The Case For Gold

In 1974, I wrote a short book, “The Reigning Error”, in defense of gold as a monetary instrument. The argument was that all paper currencies are abused by the governments or banks which issue them. Gold cannot be created or replicated by a printing press; it is therefore protected from the human abuse of over-issuance.

Many people do not realize that a strong historic argument for gold even exists. Put at its simplest, one can say that gold has the same exchange value as it did in 1900. That is approximately true in high inflation countries, like Germany, which had two wipe-out inflations in the 20th century; in medium inflation countries like Britain, which lost 98% of the purchasing power of the pound; and in low inflation countries, like the United States, which lost about 95% of the purchasing power of the dollar. In Britain, the gold price has moved with the cost of living index, at least over long periods. An ounce of gold will now buy about the same area of farmland as it did in 1660.

After my first book, gold responded to the global inflation of the 1970s. At one point, it rose from the official price of $35 an ounce to a peak of around $850, or by about 23 times. Provided one sold out near the top, gold was the star performer of a very difficult decade. Since then, gold has been a poor performer, particularly when compared to the Wall Street boom of the late 1990s.

Gold Bull Market: Losing Touch with Reality

However, I thought that the bull market in equities was seriously losing touch with reality rather too early – at around the time Fed Chairman Alan Greenspan started to talk about “irrational exuberance”. At its bottom three years ago, gold fell below $260 an ounce, and it came close to that low point again two years ago. An investor who switched from equities to gold in the course of the millennium year would now be more than twice as wealthy as one who stayed in equities, let alone the Nasdaq.

I have repeatedly written that gold has become a better investment than the Dow, and it has been. In 1980, at $800 an ounce, gold was a bubble. At $260, it was dirt cheap, and the dot-com shares were a bubble. Is gold still cheap? The gold market is certainly performing very well, up 30% in the last two years and outperforming most other investments. For several months, the gold price hovered around $320 an ounce and seemed to have difficulty breaking out above that level. What are the factors now?

The expectation of war in Iraq is probably the most important one. Gold certainly benefits from inflation, but it also benefits, more generally, from uncertainty. I think it is probable that the United States will go to war to overthrow the Saddam Hussein regime, and that the war will be short and successful. At least temporarily, that would be unfavorable for the gold price, because it would remove uncertainty. However, there is no certainty about any war. Gold remains a good protection against a spread of war, such as is widely predicted by Arab commentators. So long as the uncertainty exists, oil prices are likely to remain high, and Middle Eastern investors are likely to be putting some money into gold.

Gold Bull Market: Interest Rates

The second influence to consider is interest rates. They are abnormally low at present, not only in the United States, but also in Europe and Asia. That means that the cost of holding gold, which is always a first-class security, is very low. Governments remain afraid of another recession, so there seems to be little risk of a higher trend in interest rates for the time being. That is favorable to a higher gold price.

So is the general anxiety about the major world currencies. The dollar has been weak, because the United States has a high and rising external deficit to finance. It now amounts to nearly 5% of the gross domestic product. Because the dollar has been weak, the euro has been comparatively strong. But the European Union has agreed to accept 10 new members, with 20% of the existing E.U. population. These are poor countries and will be a burden on the currency. The Japanese banking system is in serious trouble, which affects the yen. It is not hard to see that gold is more attractive than any of these currencies. Every other currency relates to debt; gold has no debt, though individual gold holders, of course, may.

Central banks have been selling gold, but that has largely stopped. The main creditor countries, including China, Taiwan, and Japan, are in Asia. They have a gold tradition. I expect their central banks to prefer gold to dollars in 2003. This seems to be the view of the market. A year ago there were large bear positions, but now the speculative positions are bullish.

My own view is that the latest rise is only the start of a long-term bull market in gold. From the late 1960s, the last bull market in gold lasted for over 10 years. It is quite possible that what looks like a new bull market will run for some years, and go well above the present price. But, inevitably, there will be market reactions along the way.


William Rees-Mogg,
for the Daily Reckoning
January 28, 2008


The Dow has been down triple digits in 5 of the last 6 sessions. It is the “end of the cult of equities,” says the Financial Times.

“The Bubble is over for all of us,” adds the Orange Country Register.

More than half of America’s households still own stocks. And more than half of them have no idea what they are doing; they are the lumpeninvestoriat who got lured into the stock market when everybody said it was the right thing to do. These people wouldn’t know a balance sheet from a bedpan. They just go along with the mob whichever way it is headed. Sooner or later, the mob will leave the stock market, but when?

Usually, sometime after the first stage of a bear market, the mob gets spooked and panics. But so far, the lumpen have sat as still and silent as if they had had a fatal stroke yesterday. Their stocks are down 45% (Wilshire reading) from the top. Their dollars have lost 20% of their value, or more if measured against gold. Their economy – once the crown of creation – is now beginning to prick them painfully. They’re having trouble paying their debts…their net worth is going down…and their friends are losing their jobs and having a hard time finding new ones.

Yet, the poor saps just take the abuse like smokers – they do not complain.

Still, the day may come – and come soon – when they are finally disgusted. Year after year, they get older. Year after year, they get poorer, too. How much more will they take?

We don’t know. But be warned: they could panic any day. In any direction.

Eric, what did they do yesterday?


Eric Fry, reporting from Wall Street…

– Well the “kangaroo” weapons inspections reached their predetermined verdict yesterday: Iraq is guilty of something…Of what, no one is exactly sure. The approximate verdict reached by chief UN sleuth Hans Blix is this: “That Hussein guy is trying to hide something, most likely weapons of mass destruction…and we don’t like it one bit.”

