"Mphm!" Why Great Men and Women Own Gold

"It is related of the illustrious Sandy McHoots that when, on the occasion of winning the British Open Championship, he was interviewed by reporters from the leading daily papers as to his views on Tariff Reform, Bimetallism, the Trial by Jury System, and the Modern Crave for Dancing, all they could extract from him was the word 'Mphm!" Having uttered which he shouldered his bag and went home to tea. A great man. I wish there were more like him." - P.G. Wodehouse

Those of you who have kept up with this newsletter over the years will recognize the quote from Wodehouse gracing this issue's masthead. It's been there before -- almost always at summer's start -- and almost always with a reflection that perhaps we can learn something from Mr. McHoots.

It has been an interesting past 60 days or so. Gold cratered and no one seemed to know why. The stock market went higher defying gravity, the fundamentals and, some said, common sense. Bonds headed south because someone whispered a caution to the Wall Street Journal which passed it along to the rest of the world. It was this: The Fed might stop printing money. The Federal Reserve board clarified the matter by saying, it just might do that, but then again it might not. The politicians globally legislated, or failed to legislate, squabbled, pontificated and pandered to a citizenry that did not seem to take much notice.

In other words, not much has changed since the time of the illustrious Mr. McHoots (the 1920s). Nor has the passage of time done much to alter the reasons why the prudent citizen/investor might purchase gold. The fact of the matter, though rarely discussed, is that gold ownership has more to do with personal philosophy than it does finance and economics -- though by that I do not mean to diminish the importance of financial markets, or politics for that matter, in our everyday lives. Things, though, do need to be kept in perspective and gold helps toward that goal -- once one understands its true nature. My guess is that McHoots could afford a healthy disdain for current events because he was a gold owner -- and probably in the form of British sovereigns. A great man indeed. . . . .

This is the time of year when the markets traditionally take a break, but it is also a time when events can take us by surprise. Keep an ear to the rail (or an eye on the screen), but have a pleasant summer.

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What the charts on Eagle coin sales are telling us

The public's motivation for buying gold and silver

 

Editor's note: Some of you may have caught Wodehouse's casual mention of "bimetallism," a convenient segue into a couple of charts we developed at USAGOLD on American Eagle gold and silver bullion coin demand featured below.

The gold owner can take comfort in knowing that April's price jolt brought out the buyers world wide. The surge in demand came as a surprise to gold critics who see the smallest price correction as cause to take out the hammer and have at it. At the same time, it was sweet vindication for world's gold owners who understood full well why anyone would scramble for the metal at the lower prices.

The charts posted below are important for what they reveal about the public's motivation to buy gold and silver. The precious metals have always been thought of as inflation hedges, but as you can see, the huge surge in volume since 2008 did not occur during inflationary times, but during disinflationary times, when the greatest concern was the stability and viability of the financial system.

Almost completely ignored by the mainstream financial media, physical silver demand is one of the more interesting phenomena to develop in financial markets since the 2008 meltdown. Gold has always had its safe-haven adherents -- those who believe that it will get them through bad economic circumstances no matter how they are labeled. Now, poor man's gold has become the poor man's systemic risk hedge. It hints that the concern over the on-going financial crisis extends beyond the 1% to the middle class in general -- something aspiring politicians might want to take into consideration. Our volumes at USAGOLD for both the silver Eagle and silver Maple Leaf have been off the charts for over two years running.

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Why 2013 could be the best year to buy gold since 2008

The connection between quantitative easing and the gold price

 

Quantitative easing, the oft-referenced $85 billion per month shelled out by the Federal Reserve, comes down to the purchase of two kinds of securities -- U.S. Treasury paper (bonds, notes and bills) and mortgage-backed securities. The Federal Reserve buys the Treasury paper from the federal government and the mortgage-backed securities from commercial banks. The first is a direct form of monetization (money printing); the second is an indirect form since a good portion of those funds are in turn also used by the banks to purchase Treasury paper. The two together comprise the bulk of what appears on the Federal Reserve's Balance sheet as "reserve bank credit." At the present that figure stands at just over $3.2 trillion -- up about $2.4 trillion since the beginning of the financial crisis in late 2008.

