Gold Is Still the Opportunity of a Lifetime

Last October was a pretty brutal time to be in the prognostication business. I had just called Gold the opportunity of a lifetime at the end of August at a price of around $800/ounce. By the time late October came around, the price had fallen to around $725 and the catcalls had begun in earnest. The Keynesian Kakistocracy was out in full force, hurling insults so rich and humorous that I felt compelled to write some of them down. Now a year later it is time to do another quick review and probably set myself up for yet another barrage of hate mail if the price of Gold doesn’t immediately set a course for Mars.

Yes, we are one year removed from that column and Gold is up 25% in dollar terms at nearly $1000/ounce. Detractors will quickly point out Gold’s inability to land and stick above the $1000 level. In return, I will point at the Dollar’s failed rally to 90 as measured by the USDX. Detractors will point to a lack of interest and dividends from investing in Gold. I will point out that Gold is not an investment; it is money. However, for those who insist on comparing Gold to stocks, I will point out that in the year since the last article, Gold is up 25% while the Dow Jones Industrials are down 19%. Detractors will point out the new bull market in stocks. I’ll counter with the fact that stocks are merely in the middle of a countertrend rally within a bear market while Gold’s correction last year was a countertrend move within a bull market. Detractors will point to the save-haven status of the Dollar during times of economic distress. I’ll counter with the fact that Congress has ensured that the Dollar will die of nearly two trillion cuts – in FY 2009 alone. Must we really continue this?

So on the anniversary of the beginning of the first in extremis phase of the financial crisis, we’re going to look at two of the many developing situations that should give us pause when considering the stability of our financial structures despite all the positive rhetoric and hopefully compel us to consider how to adequately protect ourselves.

China’s stop-loss

Last week, China released some rather earthshaking news that was barely reported by the diligent media here in the US. And where it was reported, the significance was completely glossed over or even ignored. The Chinese Government gave a directive to its state banks to cut their losses on commodity related derivatives, many of which are tied to NY and London banks. In doing so, the Chinese government is in essence saying it no longer respects the validity of these specific performance contracts, pointing out that without performance, there is nothing special about the contracts. This is tantamount to a shot across the bow. The commodities portion of the total notional value of all OTC derivatives as of December 2008 is rather small at .75% of the total. Telling Wall Street to take a long walk off a short pier in this instance will probably not destroy the financial system in and of itself, but it will certainly give the bailout boys a hint of what could happen if the Chinese et al (think BRIC) start backing out of other more important areas such as interest rate swaps which were nearly 55% of the total notional value. (Data courtesy of BIS)

[click to enlarge]

Even the most diehard of Keynesians, who have never seen a deficit they didn’t love, are aware of the fact that it is much more favorable to have foreign cooperation in your currency burying than to have to do it on your own with direct (or around the woodpile) monetization. In that regard, they still need the Chinese if for nothing else than maintaining the façade of vendor financing and the maintenance of the status quo.

Stock markets reacted poorly to the news last Tuesday with the Dow losing nearly 200 points on a day where there was a bevy of ‘green shoots’ economic news in the form of ISM manufacturing data, pending home sales, and motor vehicle sales. Financial stocks led the decline and we must wonder if the smart money had its eyes on the Chinese as the day progressed. On Wednesday, Gold broke out of its recent doldrums and immediately headed north. Granted the technical patterns had been predicting the breakout for the past few weeks, but it is rather coincidental and we have to ask if we are not beginning to see the first shockwave from the recent Chinese action? If so, Gold gets a big thumbs up, while paper assets get the boot.

FDIC: The paper tiger is going to need more paper

We've all seen the good news that has come out on the economy in the past few weeks. While challenges remain, evidence is building that the American economy is starting to grow again. But no matter how challenging the environment ... the FDIC has ample resources to continue protecting insured depositors as we have for the last 75 years. No insured depositor has ever lost a penny of insured deposits ... and no one ever will.

