Tuesday, September 27th, 2016 MST

Fed Policies Mean Inflation

March 2002

Despite Fed Chairman Alan Greenspan’s affirmations that the Federal Reserve will guard against the threat of inflation (higher prices), his actions suggest that inflation is much less a worry than a waning economy. In fact, Fed governor Laurence Meyer recently said that the Fed’s commitment to price stability should not be taken as a goal to eliminate inflation entirely. In Fedspeak, this means price stability will take a backseat to economic stimulation if the recessionary trend continues.

In 2001, the Federal Reserve clearly revealed that it was opting for inflation over economic recession, lowering short-term interest rates eleven times and ending the year with the lowest rates since the 1950s. No matter what the Fed does next, it has adopted an inflationary monetary policy that will result in higher price inflation.

Besides making money cheaper via interest rate cuts, the Fed has been making money more abundant. Percentage changes in the important money supply indicators over the last four years are posted in the table. The numbers in the 2001 column clearly show that Fed is printing at accelerating rates.

The Fed is firing with both barrels, attempting to hold off what could become the worst recession since the 1930s. Conventional wisdom is that the Fed will make this recession short. With renewed optimism for stocks since September 21, it would appear that most investors think the Fed will pull it off. Yet, only a few months ago, most economists denied the possibility of a recession. Now, they admit that the recession is global. Asia has been hit the hardest. Europe is just behind the U.S. in feeling the effects. The U.S. economy is the key.

Almost daily, everyone from President Bush to TV commentators say that Americans need to keep consuming and going in debt so the rest of the world can export goods here. Such has been the clamor for consumers to keep buying that it has been deemed patriotic to do so. Consumers do not, however, seem to be taking the bait.

Dismal Christmas sales, which account for about 25% of annual retail sales, suggest consumers have pulled in their horns. Major retailers held pre-Christmas sales with huge markdowns in their fight for consumer dollars. Except for low-end retailers, such as Wal-Mart, retailers saw one of the worst Christmas seasons in a decade.

When zero interest rates were offered for new auto purchases, record sales were posted in October, but November sales fell nearly 12%. And, despite continued zero financing, December sales slipped again. Austrian economists tell us that the zero rates only moved future sales to the present and that future sales will suffer. Ford’s handing out 35,000 pink slips, its plans to close five plants, and the elimination of several auto models suggests just how bad things are in the auto industry. Globally, auto manufacturing capacity has long exceeded demand, a result of worldwide expansionary policies. The objective in auto manufacturing is to survive, to be there when the economy finally turns.

Meanwhile, the Democrats and the Republicans are beating each up over how to stimulate the economy. What this means is that they have not yet agreed on how much to spend and who is to receive those coveted federal dollars. (The first recipients of freshly-printed dollars receive the greatest benefit. They get to spend before the inflationary impact of the new money hits prices.) With 50-year low short-term interest rates, massive increases in the money supply, and the federal government again about to embrace deficit spending, can price inflation be far behind?

Long-term interest rates are among the best indicators of future inflation. And, while the Fed has been slashing short-term rates, long-term rates have risen. When investors lend money for the long haul, they want protection against inflation risks; to get that protection, they demand higher interest rates. Rates on U.S. 30-year bonds are rising, and during one week in December, 30-year home mortgage rates jumped nearly a half-point. Apparently, long-term lenders see price inflation in the future.

Nearly all establishment economists agree with the Fed’s lowering of interest rates, but none talk about the inflationary consequences. Economists know such policies are inflationary but are willing to accept higher prices to avoid a severe recession. And, it is a severe recession we are facing. Try to find the last the time the Fed cut interest rates eleven times in a year. It was unprecedented.

Only months ago, economists denied the possibility of a recession; today, they admit it is global. One has to wonder how the whole world entered into recession and economists failed to see it. Why do we even listen to those guys?

Actually, some economists and analysts forecasted the recession, but they did not get time on the major networks. Only those following the government line of continuous optimism get to be heard. With such policies, how do investors make informed decisions? The truth is, most do not. Most investors get in after stocks have risen substantially, and they get out after they can no longer endure the losses brought on by bear markets, which always follow bull markets.

And, monetary inflation (the creation of money and credit) is always followed by price inflation (a rise in the general price level). Establishment economists know this; they simply rationalize that a “little inflation” is better than a recession. Austrian economists argue otherwise.

