The Goldwatcher

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No Goldman lipstick on the pig?

On 23rd April Goldman Sachs posted a lengthy  rebuttal  to all charges of impropriety alleged by the SEC and others. The last sub paragraph in their  Executive Summary is relevant in relation to the SEC fraud charge with three key points made: 

1:’Goldman Sachs never created mortgage-related products that were designed to fail.’

2  ‘It is critical to remember that the decline in the value of mortgage-related securities occured as a result of the broader collapse of the housing market.’ and

3:  It (the decline in the value of mortgage-related securities) was not because there were any deficiencies in the underlying instruments. The instruments performed as would have been expected in those unexpected circumstances.’

No pig? The housing market collapsed:

Readers of the Goldwatcher will have read on page 147:

1: ‘You had to be blind not to see the bubble in the US Housing market;’ and

2:’Banks were heavily implicated in the development of the housing market bubble and the crash.’  

Can  banks now seriously claim they were  unaware that their Triple A Rated mortgage backed securities were suspect? Were they blind?   Or innocent bystanders?  Or just naive victims of a wholly unexpected housing market collapse that came out of the blue? Banks were anything but naive and can’t make any of these claims. The securities they created on the back of a bubble they helped inflate were pigs. The only question is who put the lipstick on them.

No Lipstick? The securities performed as expected :

Addressing the key contentious issue in the SEC fraud charge Goldman claim they ’never created mortgage-related products that were designed to fail.’  However there is a more general issue. The relationship between banks and the credit rating agencies they paid to rate their mortgage backed securities. Agencies  who share responsibility for the lipstick on the pig.

Commenting on the absurd Triple A Ratings banks secured for dodgy securities Senator Carl Levin has been scathing. He likens the bank - rating agency relationship to one of the litigants in a case paying the Judge. Or one sporting team paying the referee. The relationship may not have been that corrupt. But neither were banks naive. They can’t protest the housing bust came out of the blue, took them by surprise and their securities performed ‘as expected’ in ‘unexpected circumstances.’ 

A can of worms is open. Integridy of key financial institutions and key underpinnings of our credit based economies are suspect. There are no silver bullets to magic the mess away.

Gold Stateless  Money Franchise:

In a recent comment Weakness Begets Weakness the gold fund and money manager Eric Sprott references ‘the subprime mortgages rated AAA now worth pennies on the dollar.’  He tracks  both the Greek Soveriegn and Mortgage Backed Securities debacles and argues:  ’…as they relate to sovereign debt, the ratings provided by the agencies are highly suspect…there appears to be very little forward-looking information actually factored into their credit models. In some cases, the agency ratings end up looking absurdly optimistic.’

Sprott finds the Triple A rating accorded to the US Government out of touch with reality and, after citing recent analysis by the US Government Accounting Office (GAO) he  concludes ‘The ratings agencies can opine all they want, but it seems clear to us that the only true AAA asset to protect your wealth is gold.’ 

On Pages 116 and 117 The Goldwatcher addreses the bottom line as seen by the GAO : ‘Federal Fiscal Policy is unsustainable.’ That was written over two years ago. It was true and menacing then an is even more menacing now.  And it’s why people are seeking the protection afforded by gold’s stateless money franchise now.

Sprott makes a strong case for gold as the enduring Triple A Security that will survive sovereign ratings downgrades.  

# Note added 27th January: 

Yesterday Senator Carl Levin published a confrontational listing of the issues and findings of fact  on which Goldman Executives will be challenged today.  Depending on the legal advice witnesses have they may not all testify.  Levin’s summary reads:

The bipartisan Subcommittee investigation has resulted in the following findings of fact regarding the role of investment banks in the financial crisis:

Opinions and advice:

Readers, particluarly those who have not yet read The Goldwatcher,  are reminded that this blog is not an advisory service. Opinions expressed are not intended as investment advice and should not be treated or used as investment advice

gold_ic-insert.pdf18th December 2009  Investors Chronicle article

Today’s Investors Chronicle features an article commissioned from me on ‘Gold : Price, Motivation, Timing & Strategy.’  The article  includes discussion on gold price prospects.  

This blog posting follows the I/C article, the 5th November Goldwatcher  posting Are Goldrush Prices Making Sense? and the associated September 8^th Goldwatcher posting  $1000 Gold : Here to Stay or here to Play.         

Gold isn’t a very interesting asset to own when the world is in good shape. But, sadly, as we all know, that’s not the case now. Our economies are still in an unholy financial mess. Compounding the economic problems Afghanistan has become ‘Obama’s War.’  How can we justify spilling more blood, maiming more troops and borrowing more money to prolong this disaster when all we have accomplished after eight years is boosting opium production to record levels, refinancing The Taliban and financing a corrupt government?  There is ample motivation for everyone to make gold an asset allocation priority now. 

Even in the worst of times and for millennia gold has kept its value. That’s why it is  the most enduring, best and probably the only asset to own as protection against Armageddon outcomes such as financial and civic disorder. In these situations, as carefully explained in The Goldwatcher, gold’s stateless money franchise ensures some security for you and your loved ones. But, to have this protection, you need to own physical gold. Not paper gold, shares in mining companies or shares in funds owning mining companies that won’t survive the crisis. 

The unholy financial mess that nearly ended with global financial meltdown in 2008 hasn’t gone away. It’s been aborted by global money printing on an unprecedented scale and there will be consequences.  If history is anything to go by our paper money currencies are on course  to becoming  worth less and less and they may eventually be worthless in years to come. Owning gold and other precious metals can also be motivated to preserve the purchasing power of our assets. But it’s not the only way of achieving this outcome. In most cases it also won’t be the best. Let me explain why. 

Pundits are comparing apples to potatos and tomatos.

