r Portfolio Diversification Myths: Why Pension Funds Need to Rethink Their ion is Outperforming Mining Stocks Gold is Money Ensuring the Quality of x Myths about Gold Platinum: Dark Horse, Bright Future Precious Metals: onceptions 2004 Empire Club Investment Outlook 2003 President’s Message ARTICLES 10TH ANNIVERSARY BOOK OF Ten Years of Articles and Outlooks Nick Barisheff
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r Portfolio Diversification Myths: Why Pension Funds Need to Rethink Their ion is Outperforming Mining Stocks Gold is Money Ensuring the Quality of x Myths about Gold Platinum: Dark Horse, Bright Future Precious Metals: onceptions 2004 Empire Club Investment Outlook 2003 President’s Message
ARTICLES10TH ANNIVERSARY BOOK OF Ten Years of Articles and Outlooks
Nick Barisheff
I n t r o d u c t i o n
We are pleased to present a collection of 15 articles and outlooks by
Nick Barisheff, president and CEO of Bullion Management Group Inc.
The articles were previously published in magazines or periodicals, or
delivered as speeches. Nick has been a regular contributor to magazines
like Resource World, Investor’s Digest and Benefits and Pensions
Monitor. In addition, he has spoken at the prestigious Empire Club
Outlook luncheon for the past five years consecutively. His most recent
address is included in the collection.
These commentaries cover a wide range of topics, from how to buy and
store precious metals to why precious metals will continue rising in price
for years to come. With something for everyone, from those just beginning
to plan their future to the most sophisticated market expert, Tenth
Anniversary Book of Articles deserves a place on every investor’s bookshelf.
Ta b l e o f Con t e n t s
Annual Report President’s Message | March 2004 7
Gold Myths and Misconceptions | October 2004 11
2005 Outlook for Gold | January 2005 19
General Motors, the Stock Market and Gold | April 2005 27
Precious Metals: Critical Diversifier | November 2006 35
Platinum: Dark Horse, Bright Future | March 2007 41
Six Myths About Gold | November 2008 51
2004‐2009 Pompous Prognosticators Revisited | July 2009 59
Ensuring the Quality of Precious Metals Purchases| December 2009 63
Gold is Money | March 2010 67
Why Bullion is Outperforming Mining Stocks | July 2010 77
Three Dominant Factors Will Impact Precious Metals | April 2011 85
Portfolio Diversification Myths | May 2011 103
Gold and Fiat Currency: Forty Years Later | August 2011 109
Why Rising Debt Will Lead to $10,000 Gold | January 2012 113
2 0 0 3 Annu a l R e p o r t :
P r e s i d e n t ’ s Me s s a g e
M a r c h 2 0 0 4
The concept of The Millennium BullionFund was formed in 1997 when
my own research led me to the conclusion that equity markets were
forming a bubble, and that economic conditions were about to
deteriorate. My research indicated that the next bull market would be
in commodities, and particularly in precious metals. Throughout my
30‐year career in the investment business, I have always maintained
that precious metals are a vital component of an investment portfolio.
However, the investment form had to be actual physical bullion, not a
paper derivative such as a futures contract, or an equity interest in a
mining company. Although investments in commodity futures and
mining stocks were available both directly and through mutual funds,
there was no cost‐effective, convenient way for Canadians to purchase
and hold gold, silver and platinum bullion. Moreover, bullion could
not be held in RRSPs or other registered plans.
After further legal research and three long years of negotiations with
the Ontario Securities Commission, The Millennium BullionFund�
received approval for Ontario in January 2002, and after further
negotiations with the remaining provinces and territories, it received
complete Canadian approval in May 2003. For the first time, Canadians
could now fully diversify their portfolios and hold gold, silver and
platinum bullion in their RRSPs.
The Fund’s structure echoes the unique characteristics of bullion.
Unlike traditional financial assets, the value of bullion can never
8 10th Anniversary Book of Articles
decline to zero. Unlike bonds, bullion is not someone else’s liability,
and unlike stocks its value is not based on anyone’s promise of
performance. In order to maintain these unique characteristics, the
Fund was structured with a fixed investment policy of purchasing
equal amounts of each metal. As a result, unit prices are primarily a
function of bullion prices alone, and do not depend on the trading skills
of a portfolio manager. The Fund’s mandate does not allow it to
employ any hedging, or to lease its bullion holdings. The legal
structure of an open‐end mutual fund trust ensures that liquidity is
equal to that of the bullion itself, and that no third party can have any
claim against Fund assets. Because units are priced at Net Asset Value
on a daily basis, no premiums or discounts can impact their value.
The importance of holding precious metals in an investment portfolio
has been largely forgotten during the equity bull market of the past
twenty years. Traditional asset allocation theory, as represented by the
investment pyramid, advocates higher risk, less liquid assets at the top,
with lower risk, more liquid assets at the bottom. Typically, precious
metals and commodities are placed at the top of the pyramid, while
cash equivalents are at the base. While placing commodity futures
contracts at the top of the pyramid is appropriate, fully allocated
physical bullion should form the foundation of the pyramid. For 3,000
years precious metals have been the most liquid, universal form of
money throughout the world. They still are.
An effectively diversified portfolio should contain at least five percent
in physical bullion at all times. Futures contracts, options and mining
equities belong in a different asset class, with percentage holdings
based on individual investor objectives and risk tolerance. Unallocated
bullion, like pool accounts and certificates, can form part of a portfolio’s
cash component, but would not form the foundation.
This asset allocation model benefits the investor because precious
metals have an inverse relationship to other assets, like stocks and
bonds. Holding bullion reduces portfolio volatility and improves
returns during normal market conditions. During periods of economic
stress bullion acts as portfolio insurance, growing in value and
effectively offsetting losses in other asset classes. For added protection
in turbulent economic times, bullion allocation should be increased to
at least 10 – 20 percent.
