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Paul Franke is a private investor and speculator with nearly 30 years of trading experience, including investment management. Mr. Franke was Editor and Publisher of the Maverick Investor® newsletter during the 1990s, widely quoted by CNBC®, Barron’s®, the Washington Post® and Investor’s Business... More
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  • Honest Evaluation Of Gold's Price And Value In 2014

    Summary

    • The Consumer Price Index [CPI] under-reports actual inflation.
    • Gold has moved into a position of long-term undervaluation.
    • Increasing rates of fiat money printing worldwide and new geopolitical problems should support gold prices into 2015.

    I am still scratching my head a week later about the misinformation in this Bloomberg.com article being handed to (and accepted by) the general public about aspects of the money printing scheme run by Wall Street banks and the Federal Reserve on investors... http://www.bloombergview.com/articles/2014-03-28/the-real-pr...

    As I expressed in several comments at the bottom of the Bloomberg article itself, this chart is quite flawed using rigged CPI calculations. Under-reporting of CPI or whatever government inflation calculation you want to use, completely exaggerates the current relative gold value or "adjusted" price on a long-term chart. It is incomplete, oversimplified, misguided and downright incorrect, just like every government statistic using the CPI to adjust for reality.

    My Seeking Alpha article seeks to highlight a fair and accurate appraisal of the current gold price and its underlying value in early 2014, as measured against a variety of historical data points.

    Under-Reporting of Consumer Price Increases

    The governments in power the last several decades have regularly tinkered with the Consumer Price Index [CPI] and Gross Domestic Product [GDP] deflator to underestimate inflation and overstate real economic expansion. Reviews and "revisions" of what to count and how to count are made on all goods and services at least annually, with the excuse of technology improvements for goods deemed a reason to adjust their prices LOWER than available in the marketplace. The government has also moved away from actual market-based pricing of real estate to a rent model for housing, that few outside of Washington understand or can replicate. Many articles have been written highlighting the rent model seems to regularly underestimate actual housing and real estate gains the last few years.

    To keep the masses at bay and the status quo in the financial system functioning, plus make re-election easier for the powers that be, our leaders have decided exaggerating the U.S. economy's performance would help the nation retain its preeminent reserve currency status for the dollar and convince the average American - life is good. Another advantage of lower than actual inflation reporting is the decreased need to raise social and welfare expenditures at the federal and state level, which are adjusted based on the CPI calculation. The U.S. government even pulled a fast one in 1991 when it switched from a Gross National Product [GNP] calculation, which includes investment and debt flows between nations (that were turning against America progress), to inflate the idea of economic prosperity in the American mindset. Much of the current 2013-14 debate in Washington to "cut" spending and reduce our out-of-control fiscal deficit revolves around an official lowering of social program outlay needs to a "targeted" level BELOW the under-reported CPI. Amazing the games we can play, when the government is completely dishonest about the numbers it gives society, as gospel truth!

    Let's review some "free market" based examples of inflation, and you can decide for yourself if the CPI is fiction or reality. The best local indicator of inflation in your area is to track beer and pizza prices at your local pub. Just get a copy of the menu (with weights or volumes for the items) each year and track it for yourself. This simple measurement includes real world fluctuations in food costs, real estate and equipment expenses, labor wages and related benefit compensation, utility and energy expenses, local and city government taxes and regulations, federal and state taxes and regulations, and acceptable profit margins for the business owner. Trust me, you will be shocked after a few years at how different reality is vs. the government reported statistics.

    The easiest and most comprehensive independent view of inflation for the U.S. economy is to watch the increase in prices by FedEx and UPS to ship and deliver a package each year, usually announced in December. Once again, this calculation includes the effects in total of operating a large comprehensive, diversified enterprise employing hundreds of thousands of individuals. Real world changes in labor costs including wages and benefit compensation; real estate prices in the form of warehouses and office buildings; manufactured equipment like trucks, planes and technology tracking, accounting and management of millions of items shipped daily; the macroeconomic effect of government regulations like Obamacare or EPA rules; taxes at all levels of government; important energy and oil prices; plus expected changes in all the above including acceptable business profitability for the owners - in a market centered pricing environment - gives perhaps the best, most accurate read of inflation in the general economy I have come across.

