GARY NORTH ON GOLD AND WHERE IT'S GOING

Gary North's REALITY CHECK Gold's price: http://www.GaryNorth.com/snip/300.htm The Federal debt: http://www.GaryNorth.com/snip/544.htm To subscribe to this letter: http://www.snipurl.com/subscribenow Issue 799 October 21, 2008 GOLD IN 2009: UP, DOWN, OR SIDEWAYS? For the overwhelming majority of people in the world, this question is irrelevant. Except for India, in which gold jewelry is given by parents to daughters at the time of their marriage, almost no one owns gold. In the United States, the percentage of Americans who own half a dozen gold coins is probably under two percent. The United States has approximately 100 million households. I doubt that two million households own over half a dozen gold coins. The reason why I say this with confidence is simple: there are very few stores in the United States that actively sell bullion gold coins. We are talking a few dozen that have over 1,000 clients. Two million households have not ordered coins from them. Whatever the number, it is so small as to be irrelevant politically. The number of people who are committed to gold philosophically as a way to hedge against the expansion of the Federal government is so small as to count for no votes at all in Congress. There are professional commodity traders who may be long gold, but they are as happy about being short gold when the price of gold is falling. They are not committed to gold as anything more than as a means of increasing the number of dollars that they own. GOLD'S ROLE IN YOUR NET WORTH Before considering the question of which way the price of gold is headed, you would be wise to consider carefully just how important gold is in your economic future. Here is a way to estimate the importance of gold in your plans. First, what is the monetary value of the gold that you presently own or are considering purchasing? Second what is your annual income? Third, do you expect the consumer price level to double over the next 12 months? If it doubles over the next 12 months, this would mean an increase in prices of about 7% to 8%. That would be a substantial increase in the rate of price inflation. It would affect your family's budget considerably. Fourth, if the price of gold doubles in the next 12 months, would your holdings of gold offset, after taxes and commissions, the decline of purchasing power in your overall budget? Put another way, would your profits in gold in dollars (on paper), denominated in United States dollars, offset the loss that your family would suffer from an increase of the price level by 7% or 8%? Fifth, if gold's price were to double every year, at some point the increase in the price of gold would offset the losses you sustain through price inflation. But gold is not going to double every year, year in and year out, unless the price level itself is rising by much more than 7% to 8% per annum. By looking very carefully at your budget, and by comparing the effect of price inflation on your real income after taxes and inflation, you will probably discover that gold's price has only marginal impact on your net worth. It could double in price, or it could fall in price by 50%, but the impact on your net worth, let alone your lifestyle, would be marginal. Unless you have a net worth of half a million dollars or more, with 20% to 50% of your net worth is in gold, a change in the price of gold is not going to have a significant impact on your net worth or lifestyle. Nevertheless, people who have bought gold are almost obsessive about the price of gold. If they ever sat down and went through the exercise that I have just recommended, they would discover that the increase or decrease in the price of gold has very little effect on their immediate prospects. Long-term, owning gold is important. But then the short- term price moves are marginal. Yet a lot of gold owners are obsessive about a $100 move, especially if they bought at the peak. This is not true of old-timers who own gold coins. They do not sell when gold falls. This is one reason why gold and silver coins command a premium over the bullion price. Why is this the case? Why do people get obsessive about the price of gold? GOLD AND ECONOMIC FREEDOM I think it is because they have a vague understanding of the loss of freedom in their lives, but they do not really believe we are headed for a world in which millions of Americans will suffer major losses of freedom and wealth. They think it will get worse, but they don't really think it will be a disaster. So, they are concerned about the price of gold as a confirmation of their belief that freedom is declining. But they are not ready to make the changes in their lives -- job, geography, income, lifestyle -- that they ought to be making if freedom really is in long-term decline. They want a simple personal fix for what is a long-term, complex problem. The kinds of people who buy gold coins are people who recognize that our freedom is declining, and declining rapidly, in the United States. It is also declining all over Europe. They buy gold coins almost as a philosophical statement against this loss of freedom around them. They purchase gold almost as a right of passage out of conventional society. They