9
Diversification is just as important within the Fund as for individual
investors. Internal diversification is achieved by holding not just one
precious metal, but all three. Gold, silver and platinum each have
unique characteristics, and share dual roles as both industrial
commodities and monetary assets. The Fund’s investment mandate
requires it to invest equally in each metal.
This strategy reduces volatility within the Fund because the metals are
valued for different attributes: gold primarily as money; silver as money
and as a commodity; platinum primarily as a commodity. During
economic expansions, commodity demand for silver and platinum will
likely be greater than for gold. During economic downturns, monetary
demand for gold and silver will increase. Because two‐thirds of the
Fund’s holdings will perform well regardless of economic trends,
volatility is minimized and long‐term returns are maximized.
Owning units of The Millennium BullionFund provides all the
advantages of holding physical precious metals in a registered plan,
with the added value of cost‐effective purchasing, insurance and
storage. This provides investors with one of the best wealth protection
strategies available. As an added benefit, there is every indication that
we are in the early stages of a long‐term precious metals bull market
that could result in tremendous gains for unitholders.
2003 Annual Report: President ’ s Message
Go l d My t h s a n d Mi s c o n c e p t i o n s
O c t o b e r 2 0 0 4
Gold. Casually mention the word to a group of investment‐minded
friends and colleagues and watch as it inspires a visceral reaction, since
people either love gold or hate it; there arenʹt many who feel ambivalent
toward it. Those who love it realize that gold has been the ultimate
store of wealth for over 3,000 years, while various paper currencies
have come and gone. Those who hate it maintain that gold is an archaic
relic, no longer relevant in a world where the majority of business
transactions are carried out with a few clicks on a computer keyboard,
and money is nothing more than a digital entry on a computer.
Or is the antagonism toward gold because they realize that a rising
gold price makes them uncomfortable? Subconsciously the disbelievers
may sense that a rising gold price is like an economic barometer
forewarning of a coming financial storm.
Since 1971, when Richard Nixon ended convertibility of the US dollar
into gold, various myths and misconceptions have been circulating,
influencing peopleʹs opinions and resulting in a number of unfounded
myths that have dogged the yellow metal.
MYTH: GOLD IS HIGHLY SPECULATIVE!
The importance of holding precious metals in an investment portfolio
has been largely forgotten during the equity bull market of the past
twenty years. Holding precious metals in a portfolio can provide three
distinct benefits: speculative gains, hedging and wealth preservation.
12 10th Anniversary Book of Articles
However, many investors and their advisors focus only on the
speculative aspect and treat gold as if it was an industrial commodity
like copper or zinc.
Traditional asset allocation theory, as represented by the investment
pyramid, advocates higher risk, less liquid assets at the top, with lower
risk, more liquid assets at the bottom. Typically, precious metals and
commodities are placed at the top of the pyramid, while cash
equivalents are at the base. While placing commodity futures contracts,
options and exploration junior mining companies at the top of the
pyramid is appropriate, fully allocated physical bullion should form the
foundation, or base.
While futures contracts, options and mining equities can provide
leveraged speculative opportunities, they belong in a different asset
class along with percentage holdings based on individual investor
objectives and risk tolerance. They also carry much higher risks, and
have been known to decline to zero. Unallocated bullion, like pool
accounts and certificates, can form part of a portfolioʹs cash component,
but should not form the foundation as they may become illiquid and, in
certain circumstances, could lose their value completely. Fully
allocated, segregated bullion is not someone elseʹs promise of
performance, nor is it anyone elseʹs liability. It cannot decline to zero.
An effectively diversified portfolio should contain at least five percent
in physical bullion held on a fully allocated, segregated basis at
all times. This asset allocation model provides effective hedging,
benefiting the investor because precious metals have a negative
correlation, or inverse relationship, to traditional financial assets like
stocks and bonds. Holding bullion reduces portfolio volatility and
improves returns during normal market conditions. During periods of
economic stress, bullion acts as portfolio insurance, growing in value
and effectively offsetting losses in the other asset classes. For added
protection in turbulent economic times, bullion allocation should be
increased to 10 ‐ 20 percent.
MYTH - CENTRAL BANKS NO LONGER NEED TO HOLD GOLD AND HAVE SOLD OFF THEIR HOLDINGS!
The Central Bank of Canada has ignored thousands of years of
monetary history and bought into the archaic relic view, and has sold off
nearly all the gold it held in its foreign exchange reserves. From a peak
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of 1,023 tonnes in 1965, Canada now holds only 100,000 ounces of gold
valued at $45 million. This places it in 77st place, below third‐world
developing countries such as Bangladesh, Guatemala and Tunisia.
This sell off has contributed to an impression within Canada that other
central banks are also divesting themselves of gold, but statistics
compiled by the World Gold Council show that official global reserve
holdings of 36,575 tonnes in 1971 have declined by only 0.4 percent
annually to 31,736 tonnes in July, 2004. Gold sales by Canada,
Australia, Britain and Switzerland, among others, were offset by gold
purchases in France, Germany, Japan, China and Taiwan. Recently
Argentina has been buying 10 ‐ 12 tonnes per month to shore up the
value of its currency.
The Bank of England also accepted the archaic relic label, sold half of
its gold reserves at the very bottom of market, and purchased
interest‐bearing US treasury bills. Since then, the US dollar has lost
about 30 percent against the British pound, while gold has increased by
approximately 30 percent in British pounds. Gold and silver have
successful 3000‐year track records as portable stores of wealth, whereas
paper money does not. Although the US dollar is considered by
many to be the most stable currency, it has lost approximately
80 percent of its purchasing power since gold convertibility was
eliminated in 1971.