The above statement, made by FDIC boss Sheila Bair is overflowing with inaccuracies, but for the purposes of this article, I want to focus on the last sentence. The FDIC’s ‘trust fund’ is dry. At the beginning of 2008, the Deposit Insurance Fund (DIF) had a balance of approximately $52.8 Billion. By the end of 2008, the DIF had been drained to around $17.3 Billion on the back of just 25 bank failures. To date in 2009, there have been 81 failures, with the two largest failures of the recession coming in the last month. At the end of Q1 2009, the DIF balance had already been reduced to $13.1 Billion. In addition, the list of ‘troubled’ (read: dead) banks now stands at 416 as of the FDIC’s latest quarterly report.

Ms. Bair, in her statement, alluded to the notion that the FDIC sets aside reserves for anticipated failures. The problem is that their estimates of the total impact of failures have been categorically low during the recent run of bank failures. In fact the actual losses have been nearly twice (1.94X) the estimates by FDIC. In the following graphic, used in Ms. Bair’s presentation, the FDIC has estimated the cost of failures to be $32 Billion. If recent history is any guide, the real cost is likely to be a tick over $62 Billion. Given that the balance of the DIF is now at $10.4 Billion, I’d say they have more than a small problem.

What is even more interesting is that Ms. Bair considers money borrowed from the Treasury (taxpayers) and thrown into a black hole to be an asset and her chart above fails to recognize that such a loan creates a liability as well. However, this is indicative of our new accounting paradigm. In addition, she asserts that the FDIC is entirely ‘industry-funded’. Not so, when they’re tapping a Treasury credit line. While most folks are sniffing a bailout of FDIC, I wouldn’t count on it. So far, the vast majority of the bailout money has found its way to Wall Street, not Main Street.

So while the FDIC is bragging that no insured depositor has ever lost a penny and never will, it must be noted that it is incorrect to assume that Congress is under any type of mandate to bailout FDIC. When the DIF requires massive borrowing from the Treasury, bank premiums will be increased in a vain attempt cover the cost, which will mean higher borrowing costs for the real economy. And if Congress does step in and bailout FDIC, the amount will just get tacked onto the national debt. So while large banks gobble up smaller ones and consolidate on the back of TARP, TALF, TSLF and a dozen other ‘emergency’ Fed lending programs, everyday Americans will foot the bill in its entirety. How’s that for a guarantee?

The above items are just a sampling of where we stand a year later. The opportunity offered by precious metals is the opportunity to rid oneself of counterparty risk. The Dollar is the ultimate example of counterparty risk as it relies on the responsible performance of government and monetary authorities to maintain its value. Since the two aforementioned entities have been absentee custodians of the Dollar for so long, its value has deteriorated dramatically. Precious metals have allowed individuals to compensate for that loss in purchasing power. Pundits will say that Gold is a lousy investment and they’re right. The problem with their thinking is that Gold is not an investment; it is sound money and should be regarded as such, not with contempt as is routinely the case in the mainstream press corps. So as we begin another September, a time of year that seems to bring out the worst in our financial and banking system, I will say it again – Gold continues to be the opportunity of a lifetime.

Comments

[markfl]

This last Friday marked what may have been the start of the banking avalanche with the closure of 5 in advance of the holiday weekend, a faster pace than the usual 3-4 per "Failure Friday." This makes me wonder if FDIC waited for a long weekend with Monday's market closure to bury the happening. It's not clear if this was an anomaly, or if it may mark the start of a increase in the pace to 20 banks a month.

We already know that many forecasters have predicted at least 300 bank failures, so if this "Friday Five" trend continues we'd be on pace close as many between now and the end of the year as have been closed so far. If 300 is correct that pace would be right, with perhaps another 100-200 next year.

2009 Sep 07 09:02 AM

[Slimsum]

Idle conjecture on your part simply to get an article published in seeking alpha. Come back and write when you have something important to say.

2009 Sep 07 09:21 AM

[Mongoose]

Any correction here is a last attempt to shake out the weak holders, don't fall for it. Take advantage of this head fake and make the short sellers buy back above their head fake. No guts no Glory.