Recessions cleanse the economy of “malinvestments,” a term Austrian economists use to describe bad investments made during periods of expansionary monetary policies. The economy, via recessions, eliminates malinvestments, which inefficiently use capital and resources. Studies show that more malinvestments arise during expansionary periods than during times when the money supply is stable. The greater the malinvestments, the more severe the cleansing periods (recessions).

Enron may be the worst example of what can go wrong during long periods of expansionary policies. The building of over capacity in auto manufacturing and the plunging of billions of dollars into the telecom industry may be the perfect examples. Presently, the fear of a recession is that more Enrons will be exposed, turning the recession into a depression. So, a recession must be attacked the instant it raises its ugly head. The uglier the threatening recession, the stronger the attack. That is why the Fed opted for eleven rate cuts in 2001.

Previous issues of Monetary Digest have noted that “booms and busts” are results of the abuse or “mismanagement” of paper money systems. Periods when the world used gold and silver for money were void of roller coaster economies. That was because the supply of new money entering the economy was generally a slow, steady stream, the result of mining. When the money supply is growing steadily, or not even growing at all, malinvestments are less likely to arise.

Central banks give us sharp increases in the quantity of money, distorting businesses’ perceptions as to the real demand for products, resulting in the building of excess capacity. When the demand slows or fails to materialize, production is cut back and layoffs follow. We are seeing that right now.

The Fed’s loose monetary policies of the late 1990s brought on massive overinvestment, especially in the telecom industry, which is now washing out. Similarly, a loose monetary policy in the 1920s brought on the Roaring 20s, which were followed by the Great Depression of the 1930s as the Fed shrank the money supply.

Today, we are facing the most rapid and severe economic slowdown in decades. The Fed, determined not to see another Great Depression, has responded with another loose monetary policy. Interest rates have been slashed and the money supply is ballooning. CMi asserts that price inflation will follow as night follows day, as bear markets follow bull markets. These are the conditions under which gold and silver prices rise.

The manipulators can hold gold and silver prices down only so long. How long is not known because there is no way of knowing how committed the conspirators are. Frank Veneroso has estimated that at the present rate central banks are supplying gold to the market, their vaults will be empty in about six years. If true, it is a sure bet that the central bankers are well aware of their precarious situations.

While many central bankers disdain gold and some have dumped huge quantities, central bankers know that gold is the ultimate form of money. They wish it were not so. They would dearly love to have the world readily accepting their little pieces of paper. So, there are limits how far central bankers will go in keeping the price of gold down. Yet, there is no way of knowing those limits. If Veneroso is right, then the maximum is six years, but it is unlikely central bankers will go that close to the edge of the cliff.

Meanwhile, investors exiting the stock market have to decide where to park their funds. Because the Fed has driven interest rates to fifty-year lows, treasury bills and other short-term government obligations, which are supposed to be the safest of all paper assets, yield about the rate of price inflation, making such investments a wash. Some quality long-term bonds offer higher yields, but the prospects for higher rates of inflation render those bonds risky.

Because of the low return on debt instruments and the fears of inflation, many investors are opting for gold and silver. At CMi, almost daily we talk with investors who have never bought gold or silver before. They ask about the metals because they do not like their options. The low rates and the inflation risks of paper assets make them seek alternatives. Gold and silver have always been the ultimate forms of money, the safest investments.

The big knock on gold and silver is that they “pay no interest.” True, but interest is something you receive for doing without your money and for the risk you take. When you buy gold or silver, you have not loaned your money and, therefore, are not taking the risks associated with lending money, e.g., not getting the money back. However, with gold and silver you have the potential for price increases, something you never have with CDs and savings accounts. You can have price increase with bonds, but you have to accurately foresee interest rate changes, something not easily done. As for the risk in gold and silver, no one ever went broke owning them.

It was universally accepted-if you believe the media-that the Fed’s rate cuts would lower mortgage rates. They did earlier in the year, but when investors realized that the Fed’s actions were inflationary, long-term rates rose because lenders demanded higher rates to compensate for the inflation risks. Because bond prices are inversely related to interest rates, rising long-term rates sank bond prices, which is a perfect example of interest rate risks.