Gold pundits proclaim that the dollar lost over 90% of its purchasing power since Roosevelt’s 1934 devaluation. But who keeps a dollar bill or a pound note for 76 years?  We spend or invest money. It’s true we will need $16 or $13 of 2008 money, depending which yardstick we use, to match the purchasing power of $1 in 1934. However it’s also true that over 76 years a comparison with the return on $1 gained from compound interest, even at the lowest ruling interest rates,  will leave gold looking sick. A comparison with investments in equities will leave it looking even sicker. 

Another patently flawed pundit claim is that assets revert to mean and, as gold peaked at $850 in 1980, it’s now set to  breach $2000.  As explained in the Investors Chronicle article $850 was a spike – a brief encounter that occurred against the background of events very different  to what’s happening in the world now. For one thing inflation then was in the double digits. Now we are fending off deflation No logical argument can be made for mean reversion to spikes. Apples can only be compared to apples.

Note added 19th December : Gold can’t beat checking account 30 years after spike

The Goldwatcher framework: 

The Goldwatcher was structured as an information  framework supporting analysis of events affecting the value of currencies and gold.  You can make your own decisions on whether or not owning gold makes sense and whether or not gold prices make sense at any time by addressing the questions associated with key Chapters and information resources in the book. 

The ten chapters contributed by me in Part One on ‘Demystifying the Gold Price’ and associated questions are: 

1: Introduction – Why gold? 

2:  The Gold Mining Industry – What gold price gives producers a worthwhile profit? 

3:  Gold Supply and Demand - Do central banks still need gold and does gold still need central banks? (NB to read this one now)

4:  The Rise and Fall of the Gold Standard – Did gold cause the great depression?

5:  The Dollar Standard and the Deficit without Tears – Is the dollar again America’s currency and everyone else’s problem? 

6:  The Economic Consequences of 9/11 and George W Bush – For how long will Asians go on lending for Americans to go on spending? 

7: The end of Cheap Oil, ‘Chindia’ and other Tipping Points to Instability – Will alternative energy come to the rescue? 

8:  Globalisation & Global Economic Rebalancing. Can the IMF avoid Global Financial Meltdown? 

9:  Gold Prices: Inflation, Deflation, Booms and Busts: Do Trees Grow to Heaven?

10: Investing Choices: What Gold? 

I will post comments on key developments affecting gold from time to time for various websites and publications. If you would like to be informed when comments are published or have any other queries please e-mail me johnnkatz@gmail.com. All communications will be answered.

Thank you for reading The Goldwatcher.

Seasons Greetings and good luck with your investments.

CLICK HERE FOR KITCO GOLD PRICES AND ANALYSIS

CLICK HERE FOR REALTIME MULTICURRENCY GOLD PRICES  

TO BUY THE GOLDWATCHER CLICK HERE

CLICK HERE FOR REALTIME MULTICURRENCY GOLD PRICES  

TO BUY THE GOLDWATCHER CLICK HERE:

This article,  Part Three in a series on key economic developments since publication of The Goldwatcher. addresses Gold Price Prospects, Red Ink and Animal Spirits.

The articles were commissioned and published by The Stock Research Portal Review.

 Part One and Part Two address the sequence of events that led to the collapse of the Casino Capitalism House of Cards and almost led to global financial meltdown in September 2008. 

THE GOLD PRICE, RED INK AND ANIMAL SPIRITS 

‘Conventional Wisdom’ on gold prices:

Gold was again on course to breaching the magical $1000 threshold at the end of May when Goldman Sachs published a Research Note ‘The US Dollar – As Good as Gold.’ The report set out why they were not recommending gold at current prices .

Unsurprisingly the gold price retreated  within days of the research being published falling from $975 on May 29th  to  $919 on 22nd June. I say ‘unsurprisingly’ not because Goldman’s Wall Street consensus analysis was specially insightful or revealing. Rather,  because when they scent blood in the air packs of speculators,  all too often with eager investors following in their tracks, get carried away and when they hear a warning shot   they panic. 

The ‘Dollar As Good As Gold Report’ concluded: ‘With the average cost of production estimated at $500 per ounce, the marginal cost of demand at $700 per ounce and no shortage of gold for real long term use, a price of $950 seems enough to provide mining companies with very attractive returns on their capital.’  The analysts  added ‘if worries about the debasement of paper currencies persist, or any signs of inflation appear, the demand for additional gold could push prices above $1,250. Between March 1973 and August 1975, the moving 3-year average of year-on-year inflation was 10% and gold rallied 27%. Between May 1978 and November 1981, when inflation measured 12% per annum, gold rallied 47%. So clearly, unanticipated inflation is favourable for gold prices.’
As they were not expecting either inflation shocks or that the dollar would  will be debased by lax monetary policy when global economies recovered Goldman were not recommending gold.  They noted, however, ‘just like crude oil in mid-2008, if enough people worry about the dollar and inflation, momentum can carry gold to much higher levels beyond any measure of fair value.’

Though not everyone will agree  average gold production cost is as low as $500 an ounce  Goldman’s arguments were in line with a general Wall Street consensus on gold and with ‘conventional wisdom.’  We all generally  expect gold to perform well when inflationary pressures build up. The statistics they quote confirm this view. However contrarians and out of the box thinkers won’t be impressed by analysis that doesn’t address deflation.  Many among them, including the writer of this article, see both deflation and global overcapacity  as  menaces  to the global economy.