MYTH - GOLD IS NOT A GOOD INVESTMENT!
Although fully allocated gold bullion is not an investment per se, its
long‐term performance has been more than commensurate with risk.
Goldʹs decline from its 1980 peak is often cited to support the poor
investment performance myth but, when measured from a cyclical
peak, any investment will take many years to break even. The DOW
did not recover to its 1929 high until 1954. By that time, many of its
original stocks had completely disappeared and were replaced by
alternatives. Fifteen years following the peak of Japanʹs NIKKEI, it has
only achieved approximately 25 percent of that peak.
In fact, on a cumulative basis since 1971, gold has outperformed the
DOW. Goldʹs rise from $35 per ounce in 1971 to its recent $415 level
amounts to a 1,086 percent increase versus the DOWʹs 1,046 percent
increase from 868 to 9,950 today. In the past four years, goldʹs
performance has dramatically outperformed that of equities. While
Gold Myths and Misconceptions
14 10th Anniversary Book of Articles
gold has increased 63 percent, the DOW has lost 13 percent and the
tech‐heavy NASDAQ is down 62 percent.
As for the future, gold is poised to outperform equities. The DOW:gold
ratio has averaged 10:1, peaking at 44:1 in 2000. Today, the ratio has
dropped to 24:1 and has decisively broken below the 200‐day moving
average. A number of respected analysts expect to see a 1:1 DOW:gold
ratio, as occurred in 1980 and in 1935. The only question that remains is
will the ratio be 1:1 at 6,000, 4,000 or 1,000?
MYTH - PRECIOUS METALS ARE TOO VOLATILE!
The myth that gold is volatile simply does not stand up to scrutiny.
While mining stocks, particularly junior exploration companies, are
highly volatile, gold bullion is not. According to a study by the World
Gold Council, the volatility of the DOW during the past ten years has
been 16.13 percent as compared to 12.55 percent for gold.
The volatility of mining stocks, particularly during bull market cycles,
can afford tremendous trading profits. It is critical to have either a
knowledgeable advisor or to become proficient in technical analysis.
Some traders use trading profits to augment their bullion holdings.
MYTH - MINING STOCKS AND BULLION ARE EQUALLY EFFECTIVE AS PORTFOLIO HEDGES!
One of the most prevalent misconceptions is that holding gold mining
stocks is preferable to owning bullion. However, the decision between
gold mining stocks and bullion is not an either/or decision. Each asset
has a different place in the investment pyramid, representing different
objectives and different risk/reward relationships. Fully allocated
bullion is used for long‐term wealth preservation because it maintains
its purchasing power and also acts as a hedge against economic crises.
Mining stocks, precious metals mutual funds, futures contracts and
options are used for both speculation and investment during bull
market cycles, but are subject to market, management, financial, labour,
geopolitical, environmental and hedging risks.
Another misconception is that bullion is positively correlated to mining
stocks with both rising and falling in unison it is not. In the crash of
1929, Homestake Mining, the largest and oldest gold producer in North
America, initially declined with the rest of the equity market, but
recovered while equities continued down. Unless investors were both
15
knowledgeable and had staying power during that time, a hedge using
mining stocks would have failed. In the crash of 1987, mining stocks
declined more than general equities. Bullion, however, maintained a
positive position with less than 20 percent volatility.
During bull markets, mining stocks initially tend to outperform bullion.
However, as the bull market progresses, bullion tends to outperform
mining stocks. In the 1970s, Homestake achieved a 900 percent increase,
whereas gold more than doubled that level at 2,300 percent. When a
rising gold price signals a non‐confidence vote in the countryʹs fiat
currency, the flight to its safe haven status can result in dramatic gains.
MYTH - MINING STOCKS ARE MORE LIQUID THAN BULLION!
The belief that mining stocks offer superior liquidity over bullion is
another popular misconception. Total aboveground gold is estimated
at $1.7 trillion. On an average day, a net of $6 billion of physical gold is
traded among the members of the London Bullion Market Association
in London alone. This does not include gold futures trades on the
commodities exchanges, or retail investment purchases, or jewelry. On
the other hand, the total market capitalization of all global mining
stocks is less than $150 billion. The most liquid and largest gold‐
producing company in the world is Newmont, with a market
capitalization of about USD$20 billion. It trades about $200 million
shares per day, representing a turnover of about one percent of its
market cap. Even if this turnover rate is applied to all mining stocks it
would equate to about $1.5 billion, or one‐quarter of the gold bullion
traded in London alone.
In addition to higher liquidity due to higher market size and higher
trading volume, gold bullion is accepted as payment globally, whereas
a mining stock certificate would have little if any value in many parts of
the world. There is a difference between liquidity and convenience in
purchasing the investment. The purchase of physical bullion may be
somewhat time‐consuming and inconvenient for a retail investor
compared to placing a trade for mining stocks. However, as the
precious metals bull market progresses, new investment vehicles will
come to market that will provide equal convenience for purchasing
bullion as is currently available for mining stocks.
Gold Myths and Misconceptions
16 10th Anniversary Book of Articles
MYTH - THE PRICE OF GOLD AND SILVER HAS BEEN IN DECLINE DUE TO LACK OF DEMAND!
With all the attention on the latest high‐tech stocks, the price declines in
gold have been attributed to lack of demand. Surprisingly though,
gold, has experienced supply deficits for more than a decade
amounting to over 22,000 tonnes.
How can the price of a commodity decline in the presence of a
supply deficit?
Basic economics tells us that a supply deficit causes prices to rise, but
that hasnʹt happened in the case of precious metals. The fanfare that
always accompanies central banks sales gives the impression that these
sales have made up the deficits. However, net central bank sales only
account for a small part of the deficit. The balance of the deficit has
been made up through the practice of leasing, creating an artificial
supply that acts to suppress prices.