    Believe it or not, FedEx raised standard prices on average by 3.9% during January 2010, 4.9% in 2011, 5.9% in 2012, 5.9% in 2013, and 3.9% in 2014. This compares to equivalent CPI reported increases by the U.S. governments in control of 2.7% during calendar 2009, 1.6% in 2010, 3.2% in 2011, 1.7% in 2012, and 1.5% in 2013. We are comparing year-end calendar CPI to the following year's January expansion in FedEx rates. Taken together over the last five years, FedEx has escalated its market based price structure to ship a package by 27% since mid-2009 (the recession bottom), against a CPI or GDP deflator number in the 11% range! The government has under-reported real world inflation by a good 16% the last five years. You wonder why it's getting harder to pay your bills? It's because your income raises are based on CPI, while your cost of living is based on reality.

    The main smokescreen argument made by the government regarding CPI revisions is the constant "improvements" in goods and services we use should automatically translate into greater living standards, especially related to technology advances. What this arbitrary and subjective line of thought has generated is the belief that we can accurately lower real world price jumps to account for better products. Think about this a moment as an example. Organic eggs were the norm many decades ago, before corporate farming, vitamin enriched, chemically abused chickens were called an IMPROVEMENT by the U.S. government for consumers. Washington arbitrarily decided egg price increases every few years could be adjusted lower, because we were eating better eggs than previously available! Forget cheap mass produced eggs taste considerably worse than old-school organically grown ones found at the grocery store, or they will likely cause cancer and obesity and other health problems over time from all the synthetic man-made chemicals we use to expand egg production volumes (and big business profitability). If you compare the price of a dozen organic eggs in 1969 to 2014, the 1,000% to 1,600% price increase from 30 cents to $3.00-$5.00 depending where you are located, far outstripped the equivalent overall CPI rise of 630%.

    The flaw in this logic revolves around the fact advances in technology are not the same as economic advances. For some odd reason Americans have been duped into believing improved products automatically bring a higher standard of living as a necessary side effect. If "two" full-time working adults now must toil to have the same basic lifestyle as "one" could produce during 1969 of an affordable middle class home, a new car every few years, a summer family vacation, affordable health care, clean neighborhoods, the best school system on the planet, and food on the table each night for 4-5 individuals, how can anybody logically argue having a smart phone and high definition large size television MAKES UP FOR IT? Yes, life is easier from 45 years of amazing advances in technology, especially in America, but that is not the same as saying I can afford twice as many organic eggs, homes, or cars on the SAME workload as generated in 1969! That kind of economic "progress" and prosperity explains what's taking place in China and India the last few decades. Asians can now afford red meat, gold bars, overseas vacations, new homes and the like, when they couldn't just a few years ago. Think about it. Americans are trading in cars for bicycles at the same time as the Chinese are doing the opposite!

    You can easily imagine what decades of fiddling with price change reports does to a government engineered "inflation-adjusted" chart of gold, by shaving off 2% or more yearly on the actual cost of living increase for the typical American. Honestly, the free market price of gold is doing exactly what it is supposed to do in this instance of government shenanigans, slight-of-hand misinformation campaign and money printing folly for decades, it is rising strongly to protect your purchasing power.

    The compounded annual increase in U.S. dollar priced gold has been greater than 8% the last 45 years, measured from just before we left an official gold standard of accountability.

    In comparison, the CPI has risen at a compounded annual rate of 4.2% since 1969. Which number do you think is a more truthful reading of reality? The gold price (universally accepted hard currency) where 7 billion people on the planet vote daily on its true underlying value, or the CPI determined by 30-50 individuals at the highest levels of a banker supported U.S. government? P.S. The answer is easy, if you are an independent thinker.

    Further, if inflation rates in official government statistics have been systematically under-reported by 2% annually since 1969, real GDP economic progress has been over-reported by roughly the same amount. This situation would highlight little or no economic progress has been generated by the overall U.S. economy since leaving the gold standard for two generations running! The truly bad news is the slow growth reported in real median household incomes the last 10-20 years, adjusted for CPI, would actually be "overstating" the economic condition of the average American family. It is entirely probable the typical family is earning LESS and working HARDER than several decades ago, as an honest CPI reading would attest and confirm.

