The Fed & the Banks – Gold’s new Best Friends
Barnes Capital Insight Issue #24
by Daniel A. Barnes, Barnes Capital Insight | April 8, 2008
PrintGold’s going to $1000 this year: Maybe $2,000 in the next few years... Maybe higher. More importantly, Gold stocks are finally poised to really take advantage of these moves after years of retooling for growth – more on that later in the article. Let’s start at the beginning.
The Element
Gold- is unlike any other element. It is indestructible, imperishable, portable, identifiable and beautiful. The source of numerous fables and legends, Gold is the ultimate medium of exchange. Due to its unique properties, Gold is the universal, time honored standard of wealth, a “storehouse of value”. Civilizations have used Gold as currency and wealth since antiquity. Due to its physical properties, Gold has backed most governmental issued currencies from antiquity until the 1970s.
Gold maintains its purchasing power over time. “With an ounce of gold a man could buy a fine suit of clothes in the times of Caesar, Shakespeare, Jefferson, the Great Depression and today.” No other good has maintained purchasing power over the ages.
Why is Gold likely to Rise more?
There is a great battle going on in the financial markets, to save the big banks who recently got into so much trouble holding bad mortgage paper. There is also a smaller battle to ensure price stability. In fact the fight for price stability was the last great war that was waged by the Fed. Ancient Gladiator Paul Volcker declared that war in 1979, and the Fed declared the war won in the aftermath Greenspan easy money of 1% Fed Funds 2003-2005. But know, the Fed’s primary role to ensure price stability, is being sacrifice to its legacy role to ensure the survivability of the banking sector. The banks must be saved, come hell, inflation or both. Banks drive the exchange of goods and services through our 15 Trillion economy. Their dysfunction would drive a dagger through the heart of that economy. It’s a dagger that in time, we could heal from, but it’s not worth the pain to the government, or the people. The moral hazard of an inflationary economy and easy money has been permanently embedded in the cultural, fiscal and political landscape of North America. There will be no resurrection of Mr. Volcker to save the dollar, nor the asset holders who bear its cross in the coming storm.
Why is Gold $950 an Ounce?
Price stability is paramount, and persistent inflation is a highly progressive and stabile policy, if albeit, an activity in wealth destruction. For the banks to be saved, the currency must be debased because the only way to save the banks is to liquefy the markets through the creation of credit and more money. While this will be an elixir to bank balance sheets, it is a toxic potion for price stability and in-turn, currency stability. Thus, the cost of saving the banks is further erosion in the dollar. Gold, as a “storehouse of value” will rise to offset the inflationary effects of the easy money credit policies. So Gold will, at a minimum, inflate. That is why Gold now trades at $950/ounce, and that is why is pretty darn likely to continue to advance. The market is seeing the hand it has been dealt, and market forces are acting in accordance with reality. If you would like to review the primary factors that drive demand for Gold take a look at Insight #8 “Gold is Timeless Money”
Gold has been rising against all major currencies, financial assets, and commodities since 2005. In fact, Gold has been rising against all asset classes since 2005. Let’s take a look at what Golds’ move against Blue Chip stocks, Bonds, Currencies and Commodities has actually been.
This is how Gold has fared against the Dow Jones Industrials average since 2005. Remember, the Bluest and most international group of stocks make up the Dow stocks (Coca-Cola, Caterpillar, Microsoft, Exxon, Johnson & Johnson, General Electric, Boeing, etc); they truly represent the performance of America’s largest and most international stocks and the fact that Gold is rising against them indicates that Gold’s strength is not at all just a U.S. phenomena. Gold has increased more than 85% more than the Dow in just over 3 years, even adding back dividends, the out performance is more than 75%.
This is how Gold has fared against the US 10 year Treasury Note. It has more than doubled.
This is how Gold has fared against the Euro Currency since 2005. I has risen 93%.
Even against the CRB index, a broad basket of Commodities including a great amount of Crude Oil, Gold has outperformed by 47% over the last 38 months. Something’s going on here folks.
So there you have it, that ancient barbaric relic has done okay. But really you are thinking, Barnes, haven’t we missed it? Why hold the pretty stuff. Let’s examine that question for a minute.
The Comfort of Gold
We own Gold for Wealth Preservation. It won’t always go up, but it will never go to zero. Gold offers investors an attractive opportunity to diversify, reduce risk and protect portfolio wealth. Gold is the insurance part of the portfolio because gold itself will always maintain value, no matter what disaster may happen. Gold may rocket up to thousands of dollars per ounce in the coming gold rally or it may struggle and fall lower, but it will always be worth something.
Owning physical gold in your own possession is like having fire insurance on your house. While most of us don’t expect a fire, we do know that things happen that are simply beyond our control. Gold in your portfolio is insurance on your accumulated savings and wealth. Since 2001 Gold has been in a powerful bull market following a 20 year bear market from 1980-2001. Do I have your attention yet? So you want to add some Gold exposure, now the question is: how?
How do I invest in Gold?
Answer: you could buy gold itself from a Dealer in your locality, buy gold stocks, or buy gold derivatives such as the Exchange Traded funds such as GLD, the Gold-Trust closed-fund or mutual funds. You can also subscribe to Gold Newsletters and follow their suggestions or put your money with a mutual fund. There are problems and advantages in each option, not the least that is the transaction cost or ongoing fees.
Time to Buy Gold Stocks
Currently, we believe that Gold stocks are finally poised to move much higher now that the retooling of the industry has largely been accomplished. David Galland at Casey Research (www.caseyresearch.com), one of the better Gold Newsletter’s has recently written a very good article about this. In 6 years, Gold has risen from $277 on January 4th, 2002 to $950 this week. Meanwhile the S&P rose 22% in over the same period. Since Gold stocks have leverage, a $10 increase in the price of Gold can translate into increased earnings of 5% or more. Gold stocks should outperform gold bullion because they are much more risky that the mineral itself.
And in fact, Gold stocks are indeed up 625% from January 2002. However, they have not outpaced Gold Bullion at all in the last 6 months, as bullion rose 42%, but the stocks just 37%. Galland believes that’s about to change in a big way. Here’s why:
Gold companies were run in survival mode for most of the late 1980s and all of the 1990’s and into this decade. It wasn’t until the last few years that the yoke of survival-thinking and perpetual cost-cutting was taken off. Gold companies have needed to retool for growth and rising profitability, and this has led to abysmal operating results in 2004, 2005, 2006 and 2007 at many Gold producing companies. That work is largely behind them now, and Gold stocks are likely to begin to outpace the change in the price of gold to the tune of 2:1, 3:1 or more for the next up legs of this bull market.
How Can Barnes Capital help?
We view Gold as a strategic asset class. And even though we anchor virtually every portfolio with dividend paying Blue Chip stocks that increase their dividend every year, we also diversify our client’s portfolio’s with positions in Gold and when appropriate – Gold stocks. Few Advisors do this. It’s still early in this big, long, powerful trend, in which the banks and the Fed are your friends.
Sincerely,
Daniel A. Barnes, CFA
Copyright © 2008 Daniel A. Barnes, CFA
Editorial Archive
Barnes Capital builds and protects wealth for individuals, families and business owners.
contact information
Daniel A. Barnes, CFA | Barnes Capital | Lafayette, CA | Email | Website
The opinions of FSU contributors do not necessarily reflect those of Financial Sense.