The Fed has always played a balancing game between recession and inflation, with a bias toward inflation. That is why the general price level in the United States is up about 100 fold since the Fed’s inception in 1913.

The late Murray Rothbard was a harsh critic of the Federal Reserve System. He declared immoral the Fed’s (and the banking system’s) fractional reserve system. In his mildest attacks, he called the Fed an inflation machine.1

Fractional reserve banking is in use around the world, which means the entire world is on the brink of a massive inflationary spiral. Every solution to every problem seems to call for the printing of more money. In the United States, our central bank, the Federal Reserve System, is in high gear. Investors need to allow for that when investing for the future. Historically, gold and silver have been the ultimate safe havens during inflationary periods.

Krugerrands Sell at Discounts

Although 1-oz Krugerrands and 1-oz Gold Eagles contain the same amount of gold, are both 22 karat, and are the same dimensions, Krugerrands sell $7-$9 below Gold Eagles. CMi recommends that investors who buy gold coins for only their bullion content consider Rands. A little background on the venerable Krugerrand is in order.

In the mid-1960s, the Chamber of Mines of South Africa, a mining industry association, conceived the one-ounce gold Krugerrands as a means to increase worldwide sales of gold, the Republic of South Africa’s most important export. The Chamber had noted that although gold was priced on a per ounce basis, no 1-oz gold coins were being minted. Popular coins at the time were the Austrian 100 Coronas (0.98 oz) and the Mexican 50 Pesos (1.2057 oz, or 37.5 grams). The RSA made the coin legal tender, and the first proof Rands were minted by the Pretoria Mint in 1967. In 1970, the Mint began mass producing uncirculated Rands.

The uncirculated coins quickly became popular in Europe, and after Americans regained the right to own gold bullion on December 31, 1974, the Chamber of Mines made a big push in the United States. Between 1975 and 1985, some 22 million 1-oz coins were imported to meet 40 years of pent-up demand. In 1978, Americans bought more than six million Rands. Sparking interest in gold bullion in the 1970s was the worst inflation of the 20th century, two oil shocks, and a cold war that was very hot.

In 1985, however, Congress halted the importation of Krugerrands as a slap at the RSA apartheid government. In 1995, the ban was lifted. Between 1985 and 1994, however, Krugerrands dated 1985 – 1994 were illegal to possess in the United States, and some were even confiscated. Now, all dates freely trade in the U.S.

While Rands were banned, the Canadian Maple Leafs, first minted in 1979, increased in popularity, and in 1986 Congress authorized the minting of Gold Eagles. When the ban was lifted, the Chamber of Mines made another attempt at popularizing Rands in the U.S., but the Chamber was fighting an uphill battle. The popularity of Gold Eagles was insurmountable.

Recent year Rands, dated 2000, 2001, and 2002, sell at the same prices as current year Gold Eagles. But, backdated Rands sell at a $7-$9 discount to Gold Eagles. Investors wanting only a “bullion play” should consider the backdated Rands. However, Rands do have a slight drawback.

When 25 or more 1-oz Krugerrands are liquidated, i.e., sold to a dealer by an individual, the transaction is supposed to be reported to the IRS on a Form 1099-B. The IRS asserts that the liquidation of 25 or more Rands has to be reported because Rands are approved for trading on commodities exchanges. Gold Eagles are not approved for commodities exchange trading, and no reporting requirement applies to them.

The 1099-B reporting requirement, undoubtedly, has much to do with Rands selling at discounts to Gold Eagles. Most Americans want as little attention as possible at the IRS, even if it means paying more for their gold. Still, CMi recommends that investors wanting a pure bullion play consider the Rands. After all, the sale of 20 coins, which is the most common liquidation, does not have to be reported.

It is necessary to emphasize that there are no reporting requirements for the purchase of any gold, in any form, in any amount. Some dealers, wanting to sell collector coins, often talk about the “reporting requirements of bullion coins.” While there are no reporting requirements on the purchase of any gold, those dealers like to leave the impression that there are. This makes potential buyers more susceptible to going with collector coins, which provide much larger profits to the dealers.

For long-term investors, though, CMi recommends coins from the Perth Mint’s Lunar Series, which sell at slightly higher prices than Gold Eagles but have collector potential. CMi believes that a major bull market in precious metals has started, one that may make gold as popular as dot-com stocks once were. During such a market, the Lunar Series coins stand the chance of achieving huge premiums, making their present small markups over Gold Eagles worthwhile. Yet, for those investors who want pure gold plays, Rands are priced attractively.

