November 2005
In recent weeks, as consumer prices have surged higher, “revived inflation” has become the hot topic among establishment writers. Inaccurately, most writers blame higher energy costs, rising interest rates, the wars in Iraq and Afghanistan, and the costs of hurricanes. In fact, the cause of inflation is the United States’ abandonment of the gold standard.
The United States’ abandonment of gold as the foundation of its monetary system came in two steps. In 1933, President Franklin Roosevelt ended Americans’ right to surrender paper dollars for gold and even to own gold bullion. Step two came in 1971 when President Richard Nixon “closed the gold window” and denied foreign governments the right to turn in paper dollars for gold.
Roosevelt’s move was a major step in shifting the world from the gold standard to the gold exchange standard. Under the gold standard, governments fixed the prices of their currencies in terms of a specified amount of gold and stood ready to convert their currencies into gold at the fixed prices.
Under the gold exchange standard, governments could hold U.S. dollars and British sterling as reserves because those currencies were “exchangeable for gold.” The move to the gold exchange standard became effective with the adoption of the 1944 Bretton Woods Agreement. When Nixon closed the gold window, those nations counting paper dollars as reserves found themselves holding paper instead of gold.
Although in 1974 President Gerald Ford signed legislation that permitted Americans again to own gold bullion, that legislation did not put the United States back on the gold standard.
Under the gold standard, a government is limited-legally and practically-as to how much paper money it can print. As recently as the Lyndon Johnson administration, the U.S. could print paper dollars equal only to four times the value of the nation’s gold reserves.
Under the gold standard, governments that print too much paper money risk runs on their gold reserves. Runs occur as holders of the paper seek to convert to gold before the vaults are empty. A run on the dollar is what happened in the late 1960s, which culminated in President Richard Nixon closing the gold window in 1971.
“Closing the gold window” is a euphemism for the U.S. defaulting on its promise to other countries to redeem dollars for gold. As an alternative, Nixon could have devalued the dollar and continued to redeem. In effect, he chose a one hundred percent devaluation, a de facto default on the promise to redeem.
In the 34 years before Nixon closed the gold window, the money supply in the U.S. grew less than two fold. In the 34 years after Nixon’s action, the money supply expanded 13 fold. The Fed’s massive inflation of the 1990s resulted in the greatest advance in stock market history. Continued inflation is now pushing housing prices to record levels. Automobiles now cost more than houses did only thirty years ago.
Despite establishment assertions that the dollar is “sound,” investors should prepare for further declines in the value of the dollar and plan their investments accordingly. History shows that no government, after going on a fiat monetary system, ever reverses course until its paper currency is destroyed. There is no reason to believe this time will be any different.
Mother of All Double Tops Still in Place
The May ’05 issue of Monetary Digest discussed the possibility of the stock market having put in, according to Dow Theory, a double top, one that we labeled The Mother of All Double Tops. As this is written, all the pieces are still in place for that double top. If a double top has been made, then stocks are in for a long, dreadful downturn that could last a decade.
According to Dow Theory, as we understand Richard Russell’s explanations, a top occurs when either the Dow Industrials or the Dow Transportation Index makes a new all-time high, but the other index does not. That is what happened in 2000.
The Dow Industrials (often referred to as simply the Dow) closed at a new high in January 2000, but the Transportation Index did not. Actually, the Transportation Index had been in a steep decline for seven months when the Dow made its January 2000 new high. From there, stocks went lower for three years, wrecking havoc on stock portfolios and destroying the .com boom.
In early 2003, both indexes began to rise, with the Transportation Index turning in the stronger performance. Two years after the rally began, the Transportation Index put in a new all-time high. The Dow Industrials, on the other hand, rallied for only one year then stalled. The Industrials have gone nowhere for two years, but more important they have failed to register a new high as did the Transportation Index.
The failure of the Industrials to climb to a new high with the Transportation Index means, according to Dow Theory, that the stock market has put in another top. The second top signaled, if that is the way it turns out, the end of a major bear market rally. Ominously, the tops are five years apart, which could be the beginning of a major bear market for stocks.
If it turns out that a double top has been put in and stocks break badly, that would portend an investment climate that is more favorable to gold and silver. Further, many analysts say the stock market is the best indicator of future economic activity. If stocks decline, a recession could follow. Typically, during stock market declines and economic recessions, investors become more conservative. And, nothing is more conservative than holding physical gold and silver.
