´╗┐by Michael J. Kosares

Review and Outlook

By way of review, gold hit an all-time high just after Labor Day at $1925 per ounce, went into a tailspin that culminated intraday at the $1530 level (9/26) and then climbed back to $1680 (10/14) as this is being written. Corrections, though not the sort of thing any of us enjoy, are good for the heart and soul of a market. They purge it of excess and inequities, bring balance and, in secular bull markets, ultimately set the stage for the next rally. None of the conditions which caused gold's meteoric rise has been altered, in fact matters have noticeably worsened.

For the most part, the evidence points to this price correction being an exclusively paper gold market phenomena -- a technical break in a market that had risen almost 40% in a little over eight months. That said, there was an important additional development that should not be overlooked:

The banking and sovereign debt problems festering in the eurozone translated to a loss of faith in the euro which, in turn, prompted a flight to the dollar. When Switzerland announced that it would peg the franc to the euro (also at the beginning of September), it created even more captial flight to the dollar. With the dollar on the rise on currency markets, gold, at first hesitantly, and then precipitously, broke to the downside. (Please see the accompanying chart.)

In short, the dollar, through no fault or virtue of its own, had become the direct beneficiary of converging short-term market events. (Unfortunately, a strong dollar is not exactly what American policy-makers have in mind.) Once the smoke had cleared, the competitors in the realm of safe-havens sans the Swiss franc had been reduced to two -- the dollar and gold, historic adversaries on an old playing field. In the short term, the dollar took the advantage, but we have a long way to go before this particular contest is over. As of this writing, gold is up 10% off its lows and still up nearly 21% on the year despite the correction.

As for the outlook, one of the more interesting comments about the situation came from Mark Faber, a highly-respected commentator on the financial scene.

"One more currency [the Swiss franc] that was perceived to be a safe haven is no longer a safe currency because it's pegged to a relatively weak currency, the euro. Therefore I think investors will increasingly ask themselves, 'If I want to hold cash and I have US dollars, they are not very desirable because of the money printer Bernanke.' The euro, not very desirable because they will overprint money and they will probably issue euro bonds at some point and monetize them. Then they look at the pound sterling and so forth, in terms of paper currencies there is nothing really very desirable. Then people will ask themselves, 'How can I park some cash in something that will maintain its value over a long period of time?' Then they will look at gold and silver."

In the end, whatever the short-term speculator delivers to the market in terms of profit potential on either side of the market (if you happen to get lucky), it is secondary to gold's asset preservation qualities. Investors will continue to own gold not to make money, but to preserve the money they already have.

Physical gold buyers -- those who prefer to own gold in the form of coins and bullion -- are well-schooled in the benefits of volatility. Price corrections are viewed as buying opportunities and this one was no exception. At USAGOLD-Centennial Precious Metals, September turned out to be an all-time record month for sales. October volumes are shaping up to match September's. The U.S. Mint confirms the strong investor interest reporting September as its second biggest month on record for silver Eagle sales. (Silver pretty much tracked gold lower throughout the break.) Similarly, the SPDR Gold Trust holdings, a proxy for physical metal flows, remained roughly level through the correction at right around 39.5 million ounces, suggesting September's sell-off having a distinctly papery feel about it. With physical demand among investors firmly in tow, most of the elements which have fueled gold's bull market from the beginning remain in place. This correction should be viewed as just that and nothing more -- a correction -- and one likely to set the stage for better days ahead.

Reprinted with permission

Gallup Poll - Americans choose gold as the best long term-investment

"We're going back to a time when gold is seen very much as money. It has been a complete reversal of the attitudes we saw during the 1990s." - Jonathan Spall, Barclays Capital

According to a recent Gallup poll, Americans view gold as the best long-term investment over real estate, stocks, bonds and savings accounts. "Gold," says Gallup, "is Americans' top pick as the best long-term investment regardless of gender, age, income, or party ID, but men, seniors, middle-income Americans, and Republicans are more enamored with it than are other Americans." 34% of those polled chose gold, 19% real estate, 17% stocks, 14% savings, 10% bonds. 41% of men rated it the best investment.

Reprinted with permission


"That one in three Americans see gold as the best long-term investment," concludes Gallup,"may indicate a bubble in the value of this precious metal -- something that may be corroborated if gold continues to plunge as it did Wednesday. [Editor's note: It has in fact turned to the upside.] At the same time, this sentiment among many Americans may be related to the growing lack of confidence in the U.S. economy. This is particularly the case among upper-income Americans, who are now more pessimistic about the direction of the economy than their middle- and lower-income counterparts. The last time this happened was during the financial crisis of late 2008 and early 2009."