Blanchard Roils Gold Investors

Blanchard and Company, a name long associated with gold, recently jolted gold investors by releasing a report that disparages gold bullion. Titled Gold Bullion: Caught in a Bear Trap, the report recites the standard slams used by gold bears: lack of investor buying, central bank selling, forward sales, etc. A cover letter even made such absurd statements as, Gold bullion is no longer a hedge against inflation, devaluation of the dollar or falling stock prices. It is no longer a store of value. Perhaps most importantly, gold is no longer insurance against economic, monetary and political crises, including war, that diminish the value of financial assets. It appears that the Heavens have revealed to Blanchard and Company that six thousand years of history have been wrong. Gold is not the ultimate safe haven.

Although closing the door on gold bullion, Blanchard left the door wide open for numismatic promotions. CMi believes that Blanchard’s declaration is nothing more than a ploy to sell more numismatic (collector) coins, which produce greater profits-for the sellers-than do bullion coins.

Last year, Gold, the World Gold Council’s new, slick magazine, carried an article about Blanchard and Company. The article noted that while bullion coins make up the bulk of Blanchard’s sales, collector coins produce more profits. (In the industry, Blanchard has no equal in scoring such favorable publicity. Years ago, the company even convinced the U.S. Postal Service to co-publish a book on how to avoid coin fraud. The book was of little value to investors, but it gave Blanchard tremendous credibility.)

By denouncing gold bullion coins, Blanchard has revealed its intention to promote only collector coins, which yield more profits for the company. Yet, the announcement should not surprise anyone familiar with the company’s history. Since CMi has been in business longer than Blanchard, we are familiar with their history.

In the mid-1980s, when gold was cooling after its meteoric rise to $850 in 1980, not much new money was entering the gold market. To compensate, many dealers began recommending that investors swap their Krugerrands for old U.S. gold coins or even Gold Maple Leafs, which simply re-circulated gold money. In the stock market, this is called churning.

In the early to mid-1980s, South African Krugerrands dominated the U.S. gold coin market. Some 22 million had been imported. (The first Gold Eagle was not minted until 1986.) Convincing investors to swap Rands for other forms of gold was easy because at the time the U.S. political left had an all-out attack against the Republic of South Africa’s apartheid government. As a result, Congress banned the importation of Rands.

Claims that confiscation of Rands was next quickly became the new scare tactic to convince investors to trade Rands for other forms of gold. Such trades always resulted in the investors receiving less gold than they turned in. Confiscation of Krugerrands was not even discussed at government levels, much less undertaken, but many dealers used that assertion to stimulate business. CMi refused to march in that parade and even warned its clients-via Monetary Digests-not to swap their Rands for other forms of gold.

At times, Blanchard’s advertisements, often heard on the Rush Limbaugh radio talk show, have claimed that it is the country’s biggest retailer of Gold Eagles. Still, Blanchard is better known for promoting collector coins. A few years ago, it joined with several other telemarketers in promoting the “Wells Fargo hoard” of Double Eagles. More recently, it has hawked coins recovered from the S.S. Central America, a steamship that went down off the North Carolina coast in 1857.

At New Orleans Gold Conferences, the late Jim Blanchard, founder of the Gold Conferences and later Blanchard and Company, was heard to promote stamps, once bragging that he and some associates had paid $120,000 for a single stamp. So, Blanchard and Company’s turning away from gold bullion coins comes as no surprise to CMi.

After reading a recent email promotion from Blanchard, it seems that the company intends to push collector coins to the hilt. From that email: There are two basic categories of coins: numismatic and bullion. Avoid bullion. Almost all bullion coins-such as Krugerrands-are bad investments.

The email referenced an article in the January 7, 2002 Barron’s, and it is not clear from the email if the above quotation is from the article or represents Blanchard’s position. No matter which, CMi believes investors are better served by buying bullion coins, not numismatic (collector) coins. While some inspiring stories circulate about a few people who have made money in numismatics, those instances are rare. In fact, some dealers have to go back decades to find stories of investors profiting from numismatic coins. CMi hears only horror stories from investors who bought so-called collectible coins from telemarketers. Losses often hit 50%.