2009 Sep 07 09:53 AM

[anarchist]

The DJI is down 19% from the 52 week high but up 47% from the 52 week low. Gold, by my calculation of GLD is up 47% from it's 52 week low. Looks to me like they both have done well. When I see scales appear in Safeway to accommodate those who wish to pay for groceries with gold I will believe that gold is money, until then I see it as a trading vehicle.

2009 Sep 07 10:12 AM

[AndrewBaker]

It's the end of holiday time for the summet; traders are coming back and the financial cracks in the banks are showing more, so now is the time to short the banks and financials and be long gold. These two plays will make for a profitable fall and extra money for Christmas too.

2009 Sep 07 10:51 AM

[stillafewleft]

I can't find anything about the nature of the commodity contracts that China has(had?) with western banks/brokers. Who was buying what from whom, or insuring against what from whom, and what wool was allegedly pulled over Chinese entities' eyes that is making them cry foul? Help please.
TIA

2009 Sep 07 12:04 PM

[AuGod!]

This is a complex topic and has many aspects. A stock is a stock, an ETF an ETF, a gold certificate a gold certificate and I like gold bullion in my hands. Without subscribing to any apocalyptic views of the U.S. dollar and appreciating that the gold bullion market is volatile, any arguments against holding some physical gold (coin, bar) are specious. That should appear obvious when so many TV commercials offer to buy your used 10-14-22 carat gold jewelry, albeit at severe discount, which as scrap is then sold on, refined and sold on again, often to meet rising demand for gold coin and bar. It is cheaper to get the metal this way than through traditional mining and smelting. It may be a good idea to sell your used gold jewelry through "reputable" firms for U.S. dollars so you can then buy 99.99 bullion, while the price is still (marginally) under $1000. per ounce. The Asian economic meltdown of the 90s saw much gold sold by strapped consumers to meet their obligations. That asset, culturally ingrained and held in various forms, helped save many a family in the downturn. In fact a major reason why Asians hold gold is for just such emergencies. If Americans had, over the years, modestly and steadily, accumulated gold instead of (often Chinese manufactured) consumer goods through costly credit card purchases, as the Chinese government is now recommending their citizens do, American family wealth (not to mention the U.S. Treasury) would be a rosier picture. That is the bottom line and it is obvious. Have a nice Monday.

2009 Sep 07 12:27 PM

[LKofEnglish]

I'm spittin' bullets when I find myself agreeing with this article. I HATE GOLD AS AN INVESTMENT VEHICLE. Do agree price of this precious metal and more importantly silver are about to truly soar. I don't agree with what I see as an very well written piece when it concerns equities because in an evironment like this I see the capacity of the meat market greed machines to lower costs to be pretty much unlimited (insofar as paying their labor.) Moreover they have the backing of the Treasury which unlike this article states (and incorrectly in my view) so does the FDIC. There is NO WAY the treasury will let that fund go bankrupt. Not now. I do agree that we're now on the accelerated path to insolvency and if you hear yet another old geezer say to you "so sorry you and your children are screwed" in that old geezer conceited way tell 'em "really? doesn't look that way from where i'm sittin' old man." Gurantee if the place gets burned to the ground prices will drop of all commodoties and supplies will soar. And with the right regime we can end unemployment TOMORROW. Don't know what the American people are waiting for quite frankly.