Similarly, a recent Washington Post poll found 73% of Americans doubt Washington's ability to solve economic problems. The two polls taken together go a long way in explaining not only the Occupy Wall Street demonstrations and the electoral successes of the Tea Party movement, but the growing demand for gold alluded to in this issue's Review and Outlook section above. U.S. Gold Eagle bullion coin sales, as shown in the chart below, are representative of the trend. Note the substantial growth from the time of the 2008 financial crisis forward. Note also that the growth is in number of ounces, not dollar volume. Bullion coin sales are seen generally by analysts as a proxy for the overall market. If volumes at USAGOLD-Centennial Precious Metals are indicative, and I believe they are, any further erosion in investor confidence could inspire a return to the 2009 high in bullion coin sales.

Gold market amassing a boatload of potential energy

The number of people who own investment gold in the United States is miniscule when compared to those who own stocks -- no matter what the polls say. 34% of Americans say gold is the best long-term investment, but how many of that 34% actually own it in the form of coins and bullion? No one has that figure, but my guess would be less than 1% (of the total population) and I doubt I am all that far from the truth. Compare that with the number of people who own stocks -- 10% of the population reportedly owns 85% of the stocks.

Consider for a moment what might happen to the gold price and the supply of gold coins and bullion if, over the coming years, there were a steady progression toward 10% of the population becoming gold owners. When you consider that 34% of the population would like to own gold -- no matter their present circumstances -- and less than 1% actually owns it, you begin to understand why gold is not in a bubble at all, but in fact, is in a long-term secular bull market that is still amassing considerable potential energy.

In fact, it would be difficult to measure the effect of current gold owners doubling -- to let's say 2%, let alone to 10%. Let's not forget that the inflation-adjusted all-time high for gold is about $2300 per ounce -- a figure which reflects past monetary growth without regard to a significant rise in physical demand. Blend in a doubling or tripling of global investment demand from current levels -- a distinct possibility -- and you paint a whole new picture for gold.

Gold receivables on central bank balance sheets
(How it translates for the average gold owner)

When the Dutch Socialist Party made a recent inquiry on the disposition of Dutch gold reserves, the Netherlands secretary of the Treasury answered as follows: "DNB follows the rules for valuation, determination of result, and balance sheet presentation of the European System of Central Banks. The asset 'Gold and Gold Receivables' reflects the physical gold inventory." In other words, the Netherlands is not the only country that has gold receivables on the books that may or may not materialize as a physical reality down the road.

Once central bank gold is loaned out, it is generally disseminated, or better put "atomized," in the form of loans to various borrowers all over the world. Even under placid economic conditions, it is difficult for bullion banks to reassemble this loaned-out gold to repay a depositor in the form of metal. In the face of a sovereign debt and banking crisis when the potential exists for several central bank depositors demanding their gold back at the same time, it could put overwhelming pressure on the physical gold market.

Venezuela's Hugo Chavez stunned London's staid bullion bank community this past August when he demanded the return of some 211 tonnes of gold on deposit with the Bank of England, the Bank for International Settlements and a small group of major bullion banks. From Venezuela's point of view that gold sits on the balance sheet as a "receivable."

Major players in the gold market will be watching carefully to see how the Venezuelan situation works out. Dow Jones reported recently that Venezuela is scheduled to receive its first shipment of gold by air at the end of October. Any sign of weakness (or inability to make good) at the banks could prompt a general run on the proverbial bank as other gold depositors begin to worry about the solidity of the "receivables" category on their balance sheets. The price of gold would likely respond accordingly.

What do you tell your mother when she asks where to put her money?

In 2008, Michael Lewis (Liars' Poker, The Big Short, et al) interviewed Kyle Bass, the legendary hedge fund author of operator who made a fortune betting against subprime mortgages. That interview triggered an inquiry that would ultimately become Lewis' latest book, Boomerang - Travels in the New Third World.

In "Boomerang," Bass outlines a future debt crisis gone out of control. He predicts that Greece would become the first country to succumb to the crisis and eventually default -- just the first of many nation-states and financial institutions to be caught up in a general European financial collapse.

