Gold Begins to Shine Again

Dr David Evans

Gold Symposium, Sydney

October 2012

Novel money system started in 1971 when Nixon “closed the gold window”, changing from gold base to paper base.

Historically, paper currencies usually die after 25 – 50 years.

It’s now 41 years since 1971.

Stagflation in 1970s, reset in 1980 by 20% interest rates.

Amount of money ≈ Debt (gov’t + private)

Size of economy ≈ GDP

This is the financial story of our times…

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1880 1900 1920 1940 1960 1980 2000

Total US Credit Market Debt ("Bank Money") as a % of GDP

Sources: Federal Reserve - Z1, US Census Bureau - Historical Statistics of the United States, Colonial Times to 1970. Data 1871 to end of Q1 2012. Data quality excellent from 1945.

1929 crash196%

1933 depression, 298% (debt down 20% but GDP down 46% from crash)

Base money: gold -> paper1971

Normally 130 - 170%

1987 crash230%

Q1 2009385%

Federal Reserve created1913

20% interest rates1980

Restart1982

Debt-to-GDP Ratio

World ran low on borrowing capacity: 1. Not enough income to service more debt

▪ Debt ≈ 400% of GDP

▪ Interest rate ≈ 4%

▪ Interest payments ≈ 16% of GDP

2. World running low on unencumbered collateral.

Money manufacture in the private sector

stalled in 2008 Global Financial Crisis.

2008 – 2011 Governments took up

slack of money manufacture in 2008:

Borrowing

Some printing (“quantitative easing”)

Lowered interest rates.

Now Most governments cannot

borrow much more. Realization: private sector

is debt-saturated, no return to pre-2008 “normal”.

Only option left for manufacturing money is… government “printing”.

? ?

1930’s, but worse – debt-to-GDP ratio much higher, global.

During the 25 years of bubble, extra money (= debt) increased GDP. Like a credit card spree!

To return the debt-to-GDP ratio to normal, maybe a 15 – 25% fall in GDP.

Double depression! Politically unacceptable!!

You spent it, now

you gotta pay!

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1880 1900 1920 1940 1960 1980 2000

Total US Credit Market Debt ("Bank Money") as a % of GDP

Debt-to-GDP Ratio

Normally 130 - 170%

Last year’s debt has to be repaid with interest, so every year the money supply must increase or there will be widespread business and bank failures (a la 1930).

World at a fork:

Print, inflate

Don’t print, deflate

or

Basic democratic calculus: Lenders: Few Borrowers: Many (vote, might riot). Powerful business interests: Need to repay their debts.

The Keynesian fog will be used to excuse this choice, to “reduce the people’s debt burden”.

Greece, June 2012 Spain, Sep 2012 Portugal, Oct 2012

Political system won’t allow failures of big banks and corporations. TBTF. (2008)

Bernanke won’t allow 1930’s deflation.

Establishment economists already suggesting running mild inflation (6%) for a few years.

Governments everywhere spending more than tax receipts.

Rogoff (D) Mankiw (R)

Bernanke Quantitative easing

IMF concluded that austerity does not work. Had previously encouraged austerity in Europe. (Oct. 2012)

European integrationists winning in struggle with Germany’s central bank over printing: Draghi promises “whatever it takes” and announces “Outright Monetary Transactions” (July, Sept 2012)

Draghi (ECB Head) Outright Monetary Transactions

Krugman (leading Keynesian) Crows “times like this are different”

Without political interference, the current debt bubble would collapse in a massive deflation (like the 1930s).

Governments and banks will interfere to prevent this, by manufacturing more money. Increasingly, they are deliberately causing inflation to reduce the real value of debt.

Investors mainly fearful of deflation inflation plays are cheap now.

Money is a promise – of similar purchasing power in the future.

Work is motivated by those promises.

Too much money = Too many promises Promises cannot be kept: not all debts

can be repaid in dollars near current value.

Political system, not usual economic rules, will determine the

losers. Major political issue: How fast to break the promises?

1 - 2 years: deflationary, austerity, better long term

1 -2 decades: inflationary, printing, nicer short term.

(and Silver)

Gold is a currency.

It is the main non-government currency, evolved in the marketplace over 5,000 years.

Gold was the world’s base currency until 1971.

Gold is still a reliable store of purchasing power.

Gold is a superior form of cash

that debases much more slowly than paper currency.

Gold is not used in jewelry because it is shiny and yellow – there are lots of cheaper alternatives. Jewelry is made of gold because gold

is valuable. Gold is valuable because it is money.

Gold is not a commodity, like wheat or iron, because it does not get used up.

Gold is not a productive investment, something that produces goods and services (like farms or factories), because it is just a medium of exchange (like cash).

No one can print it. No one can make more without great effort.

You have to earn it before you can spend it. You either have it or you don’t.