Central banks lease out gold to bullion banks at low interest rates.
Bullion banks, in turn, lease the gold to mining companies and hedge
funds that sell the bullion and invest the proceeds in higher yielding
investments. Calling this practice leasing is a major misnomer. In the
case of the mining companies, it is more accurate to refer the practice as
covered short selling and in the case of the hedge funds, it should be
called naked short selling. In both cases, the artificial supply that
suppresses prices will be a major contributor to the coming price
increases as these entities are forced to buy bullion at market price to
mitigate escalating losses and cover their short positions.
Although there is some controversy about the total amount of leased
gold, the estimates are between 192 million and 800 million ounces.
Any sharp price rise in either metal will have a slingshot effect, caused
by a massive short‐covering demand that cannot be filled with even
several yearsʹ worth of mine production. This will greatly magnify any
increased investor demand and put extreme upward pressure on prices.
For 3,000 years precious metals have maintained their purchasing power
and have been the most liquid, universal form of money throughout the
world. Since 1971, both the Canadian and US dollar have lost
approximately 80 percent of their purchasing power while gold has
enjoyed an increase. In 1971, for example, a new car could be purchased
17
for $3,500 (100 ounces of gold) and a starter house in the suburbs for
$35,000 (1,000 ounces of gold). Today, 100 ounces would buy two new
cars and 1,000 ounces would buy two houses or an estate in the country.
If investors take the time to examine why they have a negative bias
towards gold, and can accept that what they believe to be true may be
myth or misconception, even the naysayers may realize the important
contribution precious metals can make to a portfolio and how they can
both increase and preserve their wealth in the coming decade.
Gold Myths and Misconceptions
Th e Ou t l o o k f o r Go l d i n 2 0 0 5
J a n u a r y 2 0 0 5
As Presented at the 2005 Empire Club’s
Annual Investment Outlook—January 6th, 2005
It’s January, the beginning of a new year, and the time when
economists, analysts and even astrologers like to prognosticate about
what lies in store for the next 12 months.
With respect to gold, opinions on the price vary from $400 to $500
dollars per ounce for 2005. These opinions presume that current
conditions will remain relatively stable, and if they do the $400 ‐ $500
range is reasonable. Since the range is quite broad, a review of some
history, and an examination of some current trends may be helpful in
gaining additional insights.
First, it is important to realize that the 70% rise in the price of gold since
2001 is not because of any supply/demand imbalance, as an industrial
commodity. Merely speculating on the price of gold ignores its other
benefits and relegates it to a commodity with no more stature than
copper or pork bellies. But gold has an important monetary role,
as confirmed by the billion ounces still held by Central Banks, and by
the clearing turnover of $6 billion daily by members of the London
Bullion Market Association.
Although various paper proxies and gold derivatives can provide
trading opportunities, they may not provide the wealth preservation
and hedging benefits of bullion itself. In order to achieve these benefits,
gold holdings must be in the form of fully allocated, segregated bullion
20 10th Anniversary Book of Articles
with reliable custodial arrangements. Since mining shares and other
gold proxies are either someone else’s liability or promise of
performance, they may not provide these benefits at a time when they
are needed most.
Wealth preservation has been an attribute of gold bullion, and it is the
reason gold has functioned as money for over 3,000 years. Although
gold prices in local currencies may have fluctuated during both
inflationary and deflationary periods, gold has maintained or even
increased its purchasing power in both instances.
Gold’s ability to preserve purchasing power was discussed in detail in
an essay written in 1966 by none other than Allan Greenspan, entitled
Gold and Economic Freedom.
We have all heard that you could always buy a man’s suit with an ounce
of gold. I can remember that in 1971, the price of a basic car was about
$2,500, or 71 ounces of gold. Since then, the dollar price of the car has
increased 5‐fold to $14,000, but for the same 71 ounces of gold, you can
now buy two cars. This relationship holds true for real estate, oil, and
the number of ounces to purchase the DOW, where the cost in gold
ounces has either remained the same or decreased over the last 30 years.
The same cannot be said for paper currencies. Throughout history,
currencies have come and gone as they were inflated away by
emperors, kings and politicians. Since 1971, when the US abandoned
gold convertibility, the purchasing power of both the Canadian and the
US dollar has declined by over 80% due to inflation.
Because of wealth preservation and hedging benefits, gold bullion
cannot be viewed like other portfolio holdings.
The hedging benefits of bullion are achieved because gold is negatively
correlated to traditional financial assets such as stocks and bonds.
These hedging benefits become particularly pronounced during periods
of economic stress. When you compare how poorly stocks, bonds,
real estate and currency performed relative to gold during recent
currency crises in Russia, South East Asia and Argentina, these benefits
become apparent.
The old Wall Street saying ‐ “Put ten percent of your money in gold and
hope it doesn’t work”, is particularly applicable today.
21
Often when I mention this saying I am asked what it means. Why would
you hope it doesn’t work? Aren’t you in the precious metals business?
Over the long term, a portfolio allocation of at least 10% to physical
bullion reduces overall volatility, improves returns and provides a form
of portfolio insurance. With our investment portfolios, we would all like
to maintain an optimistic outlook, hoping that the economy will
continue growing and our investments continue appreciating. However,
since financial markets are cyclical, it is only prudent to maintain some
portfolio insurance, in the form of bullion, in case markets move against
us. Even though we pay for house insurance year after year, we would
still rather that our house does not actually burn down.
Unlike traditional insurance or other hedging strategies, bullion is an
asset rather than an expense. It has a price floor approximately equal to
the cost of mining it. Unlike stocks and financial derivatives, the value
of bullion cannot decline to zero.
Because of the recent equity rally, many investors feel that the worst is
over and there is no longer a need to diversify and hedge. However, an
increasing gold price is like a financial barometer warning of an
impending storm.