– Yesterday, Blix’s report called on Iraq to prove that it has disarmed itself. We’re confused; isn’t it Blix’s job to determine whether Iraq has disarmed? Since when does the mouse alert the cat to its whereabouts? In any event, Blix told the U.N. Security Council that the various inspectors need more time to verify Iraqi compliance.

– But the Bush administration has heard enough already, and it is clearly itching to pull the trigger on an Iraqi invasion. “We can’t keep kicking the can down the road,” Colin Powell said of extending the inspection deadline.

– Countering Powell’s impatience, Senate Minority Leader Tom Daschle – a man who never met a foot he didn’t want to put in his mouth – posed two very worthwhile questions yesterday: “First, does Saddam Hussein pose a threat to our national security so imminent that it justifies putting American lives at risk to get rid of him? And second, how are our efforts to deal with this threat helped by short- circuiting an inspections process we demanded in the first place?”

– We suspect that Daschle’s question will go unanswered, drowned out by the drumbeat of war. Thus, the prospect of an American invasion draws ever nearer, and with it, the prospect of a fourth straight losing year for the stock market.

– Yesterday, stocks tumbled yet again, as the Dow dropped 141 points to 7,989, closing below 8,000 for the first time since Oct. 14. The blue chips are now down more than 4% so far this year. The Nasdaq joined the Dow and S&P 500 in the minus column for 2003 by falling 17 points to 1,325. Global stock markets are also sliding lower. London’s FTSE dropped for an 11th straight day, while most European bourses fell about 3% each.

– Conditions have become so tough out there on Wall Street that even the gold stocks are falling. The yellow metal itself continued its winning ways by gaining $1 to $369.40 an ounce, but most gold stocks declined. The Philadelphia Gold & Silver Index fell 3.2% to 79.6.

– But while share prices are tumbling, home prices are soaring. Somehow – we don’t know how – despite rising unemployment, despite intensifying global geo-political turmoil and despite deteriorating U.S. economic conditions, the U.S. housing market keeps chugging along like some sort of financial Mr. Magoo. Sales of existing homes rose about 5% in December, capping a record year for the industry, according to the National Association of Realtors. Housing remains one of the very few bright spots in a very somber economy.

– The tech sector is more typical of the tough times on Main Street. At the World Economic Forum’s annual meeting in Davos, Switzerland, Microsoft founder Bill Gates said he did not expect a big pickup soon in technology spending. “This economy is fairly flat,” said Gates, “technology spending, there’s no big uptick.” Gates gets no argument from his fellow technology company executives. In fact, the outlook is fairly grim throughout techland, which is a big part of the reason that stocks are falling – with or without the Iraqi conflict.

– “The stock market has reneged on its early promise,” says Andrew Kashdan of Apogee Research. “Pretty much all the market leaders have been forced to dampen analysts’ enthusiasm for a recovery that is looking not so imminent. The list of party poops includes General Electric, Microsoft, IBM, Sun Microsystems and Intel. To take one example, Intel beat the numbers (if anyone still cares), but another machete-like cut to capital spending did not exactly inspire confidence. Sun Microsystems didn’t even bother making a forecast for its fiscal third quarter…”

– Being a long-term investor just isn’t as much fun as it used to be. In fact, Strategic Investments editor, Dan Denning, says that investing in the U.S. stock market is far more likely to be painful than profitable. “Any strategy that counts on the relative out-performance of traditional blue chips is a lot like trading futures on death row inmates,” says Denning, “hoping you’ll own the one that gets a pardon. And unless the stock market starts acting like the Governor of Illinois and gives clemency to the hundreds of blue chips which will get crushed by the bear market, its’ not going to pay to try and guess which blue chips sill ‘survive.'”


Back in Paris…

*** Americans have been leveraging themselves with stocks, real estate, and credit card debt for many years. Debt totaled only 150% of GDP in 1950. Now it is twice that high. Little by little…or in a sudden panic…they will have to de-leverage themselves somehow. Not until that happens will the bubble really be over for us all.

*** De-leveraging can take a long, long time. Japan began in 1990. But yesterday’s news brought evidence that the process continues. Short-term interest rates have fallen BELOW zero, reflecting obstinate deflation…retail sales fell 3.9% in December…and the nation’s trade surplus shot up by more than 51%. The Japanese just won’t spend money.

*** Here at the Daily Reckoning, our beat is money. But long time DR sufferers have realized that money is just a cover…an alibi…a pretext for commenting on other things. We’re fascinated by the way the world works…and by this strange creature, homo sapiens sapiens, the infests the place. Watching him carefully – rather than studying statistics or econometric formulae – gives us clues to how his money works, too.

But we don’t really care about money, dear reader. We live simply and frugally. A bed, book, and candle are all we really need. In fact, as long as we have enough to pay for our office and our apartment…our 2-hour lunches…good vintage wines…our summer house…vacations…riding lessons…music lessons…French lessons…antique cars…Savile Row suits…19th century French landscape paintings…boarding school and college for our 6 children…the cleaning lady…the gardener…cement for our stone walls… heck, we can take it or leave it. After all, it’s the simple things that really matter.

*** Maria is on a modeling assignment in Mauritius, where she is staying at a resort called Touessrok.

“You wouldn’t believe it,” she said last night. “This place is so beautiful and so deluxe. Everybody who comes here must be super-rich. I came into my room last night and they had spread rose petals on my bed. Everywhere you look, it is stunning…There’s a white sand beach…a coral reef…the sea is a beautiful color of green…

“I had a free massage…and tomorrow I don’t have to work…so I’m going to sit by the pool and have one of these guys in the white uniforms bring me drinks with umbrellas in them…”

You see, dear reader, it really is the simple things that really matter.

The Daily Reckoning