We wouldn’t be in the current debt mess if our money system was still based on gold!

vs

The long-term value of currencies is mainly determined by the relative rate of manufacture (debasement):

Aboveground gold: 1.7% pa

Paper currencies: 5% - 25% pa since 1982

~15% p.a.

1.7% p.a.

The reasons for gold to go up are intensifying, not going away.

Big picture: Gold goes up forever against paper currencies, at a rate roughly equal to the difference in their rates of debasement (on average).

$1 million per ounce is only a matter of time.

Gold price fell for 20 years to 2001 some catch up in store.

Graph from Nick Laird at Sharelynx.com

That’s an amazingly straight line for any market!

Gold rose 20-fold 1968 – 1980, at 20% p.a.

20% interest rates in 1980 stopped money manufacture and inflation of the 1970’s.

Paul Volcker Fed Chairman 1979

Volcker's Fed elicited the strongest political attacks and most widespread protests in the history of the Federal Reserve (Wikipedia).

Gold is a currency. Most of the time, gold is a weak investment.

Gold becomes a good investment only when

the other currencies are failing, inflating, profligate, debasing, corrupt, ….

Timing is everything

Assumes central banks stay in control. This is their best case.

Main risks:

1. Deflation

2. Hyperinflation

3. Banking crisis

4. Physical gold market blows up

5. Major war.

Increasingly narrow path between the disasters of deflation and hyperinflation

Debt strangles the world economy. Moribund industries and zombie banks, mired in debt.

Society’s “pie” growing slower now, some groups lose social tensions

Governments keep real interest rates low.

High but tolerable inflation, a more intense version of the 1970s.

Reversion to the mean debt level 350% of GDP 150%

Reduction to 42% of current value

How much inflation is required? Start 2014.

12% inflation (modern CPI : 5-8%).

Interest rates of 6%

(so real interest rate is negative 6%)

14 years reduces original debts to 42% of original real value 2028

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1880 1900 1920 1940 1960 1980 2000 2020

Total US Credit Market Debt ("Bank Money") as a % of GDP

Debt-to-GDP Ratio

Normally 130 - 170%

The Age of Deleveraging, 2009 - 2028 ?

Sign that inflation will end? Governments must halt the money

manufacture:

Raise interest rates sharply, to 15 - 20%.

Cut spending severely, run surpluses.

Gold price will rise until interest rates rise rapidly to 15-20%, maybe around 2028.

Rate of gold price rise might be: 11%+ pa — difference in debasement rates

5% pa — uncertainty over future of paper money

5%- pa — catch up for 20 years of falling gold prices

Total: 21% pa

Last 11 years: 21% pa

1970’s: 20% pa

Nominal prices in USD per ounce:

1980: $ 850 $3,300 in today’s money

2001: $ 260 Start growth of 21% p.a.

2012: $ 1,900

2015: $ 3,500

2020: $ 10,000 $4,600 in today’s money

2028: $ 50,000 $8,400 in today’s money

Gold price suffered in the banking crisis of 2008 because it was a tier 3 asset in the Basel formula.

Gold only counted 50% towards their capital adequacy, so banks sold it to raise cash.

Upcoming rule changes will likely see gold soon become a tier 1 asset, counting 100%.

Many believe that the western central banks have been putting downward pressure on the gold price since 1995, to: 1. Reduce the perception of inflation.

2. Reduce competition for their paper money.

However, in a future with substantial money printing, central banks might encourage the gold price to rise.

By selling their gold to the public, they soak up some of the newly printed money, reducing actual inflation. seekingalpha.com

Investment success: 60%: right sector at the right time

40%: choices within sector.

Main gold investments: Gold bullion in your possession

Gold bullion held by others ▪ Perth Mint, Guardian Vaults, etc.

▪ ETFs

▪ Not banks (paper money competes with gold)

Gold mining and exploration companies

Gold futures and options.

Risk and Leverage

Security:

Secure, convenient ownership of companies via CHESS share system (ASX only).

Companies own mining rights to gold in the ground.

Leverage:

Gold in the ground typically $20 - $200 per ounce.

Can buy more ounces more profit as gold price rises.

Drawbacks:

Company risks

Mining risks

Country risks

Mining stocks do not necessarily track the gold price.

Ratio of gold stock prices to gold price is at a 30 year low:

Why? Most investors afraid of 1930’s deflation, not inflation.

“Gold in a bubble” story widely believed.

Started GoldNerds, to choose gold stocks.

Compare all companies in sector, peer pricing.

No recommendations.

GoldNerds has the information required to make informed decisions.

www.goldnerds.com

GoldNerds sells sophisticated spreadsheets for investors, comparing all 250 ASX gold stocks.

Microsoft Excel spreadsheets (Windows only).

Subscription New spreadsheet every two

weeks.

