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Is it OK for gold to go down? Those invested in gold would prefer it doesn’t, but
a rational answer must be “Yes.” Trees don’t grow to the sky and few assets monotonically increase in value for lengthy periods. Gold is no different. It has had a remarkable 11-year run but is this run over? Is gold just another bubble?…. Words: 1122
So asks Monty Pelerin (www.economicnoise.com) in edited excerpts from his original article*.
Lorimer Wilson, editor of www.munKNEE.com (Your Key to Making Money!), has edited the article below for length and clarity – see Editor’s Note at the bottom of the page. This paragraph must be included in any article re-posting to avoid copyright infringement.
Pelerin goes on to say, in part:
Men tend to believe that things in motion will continue in the same direction. No law, rule or guarantee exists to support such beliefs. That is not the way the world actually works, despite our brain’s tendency to see things that way.
Is Gold in a Bubble?
Many gold investors are disappointed because their expectations have not been met recently. Latecomers to the commodity may have lost money. Many are wondering whether gold still a place to be. Is the 11 year feast that began with gold less than $300 over? Is it to be followed by 11 years of famine, perhaps returning to where it began?
The above are valid questions and concerns. Everyone has an opinion, but no one can provide definitive answers to these questions. Neither life nor investing is linear. Nor are they always logical, at least in a manner in which we can comprehend.
What Are Many of the Central Banks Doing?
One thing that is meaningful, however, is the actions of central banks. They are behaving as if they believe in gold. According to Jeff Clark, they are purchasing it unlike any time in recent history:
- Net central-bank purchases in 2011 exceeded 455 tonnes…. This was only the second increase since 1988 (the first in 2010) and the largest since 1964. The trend continues. According to The World Gold Council (WGC), their purchases in Q1 2012 equalled 80.8 tonnes, or about 7% of global demand. Over the past 12 months, net purchases have averaged almost 20% of total annual supply.
- Turkey has added over 123 tonnes since last October….
- Mexico has purchased over 100 tonnes since February 2011.
- The Philippines added 32 tonnes in March, its second-largest monthly purchase ever.
- Russia continues buying, adding 15.5 tonnes in May. Its total reserves now stand at 911.3 tonnes, the highest level since 1993.
- Thailand has raised its holdings by more than 80% since mid-2010.
- South Korea has bought 40 tonnes since May 2009, an increase of 180%….
In addition, while China does not regularly report its gold holdings, there have been numerous reports that the Chinese Central Bank is diversifying out of fiat currencies (especially dollars) and into gold. We know they have encouraged their citizens to purchase gold.
The central banks presumably know more than you or me. It they are moving toward gold rapidity, it suggests they believe in gold more so than holding reserves in fiat currencies…. Recent central bank activity may be only the beginning of a trend….
What are the U.S. and E.U. Doing?
Missing from Clark’s list are the central banks of the U.S. and the E.U….[which] may believe they have the two strongest currencies in the world (at least in terms of usage) and that there is no need for them to flee to gold. After all, don’t others flee to their currencies in times of local currency or economic strains? [The truth of the matter, however, is that] they cannot protect themselves from their own currency collapses. Their fiscal problems are too great and it appears as though they will continue to attempt to paper these over at the expense of their currencies. Any attempt for them to load up on gold would likely hasten the demise of their fiat currencies, as the effort would drive the price of gold through the skyward, revealing their overextended issuance of fiat currency. Furthermore, such a strategy could not be pursued without printing even more money than they are doing today.
Take Note:
If the world’s fiat currency regime is going to blow up, the amount of dollars and Euros outstanding is too great to back/hedge with gold (without driving the price of gold multiples higher than where it is today). Countries can protect themselves against the dollar and euro by holding gold in lieu of dollar reserves. The beginning of such a transition may be what is reflected in the data presented by Clark. That is, fear of currency collapses may be driving smaller countries to gold as a protection against such an event. If disruptions are anticipated in currencies, gold seems to be a way to immunize against these disruptions.
What Happens if the U.S. Dollar and/or the Euro Collapse?
For smaller countries, the simple answer is that reserves held in dollars become worth less if not zero, but what happens to the U.S. and Europe? Great pain will be inflicted upon their economies. Debt burdens, considered impossible to maintain today, become much worse in the event of a devaluation. Default on government obligations is virtually assured.
While the U.S. would be considered a financial pariah in the event of debt default…the penalties usually exacted for such behavior will likely not apply.
- Default will occur without the usual consequences.
- Normal sanctions imposed on bankrupt sovereigns will not apply.
- The debt default will be accepted by the rest of the world.
Why do I say this? Quite simply because:
- the U.S. will demand debt forgiveness.
- The biggest military the world has ever seen will dictate the terms of bankruptcy and these terms will not be favorable to lenders.
- Default will be on whatever terms the U.S. decides.
Perhaps now U.S. military might, exceeding that of the next largest twenty-five countries combined, will make some sense. The biggest sovereign bankruptcy in the world will occur and the deadbeat will receive the most favorable terms ever!
Should (when?) this happens, anyone holding dollars will likely be wiped out or see the value of such holding drastically devalued. In my opinion, that is why smaller central banks are fleeing to gold. They are seeking protection against the likelihood of the failure of the world’s reserve currency. Small states, like individuals, must protect themselves against this event. They must hedge against or get out dollars and dollar exposure.
For many individuals in the world, it is easy to stay away from dollars (and euros). The bulk of the world’s population is outside of the U.S. and Europe. In ordinary circumstances they have little exposure to these currencies.
Why Own Gold?
For U.S. (and European) citizens, it is impossible to avoid the dollar (Euro). For them, gold is the only way to hedge against the failure of their own currency and that is why I intend to stay with a percentage of my portfolio in gold. It is insurance that I hope to never have to use, but fully expect to.
Editor’s Note: The above article may have been edited ([ ]), abridged (…), and reformatted (including the title, some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. The article’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article.
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8. Gold is Not in a Bubble – Here’s Why
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