This is the same Kyle Bass who persuaded the University of Texas to make a $1 billion investment in gold -- about 5% of the fund's total assets. "Central banks are printing more money than they ever have, so what's the value of money in terms of purchases of goods and services," Bass told Bloomberg at the time. "I look at gold as just another currency that they can't print any more of.

Here is an excerpt from that Bass interview as published in Boomerang (highly recommended):

"What do you tell your mother when she asks you where to put her money?" I asked.

"Guns and gold," he said simply.

"Guns and gold," I said. So he was nuts.

"But not gold futures," he said, paying no attention to my thoughts. "You need physical gold." He explained that when the next crisis struck, the gold futures market was likely to seize up, as there were more outstanding futures contracts than available gold. People who thought they owned gold would find they owned pieces of paper instead. He opened his drawer, hauled out a giant gold brick and dropped it on the desk. "We bought a lot of this stuff."

Former Fed governor predicts return to the gold standard

Back in February of this year, we published a special analysis about gold becoming fashionable among U.S. policy-insiders. Titled "How Gold Became Politically Correct", it featured the thinking of several economic establishment luminaries who foresee gold playing a significant role in the monetary system of the future. That group included Ben Steil (Council on Foreign Relations), Robert Zoellick (World Bank president), Thomas Hoenig (Federal Reserve) and Alan Greenspan (former Fed chairman). Now, Larry Lindsay, former economic advisor to President George W. Bush and Fed governor, has predicted a return to a gold standard saying that it will happen "probably in the next ten years." If the United States returns to a gold standard, it cannot be done at current prices. It cannot even be done at a low multiple to the current price. Paul Brodsky of QB Asset Management recently told CNBC news that a return to the gold standard would require gold trading at $10,000 per ounce.

Whether or not the United States, or the world for that matter, returns to the gold standard may be problematic, but the fact of the matter is that nation-states are already switching to gold reserves as a natural reaction to the international monetary and financial crisis. Over the course of the past year, central banks have purchased over 200 tonnes of gold -- two and a half times official sector demand over the same period last year. As for the rest of the year, the World Gold Council's Marcus Grubb says: "We do expect the trend to continue, although it is difficult to say at what rate, as these decisions are made according to policy. We would, though, certainly expect to see more buying in the second half of the year around the same kind of magnitude."

Long before the world goes back on a gold standard, more and more gold production around the world will be nationalized in varying degrees as China, the world's number one gold producer, has done with its production. This trend will tighten supplies, put a floor under the price at incrementally higher levels, and make more valuable the gold held by private individuals.

The takeaway from all of this is to put yourself on the gold standard -- and the sooner the better. As we turn the page from one chapter in contemporary monetary history to the next, the old adage -- "He who owns the gold, makes the rules" -- will take on a whole new meaning.

The Alternative Misery Index

The Misery Index was first popularized by Ronald Reagan in the 1980 presidential campaign. It combined the inflation rate and the unemployment rate. Reagan used it as a barometer for how well the country was doing economically. During Jimmy Carter's presidency, the Misery Index hit an all-time high-- almost 22%. Near the end of Reagan's tenure in the White House, he had reduced the unemployment and inflation rates meaningfully -- to 7.7% by 1986. Barrack Obama's Misery Index now stands at almost 13% and we all know things are getting worse, not better.

Many question the government's version of the consumer price and unemployment numbers, saying they are politically motivated and reported on the low side to quell public discontent. Shadow Government Statistics (SGS) publishes its own versions of the inflation and unemployment rates and its number are considerably different from the U.S. Department of Labor's versions. SGS' inflation numbers reflect the same statistical methodology the DOL used in 1980. Its unemployment numbers use the same methodology the government used in 1994. (For details, please visit the Shadow Government Statistics website.) As you can see, if SGS stats are applied, the Obama administration's Alternative Misery Index would be around 34% -- far worse than the Carter Administration's economic performance, and over 2.5 times worse than the numbers used by the federal government.

