By Andrew M. Gause
No review of gold’s potential is complete without considering the Federal Reserve. The FED controls the price of gold and everything else through it’s monetary policy. In a maneuver known as quantitative easing, they have been monetizing debt by buying bonds with newly created money at an ever increasing pace. This action makes each dollar worth less, causing prices to rise. However, recently Mr. Bernanke told an eager public that he may taper purchases of bonds. The gold market reacted violently to the downside. After all if the FED stops creating money, the price of things, including gold will fall. Another area that reacted badly is the bond market. Prices and values for long term bonds tanked 10% virtually over night. One thing to bear in mind is that the FED has already purchased nearly $3 trillion worth of bonds. These bonds are carried on the FEDs balance sheet as an asset. The value of those assets is now down by $300 Billion, so forget the prospect that the FED can sell them and get back the money paid without taking a loss or further damaging the bond market. For the moment, reason number one to own gold is that the FED WILL NOT slow its asset purchases. In fact they will increase the pace before they slow or stop.
Reason number 2 would have to be the general attitude of the investment community towards gold. As I sat to write this list I considered the main reasons why the average investor buys gold. It really boils down to two, either they believe the dollar will collapse into financial Armageddon or they expect a good dose of hyperinflation as monetary authorities print their way out of trouble. Sentiment for either reason is at all time lows and Mr. Bernanke’s statement fuels that belief. One look at the business headlines will reveal an optimistic attitude about the economic recovery and a pessimistic slant to anything gold. Lets face it, if the dollar isn’t dead or dying, why own gold? As a result both institutional and individual investors have steadily dumped their gold holding GLD shares. This, the largest bullion-backed ETF has seen its assets cut in half from its peak of $77.5 billion in 2011. A great deal of this so called “fear trade” contributed at least 30% of the upside in the last 10 years. Wouldn’t it stand to reason that their departure would have the opposite effect?
It did… which brings us to reason 3, the correction has just passed and gold is way oversold. Contrary to reports, the $1180 bottom so widely predicted is probably just that and buying in now makes a lot of sense if the fundamentals haven’t improved .
Reason 4The fundamentals haven’t improved. Unemployment remains stubbornly high, while economic growth is anemic. Although, the housing markets have shown some improvement, growth in this area is not as robust as many believe. The tripling of the FEDs balance sheet has not provided the hoped for stimulus.
Reason 5 is the Federal government’s spending habits. Despite the 2012 tax hikes and the $88 billion Treasury cut of the FED’s aforementioned bond holdings, the Federal budget deficit for May was in the top 5 ever recorded. The debt ceiling has simply been suspended, perhaps never to be heard from again. If interest rates are allowed to rise, interest on the debt will rise. Talks of slowing spending are off the table as the debate shifts from practical financial matters to social issues. Crazy deficits alone are a great reason to own gold.
While we are on the subject of owning gold, we must consider the form in which it is held. Last years bankruptcy of PFG and the previous year’s MF global debacle, have started a move toward physical gold. Owning gold and having gold is not always synonymous. As various gold ownership schemes fall into disrepute, the only sure way to own gold will be in physical form. Couple this with unrelenting physical demand from the Indian sub-continent and Chinese buyers. These factors will combine to reveal a physical versus paper gold showdown with ever increasing price disparities between the two. That is reason number 6 to own gold.
A general credit crunch is the 7th reason to buy gold. Treasury’s borrowing needs are bound to increase from here. In addition, a great many banks and other institutions in Europe are finding themselves short of cash. No one is buying bonds to hold to maturity. As interest rates fell buying bonds and notes has been a no brain, flipping exercise for most investors. Buy a batch of bonds, hold them for a few trading sessions and flip them for a profit to the FED or other flipping buyers. That has been the bond game for the past decade for a great many well heeled investors. If this trade collapses there will be no replacement. If interest rates are allowed to rise these investors will flee this picnic in panic.
Lack of monetary velocity is a reason 8 to buy gold. No growth in the monetary base for the last four years, means that Americans are not spending their money, regardless of how much quantitative easing the FED performs. However, Money with a Zero Maturity or MZM has grown with every dollar the FED creates. This is money that refuses to invest, it is liquid now. When the general public unleashes this torrent of money, inflation will rage.
The 9th reason for gold prices to rise is the cost to manufacture. It costs a lot of money to bring gold to market. Bullion must develop somewhere over $1,500 an ounce for the mining industry to be sustainable. According to Goldcorp, its cost to manufacture gold is $1135 per ounce. Gold mines are not non profit ventures. If gold mines cannot make a profit they will simply close. This will exacerbate the supply and demand imbalance
The 10th reason to buy gold is perhaps, the most obvious. Gold has been a store of value for over 5,000 years. As track records go, that’s a fairly good one. In this age of uncertainty, nothing will weather the tests of time better than gold.
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July 3, 2013 @ 8:43 am Dan
Thanks for the list, Andrew. Puts things in perspective and keeps us on track.