our time. People fight the gold standard because they want to substitute national autarky for free trade, war for peace, totalitarian government omnipotence for liberty."

If all of this is true-and from the economic news of the past few years, it appears so-what can you do to turn this situation into an advantage? The answer is to use free market gold to exploit the market tendency of gold itself. Remember, even when governments are off the gold standard, the market for gold cannot be controlled. It is worth whatever people will pay. As long as you understand what causes the price of gold to move, you have the key to investing success.

That key is: The price of gold tends to move in a direction opposite the value of the dollar.

With this simple observation, we can track the value of gold and the value of the dollar together to see how they interact with one another. From 2000 through 2006, the dollar fell and gold prices rose. As the dollar continues to fall, it makes sense that gold will move upward in direct response. We could explain this by noting that value itself is not created out of nothing; it simply changes hands. So as value goes out of the dollar, it can be measured by watching other currencies rise, but it can also be measured by watching gold prices move in the other direction.

As the Fed continues to keep the printing presses running around the clock, the dollar continues to weaken. The problem is not entirely visible because, even with its gradual decline, the dollar has remained strong. This has been so partly because China’s currency is pegged to the dollar, but also because in many respects, the United States continues to lead economically in the world. However, the trend in economic growth tells us that this cannot continue indefinitely. It is economic common sense that currencies tend to be the strongest for those nations with superior economic growth. If you understand why it is important to invest in gold as a defensive measure against the declining dollar, the next question is where to invest. You have many choices.

Addison Wiggin
The Daily Reckoning
October 20, 2007

P.S. This is continued, below. In the meantime, check out one of the many choices you have to invest in the yellow metal – this unique offer allows you to get gold out of the ground for a less than a penny per ounce.

— The Daily Reckoning Book of the Week —

The Demise of the Dollar – and Why It’s Great for Your Investments
by Addison Wiggin

This acclaimed book spent over a week in the #1 slot on Amazon’s bestseller list – knocking Harry Potter to number two. It then showed up on Barnes and Noble’s bestseller list and debuted on The Wall Street Journal’s Business bestseller list last week at #8!

The only logical next step was for the book to get on the New York Times bestseller list…which it and sat strongly at #5!

The Demise of the Dollar examines the reasons for the dollar’s slide – including the nation’s historic trade deficit, the euro, government spending habits, globalization, and other international factors – and offers an up-close look at the Federal Reserve’s attempts to "manage" the dollar’s value.


THIS WEEK in THE DAILY RECKONING: This week had it all…market ups and downs, new record lows for the greenback, record highs for oil – and reports from the Pampas. Read them all below…

Welcome to Captivity                                                             10/19/07
by Bill Bonner

"Since we live in Europe…and pay our bills in euros…but earn our money in dollars…every day, your editor loses more than he makes. His dollar assets go down. He’s getting tired of it."

Mortgages to Attack Your Comfort                                                 10/18/07
by Kate "Short Fuse" Incontrera

"Shares of financial stocks fell across the board after the release of this data. Obviously, the subprime meltdown and credit market woes have had an effect on banks – but what does it mean for the broader market?"

Cracks in the Foundation                                                             10/17/07
by Bill Bonner

"Yesterday, we noticed that credit card debt is soaring. With no more ‘equity’ to pull out of their houses, they are looking for credit wherever they can find it."

A Coast-to-Coast Downswing                                                 10/16/07
by Bill Bonner

"’Deficits don’t matter,’ Dick Cheney allegedly remarked. What was he thinking? Maybe ‘deficits don’t matter to us politicians.’ But they sure matter to people who are trying to balance a family budget."

Inflation, and the Downfall of the Shopping Mall                         10/15/07
by Bill Bonner

"In the last 30 years, consumers, business and speculators were able to add debt a lot faster than inflation took it off. But now, debtors are already stretched to their limits…and creditors are getting persnickety."


FLOTSAM AND JETSAM:Continued from above, Addison details five ways to invest in gold in the following paragraphs. Based on your level of market experience and familiarity with products, one of these will be appropriate for you. Read on…

An All-Season Hedge, cont’d
by Addison Wiggin

1. Direct ownership. There is nothing like gold bullion, the ultimate expression of pure value. Historically, many civilizations have recognized the permanence of gold’s value. For example, Egyptian civilizations buried vast amounts of gold with deceased pharaohs in the belief that they would be able to use it in the afterlife. Great wars were fought, among other reasons, to pillage stores of gold. Why the allure? The answer: Gold is the only real money, and its value cannot be changed or controlled by government fiat-the underlying reason for governments to go off the gold standard, unfortunately.

Gold’s value will rise based on the pure forces of supply and demand, no matter what Bernanke decrees regarding interest rates or greenbacks in circulation. The big disadvantage to owning gold is that it tends to trade with a wide spread between bid and ask prices. So don’t expect to turn a fast profit. You’ll buy at retail and sell at wholesale, so you’ll need a big price jump just to break even. However, you should not view gold as a speculative asset, but a defensive asset for holding value. Since your dollars are going to fall in value, gold is the best place to preserve value. The best forms for gold ownership are through minted coins: one-ounce South African Krugerrands, Canadian Maple Leafs, or American Eagles.