    Long-Term Gold Performance vs. General Stock Prices

    Something else to contemplate is since the late-1960s peak in American wealth and power, the dollar price of gold has actually risen FASTER than the S&P 500 or Dow Industrials "price," excluding dividends. Look back at the charts and historical prices on your own to verify such. The popular press and Wall Street are surely not going to bring this fact to life. Gold has moved from $35US an ounce in 1969 to $1300 today. Over the equivalent 45-year period, the S&P 500 has risen from 100 to 1850, roughly HALF the price increase for gold! The relative performance of gold vs. stocks over many decades is testament by itself the U.S. economy peaked in the 1960s and has largely been a money printing, shell game scam for some 45 years running, with little real economic progress for working Americans, regular savers and the typical investor, once you convert paper wealth to hard money assets.

    The saving grace for common stockholders has been the small dividend yield. Assuming you did not 1) expend much in trading commissions, or 2) pay an investment advisor a few percent each year for 45 years, or 3) have to pay taxes on gains, regular "theoretical" stock indexes actually did better on a compounded basis than gold, especially if your gold did not earn any type of annual yield or return buried in the back yard. (Large gold owners can sell futures or lend forward for a minimal return however without it leaving their possession.) Depending on the stock index used and how you treat dividends (reinvested or not), the stock market has outlined an annualized total return in the 10%-11% range since 1969.

    Short-term Treasury bill yields and savings rates at your local bank have proven an investment disaster over the decades of fiat money printing and official under-reporting of inflation. Averaging 4%-6% yields per annum the last 45 years, gold buried in the back yard has proven a more sound investment strategy with 8%+ compounded annual gains! The biggest beneficiaries of under-reported inflation have been those borrowing money from savers like banks and insurance companies (i.e. JPMorgan and Berkshire Hathaway), and the Treasury department needing billions and trillions each year to pay for oversized social programs. Go figure!

    You have to wonder if the explosion in social and welfare spending by Washington at the same time we left the gold standard has been the "cause" of such a financial mess in America, or simply leaving the accountability of the gold standard in the early 1970s. With no gold standard to limit crazy schemes, the Federal Reserve has printed ever greater amounts of fiat paper money at will, lacking ANY input by voters or Congress. Plus, Congress and Presidents over four decades of mismanagement have taken to monster fiscal stimulus and deficit spending sprees (debt accumulation schemes) to hold up the U.S. economy. I will leave the arguments and debates on the long-term intelligence of such alone for now.

    Cost of Gold Production Model

    A better way to "value" gold vs. historical norms is first and foremost to compare and contrast prevailing prices to the global cost of production. Since 1969, the prevailing gold price has averaged more than twice (2x) the same period industry-wide typical "cash cost" of mining an ounce and 150% the "all in" sustaining cost of production for gold (old timers like myself called it total expenses years ago), else no new exploration and mines would originate to replace depleted ones. With cash costs now above $800US an ounce for the industry and an all-inclusive sustainable cost of production in the $900 to $1200US an ounce range, depending on what you want to count as realistic operational expense to keep mining gold past 2014-15 ($1100 for a mean average number recognized by most industry experts for 2013), $1300 is on the lower end of any type of "average" you can devise. I would put today's gold quote in the 20th percentile for the last 50-100 years of data I can find for price vs. its equivalent cost of production. [I have used gold mining annual reports and income statements mostly from the U.S., including the likes of the prolific Homestake Mining company to estimate the industry's cost of production since the 1920s. I have augmented this calculation with various gold trade group data through the decades.] The only instance where the gold price sold substantially below the total cost of production was 1997-2003, when western banks tried to kill gold's allure once and for all, but failed miserably.

    Considering most nonrenewable resources on the planet are nearing depletion in the next 10-20 years, the nominal cost of mining gold/silver will surely outpace CPI or any realistic inflation increase coming down the road. If total demand for gold expands at a minimal rate consistent with the planet's population growth of 1.5% annually (similar to the past few decades), new precious metals supply cannot keep pace with the demand increases approaching soon.

