Is Gold Still a Buy?

August gold closed at $1,827 an ounce. Is there anymore upside in gold?

A Market Watch article published in June of 2003 mentioned that a hike in the price of gold was unavoidable. Then at $380 an ounce, it was written, "Statistics indicate the minimum price of gold should be $1,700 an ounce and that price levels of $3,000-$5,000 are not unreasonable. The economics associated with gold clearly favors a greater gain over the next ten years than can be seen in ownership of other investments".

There are three phases to a gold bull market. First phase is when investors realize that gold is undervalued and they begin to accumulate for their own investment purposes. These are the hard core gold bugs, coupled with smart investors, who observe unwise monetary policies. Smart investors realize those policies will force the value of currencies down and the value of gold up. These are early investors, and that phase is over. The second phase of a gold bull market occurs when everybody starts talking about the increasing price of gold. We are there. It's similar to conversations we used to have when the stock market was hot and everybody was talking about their stocks. In the second phase, the media begins to talk about gold, and the public realizes the reasons gold has increased in value. The third phase of the gold bull market occurs when there is panic and a stampede occurs to own gold. That results in a sharp run-up in price. The economics of the third phase always involves governments and bankers that are hopelessly in debt. We are not yet in the third phase, when frenzied buying occurs, even though our governments (state, local, federal), and leading banks, are hopelessly in debt.

The following problems continue to cause deterioration in the purchasing power of our country's currency and the commensurate increase in the price of gold:

1.	The administration recently agreed with Congress to enact a $2.4 trillion spending cut over the next 10 years. There are two things wrong with this agreement: they have not yet agreed upon any spending cuts; and next year's deficit spending alone is estimated to be $1.3 trillion. The debt ceiling isn't shrinking, it's rising. As with past years, they'll be up against the debt ceiling within two years, if not before, and we'll go through the same process again.
2.	There are fewer buyers to purchase U. S. government bonds. Far Eastern economies do not want more dollar investments. European banks, we have just learned from "our" sneaky Federal Reserve, were borrowers of 70% of the Fed's bailout money a few years ago. If European banks are out of the equation because they're in trouble, as is the Euro, who is buying the bonds? Russell Napier discovered that the Fed was buying 200% of the securities that the Fed, itself, was selling! Since that cannot happen, Napier went on to learn that our domestic banks are currently huge sellers of treasury bonds. The banks are selling bonds back to the Fed in return for cash. This is obviously the reason banks have such huge cash positions, and the reason the Fed can "purchase" 200% of what the Fed sells! A logical person would ask, "How could that happen?" And the answer is that the Fed prints 4.4 billion dollars every day just to pay the government's bills. The fed uses the cash they just printed to purchase treasury securities, previously issued and sold by the Fed to the banks, just like they are doing now. That is how "modern money" has been made over the last 40 years (Puff the Magic Dragon?). When money the Fed makes everyday filters down into the economy, there ends up being too much cash for the goods and services available. Therefore, the price of goods and services go up.
3.	Politicians and the press went crazy over Standard and Poors downgrading of U. S. Debt calling it ridiculous, unnecessary, and overreacting. Standard and Poors rates U. S. government bonds (debt) based upon the ability to repay the obligation, as well as the governments ability to pay the interest charges. The question should be, what took Standard and Poors so long to downgrade the debt of a country that has no plan to repay their debt, and who continues to borrow 35-40% of expenditures every year? It's unsustainable. It's like the family who makes $65,000 spending $100,000, year in and year out, until the borrowing they do to accommodate their lifestyle collapses upon them.
4.	The last several years, South American, European, Japanese and the U. S. Governments have borrowed all of the savings of their countries just to sustain their own governments. The money government spent, which has gotten us into trouble, is the spending for entitlement programs. Those programs have failed to do anything constructive. Instead of being used in a way that could create permanent and growing employment, this use of capital is known in economics as mal-investment, which means—"bad investment". The country's savings have not been used for industrial growth. They have been given away to people who are not productive, but who are "entitled" to various U. S. government payments. Now, that $14.5 trillion of expenditures is U. S. government debt that must be repaid. But, it can't be repaid until we quit borrowing money just to pay interest on the existing debt. That is the worst of all financial downward spirals.
5.	In March of 2008, the U. S. national debt was $9.4 trillion and the cost for servicing that debt was $406 billion. Today our debt is $14.5 trillion. Professor McKibbin told the Melbourne Institute Conference last month that the U. S. is forecast to have debt over 100% of GDP. At zero interest rates, that can be sustained. At 5% interest rates, however, the U. S. will have to put aside at least 5% of GDP every year just to pay interest on the debt. That is not sustainable. Current interest rates are not set by the market, but rather they are set by the Federal Reserve. Artificially low interest rates promote more mal-investment.
6.	50% of people who file tax returns pay no income taxes. The other 50% pay all the income taxes. Our tax situation is too demanding for half of our tax payers to pay no taxes at all. Our "leaders" are in a pickle: it's tough to make people start paying taxes and it's tougher to raise taxes, especially in this environment.

As the reader can see, the root causes of our economic problems are not being resolved. There are no answers to the continuation of policies that got us into trouble. It is therefore likely that the U. S. financial situation will get worse, while the value of gold and silver should, logically, continue to increase.

Question: Can we expect a big sell off from gold after this huge run-up?
Answer: There already has been a retraction from a gold high of $1,900 an ounce. And gold is holding up well.

Question: What stocks should an investor be looking at in this market?
Answer: The stock market is way overpriced. The reason the market remains so high is that yields on bonds are priced so low. Investors are buying stocks for the dividend yields that are higher than bond yields. That's dangerous, as the market is already overvalued. If the market was selling at a price that reflected the historical average annual dividend yield of 4.3%, the Dow would be selling at 7,075 points instead of 11,575 points.

Conclusion

Until structural problems that perpetuate increases in government debt, and until government spending is under control, the U. S. dollar's purchasing power will continue to decrease. Gold should increase in value. Interestingly, there are no economic reasons for gold to decrease in price. There is a host of economic reasons that point to gold and silver continuing to increase in value.

One of our favorite financial writers, Richard Russell writes, "The stupider and less patriotic the Congress, the greater should be your commitment to gold". We feel that the conclusions in the Market Watch article of June 2003 are valid: "Statistics indicate the minimum price of gold should be $1,700 an ounce and that price levels of $3,000 to $5,000 are not unreasonable".

Carpe Diem.
George Rauch
September 2, 2011

....