are declaring to themselves that they are concerned about the decline of freedom. Gold is therefore a legitimate purchase. We need affirmations in our lives that remind us that we are facing a crisis in Western civilization. But we should not be naive about the nature of this ritual purchase of gold. These people are different from those who buy gold mining shares. Mining share buyers are speculators who want to win big, but who are willing to lose big if gold falls (as it has). If you had your choice of cutting the Federal deficit by 50% next year or seeing the price of gold double, which would you choose? If, year after year, the spending of the Federal government would decline by 10%, would you regard this as a benefit to you personally greater than an increase of the price of gold by 20%? I think most people who buy gold coins would prefer to see the shrinking of the Federal government rather than an increase in the price of gold. What they are most concerned about is their loss of freedom. If, as a nation, we could regain the economic freedom that has been confiscated from us by politicians and bureaucrats over the last 25 years, we would be far richer in the next 25 years then if the price of gold increased by 20% per annum. Maybe this is not true about somebody age 30 who owns $200,000 in gold in a portfolio worth (say) $300,000, but it is true for most people who have bought some gold coins as a way to hedge against inflation. Before you worry about whether the price of gold will double next year or fall by 50%, consider carefully the kind of economy that would cause gold to double. Is this the kind of economy you really want to live in? I think most readers would say no. They would rather have no gold and see freedom restored to the economy. Now, let us consider the question at hand: Is the price of gold as denominated in dollars likely to rise, fall, or stay approximately the same in 2009? RECESSION AND GOLD We are entering a recession. Some people, probably the majority, think this recession is going to be comparable to the recession of 2001. I think they are incorrect. Pessimists may think it will be as serious as the recession of 1991. Extreme pessimists think that it will be comparable to the recessions of 1981 and 1982. I am one of these. A tiny percentage of people think that the next recession will be comparable to the Great Depression of the 1930's. For a number of reasons, I do not think this is likely. It is much more likely to become mass inflation than mass depression. In a time of recession, people run out of money to meet their monthly expenses. They have to sell assets in order to pay their bills. Today, most Americans do not imagine that for the next three years, they will be in a recession. I think it is likely that this recession will last at least 18 months. It is possible that it could last longer. One of the economists I respect most believes that it will be comparable to the recession of 1873. If it is, this recession could last three years or longer. http://www.lewrockwell.com/rozeff/rozeff231.html In the midst of a declining economy, in which annual raises are rare and unemployment is rising, people will begin to save money. They will put their money in whatever is familiar and safe. For most people, this will be the local bank. It may be a money market fund. It will probably not be in gold. Gold is primarily an inflation hedge. It is also a monetary crisis hedge. But, in times of a tight economy, such as 1975 or 1981 and 82, the prices of the precious metals fall. This is because people cease to buy the precious metals because what they are after is liquidity. They want to have savings in an account where they can write a check to meet a monthly bill. They don't want to speculate with their money. They are too afraid of the economy to indulge in speculation. This is why the stock market falls. This is why the housing market will continue to fall. To imagine that gold and silver will somehow resist the effects of the recession is to imagine that other factors will intervene that will offset the normal effect of a recession on people's investment portfolios. In a recession, people want immediate access to their money. They are worried about what is going on around them, and they see money as a way of hedging themselves against unforeseen disasters, one of the major disasters but they worry about is getting fired. They worry about a loss of income. So, they tend to invest in very safe, very liquid, FDIC-protected bank accounts. I don't blame them. We are entering a major recession. It is likely to go on much longer than the traditional 11 months that have marked the recessions since World War II. During the final stage of this recession, people will begin to lose hope. They will give up on almost every investment that they own, other than a bank account. They will be hard-pressed to meet their monthly payments. People who own gold can hold out longer than people who don't, not because they own gold, but because they are generally thrifty people who hold other assets besides gold. They will cash in these other assets first, but if the recession extends a year longer than they think is likely six months from now, they