Though we all have a pretty good understanding of the effects of inflation most of us know literally nothing about deflation. And that’s only to be expected. It’s three quarters of a century since the deflation associated with the Great Depression.  We know that since  property and stock exchange bubbles popped two decades ago Japan has experienced deflation. But we aren’t familiar with the causes and effects of deflation,  don’t know when there is a real danger of deflation or understand why gold is ultra important when there is a danger of deflation

Leading economists, including Nobel Laureate Dr Paul Krugman are also questioning old views on Japan. He warns ‘we may or may not be about to face our own lost decade, but the sheer misery millions of Americans will face in the near future probably exceeds anything that happened in Japan during the 90s.’

Gold, deflation and capital preservation:

The comments on gold and deflation that follow are from an exceptionally thorough, well informed and insightful article written in 1986 by Dr. Sam Hewitt, founder of Sun Valley Gold Company. His analysis challenges  the  flawed ‘conventional wisdom’ that because gold performed badly during recent decades in a period of  disinflation (the 1980s and 1990s) it will do even worse during deflation.  The lesson from history is that currency hoarding is a common feature in deflationary episodes and ‘the interaction between declining credit quality and currency hoarding is key to understanding the role of gold as an alternative currency.  Each historical episode of deflation confirms that whenever confidence has declined in the issuer of paper currency gold was favoured over paper currency as a capital preservation asset.’

In the Sun Valley report deflation is defined as : ‘falling levels in economic activity and falling price levels on an absolute basis. Contraction of economic activity is generally preceded by an unsustainable boom period and usually kicked off by an event which causes economic confidence to be lost. Characteristic of most deflationary periods are deteriorating credit quality and  the shift by investors from capital growth to capital preservation.  Deflations typically end after crisis conditions force policymakers to enact large-scale inflationary policies designed to counteract deflationary conditions.’

Reading this definition of deflation it is tempting to say the current financial crisis must be a poster child for the unsustainable boom,  loss of confidence and the associated poor credit quality that follows. But that’s only half what needs to said. The current crisis is also a crisis of solvency at all levels from State to household.  Further,  policymakers have made a global commitment to do whatever is necessary to restore economic growth.  In attempts to reflate economies trillions of dollars have already been committed to supporting liquidity, bailing out banks and industries. Yet the world is still faced with overcapacity and solvency crises.  Trillions more will be needed. The State of California’s inability  to meet its commitments reflects the solvency crisis at state level. The General Motors and Chrysler bailouts reflect major industrial examples. Further, after the second anniversary of the global financial crisis we have to question why the reflating formula hasn’t worked. The answer appears to be excessive credit fed the unsustainable boom.  Lax regulation made it possible. Financial leverage is now amplifying the consequences.

Putting Humpty Dumpty together again:

Commentators have used the analogy of Humpty Dumpty’s fall to describe the global financial collapse and question whether Humpty can be put together again.  A Goldwatcher blog “Has Bernanke whizzed the Humpty Dumpty economy into a Hunky-Dory economy? dates back to March 2008. 

How little we  knew about Humpty then! In their recently published book ‘Animal Spirits’ the celebrated economists Nobel Laureate Dr. George Akerlof and Dr. Robert Shiller inform us Humpty’s misfortune hails from a time before children’s story books were illustrated. This explains why over the years we have forgotten  Humpty was an egg. So, the authors conclude, ‘all the King’s horses and all the King’s men could not put him back together again.’  And, they add (emphasis mine) ‘that tale well describes the current financial crisis.’ Out of the box analysis in their book ‘Animal Spirits,’ discussed later in this article,  contributes to a better understanding of the crisis and  suggests innovative solutions.

Also discussed in The Goldwatcher is Nobel prize winner  Paul Krugman’s comment on prospects for a dollar plunge resembling the bad tempered  road runner cartoon character Wile E Coyote at the moment  he stepped over the edge of a  cliff with his legs flailing in thin air and realized, alas  too late,  he was about to plunge into a chasm.

Dr. Krugman concluded if creditors find they have been myopic there may yet be a Wile E Coyote moment for the dollar. Ironically,  it wasn’t the dollar that faced a Wile  E Coyote moment when the financial crisis hit. It was the global economy. And,  as the crisis developed,  the dollar has remained in demand as a perceived safe haven. 

 Debtor creditor imbalances  between the US, China and other dollar surplus countries  are often  cited as the root cause for global financial instability. In whitewashing President George W. Bush’s borrowing binge Fed Chairman  Ben Bernanke made the case that a global savings glut had literally foisted  trillions of dollars of cheap money on US consumers.  Indeed, as cheerleader for the global savings glut theory,  Bernanke  may have been the most myopic of all concerned parties.   Commenting on his whitewash  The Goldwatcher quoted  the well respected investment banker and economist Donald Coxe’s acerbic comment  that  it was really a case of a  global savings glutton gobbling up the savings of the rest of the world.  In any event the global savings glut story is now history. Harvard Professor Jeffrey Frankel, authoritative on currency issues,  sees the global saving glut issue as stone dead. In a recent paper on Global Currencies prepared for Central Banks Frankel writes  ‘Regardless who is right about the last 8 years  over the next 8 years national saving will fall globally.   In the short run, governments are responding to the most severe recession in 70 years by increasing their budget deficits.  In the long run, the spending needs created by the increased retired population and rising medical costs will continue to reduce saving, both public and private.  In response, long-term real interest rates should rise, from the recent low levels.’  
 

Contrarian and out of the box thinking:

While Bernanke and others were hyping the global savings glut and other patently flawed theories contrarians and other out of the box thinkers anticipated and warned of the pending  crisis. In his  book Debt and Delusion,  published in 1999,  a British economist Dr Peter Warburton  made the case that central bankers were so obsessed with rooting out inflation they only looked at credit statistics relating to  banks -  ignoring the enormous,  burgeoning and largely unregulated credit explosion taking place in what we now call the ‘shadow banking’ system.  As a consequence in the boom years linkages between reported expansion of credit in the major Western economies  and real world money were grossly understated and misleading. Further the impressive reduction in inflation reported was an illusion ‘obtained largely by substituting one set of serious problems for another.’ The effect was tipping economies into over capacity and deflation.