Further, telemarketers are known for pointing to price increases of a few collectible coins and then making the leap that all numismatic coins hold the same potential. Facts are to the contrary. Investors who purchased just about any Double Eagles in 1998 and 1999 today have huge losses. Investors who got sucked into the Wells Fargo hoard promotion have losses. Most collector coins have fallen in price since Y2K became a nonevent. With the lofty prices being asked for the S.S. Central America coins, it will be difficult for investors to profit from those coins.

Although it is true that a few collectible gold coins have risen in price over the last few years, it is also true that during the great bear stock market of the 1930s some stocks managed gains. Generally, numismatic gold coins enjoy rising prices during periods when telemarketers have good stories to tell, such as in 1998 and 1999, when everyone was suppose to prepare for Y2K.

The sad truth is that the only people who can count on making money in numismatics are the dealers. Even when buyers are lucky enough to buy coins that rise in price, the markups are often so high that profits do not come. The collectible market should be left to the genuine collectors, the hobbyists, those individuals who enjoy spending their weekends at coins shows, their evenings studying coin catalogs and magazines. Investors who fall for telemarketers’ pitches stand little chance of profiting.

What effect will Blanchard’s announcement have on the gold market? Little, except to upset a few goldphiles. As noted, the company is known for selling numismatic coins, and they have simply reinforced that. Meanwhile, the gold market-the gold bullion market-is showing signs of moving higher. Investors do not want to miss the first precious metals bull market since 1993 by owning overpriced collectibles.

(Readers who want to know more about CMi’s position on old U.S. gold coins, the most commonly promoted numismatics, should visit our Web site www.certifiedmint.com and click on pages Old US Gold Coins and Myths, Misunderstandings, and Outright Lies. The links are to the left on the menu bar.)

Not All Central Bank Activity Negative

The biggest knock against gold is that central banks are net sellers. A common perception is that central banks will sell forever, keeping the price of gold depressed. Much of this perception springs from the Bank of England’s highly visible three-year program of auctioning 415 tons (13.34 million ounces). With the last BoE auction to be held in March, a review of central bank activity in the gold market is appropriate.

The table shows the world’s top 20 official gold holdings and the percentage of those countries’ reserves that are gold, as of January 2002. (Data and calculations from the World Gold Council. One metric ton equals 32,151 troy ounces.)

After the BoE holds its final auction in March 2002, only about 315 tons of gold will back the pound sterling, leaving the UK a notch above Lebanon on the gold ownership totem pole. With the UK completing its program, Switzerland becomes the only big seller, taking up 70% to 75% of the Washington Agreement on Gold limit of 400 tons a year. Unlike the BoE, the Swiss sell quietly, and despite the large amount being sold, the Swiss sales receive little publicity. The Swiss move 16 tons to 25 tons a month.

Over the last three years, gold bears used the BoE auctions to their advantage, constantly talking about them, presenting the notion that central bank selling will keep the price of gold forever from rising. Ignored are the central banks that add to their positions.

Although Russia announced in August 2001 its intentions to increase its gold holdings, China has simply added to its gold position. Currently, China and Russia are numbers 12 and 14, respectively. China is adding at a faster pace than Russia, and with China’s massive paper reserves, it will probably move up a several more notches this year.

In December, China reported adding 105 tons of gold to its holdings, pushing net central bank acquisitions for the month to 71.4 tons, the first monthly plus reading in years. That was newsworthy. Yet, CMi doubts that any reader of this commentary has seen this development reported by any establishment source. (The World Gold Council, in its Weekly and Daily Commentaries did lightly touch on the matter, which prompted CMi to look further.)

Note in the table that percentage holdings of gold for European countries, ignoring the UK, range from Spain’s 13% to France’s 44.5%, with an average of 31%. However, the average will decline slightly as the Swiss reduce their holdings. But, the important thing to look at is the low gold holdings of the Asian nations.

Japan has only 1.7% of its reserves in gold, Taiwan 3.1%, and China 2.1%. If one of these countries were to increase its gold holdings to the European average of 31%, the impact on the gold market would be massive. Consider China, which is adding to its gold position.