Short & Sweet

Dylan Grice, Societe Generale global strategist: "Governments do not really understand the long-term effects of printing so much money. Inflation will be OK if central banks can remove the excess emergency money at just the right time and in the right quantities. I just worry that they are massively overconfident in their ability to do this."........Do government officials not read the same history books the rest of us do?........................I keep going back to the Nightmare German Inflation of the 1920s. One thing always sticks in my mind -- how quickly conditions went from benign to out of control. It happened overnight. One day all was well; the next day all hell broke loose......................CNBC's Art Cashin provided this insight in a recent column. "[T]he German Central Bank and the German Treasury took an inevitable step in a process which had begun with their previous effort to 'jump start' a stagnant economy. Many months earlier they had decided that what was needed was easier money. Their initial efforts brought little response. So, using the governmental 'more is better' theory they simply created more and more money. But economic stagnation continued and so did the money growth. They kept making money more available. No reaction. Then, suddenly prices began to explode unbelievably (but, perversely, not business activity).".........................Is such an event possible today? I wouldn't discount it. The money creation machine under Ben Bernanke is running on hyperdrive.................In another CNBC interview, Jimmy Rogers, the bow-tied professor with the big commodities fund, says the U.S. economy is likely to experience a stagflation worse than the 1970s. Echoes of the Misery Index............... Rogers "is betting on stagflation by being long commodities and currencies (such as the Chinese yuan) and shorting stocks." Says Rogers, "I wouldn't advise anybody to buy bonds, I would advise you to sell bonds. If I were a bond portfolio manager, I would get another job. In the 70s you didn't make much money in stocks, you made fortunes owning commodities."..................Tocqueville Gold Fund's John Hathaway sums up things nicely in a King World News interview: "Europe is going to print the euro and we are going to print the dollar. We had a bank go down today and France is making contingency plans for a couple of more banks to fail. This is contagion and this will certainly give new life to gold. I think that's why the gold market has started to come back from this correction.".....................That word "contagion" keeps popping up. It is difficult to get a handle on what precisely is going on in Europe. The Eurocrats can't seem to get out of the meeting mode and the public is confused. When banks start going down though, it gets people's attention. As pointed out up at the top, Europeans are buying physical gold and putting pressure on the supply of pre-1933 gold coins -- a favorite among our clientele.................Hathaway in that same interview on whether or not gold has become a crowded trade: "I don't think the gold trade is crowded, I don't think it ever has been crowded (during this bull market). It can get popular from time to time, like anything, but popular is one thing, crowded is a totally different thing. Popular means it's on the front pages and lots of people are talking about it, but crowded is like what we saw with housing or dotcoms and we are nowhere near that and never have been frankly."...............Tell it like it is, John..............Bank of England governor, Mervyn King: "This is the most serious financial crisis we've seen, at least since the 1930s, if not ever.".............China voiced strong opposition to the currency bill recently passed by the Senate -- legislation meant to punish China for its beggar-thy-neighbor currency policy. Will China play the China card and start selling U.S. Treasuries? University of Maryland economics professor Eugene Y. Lee says Fed chairman Ben Bernanke believes it will and is making plans to offset Chinese sales. In a China Daily article he says, "Few, if any, economists mentioned the China factor in the Fed's decision [Editor's Note: To resurrect Project Twist] the Fed is trying to regain its control over long-term interest rates and to keep bond interest rates lower in case China stops buying US treasury bonds." China's reserves include over $1.1 trillion in U.S. Treasuries.......................ZeroHedge, the widely read financial blog, speculated that China might already be selling: "Little did we know 5 short days ago just how violent the reaction by China would be (both post and pre-facto) to the Senate decision to propose a law for all out trade warfare with China. Now we know - in the week ended October 12, a further $17.7 billion was "removed" from the Fed's custodial Treasury account, meaning that someone, somewhere is very displeased with US paper, and, far more importantly, what it represents, and wants to make their displeasure heard loud and clear. Whether it is China - we do not know: we may have a better view in two months when the September/October TIC data hits..."...................With that we will bring this issue in for a landing.....................Wishing all a happy and prosperous autumn of the year. . .MK

Michael J. Kosares is the founder of USAGOLD-Centennial Precious Metals and the author of "The ABCs of Gold Investing - How To Protect and Build Your Wealth With Gold.

This newsletter is distributed with the understanding that it has been prepared for informational purposes only and the Publisher or Author is not engaged in rendering legal, accounting, financial or other professional services. The information in this newsletter is not intended to create, and receipt of it does not constitute a lawyer-client relationship, accountant-client relationship, or any other type of relation-ship. If legal or financial advice or other expert assistance is required, the services of a competent professional person should be sought. The Author disclaims all warranties and any personal liability, loss, or risk incurred as a consequence of the use and application, either directly or indirectly, of any information presented herein.

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