will eventually be forced to raise capital in order to pay the bills. One way to raise capital is to sell gold. GOLD AS A HEDGE Gold has been an inflation hedge during those periods in which the inflation was not predicted by most investors. Gold was not an inflation hedge from 1980 until 2001. Gold fell from $850 an ounce to $256 an ounce in this 21-year period. Silver fell from $50 an ounce to $4 an ounce. Yet consumer prices doubled. It was better to own gold than silver during this period, but it was best not to own either in heavy percentages. It was better to own the stock market. It was better to own long-term bonds. This changed after 2001. Will we see an unexpected increase in the rate of price inflation over the next year? This depends on whether the Federal Reserve will continue to increase the monetary base at the extraordinarily high rate, or anything like the higher rate, that it has expanded over the last month. Take a look at this chart: http://GaryNorth.com/public/4121.cfm The rate of monetary inflation over the last six weeks has been over 130% per annum. I don't think this will continue. I think the reason why the Federal Reserve persuaded the Treasury to persuade Congress to bail out the banks was so that the Federal Reserve System would not have to buy the banks lousy assets with the newly inflated money. Because the Treasury Department is going to wind up bailing out the financial system, as well as the mortgage market, through Freddie Mac and Fannie Mae, the Federal Reserve can back off from the panic level expansion of the money supply which it has followed over the last six weeks. In the past, the Federal Reserve has not only ceased creating money in a time of a recession, it has actually contracted money at almost the same rate for approximately the same time period. It is not just a very typical spike. It is a vertical spike followed by a spike down, then up. If the Federal Reserve follows this traditional approach, and if it somehow is able to restore the rate of monetary expansion that prevailed from the month Bernanke took over as chairman (February 2006) through August 2008, then we will not see extensive price inflation over the next 12 months. We will see an accelerating recession instead. We are in uncharted waters. It is not clear to me whether the Federal Reserve will actually contract the monetary base over the next few months. This is what it should do, but it may choose not to. But it will choose to decrease the rate of monetary expansion that has prevailed over the last six weeks. Of this, I am confident. The reason why I am confident is simple: if the Federal Reserve System does not reverse this rate of inflation, the United States will move into mass inflation, with triple-digit increases in the price level. The Federal Reserve System is not going to take this chance. So, I am of the opinion that during the first six months of 2009, the rate of price inflation will not exceed the rate of price inflation which has prevailed over the last year. The effects of the recession will force down retail prices. This will lead to price discounting by retailers. What we have seen in the price of oil since July is representative of what happens during a recession. The price of oil is much more volatile to changes in demand, but the general direction of prices in a recession is comparable to what we have seen in the price of oil over the last few months: down. When consumers begin to save, and they cease to maintain their old spending habits, which depended heavily on borrowing based on the equity in their homes, we are going to see retailers in big trouble. When retailers get in big trouble, they cut costs, lower prices, and hunker down. This is what we will see over the next six months. This is why I think there is greater pressure downward on the price of gold at the present time than there is upward pressure on the price of gold, if all we are discussing is recession versus inflation. But there is more to it than this. In times of monetary turmoil, people buy gold because they do not trust any of the currencies. They do not trust the ability of large institutions to meet their obligations, as denominated in dollars, because of disruptions in the financial markets. Under such conditions, gold can move up very fast. We have seen this over the last two months. The possibility of increasing disruptions in the international financial markets is rising. President Bush would not have called a meeting, which is called a summit, to be held sometime after the elections on November 4, if there were not major stresses in the financial system. As these stresses become public, more investors will buy gold bullion through conventional markets. This may be short-term money, but I expect to see these kinds of increases over the next year. As we have also seen, after the crisis is dealt with officially by governments, and the panic subsides, the price of gold falls back to where it had been before the panic move. People buy when it moves up. They do not buy when it is lower. This is typical. It is difficult to buy gold and silver eagle coins today. The United States Mint has ceased producing many of these coins. There has been no