Gold Hits $1,600!

Stock markets around the world have been looking pretty ugly lately, but gold has climbed for eleven straight days – reaching a new all-time high of $1,605 an ounce! Prediction: More of the same.

The European crisis is deepening. Couple that with the ills in the US and it makes for a grim picture. Concerning the EU crisis, Barron’s ran a fascinating interview over the weekend with Sean Egan, the head of Egan-Jones, an independent credit ratings agency. “Independent” means that Egan-Jones earns money from subscribers seeking insight, not from companies seeking the rosiest assessment possible. Egan-Jones’ revenue model, therefore, is in direct contrast to S&P and Moody’s, who earn money from the companies they rate.

You can bet that incentives are vastly different between the two business models. It’s like the difference between investment banks and my newsletter, Mayer’s Special Situations. The former write “research reports” that recommend the companies they do deals with. I am paid only by my subscribers.

In any event, Egan offered up some very dire predictions about the EU. He summed it up like this:

Look for the Greece situation to be replayed in Ireland, Portugal, Spain, Belgium and Italy… Companies dependent upon bank funding are likely to face extreme pressure over the next couple of years. They are going to [get] squeezed real hard. Investors should look for bank mergers, major asset sales and widespread company restructuring. The sovereign-debt crisis is probably the biggest credit event faced since the decline of the Weimar Republic. Forget about post-World War II. This is bigger.

It’s like 2008 all over again, but this time, the epicenter of the credit quake is Europe. And Europe is in far worse shape than the US was in 2008, as Egan points out.

First, it is not a unified country, which leads to a lot of dragging of feet as the different EU bankers dawdle. It means the bailouts that were so forthcoming in the US may not be in offing in the EU. Secondly, EU banks have less capital. Meaning, they have less of a cushion to absorb credit losses. And finally, the EU can’t so easily print money to get out of its troubles. The euro is not the dollar, which, despite all of its flaws, is still the world’s reserve currency.

The table below is telling. You already know these countries are in trouble, but these numbers boil it down to some essentials. Look at those interest cost figures compared to tax revenues. Greece is already paying out more in interest payments on its debt – 50 billion euros – than it is receiving in tax revenue: 46 billion euros. The picture is almost as grim in Portugal and Ireland.

Badly Needed Debt Restructuring

If interest rates rise, those interest costs will go higher. Plus, these economies stink right now. So tax revenues could easily fall. Deficits could widen, causing debt levels to go even higher.

The term that comes to mind is “death spiral.”

No surprise, then, that the gold stocks I’ve recommended to my subscribers are on the move. If you assume $1,600 an ounce sticks – which I think is a good bet – then the profitability of the gold stocks I have recommended will be extremely high, which means these stocks are still cheap.

On July 5, I wrote about the five gold stocks I have recommended and the reasons why I thought they were finally due to make a move. All five stocks are up since then, for an average gain of 12%. I think all five have a lot of room to go, especially if a $1,600 gold price is a new reality.

Hang onto your gold stocks!

Beyond that, I think you should hold a healthy amount of cash and precious metals. And no matter how you invest, be sure you can stomach the volatility that is bound to come down the pike. I have a feeling it will test the linings of your stomach.

Chris Mayer,
for The Daily Reckoning

The Daily Reckoning