The End of the World as We Know It - Gold Safe Haven / Commodities / Gold and Silver 2018
Imaginationsof the Misguided
It’s Christmas 2017 and North Korean Dear Leader Kim Jong-un is facinga crisis. Recently the United States, with UN approval, imposed the harshestround of economic sanctions yet on his reclusive regime.
While North Korea has been sanctioned since 2006 due to continuingattempts to develop nuclear weapons, this new provocation by its sworn nemesisis the last straw for Kim, who feels the great legacies of his father andgrandfather, Kim Jong-il and Kim Il-sung, weighing more heavily each day.
This time the U.S., under the leadership of its belligerentpresident - Trump, the evil, infantile capitalist - has convinced China toagree to a totaleconomic boycott of North Korea. Kim knows that preventing the North fromselling its primary export, coal, to China will deprive it of the hard currencyneeded to import food. A famine worse than the “March of Suffering” in the1990s, during which millions of people died, is on his doorstep.
Backed into a corner with no more “Trump” cards to play, Kimconsults his top generals in an underground bunker beneath the presidentialpalace. The options are considered. An attack on Guam. Nuclear tipped ballisticmissiles fired at Los Angeles. Clouds of noxious chemicals piped into the NewYork subway. An invasion of South Korea. After weighing the gruesome deathtolls and potential catastrophic effects on the American economy, Kim decidesto detonate a super-EMP weapon, anenhanced hydrogen bomb, at high altitude, smack dab in the middle of theUnited States, above the state of Kansas.
Facts - North Korea already has satellites positioned perfectly foran attack of this nature and two Russian Generals are on record saying Russiansuper enhanced EMP hydrogen bomb plans were accidentlytransferred to North Korea.
One cold winter morning, at zero dark thirty, a North Korean satellitewhile sailing over the continental United States drops an enhanced EMP bomb,which detonates 400 kilometers above its target. Immediately, the blastunleashes a flood of gamma rays, causing a massive electromagneticpulse that fries all electronics on the U.S. Mainland, including the entiresystem of electricity grids, telecommunications and cellular phones. The firstvictims are the estimated half a million travelers aloft in planes. Suddenlybereft of navigation systems, most of the aircraft plummet to earth. Trafficand train signals also fail, causing derailments and car crashes.
North American stock exchanges don’t open, and banks cease tofunction since they are unable to loan each other funds. ATMs no longer work,leaving the population locked out of their own bank accounts.
PeterVincent Pry, a nuclear strategist formerly with the CIA, warned of thedevastating effects an attack using an EMP warhead could have. Newsweekquotes Pry saying that “In the worst case scenario, food insupermarkets would be consumed within three days and within 30 days nationalfood supply in regional warehouses would begin to spoil, leading to anestimated 90 percent of the population perishing from ensuing starvation,disease and societal collapse.”
Seem far-fetched? Like something out of a Hollywood Armageddonmovie? Perhaps. The current U.S. Administration thinks the threat of an EMPbomb so unlikely that it closed the congressional EMP Commission in September.While a large-scale EMP attack has never been tried and remains theoretical,major cyber-attackshave been successfully executed.
In our post-9/11 age, where the options of colossal damage tohuman life are limited only by the imaginations of the misguided, anything nowseems possible. So how to protect oneself when so much seems out of ourcontrol?
Well, the answer lies in what has always been tangible, valuable,and rare: gold.
Gold as money
Due to its unique properties, gold was one of the first metalsdiscovered by mankind. Gold is found at surface in flakes and nuggets, makingit easily mineable. Historians agree the Egyptians were the first to smelt itand make gold jewellery using the lost-wax method. The funeral mask of King Tutis one of the most stunningly beautiful examples of Egyptian goldsmithing. TheEgyptians also learned how to alloy gold with other metals, to vary hardnessand color.
While gold was rare and valuable, it was also ideal for pressinginto coins. Because gold coins were portable, private and permanent, they fitthe early definition of a currency. Gold could be used as a medium of exchange,a unit of account, and a store of value.
