In the long run, gold has been very effective
for preserving purchasing power, and has won out over all efforts
by governments to manipulate and suppress it. It is one of the
oldest, most tried and proven forms of money,. It often serves
as a long-term inflation barometer. However, in the short run,
in addition to suffering as a victim of anti-gold campaigns sponsored
by governments and central banks, gold may also be a laggard in
keeping up with inflation and commodities. It may even do better
in certain deflationary environments.
There are obviously some paradoxes involved here,
since gold at some point has to play “catch up ball”
with commodities and inflation if it is to preserve its purchasing
power over the long run. It must also somehow outperform periods
of inflation while also outperforming deflation. On top of all
of this, gold must somehow remain an eternal form of money.
This series will try to explain these paradoxes
and why gold may still be significantly undervalued despite its
68% run from its July 20, 1999 London PM fix low of $252.80 to
its most recent high on Jan 13, 2004 at $425.50. I discuss why
we may now be in the sweet spot of a continuing gold price appreciation
cycle that could possibly last longer than five years and may
carry gold well over $1,000 an ounce. This could be augmented
by macroeconomic and political fault shifts that may become timely.
I also explain political and philosophical reasons for why gold
may be significantly undervalued today, and address the risk that
the US Government’s confiscation
of gold in 1933 may be repeated.
Gold prices are more ideologically and politically
driven than virtually all other commodities, if not investment
vehicles in general. Gold can serve as a social litmus test regarding
respect for property rights and for governmental self-restraint
and transparency. Particularly fascinating to me is strong historical
evidence that when societies cut their “golden anchor”
(go off a gold standard), this frequently coincides with cutting
other important social, political, and ethical anchors as well.
These societies tend to become more socially “leveraged”
as well as more financially leveraged. The abandonment of gold
correlates with increasing fraud, centrism, and intrigue, which
in the initial phases tends to coincide with increasing marginalization
and demonetization of the precious metals. At some point economic
imbalances and various forms of social and political fraud reach
a crisis tipping point, and then gold and silver tend to make
huge moves as they play “catch up.”
I use the term “fraud” in this series
in a very loose sense. “Fraud” suggests forms of continuous
institutionalized or individualized deception resulting from active
measures, sins of omission, or willful blindness in regard to
determining and disclosing truth. Often deception and denial are
performed on a subconscious level, hence my use of the psychoanalytic
“Id” concept. It is not just “neurotic New Yorkers”
who are involved here. We are all victims of self-deception to
some degree or another.
Although I use the term “fraud” loosely,
the reader still needs to be mindful of how even white lies can
become destructive. The hard dark side of fraud can be criminal
or war-like. The ancient Chinese martial philosopher Sun Tzu once
noted that, “All war is based on deception.” A society
that experiences growing internal fraud is likely a society that
is increasingly at war with itself. It is increasingly filling
itself up with all the toxins of rising “hate by other means.”
Intuitively we can already begin to grasp how such a society is
likely to become increasingly distorted economically and turn
its attention away from things of real value. The poisoned tree
starts producing stunted limbs and withered fruit.
Intuitively, the reader may also begin to grasp
how in an ironic way, societies often get treated in the very
long run the way they treat gold.
THE DUAL NATURE OF GOLD
Gold has a dual nature, both as a commodity and
as one of the oldest forms of money.
Gold is the most nonreactive,
ductile, and malleable of all metals. It is one of the most
reliable electrical conductors for extreme conditions and is also
an excellent conductor of thermal energy. A single ounce can be
drawn into a wire five miles long, and it can be hammered into
a sheet so thin that light can pass through. In addition to jewelry,
gold has industrial uses that include dental fillings, “fail
safe” auto airbag electrical contacts, and components for
cell phones and DVD’s. Gold is used in the manufacture of
million personal computers a year.
An estimated 90% of all gold ever mined still
exists in some above ground form. According to Gold Fields Mineral
Services, at the end of 2002 this came to 147,800
tonnes (or about 4.75 billion ounces). Perhaps
23% is held by central banks, although the amount of gold
they have loaned out since the early 1990’s and can feasibly
retrieve is subject to debate. The remaining approximate 77% is
privately held for jewelry,
bullion, and coin. Average annual demand from 1997 to 2002
tonnes, of which 81% was for jewelry, 9% for retail investors,
and 10% for industrial use. Since around 1987, demand has exceeded
mine and scrap supply. In 2002 mining supply totaled 2,600 tonnes.
The amount of scrap on top of this is difficult to determine but
is probably not significant. This suggests a supply deficit of
roughly one thousand tonnes. (Note regarding measures: 1 tonne
= 1 metric ton = 1,000 kg or 32,151 troy oz of gold, 12 troy oz
= 1 troy pound, not 16)
SUPPLY AND DEMAND IMBALANCES AND A PRICE
One might expect that if demand has exceeded
1987, that the price of gold would steadily increase. Up until
early 2001, this has not been the case. In fact, adding to the
mystery, gold began a decline from $414 in Feb 1996 down to the
mid $250-$260 area in mid 1999 and early 2001, threatening to
put half the world’s gold mines out of business. As noted
by Sprott Asset Management, while officials have acknowledged
cumulative gold short position at over 5,000
tonnes, realistically they may exceed 15,000 tonnes, which
is roughly five times annual mine supply. A day of reckoning could
eventually result in an explosive upside. In Part II of this series
I discuss how an artificially strong dollar in the late 1990’s
correlated with declining gold prices, and in Part X, I discuss
the ongoing law suit by bullion dealer Blanchard & Co. charging
conspiracy to artificially lower gold prices against Barrick,
a major gold producer, and JP Morgan Chase, a major US bank.