Is the storm over, or are we actually in the eye of a hurricane?
Leaving aside the impact of natural disasters, terrorist attacks and wars,
are the economic conditions that have contributed to a rising gold price
still relevant as we go forward into 2005 and beyond?
Are the financial vulnerabilities arising from a mortgage‐induced
realestate bubble still present? Are the concerns expressed by both
Warren Buffett and Alan Greenspan about the $200 trillion of
derivatives exposure still present? By historical measures, are equity
markets fairly valued? Will the looming peak in oil production and
increasing global demand cause a continuous rise in the price of oil,
thus impacting global economies and industrialized societies?
But the worst threat of all comes from the continuous increases in the
money supply through the expansion of credit, at all levels. Simply
put, there is an ever‐increasing amount of paper money chasing a
limited supply of physical bullion. Unless corrected, the inflationary
growth of the money supply, federal budget deficit, trade deficit and
The Outlook for Gold in 2005
22 10th Anniversary Book of Articles
current account deficit will cause the US dollar to plunge in value while
the gold price climbs. In looking forward to 2005 and beyond, we need
to determine whether it is realistic to expect that this credit growth will
be stopped or even reduced.
Today, the annual increases in the US federal budget deficit are greater
than the total federal government debt was in 1971. This is an alarming
trend. Even during reported budget surpluses in 1998 and 1999, total
government debt still grew year after year to the current level of
$7 trillion. The US is now paying over $300 billion in interest to holders
of federal debt. If this rate of increase continues, eventually annual tax
revenues will not be enough to even service interest costs.
Notwithstanding that the US Dollar Index has declined by over 35%,
the trade deficit grew to a staggering $600 billion in 2004, and now
totals nearly $5 trillion cumulatively. The phenomenon of a growing
trade deficit during a currency decline is without historical precedent.
We don’t have to look far to find the reason for this anomaly. Since the
US has outsourced a great deal of its manufacturing and is dependent
on commodity and energy imports, the trade deficit has become an
ongoing systemic problem. For the past 60 years the US has enjoyed
special privileges because of the dollar’s reserve status and the
willingness of foreigners to invest in US dollar assets.
The US Current Account deficit now stands at over $650 billion, and
represents about 6% of GDP. But what has this got to do with the price
of gold? This ratio is the highest since 1929. Most economists consider
5% a critical level for current account deficit/GDP ratios. In the past,
when third‐world countries reached that level, a currency crisis followed.
COULD THE US BE THE NEXT ARGENTINA?
This credit expansion has led to a total US debt of $34 trillion ‐ over
300% of GDP ‐ the highest level in history. In addition, we need to add
$55 trillion in unfunded pension liabilities and Medicare obligations.
In all, this mountain of debt requires that the US borrows about
$80 million per hour, and absorbs over 80% of the world’s savings.
Here is a startling fact – it now takes $7 of new debt for every
$1 increase in GDP. How much confidence would you have in a
corporation that needed to borrow $7 annually just to increase its gross
revenues by a dollar? Clearly this can not go on much longer.
23
No wonder Alan Greenspan recently warned that “foreigners’ appetite to
continue to invest in the US may not be adequate to fully sustain the expected
growth in the net indebtedness of the US”.
Translated into English, his statement means that eventually foreign
investors will stop lending the US any more money.
No one knows for certain when that day will come. It may be next
week, or several years from now. You may think that it can not happen
in the US, but history gives us numerous examples of excess debt
leading to a currency collapse. Unless there is the political will to
reduce or eliminate the current mountain of debt, the day of reckoning
must eventually come. The longer it is postponed, the worse it will
ultimately be. Since politicians are not known for their ability to control
their spending and are not elected on platforms that propose
unpleasant financial medicine, it is difficult to imagine that the steps
necessary to fix the problem will be taken.
Canadians need to pay attention to these issues as well. While I have
focused on increases in the US money supply, you may be surprised to
know that the Canadian money supply has risen at twice the rate of the
US. Because of the fractional reserve banking system and global fiat
currencies, the US has exported credit bubbles to the countries that run
a trade surplus with it. In Canada, we are particularly vulnerable to the
state of the US economy and its monetary policy. We depend on the US
to buy our exports, and US dollars represent 50% of our currency
reserves. Canada is now the only G8 country without any gold bullion
to back its currency.
Bearing this in mind, is it likely that the Canadian dollar will maintain
its recent gains against the US dollar?
Up to this point, we have simply assumed a continuation of current
conditions. Maybe the US and the global economy will “muddle
through”, and business will continue as usual. But is it really prudent
to maintain a long‐only bias in your portfolio and assume that the
longest‐running bull market in history will continue for another
20 years? After all, markets are cyclical ‐ not linear. A 10% allocation to
bullion for its hedging and wealth preservation benefits seems more
than justified.
The Outlook for Gold in 2005
24 10th Anniversary Book of Articles
However, if one of the previously mentioned vulnerabilities
experiences a trigger event, then bullion may provide impressive
capital gains over and above hedging.
Since February 2002, the US Dollar Index has declined 35%, wiping out
$3 trillion for foreign investors. If the dollar continues to decline, the day
will come when the world will no longer be willing to increase their
US dollar holdings. The US Federal Reserve will then be faced with a
no‐win situation: increase interest rates dramatically, or let the dollar fall.
If foreign investors get nervous and start selling some of their 10 trillion
dollars’ worth of US dollar holdings, it may create a descending spiral
of further dollar declines coupled with financial asset declines. If that
happens, the line between hedging and capital appreciation will
become blurred. In the 1970’s, a loss of confidence resulted in the
US dollar declining 70% in German marks and Swiss francs. Gold,
however, experienced a 2,300% increase.