explanation, but the easiest explanation is that the physical ability of the meant to stamp out enough coins, and replace the stamps as they wear out, has declined under what is now a kind of mini gold rush in the United States. People buy coins because they cannot afford to purchase huge bars of gold or large bars of silver. The little man participates primarily by purchasing coins. There is greater demand for coins than there is for bullion. Therefore, there is a delay in delivery of coins, and there is a substantial premium above the spot price of gold for the coins. This is because there are multiple markets for the purchase of precious metals. They vary in price considerably. Then there is the question of war. This is remote, but it is a reality. The possibility that the Israeli Air Force will strike the suspected nuclear facilities in Iran may be a low possibility, but it is a possibility. If this were to happen, I think is likely that Iran would sink one or more oil tankers in the Strait of Hormuz. If this were to happen, insurance rates would skyrocket overnight, and Persian Gulf states would have difficulty exporting all of their oil to the West. Oil could go over $300 a barrel very fast. If gold goes over $300 a barrel, I expect gold to go well over $1000 an ounce. WHICH PRESSURE IS STRONGER? I think the pressure on the down side from the recession is going to be greater over the next year than the pressure on the upside from monetary inflation, which leads to price inflation. The Federal Reserve certainly can prove me wrong on this point. This is why I recommend that people monitor weekly the statistics on the adjusted monetary base. The adjusted monetary base is the one monetary statistic that the Federal Reserve influences directly. It is the best indicator of existing Federal Reserve policy I recommend that you go to my website, www.garynorth.com, and go to the department called Federal Reserve Charts. http://www.garynorth.com/public/department29.cfm Here, you can monitor the adjusted monetary base. You can also monitor other important statistics. This is part of the free section of my website. The most important thing you can do to protect yourself against the recession is to increase the amount of time that you spend increasing the value of your services to your employer. This may have to be done on your own time. I talk about this on my site in the department called Fireproof Your Job. http://www.garynorth.com/members/department114.cfm My main point is this: what happens to your productivity during the coming recession is more important to you financially and psychologically than what happens to the price of gold. In the allocation of your money, you may choose to buy more gold coins to head yourself against long-term inflation by the Federal Reserve. But in terms of the value of your time, this is best spent on improving your productivity. Most people prefer to talk about an investment that will somehow save them, despite the economy's effects on their careers and their futures. Why? Because buying something is a lot easier than investing many hours extra a week in increasing your productivity in your job. So, people do what is convenient. They do not do what is rational. I am saying that what is most rational strategy is to pay greater attention to the perceived value of your services to your employer then it is to spend time reading about gold. But people prefer to read about gold if they have bought gold, so I have written this report. CONCLUSION My impression of the world economy over the next year is that the recession will be the dominant factor, not price inflation. Price inflation will eventually make itself felt in the economy, but what will really be felt over the next year is the contraction of the economy due to worldwide recession. People will be most afraid about their income and about the safety of their jobs than they will be afraid about an increase in the price level. This is why, in the long run, I believe that there will be significant increases in the price level. Governments will inflate. But, for the moment, people are more afraid about recession than they are about inflation. This is also true of central bankers. They are afraid of the collapse of the financial system. So, they are focused on the financial markets rather than the precious metals markets. What central bankers do is extremely important. Pay attention to what they are doing, not just what they are saying. I think it is wise to buy gold coins when you can get them. At present, they are difficult purchase. You should adopt a program of steadily buying gold coins, month by month, as part of your overall savings program. This is a safe way to buy gold. But, for most people, just being able to pay the monthly bills is going to be regarded as a blessing. Cutting your budget by 10% is more important than buying gold coins at the present time. Getting in control of your expenditures is crucial. Buying gold coins is a good idea, but it is not as crucial as getting control of your family budget. Assume that your income will drop over the next year. If you're in sales, you had better expect a drop of 25% or greater. Deal with this first. Then worry about gold.