Lunar Series Update
With the release of the penultimate 2006 Year of the Dog, Australia’s Perth Mint is nearing completion of its 12-coin Lunar Series. Only two coins in the Series-the Year 2000 1-oz Gold Dragon and the Year 2002 1-oz Gold Horse-have reached their production cap of 30,000 coins. Still, the Series has become popular with coin collectors worldwide. (CMIGS has shipped several Lunar Series orders to Europe and recently shipped $20,000 worth of Lunar Series gold coins to Germany.)
The best evidence of Lunar Series popularity: The 1-oz Gold Dragon now sells at premiums approaching $200, and the 1-oz Gold Horse picked up a $50 premium in October.
CMIGS’ sources say that less than 200 1-oz Gold Horses remain in wholesaler inventories. When those 200 coins are gone, the 1-oz Gold Horses will be available only when other collectors sell, making them likely to pick up still higher premiums.
Presently, it appears that the 2001 Year of the Snake 1-oz gold coin will be the next to reach the 30,000 production cap. Admittedly, snakes are not endearing creatures to most people, but the detailed artwork on the Gold Snake has made it popular. As long as the Gold Snake looks to be the next coin in the Series to sell out, CMIGS recommends that gold investors go with 1-oz Gold Snakes instead of the 1-oz Gold Eagles.
While Gold Eagles are the world’s best selling 22-karat (.9167 fine) gold coins, they are unlimited production coins and are not likely to pick up premiums. Gold Eagles are basically bullion coins, as are Krugerrands. Gold Snakes, on the other hand, sell at bullion coin prices. Because Gold Snakes are limited production coins, they stand a good chance of picking up premiums-as did the Gold Dragons and Gold Horses-after the production cap is met.
U.S. Mint to Produce .9999 Fine Coins
The U.S. Mint plans to strike in early 2006 new .9999 bullion coins to go after the $2.4 billion market for pure, 24-karat, gold coins. Studies show that pure gold coins claim 60% of the world’s gold bullion coin market. The Royal Canadian Mint’s Maple Leafs hold the number one spot for pure gold coins. The new coins do not mean the Mint will abandon or change its popular Gold Eagles but will add another product to its line of gold coins.
In going after a piece of the pure gold bullion coin market, the Mint needs to consider the mindset of bullion coin investors. Bullion coin investors seek alternatives to paper money; they are not coin collectors. Bullion coin investors prefer coins packaged so that they can be easily stored and secured.
This means the Mint should package the coins twenty to a tube, which has become–primarily because of Gold Eagles–the preferred method. Five tubes conveniently total one hundred coins. Further, the tubes should be made of the same durable plastic from which Gold Eagle tubes are made. Hard plastic tubes can and do break when dropped. Gold Eagle tubes, on the other hand, are virtually indestructible.
Packaging the coins in tubes enables investors to more easily inspect their coins. Collectors, on the other hand, want their coins in as pristine condition as possible. Although capsules are excellent for protecting collector coins, coins individually packaged in capsules require more space for storage. The other aspect that the Mint has to consider is the coin’s theme.
The Mint should make the theme uniquely American, as it did with its American Eagles coins. For the Gold Eagles, the Mint chose a slimmed-down rendition of Augustus Saint-Gaudens’ famed Standing Liberty, which he created in 1907 to grace a new Double Eagle ($20 gold coin). Nearly one hundred years later, the Saint Gaudens, which the coin is now called, is viewed as the most beautiful coin produced by the U.S. Mint.
However, if the Mint continues the Standing Liberty theme for the new coins, there is the chance they will become known as “the .9999 fine Gold Eagles,” which would create confusion in the marketplace. Continuing the Standing Liberty theme would also mean that the new coins would “cannibalize” the sales of the popular 22-karat Gold Eagles.
Unfortunately, rumors (and articles in coin publications) suggest that the committee responsible for the new coin’s ultimate design and theme is at loggerheads. If the committee doesn’t come with something uniquely American, the coin may flop in the world market.
