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Real Money, Funny Money and YOU -- Part 4.
by Professor von Braun

June 3rd, 2005

"The only thing necessary for the triumph of evil is for good men to do nothing."

-- Edmund Burke

If one were to compile a list of bearish commentators, those that have been bearish on financial market activity since 1999, it would be long enough to keep one busy reading about their 'reasons' as to why the markets are a dangerous place to be for quite some time. Some currently are bearish on precious metals, others on the usual suspects, like real estate, junk bonds, stocks, etc. The 'reasons' given are usually the same as in asset inflation, too much debt, falling profits, trade deficits, weak currency and so on.

The problem with a lot of these commentaries is that to begin with, they are one sided, since they are suggesting alternative investments, without taking into account that the potential returns are still denominated in US dollars, resulting from payments received from counter parties who also are involved in the dollar game. 'Reasons' are merely rational explanations of why something might occur, but the markets are not rational and a surprise event, by definition, is a surprise anyway. Comparisons can and should be made with similar circumstances that have occurred in the past in an attempt to ascertain a likely outcome of a current event as emotions don't change. Panic by definition is not a rational activity.

Should there be a manifestation of what Greenspan alludes to when he refers to the risk to the US financial system of a screw up by Fannie Mae or Freddie Mac or some similar corporate entity, then that's the currency he is talking about -- the same currency being used to settle transactions.

Owning a basket of other currencies, including the Swiss Franc, is no doubt a prudent step, but one has to look very closely at the pedigree to see how closely these currencies are connected to the US dollar. There are two aspects to this as well, one is the pegging of these currencies to the dollar and the other as to what degree have the respective Central/Reserve banks involved themselves in the asset inflation game.

Given the events following the French 'NO' vote and the ensuing currency decline, not to mention the uncertainty of whether the Euro can survive at all, the wholesale packaging and sale of mortgages, along with credit card debt, from countries such as New Zealand and Australia, the main market which has been Europe (it's the Belgium doctors and dentists), must now also be in doubt. This could suggest that the real estate market collapse may well have begun in the countries, such as Australia and New Zealand, that have been totally dependant upon Europeans as buyers of packaged mortgage debt.

Obviously central banks can survive with 'bad' loans on the books of their respective members for quite some time, Japan being an example. The Chinese banking system is supposedly riddled with non-performing loans as well. The reserve component of both these entities is predominately US dollars, and they can advance these numbers simply by printing more of their own paper and using that to buy more dollars. As we have seen, the BOJ can act to support the dollar to a very large degree. What they are actually buying is another question but that is their problem.

The only safe answer to the currency question is the ownership of gold, either coins or bullion, having taken delivery and then arranged safe storage -- preferably away from the reach of Uncle Sam. Whether the gold price falls from here or not, the key is actual ownership of the metal and this can not be stressed enough. Should, as the Bob Prechter camp continues to tell us, gold decline to a new low, there remains the unexplained issue of who would be the seller of gold at that price whatever it may be. Transactions would need to take place for that price to hold and I for one, doubt that would last, if indeed it did occur.

Once again, from an investor's perspective, the key is ownership of the metal, which means taking delivery! So what if gold retraces from current levels, supply is already tight and controlled by the paper market when it comes to price. The paper market as many commentators have rightly pointed out is not dependant on physical metal being delivered against the contracts. One day this will change, but that day is still some time off in to the future. Accumulate the metal while its available is the safer strategy as you don't really know the shape and form of the event that has the potential to bring down the house of cards. And I don't think anybody does.

An unwelcome event could be gradual, or it could be sudden, but any plan to go actively neutral on currencies and on currency denominated paper assets, whatever they may be, after an event, will be difficult to say the least. Calling your friendly coin and bullion dealer could be difficult as others may have the same idea and both service and supply might become 'interrupted'.

Most bearish commentators currently advise that staying predominately in cash, while reducing debt to nil, along with owning some gold, perhaps some gold stocks, an exposure to commodities and an exposure to income of some sort from a quality security is the prudent strategy.

But what is a quality security? How do you define such a thing? What is the yardstick one would use given the abuse the US financial system has received from a variety of previously mentioned activities? 25 years of asset inflation has created many inflated assets, reduced dramatically the purchasing power of the currency and put the financial world in the equivalent of no mans land. The acceleration of this unique monetary experiment, (the mass creation of greater fools), has reached a stage where good analysis of monetary instruments, including safe securities, is virtually impossible.

How does one analyze an estimated $250 trillion dollar derivatives market trading in anything and everything upon which a contract can be written? Most analysts do not know how these markets work, but derivatives are contracts written on what are traditional markets, traditional in the sense of being somewhat explainable by some one.

If you like crossword puzzles, or Rubik's cubes, or any mental complexity involving numbers, then go figure how the derivative market works as a prerequisite for finding a safe security -- one capable of paying sustainable dividends. Chances are it already has something written upon it within the derivatives market. There are few stand-alone investments that can be easily understood even by investment professionals with many years of experience.