When you superimpose the gold price over reserve bank credit on a chart, it looks like this:

At first glance, it looks like reserve bank credit and the gold price are correlated, but what is really going on with this tandem is that they are both being pushed by the same force -- a bad economy. It causes the Fed to print money and investors to buy gold. The Financial Times ran an editorial the other day explaining why some top-notch hedge fund managers -- like Paul Singer, John Paulson, Stanley Druckenmiller and David Einhorn -- don't like the U.S. Federal Reserve or chairman Ben Bernanke, the father of the QE policies charted above.

"His [Druckenmiller's] concern," the editorial explains, "is not the risk of inflation, which has prompted investors such as Mr Singer and John Paulson to load up on gold. Instead, it is a broader concern that has been voiced by growing numbers of the most powerful and influential professional investors: that by pushing down interest rates and buying up government bonds, the Fed is warping the norms of economic behaviour."

Most importantly capital, according to this group, is being misallocated driving investors into dangerous financial waters. "What kind of entity," warns Seth Klarman, another hedge fund manager, "drives the return on retirees' savings to zero for seven years in order to rescue poorly managed banks? Not the kind that should play this large a role in the economy."

It is these kinds of distortions, though, that create opportunities in investment markets, which leads me to the reasons why I went to the trouble of compiling and publishing this chart:

First, reserve bank credit has gone vertical since November's near-term bottom -- up over 15%. The Fed might reverse or moderate its purchases at some point in the future, but at the moment, it has the pedal to the metal. That alone might be worth the cost of admission when you consider we are told daily that quantitative easing might be ending soon. Pay attention to what the Fed does, not what it says.

Two, the gold price, as a result of its recent plunge, has crossed decisively under the reserve bank credit trend line. The two developments together have made for an interesting chart divergence -- the sort of thing that catches the attention of technicians and value investors alike, particularly if it defies logical explanation. This latest correction, more than any I can remember, has the experts scratching their heads. (Please see "Illogical dumping. . ." below.) When an upward or downward spike in the market proceeds sans logical underpinnings, a snap-back rally or correction often follows. The last such incident in the gold market occurred in 2008. The market sold-off roughly 30% at the height of the financial crisis, and then regained and superceded those losses before 90-days had elapsed. (From there the market climbed to all time highs in 2009.)

Three, should the quantitative easing program finally ignite price inflation, we might see an entirely different chart pattern emerge -- a different kind of divergence. Gold could go vertical while reserve bank credit stays level or heads south depending on the Fed's ability sell-off the securities it accumulated during the quantitative easing stage.

That same Financial Times editorial concludes with this important observation on the behavior of hedge funds and hedge fund managers:

"Part of the pressure comes from knowing, or sensing," says Richard Fisher, president of the Dallas Federal Reserve, "that at some point you are going to get a reversal. If I was in my old business I'd be looking around [asking] how am I going to make money without taking undue risk?" It is a big problem for the masters of the universe. They live for distortions in markets, which provide them with opportunities to throw billions of dollars at a brilliant trade that will push prices back in line with reality. Successful hedge fund managers make their reputations by being clever, brave or fast enough to seize on these chances."

One of those distortions looks like it may have materialized in the 2013 portion of the gold-reserve bank credit chart. The press greatly emphasized the withdrawals at the gold exchange traded funds over the past several months. What it failed to mention is that there are two sides to every trade. Someone was selling, but someone else was buying (and I'm not talking about just Chinese mothers and Japanese housewives). Even now the gold price has rallied off its lows, and someone is buying the mini-corrections we have seen since the big dump in April. If the longer term pattern on our chart reasserts itself, a significant upward adjustment in the gold price could be in the cards -- a change of course that could end up making 2013 the best year to buy gold since 2008.

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Illogical dumping raises questions about causes of metal's sharp decline

"So extraordinary was the 9.4% collapse on April 15, wrote Howard Simons of Bianco Research at the time, that the odds against such a move were 20 trillion to one -- 'a lower probability of occurrence than randomly selecting a [particular] $1 bill out of pile of singles representing the U.S. national debt.'