Historically, a reliable indicator for the trend direction of gold and
equities is the DOW:Gold ratio. When the ratio increases, it is a good
time to be overweight equities and when it declines, it is better to be
overweight gold. The ratio was 1:1 in 1935. In 1980, when gold was
$850 and the DOW was 925, it again approached to 1:1. The ratio
peaked at 43:1 in 2001, but has steadily declined to its current level of
25:1. Richard Russell, publisher of the DOW Theory Letter since 1958,
predicts that the DOW:Gold ratio will once again be 1:1. The question
is, will both gold and the DOW be at… 1000, 2000, or 5000?
As far‐fetched as these possibilities may sound today, they may in fact
come to pass. In 1989, investors would have found it hard to imagine
the 80% decline in Japanese equities that ensued over the next 13 years.
Equally difficult to foresee in the early 80’s, when the NASDAQ
was 400, was its rise to 5000. In 1971, when gold was $35 an ounce,
no one imagined the 23‐fold increase that gold would experience over
the next nine years.
We now appear to be entering the second leg of the precious metals
bull market, a time when institutions and hedge funds are beginning to
invest in physical bullion. Because of the tremendous market‐size
disparity between financial assets and precious metals, bullion prices
would rise dramatically if a minute percentage of global investors
allocate 10% to bullion.
25
While there is $50 trillion in global financial assets, there is less than
$1.5 trillion in above‐ground gold, less than $1 billion in above‐ground
silver and practically no above‐ground platinum.
Eventually there may even be shortages. You can not simply print
more bullion to meet demand. New mines take 5 – 10 years to bring
into production.
In 2005 whether the price of gold will be $400 or $500 does not really
matter. Would it have mattered whether you bought the NASDAQ at
400 or 500 in the mid‐80’s?
It is only important that you did not buy at 5,000.
No matter what the price turns out to be in 2005, it is still wise to put
10% of your money into gold… and hope it does not work.
The Outlook for Gold in 2005
Gen e r a l Mo t o r s ,
t h e S t o c k Ma r k e t a n d Go l d
A p r i l 2 0 0 5
If the saying “As goes General Motors so goes America” holds true then
it doesn’t look very good for America or for the stock market.
In a March 16th profit warning GM announced that significant
weakness in the North American automotive business would lead to a
loss in the first quarter and full yearʹs earnings would amount to just
one fifth on the companyʹs December 2004 expectations.
This stunning revelation caught many people by surprise and
prompted investors to drive down GM’s share price 10% in that one
day. GM’s share price is down 44% from a 52‐week high of US$50.04 to
its current low of $29.37. From itʹs market high of $93, in May 2000,
GM shares have lost 69% of their value. This indicates that GM is in
serious trouble and may prove to be an important turning point for the
entire stock market.
What does GM’s financial vulnerabilities tell us about the future of the
stock market and the price of gold?
While most people think of GM as a car company 80% of its 2004
earnings came from GMAC, its financial division. While the auto
divisions posted losses the finance division provided all of the profits.
GMAC doesnʹt just do auto financing; in fact the majority comes from
consumer credit, insurance and mortgage financing. This division
provided GM with most of its profitability. Just as with GM, the
financial industry was responsible for 50% of corporate profitability in
28 10th Anniversary Book of Articles
the US. With rising interest rates and the prospect of increasing defaults
by overleveraged consumers this is likely to change dramatically in the
near future.
This financing activity is clearly masking the problems plaguing its
automotive operations. Apart from competitive market factors for car
sales, foreign competition, rising commodity and labour costs, and
rising oil prices, the areas of greatest concern are GMʹs underfunded
pension liabilities and corporate debt. In 2003, GM faced the largest
pension fund shortfall of any US corporation ‐ $25 billion, requiring it
to float an extraordinary $17.6 billion bond issue, bringing its long term
debt to over $300 billion. This still left GM with a deficit of over
$50 billion in its health care fund. The magnitude of this becomes more
apparent when you consider that GMʹs market capitalization is now
just $16.6 billion.
GMʹs pension woes are not likely to improve. In a report for The Detroit
News Auto Insider Ed Garsten states that GM currently provides health
and income benefits to 461,500 retirees and their surviving spouses. As
of October 2004 GM retirees and their dependents outnumbered the
company’s active workforce by three‐to‐one. This imbalance will
continue to grow as more and more retirees are supported by fewer
and fewer workers.
GM’s employment and pension woes are not isolated issues restricted to
its corporate boardrooms. GM’s problems point to and underscore greater
systemic issues that could one day choke the life out of tomorrow’s
capital markets and cause havoc for the West’s financial system.
Pension underfunding is a global problem that is particularly
pronounced in the US due to the underfunding of Social Security. In
2004, the US Federal government posted the highest budget deficit in
history‐ $412 billion. However, its total indebtedness rose by
$11 trillion to $46 trillion largely due to underfunded social security
and Medicaid obligations. The magnitude of this liability comes into
focus when one considers that the 2004 annual increase is equal to the
entire GDP of the whole country. It translates into $350,000 per worker
and since both couples work in most families, this represents a $700,000
liability per family.
29
In 2003, 70% of US corporate pension plans were underfunded by
$278 billion with estimates for 2004 exceeding $400 billion. The Pension
Benefits Guarantee Corporation, that insures the pensions of over
44 million American workers, incurred a record net loss of $12 billion in
2004 increasing its liabilities to $62 billion on $39 billion in assets,
resulting in a deficit of $23.3 billion. The CATO Institute, a policy
research group estimates that the agencyʹs shortfall may top $50 billion
in the next ten years. If the economy experiences a decline due to rising
interest rates or rising oil prices the number of corporate bankruptcies
could increase dramatically. Given the precarious financial position of
GM, it could be one of them.
During the ‘90s bull market most pension plans were in surplus.