If you want a simple, easily understood investment, with no liability attached to it whatsoever, then buy gold and take delivery!

What also is overlooked is the double taxation forced upon an unsuspecting populace by the creation of credit. Obviously the worldwide attractiveness of US Treasury debt is the assured payment of the interest from tax revenues, revenues obtained from the citizens, whether direct or indirect. The second tax is interest paid to banks, which allows Fannie, Freddie and their foreign counterparts to package up home mortgages and sell them to the unsuspecting Belgium doctors and dentists. Rising real estate prices are increasing the secondary tax aspect to the degree that 'free' (free as in able to be retained) income is relatively rare. While enjoying the illusion of wealth, most unsuspecting participants don't realize that they are creating it, via their declining actual surplus income and net reduction of savings.

Should we get a similar situation to the 1929-1934 period, (probably unavoidable given the fact that the main cause of all similar situations, easy credit, is now present to a far greater degree), then a review of the outcome of that debacle may provide answers as to where and what to invest in.

Holding gold was obviously not a viable option after April 5, 1933 when ownership became illegal. The mining companies of the day essentially struggled through the period following the 1929 stock market collapse and did not benefit until after Roosevelt raised the gold price and devalued the dollar. After that event they were cash rich, returning profits unheard of during that period and for several years after. This was not an event they planned for, more it was a case of being in the right place at the right time.

Nixon's decision to activate the earlier congressionally mandated right to take the US off of the gold standard was not a decision that mining companies knew about in advance either. The ensuing years, 1972 through to 1980, saw the gold price increase 24-fold, a never before seen phenomena. One has to wonder as to what Roosevelt would have said upon being informed that a large percentage of the gold confiscated as a result of his 1933 proclamation was now in the hands of European Central Banks.

Mining companies today are a different beast, compared to both the 1930's and the 1970 period. Newmont Mining is one of the few still around, having gotten lucky with the purchase of the Empire Mine in Grass Valley, Ca in 1929 which they operated for 27 years (excluding the period 1942-46), and again with the development of the Carlin trend, which commenced in the early 1960's. Homestake is gone, having been acquired by Barrick Gold in 2001. Today the talk is of declining reserves, higher costs offsetting returns from higher gold prices, the contentious forward sales whereby future production has been sold already at a fixed price and the picture is of an industry that's looking a tad tired. It is unfortunate that much gold has been mined and sold at lower price levels during the last several years and replacing these reserves has been challenging for most mining companies.

Most 'majors' have gone global, which has both its benefits and its pitfalls. A weak US dollar may be conducive to a rising gold price in that currency, but elsewhere it's the local currency that is strong so the effects of an increase in the US dollar price of gold are offset by local returns remaining the same or being diminished and vice versa.

Being internationally diversified essentially means adding to ones basket of woes, things may improve in one country and decline in another simply because the US dollar is strong or weak. However the commodity itself also responds in price accordingly so it's a catch-22 situation, one that was not present in the boom years of the 1930's nor was it present in the 1970's. There is no question that gold stocks did well in both these periods and no doubt will do well again, once the country risk is qualified and understood by analysts and investors alike as is the issue of current bank debt.

From a US-based investor's perspective, going neutral on the US dollar means owning gold. Income to cover living expenses may have to be derived from the sale of gold, which in a rising market is sufferable. Owning selected gold stocks, those with a focus on US based mining assets, as opposed to exotic addresses may turn out to be prudent as well. Obviously having cash on hand is a requisite also.

Perhaps the ideal portfolio would include a direct ownership in a mine ready to start production once the house of cards has collapsed, as an offset to having to sell bullion. That way you either replace bullion sold by taking delivery of newly mined gold or use the proceeds as cash flow. This also potentially solves the income problem mentioned earlier as the production of gold is guaranteed cashflow. Perhaps 5% of ones gold holding could be directed towards this type of advantageous asset.

Do these situations exist? The major mining companies have not had much success in finding their desired bulk tonnage deposits but there are still some smaller deposits, in some cases drilled out, located within the US that are amenable to low cost production. The writer knows of one in particular that would work well in a private ownership situation.

The Prof can be contacted by email at

Copyright by Professor von Braun. All Rights Reserved. Reprinted at USAGOLD by permission.

