The Case For Gold, Reprise

The Daily Reckoning
Weekend Edition
December 28-29, 2002
Paris, France
By Addison Wiggin

Not surprising, of course, but certainly notable: Stocks continued their descent Friday… all four major indexes lost roughly of 1.4%. The Dow gave up 128 points.

But indexes are indexes and don’t really tell us what’s happening to the average punter…er, I mean investor. Maybe this will: According to Lipper, the average stock mutual fund is down 21.7% for the year. In this third year of the bear market retirement-hopeful investors are starting to wonder if stocks really do go up over the long run. As well they should…

Gold stocks lost ground Friday along with the rest of the indexes, but gold futures gained another 30 cents to close at $349. Of the 41 fund categories Lipper tracks only 3 will end 2002 with a gain: all three are gold funds and they’re up an average of 62%.

Only two trading days left and the dollar is down 12% for the year.

So what’s really going on? Of course, your editors at the Daily Reckoning never claim to know… all we can do is guess along with the rest of the punters. But in an effort to make our guess an educated one today, it might be worth reviewing “the case for gold”. After all, as we noted in late May while turning readers on to a report of the same name written by Tocqueville Funds’ John Hathaway, gold is the only investment story of the year worth writing about.

For assistance in recapping “the case for gold” we turn to an article authored by Frank Giustra and published by Brien Lundin’s GoldNewsletter. (I met Frank briefly in New Orleans in early November this year. As the leader of Yorkton Securities during the early 1990s, Frank helped finance some of the most important mineral discoveries in recent history. Frank left the mining business briefly in 1996 to head up Lions Gate Entertainment. You may recognize the name. They produced, among other movies, Monster’s Ball, for which Halle Berry won an Oscar. Following the recent move in gold… Frank’s baaack!… now serving as director of Endeavor Mining Capital Corp. Perhaps if Mr. Giustra is ready to give up Hollywood gold for the real thing… this as interesting a story as we’re likely to ever find ever in the investment world, eh?)…

“A Tarnished Dollar Will Put The Shine On Gold,” headlines the Giustra piece. Among the factors leading to a rising gold price, Giustra notes a widening demand/supply gap in gold due to a decline in production by the primary producers, expected to decline by an additional 30% over the next 8 years; the decline of interest rates making it less attractive for gold producers to “hedge” their future produce; and the end to the “peace dividend” – or as Harry Schultz put it recently “geopolitics is back!” and the world is as scary a place as at any time during the cold war. Iraq, al Qeada and North Korean come to mind, for some reason.

But supply and demand, the derivatives market and impending political violence are only the beginning of the crises contributing to the renewed interest in gold this year (and next?… and the year after that?). “The most important dynamic affecting the gold price is,” writes Giustra, “and will be, the fate of the US dollar.”

We need only look back 31 years to get a grasp on the relationship between the dollar and gold. In 1971, Nixon closed the “gold window”, and put the final touches on a political movement started early in the 20th century. In Europe, banks made gold coins for general trade illegal in the summer of 1914, at the outbreak of The Great War. England restored the ‘right’ of citizens to use gold specie briefly in 1925, but a run on the Bank of England’s gold reserves forced them to revoke the right again in 1931. Gold coins were made illegal in the US in 1933 by executive order of President Roosevelt. Thereby, removing gold from the radar of the average investor altogether.

But Nixon’s action – refusing foreign dollar holders from redeeming greenbacks for Fort Knox gold – in ’71 unhitched the dollar from any backing, except that of the US government. Unfortunately, any period in history of government-backed, or ‘fiat’ currency, has led to disastrous bouts with inflation. In the 70s the dollar “took a swan dive” losing 70% of its value against some currencies over the next ten years. Gold, the beneficiary of a dollar-decline, climbed until it reached $800 within the same decade.

A short history of Fed over since then would reveal repeated attempts to manage the relationship between the dollar, now the world’s reserve currency comprising 76% of all central bank deposits, and gold… which has suffered a 20 years of virtual neglect.

“The value of the dollar,” writes Giustra “is impacted by many factors including a) how much of it is printed b) the rate of return it generates c) the fiscal health of the government balance sheet sponsoring it and d) the general state of the economy it represents.”

In the past decade the US money supply has doubled from $4 trillion to $8 trillion, with a full 25% of that coming in the last 18 months while the Fed tries to reflate the economy. What’s more, currency that is actually in circulation and being used has more than doubled from $260 billion to $600 billion in the same period. Neither of these attempts to stimulate consumer spending are improving the economic picture. Most notably, the corporate profit picture is not improving.

Government “fiscal responsibility,” an oxymoron if we ever heard one, is anything if not a pipe dream. And now we have an administration promising to take “war on terror” to any corner of the earth willing to host it… on top of declining tax revenues from the busted economy affecting all levels of government from the Feds down to your local school board. Nobody has a keener interest in keeping the bull market going, we noted this week, than the government.

Record levels of consumer debt; mortgage rates at levels not seen since 1965 encouraging even more borrowing; record bankruptcy levels; and a current account deficit that requires 75% of all the global trade surplus capital to maintain… the list goes on and seems rather endless… is it any wonder interest in gold is beginning to awaken?

“As, one by one, the foundations supporting these pillars erode,” writes Mr. Giustra, “the faith in the dollar may, at best, turn agnostic and, at worst, turn outright atheist.” And if the inverse relationship of the last 30 years holds… gold is about to be the beneficiary of a whole new crop of converts. Early price movements in the year 2002 indicate the ‘conversion experience’ may have already gripped a few… the unsuspecting.

Happy New Year,

Addison Wiggin,
December 28, 2002

P.S. I’m working on getting a copy of Frank’s article posted to the website. I’ll let you know when it’s up. Thanks for reading.