The Gang that Couldn't Shoot Straight: Central Bankers and Gold

by: Joseph L. Shaefer

Numerous articles on SA have talked about the “cabal” that has kept gold from rising over the years. If it is a cabal, it is truly the equivalent of The Gang That Couldn’t Shoot Straight, The Italian Marching Band, and the US Post Office and Treasury Department all rolled into one. Why seek conspiracy when simple stupidity will suffice? These guys just couldn't get it right...

The last time gold was readily exchangeable for dollars was in 1971. While US citizens had been proscribed from owning gold as a measure of exchange, foreign nations up until 1971 could exchange 35 U. S. dollars and receive an ounce of gold in exchange. This was a price so artificially depressed that, when the lid was taken off in 1971, of course gold skyrocketed. It took nearly a decade for the blowoff to run its course once the pressure cooker lid was removed from the boiling pot. That led to the peak in 1980.

Gold last hit a nominal peak, of $850, in 1980 ($2189 in 2009 inflation-adjusted dollars). And central banks around the world have been selling at lower and lower prices year after year ever since! The lower gold went, the less attractive it seemed to the central bankers, so they sold ever-increasing amounts of it at ever-lower prices.

Since no one stood ready to convert gold bars into something that the local butcher, baker, or candlestick maker would accept in trade for their product, a whole new generation of central bankers didn't "get" the attraction of gold. To them, those gold bars were just big paperweights that got in the way when they wanted to build more private offices. The result was that whenever a dictator needed a new villa or a democratically-elected president needed to pursue a new war or social program, the central bankers would run into the back room and sell some of that heavy, shiny, useless metal to the "gold bugs" dumb enough to actually exchange their currency for the stuff.

So who were the smart guys in the room and who were the dumb guys? Central bankers were selling gold for $300 and $400 to those gold bugs. Now they are paying $1200 to buy it back. Suddenly, someone seems to have slapped the central bankers of the world upside the head with a fish (or, worse-smelling, a stack of recently issued US $100 bills.) Now, after selling gold for decades at the lows, central bankers are shouting “Buy! Buy! Buy gold!” at higher prices.

Clearly nowhere in these august bodies’ ranks of brilliant bankers and economists who went to the finest institutions of higher learning did anyone ever whisper to them the secret of successful investing: “Psssst. Buy low. SELL high.” Do we really have to ask who the dumb guys were and who the smart guys were?

The chart below (click to enlarge), courtesy of, was last updated 15 October, so the data is just a bit behind, but it tells the story from 1913 to 2009 better than any other I have seen recently.

Click to enlarge

Many economists believe that there is a direct cause and effect between the rate of inflation and the price of gold. If we look back over the entire history of gold and paper currency, however, a different hypothesis emerges. Inflation is, in fact, simply one of many processes that can cause investors to lose faith in their government and their economy. Gold also rises when war is imminent, when a nation is about to default, or when some natural or man-made catastrophe renders the social contract and/or living conditions untenable. This can occur during times of deflation as readily as it does during times of inflation.

It is less inflation by itself that causes gold to become more "precious" than it is the fear or panic that ensues whenever the community, the nation, or the world seems to have lost control of an orderly progression toward its goals -- as is obvious, among other events, when inflation is out of control.

From 1980 to 2001, at which time the entire investment world seemed hell-bent on buying B-2-B hardware and Internet pet stores, gold languished, Central bankers and most "investors" considered it a relic. Why buy gold when you could instead purchase some Internet company with no earnings, no sales, and no prospects of ever seeing either at the incredible bargain price of just 300 times earnings? It was during this less than enlightened time that gold, adjusted for inflation, sank to its lows, both in price and in respect.

Where does this leave us now? And have the central bankers learned their lessons? Do they realize now just how valuable an asset they have in something that is this portable, this timeless, and this easily divisible into smaller and even more portable pieces?

I think the answer is yes, at least for a while. The current generation of central bankers has learned that it is paper money that cannot always be trusted. It is only as good as the initiative, common sense, propensity to save, and ability to innovate and grow of the people and the government of the nation that stands behind it. With that being called into question for so many peoples and nations right now, I believe that gold’s traditional role as a haven against incompetence, confusion, and turmoil is recognized by both investors and bankers.

For that reason, I see regular corrections in the price of gold (as measured by whatever currency is being used to purchase it.) However, until the geopolitical and economic situation stabilizes worldwide, I don't see a major retreat for this eminently precious metal in US dollars or any other nation’s currency. In fact, I see central bankers worldwide diversifying their stacks of paper and electronic money with something they can see, touch, and rely upon to provide a hedge against disaster. Central bankers, I believe, will provide a foundation for our investments in gold.

If you agree, there are scores of ways you can participate. Those who believe the level of turmoil and confusion will increase markedly will probably be most comfortable purchasing physical gold, gold coins, and other highly portable and storable-wherever-you-choose forms of the metal.

For those who believe, as I do, that the current crisis will pass, but will do so in a sawtooth, ratcheting fashion that will leave plenty of bears, scares, thrills and spills along the way, you might choose physical gold ETFs or gold mining company ETFs or, eliminating the middleman, well-selected gold mining companies. The benefits of owning the gold miners rather than physical gold -- which you will only be comfortable with if you believe the crisis will ultimately pass -- is that they are more highly leveraged on the price of gold.

That is why, in the ETF world, I much prefer the Market Vectors Gold Miners ETF (NYSEARCA:GDX) to, say, the SPDR Gold Shares ETF (NYSEARCA:GLD). If you are in the "disaster is imminent" camp you might select this latter ETF or one of the closed-end funds that specialize in storing physical gold which is evidenced by shares they issue to you. Of these, I'm willing to pay the slight premium inherent in Central Fund of Canada (NYSEMKT:CEF) based upon their long history of ethical behavior and ready transparency.

Among the actual mining firms I offer for your further research are Goldcorp (NYSE:GG), Kinross Gold (NYSE:KGC), and Gold Fields Ltd. (NYSE:GFI). Another firm we own for some clients is Franco Nevada (FNNVF.PK), a gold royalty firm that does no physical mining but rather purchases or leases the land or mineral rights and accepts an overriding royalty interest in the production the miners (who in turn lease the land from FNNVF) produce. Yet a different but equally interesting way to profit from increased gold production is via shares of Major Drilling Group International (OTCPK:MJDLF) which, as its name implies, is a contract driller for many of the biggest names in gold mining.

Author's Full Disclosure: We and/or clients for whom it is appropriate are long GG, KGC, FNNVF, CEF and MJDLF.

The Fine Print: As Registered Investment Advisors, we see it as our responsibility to advise the following: We do not know your personal financial situation, so the information contained in this communiqué represents the opinions of the staff of Stanford Wealth Management, and should not be construed as personalized investment advice.

Past performance is no guarantee of future results, rather an obvious statement if you review the records of many alleged gurus, but important nonetheless –our Investors Edge ® Growth and Value Portfolio beat the S&P 500 for 10 years running but has not yet done so in the more-explosive year of 2009. There is no guarantee that we will continue to outperform on a long-term basis -- though we will do our best!

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