Friday, July 11, 2008

History Has A Way of Repeating: The Gold Price Will Run

One of the most fascinating things we have learned about history, is that we do not learn from history. Well, some of us have been taking notes, and those of you who are regular readers of our newsletter are already onto much of this.

If you choose to study money, and particularly gold’s role as money throughout history, you will find that gold (and silver) has been the one consistent currency of choice, off and on, for over 5000 years.

This is not some archaic hidden secret, facts and figures are readily available to any layman with an internet connection who knows how to execute a search on google.

Societies from the beginning of recorded time have oscillated back and forth between “Easy Money”, also known as Fiat Currency, and “Disciplined Money”, also known as some form of gold or gold exchange standard.

The reason this occurs, is that societies have always gone through a cycle that tends to repeat itself, over and over, as predictable as the tides.

Throughout history, the way that money originated, is that markets traditionally created their own currencies, and over time would almost inevitably end up using gold and or silver as mediums of exchange. This is due to the fact that of the worlds naturally occurring materials, gold serves the role the best.

The reason for this, is that over time, gold has been a reliable measurement of mans labor and time. It takes labor and great capital expense to force the earth to yield the soft yellow metal. In addition, if you measure the number of ounces of gold above ground over any period of history, you will find, that until very recently, there have been roughly one ounce of gold, for every human being on the planet. In ancient times it took the measure of a man’s life to mine roughly one ounce of gold, and likewise, in ancient times a man’s life could be purchased, for his entire life, for one ounce of gold.

Gold has been called “The Money of Kings”, and for much of human history, only Kings traded in it.

So what does this cycle look like, that we mentioned a bit before?

Essentially, once wealth is created in a marketplace, government likes to get involved because “he who controls the issue of currency controls the people and the markets”. At this point, once the government has gained control over issuance of the currency, then the government starts to debase the currency.

Why would a government do this? Well lets say for example that there was a make believe government someplace that for some strange reason wanted to spend more money than it “earned” through taxation, to pay for some silly projects such as social security, pointless wars, or other massive social welfare programs. Crazy, I know, but humor me for a moment. The way a government could do this, would be to simply reduce what each unit of currency was worth (in ancient times this meant melting down pure gold and silver and recasting the coins with a less pure metal), and then create more units of currency – in other words, add more physical money to the money supply.

This, in a nutshell, is the true meaning of inflation. Many people, and even financial analysts, incorrectly believe that inflation is increases in prices. This is not the case. Increases in prices, as well as devaluation of a currency, is a symptom of true inflation, which is the act of adding more currency to an available pool of money.

This is not rocket science. Anytime there is more of something, it becomes worth less. For example, if dollar bills were as common as rocks lying on the ground, they wouldn’t be worth much would they?

A “Disciplined Money” system of course, prevents this. If a currency system is a gold standard, or based on a gold exchange standard, then it acts as a check on the government, and prevents it from printing as much as it likes. Why? Because each dollar, if exchangeable for gold, would imply that there would have to be enough gold to give out if all the dollars were turned in.

This in fact happened in the late sixties, when the USA was printing so much money that several countries around the world got sick of it and started turning in all the dollars we were printing up for the gold instead.

What did we do? In 1971 President Nixon, by Executive Order, simply “closed the gold window”. This is a fancy way of saying we defaulted on backing our currency, and severed all ties to the gold standard that we had operated on for hundreds of years up to that point in time.

Now it is important to note here, that when a currency system is removed from a “Disciplined Money” standard and placed on an “Easy Money” standard, that is kind of like removing the thermostat from your automobile, your engine could be going super critical as far as heat, and you would not know it until steam is pouring out from under the hood, at which point the damage is already done. This is not unlike what is happening in our economy today. When we see the price of oil skyrocketing, and financial institutions failing left and right, it is a sign that the damage has already been done. Don’t fret, we have a solution, as you will see below.

Ever since that fateful day in 1971 when we closed the “Gold Window”, the government has been free to print up as much money as desired, a role it has taken to with gusto.

One thing I find very interesting, is that On March 23, 2006, the Board of Governors of the Federal Reserve System ceased publication of the M3 monetary aggregate report. In short, what this report told us, is how much money the government is creating and pumping into the financial system. The reason they cited for no longer producing this report, was that it was becoming too expensive to produce, which of course is a ludicrous argument. Ever since the Federal Reserve Act of 1913 gave permission to the Federal Reserve to essentially create as much money as it wants, the Federal Reserve can create money at will, I don’t see how they can’t afford to pay analysts to produce it. But that’s a rant for an entirely different article.

