Gold Investments Year-End Review 2008 - Outlook for 2009
Gold Outperformed Most Assets in 2008 - Gold Up 3.9% in USD; Up 5.3% in EUR and
Up 34.4% in GBP
Today’s London AM fix (23/12/08) was $844.01 (USD), £570.85 (GBP) and €603.72
(EUR). At the start of 2008 ( January 2nd 2008), gold’s London AM Fix was at
$840.75 (USD), £424.81 (GBP) and €573.34 (EUR).
Thus, in 2008 gold is up by 3.9% against the dollar, up 5.3% against the euro
and up 34.4% against the pound. The London AM Fix is a widely followed
benchmark for physical gold and silver prices and is reported in major
newspapers and at many gold-related websites
This has led to a sharp outperformance of gold vis-à-vis every major equity
indices and commodity in the word, not to mention most property markets (see
Chart and Performance table).
In March, gold fell from a record nominal high of just over $1,000/oz but it is
important to remember that gold is only down some 15% from that record nominal
high and this is after surging nearly 60% in the previous 7 months.. In the
seven months from the start of the credit crunch and the collapse of Bear
Stearns, gold had surged by nearly 60% - from $640 in August 2007 to over
$1,000 in March 2008.
Thus after a 60% surge in just 7 months, gold had become overvalued and was due
a correction. This is exactly what has happened and despite carnage in equity,
commodity and property markets internationally gold remains higher in 2008 in
all major currencies including one of the strongest currencies in the world
during the second half of 2008 – the US dollar.
Considering that gold had already outperformed all other asset classes in the
last 7 years (a roughly 20% return per annum), this is quite an achievement.
Especially given the extraordinary and unprecedented financial and economic
times that have confronted us in 2008.
Gold and silver may rise or fall a small number of percent between here and
actual year end. Should gold close down on the year, it will be only very
marginally and will be the first annual fall in gold prices in dollar terms
since 2000. Even were gold to end up being down some 5% in dollar terms in the
year – that would be quite an achievement considering how badly property
markets and major equity indices such as the FTSE (-33.4%), S&P 500 (-41%) and
Nikkei (-43%) have performed in 2008.
Equity indices are down by even larger amounts from peak to trough or from
their recent record highs.
Gold has done exactly what it should do in a financial and economic crisis – it
has outperformed other asset classes and preserved the wealth of those who have
prudently diversified.
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Outlook for 2009
Never in modern history has the outlook for global financial markets and
economies been so uncertain.
The financial markets and global economy remain in a state of heightened flux.
Deflation is clearly winning the early to middle rounds of the titanic
“flation” battle. But the concern is that inflation and stagflation will come
out swinging in the following rounds. The taboo word of ‘hyperinflation’ may
soon become a topic of debate in the coming months as stagflation and deflation
have done in recent months.
Bernanke’s academic knowledge of the Great Depression and Japan’s ‘Lost decade’
while useful is quite obsessive and myopic . He would do well to also study
Weimar Germany as there are parallels with America’s massive fiscal deficits
and world’s largest debtor status with those of Germany after World War I that
are increasing by the day.
There are real concerns of a disorderly run on the dollar as the creditors of
the world’s largest debtor nation get worried about their US dollar denominated
assets and need their own currency reserves to help protect and stimulate their
own struggling economies.
A prime distinction between the 1930’s deflation and Great Depression and today
is that then the US was the world’s largest creditor nation and the dollar was
backed by gold. Thus the US dollar strengthened in value as everything deflated
in value versus it (stocks and property fell by some 80%).. Gold was even
stronger as Roosevelt devalued the dollar by 60% and revalued gold by 60% from
$22/oz to $35/oz in 1933.
Today, the US is the largest debtor nation the world has ever seen and the
levels of debt are increasing dramatically. And the US dollar is now a fiat
paper currency, only backed by the “good faith and credit” of the US government.
It would not require significant selling by the Chinese, Japanese, Russian or
OPEC nations to create a run on the dollar and sharp move upwards in long term
interest rates (as US government bonds are sold) rather only a sharp reduction
in their purchases of US debt instruments. This possibility is looking more
probable and could see President elect Obama facing a monetary crisis in his
first term.
Especially as the economic meltdown is leading to the US’ creditor nations
having their own domestic financial and economic crisis to deal with. A sharp
decline in the dollar will likely see other nations devaluing their currencies
in competitive currency devaluations which would see the value of all
currencies decline relative to gold. Competitive currency devaluations are
already taking place in many countries internationally including in Japan (just
last week Japanese Finance Minister Shoichi Nakagawa signaled Japan is ready to
sell yen in order to artificially manipulate a weaker currency), Russia and
China.
Massive and Deepening Macroeconomic Risk in the form of Deflation now and
likely
Stagflation or Hyperinflation in the Medium to Long Term
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Deflation Now
Vicious deflation (particularly in asset markets that were based on massive
amounts of debt and leverage) looks set to be the prevailing theme of 2009 or
at least most of 2009. However, in the medium to long term we are likely to get
a sharp bout of stagflation which, if not tendered to carefully or should there
be a run on the dollar, could lead to a more serious bout of hyperinflation in
the US and in other debtor nations.
