Inflation is destroying fixed-income bonds. Stocks have tipped into a bear market, down more than one-fifth worldwide. Real estate suffers both over-supply and an historic shortage (too many units vs. no mortgage finance). And this is clearly no time to launch a business relying on discretionary spending, consumer debt or prompt payment.

As for cash-on-deposit, you’re fighting not only tax and inflation, but also the very real threat of banking failure. Anyone taking sizable profits elsewhere has to go “on risk” until they’ve found a new home for their wealth.

“Ironically,” reports MortgageNewsDaily.com, “while the Federal Deposit Insurance Corp. (FDIC) maintains a ‘watch list’ of banks in need of close supervision, IndyMac did not appear among the 90 names on the current roster.”

Between the demise of Countrywide in March and its own collapse last week, IndyMac was briefly the second-largest independent mortgage provider in the United States. Now one-in-twenty of its customers is owed a deposit exceeding the insured U.S. limit of $100,000. Attracted no doubt by the bank’s offer of 4.75% per year in interest — twice the interest paid most everywhere else on $50,000 or above — they’re now uninsured to the tune of $1 billion.

Of course, in hindsight, it’s easy to guess the good reason why IndyMac was paying above-market interest. Like everyone else, it needed the cash — only much more so! And until the FDIC either finds a buyer or goes ahead with running the new IndyMac Federal Bank as a going concern, those uninsured depositors have been told they can access only one-half of their funds. The other half-a-billion remains out of reach

The takeover of IndyMac is expected to drain $4-8 billion from the FDIC’s insurance pool. Quite what the Fed’s new loans to Freddie Mac and Fannie Mae will do to the purchasing power of what’s left — plus the Treasury’s explicit promise to underwrite their bonds — remains to be seen. They owe some $5.5 trillion between them. Now the credit-ratings agency Standard & Poor’s puts the full cost of a tax-funded bail out of the two government-sponsored home lenders at between $420 billion and $1.1 trillion.

That compares, as the RGE Monitor reports, with a final cost to U.S. taxpayers of $250 billion for the Savings & Loan rescue of the mid-1980s (inflation-adjusted).

No bail out, of course, and the destruction of wealth hardly bears thinking about. But just what would an extra $1.1 trillion in U.S. obligations mean for the value of existing dollars and T-bonds?

“[He] caused an Iron Chest to be brought, and put the money in it, then drove Posts into the Ground in his Cellar, and chained it down to the Stakes, then chained it also to the Wall, and barricaded the Door and Window of the Cellar with Iron, and all for fear, not of Thieves to steal the Money, but for fear the Money, Chest and all should fly away into the Air…”

So wrote the anonymous hack behind The Chimera, a pamphlet recalling the French Way of Paying National Debts for investors in London in 1720. The French way, the author explained — just before the British got caught using the same trick — was to print new paper money in whatever quantity took the government’s fancy, and use this new currency to pay off its creditors. It worked only as long as the paper retained some level of trust.

The anxious (if not deranged) investor described above was owed 10,000 crowns in such paper. But he gladly sold his claim for 2,500 in actual coin. Because a smaller quantity of very real wealth still beats a great sum of value-less debt.

Is that where investors today should hide their wealth, securely and safely? Inflation in prices and deflation in assets is an ugly combination. It also turns the “Long Boom” of the last 25 years on its head. So a growing number of advisors would point you to that long-forgotten asset class — physical gold or perhaps silver — as a rare store of wealth.

It might also help that you can chain down this wealth behind a thick vault door, deep underground.

“There really is no other place to hide,” believes Stephen Platt, an analyst at Archer Financial Services. “Gold’s about the only real currency out there that might hold value.”

Even after trebling in price from the low of eight years ago, there may be plenty of room for gold to rise from here. “In 1959, the amount invested in gold was about one-fifth of the market value of all U.S. common stocks,” writes Peter Bernstein in his classic, The Power of Gold. “In 1980, the $1.6 trillion invested in gold exceeded the market value of $1.4 trillion in U.S. stocks.”

The sum total of gold investment lags far behind the value of stock and bond markets today. Indeed, a 2005 study from Tocqueville Asset Management noted that, if taken altogether, “the market cap of all above-ground gold — including central bank reserves — [now] equals about 1.4% of global financial assets.”

“In 1934 and 1982,” on the other hand, “when investor stress reached extreme readings, that percentage was between 20% to 25%.” If you wanted to steal a march on the market, you might want to consider moving that portion of your wealth into physical gold today.

No, the metal isn’t guaranteed to keep gaining as “investor stress” rises to match the Great Depression or early ‘80s recession. But nor will its value fly away into the air.

For as long as the cost of living is rising but asset-prices are falling, that should prove a major advantage over holding bonds, stocks or cash.