The ancient Chinese, Lydians (in Turkey), Greeks and the Romansall used gold as money, with the Romans acknowledged as the first civilizationto employ gold as a currency across their vast empire. Historical records showEmperor Julius Caesar brought back so much gold from a victorious campaign inGaul to give 200 coins to each of his soldiers and pay all of Rome’s debts.Check out the excellent infographic byVisual Capitalist for more on gold usedthroughout history.
Over time, as countries moved to paper money, they realized theycould fix one unit of currency to a weight in gold, a system that became knownas the gold standard. Britain was the first to adopt the gold standard andother countries soon followed suit. In the 19th century, all countries exceptChina used it. Domesticcurrencies were freely convertible into gold at the fixed price and there wasno restriction on the import or export of gold.
Bretton Woods
In July 1944, as allied troops were racing across Normandyto liberate Paris, delegates from 44 nations met at Bretton Woods, New Hampshire -the United Nations Monetary and Financial Conference - and agreed to “peg”their currencies to the U.S. dollar, the only currency strong enough to meetthe rising demands for international currency transactions.
What made the dollar so attractive to use as an internationalcurrency, the world’s reserve currency, was each U.S. dollar was based on1/35th of an ounce of gold (35.20 US dollars an ounce), and the gold was to be heldin the U.S. Treasury.
With the Gulf of Tonkin incident in late 1964 and the accelerationof the Vietnam war in 1965, U.S. military spending exploded. This wascompounded by President Lyndon B. Johnson's Great Society project spending andnot raising taxes.
The ramping up, in early 1968, of the Vietnam war – because of theTet offensive and U.S. President Lyndon B. Johnson’s agreeing to GeneralWestmoreland’s proposed troop surge - brought renewed pressure on the dollar.
Since Johnson refused to raise taxes to pay for A. the socialwelfare reforms undertaken earlier and B. the war in Vietnam, the U.S. was nowrunning massive balance of payment deficits with the world. Speculation against the U.S.dollar intensified, and when other central banks became reluctant to acceptdollars in settlement, the system began to break down.
In 1971 US President Nixon ended the convertibility of the dollarinto gold for central banks, effectively demolishing the gold standard. TheBretton Woods system collapsed and gold was allowed to trade freely without aU.S. dollar peg. An official "two-tiered" price for gold was announcedto the world - the official price of US$35.20 would remain for central banksdealings, the free market could find its own price.
Gold as store of value, inflation hedge
Investors love gold because it tends to hold its value throughtime. They see gold as a way to preserve their wealth, unlike paper or “fiat”currencies which are subject to inflationary pressures and over time, losetheir value. In the U.S. there was an increasein inflation for every decade except the Depression when prices shrunk nearly 20%. The Bureau of Labor Statistics’ Consumer PriceIndex indicates that between 1860 and 2015, the dollarexperienced 2.6% inflation every year, meaningthat US$1 in 1860 was equivalent to $27.80 in 2015. This also means that pricesin 2015 were 2,828% higher than they were in 1860.
When the dollar falls, investors flock to gold, hence the inverserelationship between the two.
When the dollar slumped between 1998 and 2008, gold prices nearlytripled, reaching $1,000 an ounce in early 2008 and nearly doubling between2008 and November 2011, when gold hit $1,903 on the risk of the U.S. defaultingon its debt. Gold has since fallen due to the perception that the U.S. economyis in better shape, judged partly by the current strength in North Americanstock markets.
Gold is seen as a hedge against inflation, because its pricegenerally rises as the cost of living increases. As Investopediapoints out, “Overthe past 50 years investors have seen gold prices soar and the stock marketplunge during high-inflation years.”
Gold as safe haven
Gold investors love nothing more than a war, economic crisis orany type of geopolitical instability to watch the value of their bullion grow.Heightened global tensions such as terrorist attacks, border skirmishes orcivil wars scare investors into putting their funds into safe havens like goldand stable, high-yield sovereign debt. Geopolitical tensions also drive moregovernment spending (Eg. on arms), which brings inflation, leading investors tolook at precious metals as a place to park their money, short term.
For example during the 1970s, which saw a number of upheavals inthe Middle East including the Iranian Revolution, the Iran-Iraq War, and theSoviet invasion of Afghanistan, goldrose 23% in 1977, 37% in 1978, and 126% in 1979,the year of the Iranian hostage crisis.