We will assume, for now that a common truism concerning government applies here: “nothing ever exists (or in this case doesn’t exist), until the government officially denies it”.

What this means to me, is that whenever the government fails to tell its citizens something, or intentionally covers it up, then it is highly likely that the government is doing something naughty. In this case, that naughtyness means printing a whole gangload of money and adding it to the money supply.

The great thing is, we have private firms who still track all the variables involved, and are kind enough to tell us that the government has in fact added almost $14 Trillion (yes that’s Trillion with a T) more dollars to the money supply, at an annualized rate of almost 18% a year.

If you have been paying attention, then perhaps you have come to the same conclusion I did when I started studying this stuff. If the government is creating money at almost 18% annually, that means that my investments and income have to be increasing at OVER 18% annually, or I am going backwards!!! Holy cow Batman, what now?

Lets for a moment get back to the point of the article: The Gold Price Will Run.

Yes, yes, there has already been a tremendous amount of hoopla in the media in regards to how high the price of gold is, and that it has surpassed its 1980 high, and its so overvalued.

With respect, I must say that there has never in history been a stronger set of fundamentals pointing to a massive rise in valuation for gold (and silver, for that matter).

First of all, the current high does not take into consideration inflation, which if factored in, we see that gold must surpass at the minimum $1200 for it to come close to matching the 1980 high.

In addition, if you look at the factors which contributed to the last manic bull run in the metal, we will see factors that eerily match the 1980 manic rise almost identically. This is where that history thing comes into to play.

Once severing the gold standard in 1971, the US Treasury went on a concerted bear raid on gold. Anyone with common sense can come to the conclusion that the reason the Treasury would want to do such a thing is so that the Dollar maintained its strength. The entire world was watching the dollar value after the US closed the Gold window, and a skyrocketing gold price would not signal confidence.

In 1974, before US Citizens were again allowed to buy gold in any form, steps were already being taken to ensure the gold price would go nowhere. In 1975, the United States, aided by the principal members of the IMF, the first gold auction took place, pouring 2,500,000 ounces of gold onto the market.

In august of that same year, the G-10 leading nations decided that the IMF gold reserves should not be increased, but decreased instead, which triggered another 25,000,000 ounces to be sold into the market over the next four years.

What the US Treasury, the IMF, and the G-10 was not prepared for, was that all cycles repeat, and history shows us that when people stop trusting their governments money, they start buying gold.

Dresdner Bank saw right through the ruse, and in 1979 made a bid for the entire allocation of gold for sale at the US Treasury auction in August of 1979. The impact of this was that the entire world piled onto the bandwagon, shattering the $400 ceiling and driving gold prices out of the atmosphere. The public had finally woken up and become fearful about what the government was doing with their money, and they had had enough.

To add gasoline to the fire, in late 1979, Iranian Revolutionary Guards stormed the American Embassy in Tehran taking US Diplomats as hostages. This ignited fears of a new oil crisis.

If you combine these two events and look at what is happening today, with a falling confidence in the US Dollar, and war drums beating over a possible conflict with Iran, not to mention the fact that Americans are already freaking out about prices at the gas pump, and you will see that we have almost an exact repeat of the factors that triggered the last manic run in 1980.

Lets add a few more factors to this puzzle:

The governments of the world who are currently sitting on trillions of USD based reserves are all currently looking at each other wondering who is going to bug out first. Let’s face it, if you were China and losing 18% a year on a huge stockpile of USD, you would probably be a little nervous. When the flight comes, it will be a flight to sound money.

2. We are 8 years in to what is normally a 20+ year commodity cycle, and all of the money in Sovereign Wealth Funds sloshing around the world is looking for a place to go, and is going to seek a level – this could very well be sound money aka gold and silver.

3. We are now watching the tail end of the “Easy Money” to “Disciplined Money” Cycle. This means we may actually see a gold standard, or gold exchange standard of some type again in our lifetime. I have written in the past that I already suspect the Chinese may have ideas in this area. If this were to occur, the price of gold would be through the stratosphere overnight.

4. Oil has been catapulting. The historic ratio of oil:gold is 15:1, meaning one ounce of gold historically averages 15 barrels of oil. With oil today at $146, the gold price should probably be closer to $2190

The bottom line is, we are watching a series of events that are lining up perfectly to create a massive fundamental basis for a run in gold far beyond anything we have seen in history.

Some of us should do quite well while the rest of the equities markets are crashing and burning all around us from credit crisis fallout. The question here is: Will you? If you don’t have gold and silver yet, perhaps its time to consider it?

Author: Alex Stanczyk

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