2009 Sep 07 12:41 PM

[oldgoldbug]

When Nixon eliminated the US gold standard, gold was trading at around $40 in the international market. Today, about 35 years later, gold is trading at $990. It has returned a 9.6% compounded annual growth rate. Granted, the returns through 1983 were in the 40% annual range, so there has been a far amount of famine after the "feast". I think the author is making the point that accelerated returns approaching those of the late 70's early 80's are possible given the confluence of: 1 - growing BRIC populations with wealth, 2 - massive currency printing around the world 3 - need to prop up banking systems around the world at who knows what cost. Gold, at these prices, is a reasonable speculation and should be, without question part of a balanced portfolio, and a rather large part (20-35%) at that.
BTW, there is every possibility that the actual rise in gold will be "hidden" if investors start grabbing for every asset they can, including stocks of every type and real estate, with rapidly devaluing dollars.
For you younger readers, back in the 70's Mexico devalued the peso. Car and Driver magazine wrote an article about a Mexican businessman who ordered 3 AMG Mercedes for $100000 each (big bucks in the day). Not long afterward the peso went from 8 to the dollar to 12 to over 100 to who knows. My point is the guy still had his Mercedes and they were worth something. His pesos, on the other hand, weren't worth much.
Can it happen here? Sure, why not. I keep an eye on TLT, the long government bond ETF. It peaked out at 122 when deflation "Armageddon" was only days away, crashed to the high 80's when risk appetites increased, and is now trading 95. Gold and silver going up a lot, bonds going down a lot tells us things not going so good.
Successful investing to all.

2009 Sep 07 01:18 PM

[punk_ash]

I am a regular reader of SA and yes, most of the articles are fluff, but there are many fine articles as well. It is not fair to say that all articles are fluff. If you spend enough time here (months and years), you will be able to better take away useful information from this site.


On Sep 07 01:54 PM NUCLEAR1929 wrote:

> I am sorry you are loser and lost some $ since 2008, you are double
> loser because you write on SA for free, SA never paid here any so
> called publisher, for them you are a pipe channel to connect visitors
> with advertisers. Only freaks write for free, you must be really
> sick just like anybody else to work for free for uncle sam SA.<br/>Now
> go complain to SA and report abuse pussycat.

2009 Sep 07 02:26 PM

[JeffDB]

UN Says New Currency Is Needed to Fix Broken ‘Confidence Game’
By Jonathan Tirone

www.bloomberg.com/apps...

Sept. 7 (Bloomberg) -- The dollar’s role in international trade should be reduced by establishing a new currency to protect emerging markets from the “confidence game” of financial speculation, the United Nations said. ..."

That dovetails with Simon Johnson's piece, in "The Atlantic":

www.theatlantic.com/do...

"The crash has laid bare many unpleasant truths about the United States. One of the most alarming, says a former chief economist of the International Monetary Fund, is that the finance industry has effectively captured our government—a state of affairs that more typically describes emerging markets, and is at the center of many emerging-market crises. If the IMF’s staff could speak freely about the U.S., it would tell us what it tells all countries in this situation: recovery will fail unless we break the financial oligarchy that is blocking essential reform. And if we are to prevent a true depression, we’re running out of time. ..."

2009 Sep 07 03:15 PM

[CLH]

Gold has little upside when inflation is low. Gold topped in 1980 and took nearly 25 years to break even. A great investment?

2009 Sep 07 03:19 PM

[joeyman9]

By far the absolute best article on this subject I have read this summer. I especially liked your summation of all the arguments surrounding gold at the beginning of the article; it's nice to have them all summed up in a tidy little package. Then the Chinese and FDIC defaults (upcoming) really got to the heart of the matter. Well done, well written. I am forwarding this to everyone who is important to me who has the capacity to absorb the wisdom laid out in your article.

2009 Sep 07 04:04 PM

[whidbey]

Your arguments are great and I think telling on the issue of money and debt.

A deflationary depression is as probable as anything on the horizon. It will involve the fact that most private and public debt will not be repaid and finally the public and our creditors understand. The paper the debt represents will be found to be useless, worthless and the stuffing for zombie banks.

The depression will bring confusion, a shortage of money and a threat to survival of us all. But if we come out the other side, clear the shock waves of bankruptcy, we will see the government attempt Keynesian inflation of the money supply.

They may confiscate gold if they dare which will not be allowed, but inflation will start once the useless debt is re-categorized junk. At that point owning physical gold may be the key to survival and preservation of assets. So I agree, hold some metal, and some paper gold right through the depression. It will go down, but much less than other asset classes. Gold is not only timely, it is a necessity.