Contrary to misinformed commentators and “expert” claims that gold does not
perform well in deflation, it is worth noting that gold outperforms other asset
classes not just in periods of inflation or stagflation. Gold also outperforms
in deflationary depressions as it did in the 1930s when the dollar (which was
backed by gold unlike today in our modern floating fiat currency monetary
system) was sharply devalued overnight by Roosevelt from $22/oz to $35/oz. Thus
overnight in January 1934, gold was revalued by 59%.
It is worth remembering that the Dow Jones fell by 90% during the period and
property prices fell by more than 50%.
Stagflation and potentially Hyperinflation
President Obama must be careful that his fiscal stimulus and efforts to reflate
the rapidly deflating economy do not result in deepening inflation and
stagflation. As this would then necessitate a Paul Volker style Federal Reserve
Chairman who would hawkishly increase interest rates in order to tame inflation
and encourage Americans to forego consumption and rebuild a culture of prudent
saving, manufacturing and exports which will be necessary if America wishes to
regain its economic health again.
With central bankers, President Obama and politicians internationally
desperately trying to inflate their way out of the current deflationary spiral,
the concern is that while they may succeed in vanquishing the Charybdis of
deflation they are eventually slaughtered by the Scylla of inflation,
stagflation and potentially even hyperinflation.
Investors and savers should be cognoscente of the big picture historical trends
and prepare, invest and save accordingly.
Solvency of the U.S. government
America is the largest debtor nation the world has ever seen and its global
ascendancy is now threatened by this staggering debt and by the emergence of
new powers and a new multipolar world.
American consumers have $14 trillion worth of personal debt and the national
debt has risen sharply to some $11 trillion ($5.7 Trillion when President Bush
came to power) and projections that this debt could surge to as high as $20
trillion in the coming years. And this does not count the staggering unfunded
liabilities of either Social Security, Medicaid and Medicare. The head of the
Federal Reserve Bank of Dallas, Richard W. Fisher has said that the unfunded
liabilities from Medicare and Social Security adds up to $99..2 trillion.
There is absolutely no way that the American people can fund these Social
Security and Medicare obligations. The United States has been living way beyond
its means and will become a third world country unless something is immediately
done to drastically cut humongous military expenditures and government spending.
The demographic time bomb facing the US as 78 million baby-boomers begin to
retire in the coming years may make the current financial crisis look like
child's play.
Mr. David Walker, the US Comptroller General, chief accountability officer and
head of the US Government Accountability Office (GAO) has drawn parallels
between the US today and the end of the Roman Empire, warning there are
"striking similarities" between America's current situation and the factors
that brought down Rome, including "declining moral values and political
civility at home, an over-confident and over-extended military in foreign lands
and fiscal irresponsibility by the central government" (see David Walker's
recent article in CNN via Fortune magazine in the COMMENTARY section today).
The US government fiscal position increasingly resembles that of a Latin
American ‘Banana Republic’. While levels of corruption are not on a par with
these Banana Republics, corruption is rife and it increasingly looks like the
lower and middle classes of America have been pillaged by the Wall Street
moneyed elite and their appointed lackeys in the higher echelons of the US
government.
This is not "anti American" as "pro American" liberals and conservatives alike
have echoed these warnings in recent years. The Government Accountability
Office (GAO) has rightly earned a reputation for professional, objective,
fact-based, nonpartisan, non ideological, fair and balanced reviews of
government programs and operations.
Walker has said that fiscal responsibility must be a top priority and if this
is done the problems challenging the US can be overcome but "if they don't, I
think the risk of a serious crisis rises considerably". This crisis would
almost certainly be monetary in nature with a possible collapse in the dollar
and the dollar losing its privileged status as the global reserve currency.
The new President will face a herculean task if he is to succeed in preventing
America from becoming a second tier power as happened to Great Britain at the
turn of the last century. This has obvious ramifications for investors who
should focus on wealth preservation in the coming years.
Even the most sanguine, tunnel-visioned bull would have to admit that the
fundamentals of the US economy are bad and deteriorating.
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Solvency of UK and of many other debtor nations
Sterling has fallen precipitously in recent weeks leading to fears of a
currency crisis. The Bank of England resisted cutting interest rates by more
than 1 per cent earlier this month amid fears that the economy and sterling
would collapse. The bank revealed yesterday that its Monetary Policy Committee
had "considered cutting rates further", but it feared that "there was a risk
that going further could cause an excessive fall in the exchange rate" causing
inflation in the long term.
Ben Read, managing economist at Centre for Economics and Business Research,
told the Telegraph: that “with the credibility of UK fiscal and monetary policy
now under serious scrutiny across the international markets, each policy option
comes with potentially serious consequences for the credit worthiness of UK
plc."
As governments and central banks internationally engage in a global currency
debasement those who think that printing money is a risk free panacea to our
deflationary woes will be found wrong once again. The UK is now in the midst of
a sterling crisis and the risk is that given the scale of debt internationally,
the scale of the global imbalances (huge US trade, current account and now
budget deficits) and the scale of currency debasement that a global monetary
crisis could be the ultimate unfortunate outcome.
