The disconnect between gold and money

  • Why bother owning gold?
  • Gold going to US$10,000 per ounce — and taking gold miners with it

Publisher’s Note: This week marks the start of a brand new, five-part series by renowned global strategist Jim Rickards. The first three are an exclusive video exposé on the ground in Zurich, Switzerland, inside one of the most heavily guarded gold vaults in the world. As you’ll see, Jim had to hand over his phone and was taken to an undisclosed location in a blacked-out van in order to be able to film and uncover The Great Gold Hoax.

In Part One Jim explains why the majority of people who think they own gold, actually don’t. Who’s perpetrating this hoax? What will it mean for gold and your wealth? Watch this and you’ll begin to find out. Now, with your editor off duty this week, Jim and his protégé, Port Phillip Publishing’s Shae Russell, are taking the reins here at Port Phillip Insider. Over the next five days, Jim and Shae will explain why gold is likely heading towards US$10,000 an ounce, as we build up to the announcement of a very special new advisory service from Jim. Stay tuned.

But first, here’s Currency Wars Trader and Strategic Intelligence analyst Shae Russell…

***

I (Shae Russell) was up late on Saturday night, surrounded by a bunch of snowboarders catching the final days of the Australian ski season.

It was the usual end of day chitchat…who was a first timer, who landed their first jump, who stacked the hardest, and who nailed that elusive backwards flip.

After reliving the glory — or in my case, just being grateful that I made it down the mountain with some grace — the room full of strangers started getting to know one another.

Years on the mountain have taught me that there’s not one type of powder hound. Sure, there are the perennial ski bums. Among others in this room was a chemist, an engineer, a former banker and…me.

Once the talk turned to careers, where I revealed my profession, a young kid asked what stocks he should invest some cash he recently inherited.

It’s sort of standard for me — in fact, for any analyst. It’s no different to finding out someone is a plumber and asking for advice on what to do with some leaky tap.

Aside from the usual market jokes I have up my sleeve, I asked this kid if he had considered buying gold.

Before I get to the point of my tale, though, let’s look at the market action from today.

Markets

On Friday night, the Dow Jones Industrial Average lost 88.68 points, or 0.49%.

The S&P 500 dropped 8.10 points, or 0.38%.

In Europe, the Euro Stoxx 50 index was down 38.52 points, for a 1.30% loss. Meanwhile, the FTSE 100 closed down by 0.305%, and Germany’s DAX index was down 1.49%.

At time of writing, Japan’s Nikkei 225 index is up 114.28 points, or 0.70%. China’s CSI 300 index is up 0.72%.

In Australia, the S&P/ASX 200 is down a tiny 1.90 points, or 0.04%.

On the commodities markets, West Texas Intermediate crude oil is trading for US$43.03 per barrel. Brent crude is US$43.83 per barrel.

Gold is US$1,314 (AU$1,745.30) per troy ounce. Silver is US$19.11 (AU$25.38) per troy ounce.

The Aussie dollar is worth 75.33 US cents.

Why bother owning gold?

Shortly after I asked this kid whether he considered investing a small amount in physical gold, the former banker wanted to know why another would bother owning physical gold.

As you’re a subscriber to Port Phillip Publishing services, I’m not going to bore you with my answer. In many of our services, like Strategic Intelligence, we explain the benefits of having a small allocation of physical gold.

I’m bringing this up today because I’m continually shocked at how few people own physical gold.

As the banker added his two cents worth to the conversation, it highlighted the incredible disconnect that exists between gold and money today.

My father’s generation understood the simple concept that gold isn’t an investment — it’s money.

But somewhere between the baby boomers and Generation X, gold was pushed from being a true currency…to an obscure investment.

This kid asking for investment information pointed out that he believes he could understand the stock market. But he’s not sure he’ll ever understand gold.

Gold is elusive. No one feels they can ‘get’ it. And that’s the problem.

The correlation that the shiny metal is another form of currency doesn’t exist anymore.

Yet it should.

Clever modern day investing practices have pushed us into paper investments. Too many people believe that some finance, consumer, infrastructure and mining stocks equate to a diversified portfolio.

If you do that, all you have is a portfolio of stocks. There is nothing diversified about it.

Over at Strategic Intelligence, Jim Rickards and I often explain how the value of gold is directly linked to the value of the US dollar.

That is, the weaker the greenback…the stronger the price of gold.

Take a look at this:


10-Year Gold Spot Price Chart in US Dollars/10-Year AUD/USD Chart

chart image

Source: goldprice.org/XE.com
Click to enlarge



Gold peaked at US$1,856.40 (AU$2,464.77) in September 2011. As gold marched towards this all-time high, the Aussie dollar was trading above parity to the US dollar. In fact, when the spot price of gold spiked, the AUD/USD exchange rate was $1.06. That is, for every $1.06 Aussie dollars, you could get one US dollar.