    Just like Peak Oil production is becoming a reality at the present time, Peak Gold production is projected to hit between now and 2025. Basically, no matter what the cost of production or effort input to discover new deposits, the annual mined supply will hit a peak and decline from there. Effectively the planet will be mined out of gold resources. Gold will then have yet greater rarity and value is my read of the supply shortage coming in the next 5-10 years. Without huge new discoveries of high grade deposits on the planet, production has already been flattening for decades. The percentage rise in mined gold supplies has slipped below the rate of population increase for the first time in hundreds of years of data I can find. Since 1940, annual gold mine production has less than doubled vs. an equivalent population jump from 2.5 billion to over 7 billion people on mother earth. Basically, the number of gold ounces available to own per person on the planet has been in serious decline for quite some time.

    Gold has a long history over thousands of years as the best store of value and purchasing power, holding the widest acceptance globally for a variety of reasons. Foremost is from gold's scarcity. You could fit all the gold mined in history into a large Olympic size swimming pool! The total above ground supply has typically risen at rates close to increases in the general population, coincidentally or by design. Its indestructibility, glowing color and ability to be formed or minted into coins are other good reasons gold is the ultimate form of money.

    Peak Gold characteristics are becoming more evident as time passes. Not only is gold's mined supply not keeping pace with population growth, but the cost of discovery and mining is starting to explode as the easy to find (near the surface), high grade deposits are approaching depletion. The industry average "all in" cost of production has risen from around $350US an ounce in 2000 to roughly $1100 today, and that's just to keep total output at roughly the same level of 80-90 million new ounces per year.

    While many on Wall Street are calling for sub-$1000US an ounce gold prices in 2014, I think it quite illogical to expect such an outcome. The price of gold would have to fall below the cost of production at the same time as 1) world geopolitical concerns remain unresolved in the Middle East (Iran, Syria, Palestine, Libya, Egypt, Iraq, etc), eastern Europe (Russian and Ukraine) and around the coast of China (China vs. Japan, S.Korea vs. N.Korea, China vs. Philippines/Vietnam), 2) money printing and debt accumulation remains completely out-of-control in China, Japan, the U.S. and Europe where 70% of the globe's paper wealth and economic output resides, plus 3) mounting evidence of gold price manipulation at the London price fixings between western banks, and disappearing physical gold supplies the world over are honestly an unprecedented development in late 2013 and early 2014.

    The 1997-2003 example of gold prices trading BELOW the cost of production, was the reverse fundamental situation of today, and will likely not be repeated. Back then we had reached a point of next to zero international discontent between sovereigns, consumer and business optimism was at extremes after a 20-year run in financial asset prices, fiscal budgets and international trade were more equally balanced the world over, and gold was at the tail end of an exhaustive two decade decline from the early 1980 peak. To argue gold should be priced under the cost of new mine production today is quite stretched, if not in the realm of a delusional fantasy for the big banks and Uncle Sam.

    Gold Price Adjusted for U.S. Dollar Supply Growth

    Another way I look at gold is comparing the actual gold backing (unofficially today) for the M-1 money supply. If you use the U.S. gold holdings as reported by the New York Federal Reserve Bank, which may or may not actually exist, today's spot gold price multiplied by the ounces owned in government records, divided by the current M-1 reading (cash in circulation) gets you around $0.15 in theoretical gold backing per dollar in circulation during March 2014.

    The high for each paper dollar's theoretical gold backing the last 45 years was about $0.60 during January 1980 for each $1.00 in paper money in circulation (which led to a very strong dollar rally vs. other currencies for 5 years not coincidentally). In December 1974 this number was $0.21, in December 1987 a little over $0.20, and approached $0.30 in August 2011 at cycle highs. The lows were $0.06 in January 1970, $0.16 in December 1985, $0.10 in December 1992, and $0.07 in January 2001.