If the U.S. Mint avoids the problems that have surfaced with Gold Maple Leafs (See next article.) and offers gold bullion coin investors a strong alternative to Maple Leafs, then it has a golden opportunity to capture a big share of the .9999 fine gold bullion market. With the right planning, the Mint could shake the Maple Leaf’s hold on the .9999 bullion coin market.
Gold and Silver Maple Leafs Get New Packaging
Gold Maple Leafs and Silver Maple Leafs are receiving packaging makeovers, changes clearly mandated by investor disfavor with packaging that the Royal Canadian Mint has used since the coins were introduced. Gold Maple Leafs debuted in 1979, Silver Maple Leafs in 1988. The changes appear to be good moves, which should increase sales of Silver Maple Leafs and help keep Gold Maple Leafs the preferred pure (.9999 fine) gold bullion coins.
Since inception, 1-oz Gold Maple Leafs have been packaged ten to a tube. Because Maple Leafs are 24-karat, pure gold, they are “soft,” relative to alloyed gold coins, such as American Gold Eagles and Krugerrands. Further, because of the design of the coins and the tight-fitting tubes, it is difficult to remove, inspect, and reinsert 1-oz Gold Maple Leafs in their tubes without scratching the coins.
As Gold Maple Leafs have been sold into the secondary market, damaged coins have become such a problem that Gold Maple Leafs have lost popularity with investors. The problem has become so widespread that many wholesalers bid only “melt” for Gold Maple Leafs, regardless of their condition. By paying only “melt,” wholesalers can profitably resell the coins for industrial or jewelry purposes if no buyers are found for the coins.
Gold Maple Leafs, like the Gold Eagles and the Krugerrands, are bullion coins, which trade for the value of their gold content, plus small premiums. Damaged Gold Maple Leafs do not mean a loss of gold; they contain an ounce of gold regardless of the scratching or rim nicks. Still, buyers do not like to receive damaged coins. This means that Gold Maple Leafs sold into the secondary market have to be evaluated for the degree of damage.
With the new packaging, each 1-oz Gold Maple Leaf will be encapsulated in plastic and suspended in the middle of a plastic card, somewhat as 1-oz gold bars are packaged. However, the plastic protecting the Gold Maple Leafs will be heavier and more durable than the plastic used with 1-oz gold bars. The new packaging should keep the coins from being easily damaged.
With the new packaging, the Royal Canadian Mint made another big change: 1-oz Gold Maple Leafs will now come 25 to a box, whereas the old packaging is ten to a tube. This change could further increase sales as 20 coins are common ordering units for gold bullion coins, because the world’s most popular gold bullion coins-American Gold Eagles-come 20 to a tube. As a result of the change, investors wanting “complete original packaging” will move up to 25 ounces.
However, orders for small quantities mean the coins will have to be removed from their mint boxes-but still individually encapsulated-and put in other containers. The new packaging also will require more storage space for Gold Maple Leafs than for 1-oz gold coins that come in tubes.
Although 1-oz Gold Maple Leafs will be a little more cumbersome to handle, a large segment of the gold coin bullion market prefers pure gold coins. Gold Maple Leafs have long been the most popular 1-oz pure (.9999 fine or 24-karat) gold bullion coins on the market, and the new packaging should keep Gold Maple Leafs as the preferred 24-karat gold bullion coins. No date has been set for the new Gold Maple Leaf packaging to go into use.
New packaging for 1-oz Silver Maple Leafs has already been introduced. However, Silver Maple Leafs in their old packaging are still available. Since Silver Maple Leafs were introduced in 1988, they have been packaged twenty coins to a sheet, 200 coins in a box. Each coin was individually enclosed in plastic. The new packaging will be similar to the U.S. Mint’s Silver Eagles packaging.
Silver Maple Leafs will now come 20 to a tube, 25 tubes to a container, and 500 coins to a “mint box.” The new box will be made of durable heavy plastic, whereas the boxes of 200 are cardboard. The new packaging should make Silver Maple Leafs more competitive with American Silver Eagles, presently the most popular 1-oz modern silver bullion coins being sold.
Perth Mint Releases 2006 Year of the Dog
Although the Year of the Dog does not begin until January 29, 2006 (It ends February 17, 2007.), The Perth Mint has released the 2006 Year of the Dog. It is the 11th gold coin in The Perth Mint’s 12-coin Lunar Series and is now immediately available for delivery. Despite this not being a “hot coin market,” collector acceptance of the coin has been good, which validates CMIGS’ assertion that the Lunar Series 1-oz gold coins are set to become the most sought after collector coins released in decades.