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Competitive Currency Devaluations
Competitive currency devaluations on an international scale are a recipe for
wealth destruction on a massive scale. Devaluation is a short term panacea
which fails to address underlying uncompetitive challenges facing economies.
Countries that devalue their currencies tend not to do well over the long term
as seen in many emerging markets and South American economies in modern
history.
Countries that have strong currencies in modern history (such as Germany and
Switzerland) tend to move up the value chain in terms of exports and prosper in
the long term. A sound currency is a prerequisite for a sound economy and alas
the UK ,US (after years of profligacy ) and many other nations face major
challenges on both fronts.
Gold is a finite currency will be the default currency of choice and a monetary
safety valve where large sums of capital will flow - thus resulting in sharply
higher prices.
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Supply/ Demand Situation in Gold and Silver Remains Very Bullish
Global gold production is now estimated at some 2,500 tonnes per annum and
demand is around 4,000 tonnes. The supply demand deficit has been made up for
many years by sales by certain imprudent central banks (such as Gordon Brown’s
Bank of England) and these central banks are now greatly reducing their sales
and many central banks internationally, especially large creditor nations with
huge US dollar reserves, are now diversifying their currency reserves with gold.
Gold ETFs have created hundreds of tonnes (the world's largest ETF, the SPDR
Gold Trust, said its bullion holdings rose 6.1 tonnes, or almost 1 percent, on
Dec. 17 to a record high of 775.33 tonnes of bullion) and billions of dollars
worth of extra demand for gold in recent years. As have the creation of many
other gold storage and ownership programmes such as digital gold and Perth Mint
Certificates (the Perth Mint refines and produces some 10% of the world’s
bullion, doubled output in the past six months).
Meanwhile, global gold production has not increased despite the increase in
demand and increase in gold prices in recent years. Gold is a precious, finite
metal and gold production only increases at a rate of some 2 to 2.5% per annum
and falling.
Of the world’s three biggest gold producers (China, South Africa and
Australia), only China has managed to increase gold production in recent years
and their increase in production has been met with a corresponding sharp
increase in Chinese demand meaning that Chinese gold does not add to supply in
the international marketplace as it is all consumed in China which is a net
importer and increasingly so.
South African gold output has been falling since 1970 when annual production
was over 1,000 tonnes. Last year South Africa produced 272 tonnes of gold..
South African gold output fell to its lowest level in 84 years in 2006 because
of declining mining grades. The last time South Africa produced less than 260
tonnes of gold was in 1920.
This means that the supply/demand balance in gold is becoming increasingly
tight and likely to lead to markedly higher prices in the coming years.
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Massive Systemic Risk
The risk posed to the entire global financial system has never been as high and
counter party risk has never been as high. In a world where huge banks such as
Bear Stearns and Lehman Brothers can collapse and behemoths such as Fannie Mae,
Freddie Mac, General Motors and a long list of others need to be bailed out,
investors need to again consider systemic risk and counter party risk. Systemic
risk hasn’t gone away, and it’s entirely possible that the risk may re-elevate
in the next six months.
Stockbrokers, pension providers and many other financial intermediaries will be
at risk of failure in the coming months and investors need to be aware of
counter party risk and intermediation. They should only deal with financial
entities and investment providers who they have done much due diligence on and
who they are reassured regarding the solvency. Credit ratings of providers
should again be evaluated and scrutinized
=-= Conclusion =-=
As long as the markets continue to be volatile and uncertain which
unfortunately seems very likely - demand for physical gold and silver bullion
will likely stay very strong and should result in higher prices.
Thus, the confluence of decreasing supply (as outlined above) and increasing
demand due to strong international geopolitical, systemic and macroeconomic
factors is leading to extremely bullish conditions for the gold and silver
markets. Probably even more bullish than in the 1970s when silver rose from
$1.39/oz to over $50/oz or 3,600% and gold rose some 2,400% from $35 to over
$850 in just 9 years.
Taken individually, any one of these factors would be bullish for gold but in
unison, these combination of factors will likely lead to gold prices surging in
2009. The inflation adjusted high of $2,400/oz in 1980 remains a conservative
estimate for gold to reach in the next 2 to 5 years. Similarly, the inflation
adjusted high for silver in 1980 of some $120/oz remains a conservative price
target that will very likely be reached within to 2 to 5 years.
Disclaimer: The information in this document has been obtained from sources,
which we believe to be reliable. We cannot guarantee its accuracy or
completeness. It does not constitute a solicitation for the purchase or sale of
any investment. Any person acting on the information contained in this document
does so at their own risk. Recommendations in this document may not be suitable
for all investors. Individual circumstances should be considered before a
decision to invest is taken. Investors should note the following: The value of
investments may fall or rise against investors’ interests. Income levels from
investments may fluctuate. Changes in exchange rates may have an adverse effect
on the value of, or income from, investments denominated in foreign currencies.
Past experience is not necessarily a guide to future performance
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