Warning now of an imminent return to inflation Warburton is  again running contrary to the consensus view that a global excess capacity glut and deflationary pressures will keep inflation at bay.  He accepts consumers can expect to be the beneficiary of inventory liquidation for an extended period of time. But  lean inventories and ‘the fracturing of the supply chain mean that obtaining products will become not only more difficult  but also more expensive.’  It’s worth remembering that when Chrysler & G.M. sought  bailout  taxpayer funds among the most compelling reasons for  support  were repercussions that would follow  for the industry’s component supply chain if they went out of business. Even Ford,  still able to survive without government support, informed Congress if G.M. or Chrysler went out of business they would be vulnerable to supply interruptions and would also require government support.  Foreign  owned auto manufacturers in the US were  in the same boat.

Auto component suppliers remain vulnerable as,  compounding the  dire conditions in the industry,  they have been obliged to accept an expanded role in the supply chain requiring additional finance for just in time manufacturing programmes and associated customer support obligations. 

The message from Dr Warburton’s analysis is a Keynsian focus on the consumer will not be sufficient for economic revival. The supply chain can’t be ignored. If it’s broken the economics of the industry will be affected and prices are likely to rise. 

In spite of a cash for clunkers scheme introduced to support  car sales in the U.K. manufacturers put their prices up. Many, including  Ford,  have already increased prices twice this year  It’s unlikely now auto prices will ever be  as low as they were over the last few years. So, while there is a strong case to make that deflationary pressures will keep inflation tame, there are also instances where  inflationary pressures will prevail.

Animal Spirits, credit and unemployment:

The phrase ‘animal spirits’ was introduced into the economics lexicon by Lord Maynard Keynes who recognised people are not always rational in their financial decisions. They also act following their animal spirits – ‘ a spontaneous urge to action rather than inaction… our innate urge to activity that makes the wheel go round.’  In their book ‘Animal Spirits’ mentioned above  Akerlof and Shiller approach macroeconomics from the perspective of human behaviour and find conventional macroeconomists failed to anticipate and prevent the financial crisis because they ignored essential behavioural characteristics. These  include confidence, fairness, concerns over corruption, bad faith, and money illusions.  I can add with some satisfaction that the chapter in The Goldwatcher addressing  gold prices starts with a quote from Lord Keynes on animal spirits followed by the sub heading ‘Introduction : A crisis of Confidence.’ Not only do Akerlof and Shiller  make a convincing case for the imperative to restore confidence but they also find confidence and lack of confidence have multiplier effects. 

Bantering with the phrase animal spirits in a book  addressing economics and behaviour  makes for some entertaining reading and also for some confusion. But the key conclusions Akerlof and Shiller reach are substantial contributions to improving monetary policy. They identify the credit crunch as ‘the overwhelming threat to the current economy, and argue ’it will be difficult and perhaps even impossible to achieve the goal of full employment if credit falls considerably below its normal levels.’ To bridge the gap they propose a credit target for policy makers and note ‘achieving the credit target is urgent for several reasons. Most pressing is that  firms that count on outside finance will go bankrupt if they can not obtain credit and, if the credit crunch continues and many firms go bankrupt, it would take an impossibly large fiscal and monetary stimulus to achieve full employment.’  Akerlof and Shiller approach issues of credit and unemployment from a different perspective to Dr. Warburton but their conclusions aren’t far apart.  Talk of green shoots in the economy isn’t convincing while unemployment is rising and while firms that can’t access credit are going our of business,

Nouriel Roubini’s red alert:

Dr. Nouriel Roubini,  the economist who has most consistently identified the causes and evolution of the financial and economic crises,  now sees light at the end of the tunnel with the U.S.  and global recessions over by late 2009. But he also forecasts an anaemic and vulnerable recovery with a peak unemployment rate of close to 11% in 2010. Such a large unemployment rate,  he notes,  ’will have negative effects on labour,  income,  consumption and growth; will postpone the bottoming out of the housing sector; will lead to larger defaults and losses on bank loans (residential and commercial mortgages, credit cards, auto loans, leveraged loans); will increase the size of the budget deficit (even before any additional stimulus is implemented); and will increase protectionist pressures.’

A vulnerable dollar:
In this climate of uncertainty gold has already made a comeback in  central bank reserves after years when its retention in their vaults was often seen as pointless.  Now in the light of concerns over the stability of fiat currencies it makes sense for central banks to own gold again.  David Rosenberg, former Chief Economist for Merrill Lynch and now chief economist and strategist with Gluskin Sheff & Associates,  comments the US dollar “.. is the only policy tool that has not budged one iota since the crisis erupted two years ago. But we are sure that as the unemployment rate makes new highs and increasingly poses a political hurdle in a mid-term election year, it would make perfect sense for a country that always operates in its best interest - even if it may not be in everyone’s best interest - to sanction a US dollar devaluation as a means to stimulate the domestic economy.”  With  downside potential for the dollar he suggests investors protect their portfolios from the consequences of a declining dollar with a range of investments including gold. 

David Rosenberg’s analysis is consistent with the committment policy makers have made to take whatever steps are necessary  to revive economic growth.  Competitive devaluation is not on the agenda. But  currency debasement and inflation can also come via fiscal deficits and lax monetary policies initiated by fire fighting policy makers and central banks.  Gold attracts again as a quasi currency insulated from policy manipulations eroding the value of fiat currencies.

Reports from national mints and gold dealers in all major centers confirm physical gold is in short supply. It’s obvious why  it is. Currencies are vulnerable to debasement and,  when confidence declines in the issuers of paper currency, gold is favoured  as a capital preservation asset.

