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Longboat Key Wednesday, Sep. 30, 2009 8 years ago

The price of gold remains cheap

by: George Rauch

A Market Watch article published in June 2003 suggested that a hike in the price of gold was unavoidable. Gold was then priced at $380 an ounce. The concluding paragraph said, “Statistics indicate the minimum price for gold should be $1,700 and that price levels of $3,000 to $5,000 an ounce are not unreasonable.
The economics associated with gold clearly favors a greater gain over the next 10 years than can be seen in ownership of other investments.”

A July 2005 Market Watch article mentioned that gold was the only cheap investment. Gold was $450 an ounce at that time. “Gold experts believe gold will obtain a value of at least $1,500 to $3,000 an ounce in the next five to 10 years,” the article said.

In April 2007, a Market Watch article opined that gold was still underpriced. The price was $700 an ounce.
“Under present day circumstances,” it was written, “$2,500 an ounce to $5,000 an ounce is a realistic price for gold.”

Here we are today, with gold at $1,024 per ounce, and one has to wonder whether further gold price increases are possible. Let’s look at a series of facts about gold:

1. Declining purchasing power of the dollar. A 1913 dollar, the year the Federal Reserve System was created, will now purchase less than 2% of what it would have in 1913. That is 1/50 of the value of the 1913 dollar. Looked at another way, in 1913, gold was $20 an ounce. Twenty dollars (per ounce) times 50, equals $1,000 (an ounce), which is approximately the price of gold today. As long as inflation continues to exist, we can conclude that gold will rise in concert with the depreciation in the purchasing power of the dollar.

2. Demand for gold is increasing. For the first time in decades, central banks are not selling gold, but, rather, they are accumulating gold. Additionally, China has entered the market and is both the No. 1 producer and the No. 1 consumer of gold. Less than 2% of newly mined gold is added to the world’s gold supply each year, so increases in demand by huge buyers such as China, or central banks, can influence the price of gold on the upside.

3. The math of our monetary system is forcing gold to increase in price. In the 1930s and the 1940s, every bit of the U.S. money supply (M3) could be redeemed in gold. Every dollar obligation was covered by specie. The Constitution states: “All public debt will be settled in gold and silver species (Section 10).” The Founding Fathers wanted debts settled in gold and silver species because that rule prevents government from getting out of control financially. When a public debt could not be satisfied, services would cease or be cut down to a point at which the services could be paid. This was one of the checks and balances placed in the Constitution to limit the growth of central government. Each ounce of gold in the U.S. money supply represented $20 worth of outstanding obligations. 

Today, every ounce of gold in our money supply represents $59,000 of U.S. monetary obligations. It is easy to see with increasing U.S. indebtedness, persistent inflation and unfunded liabilities, how math alone will push up the price of gold.

4. In 1949, the U.S. had 36 million tons of gold backing our money supply. That amount has been pared down over the years to 8.2 million tons, less than 25% of what we owned half a century ago. The transfer of gold to other countries is a transfer of power. Let’s not forget the golden rule: He who has the gold, rules!

5. The world’s largest gold producer, Barrick Gold Corp., will soon issue $3.5 billion in new stock. It will use the funds to close out its hedge book (which means buying back “gold short positions” used to hedge its inventory). Barrick is investing $3.5 billion in gold at these prices, presumably because it does not think we will see these prices again soon, if at all.

6. The U.S. money supply’s approximate 236 million ounces of gold are worth about $250 billion as compared to our M3 money supply of about $14 trillion (they quit publishing our money supply statistics about two years ago, so we must now make an educated guess as to the amount of our own money supply).

7. Even though gold was $252 an ounce in 1999 and it now exceeds $1,000 an ounce, the public is still not a big buyer of gold. Various investment funds have begun to take positions in gold and in gold stocks.
When more funds focus upon gold, and the public catches on, there is likely to be a spike upward in the price. China did not allow gold ownership for years, and they are now encouraging Chinese citizens to purchase gold. China has a high rate of savings; a diversion of savings to gold, in China, would impact world gold markets.

8. In 2001, when President George W. Bush was elected, gold was selling at $285 an ounce. With gold at $1,024 an ounce, the U.S. dollar has been devalued against gold by more than 70% since 2001.

It’s hard to see how upward pressure on the price of gold can possibly be relieved with increasing government obligations paid for by debt. Debt undermines the value of the dollar, and the loss in the value of the dollar goes hand-in-glove with increases in the value of gold.

A terrific financial writer, Richard Russell, recently referred to the possibility that gold will increase substantially in value over time. “Let me get this straight — Obama’s health-care plan will be written by a committee whose head says he doesn’t understand it, passed by a Congress that hasn’t read it and whose members are exempt from it, signed by a president who smokes in secret, funded by a treasury chief who did not pay his taxes, overseen by a surgeon general who is obese and financed by a country that is broke.
What could possibly go wrong?”

The point is that this country is mired in a huge and complex economic mess. Economic uncertainty always leads to increases in the value of gold and silver. When people are unsettled and distrust their government and when they are distressed about money, they do what they have done for 7,000 years — accumulate gold.

The bottom line is this: (1) If you believe the government will get it together, don’t buy gold because over time it will go down in value; (2) If, on the other hand, you feel the promised “change” we are experiencing with the new administration means “business as usual” with more taxes and more government, gold should gain dramatically in value.

Carpe Diem.
(Psssst — government is unlikely to change.)

George Rauch, Longboat Key, is chief executive officer of Bradenton-based General Propeller and a former Wall Street investment banker.



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