Regards,
Adrian Ash
BullionVault
July 18, 2008

IndyMac’s Collapse was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

The whole truth is that gold has very few industrial uses at current prices. Gold is worth about 55 times silver and more than 3,000 times copper per unit of comparable weight. If it were as cheap as copper, we would have wired our houses with it, as well as the Internet; if it were even cheaper, you’d probably be sitting on it in the bathroom, as that Commie Lenin advocated.

We don’t use gold in more common applications because of its finer qualities: Relative scarcity, our vanity, to name just a few. And the bulk of gold’s value is still monetary, a fact that its enemies are loath to admit. Consequently, changes in the price of gold tend to reflect mainly changing monetary factors.

Gold bugs can’t ignore the market’s judgment, either. They must acknowledge that the monetary demand for gold had in fact ebbed during the 1980s and 1990s in favor of the dollar standard — a standard launched by default in the early 1970s.

The waning view of gold as money helps explain why gold didn’t keep up with the Consumer Price Index (CPI) through the ‘80s and ‘90s, despite the three-fold increase in narrow money (M1) and the five-fold increase in broad money (MZM). The bears claim this poor record shows just how bad an inflation hedge it is. But their time horizon is both short and selective.

I’ll give the bears credit for identifying the drop in the monetary demand for gold as the reason it lagged the CPI in the ‘80s and ‘90s. But they are hopelessly naïve if they believe that the 35-year-old dollar standard is an evolution in the monetary system, as if it were progress. Gold served as the market’s solution for money for thousands of years.

The government forced the dollar onto the U.S. producer by legal tender and other laws. It forced the dollar onto trading partners by extortion. These partners were already drowning in dollars no longer backed by gold. They had to choose between letting the whole system fall apart and using the new “dollar standard” to their advantage. America had the largest and most developed consumer market in the world at that time, and they all wanted in.

Fast-forward to today: After a couple of decades of experimenting with this system, it is no longer working to anyone’s satisfaction. In order to maintain their trade advantage, America’s trading partners have to inflate at an ever faster pace (than the Fed) and soak up increasing quantities of dollars. This scheme always was untenable, but now it’s falling apart. There’s even talk of the need for a new global reserve currency.

So far, the media spotlight has been on the euro as contender, but the media will see that is untenable too. Gold is really the only alternative to the dollar. But that’s a lesson the gold bull market has yet to teach. Let me know when you can use the euro on the streets of Bombay or in a Wal-Mart in California as easily as you can use the U.S. dollar, or at least when the price of gold stops outperforming the euro. Then I might consider taking it seriously. Meanwhile, we’re likely heading back to where this story left off in 1980.

Playing with Numbers

Before I delve into a rudimentary analysis and probably futile attempt to value gold, let me admit that I don’t know how high it is going to go. No one really does. We’re all just guessing. A bull market in gold basically means that gold’s monetary allure is on the rise. That is, market participants are beginning to prefer it again — either as a hedge against inflation (investment), a measure of monetary value, a means of international settlement, a monetary reference point, or even as a genuine medium. These reasons all constitute what I mean by “monetary demand.”

Of course, no such thing as a bull or bear market in gold would exist if gold were already money, because the total demand for money does not fluctuate very much. On the other hand, the total demand for a particular kind of money may. The bull market in gold is a byproduct of the decline of the dollar standard. Not surprisingly, it is outperforming the CPI again.

If the CPI were an accurate measure of changes in the value of money, and the monetary demand for gold were constant, the CPI-adjusted gold price might represent some notion of fair value for gold prices. But the CPI is anything but a reliable measure of change in money values. Chances are it understates this problem.

Is a Gold Correction Coming?

I have been forecasting “Gold: $2,000-2,650” for many years now. My early forecasts, back in 1999 and 2000, called for a straight-up move to $2,000 per ounce. That forecast overestimated the willingness of investors to grasp the gold story and underestimated their addiction to the prevailing monetary policy, and I scrapped it in 2001 in favor of a more drawn-out affair.

I adopted the view that this bull market would last 10-15 years and include two-three sequences.

We are now on year seven of the current advance — the first primary sequence. There is little doubt in my mind that the dollar standard is on its way out and that the monetary demand for gold will return to the levels of the late ‘70s. But the exact prognosis is anyone’s guess.

As a trader, I can tell you that nothing goes straight up. The market tends to change the rules just when most people have become accustomed to a particular set. Hence, every bull market contains surprisingly violent corrections. These corrections convince many latecomers that the bull market has ended.

None of the corrections we’ve seen in gold during the past seven years qualify as this type of correction. The rise in gold prices to this point has been steady and sustainable. For much of its rise, gold has been in a stealth bull market. But the gold price advance is no longer stealth. It’s not as spectacular as oil’s advance or some of the base metals’ advance in 2006, yet. But the chart says it wants to go parabolic.

That’s the good news. The bad news is that such moves bring in weak hands, which set the stage for a big correction. Remember this whether you want to trade the trends or buy and hold.

Regards,
Ed Bugos
February 6, 2008

The Price of Gold was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.