Gold became underappreciated, undervalued, under-owned

For a number of years, this column has been predicting that the price of gold would move higher. It is time once again to review the reasons for continuing optimism about future, substantial price increases for this precious metal.

As a background, above all noted should be the significant financial deterioration in the United States. The federal government budget surplus has turned into a massive deficit of nearly $2-trillion, now at a height relative to GDP unequalled since expenditures for the Second World War. Also, the trade and current account deficits reached levels that historically have led to a currency collapse. Then, too, the debt position of individuals attained unsustainable levels, triggering the current business recession.

To overcome those difficulties, the United States has embarked on a major currency debasement, hoping that this flow of “money” will revive the economy. Almost all countries are reluctant to see their currencies appreciate, and thus resist the inevitable fall in the U.S. dollar. Hence, other nations now are debasing their currencies, which will see tangibles, most notably gold, rise in price.

In addition, to combat the business recession, interest rates have been reduced to levels unseen since the 1930s, and adjusted for inflation, they now are at negative interest rates. There has been a strong historical relationship between negative real interest rates and a stronger gold price, as the eventual outcome of negative real interest rates is inflation.

Banks, hedge funds and some of the public, have flocked to such speculative options as financial derivatives that have been characterized as “weapons of mass financial destruction.” Furthermore, complicated credit swaps have proliferated and all that has added to risks in the entire financial system.

As for gold itself, mine supply is declining, a trend that is certain to continue as exploration costs limit profit possibilities.

Hitherto gold producers and central banks have been selling gold, adding to supply, in the expectation of lower gold prices. Rumors abound that central banks have leased some of their gold to speculators. If banks were to demand that their gold be returned, it could lead to a squeeze, pushing prices much higher.

Some central banks, particularly the Chinese and Russian ones, along with a few in eastern Europe, are likely to increase their purchases of gold now that it is rising. China has been accumulating trillions of U.S. dollars, and has made known its plans to diversify its holding, primarily into gold. Recently, Chinese citizens have been given permission to buy gold, which they have been doing, along with many in India. Gold is undervalued relative to the vast increase in paper money, and is below its historic ratio to the price of oil. It is under-owned by investors.

With supply drying up, inevitably gold prices will rise, perhaps to a spectacular peak.


Bruce Whitestone