The Perth Mint Lunar Series gold coins come in eight sizes: 1-kilo, 10-oz, 2-oz, 1-oz, 1/2-oz, 1/4-oz, 1/10-oz, and 1/20-oz, with monetary denominations of $3000, $1000, $200, $100, $50, $25, $15, and $5 respectively. An image of Her Majesty Queen Elizabeth II graces the obverse; the reverse carries the image of a beagle. The 1-oz ounce ($100) is by far the most popular of the Lunar Series gold coins and is the only Lunar Series coin that CMIGS recommends for investment purposes.
The silver coins in the Lunar Series come in seven sizes: 1-kilo, 1/2-kilo, 10-oz, 5-oz, 2-oz, 1-oz, and 1/20-oz, with monetary denominations of $30, $15, $10, $8, $2, $1, and 50 cents respectively. As with the gold coins in the Series, the obverse of the silver coins bears a likeness of Her Majesty Queen Elizabeth II. However, the reverse of the silver coins carries the image of a German shepherd. CMIGS does not recommend the silver coins of the Lunar Series because they are priced as collectibles, which means big premiums.
The one-ounce gold coins in the Lunar Series have become immensely popular with coin collectors worldwide for several reasons. Although the theme is not unique, other mints having done lunar series during earlier lunar cycles, timing seems to be perfect for The Perth Mint Lunar Series because China will host the Summer Olympics in 2008, one year after the Series ends with the Year of the Pig. Interest in China-and anything related to China–-is increasing.
Further, production of the 1-oz coins is limited to 30,000-a number that has turned out to be ideal for a collectors’ series. The 2000 Year of the Dragon reached the production cap of 30,000 and sells at a big premium in the secondary market.
The 2002 Year of the Horse 1-oz gold coin also hit the production cap and is no longer available from The Perth Mint. In late September, prices of 1-oz Gold Horses took a big jump as steady buying diminished wholesalers’ Gold Horse inventories toward zero. When the wholesalers sell out, the Horses are likely to pick up still bigger premiums. The 2001 Year of the Snake will probably be the next 1-oz gold coin in the Series to hit the production cap.
But perhaps the primary reason for the popularity of the Lunar Series is the exquisite quality of the coins. The Perth Mint holds an uncompromising commitment to quality, and no other mint turns out more beautiful coins. The Perth Mint was established in 1899, operated as a branch of Britain’s Royal Mint until 1970, and now is owned by the government of Western Australia.
None of the silver coins in the Lunar Series have reached their production limits, probably because the silver coins are priced for the collector market. The gold coins in the Series, on the other hand, are priced at about the same prices as popular bullion coins, such as the American Gold Eagles and the Gold Maple Leafs. This means that by going with Lunar Series gold coins bullion investors can own collectible gold coins without paying huge collector premiums.
Although collectors will want to add Year 2006 Gold Dogs to their collections, gold bullion coin investors should continue to buy Year 2001 Gold Snakes, which are available at the same price as new Gold Eagles and seems likely to be the next coin in the Lunar Series to reach the production cap of 30,000.
Dr. Murenbeeld’s Gold Price Forecast for the Coming Year
by Paul Van Eeden
I got to hear Dr. Martin Murenbeeld at the Denver Gold Forum earlier this month, and, as I said last year after attending his talk, he is hands down the best gold analyst I have ever come across.
At last year’s Denver Gold Forum, Dr. Murenbeeld forecasted three possible gold prices: a low price, a most likely price and a high price. He assigned a probability to each and then calculated the weighted average gold price as his forecast for the average gold price in the year ahead. His probability weighted average gold price forecast last year was $431 an ounce.
Dr. Murenbeeld always starts his presentations by reviewing his previous forecast to see if reality had the good manners to obey him, so it was impressive to see that from the date of last year’s conference to this year’s conference the average gold price was exactly $431 an ounce.
I’m going to skip to the end of his presentation and tell you that his probability weighted average gold price forecast for the next twelve months are $502 an ounce. Now, before you dismiss this number as too low, here is what it means.
