Gold is a Bargain, Even Above $1,000

Michael J. Kosares says ......
Despite a four-digit price tag, gold remains a relative bargain when a little perspective is applied.

The inflation-adjusted price of gold at its 1980 peak is just over $2350 — that leaves a considerable amount of headroom just on the basis of making up for past inflation, let alone the prospect of continued inflation.

The gold rally of 1970-1980 began in much the same way as the current rally, eventually catching up with inflation, ultimately pushing significantly higher to price-in future inflationary expectations. Having said that, we could indeed still be a long way from any potential top.

The new gold market began in 2002 and is now in its 7th year (in 2009). In terms of cycles, the gold market may have years left to run, consistent with the bullish implications of inflation-adjusted gold.

Jim Rickards, director of market intelligence for Omnis, said in a recent CNBC interview that the Fed is going to have to manage a 14-year devaluation of the dollar – by as much as 50% — with the goal of inflating away a portion of our massive and still growing debt.

I believe Rickards chose a 14-year timeline because it equates with 3.5% to 4.0% inflation over the period. An oppressive inflation rate to be sure, but shy of true hyperinflation. If Rickards’ assessment is accurate, it likely equates with at least 14 more years in gold’s bull run.

Unfortunately in this age of instant gratification, most investors tend to focus on the short-term, when it is the long-term that really matters. Examining the more familiar secular bull market in U.S. equities provides an opportunity to perhaps ascertain where we might be within the current bull market in gold.

The first gold bull market lasted about 13-years, beginning in the late-1960s and lasting to the early-1980s. After a few years of adjustments, the bull market in stocks began around 1982 and lasted until 2007, with a brief respite when the tech-bubble burst in 2000, which was quickly offset by extremely loose monetary policy.

During the 25-year bull market in stocks, the DJIA went from a low of 770 to a 14,480 high — up nearly 19 times. In its first seven years, 1982 to 1989 stocks rose roughly 3.6 times — or roughly 15% of the complete move. Similarly, gold during its first seven years has appreciated roughly 4.0 times having started its bull move at $250 and trading in 2009 at just over $1000 (1032 high as of this writing), and we are not yet at the end of the year.

Some analysts believe the DJIA/Gold ratio is heading back to a not unprecedented 1 to 1 ratio. The chart above shows that such a move is very feasible and could be attained by a dramatic rise in gold, a dramatic drop in the DJIA, or more likely some combination of significant gold gains and significant stock market losses.

If gold were to continue to track the stock market’s bull market performance, gold would top over the next years in the vicinity of $4750 per ounce. Will $1000 gold represent less than 25% of the gold market move?

Of course, any number of events could intervene to prevent gold from reaching that level, or vault it even higher.

As an example of the latter, take into consideration the nightmare German inflation that took hold in the period between the First and Second World Wars. Famed economist John Maynard Keynes summed it up nicely: “The inflationism of the currency systems of Europe has proceeded to extraordinary lengths. The various belligerent Governments, unable, or too timid or too short-sighted to secure from loans or taxes the resources they required, have printed notes for the balance.”

At the beginning of World War I in 1914, an ounce of gold cost 86.8 marks. By November of 1923, the hyperinflationary blowoff drove the price of an ounce of gold to a staggering 63,016,800,000,000 (paper) marks. (Yes, that’s 63 TRILLION marks!)

The following chart shows the ascent of one gold mark in relation to one paper mark. Invert the chart, and you have an illustration of the demise of a fiat currency in just a few short years. Similar events are unfolding even today, where an ounce of gold was not available at any price in terms of Zimbabwe dollars as a result of massive money printing.

I’m not suggesting things are likely to get as bad as Weimar Germany in the 1920s, but none of the conditions that have shepherded gold above $1,000 on several occasions now have suddenly gone away. In fact, one could argue that they have accelerated of late, resulting in the first ever monthly close above $1,000 (September 2009).

At the end of the aforementioned CNBC interview, host Joe Kernan says to Jim Rickards, “You just made a heck of case for buying gold right at $1,000…”

It would seem there are any number of cases for such action.

With due apologies and full credits to the author

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Monday, 28 September 2009

Gold: Hyperinflation: Millions, Billions, Trillions And Then...

John R Ing says .....