    Believe it or not, we are BELOW the average theoretical gold backing number today compared to the last 45 years, since leaving an official gold standard for U.S. dollar bills. Today's $0.15 number is less than the $0.17 mean average since 1969. Plus you have to gulp and believe the physical gold holdings reported by the Feds actually do exist. If they do not exist from all the forward sales and swaps rumored to be entered more than a decade ago under Alan Greenspan, former chairman of the Federal Reserve system (as many including myself conclude), the gold holdings/backing per dollar at spot market prices are likely much LOWER than the $0.15 number I come up with.... it could even be ZERO!

    If we continue to print 10% more each year in M-1 dollars, like we have since 2008, one would EXPECT the price of gold to rise by 10% also annually in the future, if we remain at the same implied hard money backing for dollars.

    However, if it becomes more evident the government is lying about its gold holdings, and the U.S. in fact holds little physical unencumbered gold reserves, the price could skyrocket in U.S. dollars soon even if gold does not rise much in foreign currencies. The gold market could be at a critical juncture in 2014, with Germany and other nations demanding their gold holdings be moved from the U.S. central bank and COMEX deliverable gold inventories nearly exhausted. A loss of faith in the U.S. dollar could approach quickly. A perfect financial storm leading to a hyperinflation accident is something every investor should hedge against in his/her portfolio presently. Not holding gold may prove a greater disaster for your net worth, than waiting for lower precious metals prices. Just like missing out on a big stock market rally can bring regret for the timid investor, missing out on a monster rally in gold, when you have plenty of reasons to own it currently, may ruin both your mood and ability to live well in the future. Food for thought!

    At What Price Should Gold Sell?

    The gold market is more fickle than even the stock market in trying to predict prices and returns over the short to intermediate term, based on my 27 years of trading it. When gold was selling for less than its cost of production 15 years ago, I knew it would be a good idea to hold some. Others my age asked for video game systems for Christmas, I asked my parents and brother for gold coins. Hey, they were about the same price, and I wanted to save for my future. I stashed many of them in a safety deposit box each year after Christmas at prices less than $300 per ounce coin. Conversely, from late 2009 to late 2012 I owned little or no gold investments, as gold was clearly overdue for a multi-year breather. Gold was overhyped by Wall Street, over-owned by investors and getting quite expensive on my relative screens. Since mid-2013 I have been acquiring more gold, silver and palladium investments, and built very sizable positions.

    Clearly, the near universal bearishness and skeptical sentiment from November 2013 to January 2014 highlighted a great entry point for precious metals investments. We reached record low, or nearly so, premium levels on call options for the gold and silver mining companies in December-January, and this group was the poster child LOSER as an investment class for 2013 by the mainstream media and investment professionals alike. Futures trader, Wall Street analyst and investor surveys of sentiment regarding gold's future were incredibly low, some at records.

    The sentiment and technical chart backdrop for gold miners in particular (and many miners in general) reminds me of the year earlier position the solar stocks found after their multi-year bottom. I wrote a few stories on Motley Fool about the once-in-a-lifetime opportunity to buy solar companies in early 2013. Here is a link to see how far they have traveled for smart, thoughtful, contrarian investors the last 12-18 months.

    Starting with a purely historical perspective of the average cost of production and normalized implied gold backing of U.S. dollars, including trends in place conservatively projected throughout 2014, my calculations point to gold's true underlying "worth" at a little under $1500 on January 1st - moving to a little over $1600 by the end of the year, at a minimum.

    Billionaire investor Eric Sprott's call for $2000US gold in late 2014 or early 2015 might seem farfetched or not realistic, but I believe he may be proven correct in the end! Increasing rates of paper money printing by central banks appear likely if the global economy stumbles from geopolitical concerns, an oil shock out of the Middle East supply network, or some new unforeseen black swan event. Already, as I have warned since late 2009, the Federal Reserve is now required to double down on the total of Quantitative Easing (direct interference in the Treasury market, another form of money for the banking system globally) and fiat currency printing every year or two to keep the scheme going.

