Working in the precious metals
business these past 16 years has its benefits. One of those is
never knowing who is going to be on the other end of the telephone
call when my phone rings. In recent years, potential investors
in gold have raised the option of buying foreign currencies,
especially the Euro, instead of buying physical gold in order
to hedge against a severe decline of the US Dollar.
The chart immediately below
illustrates the performance of gold versus the euro, British
pound, Japanese yen and Swiss franc in dollar terms from 2000
to the present. Gold significantly outperformed all major currencies
during the period. For example, the Euro hit a low of $0.84 sometime
in 2000 after it was introduced at par in 1998, but it has subsequently
risen to $1.37 at its peak two weeks ago. From low to high, that
is only a gain of 63%. Now let's compare that performance to
that of gold. Gold hit its low in April 2001 at $252/oz. and
has subsequently risen to $672/oz. as of last Friday, May 11,
2007. I am not counting last year's peak at $729/oz. which makes
the numbers look even better. From low to high, that is a gain
of 166%. The gain is 189% if you measure from $252/oz. to $729/oz.
Now how can anyone seriously argue that foreign currencies are
a better store of value than gold? People delude themselves into
thinking this nonsense until they look at the numbers.
Now let's consider what is
happening in 2007 to these much-praised foreign currencies. One
of my clients supplied me with the following source for the M3
money supply figures. In some cases, the only available figures
were for M2 or M4. My client got them from Richard Daughty who
frequently writes for "Safehaven" and "The Daily
Reckoning". Apparently, Mr. Daughty got these figures from
John Embry of Sprott Asset Management. These M3 numbers will
cause you to do a double-take in disbelief.
Eurozone M3: up 10%
UK M4: up 13%
India M3: up 20.3%
China M2: up 17.2%
South Korea M3: up 11.3%
New Zealand M3: up 18%
Australia M3: up 13%
Japan M3: up 6%
Russia M2: up 49%
The US M3 figure is missing
because the US government stopped reporting it in March 2006.
Some sources, who have pieced together the information from
various governmental sources, state it is running around
15%. Rumor has it that Canada stopped reporting its M3 number
officially about the same time. As I have stated repeatedly
on the telephone to my clients, ALL governments are involved
in currency debasement. It is the nature of governments (conservative
and liberal, democratic and communist/totalitarian) to print
paper money and to engage in make-work projects, transferring
wealth from one part of society to another, etc. The one thing
they cannot do is print gold or cornflakes or soybeans or any
other commodity for that matter. That is why it is so vitally
important to understand what is going on worldwide at the macroeconomic
level.
As most students of the economic theory of monetarism know, stoking
the money supply eventually leads to rising consumer prices.
Milton Friedman made this theory his cornerstone which has come
to be known as the University of Chicago school of economics.
However, even this relationship has broken down lately, especially
in the US and UK where those governments employ a very narrow
index of what constitutes the Consumer Price Index. Whether intentional
or not, the governments of the US and UK tend to understate real-world
consumer price inflation to the detriment of those citizens.
Lower CPI numbers help the government sell bonds at lower interest
rates, thus keeping borrowing costs under control. Lower CPI
numbers also help corporations keep wage gains in check (during
contract negotiations) to the detriment of their employees. A
lower CPI number robs senior citizens of their cost-of-living
adjustment (COLA) to their monthly social security checks. A
smaller COLA means the government pays out less in retirement
benefits, which helps keep the government deficit from looking
really ominous.
This discussion of the inability
of government-constructed consumer price indices to accurately
reflect real-world inflation was captured in an article in the
Financial Times, dated 14 May 2007. In the article by Wolfgang
Munchau, he discusses what happened to consumer prices (and to
his own personal inflation rate) when the Euro banknotes and
coins were introduced in 2002. As he says, "prices charged
by many hotels, restaurants and dry cleaners effectively doubled."
He estimated that his own personal inflation rate was about 10%
while "the official inflation index did not register any
significant movements." He attributes this disparity to
the fact that the official inflation index no longer reflected the
real cost of living. "The index basket is full of manufactured
goods largely produced in Asia, while we spend most of our money
on services, such as childcare, education, healthcare, transportation,
travel and gastronomy".
Does this sound familiar to
the US consumer? It should because the Bureau of Labor
statistics strip out "volatile" items, such as food
and energy, when reporting the "core" inflation rate.
Actually, there are two inflation numbers reported: the regular
inflation rate and the "core" inflation rate.
When inflation is discussed in the media, one cannot help but
notice that the core rate is emphasized while the regular
rate is minimized. With the real increased cost of living
obscured, the typical middle class person cannot figure out why
his paycheck can no longer cover all his expenses.
In my opinion, a truer
(and thus more honest) approach would be to include all basic
living expenses but on a weighted basis, apportioning a percentage
to each category rather than excluding them altogether. Seasonal
factors, which affect availability and thus costs of food and
energy, could be easily adjusted to arrive at a truer, real-world
inflation rate. Quite frankly, if you don't need food and energy
to live, you might as well go live in the cemetery. All joking
aside, we need real-world inflation indices that reflect the
basic cost of living. Referring once again to the article by
Wolfgang Munchau, he says "[t]he Federal Reserve follows
a reasonably well-behaved core inflation index, yet this index
has become totally irrelevant for middle-class families who spend
most of their income on items such as education and healthcare,
where cost inflation has exploded. While the official indicators
are extremely convenient for policymakers, nobody in their right
mind would rely on a measure that persistently misjudges what
21st century families spend their money on."
So what is a person to do?
I submit that the price of
gold is a truer gauge of inflation than any government index,
and thus a truer hedge. A large section of the world's population
apparently agrees since gold has been rising internationally
in terms of all major foreign currencies. (The accompanying charts
of gold in euros and British pound sterling which begin in 2002
are just two representations of the global trend.) It won't take
long until the inflation-driven move out of paper investments
and into gold accelerates.
Deciding how much of one's
portfolio should be devoted to gold is up to each individual
investor, but our general recommendation ranges from 10% to 30%.
The final diversification should reflect one's level of concern.
In my opinion,
the gold price will not stay down for very long. In fact, it
would not surprise me to see a counter-seasonal rally in the
metals from late spring through the summer months. After the
$30 selloff of the last two weeks, my trusted and confidential
sources (who live in Europe and have provided very accurate and
timely advice in the past) told me once again to buy every dip
in price and hold on for $1000/oz. because absolutely nothing
has changed. Add to that advice the information about worldwide
currency debasement and I rest my case for the purchase of physical
gold and silver.