Companies were able to add surpluses to their operating income
thereby distorting price/ earnings ratios. After the market decline in
2000 many defined benefits plans became underfunded. Today, the
picture is still distorted as pension funding obligations are based on
overly optimistic portfolio returns, resulting in a much higher level of
underfunding than is being reported.
As an example, prior to its bankruptcy, Bethlehem steel reported
that its plan was 84% funded when in fact it was only 45% funded.
This resulted in a $4.3 billion liability that the Pension Benefits
Guarantee Corporation had to assume. Robert S. Miller, Chairman and
CEO of Bethlehem Steel told Bloomberg News: “I hope other
companies are ready for this, because many of them, including some
automakers, aren’t going to be able to outrun their pension liabilities.
At some point, the great sucking sound of pension and health care
liabilities just overwhelms your ability to raise capital or invest in new
plants or equipment.”
Like many other members of the S&P 500, GM projects an expected rate
of return of 9% on its pension assets. Such exceedingly optimistic
assumptions served to increase GMʹs operating profit by $8.7 billion in
2001 and $8.1 billion in 2002 even though pension assets posted losses
of $5.3 billion in 2001 and $5.4 billion in 2002.
These pension liabilities may ultimately cause a decline in the entire
stock market. Since 360 of the S&P 500 companies have defined
benefits pension plans these obligations will negatively impact earnings
as more profits will have to be diverted to pension plans. As lowered
General Motors, the Stock Market and Gold
30 10th Anniversary Book of Articles
profits negatively impact share prices these will, in turn, result in greater
pension deficits due to the fact that these company’s pension portfolios
are invested in each other’s stocks. This can become a descending spiral
of pension deficits, leading to reduced earnings that in turn lead to
lower stock prices, that lead to even greater pension deficits.
With the stock market starting to trend down, long term bonds yielding
under 5% and treasury bill yielding 2.7% it is hard to imagine how an
assumption for a 9% rate of return can be achieved without adding
significant risk. Rather than improve, the situation is likely to get much
worse. By 2011 approximately 100 million US workers or roughly the
entire population of Japan will have retired from the workforce.
Economists agree that this event will have marked consequences for
both the US economy and its capital markets. Unfortunately,
economists also agree that the effects of this massive retirement wave
will be for the most part negative.
In addition to the pension and health care liabilities GM’s debt is also of
concern and is symptomatic of the high consumer, corporate and
government debt levels. US corporate debt grew to new highs of over
$9 trillion, representing 84 percent of GDP. These high debt levels are
significant when you consider that the Federal Reserve has stated it
intends to continue to raise interest rates, and that equity markets are
overvalued by all traditional measures. The combination of decreasing
consumer spending and increased debt service costs will ultimately
translate into slower growth, a contraction in earnings and reduced
profit margins. This will all translate into declines in stock prices.
GM’s total consolidated debt was $301 billion on December 31, 2004.
To put this into perspective this is almost as large as Canada’s entire
Federal Debt of about $363 billion. It is larger than the value of the US
gold reserves of 512 million ounces, worth about $217 billion at
$425/ounce gold.
GM is a benchmark bond issuer, being the world’s third largest
corporate borrower with $114 billion in outstanding bonds. Much of
that debt may soon fall below investment grade status among the most
influential credit rating agencies, relegating the once venerable GM to
“junk bond” status. Since the recent announcement the yield on GM’s
euro denominated bonds have soared to 9.59%. Fitch Ratings recently
31
lowered its ranking on GM to one step above junk, while Moody’s said
that it may lower its rating to one step above junk or high yield status.
Dominion Bond Rating service had lowered its rating on GM last week
to two levels above junk status with a negative bias. What will happen
to global bond markets if GM’s bonds go into default?
With borrowing costs surging to their highest level in almost two years,
increasing pension shortfalls, declining auto sales, reduced credit
demand and increasing default risk the earnings picture looks bleak for
both the auto and financing divisions. Instead of a $2 billion positive
cash flow for 2005 GM now projects a $2 billion cash shortfall.
GM’s troubles have immediate ramifications for today’s stock markets.
This is due to the size of GM, its role in the North American economy
and the place it enjoys on its representative index. General Motors
Corporation is one of the 30 “blue chip” companies that comprise the
Dow Jones industrial Average. These 30 companies represent just two
percent of all listings on the stock exchange, but account for 25% of the
daily trading volume of the New York Stock Exchange.
The popular belief that a diversified portfolio of stocks and bonds will
provide long‐term capital preservation and growth is simply not true
during bear markets or during periods of rising interest rates. For full
diversification, portfolios need an allocation to tangible assets,
including precious metals in order to provide negative correlation to
financial assets, and to offset any declines. While North American
investors have participated in the longest and highest equity bull
market ever during the past twenty years, it is important to understand
that this period was not the norm ‐ nor is it likely to be repeated over
the next twenty years. Today, most investment portfolios are not fully
diversified and are at risk of capital loss.
A secular bear market could last for a decade and wipe out any gains
achieved during the bull market. The 1920s bull market took the Dow
from 66 in 1921 to 381 by September 1929, and the ensuing decline took
it down 89% to 41. The current bull market started in 1982 at 777 and
reached a peak of 11,750 in January 2000. The rally in 2003 is typical of
a bear market rally similar to the 1930 rally in the US, and the 1980 rally
in the Japanese Nikkei Index. Will this bear market repeat what
previous secular bear markets have done? Will the ensuing decline
take the Dow below 777?
General Motors, the Stock Market and Gold
32 10th Anniversary Book of Articles
If a secular bear market is coupled with rising interest rates then GM’s
pension problems, as well as the pension problems of many of the
S&P 500 corporations, could lead to insolvency. GM’s pension plan has
a traditional split of 55%‐60% equities, 30%‐35% bonds and 10%‐15%
other assets. There is no mention of any allocation to precious metals
to provide portfolio insurance and to help offset losses that these
assets may suffer.