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CNBC’S interview with Frank Holmes, Goldwatcher co-author yesterday: 

Following dramatic rises in the gold price yesterday - and even more dramatic falls  in equity and commodity markets world wide -  CNBC interviewed Goldwatcher co-author Frank Holmes,  one of the world’s most authoritative and respected voices on gold.  

The CNBC interview covers key issues investors must keep in mind and is supported by comments from CNBC analysts. Frank Holmes’s headline advice is straightforward  ’Don’t buy gold to get rich - buy gold for protection.’

 You can  Access the CNBC interview through this link.

The Goldwatcher and this blog contributed by co-author John Katz:

My content in the Goldwatcher is unbiased. I am an independent analyst and neither a gold bull or bear. In a nutshell my contributions point to when owning gold makes sense and when it doesn’t and when gold prices make sense and when they don’t. The Chapters I contribute address the questions investors interested in gold must ask,  starting with their motivation, timing and strategy for making and managing their investments.  

The most recent update on gold price prospects in this blog was posted on 22nd January

The Goldwatcher book and the blog address the issues of the day affecting demand for gold,  other currencies and other assets. They include subjects ranging from  the wars in Iraq and Afghanistan to our once rock solid British Banks now going bust.

The Goldwatcher Book Chapters follow this sequence

 Foreward by Dr. Marc Faber - starting with this comment:

‘Years from now, the events of late 2007 and early 2008 will be remembered as a classic case of the flawed thinking by Governments that choose to use monetary policy to try and sustain an unsustainable economic bubble, and how that action broadens and deepens the pain when the bubble inevitably busts.’

Part 1 : Written byJohn Katz  ‘The Goldwatcher’ in this blog -  e-mail address : john@thegoldwatcher.com

1:  Introduction : Why Gold?

2: The Gold Mining Industry : What price gives producers a worthwhile profit?

3: Gold Supply and Demand : Do Central Banks still need gold, and does gold still need Central Banks?

4: The Rise and Fall of the Gold Standard : Did Gold Cause the Great Depression?

5: The Dollar Standard and the ‘Deficit without Tears’ : Is the dollar again America’s currency and everyone else’s problem?

6: The Economic Consequences of 9/11 and George W. Bush : For how long will Asians go on lending for Americans to go on spending?

7: The End of Cheap Oil, Chindia and other Tipping Points to Instability 

 Will alternative energy come to the rescue?

(The causes and evolution  of the present economic crisis including the housing boom and bust, the CDO racket, Alan Greenspan’s misguided views on regulation  etc are all covered in the above Chapter)

8: Globalisation and Global Economic Rebalancing

Can the IMF avoid global financial meltdown?

9: Gold Prices : Inflation,Deflation, Booms and Busts

Do trees grow to heaven?

10: Investing Choices . What Gold?

Part Two : Written by Frank Holmes:

11: Inside US Global Investors

12: Investing in Gold Equities

13: Gold Mining Opportunities and Threats.

PART THREE : THE FACT BOOK APPENDIX - includes detailed analysis of global gold mining production, fabrication, scrap recovery and central bank holdings, sales and intended sales;  a Chart Book, Chronology and Webliography.

The Goldwatcher is available from Amazon and all leading booksellers

 Chevrolet Malibu Hybrid. For the scrap heap? 

The G20 and the Detroit 3:

The Goldwatcher posting on the G20 get together last weekend  was held back while the Chief Executives of the Detroit 3 - GM, Ford and Chrysler - made their plea to Congress for ‘bridge’ financing. The G20 event was a blogger’s treat.  A wedding without the bride unaffeced by the Obasm that overcame the world.  But The Detroit 3’s crisis is another story.  Another consequence of the systemic financial and globalisation crises roiling financial markets. But in this case it’s nobody’s treat. The Detroit 3 are visibly close to ruin.  Decisions taken by Congress over the next few days or weeks will have dramatic effects on the US economy and the dollar currency.  Comment will follow the decisions when the issue returns to Congress on December 2nd.

Contrarian investors and Gold Mining Shares:

The Goldwatcher book and this blog follow the line that excessive money creation, whether through debt expansion, money printing,  or any other devious means will lead to  erosion of the purchasing power of fiat paper money currencies.  Milton Friedman famously observed inflation is always a monetary phenomena.  Prospects for the dollar in a context absolutely relevant to current developments are addressed in The Goldwatcher Chapter 5.

Contrarian investors have the best track record with gold. Many among them currently see opportunities with shares in gold mining companies. Gold has performed well compared to other financial assets. Particualrly  well in currencies like the British £ that have fallen in relation to the dollar. Gold coins and other items of physical gold  are in short supply and are selling at premiums to the gold price. But the prices of all gold mining shares have been trashed. This, as we all all know, follows forced redemptions by fund managers, margin calls and other adverse factors forcing equity prices down. 

We also know that at times like this the baby often gets thrown out with the bathwater. Gold mining shares on the cheap aren’t  the sort of opportunity that will excite a day trader. Contrarian investors take a more fundamental approach and have longer investing horizons.

In an article today on a visit to the Agnico Eagle Mine Mineweb include a useful table on prices and recent price movements of Gold Mining Shares

Chapter 4: The Rise and Fall of the Gold Standard associates with the question ‘Did gold cause the Great Depression?’  Ben Bernanke sides with the economists who accept Milton Friedman and Anna Jacobsen Schwartz’s conclusion that  flawed Fed policies at the time, including excessive concern with the nation’s commitments to the gold standard, caused the depression.   At Milton Friedman’s 90th birthday celebration, shortly after becoming a Governor,  Bernanke spoke for the Fed.  This was his message: ‘I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.’