China now owns 500 metric tons, or 16.08 million ounces, of gold, which represents 2.1% of China’s total reserves. This means that China has about $4.43 billion in gold and about $206.5 billion in paper reserves. If China were to increase its gold holdings to the European average of 31%, it would have to buy about $65 billion in gold. At $300 gold, $65 billion would buy 216.7 million ounces (6739 metric tons), which would leapfrog China to the number two position, just behind the U.S. Of course, the price of gold would not remain at $300 if $65 billion went hunting for gold.

CMi claims no inside knowledge as to how much gold China intents to buy. However, we do know that some Chinese economists have urged the Bank of China to increase its gold holdings, a move that would reduce China’s vulnerability to the dollar, which is overvalued.

If the Dragon has entered the gold market, the gold price manipulators can kiss their wallets good-bye.

Perth Mint Lunar Series Coins

Since December 31, 1974, when Americans regained the right to own gold bullion, CMi has recommended that gold investors buy bullion coins, not numismatic or collector coins with high premiums. Numismatic and collector coins have several drawbacks that often result in investors sometimes incurring huge losses. First, premiums on numismatic coins can shrink. So, even when the price of gold rises, prices of numismatic coins can fall.

Second, telemarketers often add huge markups to the numismatic coins that they promote; consequently, investors rarely profit on coins purchased from telemarketers. CMi does recommend, however, that investors buy bullion coins that hold numismatic potential. Two examples illustrate this approach.

In the late 1980s, old U.S. gold coin prices were depressed. Double Eagles, grades VF to even BU, sold at or near spot. Although Double Eagles are not bullion coins, they sold at bullion coin prices. Because of those low premiums, CMi believed that investors could see increased profits by going with old U.S. gold coins, instead of bullion coins. The increased profits would come from premiums returning to old U.S. gold coin prices, which happened in the mid 1990s.

Over years, premiums on old U.S. gold coins, especially Double Eagles, contract and expand. When premiums are high, Double Eagles should be avoided. However, when Double Eagle premiums are small, Double Eagles offer added upside potential because of potential premium increases. One client enjoyed a 50-oz increase in her gold holdings by purchasing VF $20 Libs in 1989 and later trading them for 1-oz Gold Eagles when premiums returned. (She started with 192 $20 Libs and ended with 236 1-oz Gold Eagles.) Presently, Double Eagles carry sizeable premiums and should be avoided, except by those buyers who like old U.S. gold coins, which truly are magnificent coins.

As for bullion coins that have numismatic potential, CMi recommends Australia’s Perth Mint Lunar Series 1-oz coins, which carry premiums of only a few dollars over the 1-oz Gold Eagles, the most popular gold bullion coins now being sold. The Perth Mint launched the Lunar Series in 1996 with the Year of the Rat, which is the first year in the 12-year cycling Chinese Lunar Calendar. Four coins are minted for each year, a 1-oz, a 1/4-oz, a 1/10-oz, and a 1/20-oz. CMi recommends only the 1-oz coins for investors. Premiums on the fractional-ounce coins are high, making them suitable mostly as jewelry pieces. The series will end in 2007, with the year of the pig.

CMi likes the 1-oz Lunar Series coins for several reasons. First, the Perth Mint is renown for turning out exquisite coins. (CMi has yet to have a client not be impressed with the quality and beauty of the Lunar coins.) Second, production of the 1-oz coins is limited to 30,000. Although the Perth Mint’s brochure for the year 2002 Horse says that production will be capped at 50,000, subsequent to the brochure being released the Mint stated that production of the 1-oz Horse will be limited to 30,000, as were the first six coins in the Series.

Additionally, the Perth Mint has said that production of all future 1-oz Lunar Series coins will be limited to 30,000. Thirty thousand is a small number for a coin with worldwide appeal. As one would guess, Lunar Series Coins are quite popular among the Chinese. Yet, many non-Chinese buy their birth year Lunar Series coins.

CMi learned about of the Lunar Series in early 2000 when a client from Hawaii wanted to put Perth Mint 1-oz Gold Dragons in his IRA. We suppose that his being closer to Australia had something to do with his finding out about the coins. We had never heard of the coins but after a few phone calls found an importer. Many good things happen by chance, and CMi believes that client’s phone call was one.