Dr. Murenbeeld always includes three possible prices with the minimum probability assigned to any price being 10%. For the next year, an average gold price of $381 an ounce was assigned a 10% probability, $470 an ounce was assigned a 47% probability, and an average gold price of $565 an ounce was assigned a 43% probability.
Assigning such a low probability to a decline in the gold price and such a high probability to a substantially higher gold price is a very bullish forecast indeed. Keep in mind that this forecast is for the average gold price over the next twelve months, so by this time next year the gold price could be substantially higher than $502 an ounce and Dr. Murenbeeld’s prediction could still be spot on.
Why is Murenbeeld so bullish?
Devaluation of the US dollar
Trade data suggests that the US dollar is overvalued and uncompetitive. It shows that international trade is out of equilibrium — the result of a distortion of the dollar’s exchange rate. Since markets always try to reach equilibrium, there is pressure on the dollar to decline.
The US trade deficit with China is growing particularly ugly; it is now over $180 billion annually. In 1993 China devalued its currency relative to the dollar by about 34%. Dr. Murenbeeld argues that the renminbi now has to appreciate by at least that much against the dollar. Given that anti-China sentiment is growing in Washington with talk of protectionist duties on Chinese imports, there is no doubt the dollar will fall against the renminbi.
The US also runs a record trade deficit with Europe, to the tune of $120 billion annually. I am no fan of the euro — it is the ultimate fiat currency — but the trade data clearly shows that the US dollar is overvalued even against the euro.
It follows from the large trade deficits that the US should also have a current account deficit. At the moment the current account deficit is a whopping 6% of GDP and a nominal $800 billion. This implies that nearly $4 billion is pushed onto foreign exchange markets each day. Will the world continue to absorb increasing amounts of US dollars? Dr. Murenbeeld thinks not.
To date more than 50% of the capital flows required to finance the current account deficit come from (mostly Asian) central banks that buy dollars in foreign exchange markets to prevent the dollar from falling, thereby keeping their own currencies and economies competitive in the US consumer market.
As interest rates have risen, private capital flows into the US have picked up, and these are particularly important in financing the creative real estate mortgage market in the US.
In 1987 the US current account deficit reached almost 3.5% of GDP and caused the dollar to fall by more than 40%. If history is a guide, the dollar could easily fall another 15% to 25% according to Dr. Murenbeeld. I think he’s optimistic, and that the dollar could actually fall much more.
US monetary inflation
It is well understood that a decline in the US dollar will lead to higher US dollar-gold prices. But we also have to consider US monetary inflation.
The US budget deteriorated from a surplus of $255 billion in 2000 to a deficit of $430 billion last year. Larger tax receipts subsequently reduced the deficit, but Katrina et al. will most likely absorb any increase in Treasury revenues and push the deficit further into negative territory.
But that is only part of the story. Total US debt (government debt, corporate debt and household debt) is now in excess of 200% of GDP. Last time the US had this much debt relative to GDP was during the Great Depression and the result was a sharp contraction of debt.
During past economic cycles both higher oil prices and rising short-term interest rates (relative to long-term rates) played critical roles in pushing the US economy into recession. Both these factors are now present while household debt is at record levels, the debt service burden is at a record high level and the US savings rate is negative.
Demographics now come into play as the first major wave of baby-boomer retirements is coming up. Dr. Murenbeeld estimates that the US government’s net financial liabilities (gross liabilities less assets) could double in the next 25 years, and that is assuming the budget deficit comes under control.
What is the government likely to do? It has, essentially, four choices: renege on promises, cut services, raise taxes and create more money. The first three options shift the financial burden to households and that means less consumption and slower economic growth. The last option (creating more money) reduces the real value of debt. Last year Alan Greenspan suggested that the pressure of rising budget deficits could force the central bank to create more money.
Creating more money increases prices, including the price of gold. Dr. Murenbeeld has a chart showing the correlation between the gold price and money supply of the G-7 nations. There is no question in my mind that the gold price in any currency is primarily a function of the differential inflation rate of that currency versus the inflation rate of gold.
Increased gold holdings as foreign exchange reserves
According to Dr. Murenbeeld’s figures, Asian foreign exchange reserves now exceed $2.2 trillion. In total these countries have 1,932 tonnes of gold, representing only about 1.68% of their foreign exchange reserves at a gold price of $450 an ounce. The Asian central banks have not publicly shown any willingness to add to their gold reserves yet.