$16 for a loaf of bread? Money carried in wheelbarrows? Hyperinflation, an event from the past?
Most investors today are now familiar with the lessons of the Great Depression. But few are so sanguine about the lessons of the 20s and the Weimar Republic's hyperinflation. History is full of examples of countries that failed to pay their debts, opting instead for hyperinflation to pay their bills. Inflation simply reduces the value of debt, hurting creditors and postpone the inevitable adjustment. History also shows that deficit spending and printing money is so addictive and politically expedient that governments rarely manage to reverse the downward spiral. Hyperinflation is a greater evil that wipes out savings and destroys more economies than depressions. Right now, hyperinflation is a greater risk than the 1930's style depression that so many fear.
In the last century there were over 25 episodes of hyperinflation with most occurring in the half century. While many know of the Weimar Republic hyperinflation, few recall the French hyperinflation in the 1800s, nor of China's from 1935 to 1949. Ukraine faced hyperinflation in 1994. And fast forward today, Zimbabwe is still experiencing hyperinflation.
In the last two decades, inflation was like the five cent cigar. The lack of inflation has allowed America's politicians to spend more, promise more and the consequences have resulted in a series of bubbles. Easy money allowed homebuyers to buy homes they could ill afford leading to an inflation in property prices and of course the inevitable bust. But few people remember that America has experienced double digit inflation in 1910s, 1920s, 1940s, 1970s and even in the early 80s. It seems like only yesterday that we were on the verge of a collapse of the world's financial system. A year on the steep rally that started in March has been fed by the identical recipe of cheap money and big doses of government spending that spawned previous bubbles.
Recession, What Recession?
The good news is that Washington, contained the meltdown through government support and bailing out Wall Street. The bad news is that the record amount of debt will cause yet another and deeper wave of financial crisis. The really bad news is that America's creditors are running out of patience, and the unprecedented monetary easing and fiscal expansion will push down the dollar causing a bigger decline and hyper-asset inflation. Having just emerged from an economic trauma caused by excessive spending and debt, what we don't need now is more spending and debt.
While largely a twentieth century phenomenon, in every decade we have experienced hyperinflation. A study of some 20 hyperinflation episodes reveals that most lasted about five years and all were preceded by up to a decade of excess government spending such as today. And in all hyperinflations there was a common ingredient of loose spend and the excessive printing of money by these heavily indebted countries.
One thing is now clear. When governments spend more than they bring in, monetize their debts with increased supplies of fiat currency to fill the gap, great countries can go insolvent. Weimer Germany became the world's largest debtor facing huge war reparations that exceeded its GDP and could not pay their bills so took to printing money that ended in hyperinflation. France's eighteen century collapse was caused by printing so many assignats that businesses closed and it took over forty years for a full recovery. In Zimbabwe today, Robert Mugabe expropriated land, printed dollars and the economy came to a halt, revived only when they used outside currencies. Or there is Argentina which monetized its deficits and is going through a second bout of hyperinflation. And then there was China's near bankruptcy caused by Chiang Kai-Shek's numerous wars with Japan and the Communists which caused his government to takeover the banking system in order to fund its deficits with printed yuans that ended in hyperinflation and the collapse of his government.
What is Hyperinflation?
The major cause of hyperinflation is a massive increase in the supply of paper money to finance a sovereign government debt, usually over 100 percent of GDP. One far reaching consequence of the global financial meltdown is that debt made a bad slump worse, particularly those with high debt to GDP ratios. We believe that despite the green shoots of recovery, the United States is running up such an enormous national debt as a percentage of GDP that they risk eventual default. Indeed, a look at America's monetary base shows it has exploded at an unprecedented 110 percent flooding the financial system with money.
Another obvious parallel, is that the hyperinflation countries in the past often abandoned a tangible backing such as gold or silver in favour of printing a fiat currency. Many even created financial instruments as substitutes for money. For example in the French experience, land for a time backed the assignat in the modern day equivalent of a mortgage backed security. Without the need of a monetary discipline like gold or silver to back money, governments find it too tempting to resort to the printing press to pay their bills. After all, money is a form of a government liability so a paper currency without an implicit backing other than a state based faith, is dependent upon public confidence.
Milton Friedman once said, "Inflation is always and everywhere a monetary phenomenon". Inflation enabled governments in the past to reduce or avoid repayment of their debt burdens. Inflation also makes certain assets worth more and today we have a healthy dose of hyper-asset inflation. When too much money chases too few goods it creates pricing pressures. Stock markets and tangible assets are up. Price inflation is next.
We believe a look at the crises of the past gives us a better understanding of the present and the future. Today there are too many similarities with past hyperinflations from the usage of the Fed's quantitative easing methods to pay for deficits caused by wars and excess spending, to the mobilization of the banking system as surrogates of the central bank, to the Fed's mark up of Wall Street's toxic assets to pay off loans. The US is not the first country to resort to the printing presses but the sad truth today is that no one, including "Helicopter Ben" is talking about how to fill the gaping hole in the federal budget. History shows that hyperinflation is often the obvious solution, choice and consequence.
Hyperinflation in the Weimar Republic
Before World War I, Germany was a prosperous country with a gold-backed currency. Germany abandoned the gold backing in 1914 to finance the war with some 160 billion marks. The dollar then was worth 4.20 marks. After WW1, Germany became the biggest debtor in the world facing huge war reparations primarily to the Americans who had become the creditor to the world. Today, the roles are reversed with America, the biggest debtor while China now plays the role America played then. Germany's debt to GDP was over 100 percent. In order to pay for the war reparations under the Treaty of Versailles, the German government borrowed heavily issuing more and more paper. By December 1922, the mark fell to 8,000 marks per dollar. Postage stamps even had a face value of 1 billion marks, and by November 1923, the dollar was worth 4.2 trillion marks as monthly inflation ran at 322 per cent.
So much money was issued that over 130 companies were commissioned to print banknotes, not dissimilar to California who recently was forced to issue IOUs to honour its debts. Tangible or hard assets like diamonds or art were hoarded instead of worthless paper. Corruption flourished. Price controls were ineffective. The German people soon lost all confidence in their money. Pianos were bought by non-musical families. Tellingly, the great German industrial businesses like Krupp, Thyssen and Stinnes survived and prospered calling for a lower mark so that German goods would be cheap and help out exports. Industrialists with taxable assets did exceptionally well as did farmers who owned productive land and crops. Between 1919 and 1920, stocks went up 95 percent. Savers were the big losers. To collect its debts, the French occupied the Ruhr. Debtors became winners. Inflation then was seen to be good. In late 1923, hyperinflation was exhausted as monetary reform created the Rentenmark backed by real estate and bonds with a certain value of gold but this time, fixed in quantity. Late in November 1923, Adolf Hitler arrived on the scene with the Munich beer hall Putsch.