Although the fifth coin in the Series, the 1-oz Gold Dragon was the first to reach the production cap of 30,000. Now, no more Year 2000 1-oz Gold Dragons will be produced by the Perth Mint. Investors wanting 1-oz Gold Dragons have to buy them from the secondary market. Coins from the secondary market are those that previously have been owned by investors. Coins that come from the minter through its distribution system are said to be primary market coins.

One reason CMi became excited about the Dragons was that the earlier coins-the 1996 Rat, the 1997 Ox, the 1998 Tiger, and the 1999 Rabbit-were selling at premiums in the secondary market when we learned about them. The Ox, which at times was next to impossible to find, sold as high as $480. The Rat also topped $400, and the Tiger and the Rabbit sold in the $330-$380 range. For clients who wanted the earlier coins of the Series, CMi worked with a dealer who imported them from the Australian secondary market, where most of the earlier coins were sold. However, CMi has since learned that it was not necessary to go the secondary market because Perth Mint policies differ from U.S. Mint policies concerning the minting of backdated coins.

Whereas the U.S. Mint is prohibited from minting backdated coins, the law authorizing the Lunar Series coins made provisions for minting backdated coins until the cap is reached. This policy was virtually unknown in the United States. (Frankly, we doubt it was well known in Australia.) The dealer who brought in the earlier coins from the secondary market did not know about the policy, and he has been dealing in Asian and South Pacific coins for nearly two decades. The importer from whom we bought the Gold Dragons, and now buy the Snakes and Horses, did not know. In fact, the representative that the Perth Mint used to promote all Perth Mint coins in the U.S. did not know about the policy until CMi brought up how difficult it was to obtain the earlier coins. When the representative contacted the Perth Mint, he learned that the earlier coins would be available from the Mint until the production cap was met.

On learning that the earlier coins could be brought in via the primary market, CMi refused orders for the earlier coins until we convinced an authorized importer to bring in the earlier coins. Although the earlier coins now come through normal channels, they sell at slightly higher prices than the 2001 Snakes and the 2002 Horses, which are considered current year coins. Shortly, the Snakes will become “earlier year coins,” and their premiums will rise slightly.

Despite selling at slightly higher prices than 1-oz Gold Eagles, all the 1-oz Lunar Series are what CMi calls “bullion coins with numismatic potential.” As noted above, the 1-oz Dragons are available only in the secondary market and, at times, not available at all. The earlier coins once sold significantly higher than current year coins, and they can again, when more investors learn of them and when the production cap of 30,000 is reached.

CMi remains excited about the Lunar Series coins for two additional reasons. In 2008, China will host the Summer Olympics. As that time approaches, more people will learn of the Lunar Series. The brouhaha surrounding China hosting the Olympics should result in widespread publicity about China’s culture, their Lunar calendar, and even the Lunar Series coins.

Additionally, until the year 2002 Horse, the Perth Mint publicized only the current year coin. Now, the Mint has begun promoting the earlier coins. For example, the brochure for the Horse contains illustrations of the earlier coins, something not done with the brochures for the first five coins.

Many investors take the position that “an ounce of gold is an ounce of gold.” Believing that, they buy the cheapest gold available, which usually are Krugerrands. However, this position ignores the fact that some 1-oz gold coins, while containing an ounce of gold, do rise in price above 1-oz bullion coins. As noted above, Double Eagles, which contain 0.9675 oz of gold, often sell at significant premiums. And, when the earlier Lunar Series coins were thought not to be available except through the secondary market, investors were willing to pay as much as $200 per ounce above the price of gold to get those coins. We believe that with the Perth Mint now marketing all the coins-and not just the current year coins-the earlier coins will sell out and achieve premiums in the secondary market. If so, investors who buy at current prices should benefit from premium increases.

As for the belief that “an ounce of gold is an ounce of gold,” consider this: Some stocks paying a $4 per share dividend sell at $100 for a 4% yield while other stocks paying $4 per share sell at higher prices, yielding as low as 1%. Why? Because the market (the collective thinking of all investors) has put a higher value on latter. The market expects dividends to rise, thereby causing the yield to increase. Or the market expects the price of the stock to rise, for whatever reason. With the coins that sell at prices significantly above the value of their gold content, investors are willing to pay those higher prices simply because they want those coins. CMi believes that the Lunar Series coins stand a significant change of becoming sought after and achieving premiums. For more about the Lunar Series coins, see page 6.

