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2.
Negative Real Interest Rates in Reserve Currency (U.S. Dollar)
To
combat the economic and financial fragility in the U.S., interest
rates will be steadily lowered. Using true inflation numbers, real
interest rates along the curve are negative. There has been a strong
historical relationship between negative real interest rates and
stronger gold prices.
3.
U.S. Federal Reserve Policies in the Event of Adverse Economic
Conditions
Fed
chairman Ben Bernanke has been very explicit in suggesting that the
U.S. government has a printing press and would be prepared to use it
to avert a deflationary spiral. The validity of fiat paper money rests
upon the confidence that its supply is limited. Policies approximating
‘helicopter money’, if ever implemented, would surely destroy that
belief.
4.
The Resulting Endemic Weakness of the U.S. Dollar
Because of the aforementioned difficulties, the U.S. dollar is both
fundamentally and technically weak and could fall precipitously.
5.
Global Currency Debasement
However, most other countries are very reluctant to see their
currencies appreciate and will resist the inevitable fall of the
dollar.
6.
The Onset of the Malign Side of Financial Derivatives
The
dramatic increase in the usage of financial derivatives in recent
years, many of them over the counter and thus unregulated, has created
an unquantifiable risk element in the financial system. With notional
values in excess of U.S. $500 trillion, this is a hugely significant
issue. It is worth noting that Warren Buffett, one of this
generation’s most successful investors, refers to derivatives as
“weapons of mass financial destruction”. An adverse development on
this front would dramatically impact confidence in paper money, and
threaten widespread bankruptcies in the financial sector.
7.
Gold as Money Continues to Gain Credence
Islamic nations have investigated a currency backed by gold (the Gold
Dinar), countries such as Russia, which were previously plagued by
weak currencies, are talking about fully convertible currencies backed
by gold, and a member of the influential Council on Foreign Relations
has recently suggested that a privately circulated, digital gold
currency may be feasible. All of these initiatives reflect an
acknowledgement that the current international monetary system is
fundamentally flawed, with too much debt weighing on major currencies.
8.
Existence of a Huge and Growing Gap Between Mine Supply and
Traditional Demand
Gold mine supply in 2006 was 2470 tonnes according to GFMS Ltd.
Traditional demand (jewellery, industrial uses, etc.) has exceeded
this by a comfortable margin for a number of years, even before the
recent upswing of investment demand. Some of the gap has been filled
by recycled scrap but central bank gold has been a key source of
aboveground supply.
9.
Mine Supply Has Not Risen Despite Much Higher Prices
Despite gold prices surging from a low of $252 in 1999 to record
levels, gold mine production as actually fallen marginally in this
period. This indicates that primary gold supply is very insensitive to
higher prices. Given that very little exploration was done when prices
were low, capital and operating costs are exploding, and many
gold-rich countries are becoming increasingly hostile to foreign
capital, significant constraints on mine supply are likely to
continue.
10.
Large Short Positions
To
fill the gap between mine supply and traditional demand, central bank
gold has been extensively mobilized for many years, primarily through
the leasing mechanism that facilitated both producer hedging and
financial speculation. Strong evidence suggests that at least 50% of
reported central bank gold reserves have entered the market in this
process. Central banks are owed this borrowed gold by counterparty
bullion banks. Whether the central banks ever get their gold back is
immaterial to the case for gold, because the gold is gone and cannot
be sold again. However, if the central banks were to demand that their
gold be returned, it could trigger an epic short squeeze.
11.
The Central Banks are Nearing an Inflection Point When They Will be
Reluctant to Provide More Gold to the Market
The
central banks have already supplied too much gold via the leasing
mechanism, a development somewhat reminiscent of the late 60s and
early 70s when central banks sold well over 100 million ounces in an
ultimately failed attempt to hold gold in the neighborhood of U.S.
$35.00 per oz. A new generation of central bankers appears to have
learned nothing from the past. Many observers may have misinterpreted
the renewal of the Washington Agreement, permitting European central
banks to sell 500 tonnes per year for five years. In the past two
Agreement years, signatories have not filled their quotas by a
combined 130 tonnes
12.
Increasing Likelihood of Central Bank Gold Purchases
The
Russian and Far Eastern central banks have been accumulating enormous
quantities of U.S. dollars in their reserves and have stated their
intentions to lessen that exposure by diversifying into other
currencies. Gold, which is regaining its status as a currency,
comprises a very low percentage
of
their reserves currently and is an obvious candidate for inclusion.
13.