Gold also spiked when the US bombed Libya in 1986, right after theGulf War in 1990, and more recently, when ISIS attacks put oil supplies in theMiddle East at risk. However it is interesting to note that the price of gold “tends to rise inanticipation of a conflict,” such as the currenttensions between the United States and North Korea, “but often fallswhen tensions turn into a full-blown war,” writesSimona Gambarini, an analyst with Capital Economics. For gold investors,this means timing is crucial in making a gold trade in the lead-up to a war.Staying in too long could mean losing out to other competing assets.
Goldis also bought as a hedge against what investors see as government policiesthat drag down the dollar and create inflation. In other words, gold is aneconomic safe haven. The most obvious example is the quantitative easingprograms imposed by the United States, the European Central Bank and Japan.During QE the central bank “prints money” by adding credit to its member banks’deposits, which has the effect of increasing the money supply, ergo, creatinginflation. Between December 2008 and October 2014, the US Federal Reserve forexample added$4 trillion to the money supply by buying Treasuries from its member banks.
Theother concern that drove investors into the arms of precious metals during thisperiod was the exhorbitant spending by the U.S. government, which hiked thedebt to GDP ratio above 77%. An increase in debt not only causes inflation butsinks the dollar, and as explained above, when the dollar falls gold climbs.
Goldand stocks also move in opposite directions, since equities often pay dividendsand grow in times of stock market expansion, like the current bull market onthe Dow and S&P/TSX Composite indices. Gold in contrast does not pay theinvestor any income while holding it. But gold is usually the best hedgeagainst a stock market crash, such as occurred in 1929, 1987 and 2008.
Anotherreason to own gold are the calamities associated with climate change. Whilesome dispute that the planet is warming or whether temperature changes arehuman-caused, the increased frequency of major storms in the U.S. and elsewhereis costing nations billions of dollars they had not accounted for. Just look atthe recent devastation caused by Hurricane Harvey in Texas and Hurricane Mariain Puerto Rico. Natural disasters not only blow holes in budgets where themoney could have been otherwise spent, such as schools and hospitals, they alsoadd to national debts and threaten major social dislocation. Imagine how muchdamage even a few inches of rising sea levels could do to global coastlines.The prospect of billions of dollars in lost property, and a flood of refugeesseeking higher ground is another good reason to own gold as insurance againstnatural disasters, whether they are caused by climate change or not.
Inan earlier article I wrote about how extremesolar storms pose a threat to all forms of high-technology.
Peak gold?
Muchis written about gold demand but relatively little about mine supply and howthis impacts the price. Of course, if supplies can’t keep up with demand theprice will only go higher. While the idea of “peak gold” has its detractors, aThomson Reuters report said 2016 was thefirst year since 2008 that gold mine output actually fell - by 22 tonnes or3%.
“There are relatively few new projectsand expansions expected to begin producing this year, and those in thenear-term pipeline are generally fairly modest in scale, hence our view thatglobal mine supply is set to continue a multi-year downtrend in 2017,” wrote the authors of the GFMS GoldSurvey, last January.
SouthAfrican gold production has plummeted below 250 tonnes compared to 1,000 tonnesin the 1970s, and China, the leading gold producer, is the onlycountry to increase production in recent years, notes Goldcore via ZeroHedge.
As for new gold mines, the bear market of 2012 to 2016 meantmost large gold companies slashed exploration budgets and small explorers hadan extremely tough time raising cash. The experts agree the industry is seeinga significant slowdown in the number of large deposits being discovered. FrankHolmes quotes Franco-Nevada cofounder Pierre Lassonde saying recently that he doesn’tknow how we’ll replace the massive deposits found over the last 130 years:
“Ifyou look back to the 70s, 80s and 90s, in every one of those decades, theindustry found at least one 50+ million ounce gold deposit, at least ten 30+million ounce deposits and countless 5 to 10 million ounce deposits. But if youlook at the last 15 years, we found no 50 million ounce deposit, no 30 millionounce deposit and only very few 15 million ounce deposits,” states Lassonde.
Thus with gold productionfalling everywhere except China, whose statistics are often exaggerated bygovernment and can’t be trusted, combined with a lack of large gold depositsthat could move the market, you have the setup for a continued rise in the goldprice - irrespective of what happens on the demand side.