Investors who are likely to sell if gold moves higher quickly, say to the $350 level, should buy Gold Eagles or Krugerrands. Lunar Series coins are best suited for long-term investors and ideal for investors who want gold in their IRA accounts.

Recommendations

Historically, during precious metals bull markets, silver has always climbed higher than gold on a percentage basis. CMi expects this emerging precious metals bull to see silver again out-perform gold, perhaps by wider margins than in the past.

In addition to being a monetary metal, silver is an industrial metal, with thousands of uses and new ones being announced almost weekly. The newest and most exciting use is the recently patented super-conducting electrical wire, the most revolutionary development in electricity transmission in a hundred years. The Silver Institute projects annual demand from this new wire to reach 50 million ounces within ten years. (The October-November 2001 Monetary Digest discussed at length this new wire.)

The industrial demand should give silver a huge boost when prices start moving. For the last eleven years, silver has been in “production deficit,” which means that industrial demand has exceeded primary production and scrap recovery. The deficit has consumed over a billion ounces, and aboveground supplies are getting critically short.

Silver’s low prices can be attributed only to shenanigans on the COMEX, where “paper silver” is traded. However, as aboveground supplies dwindle, those shenanigans will come to an end. Recently, the London Metal Exchange announced it was canceling its silver futures contract. In late December, monthly lease rates (the cost of borrowing physical silver on an annual basis) topped 25%. The COMEX will face the same problem with the next strong run-up in the price of silver.

Meanwhile, gold remains entangled politically and legally. The U.S. government, recognizing that increases in the price of gold warn of inflation and a lack of confidence in paper currencies, wants the price to stay low. Admittedly, no government official has said as much, but history shows that our government has always attempted to keep the price of gold down when it is creating huge quantities of money. During the last half of the 1990s, the Fed was especially active, responding to every crisis with the creation of more money.

While no government official has admitted that the government has been working behind the scenes for low gold prices, the gold world awaits a Boston judge’s decision whether discovery will commence in the GATA lawsuit against major bullion houses, the Fed, the Treasury, and a host of government officials. GATA alleges those entities have conspired to keep the price of gold down, contrary to U.S. anti-trust laws.

CMi has warned its clients not to expect a favorable decision for GATA. Federal judges know who butters their bread. The efficacy of gold as an investment lies in gold being virtually indestructible and having been used as the ultimate safe haven over the last six thousand years. Gold will still be with us long after the dollar is laid to rest in the paper currency cemetery. This effort to stymie gold will fail as have all others. And, looking at gold price action over the last two years, evidence suggests a bottom has been made. Overall, gold (and silver) prices should move higher over the next five to seven years, perhaps longer.

CMi does not recommend platinum at these levels. When platinum sold within $30-$40 of the price of gold-and at times lower-we strongly urged clients who liked gold to go with platinum. However, at present prices for platinum, we cannot recommend it.

Silver

Both 100-oz silver bars and bags of circulated pre-1965 U.S. 90% silver coins are bullion investments; their prices will rise with the spot price of silver. Nevertheless, during periods of strong buying, bags of 90% pick up premiums, whereas 100-oz bars do not. This is because 100-oz bars are being manufactured while 90% coins were last minted in 1964.

In 1999, thousands of investors, fearing Y2K, bought bags of 90%, regardless of the price, because that’s what Gary North said they should buy. Most buyers never stopped-or knew-to ask the price on a per ounce basis. As a result, those buyers drove the premium on bags to 50% at the peak of the buying frenzy. Because 90% coin can pick up big premiums, silver investors should make it their first choice if storage is not a problem. One hundred ounce bars have the advantage of being easier to stack and store.

Gold

One-ounce Gold Eagles remain the best selling gold bullion coin in the country. Investors wanting a strict gold investment cannot go wrong buying Gold Eagles. However, as noted on page 3, Krugerrands, while containing the same amount of gold, sell at $7 to $9 below Gold Eagle prices. Bargain hunters should seriously consider Rands when looking for cheap gold.

Investors willing to pay a little more to get greater upside potential should investigate the Perth Mint’s Lunar Series coins. They are covered extensively on page 6, and more information can be found on our Web site www.gold-dragons.com. CMi believes the Lunar Series coins to be the best choice for long term investors, long term being two years or more.