Investment Demand for Gold is Accelerating
When the public finally recognizes the inflation that will most
assuredly accompany the exploding international monetary creation,
they will seek an alternative to paper currencies and financial assets
and this will create an enormous investment demand for gold. This
phenomenon is already well underway in gold friendly areas like India
and the Middle East, but is only in nascent stages in the Western
world. To facilitate this demand, a number of new vehicles like the
Central Gold Trust and Gold Exchange Traded Funds (ETFs) have been
created. The most popular ETF, the streetTRACKS
Gold Shares, now owns over 600 tonnes of gold.
14.
The China Factor
Despite rising prices, gold demand from China is increasing
substantially. Recent figures from the world Gold Council show that
third quarter 2007 demand rose 25% in tonnage terms, despite a 9%
increase in prices. With China in a major economic boom, rising
prosperity in a country with an affinity for gold augurs well for
future demand.
15.
Sovereign Wealth Funds May Purchase Gold
A
recent Financial Times article suggested that sovereign wealth funds
have started to purchase commodities, particularly gold, as a hedge
against U.S. dollar weakness. The sponsors of these funds have
significant dollar exposure. One estimate pegs the amount of sovereign
wealth fund money to
be
invested globally at $3 trillion. If a fraction of this were invested
in gold it would be sufficient to send gold soaring.
16.
Strains in International Monetary Order Increasingly Obvious
The
U.S. has long acted as the world’s consumer of last resort. To
facilitate this, it has borrowed extensively from the rest of the
world. Many nations reinvest their surplus dollars into U.S. assets,
thereby keeping the U.S. dollar strong. This virtuous cycle is being
threatened by current dollar weakness, as holders such as China are
worried that they are consistently losing money from their U.S.
investments. One senior Chinese official recently suggested that his
country would diversify into “stronger currencies”. Presumably gold
would be considered.
17.
Rising Geopolitical Tensions
The
increasing probability of a long conflict in Iraq, deteriorating
conditions in general in the Middle East, the nuclear ambitions of
Iran and North Korea, unfolding problems in Pakistan and the ongoing
terrorist threat posed by Al Quaeda are among many geopolitical issues
that could make investors very uncomfortable. A fearful public has a
tendency to gravitate towards gold.
18.
Large Increases in Outstanding Gold Derivatives Despite a Major
Reduction in Producer Hedging
Producer hedging has been sharply curtailed in response to several
corporate blow-ups caused by excessive hedging. In addition,
underperformance by the stocks of heavily hedged producers, rising
gold prices and materially lower contangos (forward premiums) have
reduced the incentive to hedge.
So
instead of producers supplying additional gold to the market through
the hedging mechanism, the reverse is now happening. Despite this,
gold derivatives, as reported by the Bank for International
Settlements (B.I.S.), have continued to rise, reaching $640 billion in
December 2006 versus $334
billion one year earlier. This suggests either a major legitimate bet
against the secular trend of the gold price or the possibility of
nefarious activity (i.e. price suppression) in the gold market. Other
than the central banks and their bullion bank allies, it is difficult
to imagine which parties are taking the short side of the gold market.
19.
Increasing Acceptance that the Gold Market Has Been Suppressed
Very recently, analysts at Citigroup acknowledged that central banks
have been acting to artificially depress the gold price. More and more
members of the financial establishment are finally admitting that gold
has been subjected to heavy price management by the official sector.
As this acceptance spreads, investment demand for gold may accelerate
based on the realization that gold has long been artificially low.
20.
Gold is Remarkably Cheap in the Context of Oil and Platinum Prices
Since gold began to trade (allegedly) freely in 1971, one ounce has on
average bought 15-17 barrels of oil. That relationship would justify a
gold price in the neighbourhood of $1500 per ounce today. With a
strong probability that high oil prices may be here to stay, gold
looks very undervalued. In the same vein, for many years, gold and
platinum traded at similar prices per ounce, with gold often
commanding a premium in times of financial stress. Platinum is
currently trading in excess of $1500 per ounce.
Summary: Limited Size of Total Gold Market Provides Tremendous
Leverage
All the physical gold in existence is worth less than U.S. $4 trillion
and the capitalization of all publicly traded gold companies is
approximately $200 billion. When the foregoing fundamentals encourage
a strong flow of capital towards gold and gold equities, the trillions
upon trillions worth of paper money will propel both to unfathomably
high levels. Gold is undervalued, under-owned and under-appreciated.
It is most assuredly not well understood by most investors. At the
beginning of the 1970s, when gold was about to undertake its historic
move from U.S. $35 per oz to over U.S. $800 per oz in the succeeding
10 years, the same observations would have been valid. The only
difference this time is that the fundamentals for gold are actually
better.
Want an advisor familiar with precious metals investing and
fundamentals contact DeWinter Financial.
More
Investment Products ...
Call Bill DeWinter
- Toll Free:
1.888.665.7534
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