John Fisher, Fort Lauderdale, FL
Gold closes $1019 Silver $17.42
Fundamentals
Swiss banks are running out of secure storage space for gold bullion held by investors and institutions due to fears of inflation – and hyperinflation.
In April of this year, China announced that it has secretly been building its gold reserves to more than 1,000 tons. The increase makes China the world’s fifth largest holder of gold, just ahead of Switzerland. In August, China reiterated that it is continuing to dehedge its paper assets and encouraging their populace to do likewise.
While gold demand is rising, global gold production is falling. With most of the low-hanging fruit already plucked, gold producers are moving into remote and risky regions to keep up with demand. With few major gold projects coming on stream, increasingly tight supplies will play a bigger role in driving prices higher in years to come.
For these reasons, we believe that gold will top $1,500 before the end of this year. Some analysts believe that $1,500 will become a floor, not a ceiling.
If gold holds above $1,000, the next stops are $1,250, $1,500 and $1,640. And remember, the 1980 inflation adjusted high for gold is now approximately $2,350 and $132 for silver.
Inflation or Hyperinflation
Inflation is defined as an increase in the volume of money and credit relative to the supply of available goods – causing a substantial, continuing rise in general price levels. Inflation is a monetary (money) phenomenon. If you produce too much (fiat) money, you get inflation.
Inflation erodes the purchasing power of money. Once an inflationary spiral begins, it is extraordinarily difficult to stop. Demand for higher wages leads to businesses raising prices, which triggers more inflation, which in turn brings about a new round of wage demands. People begin taking their money out of banks and using available credit to buy any hard assets. Investors’ logical expectation is that goods will be worth more next month or next year, as opposed to their dollars, which they expect to be worth less.
With inflation, investors turn away from stocks and bonds and buy gold and gold investments. On the surface, it would appear that common stocks – which represent a claim on real assets – would be an effective hedge against inflation. However, throughout the post-war period, inflation and stock prices have been negatively correlated. This is due in part to the negative impact of higher interest rates and higher wages on corporate profits. Inflation encourages investors to divert funds to alternative assets such as real estate, commodities and gold.
The five highest years of inflation in the U.S. since World War II were 1946, 1974, 1975, 1979, and 1980. During those five years, the average real return on stocks, as measured by the Dow, was minus 12.33 percent; the average real return on gold was 130.4 percent.
The Federal Reserve board’s unconventional monetary policy – quantitative easing – is inflationary. In testimony before Congress in late July, Bernanke reiterated his earlier statements that key interest rates will remain low for an “extended period.”
Why the Dollar Is Likely to Decline, Pushing Gold Higher
Over the past year, the federal government has poured hundreds of billions (now into the trillions) of dollars into the economy. It has also guaranteed investments, loans and deposits worth $8 plus trillion. Confronted with a collapsing economy and a dysfunctional financial system, the Fed has vastly expanded its balance sheet, essentially creating money out of thin air to fund a variety of new programs. If you add up just the funds that have already been committed to the U.S. Bailout, you get a figure that is larger in today’s dollars than the cost of the Marshall Plan, the Louisiana Purchase, the New Deal, the Korean War, Vietnam and the S&L crisis – combined. These massive injections of cash by the Fed will, inevitably, cause rampant inflation, a falling dollar and a rising gold price.
A series of bailouts, bank rescues and other economic lifelines could end up costing the federal government as much as $23 trillion, or more. According to the CBO – the U.S. government’s watchdog over the effort – this staggering amount is nearly double the nation’s entire economic output for a year. In fact, $23 trillion is more than the total cost of all the wars the United States has ever fought, put together. World War II, for example, cost $4.1 trillion in 2008 dollars, according to the Congressional Research Service. The annual gross domestic product of the United States is just over $14 trillion.
Consumer prices are rising more than forecasted by economists surveyed by Bloomberg, and producer prices are increasing twice as much as expected. The jump in the PPI and CPI is a wake-up call that the inflationary threat of the Federal Reserve’s easy-money policy is real and rapidly approaching.
Gold Recognized by Mainstream Investment Banks
The case for gold is being made by those who, in the past, recommended only stocks. In Merrill Lynch’s “Metals Strategist,” Merrill predicts that the unintended consequence of the Bailouts will be a return of inflationary pressures to the commodity markets. If the Fed fails to keep foreign capital interested in financing its twin deficits, the U.S. dollar could spiral down, providing strong support to commodity prices. The weaker dollar will then help gold break through $1,200 per ounce and move up to $1,500 per ounce.
Morgan Stanley’s analysts are divided on which threat is worse for the global economy, deflation or inflation, but say that gold is a safe bet in either outcome. Morgan Stanley looked at the possibility of hyperinflation hitting the U.S. Their conclusion was as follows:
“With policymakers around the world throwing massive conventional and unconventional monetary and fiscal stimuli at their economies, we think that it is worth exploring the black swan event of very high inflation or even hyperinflation. While such an outcome is clearly not our main case, the risk of hyperinflation cannot be dismissed very easily any longer, in our view.” (Just as a point of interest, the classification of hyperinflation is an episode where the inflation rate exceeds 50% per month!)
All Things Considered, Here’s What We Think…
Since 1998, I have shared with those who were interested, that the price of gold was going to continue to go up – way up! And silver would enjoy even greater gains! We believe that the current bull market will end only when gold surpasses its old constant dollar high of $850. In today’s dollars, that would mean a price of more than $2,350 per ounce. We’ve still got a very long way to go.