While many retail investors and pension fund managers believe in
the buy‐and‐hold strategy, it does not work during a bear market.
Many of the baby‐boom generation will not live long enough to even
break even on their investments during the coming bear market.
Many corporations with underfunded pension liabilities may face
bankruptcy long before this strategy delivers the necessary returns to
fund their pension obligations. Investors in the Dow of 1929 had to
wait 30 years just to break even in inflation‐adjusted terms. Japanese
investors who held stocks in the Nikkei are still down 71 percent,
15 years after the 1990 high.
Rather than buying and holding, investors need to consider the benefits
of reallocating portfolio holdings during cyclical trend changes. Apart
from the fundamental vulnerabilities for traditional financial assets,
it is important to understand the cyclical nature of markets. As asset
classes move through individual bull and bear phases, investors should
adjust portfolio allocations in order to maximize long‐term growth. A
portfolio overweight in a bear‐phase asset class can result in huge
losses requiring decades to recover from.
With respect to equities and precious metals, an important indicator for
portfolio adjustments is the Dow:Gold ratio. An increasing ratio, such
as that experienced from 1921 to 1929, from 1933 to 1968 and from 1982
to 2000, indicate that portfolios should be overweight in equities.
Declining ratios, such as those experienced from 1929 to 1933, 1971 to
1980 and 2000 onward, indicate that portfolios should be overweight in
gold. In 1933 and 1980 the ratio came close to 1:1, while in 2000 it
reached its highest level of 43:1. Since then, it has declined to 25:1 and
is trending lower. This indicator suggests that since March 2000
investors should have been allocating higher percentages to precious
metals and smaller percentages to equities. Will this ratio again be 1:1,
as the bear market in equities continues and the value of gold increases?
33
As the outlook for financial assets deteriorates, the importance of a fully
diversified portfolio with an overweight position in precious metals
will become increasingly more critical. Although no one knows for
certain the impact of rising oil prices, the risks posed by derivatives and
high debt levels, and the threats posed by overvalued equity and real
estate markets, there is more than enough justification to consider an
overweight position in bullion. Apart from a portfolio allocation of
5 percent in bullion during all market conditions, an overweight
position of at least 10 percent is essential today.
General Motors, the Stock Market and Gold
P r e c i o u s Me t a l s :
C r i t i c a l D i v e r s i f i e r
N o v e m b e r 2 0 0 6
Gold is on the rise. It recently surpassed $630 per ounce, an increase of
more than 145% from its low of $254. As of mid‐2005, it has increased
approximately 30% in all currencies, and is no longer simply reflecting
US‐dollar weakness. Media coverage attributes these increases to
deficits further and force governments to borrow even greater amounts.
Governments find themselves between the proverbial rock and a hard
place, as even austerity measures tend to negatively impact GDP.
As GDP falls and debt increases, credit downgrades are likely to follow,
resulting in higher bond yields followed by even greater deficits. This
becomes an unstoppable descending spiral.
Loss of purchasing power against gold continued unabated last year
(Figure 2). The US dollar and the British pound have lost over 80
percent of their purchasing power against gold over the past decade,
and the yen, the euro and the Canadian dollar have lost over 70 percent.
As we remind our clients this is not a typical bull market. Gold is not
rising in value, currencies are losing purchasing power against gold,
and therefore gold can rise as high as currencies can fall. Since
currencies are falling because of increasing debt, gold can rise as high
as government debt can grow.
The sovereign wealth funds as well as the more conservative central
banks will have little choice but to re‐allocate to gold in order to
outpace currency depreciation. This is why some central banks,
particularly those of China and India, accelerated their gold buying in
2011, for a third year in a row, to nearly 500 tonnes—about one‐fifth of
annual mine production.
While central banks have been net purchasers of gold since 2009, the
real game changers will be the pension funds and insurance funds,
which at this point hold only 0.3 percent of their vast assets in gold and
mining shares. Continuing losses and growing pension deficits will
make it mandatory for them to eventually include gold—the one asset
class that is negatively correlated to financial assets such as stocks and
bonds. When this happens, there will be a massive shift from over
$200‐trillion of global financial assets to the less than $2 trillion of
privately held bullion.
In considering where gold will be at the end of 2012, I looked back to
my first Empire Club talk of 2005. I said then that it didn’t really
matter whether gold closed the year at $400 or $500 an ounce—the
trends were in place to ensure it had much further to rise. Seven years
later, we can say the same thing. It doesn’t matter whether gold ends
2012 at $2,000 or $2,500, because gold’s final destination will make
today’s price seem insignificant.
Why Rising Debt Will Lead to $10,000 Gold
118 10th Anniversary Book of Articles
These can be frightening times, but gold always offers hope. We may not
be able to heal the global economic problems of government debt, but
individuals can protect and even increase their wealth through gold
ownership. Gold bullion ownership, not mining shares, ETFs or other
paper proxy forms of ownership, is an insurance policy against
accelerating currency debasement. We use the analogy that ‐ In the case
of fire, would you rather have a real fire extinguisher or a picture of one?
A number of people have approached me recently and said they
wished they had listened five years ago. They feel they have missed
the boat, that it’s too late to buy gold. For those who feel that way, let
me close with a Chinese proverb I discovered last year:
The best time to plant a tree is 20 years ago.
The second best time is today.
Why Rising Debt Will Lead to $10,000 Gold Gold and Fiat Currency: Forty Yea Strategies Three Dominant Factors Will Impact Precious Metals in 2011 W Precious Metals Investments 2004-2009 Pompous Prognosticators Revis Critical Diversifier General Motors, the Stock Market and Gold Gold Myths an
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