These improbable moves have made gold bugs suspicious, which isn't unusual. Folks who own gold do so because they don't trust the status quo, especially when it comes to government-issued paper money. But just because you're paranoid doesn't mean somebody isn't out to get you. They point to bursts of selling on Friday, April 12, which resulted in prices plunging by more than 5%, and to dumping that resumed the following Monday in Asia, early in the day when markets are illiquid. That culminated in a 9% collapse by the time the New York market had settled. But a seller who wanted to unload a large position at the optimal price would have done precisely the opposite—liquidate as discreetly as possible. Instead, sellers dumped the equivalent of more than 300 tons of the metal in staccato-like blasts during those sessions."

--Randall Forsyth, Barron's, This time, the gold bugs may have a point, 5/18/2013

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Short & Sweet

The Reserve Bank of India has asked banks to stop pushing gold coins. The request "stems from a need to draw customers back towards financial saving instruments, which, in turn, are good for the economy." Gold demand in India is off the charts the result of a depreciating rupee and the Indian peoples' traditional attachment to the yellow metal. The World Gold Council reported that it expected India to import 350-400 tonnes of gold for the second quarter -- a 200% increase over last year. It also reported that it expected India to import 965 tonnes by the end of 2013 -- about one third the world's annual mine production. Indian authorities have instituted various policies to dampen demand ranging from import restrictions to begging the public to stop buying gold. Despite those efforts, demand continues to ramp higher. One more price drop like the one we saw in mid-April and India just might clear the decks of any yellow metal available.

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"We have to always remember that China will do what suits China and not the outside world. But the inescapable conclusion we have to reach is that the Yuan is set to replace the U.S. Dollar to a greater or lesser extent as it arrives on the world stage. This will inevitably lead to more global uncertainty and instability as dollar hegemony is cracked and more currency volatility batters the currency world. Market reactions could well discount the future and cause premature reactions that, we believe, will benefit gold." Julian Phillips, The Gold Forecaster

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"When you're at your best health, you're feeling good, that's the time when your insurance policies are actually the cheapest. It's been very volatile and painful on the way down but as a whole, a small allocation to gold as part of an overall portfolio still serves its purpose. Once you find out you're sick it's going to cost a lot more, it's going to be a lot more expensive." - Steve Laird, Franklin Templeton, Lead Portfolio Manager

Editor's note: Though I agree with the sentiment expressed, a "small allocation" isn't going to cut it. You do not want be underinsured. Underinsured is very nearly the same as being uninsured. We recommend a diversification of 10% to 30% of your assets (not including your primary residence). The level between those two numbers depends upon your own reading of the overall economic situation. Over the past several years of economic uncertainty and outright asset destruction, gold has strengthened, even saved, personal balance sheets buffeted by the ill-wind that still blows through contemporary finance. In fact, we have had very little selling all the way up, and plenty of additions to existing gold savings positions. Peoples' attitudes haven't changed despite all the hoopla about gold in the press these past several weeks.

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"While mainstream news sources continue the war against gold and gold-related investments, three of the world's top performing hedge fund managers have been busy at work building speculative gold positions during the first quarter. George Soros, John Paulson, and Steve Cohen, who in aggregate control over $60 billion dollars, have been aggressively buying the most speculative vehicles associated with gold: call options on gold mining stocks." - Bull Market Thinking, /Tekoa da Silva

Editor's note: So all the negative hype about Soros selling his ETF gold position is just that "hype." Hedge funds are charged with maximizing returns and beating the market averages (seeking alpha). To do this, they employ often times complicated strategies, usually with leverage, and go where assets are undervalued. This trio of hedge fund managers would not be buying yellow metal in various forms and representations, if they didn't think the gold story rested on a solid foundation -- a position the opposite of the tale the mainstream financial press and Wall Street have been weaving the past several weeks.

 

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Michael J. Kosares

Founder – USAGOLD

Author – The ABCs of Gold Investing: How To Protect and Build Your Wealth With Gold