Bernanke thought he had all the answers. He wrote at the time ’a smart central banker can protect the economy and the financial sector from the nastier side effects of a stock market collapse.’ (The Goldwatcher Page 61). We all know he was wrong on that one for a range of reasons.  Now,   92 year old  Anna Jacobson Schwatz has commented in a WSJ Interview , Bernanke knew history and should have responded differently when the present crisis erupted.  In her opinion ’ Today’s crisis isn’t a replay of the problem in the 1930s, but our central bankers have responded by using the tools they should have used then. They are fighting the last war…I don’t see that they’ve achieved what they should have been trying to achieve. So my verdict on this present Fed leadership is that they have not really done their job.”

Chapter 5: The Dollar Standard and the ‘Deficit without Tears’ associates with the question ‘Is the $ again America’s currency and everyone else’s problem?’ Opinions from several respected economists are discussed in this Chapter, including Nouriel Roubini’s criticism of the so called ‘Bretton Woods 2′  arrangements - the foundation for the convenient ‘America spends Asia lends’  pattern promoted by Alan Greenspan, George W. Bush and Ben Bernanke to give the illusion of prosperity.  Nouriel has been forecasting a breakdown of Bretton Woods 2 since the theory was first introduced. But  at an IMF Seminar he presented a year back he acknowledged that, in the event of a recesssion, once China  realised the extent to which it would be a loser following an economic collapse in the US,  it would be unlikely to ‘pull the plug’ on the US. (The Goldwatcher pages 86/87)  I had the opportunity to discuss this with him in June this year. That was still his view - and as far as I know still  is. It’s also consistent with the view of Frank Holmes in the post below.

# Note posted on 24.10.08 : In this Bloomberg Video of  Roubini mentioned above he argues that  if the US can’t import substantially from China it won’t have the benefit of vendor finance and will be unable to secure funding from China on favourable terms.

 Can We Save the World Economy? A Conversation with Geroge Soros, Nouriel Roubini, and Jeffrey Sachs 

This video of a discussion at Columbia Columbia University moderated by CNN’s John Roberts is essential listening for readers seeking a better understanding of the origins, potential results and possible ways out of the present crisis. Roubini (pictured above) is as usual straight talking,  pragmatic and he pulls no punches. George Soros,  who has been writing about the end of the era ‘of international expansion based on the dollar as the international currency’ explains the errors in policy and general perception that  led to the flawed belief that the market is always right. (The Goldwatcher Page 96.) Jeffrey Sachs reviews wrong  priorities over the the Bush YEARS..  A common thread they share is the need for a well directed fiscal stimulus - not only in the US, but globally. Again to an extent consistent  with the view expressed by Frank Holmes below.

For those concerned over the recent fall in the gold price it;s worth  listening carefully to George Soros’s commentary in the CNN video and not assuming the market is always right.

 Jacques Rueff & ‘The Deficit Without Tears,’ that could end in tears:

The French Economist Jacques Rueff, committed believer in a gold standard  and relentless critic of the dollar standard,  coined the phrase ‘deficit without tears.’ It describes the privileged status of the US under the Bretton Woods arrangements that made it possible for it to run a deficit that would never disappear while the dollar standard prevailed. (The Goldwatcher Page 87). Rueff’s conclusion was inevitably the dollar standard and associated deficit will lead to a global economic crisis that will end in tears and an event akin with the Great depression.  Rueff could, alas, still be proved to be right

Chapter 9: Gold price prospects and owning gold:

This Chapter on gold price prospects anticipates the Global Crisis of Confidence and ends with serious oncerns over both outcomes for the dollar and an economic crisis on the scale of the Great Depression. But it’s acknowledged  that strong leadership can still get the US and Word Economies back on track. That’s also very much the message I got from the interviews with Roubini, George Soros and Jeffrey Sachs. And it’s also what most of us, optimists a heart. expect.

But what if outcomes are not as benign as we hope they will be?  While no one can answer that question everyone can be better equipped to deal with the consequences of worst case scenarios by holding some gold as insurance against the unthinkable.(The Goldwatcher Pages 8-9)

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Foolish optimists may deny reality:

A clear message on ’stuff that happens’ in a depression comes with this week’sTime Magazine’s. It’s not scaremongering. The cover note reads  ’No, this isn’t Depression 2. How history can help us avoid it. ‘ Renowned economic historian Niall Ferguson identifies the real cause of the 1930s Great Depression as a contraction of credit following an epedemic of bank failures. This time round,  he argues,  policy makers can avoid the ravages of a depression by running deficits and printing money. President Franklin D. Roosevelt,  in  his 1933 unaugural  address,  lamented ‘the withered leaves of industrial enterprise on every side…the savings of many years in many families gone.’   Sounds familiar?  The  US President taking office in January 2009 will again see withered leaves  and a nation of stock exchange investors distraught at losses in their their recent 401K statements. Roosevelt concluded  ’Only a foolish optimist can deny the dark realities of the moment.’ (The Goldwatcher page 63).

You may think it a lot of tosh to quote from a 1933 speech now. US unemployment is only 6.5%. It was 25% in 1933. But keep in mind crumbling fortunes in the automotive industry. Unless the rot can be stopped now US unemployment could surge. Though he has since sounded more optimistic only yesterday IMF Chief Dominique Strauus-Kahn warned ‘Intensifying solvency concerns about a number of the largest U.S.-based and European financial institutions have pushed the global financial system to the brink of systemic meltdown.” The Goldwatcher Chapter 8  ‘Globalisation and Global Economic Re-balancing’ addresses the question ‘Can the IMF avoid global financial meltdown?’ (Pages 153ff).

Can GM & FORD survive?

