Pedal to the Metal: Precious metals "store of value" in global financial storm
By Tony Allison, March 28, 2008
Commodities, including precious metals, have lately been lauded as the sector-du-jour by the momentum-investing crowd. Suddenly, the mainstream financial media is fervently discussing the merits of fertilizer companies, farm equipment companies, and even gold mining companies. Wall Street is piling on late to the commodity bandwagon, while waiting for tech and financials, the true darlings of the street, to recover. They may have a bit of a wait. The Nasdaq is still not even half of its 5132.52 peak reached on March 10th, 2000. The financials are now experiencing their very own bursting bubble. Technology and financials were down 15% and 14%, respectively, in the first quarter ending today.
The Fed Steps on Monetary Pedal
One of the reasons for the decade-long commodity bull market is that sound money policies by the Federal Reserve have been thrown overboard, causing the dollar to weaken dramatically against tangible assets, as well as other major currencies.
The markets typically react with euphoria when the Fed takes “aggressive” action to “fix” the current problems. Unfortunately, the Fed solves nothing by throwing more money at problems ironically created by excessive Fed money creation. The euphoria is invariably short-lived. All the Fed can do is make the situation worse, or trade one problem for another. Countries throughout history have tried, and failed, to print their way to lasting prosperity. The road to Zimbabwe is now visible in the distance. Hyperinflation is not prosperity; it is economic enslavement.
Dysfunctional Global Financial System
As the Fed deals with a multitude of challenges, from sub-prime loans to credit default swaps to derivative melt-downs to major bank insolvencies, it is obvious we have a dysfunctional system. This may just be the culmination of decades of undisciplined credit and massive debt creation since the US dollar became the de facto reserve currency in 1971.
The only real weapon available to the Fed to fight these challenges is creating more newly minted money and throwing it into the fray. And the Fed has now taken on 29 billion dollars in very questionable loans to bail out the banking system, as it opens up its balance sheet to even greater taxpayer risk. The odds favor larger and more widespread bailouts, as the Federal Reserve and other central banks struggle to plug the spreading holes in the global financial dike.
Given this background, it is no surprise to see this gradual shift of wealth from financial paper assets to tangible assets as people around the world seek a safe-haven “store of value” in the ongoing currency debasement storm. With the recent financial system breakdowns of the last year, the shift has grown more rapid and more emotional. Notice in the following paragraphs that a certain market expert was concerned about deficit spending and inflation over 40 years ago.
Wisdom From a Young Alan Greenspan
“In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all their bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.
This is the shabby secret of the welfare statists’ tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists’ antagonism toward the gold standard.” — “Gold and Economic Freedom” — 1966 by Dr. Alan Greenspan
As of 1975, gold was once again legal for Americans to purchase. Perhaps one ought to heed this ironic warning from the architect of our current financial debacle.
Precious Metals in Short Supply
Compared to skyrocketing currency creation rates around the globe (see February 4th Market Observation), the supply of gold is growing at only 1-2% per year, and silver is chronically in production deficit against growing industrial and investment demand. Even with gold and silver prices rising rapidly the last seven years, the supply is constrained. There is just not that much gold and silver out there, and it is difficult to find and expensive to extract.
Gold or Gold Shares
The ratio between bullion and the gold stock indices ebbs and flows, indicating when gold equities are over or undervalued versus gold bullion. The ratio between gold and the XAU currently shows gold shares are significantly undervalued. Of course, they can become even more undervalued, but these are historically the best times to acquire gold shares.
The juniors are the most undervalued sector of all, not really recovering from the August 2007 beating, even as gold has risen significantly since then (from under $700 per oz. to over $900 per oz. today). Eventually the market will recognize the value of quality juniors, many selling for a fraction of “gold in the ground” (in the $50 per oz. range) compared to the mid-tier and major producers (many over $700 per oz.). The best time to acquire quality juniors is when no one is interested. Watch for the larger cap gold companies to increase their acquisitions of juniors in the months ahead.
When money begins to flow into the sector in earnest, seeking a safe haven or just an inflation hedge, the prices may move too quickly for most value investors to chase. The precious metals are traditionally volatile, but can provide ample opportunities to those with the patience and knowledge to get in early and add prudently to positions when the sector corrects.
This is not the 1970’s. The world is much more connected, and so are the problems and opportunities. The underlying fundamentals of the precious metals market reflect not only supply and demand realities, but a global financial system at risk. Since there are no readily available solutions to the latter, the tangible asset bull is likely to last much longer than CNBC would prefer.
U.S. stock indexes climbed Monday, as the day's sole economic data proved better than anticipated, with equities snapping a three-session losing streak but closing the quarter with their steepest decline in nearly four years. "The worst quarter since the first half of 2002 will be in the books at the close today, and not a day too soon," said Paul Nolte, director of investments at Hinsdale Associates.
The Dow Jones Industrial Average was up 46.49 to close the first quarter at 12,262.89. The S&P 500 Index rose 7.48 to close at 1,322.70. The Nasdaq also closed higher, ending at 2,279.10, up 17.92.
Crude-oil futures fell nearly 4% Monday to close below $102 a barrel, joining a broad sell-off in commodities, as concerns eased about the disruption of oil exports in Iraq and as a stronger dollar reduced crude's attraction as an investment haven. Crude for May delivery dropped $4.04, or 3.8%, to settle at $101.58 a barrel on the New York Mercantile Exchange. It earlier fell to an intraday low of $100.25. Crude ended the first quarter's trading up $5.6, or 5.8%. It fell 26 cents in March.
Gold futures finished down sharply on Monday and for the month of March, but the precious metal advanced 10.3% during the first quarter. On Monday, gold for June delivery ended down $15, or 1.6%, at $921.50 an ounce. For March, gold lost $50.60 or 5.2%. But for the first quarter, the precious metal still gained $86.60, or 10.3%.
The dollar slipped against most major rivals Monday, despite an initial small bounce after the slightly better-than-expected Chicago Purchasing Managers Index, losing ground to the euro after a stronger-than-expected surge in inflation in the euro zone.
Wishing you a good evening,
© 2008 Tony Allsion