Gold Is Going and Going Is Good by Navin Doshi (March, 2007)

“To prefer paper (money) to gold is to prefer high risk to lower risk, instability to stability, inflation to steady long term values, a system of low grade performance to a system of higher, though not perfect, grade performance.” – William Rees-Mogg, Former Editor, columnist, Times of London.

The advent of the 21st century brought with it an increase in the price of the metal that alchemists strove hard to produce. Gold. The obvious question that now arises from this interesting trend is, why has the price been rising? The answer is that even currencies like the dollar have to follow the supreme law of demand and supply, meaning that there is a lot more supply of dollars than gold. Furthermore, there are reasons to believe that the price increase has not reached its zenith. Is it obvious that gold is going higher? Or is it obviously wrong as it happened in the 1980’s when gold entered a 20 year bear market after it peaked over $800/oz? It is definitely not like the 1980s when the dollar was defended by raising interest rate to the stratosphere, squeezing liquidity out of the system. Today, most major countries are inflating their currencies to keep their export in tack.

I wrote an article in this newspaper first in 2002 projecting that both gold and silver will trade at much higher price when gold was trading at around $300/oz and silver was around $4.5/oz. in the December of 2003 when gold was around $400/oz, I had projected the price would go even higher. Subsequently the gold has traded over $700/oz and silver went over $15/oz and currently they are around $640/oz and $13/oz respectively. In spite of the current market gyrations, gold could go over $800/oz or even $1000/oz and silver could go to $20/oz in a period of 12 to 18 months.

In Roy Jastram’s book, “The Golden Constant”, he has stated that when anthropologists study different ancient cultures, they have observed that gold has always been a constant for the appreciation of beauty, the storage of riches, or the exchange of goods and services. Gold can never be cast away. It can be melted, however, its chemistry and weight would never change in the process.

When there is a fear of inflation or catastrophe, people generally flock to precious metals. This is because the idea is that hard assets are safer when paper money is losing its value. Historically, when hard assets are appreciating, financial assets are depreciating.

Throughout history, whether it was Lenin, Hitter, Mao, Mussolini or FDR, all these leaders banned the ownership of gold. Why? If you control gold, you can control the country’s money. Lenin had said, that the best way to destroy a capitalist system was to debauch the currency and with inflation, governments could confiscate-secretly and unobserved- the property and wealth of the citizens. Removing the gold standard of an economy is one of the major steps in that scenario.

It is believed that in a chaotic environment, which involves war or stagflation, people buy gold since it is considered a safer store of value. There is also a fear that America may open another war front by striking Iran’s nuclear facilities. Gold is the ultimate reserve of value since nature controls its supply. Gold’s purchasing power is almost the same as it was in the middle of the 17th century. Gold is unique because it is a credit risk free asset; the demand for gold rises in times of fear. However fear is not the only reason why prices go up.

Another reason is basically reverting to the classic rule of economics- the demand-supply equation.  One corollary of the law of demand and supply is that money flows where there is a perception of a higher return with acceptable risk. When the price of gold descended from a high $800 to a low of $270 in the late 1990’s, top mining companies backed off new developments. This action contributed to a current supply crunch of gold and a current market perception that gold will always be supplemented for by new banks or central bank sales.  To see the price of gold going higher, mining companies are increasing their exposure to gold, because they have determined, based on their research that gold is now in a bullish trend.

With companies like Castro and Wal-Mart, which are basically distribution portals for manufactured goods from China, the US economy has become more and more service oriented rather than production oriented. We may be building a huge “black-hole” if we ever have to face the reality of what’s going on. The middle class will continue to shrink as manufacturing jobs disappear from the US. The paper currency will continue to expand. It is therefore a no brainier, as Richard Russell would say, to invest in gold today just based upon the law of supply and demand. I had an opportunity to speak to Raghuram Rajan, IMF economist when he was speaking at Milken Institute. My question to him was if America would ever go back to the gold standard. His reply was an emphatic “NO”. He explained in essence that the Government of any country would not let go the elastic nature of the currency that helps them to keep high employment and reasonable economic growth.

In the past, banks would let you borrow gold, but that tendency is slowly going down. The banks are less inclined to sell if they believe the prices are going up and when they see that the miners are not hedging. Today, in fact, bankers of countries like China are replacing dollar reserve in part by gold against dollar downfall.

In summation, it definitely appears that an investor should consider diversifying their portfolio by investing in gold. But the straw hat in winter not in summer! As a true contrarian I believe that the bullish trend of gold will end when you start seeing headlines in popular magazines and newspapers expressing the bullishness in gold.  Before the gold rally is over, we will hear Kramer of CNBC yelling to buy gold and gold stocks.

“US government has a technology, called printing press that allows it to produce as many dollars as it wishes at essentially no cost. Under a paper money system, a determined government can always generate higher spending and hence positive inflation,” – Fed Chairman, Ben Bernanke.

Navin Doshi (March, 2007)
(Mr. Doshi is a financial market trader, writer and a philanthropist)

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