2009 Sep 07 04:22 PM

[nobby73]

You're not really ultra-bullish on gold but rather ultra-bearish on Dollars. I don't disagree with this, but would suggest a broad variety of commodities, such as oil, uranium, copper, aluminum and a few soft commodities will do better than gold in the next 12 months. Gold makes sense if you expect a global meltdown, but this is not what I am seeing.

2009 Sep 07 06:27 PM

[rosey99]

I find it hard to take an argument too seriously when it appeals solely to base emotion; fear for example. I don't know why so much of the commentary relating to gold has this tendency, but I find the phenomenon itself interesting. There are reasonable arguments for and against investing in precious metals, and I find only a hint of their existence here. Interesting that this piece is an Editor's Pick.

2009 Sep 07 06:31 PM

[JeffDB]

On Sep 07 01:54 PM NUCLEAR1929 wrote:

> I am sorry you are loser and lost some $ since 2008, you are double loser because you write on SA for free, SA never paid here any so called publisher, for them you are a pipe channel to connect visitors with advertisers. Only freaks write for free, you must be really sick just like anybody else to work for free for uncle sam SA.>

It looks like they must have suckered you in. You're writing for them for free now... ;)

On Sep 07 03:13 PM NUCLEAR1929 wrote:

> I agree with you, I would love to read even the garbage and I did it when I was a teenager, since then some years passed and today I don't read even magazines which I loved before and read in full, The Economist, Forbes....and the like, because I learned something that 90% of investors lose over time anyway.
Assuming that this masses also watch CNBC, Bloomberg, read WSJ, Barron's, SA, WSJ.......I understood many years ago that it will not help me make money reading what others read and watching what others watch, so I developed my own system and I call it CIFRA.
I have my own opinion about things and most of the time seeing the title I understand what is the content, I spend about 5-8 seconds per article, for me it's not worth more but I have nothing against they post their stuff on SA and poison others with news nobody can use. >

and you've apparently been suckered in to spend more than your allotted 5-8 seconds per article to argue with those SA readers you deem so foolish.

But, I like reading your comments. Perhaps you've deigned to give a little pro bono advice to the masses...

2009 Sep 07 06:39 PM

[bkdc]

It's always convenient to pick the high when deriding an investment category. So Mr. Objective - How long did it take for the STOCK MARKET to reach its 1929 high after the great crash?


On Sep 07 03:19 PM CLH wrote:

> Gold has little upside when inflation is low. Gold topped in 1980
> and took nearly 25 years to break even. A great investment?

2009 Sep 07 06:40 PM

[Econ Base]

We cannot ignore the fact that we live in a paper currency world. The Fed can manipulate on a short term basis by pumping or withdrawing liquidity. As I wrote earlier, better have an assett allocation for precious metals in your "portfolio for life".

portfolioforlife.blogs...


On Sep 07 10:12 AM anarchist wrote:

> The DJI is down 19% from the 52 week high but up 47% from the 52
> week low. Gold, by my calculation of GLD is up 47% from it's 52 week
> low. Looks to me like they both have done well. When I see scales
> appear in Safeway to accommodate those who wish to pay for groceries
> with gold I will believe that gold is money, until then I see it
> as a trading vehicle.

2009 Sep 07 07:53 PM

[Moon Kil Woong]

The chance that the government will not bailout FDIC is almost 0. As for gold, as a hard asset it is always just worth itself. It hedges inflation but that's just about all. In order to really benefit you need a leveraged gold position like a commodities contract.

The author is right if people bought gold rather than spent every penny they had and then some we would be better off. Whether in gold or in stock or cash, the fundamental important thing is "had Americans saved". I certainly hope we inculcate our children in the merits of saving for a rainy day, not believing the end of downturns is a reality as Greenspan eluded to more than once during his tenure on the Federal Reserve.

2009 Sep 07 10:43 PM