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The Rocket School of Economics -- The Lecture Series Index

  • 22 May 2009 -- An Often Overlooked Issue!
  • 28 Mar 2009 -- Problematic Banking Systems!
  • 14 Nov 2008 -- What Exactly is an Asset?
  • 23 Aug 2008 -- Through the Looking Glass?
  • 02 Aug 2008 -- Compounding to the Downside!
  • 26 May 2008 -- Back to Basics Again!
  • 31 Mar 2008 -- The Broken Watch -- Part 2.
  • 27 Mar 2008 -- The Broken Watch -- Part 1.
  • 06 Feb 2008 -- The Financial Equivalent of Faulty Towers.
  • 10 Dec 2007 -- Monetary Systems & Productive Assets.
  • 14 Feb 2007 -- Divorced from Reality
  • 06 Sep 2006 -- Gold, Bankers, the Trade Deficit and Unsettled Transactions
  • 19 Jun 2006 -- When is a Reserve Not a Reserve?
  • 31 May 2006 -- The significance of August 15, 1971.
  • 08 Apr 2006 -- Keep Your Eye on the Ball!
  • 30 Mar 2006 -- What came first?
  • 11 Mar 2006 -- An Unanswered Question.
  • 08 Jan 2006 -- Where have all the projects gone!
  • 11 Dec 2005 -- Gorillas, Rising Gold Prices and Depreciating Paper Currencies!
  • 23 Oct 2005 -- Custodial Risk.
  • 16 Sep 2005 -- An Inherent Flaw.
  • 08 Aug 2005 -- Central Banks and 'Reserves'.
  • 31 Jul 2005 -- Central Bankers, Actors and 'We'.
  • 17 Jul 2005 -- Unintended Consequences! -- Part 3.
  • 07 Jul 2005 -- Unintended Consequences! -- Part 2.
  • 25 Jun 2005 -- Unintended Consequences! -- Part 1.
  • 14 Jun 2005 -- The Two Greater Fools Theory.
  • 03 Jun 2005 -- Real Money, Funny Money and YOU -- Part 4.
  • 30 May 2005 -- Real Money, Funny Money and YOU -- Part 3.
  • 26 May 2005 -- Real Money, Funny Money and YOU -- Part 2.
  • 21 May 2005 -- Real Money, Funny Money and YOU -- Part 1.
  • 09 Nov 2002 -- Carrying a Big Stick.
  • 17 Sep 2002 -- Wishful Thinking!
  • 27 Jul 2002 -- Gold Bugs Beware -- part 2.
  • 10 Jun 2002 -- Gold Bugs Beware!
  • 06 Apr 2002 -- Currencies versus Gold.
  • 26 Jan 2002 -- Bear Market Strategies.
  • 01 Jan 2002 -- 2002 -- A Perspective.
  • 20 Oct 2001 -- The Storm Clouds are Gathering.
  • 30 Sep 2001 -- What to Say?
  • 01 Jul 2001 -- ...Said the Fly to the Spider.
  • 14 Jun 2001 -- Upward and Downward!
  • 28 May 2001 -- Volatility Time, Again!
  • 14 May 2001 -- The Coming Bull Market in Gold Stocks?
  • 24 Feb 2001 -- High Hopes, Wishful Thinking & The Absurd
  • 20 Feb 2001 -- Who Put the Holes in the Swiss Cheese?
  • 22 Jan 2001 -- US Dollar Admits Identity Crisis!
  • 16 Jan 2001 -- Dear George W.
  • 24 Nov 2000 -- The Bubble Has Burst
  • 11 Nov 2000 -- The Media, Bull Markets & the Gold Price
  • 02 Nov 2000 -- Gold Stocks
  • 29 Oct 2000 -- Oh The Tangled Web We Weave ...When We Set Out to Deceive
  • 24 Oct 2000 -- A Mystery!
  • 16 Oct 2000 -- A Peso Here ...and a Few Thousand Pesos There
  • 10 Oct 2000 -- The Unfolding
  • 30 Sep 2000 -- What's Wrong with THIS Picture?
  • 25 Sep 2000 -- Buy Gold Now!!
  • 23 Sep 2000 -- The Times, They Are a' Changing
  • 15 Sep 2000 -- Time WILL Tell!
  • 27 Aug 2000 -- SS "Paper Assets" Begins to Take on Water
  • 06 Aug 2000 -- The Indian Summer
  • 26 Jun 2000 -- A Yellow Brick Wall
  • 22 May 2000 -- The King IS Naked
  • 30 Apr 2000 -- Goodbye Yellow Brick Road
  • 18 Apr 2000 -- Beware the Ides of March, April and May
  • 08 Apr 2000 -- Really, Sir Aldot!
  • 25 Mar 2000 -- Where To From Here?
  • 18 Mar 2000 -- The Gnomes of Zurich
  • 12 Mar 2000 -- The "New" Economy??
  • 06 Mar 2000 -- Two Questions
  • 04 Mar 2000 -- Iceberg Dead Ahead!
  • 28 Feb 2000 -- The Wizard of Oz
  • 06 Feb 2000 -- Here We Go Again!!
  • 15 Jan 2000 -- Comments on the Gold Market
  • 29 Dec 1999 -- No Raw Ingredients Required
  • 28 Dec 1999 -- No Way Out
  • 14 Dec 1999 -- Ho, Ho, Ho!
  • 07 Dec 1999 -- Greenspan's Bubble
  • 03 Dec 1999 -- Early Warning Signs

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