    At some point, perhaps soon, the kindness of strangers from the likes of China, Russia, Japan and Europe to financially support our reckless monetary and fiscal policies will end. A result of self-interest or in retaliation for a myriad of possible calamities foreigners blame the U.S. for instigating, the music will almost surely stop in either a massive deflationary depression, or more likely, a hyperinflationary one. Not coincidentally, a hyperinflation environment would be a better endgame for both equity and real estate investments. Slow motion hyperinflation (if that makes any sense) is being pushed as the final outcome by a majority of Federal Reserve governors in power today to keep some semblance of price equilibrium with exploding national debts. They are openly advocating in 2014 policy speeches inflation is too LOW! Of course the biggest beneficiary of YET higher inflation rates will be the precious metals.

    Conclusion

    A 2015 gold price range of $1500-$2000US an ounce seems about right to me. As "reckless" monetary and fiscal policies everywhere fiat currencies exist on the globe combine with new geopolitical issues like the recent Ukraine/Russia confrontation, gold investments may prove one of the big winners for 2014-15. $1100-$1200 gold prices appear less likely - my guesstimate would be at 10% probability, with equal odds of $2000 an ounce or higher quotes in 2014-15.

    The safest ways to play a gold rebound in 2014-15, either for speculation or a hedge, in regular brokerage accounts are by holding SPDR Gold Shares (NYSEARCA:GLD), Market Vectors Gold Miners ETF (NYSEARCA:GDX), Market Vectors Junior Gold Miners ETF (NYSEARCA:GDXJ), and Goldcorp (NYSE:GG) in my opinion. Plenty of mining companies retain value and considerable upside leverage if gold bullion skyrockets. From my research and perspective, the mining equities as a group are quite undervalued historically on price to sales, price to earnings and price to cash flow, assuming $1500-$1600 gold prices are in the offing.

    SPDR Gold Shares are the most direct and lowest expense exposure to gold prices for small investors using a stock brokerage account. Next to the attractiveness of holding gold bullion and coin investments directly in a safety deposit box or buried in the back yard to prepare for rising rates of inflation, this ETF scores highly as a strong risk-adjusted hedge and speculation candidate for investors today. You can read more information on how the SPDR Gold Shares work here.

    (click to enlarge)

    Charts courtesy of StockCharts.com

    Market Vectors Gold Miners ETF is perhaps the smartest, low cost way to buy a basket of the biggest gold mining companies on the planet. It is a great gold/silver diversification tool in one easy to trade, liquid and respected product. Just like gold priced in U.S. dollars, gold mining investments have been turning higher since December. After the March-April selloff retraced and backfilled some of the early year advance, now may be a great time to purchase shares. Read more about the Market Vectors Gold Miners ETF here.

    (click to enlarge)

    Market Vectors Junior Gold Miners ETF is a basket of smaller gold mining and exploration names. It is somewhat higher risk, with increased volatility and price swings than the large mining company ETF option. The upside for investors is the micro-size, small and middle capitalization precious metals miners usually rise much faster in bull markets for gold and silver. The downside is they fall even harder when bullion prices are declining. I would consider purchasing this ETF only after owning other lower risk gold ideas. Here is a link to learn more about Market Vectors Junior Gold Miners.

    (click to enlarge)

    I would rate Goldcorp as the single best - low country risk, low mining cost, strong balance sheet, diversified production profile miner to own today. It trades at premium valuations to other gold mining companies, but deservedly so. Goldcorp likely holds the highest "margin of safety" in the precious metals mining group, with plenty of unhedged exposure to both gold and silver prices going forward. Here is a link to the company's website.

    (click to enlarge)

    If you have never owned precious metals investments, you will be surprised how much better you sleep at night knowing you hold real world protection for your net worth and future income stream. Putting just 10% or 20% of your financial assets into gold related investments and other precious metals is a sound, time tested strategy over hundreds of years of experience. Commit your physical gold investments to a long-term horizon, ignoring short-term price changes and the urge to sell to lock-in quick gains or cut some losses. You don't have to count on Uncle Sam alone taking care of you and your livelihood in ten or twenty years. It's time to take care of yourself and your financial future, and reason independently of conventional wisdom, like found on Bloomberg, CNBC or the Wall Street Journal. You can do it. I have faith in you and mankind generally!

    Disclosure: The author is long GDX, GDXJ, GG, GLD.

    Tags: GDX, GDXJ, GG, GLD
    Apr 11 9:41 AM | Link | 6 Comments
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