Gold remains one of the most difficult and costly
metals to find and extract. Compared to iron, which must be concentrated
in geological anomalies five times more than it is randomly found
in the earth’s crust to be economically mined, gold must
be at least 1,000
times more concentrated than its random natural occurrence.
Only about one in five thousand gold mining claims results in
a profitable mine. Most rich surface anomalies quickly fade out
rather than form economic trends. It takes typically five to seven
years from the discovery of an economic anomaly to complete the
permitting and feasibility study stages and get a mine into production.
Gold costs an average of between $238
an ounce to $300 an ounce (1997
Fed Reserve Board estimate) to extract. The average wedding
ring requires extraction and processing of ore in a volume amounting
to about six feet by six feet by ten feet.
Despite its rarity, like other commodities, the price of gold
responds to supply and demand changes. As an example, over a period
of two centuries (16th and 17th), the steady accumulation of gold
and silver brought to Europe from the New World by Spain doubled
the supply of these precious metals, and dramatically reduced
the price of gold and silver in many countries. Supply additions
from the California gold rush of the 1840’s and also from
South African finds and Klondike in late 1800’s also had
an impact. However, since 1492 the annual global gold supply increase
has never exceeded 5%, and in the last century it has never
exceeded 2% a year.
The demand for gold within a country varies directly
with both its degree of industrialization and its per capita wealth.
Jewelry demand corresponds not only to wealth but also to cultural
and other “mind share” factors. Asians have historically
demanded more gold per unit of wealth per person than their Western
counterparts. Despite America’s relatively lower “mind
share,” the Mineral Information
Institute and the Geological
Society of America supply information suggesting that the
average American consumes in his lifetime more than twice the
.75 oz of gold that exists per each of the 6.3
billion inhabitants of earth.
GOLD AS MONEY
Gold increases dramatically in price as it becomes
“monetized,” that is, the more people use it in the
place of fiat currencies. Fiat money consists of paper currencies
backed only by the taxing power of government. Based upon thousands
of years of trial and error, civilizations have found gold to
be the most highly desirable form of “commodity money.”
Gold is highly portable,
divisible, fungible, durable, and has a high ratio of value per
unit of weight. These characteristics make gold highly suited
to fulfill the three basic functions of money, namely as a medium
of exchange, store of value, and unit of account.
Gold can significantly lose value when it is
“demonetized” and shoved aside by fiat currencies,
but still it tends to retain a certain minimal “mind share”
relative to national wealth based on both its jewelry value and
fear that some day the fiat currency will become totally debauched.
Significantly, no major countries today are on the gold standard.
For the first time in history, they all float on oceans of fiat
currencies backed only by confidence in their respective governments
that they will not completely debauch their currencies. It is
very hard to think of any fiat currency in history that has survived
for many generations without becoming totally debauched.
Under a gold standard, owning gold can act almost
like owning a share in a country mutual fund that benefits from
steady GDP growth. As an example, a person in Britain could buy
nearly twice as much with an ounce of gold at the end of the gold
standard period in 1914
as in 1821. During this entire period one ounce of gold remained
fixed at 4.25 British
pounds. Average consumer prices during this period declined by
roughly one half as a result of the Industrial Revolution, prosperous
overseas trade, access to raw materials, the absence of catastrophic
wars, and other factors. Trains reduced the cost of overland transportation
by over 90%, and steam and electrical engines dropped the cost
of manufactured goods over 50%. During this period, additions
to Britain’s gold-based money stock from mining supply grew
at a much slower rate than the rate of productivity increases.
As explained in Part VI of this series, a number of sources such
as the Mises Institute video on Money,
Banking, and the Federal Reserve claim that business cycles
were less severe and economic growth was more consistently strong
for both Britain and America while both were on the gold standard
than after they abandoned it.
Obviously there are a lot of relativistic variables
that continuously impact on the value of gold as both a commodity
and as a form of money. The platitude that gold will always be
“the eternal constant,” or that in the long run “gold
only stores but never gains value” are both too simplistic.
Gold is very likely, but not guaranteed, to remain relatively
more constant and limited in supply than most other commodities.
Under certain conditions, it can steadily gain in value as well
as preserve wealth. The value of gold can also decline dramatically
due to such factors as demonetization, supply increases, or catastrophic
reductions in per capita wealth. It remains highly unlikely in
the foreseeable future that nuclear physicists will figure out
how to economically move elements on the Periodic Chart into the
When the pros and cons of a gold standard are
weighed against those of alternative monetary systems, I believe
that gold remains the least bad long-term approach to money, particularly
when managed by a least bad form of government.
II of series
Bill Fox is VP/Investment Strategist and
private client money manager, America First Trust. Bill welcomes
phone calls and responses to this article. His web site: www.amfir.com.
Address: VP, America First Trust, Reg. Rep., Sammons Securities
Co., LLC P.O. Box 820669, Vancouver, WA 98682, telephone: 360-882-5369,
toll free: 866-945-5369 (866-WILL FOX), email: firstname.lastname@example.org.
Securities offered through Sammons Securities Co LLC, member NASD