Company EV per Resource oz $/oz

Future Cash Cost $/oz

Ongoing Capex $/oz

TCO Plus $/oz

Price Change from 1 Jul 2012 %

Tribune Resources -126 635 272 752 13

Newcrest Mining 160 585 204 1,018 25

Regis Resources 313 544 68 1,047 38

St Barbara 75 850 283 1,253 34

Silver Lake Resources 187 684 399 1,328 38

Northern Star Resources 337 650 308 1,484 65

Apex Minerals 14 1,390 190 1,602 -31

Focus Minerals 47 1,238 380 1,690 -5

Ramelius Resources 42 887 833 1,781 -17

Saracen Minerals 68 1,105 640 1,842 -8

Navigator Resources 28 1,718 546 2,306 -80

Price dropped compared to peers for no apparent reason in April 2011. Later confirmed as a fund selling out. Recovered by Aug 2011.

Took over Allied Gold late June. Price dropped 40%. Cost of gold in the ground very low compared to peers, overdone?

Ever noticed that there are a lot more regulations around than there were, say, 20 years ago?

So someone is doing more regulating.

Government is gradually getting bigger, it is making more decisions for us, and we have less freedom.

The biggest political issue of our age.

Echoes of the old communism vs capitalism fight, morphing into big bureaucracy vs the marketplace.

This is having a major effect on the investment landscape.

vs

Prefer big government. University-educated. Prefer government

(politics and coercion) to the marketplace (voluntary transactions).

Prefer to pay themselves

what they think they are worth, out of tax revenues.

The rest of us are under the discipline of the marketplace.

Dislike capitalism.

Wordsmiths. An intellectual upper class of word users, who regulate and pontificate rather than produce real stuff.

Arguably a class of parasites enriching themselves at the expense of producers.

Core belief: they are superior to the rest of us Smarter More moral (e.g. less racist). Justifies less democracy, more decisions by them.

Bigger government more business and social welfare more dependency on government.

In Europe, a bureaucratic super-state is replacing national democratic governments: Most government decisions made in

Brussels bureaucracy. Lisbon treaty: referendums overridden. Greece and Italy ruled by appointees.

MSM sympathetic: Most journalists identify with the

regulating class. Regulating class threatens media with

more regulation.

Keynes was a socialist in the 1930s whose economic theories were used to justify Artificially low interest rates Large-scale government

intervention in the economy Distribution of newly-printed

money by government.

Keynes’ ideas were considered crackpot before the 1930s: Problem of high debt/money levels solved by more of same?? Counterfeiting by government is the solution?? Really? Distorts economy with appearance, but not reality, of cheap capital. Transfers value from savers to recipients of government largesse.

Keynesianism is poor in the long run.

Why is this theory so important to the regulating class? 1. To regulate CO2

emissions is to control energy use throughout the economy.

2. To regulate CO2 worldwide requires being able to regulate every economy.

Axel Rouvin

All the world’s leaders met, to sign the Copenhagen Treaty.

China refused, citing uncertainties in the science.

On the Internet. 181 pages of dense

bureaucratic language.

A UN bureaucracy would regulate CO2 worldwide.

Over-ride national government as required.

It could tax and fine any signatory government.

No democracy or elections.

Power would be parlayed up into strong global bureaucracy affecting more than emissions.

Media almost entirely silent about the treaty and loss of national sovereignty.

Narrowly-averted silent coup by the regulating class.

Climate “science” is clearly flawed, just an excuse.

Macroeconomics and Climate Science: Governments (and their allies the

banks) Fund university departments.

Are the main employer and ultimate provider of lucrative consulting jobs.

Only hire like minded people.

Cannot get a PhD without believing

and being trained in the theory. All certified “experts” believe in the

theory.

"We are all Keynesians now“, R. Nixon 1971

Skep

ticalScien

ce.com

Artificially low and near-zero interest rates will hurt savers and retirees for years.

Excuse to promote their agenda: More bureaucrats running more of the

economy Higher taxation Less democracy, increasingly global

bureaucracy. Lower growth, lower investment returns

Ultimate Keynesian solution to any

crisis: PRINT.

If you oppose the regulating class, you get called:

“extremist”

“nut”

“conspiracy theorist”

every version of “stupid” and “ignorant”

The names mean nothing, except they want to shut you up.

If they’re not calling you names, you’re not over the target.

Scares most people into submission.

Name-calling only works because the media is on their side, framing the public discussion.

They don’t debate, just

denigrate their opponents.

They always get last word.

Western public was 20% climate-skeptical in 2008, now 50%.

Internet trumps the mainstream media – it just takes a while.

Suppressed data (not shown by MSM) gets through.

Precedent: Printing press broke church’s monopoly on “truth”.

The regulating class don’t like: The private sector People who make real stuff Capitalism.

Bleak mainstream investing

outlook. Bet against government Buy gold!

Freedom from the demands of a new hostile ruling class.

Chairman of the UN’s IPCC, Rajendra Pachauri

Head of the IMF, Christine Lagarde

The President of the European Council, Herman Van Rompuy