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Currencies versus Gold.
by Professor von Braun
April 6th, 2002
The comments by the head of the ECB this week that the ECB would approve of the Bundesbank selling gold and buying equities does not, in the short term, bode well for a rising gold price. The implications of such a proposal are many.
Over the last few years the relationship between stocks and currencies has grown closer and closer, to the degree that perhaps they have become the same. Currencies today have nothing to back them up, as in they are not redeemable for anything other than some form of paper. Yes they can purchase tangible goods such as real estate but these markets are way overvalued as well. In fact, the world is awash with promises to pay, but pay what? More promises to pay of course.
A stock certificate is a piece of paper the value of which can fluctuate, but what is that fluctuating value other than a promise to pay? The Central Bankers know this of course, and they have gotten very good at disguising the fact that they have no tangible hard assets to back up the currencies that are criss-crossing the globe like there is no tomorrow.
The investing public has accepted this concept of empty promises to pay without question, and it is this acceptance that has allowed the CB's to increase the money supply, which has worked its way into the stock market. The stock market has become in a sense a barometer of a currency's health (and I use the term health loosely), and while stock markets perform to the upside, creating the feeling of wealth among its participants and keeping the emphasis on this dubious wealth status, little is said about the actual value of the coin of the realm.
What the head of the ECB is saying is that the Bundesbank will sell tangible hard assets and support this game of endless promises to pay by buying equities and maintaining the feel good concept of the local investors. In a sense this announced move shifts the CB reserve base from gold to stocks, from tangible assets to intangible assets and does away with the need for Central Bankers to hold any reserves at all.
Greenspan and his merry men at the Federal Reserve (and people need to be reminded that the use of the word Federal in the term Federal Reserve has nothing whatsoever to do with the Federal Government, they are NOT related at all) have been doing the same thing. Although Greenspan has certainly had help from Federal Government entities like the GSE's and an unregulated derivatives market, which has been expanding at an amazing pace (all this is the constant creation of more promises to pay, albeit of a more exotic variety) this game depends only on one thing.
That one thing is the investing public's ongoing acceptance of these promises to pay promises ad infinitum. Should this amazing confidence begin to erode, then the CB's have a problem and they know it. They may not know the extent of the problem but they do know that this entire currency game has no substance to back it up, something the investing public have cared to forget about, an error we believe will come back to the point that they rue the day they ever bought stocks, took out mortgages, bought second homes, had multiple credit cards and believed Alan Greenspan and the Central Bankers were infallible.
Now the following two points should be noted in the order they appear. The first concerns the gold mining industry and the gold market. In the overall scheme of things when it comes to the markets -- whether they are stocks, bonds or currencies -- gold and gold stocks are but a very small percentage of them. Hard assets are being sacrificed to maintain the promises-to-pay-promises game and we have not seen the last of the sacrifices yet. The gold mining industry is already mortally wounded as a result of the CB's policies and in most cases the diagnosis is terminal. Once again the role played by mining stocks in the gold market is minimal and if gold gets sold off, resulting in lower prices, then the remaining miners will suffer accordingly.
The BOE has sold most of its remaining gold, the Swiss CB still has 900 ton left to sell and the Bundesbank has 3500 ton at it's disposal. That does not bode well for rising gold prices at all nor does it aid to the health of the already ailing gold mining companies.
Getting emotional about gold stocks won't stop the CB's from pursuing the policies they currently have, policies that are as empty of substance as are the units of currencies now in abundance and happily accepted by the ever gullible investing public, aided and abetted by the CB's cheerleading groups masquerading as the CNBC's and Bloomberg's of the electronic age.
We believe that gold prices will rise and our often stated view of accumulating physical metal and taking delivery at the $280 level and below remains. We have stated over and over since September of 1999 that gold stocks are for the quick and the nimble, they are not as yet a long term hold and won't be for some time. Best to wait for a real rising market and see who is still left for we believe that there are some spectacular collapses ahead.
The second point is what will change the investing public's perception of happily holding worthless pieces of paper and derail the CB's game of accommodating this perception? The answer is a repeat of the period from 1971 through to 1980, a period when commodity prices went through the often referred to roof. Rising commodity prices cannot be contained or disguised by a Central Banker as they, too, have to pay them, whether it's at the pump, the supermarket or the home improvement shop. During this period gold increased from $35 an ounce to $850, a 24-fold increase. Preceding this period was a large sell off of gold holdings by CB's, in particular the BOE which sold 2/3rds of their holdings over a period of several years. They reduced their holdings from 2100 ton to 700 ton and have since sold nearly 2/3rds of the remaining holdings. Now it's the CRB index that is the key here and other commodities will need to rise first, before gold and silver begin to catch up. Rising commodity prices other than gold and silver will be the signal that inflation is back and that the promises to pay promises -- whether they be of the Euro variety, the Yen variety or the dollar variety -- are beginning to lose their purchasing power; which, by the way, is closely tied to their acceptance level and their willingness to be held as an asset. When the investing public begins to see that the purchasing power is being eroded AND that the CB's are helpless to stop this event, then gold and silver will begin a serious rise in price.
The CB's cannot grow wheat, corn or beans, nor can they produce cotton, or oil and gas, or metals for that matter. All they can do is issue promises to pay promises to pay promises, something they have gotten remarkably good at doing and are still doing it to this day.
We suggest that a close watch be kept on the CRB index as overall rising commodity prices associated with this index will be the clue to the first test of the CB's abilities to maintain the promises to pay promises game, a test which will reveal their inability to lie about how healthy things are. Perhaps their first reaction will be to dump on the gold market even harder than they have been doing, who knows. But it needs to be remembered that a falling gold price is the only weapon they have against the early warning signs of rising commodity prices and they still have a considerable amount of ammunition should they need it.
A twofold strategy of buying into a rising commodity market and buying physical gold in a falling market may be the way to play the collapsing currency/stock game that is in the process of beginning, but do not expect the CB's to give up without a fight. Their very existence in the form they currently appear in will be defended although rising commodity prices will see their demise.
The Prof can be contacted by email at email@example.com
Copyright by Professor von Braun. All Rights Reserved. Reprinted at USAGOLD by permission.
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