Should they decide to diversify into gold the impact would be staggering. If only China and Japan adopted the same 15% of reserve policy of the European Union, then they would need to buy 17,000 tonnes between the two of them. That is more gold than the Bank for International Settlements, the IMF and all the signatories to the Washington agreement own in aggregate, and it would still amount to only petty cash for Japan and China.
Turning to OPEC nations: In 1970 it took 30 barrels of oil to buy an ounce of gold, and we know that gold was undervalued in 1970. Today it takes less than 8 barrels of oil to buy an ounce of gold. OPEC countries have not publicized any desire for gold, but when OPEC foreign reserves increased from 1973 to 1981 they added 270 tonnes of gold to their reserves. If OPEC were to bring their gold reserves up to 15% of their foreign exchange reserves they would need to buy more than 1,500 tonnes of gold and, again, it would be pocket change for them.
Gold is not only inexpensive relative to oil. When the gold price is compared to the S&P500 we see that there were three stock market bubbles during the past 100 years. In all three cases the S&P500 rose dramatically relative to gold and in all cases the ratio collapsed back to unity again. It is impossible to predict at what gold price, or what level for the S&P, the two will be at unity, but history does suggest they could again reach unity.
If the S&P were to stay where it is then the gold price would have to rise to $6,000 an ounce. That is not very likely, since the same conditions that would cause the gold price to rise would probably bring stock prices down, so you can pick your own favorite number between $500 an ounce and $6,000 an ounce.
Paul van Eeden works primarily to find investments for his own portfolio and shares his investment ideas with subscribers to his weekly investment newsletter.
Recommendations
As has been our position for years, we recommend that precious metals buyers who are in the market for investment purposes go with as much silver as possible because historically silver has always outperformed gold in precious metals bull markets. In this bull market, we expect silver to show a still bigger percentage gain than gold because of the growing industrial demand for silver.
Silver
Presently, circulated 90% silver coins carry premiums of about $0.15/oz. Circulated 90% coins often pick up high premiums in precious metals bull markets and during periods of heavy buying, even without a bull market. In 1999, during the Y2K buying frenzy, circulated bags sold at 50% premiums over the value of their silver content.
For investors wanting a pure silver play and wanting silver in a convenient form, 100-oz bars are recommended. As this is written, 100-oz silver bars are selling for $.40/oz over spot. In a market in which the public is buying heavily, 100-oz bars sell for $.60/oz premiums.
Investors wanting pure silver and “survival coins” should go with 1-oz silver rounds. Engelhard Prospectors and Sunshine Minting Eagles are selling at $.80 over spot. Generic 1-oz silver rounds are selling at $.60 over.
Gold
Investors who want “cheap gold” should go with Krugerrands, which are selling at $10-$12 below Gold Eagles. Despite Gold Eagles selling at high prices than Krugerrands, Gold Eagles remain the world’s best-selling gold bullion coins.
Investors who are inclined to buy Gold Eagles should consider 1-oz Gold Snakes, which are minted by Australia’s renowned Perth Mint. Gold Snakes sell at the same price as Gold Eagles, but Gold Eagles are unlimited production coins, while production of 1-oz Gold Snakes will be limited to 30,000 coins. As are Gold Eagles, Gold Snakes are legal tender coins.
Gold Snakes are part of a 12-coin series based on the Chinese Lunar Calendar. Two coins from the Series, the 2000 Dragon and the 2002 Horse, have already reached the production cap of 30,000 and are selling at big premiums in the secondary market (See article on Lunar Coins in this issue.) Still more information on the Gold Snakes and the Lunar Series can be found on our website www.cmigs.com.
Platinum
CMI continues to believe that platinum is too high compared with gold and silver and should be avoided at this time.
Palladium
In early 2001, palladium traded above $1,000, and that makes $225 palladium look cheap. Maybe palladium is cheap here, and if clients want to buy palladium we will not try to talk them out of it. However, investors need keep in mind that in July palladium traded at $175. We like palladium better as an investment when it is trading in the $175-$185 area.
Still, gold and silver remain CMIGS’ favorite precious metals investments because they are monetary metals.