Long term chart showing share prices for GM, Ford & Mattel (Matchbox Toys)

Click image  to increase size

Last week equity markets had little faith in General Motors future. The market value of GM shares fell to less than $2.8 billion - about half the $5.5 billion value for the maker of Matchbox toy cars Mattel!  In inflation adjusted dollars GM is now worth even less  than it was in 1932.   Hat tip to Bloomberg for that info.  As Ford celebrates the centenary this year of  the car that literally put the world on wheels,  Henry Ford’s Model T,  Ford’s $4.5 billion market cap is nearer the ‘Matchbox Standard’ than GM. But it’s still less than Mattel and far from encouraging. Ford’s prospects for the future are probably on a par with GM.

# llustrations above: A 1932 GM Chevrolet and 100 year old Ford Model T

           # Reference added 27th October : F.T. Interactive on Auto Industry employment

A $2 trillion deficit for the US in 2009 & other money printing orders:

Over this weekend the Washington meetings of G8 Finance Ministers, the IMF and the World Bank  appear to have recognised, belatedly, the extent of the world’s economic crisis and agreed to co-operate in as yet undefined ways. The key measures announced were:

# a pledge to guarantee until the end of 2009 bank debt issuance of maturities up to five years;

#permission for governments to shore up banks by buying preferred shares; and

# a commitment to recapitalize any “systemically” critical banks in distress The participants don’t know how much money will have to be printed to paper over the cracks or who will have to print the money. If they do, they haven’t told us.  Dr. David Greenlaw, Morgan Stanley’s chief monetary economist, estimates the US federal deficit next year will not be less than $2 trillion.

In the UK we are also bailing out and investing in our banks. Over $1 trillion has been mentioned as the tab.  Add in the US $2 trillion and $3 trillion is accounted for by the Anglo Saxon World alone. And, as we still fantasise that the Anglo Saxon countries run the world lets add a meager 1$trillion to the money printing order for the rest of the world. Adding everything together at least  $4 trillion is needed to keep the global economy ticking. In the heyday of the age of entitlement we also expect tax cuts and an economic miracle.

Niall Ferguson writes in Time Magazine :

‘Now, unlike as in the Great Depression, central banks and finance ministries know it’s better to run deficits and print money than to suffer massive losses of output and jobs.’ 

Even Ferguson is silent on what stabilising the financial system will cost or what depreciation in the purchasing power of paper to expect after all the money printing.   Extreme examples of hyperinflation are the Wiemar Republic and Zimbabwe. More relevant to us now, however, are the 1930’s after the Great Depression and the 1970/80’s after President Nixon abrogated America’s obligation,  when required to,  to settle debts to foreign treasuries  in gold at a parity of $35 per ounce of gold. The sustained global inflation in the teens that followed led to the greatest peacetime inflation in history. (The Goldwatcher Pages 78/9)

The crisis of confidence:

The introduction to The Goldwatcher Chapter 9 is sub titled ‘A crisis of confidence.’ It’s more acute now than at the time the content was written at the beginning of this year. Gretchen Morgenson makes these astute comments in this morning’s New York Times:

‘WORLD financial markets operate on confidence…But the leading lights of finance, whether in Washington or on Wall Street, have completely squandered any trust that taxpayers may have had in them. Earning it back is going to take time and a commitment to transparency…the same people who are scrambling to reassure investors with bold actions were as recently as July telling investors that everything was hunky-dory. Here is Mr. Paulson, quoted by The Associated Press, on July 20: “It’s a safe banking system, a sound banking system. Our regulators are on top of it. This is a very manageable situation.”Let’s rewind further, to early May. Mr. Paulson allowed that the worst was “likely” to be behind us. “There’s no doubt that things feel better today, by a lot, than they did in March,” he said. His take on May 16, when the Dow Jones industrial average stood at 12,986, was as follows: “Looking forward, I expect that financial markets will be driven less by the recent turmoil and more by broader economic conditions and, specifically, by the recovery of the housing sector.”…In the first half of 2007, almost every senior regulator assured us that troubles in the mortgage markets would be “contained” to sub-prime loans.’

Currently the intelligent investor is likely to be contrarian.  Yes, co-ordinated global  initiatives are in progress to get money flowing again and restore trust. With enough money thrown at the situation the present crisis will settle down. Treasury Secretary Paulson has reported on progress with his initiatives to enlist global support directed at ending the current financial crisis. The IMF Chief Dominique Strauss-Kahn has announced the IMF is on board. Paulson has acknowledgeds he will get a better return on Federal Funds  by investing and supporting the capital base of American banks instead of only underwriting and buying the risky toxic debt no one else will buy. 

Intelligent Investing through a reflationary rescue: 

 The reflationary rescue orchestrated by Bernanke and Paulson has now gone global. Gold remains the ‘prime beneficiary’ of the reflationary rescue and belongs in the anti risk investing strategy outlined in The Goldwatcher page 184.

On line debate Friday 27th June.

Two of the world’s well respected commentators on gold will exchange views on the most significant global threats and top global opportunities on Friday at 11 a.m. ET. ( 4 pm UK time.)  

In the foreward to The Goldwatcher Marc Faber warns of the Zimbabwe-isation of the dollar. In a recent posting on his blog Frank Talk Frank Holmes attributes the surge in commodity prices to lack of foresignt…….  ’we have to turn around and adjust to the fact that the population of the world has doubled. We’ve underinvested in the exploration and development for energy, for copper, potash, there’s no copper or potash mine being brought onstream, of significant size, for the past 30 years. Same thing with oil and gas fields.’   And, I expect, with gold and other precious metals.

The link to the Friday webcast hosted by US Funds gives the log in details.  The debate is bound t0 explore the key macro issues affecting gold, energy etc and will include practical information for investors. 