Physical gold better than paper
Historically the only way for investors to buy gold was topurchase gold coins or bars, but since 2004 gold, silver, platinum andpalladium ETFs have offered a more convenient way to invest in precious metals.According to a 2016article by Kitco, GLD, the world’s largestgold ETF, and other precious metals ETFs, transparent bullion depositories, andfutures exchanges, combine for a total market capitalization of about USD$150billion - which is almost the value of the entire world’s annual gold miningsupply.
The convenience of buying “paper gold” through ETFs however hassome serious drawbacks especially in the event of a financial meltdown like2008 or a cataclysmic event like nuclear war, an EMP attack or solar storm. Thebiggest downside is that unlessyou have 100,000 GLD shares, you cannot take physical delivery of your gold; rather, the shares will be settled in cash. At the current GLD price,actual delivery of physical gold then is limited to those with a position ofabout $12 million or more.
The other problem is potential breaks in the chain of custody.When you buy shares in a gold ETF, the purchase is through an AuthorizedParticipant, usually a large financial institution. If a primary reason inbuying gold is as insurance against a financial calamity Ie. banking systemcollapse, an ETF really fails to offer any guarantee that your GLD shares wouldbe safe if the bank were to fold.
“Physical bullion could go supernovain both price and value, yet ETF proxies could deflate or possibly go bankrupt.All long term investors with exposure to exchange traded funds should reexaminethe inherent risks associated with these investment vehicles,” writes Kitco.
Goldmining stocks are like a “coiled spring”
Manygold investors choose bullion for all the reasons cited above: inflation hedge,long term store of value, and safe haven. But to make any short-term moneyinvesting in gold, the junior mining market offers the best leverage to golddue to the potential for profit-taking - albeit, with considerably more risk.
Unfortunately2017 was not the best year to make money in junior gold mining, with thecombined strength of other equities, witnessed by record-setting highs on theDow and S&P 500 exchanges, sucking a lot of wind out of the gold sector.Yet despite parabolic stock market highs, a hike in U.S. interest rates onDecember 13, and frenzied bitcoin buying, the gold price still managed to gain10% this year.
Butas longtime gold market commentator Adam Hamilton pointed out recently,interest in gold meanders constantly between excessive greed and fear. Hepoints out that the last time gold stocks were this out of favor was the secondhalf of 2015, but then, the arc swung violently the other way, with HUI, thedominant gold-stock index (NYSE Arca Gold BUGS Index), rocketing 182% in sixand a half months. Hamilton thinks it’s time foranother gold stock surge.
“2017’spainful consolidation is the perfect breeding ground for another monstergold-stock upleg in 2018. After spending a year basing at deeply-undervaluedprices relative to today’s gold levels, it shouldn’t take much of a sentimentshift to catapult gold stocks way higher,” he writes. “From acontrarian standpoint this unloved sector’s technicals are actually quitebullish today, with the gold miners’ stocks wound up like a coiled spring.”
Conclusion
Despite the assurances ofsome world leaders, over the last couple of years the planet has become moredangerous, not safer. The threat of nuclear war with North Korea, the repeatedcyber-terrorism attacks that will only escalate in frequency and severitycontinue to occupy headlines. Weather-related events keep wreaking massivedamage to crops, property and sometimes, take human life. The prospect of aglobal financial collapse that could topple major banks as in 2008 never seemsto be off the minds of pundits.
Iown gold bullion, the Boy Scout motto ‘Be Prepared’ still resonates within me.
While many investors thinkstocks are the place to be, with no end in sight to the rally (of the S&P’s11 main sectors, six are up double digits and only two - energy and telecoms -were down in 2017), the reality is that we are due for a correction. As waspointed out earlier, when this happens, gold tends to rally.
I own gold stocks foranything short of outright disaster. I think gold’s price is going to go up, alot – shares of gold focused exploration and development companies offer thegreatest leverage to a rising gold price.
The Imaginations of the Misguided, gold and gold equities have been, and will continue tobe, on my radar screen. Are they on yours?
If not, maybe it should be.
By Richard (Rick) Mills
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