2. Gold exchange-traded funds. The recent explosion in exchange traded funds (ETFs) presents an even more interesting way to invest in gold. An ETF is a type of mutual fund that trades on a stock exchange like an ordinary stock. The ETF’s exact portfolio is fixed in advance and does not change. Thus, the two gold ETFs that trade in the United States both hold gold bullion as their one and only asset. You can locate these two ETFs under the symbol "GLD" (for the streetTRACKS Gold Trust) and "IAU" (for the iShares COMEX Gold Trust). Either ETF offers a practical way to hold gold in an investment portfolio.

Another option to the gold ETF are EverBank’s MarketSafe Gold Bullion CD. And lucky for you, they just reissued the funding deadline for this CD.

3. Gold mutual funds. For people who are hesitant to invest in physical gold, but still desire some exposure to the precious metal, gold mutual funds provide a helpful alternative. These funds hold portfolios of gold stocks-that is, the stocks of companies like Newmont Mining that mine for gold. Newmont is an example of a senior gold stock.

A senior is a large, well-capitalized company that has been around several years and has a profitable track record. They tend to own established mines that produce known quantities of gold each year. For many investors, selection of such a company is a more moderate or conservative play (versus picking up cheap shares in fairly young companies).

Dan Amoss has recommended that his Strategic Investment readers to patiently hold stock in the best-managed gold mining companies, and to reap the rewards of that patience. Newmont, in particular, remains an SI recommendation, because its new CEO is improving operations and it will be the first stock that hedge funds will turn to when they want quick exposure to the gold mining industry. They’ll rush into names like Newmont because they know how powerfully earnings can ramp once a high-fixed-cost business starts experiencing ideal conditions.

4. Junior gold stocks. This level of stock is more speculative. Junior stocks are less likely to own productive mines, and may be exploration plays-with higher potential profits but also with greater risk of loss. Capitalization is likely to be smaller than capitalization of the senior gold stocks. This range of investments is for investors whose risk tolerance is broader, and who accept the possibility of goldbased losses in exchange for the potential for triple-digit gains.

5. Gold options and futures. For the more sophisticated and experienced investor, options allow you to speculate in gold prices. But in the options market, you can speculate on price movements in either direction. If you buy a call, you are hoping prices will rise.A call fixes the purchase price so the higher that price goes, the greater the margin between your fixed option price and current market price.

When you buy a put, you expect the price to fall. Buying options is risky, and more people lose than win. In fact, about three-fourths of all options bought expire worthless. The options market is complex and requires experience and understanding. To generalize, options possess two key traits-one bad and one good.The good trait is that they enable an investor to control a large investment with a small, and limited, amount of money.The bad trait is that options expire within a fixed period of time. Thus, for the buyer time is the enemy because as the expiration date gets closer, an option’s "time value" disappears.

Anyone investing in options needs to understand all of the risks before they spend money. The futures market is far too complex for the vast majority of investors. Even experienced options investors recognize the high risk nature of the futures market. Considering the range of ways to get into the gold market, futures trading is the most complex and, while big fortunes could be made, they can also be lost in an instant.

This level of risk should not scare off prospective investors – our own Maniac Trader, Kevin Kerr, has been leading subscribers of his options trading service, Resource Trader Alert, to major profits for years now. In fact, in the past month, they sold half of their December gold spread for 100% gain in about eight months.

We cannot know, predict, or even guess, when the demise of the dollar is going to occur, or how quickly it will take place. But we do know it is going to occur. The tragic mismanagement of monetary policy by the Fed over many years has made this inevitable.

VIEWS FROM THE FUSE:In the summer of 2005, while we were working at a frantic pace on Bill Bonner and Addison Wiggin’s second joint effort, Empire of Debt, Addison quietly released another book, The Demise of the Dollar. We didn’t expect much from Demise…we knew it was a good book (and a timely one, at that), but it wasn’t exactly what most would consider "beach reading".

However, while we were at our annual Agora Financial Investment Symposium in Vancouver, a colleague gave us an excited head’s up: Demise of the Dollar had knocked the latest Harry Potter book from his perch as the number one bestseller on, where it stayed for over a week.

More than two years have gone by since the release of Addison’s surprise bestseller, but as the dollar sits at record lows against almost all major currencies, Demise seems just as relevant (if not more relevant) as it did in the summer of 2005. In the essay below, Addison explains why the falling dollar doesn’t have to be a disaster for your portfolio – and what commodity you can take advantage of to profit as the greenback’s value continues its slump.

Keep reading for an excerpt from the book that knocked the boy wizard’s glasses from his nose, took his lunch money and stole his spot at the top…


Short Fuse
The Daily Reckoning