Gold price expectations:

 Global catastrophists see $10,000 on the horizon for gold.  Raging bulls are looking north of $2000. Even the tamest of bulls have $1000 in their sights. To be sure, there hasn’t been a time in living memory when supply and demand fundamentals for gold were as positive as they are now, but in 1980 and 1981 there were some similar conditions to 2007 and 2008.  Lame duck US Presidents in office till the imminent end of their disastrous administrations (Carter and Bush). Global economic problems.  Geopolitical insecurity in Iran  and Afghanistan. Surging oil prices. Rising inflation and a falling dollar. 

Gold isn’t expensive at  $900 or $1000 dollars  compared to 1981. The $460 average gold price for 1981 equates to $1000 in 2008 dollars after allowing for consumer price inflation. The price spike in January 1980 to $860 equates to $1900 in 2008 dollars!

In 2008 we must add to our serious worry list nuclear and other risks from Pakistan. We must also add to our list of the virtues of gold’s stateless money franchise a U.S. Fed Funds rate now below the rate of inflation and surging wealth in regions traditionally addicted to gold. They include Middle East, Russian and other petro dollar mega rich oil exporting countries and,  of course China and India,  the world’s most populous nations and fastest growing economies

The LBMA price forecasts for 2008:

Where is the gold price going from here? The 2008  London Bullion Marketing Organisation annual survey of analysts is a useful guide to prospects. The average of the forecasts for 2008  is $862 – up appreciably from the $652 forecast for 2007. Over half the contributors also expect gold to reach prices above $1000 in 2008. Forecasts in the LBMA survey are all supported by reasons for conclusions reached. The track record of the forecasters over the last few years can also be reviewed. 

Commentary from the experts:

BlackRock Merrill Lynch Managing Director Evy Hambro manages  the $15 billion World Mining Fund. The fund rose the most among Europe’s 10 largest stock funds last year. Hambro gives a clear account of the powerful supply demand factors supporting gold in an interview in the February 2^nd  edition of Money Observer.   He describes the prospects for gold as beating anything he has seen in his career and expressed similar views in an interview with Bloomberg Television early in January.

Frank Holmes, co-author of The Goldwatcher, presents comprehensive analysis on supply and demand for gold in a web presentation ‘What’s Driving Gold.’   Contrarian investors have consistently scored the best results with gold and Frank Holmes’s recent comment on being an ‘Intelligent Contrarian.’ is a must read. He warns on market over reactions ‘when the media works itself into a frenzy—either bullish or bearish’ and advises investors in gold shares to buy at ‘wholesale prices’ and sell at ‘fairytale’ prices.

As issues are seldom black or white different perspectives on a subject are essential. The Economist January 24^th edition features two perspectives on the global economy. Commentators have latched on to the dire story ‘It’s rough out there’ addressing the scary panic in financial markets.  However another article in the same edition ‘Somewhere over the rainbow.’ has been ignored. In that article The Economist looks behind the headlines and finds  a world  unexpectedly prosperous and peaceful.

Gold price overshoots and undershoots:     

The average price for gold over 2006 and 2007 was $540. With gold at over $900 it is up about 70% on that average. Nothing to say it won’t go higher fast if there is a catalyst for a further  rise - or if buyers or speculators are enthusiastic enough to drive the price further regardless. But,  while fundamentals certainly support strong prices,  gold may not continue to surge at a breathtaking pace. Price overshoots and undershoots are par for the course in currency and commodity markets and,  with over fifty e-mail messages on the death of the dollar and future astronomical gold prices coming in the e-mail every day, gold may no longer be a pukka contrarian investment opportunity. Prospects for the gold price are certainly good. But following the herd to the bandwagon doesn’t always pay.

Part One of The Goldwatcher comprises Ten Chapters with background information on  when gold prices make sense and when they don’t. Yes, there is a danger of a Wile E Coyote moment with the dollar falling over a cliff and plunging,  but the market has known about it for some time and the dollar has already fallen considerably.  A February 2007 video interview with Paul Krugman delves his views on risks to the dollar including a plunge.

Publication of The Goldwatcher.  

 Thanks to the evolving sub prime mortgage, securitisation, shadow banking and regulatory failure crises that evolved over the second half of 2008  it took me much longer to write my contribution to The Goldwatcher than was expected  - or intended.The book is in production now and will be on sale by May

The Iraq fiasco

‘President George W. Bush’s decision to invade Iraq in 2003 ultimately may come to be seen as one of the most profligate actions in the history of American foreign policy” according to Tom Ricks, Washington Post columnist and author of the bestseller Fiasco: The American Military Invasion in Iraq. He concludes ‘Democracy may yet come to Iraq and the region, but so too may civil war or a regional conflagration, which in turn could lead to spiraling oil prices and a global economic shock’  The US will probably have combat troops in Iraq for ten to fifteen years.  He is a  contributor to the PBS Film ‘The Lost Year in Iraq’  that relates how the United States reached the predicament it is in.  An on line interview with Ricks recorded yesterday brings his analysis up do date.This terse ten word summary from a military chief in Iraq on the new American chain of command and strategy is worth repeating :  ‘Bottom line -  right people - right strategy - too little – too late.’

The other hard place: Afghanistan

It’s also going to be ten to fifteen years for us in Afghanistan. Word from Sir Sherard Cowper-Coles,  the new British Ambassador is the task of shoring up a government in that war-torn nation will be a “marathon rather than a sprint. ” Britain is establishing a larger embassy in Kabul than we have in Washington. Evidently the Taliban don’t like that idea. News from the Taliban   is they are adopting the strategies of Iraqi insurgents with Kabul in their sights.

The right strategy

Recognise the risks of  civil wars ‘or a regional conflagration that will lead to spiralling oil prices and a global economic shock” with war time economies burdened by inflation.