Attention Miners, the Canary is Dead

If the stock market was a coal mine, and investors the miners, gold would be their canary. A sharp increase the price of gold is a warning signal that all is not well. It is a precursor to rising inflation, higher interest rates, reduced profits, and a general loss of confidence in financial assets.

One of the more astounding aspects of the recent gold rally, which has brought it to fresh eighteen-year highs, is the extent to which excuses have been made to minimize its significance. It's as if a group of coal miners is casually standing around the body of a dead canary, confident that the bird met its demise due to natural causes.

As the third quarter draws to a close the S & P 500 has managed a 3% gain, despite gold's 8.5% rise. Some of the popular excuses offered to "explain" gold's gain are "increased jewelry demand in India" "momentum buying from hedge funds and other speculators," "rising demand in China," "short-covering," and "demand outstripping supply."

While all of the above may in fact be true, they are merely the result, not the cause of gold's rise. Gold is rising for one reason and one reason only, which is the same reason that gold has always risen-- INFLATION. Gold, unlike national currencies, has no yield, so its rising popularity reflects the increased perception that interest rates are not high enough to compensate for inflation. Gold's new found strength is a sign that the world's misplaced confidence in central bankers, and their alleged commitment to limiting the issuance of currency, is finally coming to a long overdue end.

For fiat money to maintain its value there must be a general consensus that its issuers will keep it scarce. Without such a perception, all fiat currencies will eventually decline to their intrinsic values, which is zero. Gold, on the other hand, will always be scarce, as its supply is limited by the cost to mine it. As inflation accelerates, and the world's major central bankers look the other way, or worse deny its existence through slight-of-hand statistics, more people are re-discovering the value of gold.

Unfortunately the vast majority of investors have been lulled into such a false sense of confidence that they are oblivious to the warning that gold is providing. Rather than admit the unthinkable, they find it far easier to rationalize and deny. The result, as would be the case for coal miners ignoring the lifeless body of canary lying at their feet, will be the financial equivalent of death.

September 30, 2005

Peter D. Schiff

President/Chief Global Strategist

Euro Pacific Capital, Inc.

www.europac.net