As Jim explains below, there are other factors that affect the spot gold price. This is just one of them.

The point is that we need to shift our thinking away from gold serving as an obscure investment — a relic from a bygone era.

Gold is money. And this week, I’m going to explain exactly why. And I’ll reveal what markets it’s going to take with it when the next super-spike comes.

For now, I’ll hand you over to Jim.

Regards,

Shae Russell

……………………………………………………………………………………………………..

Gold Going to US$10,000 per Ounce — and Taking Gold Miners with It

The world stands on the brink right now.

And the ‘macro’ drivers that will send gold to US$10,000 are very likely in my view. But in the interests of full transparency, it may take more time for them to fully play out. Does this mean you have to wait to speculate on the trend in the gold mining space?

Not at all…because, while we wait for the ‘big picture’ to fully develop, there are other reasons gold could rise substantially in the meantime.

Of course, there are short term forces that drive the price of gold.

Over time, gold might be headed to US$10,000 per ounce. But between now and whenever that happens, the price action will not happen in a straight line. Instead, the price will go up and down day to day. Depending which way gold goes, and by how much, gold miners will be impacted accordingly based on their particular circumstances. Here are some short term forces that can drive the price of gold:

  • Gold Supply/Demand: Central banks have moved from being net sellers of gold to net buyers for the first time in decades. With few official sellers and many official and unofficial buyers, gold demand now exceeds gold supply from mines, putting pressure on scrap gold and other weak hands to fill the gap. Physical markets are skewed toward excess demand because China, Russia, Iran and other countries continue to demand gold to diversify reserves away from dollars, while output is flat and official sales by the West have ceased.
  • High Real Interest Rates: Almost every financial commentator today talks about historically low interest rates. The key to remember is that those are ‘nominal interest rates’. The ‘real’ interest rate is the nominal interest rate minus inflation. Since inflation is basically zero, or even negative, if we’re experiencing deflation, then real interest rates right now are not historically low. They’re actually relatively high, especially if you compare them to real interest rates during periods of high inflation in the 1970s. Central banks cannot tolerate high real interest rates because they mean lower consumption and investment, which leads to low economic growth. In response, central banks implement new easy money policies like they did with quantitative easing, which is positive for the price of gold.
  • Falling US Dollar: Easy monetary policies by central banks cause the price of gold to rise. As the Federal Reserve backs off their plans to raise interest rates here in the US, the US dollar has been falling in value relative to other major currencies like the euro and Japanese yen. As the dollar becomes weaker, the dollar price of gold rises.
  • Gold Manipulation: Gold manipulation can be done by market players like hedge funds, COMEX operators, and other players using ETFs, alongside leasing and unallocated contracts. These manipulations do exist and can influence the price of gold in the short term. Ultimately, the macro forces driving gold to US$10,000 that I outlined above will overpower the manipulators. But, until then, the price of gold will move, in part, because of manipulators’ actions.

The environment for gold is the best it has been in years. This is because the international monetary elites have embarked on a path to weaken the US dollar against other currencies. This is designed to push inflation in the US toward the Fed’s target level of 2%. Inflation hasn’t come close to the target in five years, and now the Fed is getting desperate. Currency wars are the last resort when all else fails. Helicopter money is not far behind.

Whatever makes the US dollar cheaper makes the US dollar price of gold higher. History bears this out. The all-time low for the US dollar was August 2011. That was also close to the all-time high for gold, at nearly US$1,900 per ounce. No coincidence there. It’s that simple.

Now those forces are in play again.

When it comes to gold miners, we all know that, when gold goes up, the prices of mining stocks go up faster. That has to do with the role of fixed versus variable costs in mining company income statements. Once fixed costs are covered (a difficult challenge), mining profits can drop to the bottom line directly because variable costs are low in relation to fixed costs. Since stocks are priced on a multiple of earnings, the stock prices go up faster than earnings. That’s the environment we’re in today.

Now, there’s a third factor moving the market, in addition to higher gold prices and higher gold company earnings. Big mining companies are looking at the same equations. A big mining company can buy a small mining company and add to its own bottom line without lifting a finger. The stock multiplier effect kicks in for the large miner, increasing its stock price, too. That increase in valuation can ‘pay for’ the acquisition. It’s almost like getting free gold! That’s how gold and stock markets interact.

There’s just one catch. You have to move fast. If you’re a large acquirer and you wait for junior valuations and gold prices to climb, you’ll miss the boat and overpay. So the big companies are on the prowl. There’s no better environment in which to own junior miners.

The challenge is selection. Not all juniors are created equal.

Over the next few days I’m going to explain why in greater detail. I will give you all the information you need about the greatest gold market swindle; you’ll understand why the price of gold is going higher, why most investors will actually lose…and how you could win.

All the best,

Jim Rickards